On Danger­ous Ground

The Fo­cus Fi­nan­cial IPO calls at­ten­tion to the prob­lems that out­side in­vestors may bring to the plan­ning-client re­la­tion­ship.

Financial Planning - - CONTENTS - BY BOB VERES

The Fo­cus Fi­nan­cial IPO calls at­ten­tion to the prob­lems that out­side in­vestors may bring to the plan­ning-client re­la­tion­ship.

I’ve been watch­ing, with in­creas­ing dis­may, the trend of non­fi­nan­cial plan­ners tak­ing over own­er­ship of plan­ning firms. We have pri­vate eq­uity firms buy­ing fi­nan­cial ser­vices firms, and fi­nan­cial ser­vices firms that are ei­ther go­ing pub­lic or promis­ing to as part of their roll-up pitch to in­de­pen­dent ad­vi­sors. The dis­tress be­came es­pe­cially acute when Fo­cus Fi­nan­cial Part­ners went pub­lic and raised just over $600 mil­lion from its new share­hold­ers.

Don’t get me wrong; I don’t have any­thing per­son­ally against Fo­cus founder and CEO Rudy Adolf, or Stone Point Cap­i­tal, which now owns more than 50% of the Fo­cus firm and its port­fo­lio of dis­parate plan­ning of­fices around the coun­try.

I don’t know any­thing trou­bling about Lee Eq­uity Part­ners (in­vestors in Hightower Ad­vi­sors and Atria Wealth So­lu­tions), Hell­man & Fried­man (ma­jor­ity own­ers of Edel­man Fi­nan­cial Ser­vices), Long Ridge Eq­uity Group (Car­son Group), Pan­theon Cap­i­tal (Han­son Mc­clain Ad­vi­sors), or any of the other firms look­ing for a high pay­out from the labors of fi­nan­cial plan­ners.

I have noth­ing against the pub­lic mar­kets. What trou­bles me are the in­cen­tives that th­ese out­side in­vestors may be in­ject­ing into the plan­ning-client re­la­tion­ship.

When a plan­ning firm is owned by one or more plan­ner part­ners, the terms of the re­la­tion­ship with clients takes place be­tween two par­ties: the client and the ad­vi­sory firm. More­over, the ser­vice model and the del­i­cate bud­get bal­ance be­tween how much time and trea­sure is ex­pended on serv­ing clients ver­sus go­ing into the pock­ets of the firm own­ers, are typ­i­cally dic­tated by peo­ple who sit in front of clients and have mo­ti­va­tions not to scrimp on their ser­vices. In­sid­ers are mo­ti­vated to im­prove the lives of clients.

But what hap­pens when a third party — be it share­hold­ers or a pri­vate eq­uity firm — is in­tro­duced into this cozy dy­namic? Sud­denly, there’s an ad­di­tional mouth to feed, and the plan­ner (and plan­ning firm) now owes obli­ga­tions to both the client (for ex­cel­lent ser­vice) and to the out­side in­vestor (for in­creased prof­its). This cre­ates a sig­nif­i­cant con­flict of in­ter­est that can de­tract from the ser­vices pro­vided by the pur­chased plan­ning firms to the pub­lic.

In fact, the na­ture of this con­flict is so sub­stan­tial and se­ri­ous that it is ac­tu­ally pro­hib­ited in other pro­fes­sions. A CPA firm may not let its to­tal non-cpa own­er­ship ex­ceed 49% (in this coun­try), and work­ing in the firm must be the prin­ci­pal oc­cu­pa­tion for all eq­uity par­tic­i­pants in the firm.

Those non-cpa share­hold­ers must, at a min­i­mum, have grad­u­ated with a bac­calau­re­ate or higher de­gree and the prin­ci­pal ex­ec­u­tive of­fi­cer of any CPA firm must be a li­censed CPA.

Sim­i­larly, U.s.-based lawyers are specif­i­cally pro­hib­ited from al­low­ing non­lawyers to own any in­ter­est in their law firms. Nor can a non­lawyer be a cor­po­rate of­fi­cer or di­rec­tor

Ideally, we do not want con­sumers to be work­ing with pro­fes­sion­als who are pri­mar­ily be­holden to oth­ers.

of the law firm, and non­lawyers can’t have the right to di­rect or control the pro­fes­sional judg­ment of a lawyer.

Th­ese pro­hi­bi­tions were put in place to ad­dress ex­actly the con­cerns that I have about the roll-up go­ing pub­lic and pri­vate eq­uity phe­nom­ena. Ideally, we do not want con­sumers to be work­ing with pro­fes­sion­als who are pri­mar­ily be­holden to oth­ers. We don’t want the pro­fes­sional sit­ting across the desk to be cut­ting cor­ners or mak­ing rec­om­men­da­tions that are more in the in­ter­ests of share­hold­ers than the client or cus­tomer.

The Fo­cus Fi­nan­cial IPO par­tic­u­larly both­ered me be­cause the prospec­tus made it clear that the money raised from share­hold­ers would be used to fi­nance more ac­qui­si­tions of plan­ning firms. More im­por­tantly, com­pany stock would pro­vide Fo­cus with a pow­er­ful new ac­qui­si­tion tool.

A Real Dan­ger

I had, in the past, wor­ried that the pre­pub­lic Fo­cus was si­phon­ing off rev­enues from its plan­ning of­fices, and th­ese wor­ries were not to­tally al­le­vi­ated when I saw, in the Fo­cus of­fer­ing doc­u­ments, that Adolf re­ceived a salary of $736,837 last year, with a bonus of $1,779,692 and op­tion awards val­ued at $1,269,102. The doc­u­ment cited “ad­di­tional com­pen­sa­tion” of $131,820, and later, it said that he is also re­im­bursed for the ex­penses of his per­sonal air­craft.

There is a real dan­ger that this train will have left the sta­tion be­fore any­body thinks to en­act the sort of safe­guards that have been ap­plied to CPA and law firms. In the next few years, we could see enough ad­vi­sors, late in their ca­reer, sell out to newly pub­lic roll-ups or alert pri­vate eq­uity in­vestors whose loy­alty is to pro­vide the high­est re­turn pos­si­ble to their share­hold­ers, rather than the best ser­vice pos­si­ble to the pub­lic.

By the end of the decade, we might have too many plan­ning firms in the hands of non­plan­ners for there to be any hope of im­pos­ing a pro­fes­sional re­stric­tion on own­er­ship.

Clients may re­ceive an in­fe­rior form of fi­nan­cial plan­ning as our pro­fes­sion falls into a con­flict-ofin­ter­est po­si­tion.

In an ef­fi­cient mar­ket­place, this might not mat­ter. The firms that pro­vide the best ser­vice will win the loy­alty of the most clients, right?

Alas, this only works if the pub­lic truly un­der­stands what fi­nan­cial plan­ning means. In the cur­rent mar­ket­place, insurance agents rou­tinely call them­selves plan­ners or ad­vi­sors, sell an­nu­ities and skip away from one cred­u­lous cus­tomer to an­other.

The SEC is de­bat­ing whether bro­kers can hide in “wealth man­ager” cloth­ing. The an­swer is ap­par­ently yes, so long as they don’t re­fer to them­selves as “ad­vi­sors.”

It is not hard to en­vi­sion a new class of firms that claim to of­fer full-ser­vice fi­nan­cial plan­ning — many of which once did of­fer full-ser­vice fi­nan­cial plan­ning — that will be op­er­ated as cor­po­rate providers of some­thing that looks like fi­nan­cial plan­ning. But it will be fi­nan­cial plan­ning where ev­ery short­cut is taken and ev­ery cor­ner cut in or­der to squeeze the last ounce of profit from each re­la­tion­ship.

The firms will look much more like in­de­pen­dent plan­ning firms than the wire­houses ever did. The folks wear­ing green eye shades in some re­mote cor­ner of­fice will be mak­ing de­ci­sions on what to rec­om­mend, how much time a plan­ner can spend with clients and what prod­ucts to rec­om­mend un­der what­ever group agree­ment is de­signed to gen­er­ate the most prof­its. We might see sales con­tests and in­cen­tive trips slip­ping back into the pro­fes­sion through the back door.

That doesn’t mean th­ese firms will ul­ti­mately win the ma­jor­ity of con­sumers. After all, Van­guard and TIAA are the largest mu­tual fund and an­nu­ity firms in the mar­ket­place, and they don’t have pub­lic share­hold­ers. There’s an ad­van­tage to hav­ing fewer con­flicts. The more the peo­ple who sit face-to­face with clients can con­cen­trate on the client’s wel­fare with the fewest dis­trac­tions, the more likely the firm is to hold its own in the mar­ket­place.

The Temp­ta­tion

But in the mean­time, many thou­sands of clients — I guess I would rechar­ac­ter­ize them as “cus­tomers” — may re­ceive an in­fe­rior form of fi­nan­cial plan­ning as our pro­fes­sion falls into a con­flict-of-in­ter­est po­si­tion that other pro­fes­sions wisely avoided. I know that there are a lot of ad­vi­sors out there near the end of their ca­reers who are at­tracted to the temp­ta­tion of a well-fi­nanced buy­out. All that pri­vate eq­uity money, and stock own­er­ship in a pub­licly traded firm, seems like the per­fect re­ward for all their years of work­ing hard for clients.

I hope, be­fore they reach out their hands, that they think about how fi­nan­cial plan­ning ser­vices will be of­fered by the new own­ers. And I hope that some­body, some­where, finds a way to stop this man­i­fest con­flict of in­ter­est from in­vad­ing what has been a very client-fo­cused pro­fes­sion — be­fore it’s too late.

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