Menu of Models

Three major custodians have introduced zero trading cost models for advisors.  BNY Mellon/Pershing took the opportunity to get creative.

certain custodian’s zero-commission pricing model for stock and ETF trades was quickly taken up by its largest rivals: TD Ameritrade Institutional, E*TRADE Advisor Services (now a unit of Morgan Stanley) and Fidelity Clearing & Custody Solutions.  It was instantly rejected by Shareholders Service Group and TradePMR,  while Foliofn (which has offered free trading for more than a decade) wondered what all the fuss was about.  Altruist, as the new kid on the block, moved ahead with its $1 per client account per month model that pays for all trading.

The most interesting move came when BNY Mellon/Pershing rolled out, not just a free trading model, but three different options for its advisors to choose from.

“After the [Schwab] announcement,” says Ben Harrison, who on June 1 takes over from Mark Tibergien as the custody unit’s new CEO, “we got a lot of inquiries from firms we were working with, and prospects, and the press saying: Why isn’t Pershing going to do this?  Why haven’t you decided to change your model?

Instead of following the knee-jerk responses, Harrison says, the firm took its time and polled its advisors—and discovered that there was a diversity of opinion about the new revenue model. 

“Some said, if I do the math on this, I would rather continue to have more cash management options, says Harrison.  “Others said: I am buy-and-hold, I don’t do that many transactions, so I’m okay with paying nominal ticket charges and having access to more cash solutions.  I don’t want to go to that new model.”

Still others told his team that their clients were seeing TV commercials about free trades, and they wanted to be able to offer the same thing. 

Zero trading fees was, first and foremost, a gambit to one-up the competition in the retail marketplace; free trading for advisors was an afterthought that would have to be provided in order to avoid an uprising.  TDA and Fidelity had to respond to the Schwab initiative because (like Schwab) the bulk of their revenues comes from individual investors who would otherwise have flocked away from their platforms to the free trading alternative. 

But Pershing lives in a different revenue environment.  It doesn’t have a retail presence driving its decisions.  Harrison says this gave his team the luxury of listening and thinking before responding.

“For some time before this, we had felt that the pricing model in the custodial landscape was been ripe for disruption,” Harrison continues.  “There’s been this conflict that everybody is aware of, that was just too daunting to address: that product fees pay a lot of the freight, and the spread on the cash sweep accounts was really subsidizing a big part of an advisory firm’s custody relationship.”

After a long huddle, Pershing unveiled a creative solution that might change the economics of the advisor custody business—and also might force some of Pershing’s competitors to decouple at least some of their pricing decisions on the advisor side from the consumer side.  The firm introduced a menu of three pricing models.  This, Harrison admits, is a work in progress, but it addressed several goals in the first iteration.  One was to provide a new level of transparency to the advisor/custodian relationship.  “We have to get paid; we are not a not-for-profit,” Harrison says.  “We need to be a viable company that offers a resilient platform, especially in times of uncertainty.”

Another goal was to better align the interests of the advisor and client with the custodial revenue model.  “We know that advisors use a variety of products,” says Harrison.  “But we all know that some products are not as profitable for the custodians than others,” which, of course, leads to the platforms emphasizing or encouraging some at the expense of others.  “And we know that cash is absolutely an important part of the equation,” Harrison adds.  “Any time you move beyond sweep cash to portfolio cash, investors and advisors really care about yield.  So we wanted to create a level playing field for products, where you have the option to pay one flat fee for access to equities and ETFs, mutual funds and fixed income, and have a hybrid or multi-tiered cash product available so you get some yield back into the marketplace.”

The three pricing options are fairly simple.  Option one is to continue to pay trading costs as you did before, with a low-yielding sweep account and access to a number of investment options for the cash allocation of client portfolios.  Basically, business as usual, pre-Schwab’s zero trading costs announcement.

The interesting innovation here is that, at the time that the new pricing options were announced, BNY Mellon Investment Management introduced eight new passively-managed ETFs that trade on Pershing’s platform for free no matter what model you choose, and have competitively low expense ratios ranging from zero (U.S. Large Cap Core Equity ETF and Core Bond Fund ETF) to 0.04% (U.S. Small Cap Core Equity ETF, U.S. Mid Cap Core Equity ETF and International Equity ETF), with a short duration corporate bond, an emerging markets equity, and a high-yield beta ETF at prices ranging from 0.06% to 0.22%).  Advisors who use these ETFs, even if they’re in the transaction-fee model, will encounter zero trading costs when they buy and sell them.

Option two?  The same deal you would get from Schwab, Fidelity and E*TRADE: free trades, but the firm will make money on the cash accounts.  “These days, there is nothing innovative about that,” Harrison comments drily.  But it IS new to Pershing.

Option three is the real innovation.  Here, advisors could opt to pay a flat subscription fee for all their custodial services.  The fee will range from $25 a month per client account to $75, depending on the size of the account (larger ones will pay higher fees, contrary to what you were probably expecting), and this option opens up access to cash sweep options that pay competitive market rates.  The innovation here is that, if you want those competitive cash rates, the client would have to have at least $100,000 allocated to cash.  Below that, the yield will be nominal, so the best practice would be to use the sweep account only for wire transfers and to pay advisor fees.

Any monies that a client has invested in the BNY Mellon ETFs are excluded from the portfolio size calculation.  A $2 million portfolio invested entirely in Vanguard funds or Blackrock ETFs would pay the full $75 a month.  But if all but $250,000 of that particular client account is invested in the in-house ETFs, then the client would pay $25.  (This monthly fee, to clarify, is per client account, not per client.)

As Harrison said earlier, this pricing menu is a work in progress.  He points out that the standard custodial revenue model (including Pershing’s) also includes product fees paid by funds and ETFs, and larger fees paid for space on the mutual fund supermarkets.  For now, Pershing will continue to collect those fees, as its larger competitors do (though, it should be pointed out, not Shareholders Service Group, TradePMR, Foliofn or Altruist). 

“That’s a fundamental infrastructure issue that we believe is going to continue to evolve,” says Harrison.  “We’re in the early innings of this pricing evolution.”  He notes that the custodians really can’t afford to reduce or eliminate the product-based fees in this ultra-low interest rate environment, when spreads on cash are, shall we say, not filling their coffers the way they did a few months ago.  But once rates go up and spreads loosen up, it might provide the custodial competition with an opportunity to revisit those product fees.

Broadened target

The three-part revenue model announcement also marked a change in the firm’s target market.  BNY Mellon/Pershing has, under CEO Mark Tibergien’s guidance, been very disciplined about targeting only the largest and fastest-growing firms in the advisor marketplace.  But now the firm is expanding its reach, at a time when there may be a lot of TD Ameritrade Institutional-affiliated advisory firms in play.

“That was intentional,” says Harrison.  “Under Mark’s leadership,” he adds, “We built this business from $50 billion back in 2008 when he arrived to over $800 billion today.  It was very masterful in the way that he had us focus on the growth-minded, professionally-managed firms serving complex investors.”

How does he define the new, expanded target market?  “We still want to work with professionally-managed, growth-oriented firms,” says Harrison.  “Lifestyle practices and sole practitioners are not in our bailiwick.  We traditionally had a $250 million minimum; now we have a $100 million minimum,” he adds.  “An SEC-registered $100 million advisory firm that aspires to grow is absolutely a target client for us now.  And we know that there are a lot of advisors of all sizes in this current disruptive environment who are looking for a new home or contemplating what they’re going to do next.”

If there’s a takeaway from Harrison’s conversation, it’s that Pershing’s larger competitors are driven by the imperatives of the retail marketplace, while BNY Mellon/Pershing is a bit more free to innovate, free from the constraints of trying to attract individual investors with free this and free that.  “Instead of taking a retail chassis and orienting it towards an advisory practice,” says Harrison, “We’ve taken an institutional chassis that services multi-business line financial services companies and brought that to the RIA marketplace.  Everything is designed for advisory firms.”

Because it has, in the past, worked exclusively with larger (read: demanding) firms, Pershing has by necessity developed a dedicated service team approach to servicing advisor needs.  Beyond that, under Tibergien’s leadership, Pershing has built out the largest—and some would say the best—business and tech consulting team in the custodial business.  The goal has been to help growth-minded firms professionalize their internal management.

But that raises the question: will smaller advisory firms receive a different service experience from the firms with Pershing’s traditional profile?  And will advisory firms that choose one model over another end up with a different service experience?

“Access to practice management and business consulting remains a core part of our value proposition for all the firms we work with,” says Harrison.  He says that while the larger custodians are moving their smaller advisory relationships over to call centers, that will not be part of Pershing’s service model.  “We know that for advisory firms, dedicated high-touch service is absolutely non-negotiable,” he says. 

And the firm is continuing to take advice and suggestions from its advisors, not just on the new revenue models but also other aspects of the business.  “This pandemic that we’re all experiencing together is disruptive and in some ways unimaginable,” says Harrison.  “But it has given us a lot of perspective on the core attributes of a custodial relationship.  When things are choppy, when things really matter,” he adds, “you want to be a partner who has the strength and stability and resiliency and ability to serve your clients in tough times.”

Quick goodbye

Meanwhile, all of this news was almost overshadowed by the announcement that Mark Tibergien would be retiring from his leadership post at Pershing after 13 years as arguably the most prominent custodial executive in the advisory space.  “I joined Pershing just at the beginning of 2008, at the precipice of the last great crisis,” he says.  “And now I’m leaving at the beginning of the next great crisis.”

Tibergien was, of course, a major architect of the new pricing models, and he has been saying for longer than any of us can remember that eventually the custodians would have to charge subscription/membership fees in order to better align their revenue model with the fee-only advisor model.  When I asked about the three options, he seemed almost dismissive of the no-trading-fee model, and who isn’t familiar with the more traditional pay-per-transaction arrangement?

But Tibergien appears to have spent considerable time envisioning how the subscription model would work in the real world.  For instance, doesn’t it shift the burden of custodial fees from the client onto the advisory firm?  “That isn’t required,” he says.  “That is a choice that advisors can make; they can pass the fee back onto the client like they do today, or they can absorb it.”

In fact, the subscription arrangement moves the custodian/advisor relationship in the direction of the fiduciary advisor/client relationship. “I think it becomes a critical strategic move,” says Tibergien, “for advisors to say: do I want to be fully-transparent and all-in with my costs, or do I want to keep layering on? Some advisors might say: this [the custodial service] is part of my value-add, and the client doesn’t have to pay additional for things like product access and custody.”

Won’t some advisory firms select their preferred model based on their ability to game the system?  Perhaps they can get zero trading fees and stay on top of cash balances, minimizing the return to the firm.  Or they could use the traditional model and do block trades and generally as little trading as possible.

“We monitor these things on a regular basis,” says Tibergien.  “For the relationship to succeed, the economics have to work for both parties.”  He points out that Pershing has terminated 125-130 relationships over the last three years, some of them because they determined that the advisory firm is high risk, but others because the relationship was not profitable.  “And sometimes they were not good to our people,” he adds.

Advisors, says Tibergien, have to know a good client from a not-good client—and so too does any service provider who contributes to the advisor ecosystem.

A lot of us were startled when Pershing expanded its target market, though the move certainly makes sense given the Schwab acquisition of TD Ameritrade, and the potential for a lot of advisory firms to reexamine their custodial options.  But Tibergien says that the broadened focus has more to do with Pershing becoming an equal competitor to the firms it had spent a decade catching up with.

“Once a firm like Pershing goes through a period of growth,” Tibergien adds, “there comes a time when you have to say: what’s next?  You have to reinvent yourself.  That could mean offering new services,” he says.  “Or offering new pricing.  Expand the market definition.  Decide to compete with the other firms in a different way.  Once we surpassed the third largest firm in total assets, and were closing in on the second-largest firm, we felt like we had to begin behaving like a leader, not just a chaser of the competitors.”

Beyond that, says Tibergien, there are a number of $100 million firms today that have many of the same characteristics as the $250 million firm of a decade ago.  “The way Ben and the team redefined it is to focus on SEC-registered RIAs,” he adds.  “But that doesn’t mean we would automatically deal with a firm that is at that level.  They also want to know: how serious are they about their growth?  How do they value the relationship with the custodian?  How automated are they in their processes?

A better definition of the threshold is: not-state-registered, and the firm leaders take their businesses seriously.  That, of course, would also be the kind of firm that would benefit most from the practice management consulting group that Tibergien has built as arguably Pershing’s biggest value-add.

Advisor evolution

This raises a bigger question: what will be the economics of the custodial customers—the advisory businesses—in an environment where the custodial economics are shifting rapidly?

“The first thing I would say is that this [pandemic environment] is when good advisors demonstrate their value,” says Tibergien.  “It tends to prove that market performance is not where success is measured.  Success today is measured in peace of mind and responsiveness and empathy, and the way in which advisors plan for a crisis in advance.”

However, he continues, the advisor pricing strategy has never been aligned with that reality.  “Advisor pricing,” says Tibergien, “has always been around: how many assets are you bringing me to manage?  If the markets go up, you are going to pay me more even though I didn’t do anything to earn that extra money.”  He doesn’t come out and say that a shift from AUM is coming soon, but the message is certainly implied.

Tibergien’s second point is about internal firm management, a topic where he’s become the profession’s leading thinker.  He envisions a day when the regulators will examine not just whether advisory firms are following the compliance guidelines, but also the sustainable health of the firm.  “Mistakes happen when people are working remotely, and you don’t have the same close supervision of what’s going on,” he says, adding that this crisis will be a test of which firms are indeed cohesive managerially, and which are not.  “My big question is: how successfully will firms adapt to this environment?” he says.

Third: Tibergien wonders whether the advisor/client relationship is going through some sort of rapid evolution during the pandemic crisis.  “Every advisor is trying to mitigate their clients’ investment risk,” he says.  “But now, all of a sudden, clients are not working.  Some may have lost a spouse or a child, or some other crisis occurred.  How well are you helping your clients deal with those kinds of issues?  Are advisors demonstrating to their clients that they’re there not just for the financial issues, but to help them manage through difficult times?” 

The next adventure

Over the course of his career, Tibergien managed to shift the professional conversation from only talking about best practices for serving the client, to how to run an effective advisory business and create a strong platform for those services.  Then he helped the profession think through the thorniest of issues around managing advisory practices like  real businesses.  If Tibergien had followed another career, I suspect that the profession as a whole would be much further behind in this conversation than we are today.

“Just to give you some perspective on this,” he says, “when I moved from Chicago to Seattle in the mid-1970s, my boss at the time was in the very first CFP class.  He said to me: you really should get involved in this financial planning business in some way. It’s going to be a real growth business.”

Back then, going to IAFP meetings (the precursor to the FPA), he says, if you met somebody who managed $10 million, that was a really big thing.  “I remember saying to myself,” Tibergien adds, “maybe there’s a way that I can create a method for people to actually grow their enterprises, evaluate their performance, build value, and ultimately achieve liquidity with the business investment that they’ve created.”  That led to the first benchmarking study for financial advisors, the consulting work on the Moss Adams platform, and a lot of those dreams about the profession becoming a reality.

“When I look back on all the seven careers that I’ve had, each of them has given me something special,” Tibergien says.  “The experience at BNY Mellon/Pershing has been among the most unique, because of the company’s position in the global financial system, and the things that it deals with on a worldwide basis.  My ability to have a window into that world,” he says, “is something I couldn’t have ever imagined growing up in Michigan as a liberal arts major.”

What’s next?

“I am not hanging up my spurs, but I am not competing in rodeos anymore,” Tibergien says.  He still intends to be active in the profession, do some consulting, help firms move forward, but for now he’s going to take some time off, and has vowed never to return to a full-time executive position.  “I want to work with organizations and people I find enjoyable,” he says.  “And I also want to continue working on the financial literacy initiatives that I’ve spent so much time and resources building up, and probably finding another cause to get behind as well.” 

Retirement will be working in the profession on his terms—something we can all envy.