© 2020 Arizent. All rights reserved.

Danger ahead when non-advisors buy planning firms

Register now

I’ve been watching, with increasing dismay, the trend of non-financial 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 rollup 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 especially 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 is the incentives that these outside investors may be injecting into the planner-client relationship.

What troubles me is the incentives that these outside investors may be injecting into the planner-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 actually sit in front of clients and have motivations not to scrimp on their services.

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 non-lawyers to own any interest in their law firms. Nor can a non-lawyer be a corporate officer or director of the law firm, and non-lawyers cannot 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 rollup-going-public and private equity phenomena. Ideally, we don’t 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.

I had, in the past, worried that the pre-public 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 rollups 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 non-planners for there to be any hope of imposing a professional restriction on ownership.

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

Ideally, we don’t want consumers to be working with professionals who are primarily beholden to others.

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 that 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-to-face 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.

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.

For reprint and licensing requests for this article, click here.