The Gluck Report, Behind Schwab's February Bombshell Hot

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Andrew Gluck wrote the story below for the April 2002 issue of Investment Advisor.  

See the RIA Technology Award for Lifetime Achievment Advisors4Advisors gave John Norwood.  

A week before I was scheduled to moderate a panel about portfolio management software at the T.D. Waterhouse Institutional conference on February 22, I received a call from TD’s Chris Murtha. Murtha, who was responsible for putting together the TD conference schedule, had received a telephone call a day earlier from Performance Technologies Inc. (PTI), the developer of Centerpiece, informing him that John Norwood, the president of PTI would not be appearing at the TD conference.
It was a shocker. How could Schwab and PTI do such a thing?
Centerpiece, the software Norwood had developed years earlier before PTI was purchased by Charles Schwab, is perhaps the most popular software package used by Registered Investment Advisers with less than $100 million under management. While PTI is owned by Schwab, PTI has never shown favoritism toward Schwab Institutional at the expense of other custodians, and there was an implicit promise never to do so. In fact, TD Institutional in the last couple of years had purchased Centerpiece licenses in bulk and given away them away to advisors as part of a soft-dollar arrangement. Schwab and PTI executives would proudly boast that PTI was independent of Schwab Institutional. Norwood’s decision to back out of his appearance just days before the TD Institutional conference shattered any illusion that PTI was independent.
But the decision was a bombshell for immediate practical reasons as well as political ones. Norwood was scheduled to appear at a general session that would be attended by all 500 advisors attending TD Institutional’s annual conference in Orlando. Norwood was to appear on a panel that included the director of marketing director at Advent and the president of TechFi and the session would put the three top-rated software packages used by RIAs on one stage. It was a fairly important session in the overall conference schedule. Standing up TD Institutional, when so many Centerpiece users are TD customers, was a slap in the face.
When I got off the phone with Murtha, I was dying to know why Norwood had canceled so abruptly. I’ve known Norwood for about five years and this was completely out of character. Unlike the shrewd politicos Schwab often provides for me to speak with, Norwood is always straight and honest. He’s a good guy. To learn why Norwood was backing out and to try to convince him to change his mind, I tried reaching him at his office. No luck. Then I tried his cell phone.
“John, what’s going on? Is it true that you are not going to be on my panel?”
“I can’t talk to you about it, Andy.”
“John, this is really strange. Do you still have a job? Is PTI being sold?
“Andy, I just can’t to talk to you.”
Schwab spokesman Lance Berg knew nothing. He tried getting an answer but all of the top Schwab Institutional executives were sequestered in several days of meetings at Schwab headquarters in San Francisco, and Berg could get no answers. Three days after I learned that Norwood was backing out of the TD conference, Schwab spokesman Glen Mathison explained to me why: Schwab was changing its strategy and would stop selling Centerpiece to advisors who did not have, or plan to have, a custody relationship with Schwab.
Mathison said Norwood had little choice but to cancel. If he went to the TD conference, the decision by Schwab to stop selling Centerpiece to advisors who are not Schwab customers would look like an attempt to upstage TD at its own conference. Norwood would be on the panel talking about a product that could not be sold to advisors who were TD customers but not Schwab customers. And, if Norwood did attend the conference and make no mention of the policy change only to see it put into effect a few weeks after the conference, he would look like liar who had been completely disingenuous. A TD executive says that while it was disappointing that PTI backed out of the appearance, it was understandable under the circumstances.
The fact that Norwood backed out of the TD Institutional conference and snubbed TD is sensational news but unimportant in the big picture. The important issue is what’s going on in the industry that is causing such titillating news to come out of Schwab lately. A quick recap:
  • In December, Schwab sued Advent, charging Advent failed to live up to an agreement to support its Schwab download interface. Those two companies are now in settlement talks but could still wind up fighting it out in court.
  • In January, Schwab revamped its AdvisorSource retail branch referral system. Of the 400 RIAs in the referral program, Schwab Institutional kicked 80 out and handpicked 80 replacements while also implementing a fee-splitting arrangement that would draw those participating into a tighter partnership.
  • Then, in February, Schwab said it wanted to leverage the technology it’s building for it advisors. It won’t sell new Centerpiece licenses to advisors who do not do business with Schwab. This opens the way to creating a two-tier system where advisors who do business with Schwab will get Centerpiece and other proprietary technology for free or at a discount, while advisors who do little or no business with Schwab or who are pulling assets out of Schwab might get no discounts and no technology freebies.
What’s going on? Schwab Institutional, king of the hill in the independent RIA business, is under attack. Its dominant market share of around 75% throughout the much of the 1990s had dropped to about 70% in 2000, according to data from Cerulli Associates, and while no current data is available on custodian market share now, my guess is that the trend away from Schwab is accelerating.
Since I started covering Schwab Institutional six years ago, many advisors I speak with have expressed skepticism about Schwab’s commitment to them as a partner. Comments have ranged from rabid conspiracy theory craziness to a more rational acceptance that Schwab was a publicly held company that would compete for retail clients with advisors.
But even those most accepting of Schwab’s business strategy have always expressed some trepidation about becoming too dependent on Schwab Institutional. Schwab’s incremental moves into the retail advice business even as the company assured advisors it would not compete with RIAs and would never steal their clients fueled fears about becoming too dependent on Schwab.
I’ve been hearing advisors threaten that they would move their assets to new custodians for years. Nothing ever came of it, however. Advisors would open one or two accounts at Fidelity Institutional Brokerage Services or TD Waterhouse Institutional and complain that service was poor and technology was not as good as at Schwab Institutional. Many times, I believe, advisors would complain merely because they were used to the way Schwab did things and they didn’t know the other systems.
I’m not sure exactly what’s changed, but in recent months something did change. Maybe Fidelity and Waterhouse got better. Maybe RIAs were angry at Schwab for purchasing U.S. Trust about 18 months ago or about Schwab’s other advances into the retail advice business. Maybe more RIAs just got used to the way Fidelity and TD handles accounts. Or, maybe advisors had grown more comfortable with download interfaces in their portfolio management software that allowed the use of multiple custodians. It was probably a combination of all of these factors. 
Over the last 18 months or so, I have been hearing more and more from RIAs I speak with that they were opening new accounts with custodians other than Schwab, and based on my unscientific conversations with at least several advisors a day, the trend has accelerated in the last six months. Fidelity and Waterhouse were the two firms most often mentioned as benefiting.
Nick Georgis, a senior vice-president of sales and relationship management at Schwab Institutional, concedes that RIAs have entered a new era and are embracing the multiple-custodians in greater numbers. “We know we cannot have success unless advisors have a solution that’s allows them to have custody wherever they want,” says Georgis. “And if we try to control them, ultimately we’ll be out of this business.”
Georgis flatly denies that Schwab is in the first stage of an incremental plan that would create a virtually captive sales force. He says that instead of using the seven Centerpiece sales reps to sell software to advisors who often are not doing all or most of their business with Schwab Institutional, the sales reps can now be deployed to help Schwab Institutional advisors use the software to run their practices better. And as Centerpiece gets re-engineered to a Microsoft SQL database that will be more scalable and easier to integrate with other applications in preparation for a release in September, focusing on support to existing users is good sense.
Drawing advisors into closer partnership in AdvisorSource and creating a proprietary technology platform that could be used as leverage is simply the best strategy for offering RIAs better opportunities if they do business with Schwab. And it’s not hard to see that many advisors could benefit from such a platform and from a tighter partnership with Schwab. But Georgis concedes that there are two sides to the coin.
The same moves that will allow Schwab Institutional to serve advisors and make them less likely to diversify among multiple custodians will make them more dependent on Schwab Institutional.
“There are two ways financial services firms keep their customers,” explains Jaime Punishill, a senior analyst following the financial services industry at Forrester Research in Cambridge, Mass., a leading technology research firm. “They give customers reasons to stay and they give them reasons not to leave. There’s a subtle difference. 
“Giving customers reasons to stay because they would be giving up something by going elsewhere is one thing,” says Punishill. “Giving customers reasons not toleave means building big walls that make it hard to leave.”
Punishill, who understands the independent advisor industry better than any research analyst I’ve ever interviewed, says Schwab’s decision to stop selling Centerpiece to advisors who do no business with Schwab makes sense because Schwab has been selling the software for years without making money on it.
“Schwab wanted advisors to use it and hoped it would generate business for Schwab Institutional,” he says. Now that Schwab must look at building the next generation of Centerpiece and adding functionality to it, Punishill says a huge price increase in the Software would be needed and that would make the product too expensive versus TechFi’s or Avdent’s systems. But Schwab can justify the new expense if Centerpiece will be used as a lever to attract business to Schwab Institutional and make it harder to leave the firm.
The decision to stop selling Centerpiece to advisors who do no business with Schwab Institutional is a precursor to special deals for access to Schwab’s proprietary technology platform. Schwab Institutional can be expected to make soft-dollar arrangements and offer discounts to RIAs who keep all of their assets at Schwab, for instance. The level of free technology you’ll get will depend on your commitment to Schwab. That’s good business and you can’t blame Schwab for pursuing such a strategy.
“Schwab will make this very attractive for the best advisors to do, and make a strong case for the tight coupling of all the technology pieces it will offer,” says Punishill. “And it won’t be a fake case. It will be rational and well thought out and maybe financially attractive to many advisors given favorable pricing.”
But Punishill says advisors may not always realize the price they will be paying, and that Schwab will use its new and improved technology platform like a moat around a castle. “Schwab is trying to build enough pieces so you get comfortable and it’s a painful to leave them,” he says. “If they build enough pieces and integrate them and it’s painful to leave, then they have a winning solution.”
Punishill’s comments seem tinged by skepticism about Schwab. I ask why. 
“It’s not that I’m skeptical, it’s that I know how hard it will be for the advisors to exit,” he says. It will be much harder than it is today. This is a real decision point coming up. You need to decide by following this path that you will remain committed to Schwab for some time.”
Advisors who custody assets at Schwab Institutional all seem to know that Schwab is trying to lure them closer. There is no disagreement on that. But they differ as to how far they will go into partnership with Schwab and still feel comfortable.
For instance, I called Timothy Hatton, an advisor at Hatton Consulting in Phoenix, who left a wirehouse two years ago to become independent and is “extremely pleased with Schwab.” I asked Hatton the open-ended question, “What do you think of all of Schwab Institutional’s new initiatives?” Hatton said it was “great” that AdvisorSource had moved toward a fee-splitting arrangement to foster a tighter relationship with advisors and said he was only sorry that he would have to wait another year to satisfy Schwab’s requirement of three-years as an RIA.
“Oh,” I asked, “then do you regret that you opted to use TechFi portfolio reporting software and did not use Centerpiece, which is likely to allow for a tighter integration with Schwab in the future?” No, says Hatton. 
And that’s how it is with other advisors, too. For instance, Greg Galecki, he also is a Schwab fan. He uses Centerpiece, and unlike Hatton, he sees no threat in Schwab’s move to make it more proprietary. “That’s free enterprise,” he says. But he’s changed his mind about using Junxure, the contact management software integrated into Centerpiece by PTI. “I don’t want to be beholden to Schwab.”
Schwab is making it clear that advisors will have a choice. They won’t in any way be required to use the entire platform. It will be like a back-office buffet, and you’ll pick what appeals to you—a portfolio reporting service that will reconcile your data for you, a website management application, AdvisorSource, software for portfolio management and other tasty tech items that can make an advisor’s practice run more smoothly.
Some advisors draw the line at using Schwab’s portfolio reporting system, others with contact management and still others with splitting fees for referrals. But the common perception is that independence is the top priority.
“I wouldn’t want to use Centerpiece because it’s now moving in the direction of becoming a proprietary product, and I’d be worried that if I want to use another custodian, I might be handcuffed,” says Hatton. “One of the reasons I left Morgan Stanley two years ago was because there was a set of rules and tools that I had to use, and if it was not the best one I still had to use it. It’s an investment manager’s job to maintain their objectivity and if that means not using some of the things Schwab brings in, you need to be able to do that if you want to be able to objective and independent. If there is a better custodian out there, you want to be able to move business to them with as few obstacles as possible.”
The tough decision advisors will have to make now is how deeply they want to be integrated into Schwab’s platform. Schwab will have much to offer of benefit, including a technology platform that will be much improved when it gets fully deployed in the fourth quarter and the AdvisorSource referral system that numerous advisors have told me has been a major factor in the growth of their business in the last couple of years. But be aware of the potential risk.
“This puts advisors back in a position that is similar—not exactly—but similar to an advisor who is part of a captive sales force,” says Punishill. “To leave Schwab could soon be similar to leaving Merrill Lynch—giving up products and an entire technology platform.
“What Schwab is doing has begun to muddy the waters even more than they have been about who owns the client because Schwab will now have all your client data, and the practical problem of exporting it all to another system is also no trivial task,” says Punishill.
“Schwab is trying to reward the advisors who are its best revenue generators with a highly competitive full integrated workstation and to cut out advisors who aren’t committed to Schwab,” says Punishill. “It just so happens that it also builds a moat around the advisor who chooses to commit to Schwab.”
Advisors for years have been asking for an affordable integrated platform to handle contact management, portfolio reporting, trading and other labor-intensive aspects of their back office. You are closer than ever to getting it from Schwab Institutional.


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