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A History Of Wealth Management - UHNW Institute

Robert Casey and Jamie McLaughlin, May 16, 2019

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The authors of this article for the UHNW Institute set out a narrative of how US wealth management came to be what it is today.

As part of a continuing series of articles produced by the UHNW Institute, with which Family Wealth Report is the exclusive media partner, here is an outline about how the wealth management sector in the US got to be where it is today. Amidst all the debate about this or that business model, it is good to have the chance to stand back and look at the journey so far. McLaughlin is chief executive of J H McLaughlin & Co, a member of FWR's editorial advisory board and a founder of the UHNW Institute. His co-author is Robert Casey. He is a member of the Institute’s editorial board and senior managing director for research at Family Wealth Alliance. (More details on the authors and other UHNW Institute people here.)

This article follows yesterday's overview of business models - and the challenges around them - published here yesterday and written by McLaughlin.

Any attempt to understand the contemporary US wealth management landscape requires a step back to look at how we got here. Regulation and technology were the drivers of change and evolution.

Regulation had its biggest impact under the New Deal. Since then, it has played a more secondary role as technology has been the primary driver of change. At key junctures, disruptors employed technology to get around regulatory barriers or they capitalized on openings created by regulatory change and used technology to build successful businesses. The focus here is on the principal historical developments that gave form to today’s wealth management industry.

Our founding fathers engaged in a tortuous debate over states’ rights, resolving in Article 10 of the Bill of Rights (i.e. the 10th Amendment of the US Constitution) that any power not given to the federal government is given to the people or the states.  Despite Alexander Hamilton’s plea for a national bank as a stabilizing force for the emerging nation, it took nearly 50 years for the adoption of a true central bank as leading critics such as Thomas Jefferson and James Madison warned of any centralized authority that would serve merchants and investors and not “the people.”

Nineteenth century economic cycles and ensuing wars ultimately settled the debate over a strong national bank. There was a general understanding that a government system of monetary and fiscal policy would be useful, if cumbersome, and that a dual state/federal chartering system for banks should be retained. While dual chartering remains in place, we’ve largely moved to a federal system of regulatory oversight in response to various events.

The modern era of regulatory history was shaped by the seminal events of the stock market crash of 1929 and the Great Depression. Financial institutions had failed to serve the common good. Prior to 1933, the regulation of securities was chiefly governed by state laws. Those days were over. The Securities Act of 1933 (the 1933 Act) clamped down on fraud and misrepresentation in the securities markets. The Banking Act of 1933, known as the Glass-Steagall Act, separated commercial banking activities from much-riskier investment banking activities. The Securities Exchange Act of 1934 (the 1934 Act) established the Securities and Exchange Commission to ensure greater financial transparency and combat fraud. 

Additional New Deal legislation - the Investment Company Act of 1940, and its companion, the Investment Advisers Act of 1940 - provided frameworks for the regulation and oversight, respectively, of pooled public funds such as mutual funds and unit trusts, and of investment advisors. Advisors at the time numbered only a few hundred firms nationwide and were generally known as investment counsel. 

The Advisers Act was seen in Congress as a patch. Banks had their new regulatory structure, broker-dealers had theirs. The independent advisors were falling through the cracks. Abuses in their tiny new industry were said to be widespread, but in hearings Congress found essentially none that the states weren't already addressing.

The new law was attached as a sort of addendum to the Investment Company Act. It essentially codified the business practices of the leading investment counsel firms. The bill was written by the lawyer for the investment counsel trade group and, of course, proved anything but onerous. Advisors willingly took on the yoke of federal regulation and as a group kept a low profile going forward. The emergence of the modern registered investment advisor industry would take another four decades.

In 1974 at a time of both staggering inflation and plunging stock and bond markets, Congress passed the Employee Retirement Income Security Act (ERISA) giving the federal government authority over pensions and largely setting the retirement plan landscape as we know it today.  Individual retirement accounts were introduced by ERISA, as were the burdensome regulations that would ultimately doom traditional private sector defined-benefit pension plans.

The Revenue Act of 1978 caused further retirement plan upheaval. It had a sleeper clause, known as Section 401(k), that was spotted by actuarial consultant Theodore Benna. He developed a structure using the provisions of Section 401(k) for a new form of defined-contribution plan with greatly enhanced contribution limits and much more flexibility. It got regulatory approval forthwith and stormed the market of large private employers, welcomed by those who wanted to shed their defined-benefit plans and also those reluctant to start new ones. The result would be nothing less than revolutionary for the world of financial services.

By the early 1980s, after two decades of no net gain in the market, stocks began an unprecedented upward march and investment management as a business flourished. Prompted by a few corrections (the crash of 1987, the 2000 tech bubble) and business cycle turns, investors sought out institutional-quality managers. Separately, asset managers built distribution networks targeting “retail” or high net worth clients, heretofore served by trust companies and trust departments of commercial banks.  The latter responded to market demand by changing their high net worth consumer banking divisions to “private banks” and competing aggressively in the evolving wealth management space.

Concurrent with the stock market’s rise, financial institutions consolidated.  Money-center banks, super-regionals and regional banks merged at unprecedented rates with combined state and national banks going from 14,000 in the mid-1980s to fewer than 10,000 in 2000. An entire class of banks, the savings and loan associations, went extinct in the early 1990s.   

In contrast to the dizzying pace of consolidation and financial re-engineering among the largest financial institutions was the slow but inexorable emergence of independent registered investment advisors.  Their self-identity and market appeal were their Mom and Pop structures with access to their owner-principals, their implied independence and strict if not at times militant adherence to a fiduciary duty of care and loyalty to their clients. As David was to Goliath, they lacked the capital and operating scale of big firms. But their adoption of open architecture for investments and their cultural ethos of client allegiance stood in stark contrast to the big public companies that were part of a larger manufacturing and distribution complex.  A new industry force was awakening.  

Growth among independent registered investment advisers was kickstarted by the advent of financial planning. This new profession came to adulthood in the early 1970s, having been incubated in the insurance industry, where sales agents developed rudimentary planning techniques to gauge a client's need for life insurance. It became a full-fledged profession by the end of the decade, complete with its own Certified Financial Planner (CFP) credential.

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