UHNW Institute

A History Of Wealth Management - UHNW Institute

Robert Casey and Jamie McLaughlin, May 16, 2019


Financial planning was client centric, as opposed to the product centric service model then widely used in the financial services industry. It focused on understanding the client's needs, developing financial goals to be provided for, then making the inevitable trade-offs to align those goals with available financial resources. Its time horizon was lifelong, not just pegged to the stock market's next twist or turn. It paid heed to risks of various kinds, and to mitigating those risks. It was holistic, comprehensive, and integrated.

If all that sounds familiar, it is because financial planning provides the structure of wealth management today. The numbers in wealth management may have extra zeros because the clients have a lot of money, but the essence is comprehensive financial planning, not investments. The range and complexity of the services offered by wealth managers are simply a function of the greater needs of highly affluent families. The difference between a wealth manager and a financial planner, therefore, is the length of the service menu, not the modus operandi.

That said, financial planners still needed a way to offer investments to their clients. Financial planning per se was largely unregulated, but not so the investment business. Their vehicle of choice was to register as investment advisors under the 1940 Act, and as the ranks of financial planners swelled, so did the population of independent investment adviser firms.

As chief driver of change in wealth management, regulation began to give up its primacy to technology. Technological changes took many forms. Some helped break down barriers to entry and open the way for more competition. That meant better products and better prices. Others delivered information on a faster, more useful, more comprehensive, more easily accessible basis. The result was often more transparency, better-informed decision making, and more convenience for investors.

In some instances, technology would be used to get around regulatory restrictions, as was the case with money market mutual funds. In 1972, retail bank deposit rates were capped by regulation at 5 per cent. Money managers Bruce Bent and Henry Brown that year devised a mutual fund invested in short-term money market instruments such as commercial paper that featured a constant net asset value of $1 per share and check writing privileges. It worked just like a checking account but paid much more than the rate of interest offered by banks on savings deposits.

A marvel of the day's back-office technology, the money market mutual fund was soon followed by an even more marvelous tech-enabled product, the cash management account. Pioneered by Merrill Lynch, the cash management account swept cash balances into money market fund shares. It also offered checkwriting and all-in-one access and reporting on the client's stocks, bonds, and other securities holdings. 

Meanwhile, more regulatory history was being made by the SEC. In 1975, the agency abolished fixed brokerage commissions and opened the door for the discount brokerage industry. Few other regulatory moves before or since would have more impact on today's wealth management industry landscape. Consider this partial list of benefits from the demise of fixed commissions:

-- Open architecture. Discount brokers introduced retail clients to the concept of open architecture, both the appearance and the substance thereof. In one account, investments could be aggregated from all over the landscape, not just from approved buy lists. For the first time, individual investors were in control. 
-- Price discovery. Full-service brokers did not compete on price and were happy not to discuss their (high) commission levels. The discounters plastered their (low) prices all over the place.
-- Empowered do-it-yourselfers. Full-service brokers were never happy with this crowd, and the feeling was mutual. With the end of fixed commissions, do-it-yourselfers emerged as a force in the marketplace. Today, even some of the wealthiest investors eschew full-service brokers and advisors and do it all themselves; and
-- Back-office platforms. The discounters, led by Charles Schwab, became the back offices where independent advisors obtained their client trading, custody, and account reporting services. Many leading wealth management firms use such platforms at discount brokerages to this day.

Growth in the independent RIA sector began to accelerate. Introduction of the IBM Personal Computer in 1981 and rapid improvements in the PC's power and data communications capabilities fueled a rocket-like takeoff. Portfolio management software helped firms scale their businesses. Financial planning and customer relationship management tools did the same. By the 1990s, it was not uncommon for small PC-based firms to have technology tools that were superior to those of their huge competitors. 

Sometimes a good idea for one thing opens the door to an even better idea for something else. That was the case with the no-load mutual fund marketplace concept introduced by Charles Schwab. The idea was to give clients direct access to a broad range of no-load fund providers through Schwab retail brokerage accounts. At the time, no-load funds had to be bought directly from each fund company, with separate account-opening rigmarole, separate statements, etc., from each. This was an inconvenience for retail customers but a serious impediment to financial planners wanting to use no-load funds 

If only they could find a way to get access to Schwab's no-load marketplace for their clients. Soon some did. Schwab noticed that a growing number of discount broker clients were signing powers of attorney giving third parties the ability to trade their accounts. The third parties, it turned out, were typically financial planners investing clients' money in no-load funds from Schwab's fund marketplace. The Schwab people wondered: could this become a business for us? 

And so it happened, quite serendipitously. Already a two-time disruptor in the wealth management space, with its discount brokerage leadership and no-load fund marketplace, Schwab pulled a hat trick by inviting independent advisors to custody client assets within its doors. Schwab now provides custody, trading, and recordkeeping of client accounts to more than 7,500 advisory firms, still dominating a marketplace it pioneered almost by accident more than three decades ago.

The burgeoning competition from independent firms drew pushback from the big banks and broker-dealers. To enable themselves better to offer comprehensive, integrated services in a client centric manner, the biggest brokerages, known as wirehouses, encouraged formation of multi-disciplinary broker teams. Team members provided investment consulting, planning and other non-investment services, as well as liaison with outsource providers of such services. As part of their pushback, brokers started charging fees instead of commissions to better align their compensation with client interests (and better compete with their fee-charging rivals.)

In 1999, the Securities and Exchange Commission gave its imprimatur to this latter practice, causing a fierce regulatory turf fight. Under the 1940 Act, brokers enjoy a limited exemption from also having to register as advisors as long as 1) any advice they give is solely incidental to brokerage transactions, and 2) they don't receive any special (i.e. non-commission) compensation. Critics of what became known as the SEC's Merrill Lynch Rule cried foul, saying the fees charged by brokers amounted to special compensation and the brokers needed to register as advisors.

The agency ignored the critics for several years until it was sued by the Financial Planning Association, which triumphed when the US Court of Appeals eventually ordered the SEC to throw out the new rule and abide by the letter of the 1940 Act. One result was further proliferation of what are known as dual registrants, firms that are both broker-dealers and registered investment advisers. Another result was further proliferation of confusion among the investing public. The dispute also set the table for the impending debate on the fiduciary standard. 

The market tumult of 2007-2009 shook central banks, financial institutions, and private investors to their core, doing particular damage to the largest banks and broker-dealers whose balance sheets were impaired, and brands sullied.  Many became extinct, merged or were reorganized.  Trust companies, with their conservative capital requirements, and registered investment advisors emerged largely unscathed with their reputations intact. 

Cries for fundamental regulatory reform were heard before the dust settled. Congressional action was swift in the form of the 2010 Wall Street Reform and Consumer Protection Act (i.e. Dodd-Frank). Its primary focus was on cleaning up the large institutions, but the massive new law touched on the world of wealth management as well, in particular the issue of fiduciary responsibility. Advisors have a fiduciary obligation to put the interests of clients first. Broker-dealers need only ensure that investments they recommend are suitable for a particular client.

Dodd-Frank gave the SEC power to impose on broker-dealers a standard of conduct “no less stringent than the standard applicable to investment advisors.” A later SEC staff study recommended that very action. However, any possible SEC action needs to be meshed with an ongoing effort by the Department of Labor to impose fiduciary standards on retirement account managers. As a result, the fiduciary standard issue has not been settled and can be expected to be debated for the foreseeable future.  

Certainly, “harmonizing” the application of a fiduciary standard across various business models appears unlikely. Regardless of the regulatory outcome, the debate between various financial institutions has raised the issue as a matter of public discourse for investors. Clients are beginning to ask questions about their advisors’ alignment of interest with their own interests and about their advisor compensation systems and the incentives that those systems create.

Register for FamilyWealthReport today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes