The Arab Spring Comes to Wall Street

One of the most heartening developments of 2011 has been the Arab Spring.

A year ago, people fed up with oppression began challenging dictators in Tunisia and Egypt. Inspired by their success, popular uprisings spread across the Middle East, taking down strongmen like Mubarak and Ghaddfi. After decades of suffering, tens of millions of people now have the promise of a better way of life.

Many factors contributed to the downfall of authoritarian regimes, but one cause that will certainly loom large in history is the power of information.

Information flowing across the Internet and via social media enabled repressed people to share new ideas and collaborate in ways that simply weren’t possible in prior decades. They were empowered when they realized that many other people shared their opinions.

Demonstrations were organized over Facebook. Firsthand accounts of government crackdowns traveled the world by Twitter. Mobile phones transmitted shocking video that triggered outraged in people everywhere.

That the hero of the Egyptian revolution was an executive of Google – the nexus for sharing ideas and information around the globe – is the perfect metaphor for the Arab Spring. Google embodies the liberating force of information, which ultimately outgunned soldiers, tanks and secret police.

Wall Street Feels The Breeze Of Liberty

For investors and advisors, a similar sense of liberation is occurring for the same reason: Information is breaking through Wall Street’s facade of omnipotence.

One of the positive outcomes of the financial crisis is that the veil has been pulled back on Wall Street business practices. The post-mortems on the financial meltdown have revealed the naked self-interest of Wall Street’s conflicted business model.

Many investors have come to realize that Wall Street frequently acts first in its own self-interest. After that comes investors.

Advisors have also gotten fed up with Wall Street. The dictatorial style management that intimidates advisors with a “just-buy-this-we-know-best” approach has prompted many advisors to break away so they can do right by their clients.

The Unstoppable Tide of Human Aspiration

As hopeful as the Arab awakening has been, it will no doubt be messy as countries lurch toward democracy and free markets after being under the yoke of tyranny for so long.

The same can be said about Wall Street and its business practices. As information sheds light on Wall Street, more will choose the freedom and choice offered by an independent advisor. But it would be unwise to underestimate Wall Street’s staying power. This will not happen overnight.

The good news is that it’s become impossible to turn back the clock on progress. The free flow of information cannot be thwarted thanks to the Internet and social media. Information will remain the jet fuel for the unstoppable tide of human aspiration.

Happy Holidays from the team at Sanctuary Wealth Services.

Loss of Confidence

There’s a striking similarity between the current state of affairs in government and our financial system: Both are paralyzed by gridlock and in desperate need of regaining credibility. Voters and investors are losing confidence.

The Congressional supercommittee’s inability to address government spending is only the latest failing by our nation’s leaders. Likewise, the financial system’s refusal to remake itself after the trust-busting financial crisis is equally disheartening.

On Wall Street, it’s exasperating that it’s still business as usual. Big banks and wirehouses continue to create wealth management programs that place asset gathering and the firm’s profitability ahead of the interests of clients.

They’re still missing the boat on the most fundamental tenent of wealth management: If it is good for your client, it will be good for your business. Meanwhile, Wall Street is trying to actively torpedo any reform by dismantling Dodd-Frank and other protections for taxpayers and investors.

It’s no wonder the Occupy Wall Street movement still has oxygen left.

A Better Way

In the spirit of extricating the industry from a crisis of investor confidence, we’re proposing a modest agenda of reform:

Be honest. The wealth management industry has positioned itself as an omnipotent, all-knowing purveyor of financial security. What has been lacking is honesty. Investors need to be told the truth about risk and reward, even if they don’t want to hear it. The good news is that unconflicted advisors who don’t have to peddle opaque products or be held hostage to their large firm’s profitability targets are beginning to have an honest dialogue with clients.

Acknowledge mistakes. Large institutions attribute the financial mess to a once-in-a-lifetime debacle, as opposed to any systemic defect in their business models. The rationalization is that no one could have seen the crisis coming. If you’re an unconflicted, independent advisor, you still may not have seen the flood coming. However, you could have responded faster in heading for higher ground. You wouldn’t have been locked in by Wall Street’s investment products that stifle flexibility.

Establish new standards. Advisors need to re-educate investors about performance. It’s not simply about high returns, but rather about performance versus established risk parameters. Particularly for high net worth clients who have already hit the home run, wealth preservation and definable risk management are often a higher priority. Using risk as your primary performance benchmark might not be as “marketable” as cocktail party worthy high returns, but taking the easy route rarely works.

Independent wealth advisors should play a particularly valuable role in advancing this agenda. They can be a catalyst because they don’t need to buy into the Wall Street mirage that “we are smarter and have all the answers.” They can tell the truth, and investors will reward them with the biggest prize: their business and their trust.

At the end of the day, voters and investors are actually looking for the same thing – an alternative to sclerotic party politics or an anachronistic financial services business model. Whoever steps up and tells the truth – and delivers a credible solution – will win the hearts and minds of both for the long run.

I'm Sorry

Time For Wall Street To Apologize

Each day, the Wall Street protests grow. Over the weekend, demonstrations spread to dozens of U.S. cities and three continents, with scores of arrests and increasing violence. Sympathizers in Rome went on a rampage that caused more than $1 million in damage.

The revolt against Wall Street is about many things: Disgust with the broader economy, anger at government gridlock and policy failures, revulsion over bank bailouts, resentment about the growing gap between rich and poor, and generalized rage at the machine. There is also legitimate fury for Wall Street’s role in the misery many are experiencing.

Everyone Needs To Fess Up

The Wall Street establishment clearly needs to do something. After all, the “Occupy Wall Street” movement has its name on it.

What should be done? First, Wall Street needs to atone for the sins that got us into this mess. A mea culpa is due because Wall Street’s multi-billion dollar propaganda machine effectively peddled the worst kind of fantasy – that individuals and institutions who invest with them can achieve superior returns using their newly created “AAA” investments.

Unfortunately, the only people who made money were those who took the other side of the trade. Given that investing remains a zero sum game, not even Wall Street could change the laws of finance.

Wall Street firms need to start with an apology to anyone who ever purchased these new investment products and opened an investment or retirement account with dreams of a predictable financial future.

Advisors Share The Blame

Second, an apology is due from advisors. They believed their bosses who prodded them to sell the delusion that Wall Street’s best and brightest had figured out a way to squeeze addition return out of AAA-rated securities.

Brokers and advisors didn’t need much convincing to get them to go along. To address the fee compression caused by new regulations, wealth professionals looked for additional revenue opportunities by selling these opaque but “safe” investment vehicles.

So Do Clients

Third, clients themselves need to make amends. Their own demands for a safe but outsized return fueled the mania. Investors had come to expect outsized returns during the 20+ year bull market and had established a lifestyle to assume the good times would continue forever.

Clients relentlessly requested high returns and threatened their advisors that they would pull their accounts if their demands weren’t met.

The Way Forward

Once the apologies are made, Wall Street needs to tell it straight.

For starters, Wall Street needs to explain that the new normal for equity returns is likely to be 6% to 8%. That’s a sharp departure from the 10% to 12% growth that led some to believe their wealth would double every seven to 10 years.

In the short term, even the 6% to 8% growth is suspect. Those kinds of returns should be viewed as an intermediate term goal, if we’re lucky. As The Economist noted this week in its cover story, Nowhere to Hide, there aren’t many places to invest these days. The perils include the foundering U.S. economy, still-deteriorating housing market, European crisis, and the slowdown in emerging economies.

In addition to systematically lowering expectations, Wall Street also has an obligation to be more transparent. It desperately needs to fix its broken business model and return to a business that charges a disclosed fee for advice and raising capital.

If Wall Street doesn’t make it right, it will only accelerate the independent advisor movement. That may be the sliver lining after all. We believe strongly that leaving Wall Street is the best option for both investors and advisors.

For their part, clients need to find an advisor at a firm whose business model they can trust for the long term. Parking money in cash is only a short-term solution.

More truthfulness and an apology will be a good start in repairing the damage. Coming clean will also show protesters – and the rest of the America – that Wall Street acknowledges that it must do better.

Sallie Krawcheck’s Departure: The End Of The Experiment

This week, history repeated itself. Bank of America ditched its top wealth management executive in favor of a banKer whose assignment is to increase profitability by “encouraging” the 16,000 members of Merrill Lynch’s thundering herd to cross-sell bank products.

On Tuesday, Sallie Krawcheck was fired. I suffered the same fate not that long ago under very similar circumstances. After Bank of America took over Montgomery Securities and asked my management team to integrate our group into The Private Bank, I was fired and replaced by a banKer.

We wrote about this in our blog on September 25, 2008 – the most widely read and commented piece we’ve ever penned. What we said then is happening all over again – to the detriment of brokers and THEIR clients.

Wielding The Axe

Why are brokers and their managers inevitably sacrificed when banKers take over?

For two reasons. First, both Sallie and I weren’t willing to accept the bank’s demands to place a higher priority on cross-selling bank products. Brokers got into the business because they have a passion for helping clients manage their wealth, not selling checking accounts, home equity lines of credit, or toasters.

Second, we both refused to sell out our brokers on comp. We understood that the brokers’ compensation plan needed to be different than their “Bank of America teammates” who are paid salary plus bonus.

That an old-line NationsBank banKer since 1979 will now head wealth management definitively signals the end of the grand experiment between Bank of America and Merrill Lynch.

BofA CEO Brian Moynihan has given this no-nonsense banKer explicit marching orders: Deliver “our entire franchise to all OUR (our emphasis) customers," to quote a BofA press release. Translation for brokers: You're a banker now.

For someone who has lived through this before, I’m astonished BofA is still drinking the same Kool-Aid. Namely, that BofA believes the bank – and not the individual broker – owns the customer relationship. The conceit is breathtaking.

What Happens Next?

First, YOUR clients will start to ask when you are leaving. Clients read the news, too. They understand what’s coming, allegedly in the name of additional benefits.

Second, the bank will begin to monitor brokers’ daily interaction with clients. They want to quickly find out who is with them and who is against them. The oversight is designed to hopefully control when brokers leave. As one BofA banKer once told me: “We want to make sure brokers leave on our terms, not theirs.”

Third, some brokers will get fired. In fact, that's exactly what happened to us. Some of our top producing brokers got fired because they were looking for a new job. The term used by Bank of America’s legal department to describe their job-hunting was “skullduggery.” In essence, the bank tried to act preemptively to out the brokers who were looking, allowing the bank to gain a timing advantage when trying to retain “their” clients. Of course, everyone knows that clients are loyal to people, not companies.

The Bottom Line

The capitulation to the banKers isn’t surprising. BofA knows that selling bank products is ultimately more profitable than the brokerage business. The profit margin on brokerage is in the low teens. For banking products and services, it’s 30%+. If there is one thing banKers know, it’s math.

Because the banking business model is so much more profitable than the brokerage model, two things will happen: 1) The banKers will remain in control; 2) Brokers (and THEIR clients) will be on the short end of the equation. Read another way, brokers will face lower comp and their clients will be subject to statement stuffers promoting bank products. Each month. Not even the powers that be at BofA can suspend the laws of economics over time.

For clients at big banks, prepare for the onslaught – and forgive your broker if he or she is a little cranky. If you’re a broker, there’s no better time to learn what skullduggery means and to gain the timing advantage by breaking away on your terms.

Fighting Back Against A Common Nemesis: Insecurity

What accounts for the mediocre performance of so many companies and individuals? If you look beneath the surface, insecurity is often the common culprit.

Seth Grodin called insecurity the work of our lizard brain, the pre-historic lump of gray matter responsible for fear and rage. The lizard brain holds you back when you want to go forward. It reflexively fears the unknown.

Steven Pressfield refers to insecurity as the resistance. The resistance is the voice in our heads whispering caution, to go slow, to compromise. It is also the impulse that makes us drag our feet or keeps us from finishing what we started. Worse, the resistance, seems to get stronger the closer you are to making a necessary change.

Not Pretty

Call it whatever you want, but we are all dogged by fear of change.

For individuals, insecurity appears in the need to be liked by everyone. We all know that never works, and it often backfires. For politicians, insecurity rears its ugly head in the overpowering drive for election or re-election. History is littered with examples of well-meaning pols who sold out their principles to keep their elected office.

For corporations, insecurity breeds incrementalism. An executive may know that to succeed in the long term there may be significant short-term pain to change a business model, kill a product or invest in an unproven solution. But the fear of losing one’s job frequently quashes a leader’s better instincts to take a bold step.

Wealth advisors are not immune to insecurity, either. Like corporate executives, many advisors realize that their firm has serious shortcomings, for both themselves and their clients. But advisors may be just comfortable enough, so they stay put – even if they know a better future is very possible.

The Solution

How do you vanquish insecurity? One of the most effective ways is to mimic Silicon Valley. The whole ecosystem in the Valley is focused on isolating things that can be done better. Then, the doers charge ahead. The bumper sticker version is “No Fear.”

Silicon Valley is all about disruptive ideas and technology. Many ideas are tried and failed, but many others produce spectacular results.

Google is a perfect example of a Silicon Valley company who gets it. Google gives employees something known as Google Time. Employees can devote 20% of their time to developing something new and original of their own making. Gmail and Google + are among the innovations born from Google Time. Google has managed to institutionalize the better angels of our entrepreneurial spirit.

Living and working in San Francisco and Northern California, one gradually sees risk-taking as part of the natural landscape. Striking out on one’s own is what people do, and it’s invigorating. With so many other risk-takers in close proximity, there is security in the number of people who are confronting their own insecurity.

I was recently reminded of that by the principal of an advisor team who recently hired Sanctuary. “You take for granted just how entrepreneurial people are here. It's just not like this everywhere.”

The Unstoppable Tide of Human Aspiration

At the end of the day, the only real cure for insecurity is action. The self-confidence that comes from taking the initiative can overwhelm the reptilian corner of your brain. Conversely, the positive experience of successful change is a great motivator. It also has the corollary benefit of tapping that other instinct in us: the human drive for greatness.

For advisors who are thinking about breaking away, client uncertainty shouldn’t be the reason to hold back. In our experience, a large majority of clients who work with independent advisors are themselves entrepreneurs and serial risk takers. They appreciate advisors who have the gravitas to make a move that is all long-term gain.

Tame the lizard. Go out and make it happen today.

Win-Win

The burning question for many advisors each day is: “How do I monetize my business?”

The conventional answer is: “I’ll sell my business some day at a lofty premium to an unwitting bank, wirehouse or roll-up firm and ride it out until retirement.”

Many independent advisors will be relying on the greater fool theory to strike a rich deal. Independents know that larger institutions and roll-ups routinely overpay for an advisor’s book of business. The word on the street is that buyers frequently overestimate how much advisors can cross-sell and grow their business.

For their part, buyers believe their brand is the magic elixir. A new advisor’s book of business, they believe, hasn’t been more profitable because the advisor didn’t have Brand X’s killer portfolio of products and services and management expertise.

The High Road

Is a sale based on the greater fool theory really the best approach for advisors and clients? The short answer is no.

Clients don’t commit to an advisor thinking the advisor will sell the business. Clients engage advisors because they trust their advisor and they believe the advisor is competent. And, just like no one gets married thinking they’re going to get divorced, clients believe they’ll be with an advisor and the advisor's firm for the long term when they hire the advisor.

Independent advisors often think that because their unconflicted model has more integrity than a big bank’s or brokerage’s that they may be more enlightened in considering how a sale impact clients. In fact, money corrupts. An advisor has to make an active choice to take the high road.

Looking For A Fool

The greater fool theory has currency because as long as institutions have been buying books of business, they’ve been overpaying. A premium is typically paid when an acquirer overestimates the value of any one of these three variables:

1. The retention of the advisor's current clientele.

2. The ability of the advisors to continue to grow their business.

3. The strength of the acquiring firm’s brand to generate more fees from the advisor's current clients.

To earn the full purchase price, advisors must commit to generating more revenue. For clients, that’s almost always trouble. The bargain that advisors make with their new employers translates into more client solicitations and sales pressure to buy additional products and services. This is the approach especially championed by banks. Or, it could mean raising client fees. Sometimes, it is both.

On balance, the transaction is negative for clients, even if clients gain access to additional investment solutions. For advisors, there may be an upfront, short-term gain, but they forfeit the longer-term payday that comes from building and maintaining an independent firm.

A Better Way

What’s a better approach?

For both advisors and clients, the solution is remaining an independent firm and continuing to grow the business, even after the founder has retired. By having an orderly succession plan and grooming a successor, there is no need to sell.

There are two key benefits in this approach.

First, clients will fare better. Clients will transition to a new advisor who is apprenticed by their current over a two- to three-year period. The new advisor will continue to use the same products and services that the client enjoys.

Second, the retiring advisor can actually make more over time. The profitability and ownership formulas common today will pay the retiring partner on a sliding scale over a number of years even after they retire.

To achieve this objective, there must be a defined succession plan that gives the junior partner an opportunity to buy an ownership interest using contractual metrics over a defined time period. All parties must have a willingness to take the long view of the franchise for the benefit of all.

An independent wealth management firm that sells to a big bank or roll-up firm is no different than a broker who takes a big recruiting check from a wirehouse. The good news is that by remaining independent, an advisor can do right by clients and by themselves creating a win-win scenario consistent with their independent mantra of always acting in the best interests of the client.