Transitions Magazine - April 2010

Business Management for Independent Financial Advisors

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How Does Your Money Manager Measure Up? Page 7

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A Forgiving IRS? Page 19

TABLE OF CONTENTS Letter from the Editor ..................... 1 In the News .................................... 2 Calendar of Events ........................ 5 The New "Trust but Verify" ............. 7

by Ron Surz How to Set Up Your Business, III .. 13

by Sydney LeBlanc Virtual Insurance for Advisors....... 17

by William R. Nelson, Ph.D. & Scott Winters The 2010 IRS... Kinder? Gentler?

How About Just Smarter? ...............19

by Richard Boggs The Exit Planning Process: Step Five ........................................ 21

by David Leitner, Esq. CExP™ Beyond Reproach: Ethics Integrity, Trust ............................... 23

by David Loeper, CIMA®,CIMC® Book Review: Preparing Heirs Through Philanthropy ....................... 27 authored by Roy Williams & Vic Preisser

Advisor Advocate "High Five" Starpoint Consulting Group LLC ...... 29

GRIN & BEAR IT!

Advisor Advocate "High-Five"

A Conversation with John Burns, Founder and CEO, Burns Advisory Group, LLC .................... 31 Grin and Bear It! ........................... 35 Resource Directory ...................... 36

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Transitions Magazine

From the Editor Ethics: It’s What Happens When No One is Watching

Note: I had so many nice phone calls and emails from readers over the past few months asking me to re- run my editorial on Ethics, so here it is. Some, in our industry, our government, and in our country have lost their way and I thought it was the perfect time to for us to remind ourselves what ethics is really all about. — Syd I learned my first lesson in ethics in 1953 when I was six years old from a poor, hard-working railroad man — my dad. Early Saturday morning, once a month, I would go with him to the train yard to pick up his monthly pay. Payday was exciting because I knew I’d soon have a shiny new quarter to add to my piggybank. But, on one particular Saturday morning, I learned a lesson I would remember forever.

At 8 am sharp, we marched into the payroll office and, George, the elderly payroll clerk, snapped off 10 crisp $20 bills — as he did each month — and handed them to my dad. “See you next month, Bob, bright and early,” George said. My dad thanked him and off we went. We were halfway across the old tracks, when my dad stopped and said, “Let’s go back and see George again, honey, it will only take a minute.”

For so many years since then, I have wondered exactly what was going through his mind when he realized that far-sighted George mistakenly had given him $50s instead of $20s---almost triple his monthly pay! Was he hesitant to go back? Did he weigh the pros and the cons? Did he regret giving back the extra money that we desperately needed?

That incident of honesty and ethics was the true test of my dad’s character. And to analogize it with the problems we have experienced in our industry recently only dwarfs my story in comparison. Perhaps to some, it may not even seem relevant. But I believe, as most do, that the ethics of an industry begin and end with just one person: YOU. Ethics trickles down from the top, from those leaders who are admired and respected. Hard-working advisors need moral leadership and ethical guidance, clients need to feel trust and confidence again, and our industry needs to have integrity and values.

Each and every one of us needs to look in the mirror and ask ourselves, “If no one was looking, what would we do differently?”

We need a new awareness of the awesome responsibility and accountability we all share and, at the very least, talking about it inspires us to set new rules, walk new paths, and acknowledge and practice, once again, the lessons we learned long ago.

Ethics. I didn’t know what the word meant back them, but I knew my dad had them and I guess that was all that really mattered.

From the Editor s

Back we went, up the stairs and back to the payroll counter. “Better get those glasses changed, my friend,” said my dad as he walked briskly across the room after he and the elderly clerk exchanged bills, a smile, and a wink. Then down the steps we went again, running back to the old Studebaker. As we rolled out of the train yard, Dad, with the simplest of wisdom said to me, “You won’t understand this today, little Sydney, but sometimes it hurts to do the right thing. It only hurts for a minute, but it’s the real test of a person’s character.” Huh? I didn’t get it. But it was ok because I was going to the dime store to spend my quarter and that was all that mattered at the moment.

* In memory of Robert J. LeBlanc 1921-1961 www.transitions-mag.com

April 2010

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Transitions Magazine

Industry News Publishers Lyn Fisher & Sydney LeBlanc Editor-in-Chief Sydney LeBlanc sydney@transitions-mag.com Managing Editor Cami Miller cami@transitions-mag.com Contributors Richard Boggs David Leitner, Esq., CExP™ David B. Loeper, CIMA®, CIMC® William R. Nelson, Ph.D. Ron Surz Scott Winters

In the News

IT Directors John Weeks Shane Hansen Advertising Sales • Stephanie Kunz stephanie@ffpublish.com 435.750.0062 x3 • Lyn Fisher lyn@ffpublish.com 435.750.0062 x1

Published by Financial Forum Inc. 550 North Main, Ste. 221 Logan, UT 84321 435.750.0062 • info@ffpublish.com 2

REAL ESTATE INVESTMENT SECURITIES ASSOCIATION (REISA) HOSTS REGIONAL SYMPOSIUM IN DALLAS The Real Estate Investment Securities Association (REISA) will hold a one-day, regional symposium on April 12, 2010 at Marriott Quorum by the Galleria in Dallas, Texas.

REISA’s regional symposium will provide time during breakfast, lunch and a closing cocktail hour for attendees to network, share ideas and gain new industry knowledge. Attendees will have the opportunity to attend six different sessions on private and non-traded REITs, Regulation D real estate programs, energy investments, the current regulatory environment and emerging real estate securities industry trends from the industry’s top producers.

This meeting will attract hundreds of local real estate securities professionals including financial advisors, sponsors, broker-dealers, registered representatives, registered investment advisors (RIAs), CPAs, attorneys, lenders and other industry-related professionals.

“Our new regional symposiums will provide a venue for sponsors to network with registered reps, financial advisors and brokerdealers and create new distribuApril 2010

tion channels to grow and expand their businesses,” said Renee Brown, President of REISA. “We hope to attract new industry professionals in the Dallas area and give them the educational tools to build investment portfolios with securitized real estate products and ultimately build their business.”

REISA will host two other regional symposiums in 2010 including an East Regional Symposium in Washington, D.C. in May and a Midwest Regional Symposium in Chicago on June 14, 2010. Additionally, REISA will hold its annual conference on October 17-19, 2010 at the Paris Las Vegas Hotel.

To register, contact Anne Boley at aboley@reisa.org or 317.663.4174. For additional information contact Jill Delaney at jdelaney@reisa.org or go to www.reisa.org The Real Estate Investment Securities Association (REISA), formerly known as the Tenant-In-Common Association (TICA), is a national trade association for professionals who offer and distribute securitized real estate investments.

These offerings represent all fractional interests in land, commercial real estate, energy and natural resources including DSTs, TICs, funds, partwww.transitions-mag.com

Transitions Magazine

Industry News

FIRST ALLIED CUTTING-EDGE TECHNOLOGY

LAUNCHES IMAGING

In partnership with Laserfiche, First Allied financial advisors will enjoy an imaging solution that will allow them to go paperless.

First Allied Securities, Inc., a leading independent broker/ dealer, announced last month their partnership with Laserfiche to deliver a customized, innovative imaging solution to their nearly 1,000 independent financial advisors. Laserfiche will be a key component to the firm’s efforts to transition its advisors to a truly paperless office.

“Laserfiche is the perfect complement to our ongoing workflow initiatives. It’s advisor-friendly, complianceoriented and seamless in operation,” said Adam Antoniades, President and CEO of First Allied. “When you’re focused on growth such as we are — both at the broker/dealer and in our advisors’ independent www.transitions-mag.com

offices—you must have solutions that will support expansion. Laserfiche will help our current and future advisors save money through reduced administrative expenses and seamless integration with many of our other systems. It frees them up to spend more time with clients by eliminating hours spent on administrative tasks.”

The intuitive system has superior organizational options, improved search capabilities, and is easily implemented as a paperless option, said Steve Krameisen, Chief Technology Officer at First Allied. “This system will allow our advisors to go entirely paperless, which not only saves on the cost, time and effort of storing physical files, but also makes it much easier to meet compliance regulations which require ongoing, scrupulous documentation.”

Laserfiche is familiar with the requirements of the financial services industry, which was critical in First Allied’s selection process, Mr. Krameisen said. “Laserfiche is a robust, secure, Web-based document and imaging system. New features such as bar code recognition, an easy-to-use folder system, and more advanced search capabilities—backed April 2010

by their proven track record— made them our No. 1 choice.”

Chris Wacker, Senior Vice President at Laserfiche, said “With regulatory requirements increasing all the time, it is critical for financial services firms to stay ahead of the curve by harnessing the power of enterprise content management to streamline compliance while decreasing costs. While other financial advisors struggle to find the time, money and staff to comply with industry requirements, First Allied’s advisors will find themselves more efficient than ever before thanks to First Allied’s vision and commitment to providing the most agile ECM solution on the market.”

First Allied Securities, Inc. (Member FINRA/SIPC) (www. joinfasi.com is a wholly-owned subsidiary of Advanced Equities Financial Corp., a diversified financial services company.

Founded in 1987, Laserfiche (www.laserfiche.com ) creates simple and elegant document management solutions that help organizations run smarter.

The solutions support straightthrough processing while cutting the costs of compliance and ensuring greater security, privacy, transparency and accountability at every level of an organization. Laserfiche

In the News

nerships and REITs sold on a securities platform. REISA promotes the highest ethical standards to its members and provides education, professional development, networking opportunities and resources. For more information about REISA, call 866.353.8422.

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Industry News solutions provide operational benefits that transform compliance from a cost center into an opportunity for achieving greater competitive advantage.

Laserfiche solutions are used in more than 28,000 organizations worldwide, including numerous investment advisors, financial advisors, and broker/dealers and government offices.

In the News

Next Generation of Investment Gurus to Compete in CFA Institute Investment Research Challenge

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University students in the U.S., Canada, and Latin America – all of whom are studying business, finance, and accounting –are gearing up to compete in the CFA Institute Investment Research Challenge (Americas). This next generation of investment professionals from schools such as MIT, University of Denver, University of North Carolina, and University of Richmond will match wits and analytical, presentation, and research skills for the chance to travel to Hong Kong and compete globally.

The CFA Institute Investment Research Challenge offers students the unique opportunity to learn from leading industry experts and their peers from the world’s top business schools.

This annual educational initia-

tive is designed to promote best practices in equity research among the next generation of analysts through hands-on mentoring and intensive training in company analysis and presentation skills. This year, more than 75 CFA Institute member societies hosted local competitions with more than 1,500 students from more than 425 universities worldwide participating. (Read more.)

Twenty-eight universities from across the U.S., Canada, and Latin America have won their local competitions and will convene in New York on March 17-18, 2010. The students, typically in teams of four or five, will present their analysis and buy/sell/hold recommendations on public companies such as Staples, Chipotle, International Paper, Tim Horton’s and Dolby Laboratories. Their presentation at the Americas regional competition is the culmination of six months of research, interviews with company management, competitors, and clients, presentation training, and evaluation.

The Challenge consists of the following components: •

Analysis of a public company – Teams research a publicly traded company, and company management presents to the team and April 2010

participants in a questionand-answer session.

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Mentoring by a professional research analyst – Each team works with an investment professional who mentors the team on the research process and reviews their report.

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Writing a research report – Students produce an initiation of coverage report on the chosen company.

The report is reviewed and scored by a group of judges.

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Presentation of research to a high-profile panel of industry professionals – The team with the highest presentation score is the winner.

•

Advancement to the CFA Institute Global Investment Research Challenge – The winners of the four regional challenges advance to compete in the global finale on April 17, 2010 in Hong Kong.

Thomson Reuters is the worldwide sponsor of the regional and global challenges. They provided the student teams with access to Thomson One Analytics, a real-time, integrated research and analytical application. In addition, John Wiley and Sons, Inc. will donate a set of CFA Institute www.transitions-mag.com

Transitions Magazine

Industry News

CFA Institute is the global, nonprofit professional association that administers the Chartered Financial Analyst® curriculum and CFA and CIPM examination programs worldwide, publishes research, conducts professional-development programs, and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has nearly 100,000 members worldwide and 136 member societies in 57 countries. More information about CFA Institute may be found at www.cfainstitute.org or contact kathy.valentine@ cfainstitute.org.

For a detailed agenda and other important information, please click http://www.investmentadviser.org/eweb/docs/Public/ AC_2010_brochure.pdf to download the conference brochure.

For more information contact IAA Director of Meetings and Events Lisa Gillete at (202) 293-4222 or lisa.gillette@investmentadviser.org CFA Institute Newsletter Available The latest issue of the CFA Institute Private Wealth Management Newsletter addresses topics such as adapting a triedand-true pension risk management method for individual investors, family governance best practices, and how to best navigate the legal and tax issues of cross-border investing. Here is a sampling: •

IAA Annual Conference, April 28-30, 2010 2010’s IAA Annual Conference program, held at the Trump International Hotel and Tower in Chicago, IL, features a distinguished and knowledgeable group of speakers who will address a wide range of compelling issues that are of interest to executives involved in the investment advisory profession.

The conference is also a great way to meet and network with industry colleagues. www.transitions-mag.com

•

Asset-Liability Risk Management with Private Wealth —Institutional investors and consultants use ALM to ensure that assets are allocated effectively to offset the stochastic risks of current and future liabilities.

Family Governance: Global Issues and Trends — With family-owned businesses, the presence or absence of good family governance can make the difference between success for many generations and complete April 2010

failure in just two or three generations.

•

Enhancing Global Investment Returns with Attention to Legal and Tax Issues

This current issue and archives can be found at www.cfainstitute.org/memresources/communications/privatewealth/ index.html. For more information please visit www.cfainstitute.org or call 434-227-2177 — 2010 — CALENDAR OF EVENTS MAY May 17-19 IMCA National Conference Orlando, FL May 19-21 NAPFA National Conference Chicago, IL

JUNE June 9-11 Pershing Insite 2010 Hollywood, FL

SEPTEMBER Sept 11-14 NAIFA Career Conference & Annual Meeting Seattle, WA

OCTOBER Oct. 9-12 FPA Annual Conference Denver, CO Oct 17-19 REISA National Conference Las Vegas

In the News

Investment Series to each student on the winning team from the Americas, European, New York, and Asia Pacific regional challenges.

To include your upcoming events, please email the info to: info@transitions-mag.com 5

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Transitions Magazine

The New

"TRUST but VERIFY"

By Ron Surz

“Today’s money managers say they compete with other money managers by generating the highest alpha. They denigrate the role of marketing.

Yet each money manager has ready stories about other money managers with low alphas who snatched clients through clever marketing.”

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he old “Trust but Verify” was all about the accuracy of performance results reported by money managers. We even distrusted custodians, so consulting firms performed custodial audits. The pressure worked. Today we have performance reporting standards promulgated by the CFA Institute, enlightened custodians, and a raft of computer checks and balances. So you’d think the past is behind us, but it would appear not. Service providers, especially performance attribution vendors, sell real time, or at least daily, product because it is more “robust.” The pitch is that attribution is more accurate because the manager’s calculated performance is more accurate.

But do we really need to calculate manager performance over and over to achieve accuracy? Today we get performance numbers from managers, custodians, consultants, service bureaus, performance verifiers, etc. etc. Want to see a “robust” return?

Run a daily attribution system and see if it produces anything different than the myriad other sources; if it does there’s a good chance something is wrong with the attribution system. We’re wasting our time, money and energy on the old “Trust but verify” and missing an important fact in the process: if the benchmark is wrong all of the analytics are wrong. Most attribution systems do not allow careful benchmark specification, unless the manager is an index hugger, which is generally pretty uninteresting. Performance attribution tells us why the manager has succeeded or failed relative to a benchmark, so if the benchmark is wrong we are completely misled. We pay a lot of money for flawed information.

Even worse, we make bad decisions. It’s the old garbage-in, garbage-out. www.transitions-mag.com

April 2010

Cover Story s

—Professor Meir Statman, Santa Clara University, Statman, 2004

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Cover Story

By contrast, the new “Trust but verify” is all about the spin. Professional sales people can turn mold into gold right before our eyes. The most accurate performance results are presented in the most favorable light, even when the money manager has failed. This subterfuge has gone on for so long that it is commonly accepted, hence the Meir Statman quote that introduces this article. We frequently hear “laughable” sayings like “I have never met a money manager who has performed below median” or “Every manager wins against the right benchmark.” But the clients aren’t laughing. Consultants need to take back control of the due diligence process by getting serious about the two key questions: • What does this manager do?

• Does he/she do it well?

Both questions have everything to do with accurate benchmarking, and absolutely nothing to do with verifying reported manager performance, although answering these questions can reveal deceitful reporting as well.

Bernie Madoff’s scam was there for all to see if they seriously addressed the two due diligence questions, but only a few did. We can trust the accuracy of reported performance, but not the story that is told about that performance. If the performance is cooked, we’ll discover that when we perform real due diligence, but we need to do it right. Complacency and laziness have allowed us to be fooled, and clients are demanding better. The activepassive debate has much to do with our inability to differentiate winners from losers; if you can’t tell the difference, you really should go passive – be honest now.

Stepping up the Due Diligence Process Indexes and peer groups do not work for addressing the two key due diligence questions. In identifying what the manager does, most managers do not live in a style box; although most will agree to be benchmarked against whatever it takes to get the account. Style boxes are convenient shorthand that has gotten out of hand.

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As for the second question, performing well against a “representative” peer group tells us nothing. Peer groups are loaded with biases and sales people can always find a peer group that makes them look good, provided by a reputable source and that has a name that sounds like what they do. Don’t like your peer group ranking? Find another peer group. Clever sales people find clever ways to turn mold into gold.

To properly answer the first due diligence question – What does this manager do? – We need tools that capture the people, process and philosophy (the three Ps) of the management firm. Importantly, we must allow for liberated managers who are not index huggers. Nothing against index huggers, except that the consulting industry seems to want to treat everyone like an index hugger, perhaps as a convenience or perhaps because they have swallowed the poppycock that tracking error is risk. One of the tools we have available to us is style analysis, in particular analysis that advocates custom blends of styles. We can use either performance or holdings to see how the three Ps manifest themselves. The best style analysis uses the best style indexes, and it has been shown that the best style indexes are mutually exclusive (no stock is in more than one index) and exhaustive (the collection of indexes spans the entire market).

With a custom benchmark in hand we can address the second question – Does the manager perform well? At this point we always have the choice of active or passive management. Even hedge fund managers can be inexpensively replicated. This second due diligence question is best addressed with hypothesis testing. We test the hypothesis that the manager can and has outperformed.

But relative to what? Relative to all of the possible implementations of his approach. Hypothesis tests compare the actual outcome to all of the possible outcomes. If the manager’s performance is in the top decile of all the possibilities, he has had significant success. Note that this approach is bias free and customized to the manager, unlike traditional peer groups. Today’s computer technology

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Cover Story

makes it possible to simulate all, or a reasonably good sample of all, of the paths the manager could have taken through time, creating portfolios from stocks in the custom benchmark.

Does It Work?

In May of 2005 I criticized Don Trone, then founder and president of the Center for Fiduciary Studies, for his due diligence criteria, which made extensive use of indexes and peer groups. Don responded with a challenge and an acknowledgement that “Our due diligence criteria is designed for one purpose: to define the minimum due diligence process that should be applied by an investment fiduciary - it is not intended to be an industry best practice - that space is reserved for you!!.“ Don’s challenge was to create competing multi-manager portfolios. Can best practices actually perform better than common practices? I won, & have the congratulatory e-mail from Don to prove it. By the way, it’s been said that “Best practices that are not common practices are simply someone’s unpopular opinion.”

How does that thought strike you?

Here’s an up close look at best practices in action — a case study. In the exhibit below, We Have a Winner, a large cap growth manager has outperformed the Russell 1000 Growth index by 270 basis points per year. Would you hire this manager?

Before you decide, let’s take a closer look. The exhibit on page 10 shows two returns-based style analyses, one using Russell indexes and another using Surz Style Pure® indexes. The Surz indexes are mutually exclusive and exhaustive while the Russell indexes are not. The two analyses agree that the manager is not pure large growth, although large growth is the predominant allocation. The analyses disagree however on the exposure to small companies, with Russell showing a 30% exposure and Surz showing very little. A closer examination of the holdings in the portfolio reveals that the manager’s smallest holding had been $6 Billion, hardly a small company. Indexes that are not mutually exclusive and exhaustive make poor style palettes for returns-based style analysis. www.transitions-mag.com

April 2010

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Cover Story

So now we can re-assess the manager’s success or failure using a custom benchmark that is more precise about what this manager actually does. The exhibit on the right [Evaluate Skill not Style], shows that the manager has actually underperformed by 60 basis points per year. In other words, had we not customized the benchmark we would have evaluated style, not skill – a costly but common mistake. So now would you hire this manager? Before you decide, let’s do some attribution work.

The New Attribution In keeping with the new “Trust but verify," the new attribution is most concerned about benchmark accuracy although of course it’s also important to have an accurate manager return. The new attribution takes linked monthly 10

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Cover Story

buy-and-hold returns and the most accurate actual return we can find, and uses these two pieces of information to calculate “activity” as a measure of value added or subtracted by intra-month decisions. Activity is the difference between the most accurate actual return and the linked monthly buy-and-hold return. This provides an additional insight that is frequently quite interesting.

Most importantly, the benchmark in the new attribution is customizable in a variety of ways, as follows: • Customizing the benchmark in the new attribution • Blend of styles, sectors or countries • Normal portfolio, which is a list of stocks with their neutral weights • Any fund, like a competitor or an index fund When the benchmark is right we can rely on the sources of success or failure revealed by attribution. Also, we can dispense with the slicers and dicers that segment the portfolio and the benchmark by characteristic, such as capitalization and price/earnings ratio. These segmentations serve only to demonstrate that the benchmark is wrong, and to complicate an already complex analysis.

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Cover Story

The exhibit on page 11 [Custom Attribution] exemplifies the new attribution and its incorporation of hypothesis testing. The floating bars in the exhibit represent all of the portfolios that could have been formed in sectors of the customized benchmark. In this way, we can see significance straight away. A dot plotted in the top or bottom decile is statistically significant at the 90% confidence level. The dots are the manager’s actual returns in the sector, and in total.

As you can see in the bottom of the exhibit, the benchmark in this case has been specified as a custom blend of styles. Accordingly the rankings of performance within sector are customized to this style blend, and employ hypothesis testing. Also shown in the exhibit are allocation “bets”. The blue shaded area at the bottom of the exhibit is the portfolio’s average allocation to sectors and the red line is the custom benchmark’s average allocations.

Since we can rely on the sources of success or failure reported in the new attribution, we can question the manager about both. We’d like to confirm that the successes are likely to continue and that the failures have been identified and are being corrected. After all, due diligence is all about the future.

Conclusion Just as the Bubonic plague is no longer a concern, we need not worry anymore about the accuracy of reported returns because there are plenty of cross-checks in place. We need to move on to what really matters, namely accurate benchmarking, especially in the critical and expensive area of performance attribution.

If the benchmark is wrong, all of the analytics are wrong. uuu

Ron Surz is President PPCA Inc Ron@ppca-inc.com (949)488-8339 REFERENCES

Statman, Meir. “What Do Investors Want?” Journal of Portfolio Management, 30th Anniversary Edition 2004, pp. 153-161 Surz, Ronald J. “Getting All the Pieces of the Puzzle.” The Sortino Framework for Constructing Portfolios, edited by Dr. Frank Sortino, 2010 Elsevier Inc.

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Transitions Magazine

How to Set Up Your Independent Business: Part 3 Which Legal Structure Should You Use?

Editor’s note: This is a great article that originally was published in a book Lyn Fisher and I wrote for John Peluso, President, Wachovia’s FiNET division (now WellsFargo Advisors Financial Network). The book is called “Independent Business Ownership: Navigating to Your New Destination.” We think you will find it very helpful when starting up your new business.

B

efore diving into the deep end of the pool it is necessary for you to decide under which type of legal entity you will be doing business. Factors to consider here include future plans for your business, as well as tax issues, and whether or not you ever intend to add partners somewhere down the line and how that might affect your decision.

You have four options from which to choose when setting up a small business venture: • Sole Proprietorship • General Partnership • S Corporation • Limited Liability Company (LLCs) Worth noting is that many industry experts believe neither sole proprietorships nor partnerships offer the kind of liability protection suitable for your company, but they are covered here nonetheless so that all options are on the table for you to review.

Sole Proprietorships The vast majority of small businesses start out as sole proprietorships. These firms are owned by one person, usually the individual who has day-to-day responsibility for running the business. Sole proprietors own all the assets of the business and the profits generated by it. They also assume complete responsibility for any of its liabilities or debts. In the eyes of the law and the public, you are “ one and the same” with the business. www.transitions-mag.com

April 2010

Setting Up Your Business

By Sydney LeBlanc

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Setting Up Your Business the three types of partnerships you might consider:

Advantages of a Sole Proprietorship:

1. General Partnership — Partners divide responsibility for management and liability, as well as the shares of profit or loss according to their internal agreement. Equal shares are assumed unless there is a written agreement that states differently.

• Easy to organize • You have complete control • You receive all income • Profits flow directly to your personal tax return • Business is easy to dissolve, when appropriate Disadvantages of a Sole Proprietorship: • Unlimited liability and legally responsible for all debts against the business.

• Business and personal assets are at risk.

• May be at a disadvantage in raising funds, and are often limited to using funds from personal savings or consumer loans.

• May have a hard time attracting high-caliber employees, or those that are motivated by the opportunity to own a part of the business.

• Some employee benefits, such as owner's medical insurance premiums, are not directly deductible from business income (only partially deductible as an adjustment to income).

Partnerships In a Partnership, two or more people share ownership of a single business. Like proprietorships, the law does not distinguish between the business and its owners. The Partners should have a legal agreement that outlines how decisions will be made, profits will be shared, disputes will be resolved, how future partners will be admitted to the partnership, how partners can be bought out, or what steps will be taken to dissolve the partnership when needed. Yes, its hard to think about a "break-up" when the business is just getting started, but many partnerships split up at crisis times and unless there is a defined process, there will be even greater problems. Here are 14

2. Limited Partnership and Partnership with limited liability —"Limited" means that most of the partners have limited liability (to the extent of their investment) as well as limited input regarding management decisions, which generally encourages investors for short-term projects, or for investing in capital assets. This form of ownership is not often used for operating a service businesses. Forming a limited partnership is more complex and formal than that of a general partnership.

3. Joint Venture — Acts like a general partnership, but is clearly for a limited period of time or a single project. If the partners in a joint venture repeat the activity, they will be recognized as an ongoing partnership and will have to file as such, and distribute accumulated partnership assets upon dissolution of the entity.

Advantages of a Partnership: • Partnerships are relatively easy to establish; however time should be invested in developing the partnership agreement.

• With more than one owner, the ability to raise funds may be increased.

• The profits from the business flow directly through to the partners' personal tax returns.

• Prospective employees may be attracted to the business if given the incentive to become a partner.

• The business usually will benefit from partners who have complementary skills.

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Setting Up Your Business Disadvantages of a Partnership:

S Corporation

• Partners are jointly and individually liable for the actions of the other partners.

• Profits must be shared with others.

• Since decisions are shared, disagreements can occur.

• Some employee benefits are not deductible from business income on tax returns.

• The partnership may have a limited life; it may end upon the withdrawal or death of a partner(s).

Corporations A corporation, chartered by the state in which it is headquartered, is considered by law to be a unique entity, separate and apart from those who own it. A corporation Magazine can be taxed; it can be sued; it can enter into contractual agreements. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. The corporation has a life of its own and does not dissolve when ownership changes. The following are the most desirable for a small business:

A more beneficial way to go for your company’s legal structure is the S Corporation, which operates like a C Corporation, but places better tax advantages in your corner. It enjoys the same rights and limited liability protection of a C Corporation without suffering the C Corporation’s plight of double taxation.

Limited Liability Company A Limited Liability Company (LLC) couples the tax advantages of a partnership with the liability protection of a corporation. LLCs are owned by members instead of shareholders in an S Corporation. This entity can operate with a single member or can have multiple members.

This article provides a good overview and a basic understanding of your options. You should seek the advice and counsel of an attorney who is experienced in compliance and regulatory matters for the financial services industry or consultants who specialize in helping set up B/Ds or RIAs. Better safe than sorry. Good luck. uuu

Resources: Keiter, Stephens, Hurst, Gary & Shreaves; www.kshgs.com; Small Business Administration (SBA) www.sba.gov

Differences Between S Corporations and LLCs Charles Young, CPA (Excerpt from Financial Savvy for the Small Business Owner, Financial Forum Publishing, 2009) An S Corporation can have no more than 100 shareholders, and only certain types of shareholders can own an S Corporation, including: individuals, estates, and qualifying trusts. Non-resident aliens cannot be S Corporation holders.

S Corporations can only have one class of stock. Income and expenses from an S Corporation, as well as any distributions paid to shareholders are allocated based on the shareholder's ownership percentage. The S Corporation net income reported on the shareholder's personal tax return is not subject to self-employment taxes. And S Corporation shareholders who are active in the business must be paid a reasonable salary.

The amount of your investment in the S Corporation, referred to as your cost basis, is calculated as follows: •

Increased by your contributions of cash and property

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Setting Up Your Business

•

Increased (decreased) by your share of S Corporation profits (losses)

•

Decreased by your share of distributions

•

Increased by loans made directly to the Corporation by you

This cost basis calculation is your tax cost. The higher your basis the more losses you can claim on your personal tax return.

LLCs, taxed as partnerships, are more flexible than S Corporations. There is no limit on the number of owners and any person, business, or trust can be an owner. With an LLC you can make special allocations with particular types of income and expenses among owners. The status of the business's net income reported on the owner's personal tax return that is subject to self-employment tax is unsettled tax law. Current thinking is that some of the taxable income, representing reasonable compensation paid in the form of guaranteed payments to owners active in the business, is subject to self-employment tax.

•

Your cost basis in an LLC is calculated as follows:

•

Increased by your contributions of cash and property

•

Increased (decreased by your share of LLC profits (losses)

•

Decreased by your share of distributions

•

Increased by your share of the LLCs debts (if you are personally liable for the debts

Magazine

The advantage of LLCs over S Corporations is the ability to increase the owner's cost basis in the LLC for LLC debts the LLC owner is personally liable for. u

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I

Advisors are in the information business. Information is most commonly conveyed by voice, electronic page, or hard copy. Historically, organizing, storing, and accessing this information has been performed in cumbersome, relatively ineffectual ways. Fortunately, recent technological advancements can be easily implemented to help you save time and make more money.

Information Strategies, Storage, and CRM Formulating an effective information strategy requires understanding the different kinds and uses of information in your firm. There is unique information tied to a specific person you interact with compared with information used within the firm but not limited to interactions with a single individual. Examples of individual-specific information are notes from a telephone conversation or a client’s account-opening paperwork. Individual-specific information is best “storganized” in a contact relationship management application (CRM). By definition, a CRM is organized primarily by contacts to which users can typically attach notes and files. Advisors have a multitude of CRM options to choose from.

One major decision is whether to choose a desktop or online application. I recommend an online application because the data is stored more reliably on servers than on any computer you manage yourself, especially if you use a CRM that is hosted in a reliable cloud environment such as Salesforce.com, who use their own servers, or Tactile CRM and Eqis Capital (my company) who host on Amazon Web Services. Any responsible service will back up your data in several locations to ensure safety and accessibility. These infrastructures are far more reliable than anything you can set up yourself. In addition, online solutions allow you www.transitions-mag.com

April 2010

Data Management

magine the nightmare of your firm’s data being lost. Imagine, for example, the time it would take to recover if you kept unique copies of client files in your office and they were destroyed by flood or fire. Safeguarding and organizing your information is a mundane yet critical aspect of your business. Clear systems and plans can reduce the cost of storing data, increase the data’s safety, and improve your ability to use this data to increase sales. The alternatives for a simple and secure information strategy are discussed below.

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Data Management

You have two types of data that should be managed in two different ways. Individual-specific information should be stored in a hosted (internet-based) CRM. Time can be saved and errors prevented by using a CRM that integrates with other systems, such as your asset management solution. Non-individual data, such as projects, is most conveniently stored on your desktop and Dropbox provides a user-friendly and secure solution for backup, synchronization, and sharing. Implementing these simple solutions can reduce the risk of lost information, increase your ability to access information, facilitate sharing information, and limit compliance nightmares.

Non-individual-specific information is not well suited to saving in a CRM, because it is not tied to an individual and is often associated with projects that involve many files stored in a hierarchy of folders. Most CRMs' storage systems are not sufficiently flexible to facilitate sophisticated hierarchies. Specialized document management programs are available and more appropriate for large firms, but an excellent alternative is available for small RIA offices. Dropbox (www.dropbox.com) provides an incredibly simple, elegant solution. Go to their site, download and install their desktop application, and you will have a Dropbox folder placed inside your «My uuu Documents» folder (default option). Use this folder as Scott Winters is National Sales Direcyou would any other by dragging folders and documents tor of Eqis Institutional, and Dr. Wilinto it. I suggest dragging in all your document folders. liam R. Nelson is the Chief Financial All the files and folders in your Dropbox are backed up on their servers (hosted by Amazon Web Services). In addition, you can download the Dropbox application onto other computers and the Dropbox folder will appear there also. Files are automatically synchronized between both computers. And, if you are at a computer other than your own, files can be accessed directly through their site. Log in to see your familiar hierarchy of folders and documents are available to download on an individual basis. Sharing folders with other Dropbox users is easy; simply enter the other user’s email address and they will see your folder under their shared folders; all folders automatically sync.

A free Dropbox account contains two gigabytes of storage, enough for many people. Paid accounts cost $9.99 18

Scott Winters

Another consideration when choosing a CRM is how it integrates with your sources of information. The more integration, the less manual transfer of data between systems is required, saving you time and preventing errors. For example, Eqis Capital built a CRM into the money management platform.

for 50 gigabytes or $19.99 for 100 gigabytes. Deleted files are retained for 30 days on all accounts and, for paid accounts, the “Pack-rat” add-on saves all files ever uploaded, even if deleted, as long as $3.99 is paid per month for the Pack-rat service. I know this reads like an advertisement, but I perceive disseminating information about great providers to be an important service.

Strategist of Eqis Capital. Dr. Nelson’s acclaimed original research has been published in the American Economic Review, The International Conference on Information Technology ITCC 2004 Proceedings, the Journal of Economic Behavior and Organization, Latin American Finance and Capital Markets, among many others. Eqis Capital provides a turnkey asset management platform that delivers enhanced power, flexibility and efficiency. Based in San Rafael, California, the company enables Registered Independent Advisors (RIAs) and Registered Representatives (RRs) to engineer portfolios that combine diversification, sophistication and world-class insight. Eqis provides pioneering technology with a global reach.

For more information, visit them at www.eqiscapital.com

April 2010

Dr. William R. Nelson

easy access to your data regardless of location so long as internet access is available.

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Transitions Magazine

The 2010 IRS ... Kinder? Gentler?

How About Just Smarter?

W

By Richard Boggs

When word of the latest leniency hit our offices, the reaction from my team of attorneys and tax professionals was mixed and the high-fives were nearly drowned out by the groans of “finally” and “it’s about time.”

At last the IRS seems to be realizing there are much easier ways to collect much greater amounts of money.

Take it from one who represents thousands of people suffering with tax debt issues, this is no bailout. The IRS is not giving a break to the overwhelming numbers who are already paying, nor to those who can afford to pay. The IRS is reaching out to those who are hiding out, to those who are off their radar and to those who can prove they completely lack the ability to pay what they owe.

This latest good faith offering from the IRS actually represents leniency on top of leniency. In January 2009, for the first time in history, the IRS officially announced they would allow more leniency by relaxing some of their settlement rules, easing up on some of their harsher collection procedures and specifically helping taxpayers by allowing lower current home values to factor into their Offer in Compromise (OIC) formula. Fourteen months later we can assume, with some confidence, that this relaxing of their settlement rules is working because the 2009 leniency is still in effect and the new 2010 announcement offers greater leniency still. The IRS is further widening their conditions for granting relief, this time focusing more on income allowances in the OIC formula, helping those who make less due to the recession. This will allow even more delinquent taxpayers to settle for less than they owe. This truly marks the best time in decades www.transitions-mag.com

April 2010

Tax Relief

hen IRS Commissioner Doug Shulman speaks, people listen. On March 9, 2010 he announced the second offering of “leniency” to delinquent taxpayers in as many years. The first such announcement in 2009 prompted millions of Americans to reach out to the IRS to settle their tax debt with the hope of cutting a deal, and it seems even more will take advantage this spring. Is the IRS joining the ranks of other government agencies, offering billions in bailouts to the undeserving? Many fear this is true.

But, if the 2009 leniency is any indication, this relaxing of its settlement rules is sparking millions of Americans to begin to pay taxes again while helping to cover our $600 million tax gap at the same time. To say that the March 9 announcement is unprecedented is an understatement and this latest promise of easier settlement guidelines, overdue or not, is a no-brainer.

Uncle Sam is cutting deals with tax dodgers like never before, and thus far has been quite successful in collecting more taxes by doing so. This is not fiction – this is the 2010 IRS.

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for anyone who has been struggling with a tax debt and wants to come clean.

However, this is not a “get out of jail free” card. The IRS stands firm that there is no magic bullet and their strict procedures to hold those who can pay their back taxes accountable has not changed. What seems to be shifting is how they wish to deal with those who cannot pay, and an even greater shift seems to be the IRS’ concern with their image. I can speak first-hand to the fact that the majority of Americans' perception of the IRS is one of fear.

A recent poll states that most Americans' fear the IRS more than the FBI and the CIA combined. I believe this to be quite possibly the largest contributing factor perpetuating our $600 billion (and rising) annual tax gap. As one who lives on the front lines of tax debt negotiations for clients I’ve found that Americans who have no reason to be frightened of the IRS are typically the most fearful, and those who are in the most precarious positions of delinquency seem to thumb their noses at the IRS. The reasons for the IRS’ image problems are not new, most involve the IRS being stuck working with outdated procedures and antiquated collections systems. A long time joke in our offices has been, “The IRS is tripping over millionaires and non-filers just to garnish 10% of Grandma’s SSI check.” Taxpayers that regularly slip below the IRS’ radar come in many shapes and sizes, from the self employed 1099 workers who have not filed in 5 or 10 years to those who have file every year and owe more than $100,000 in back taxes. New attorneys who work at my firm are shocked to find the IRS’ system allows so many who owe so much to slip through the cracks for so long.

The IRS might be caught in a huge Catch-22. It is possible that their outdated procedures and systems simply zero in on those who are the biggest waste of their time and resources, but they can't afford to install modern systems that easily calculate those taxpayers who are the highest risk for owing the most. The Tax Advocate’s yearly report suggests much of this is true, and maybe the 2009 — and now the 2010 leniency — is their first step in cracking this fundamental problem.

Whether the IRS is finally waking up or it’s a chang20

ing of the guard, their new message of leniency has been game-changer for those who owe back taxes. And it couldn’t come to a crowd who needs the help more.

It’s important to remember that while people are usually willing to discuss other financial problems, like foreclosure, credit card debt or overdue medical bills, when it comes to discussing issues with the IRS they often remain silent. Why? Because the stigma of tax debt makes those who owe feel unpatriotic. Those who owe feel they are the only ones. Others who owe, like them, remain silent and go for years paying nothing to the IRS. The problem is perpetuated by their fear of the IRS and the stress only grows year after year.

However, we now have a very real silver lining. If you have a client that you feel may not be fully disclosing a potential IRS problem, you can confidently state to them that this is the best time in 50 years for them to take the necessary steps to get a fresh start with their back taxes. These leniency announcements are not a ‘bait and switch.’ This light at the end of the tunnel is not the IRS collections' freight train in disguise. The IRS is relaxing their settlement procedures, plain and simple. This is real relief. A good suggestion if you want to bring yourself up to speed is to take a look at the IRS website (www.irs.gov) and review their 2009 and 2010 leniency announcements. While you may not be a tax resolution specialist, you’ll still be providing your clients with an additional, valuable service by pointing out the new options that are now available uuu

Richard Boggs is the Founder and CEO of Nationwide Tax Relief (NTR), one of the largest and most respected tax resolution firms in the country. NTR has successfully negotiated the tax debt of thousands of taxpayers and is comprised of the industry's top tax attorneys, enrolled agents and tax controversy experts. For more information about Nationwide Tax Relief, their services and areas of expertise, please go to www.nationwidetaxrelief.com.

April 2010

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Transitions Magazine

The Exit Planning Process Step Five: Transfer to Insiders

By David Leitner, Esq., CExP™

7-Step Process for Exit Planning Step 1 Your Destination Step 2 Valuing Your Business Step 3 Enhancing Your Value Step 4 Sell to Outsiders

Step 5

Transfer to Insiders

Step 6 Step 7

Business Continuity Estate Planning

In Step 5 of the 7-Step Exit Planning Process you consider a transfer to insiders. This is often the most attractive route to exit and frequently the most complex. An insider, for purposes of this step, is defined as either your employees, a group of keyemployees, your business-active children or your co-owners.

Three Key Ingredients There are three key ingredients that go into the sale of your business to an insider, and each is equally important. The recipe includes, in equal measures, the ability, experience and dedication of the prospective new owners; a company with a strong consistent cash flow and little debt; and a transaction designed to prevent income tax from eroding the cash flow available to the seller.

Perhaps less obvious, but equally important, is the corrosive effect of income tax upon a transfer of a business to insiders. One hazard associated with sale to insiders is that your children or key-employees probably do not have sufficient cash to buy you out. Therefore, a typical sale to insiders can take several years to complete, and this is a risky prospect indeed, especially if proper planning has not been engaged in to smooth the transition process. A substantial percentage of the cash that will be used to buy the business will likely come from the future cash flow of the business after you have left it.

Double Taxation Another hazard associated with transfer to insiders is that cash flow can, without proper planning, be taxed twice. It is this double taxation, frequently totaling more than 50 percent of the sale price, that can prove to be disastrous for many internal transfers. Through effective planning, however, much of this tax burden can be avoided. A Certified Exit Planner (CExP) and your advisor team can recommend several ways to reduce the tax burden associated with the transfer to insiders as well as providing for a smooth transition to new owners.

Exit Planning

It is clear that a business can not be successfully transferred to new ownership unless that new ownership is capable of operating the business successfully. By the same token, if the business does not have sufficient cash flow to provide enough income to pay for the business acquisition, the transfer will not be successful.

Qualifications of Insiders When considering a transfer to insiders, the first consideration is the qualifications of the insiders. Are they, www.transitions-mag.com

April 2010

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in fact, key-employees of the company? A key-employee is someone without whom the company would not be able to function as profitably as it does. It is important to make a distinction between key-employees, such as the sales manager responsible for a substantial percentage of sales or the broker who has great ties in the community and generates a lot of business for the firm, from important employees. These might include the receptionist who greets people and takes phone messages. While he or she may be very important to the operation of the business, that employee’s significance is not on the same level as the key-employee’s importance.

Employee Transfers and ESOPs What if you want to transfer the business to all of your employees? This can be done in a number of ways. The most popular, and possibly most efficacious method is to transfer ownership to an employee stock ownership plan (ESOP), in which all the employees have a part. The company will then become an employee-owned company. This opens a wide range of financing options and tax benefits. But it is still vitally important to retain the key employees responsible for the actual management and operation of the company. This can be done through a variety of qualified and non-qualified plans that will keep these key employees motivated and loyal to the company for years to come. A Certified Exit Planner (CExP) can explain the various options and help you evaluate which are most appropriate for your particular circumstances.

Pre-Fund with Insurance Products There are numerous ways to pre-fund the sale through certain specialized insurance products. The cost effectiveness of these plans depends to some extent on the seller’s age and state of health as well as the cash flow of the business. Your Certified Exit Planner (CExP) can help you navigate these waters successfully.

Transfer to Your Children In the case of wanting to transfer the business to some or all of your children, it is generally important that your offspring be actively involved in the business, at least at 22

the level of important employee, if not key employee, and be able to manage the business as effectively as you have. Because of the family relationship there are several additional ways to transfer ownership that are not otherwise available, but avoid substantial taxation issues. A Certified Exit Planner (CExP) can develop these methods with you as part of your exit plan.

Staying Around for a Smooth Transition Much as in the sale to an outsider, step four, it is generally required that the seller remain active in the business for some period of time during the transfer process.

This gives the seller an opportunity to make sure that the transition goes smoothly and the company remains sufficiently profitable to pay the purchase price. An active period of one to three years is quite common. Payout periods of five to ten years are also relatively common.

So, the importance of retaining key employees and giving them incentive to move the company forward is obvious. You payout depends on the future success of the company, even after you leave it.

Note: Because of the tax issues, a transfer to insiders if often a very complex and paper-intensive affair. In order to take this step as successfully as possible, planning is essential. You should begin the planning process at least two years before your anticipated departure date. uuu

David Leitner, CExP™ has helped numerous business owners achieve their goal of exiting from their business in style and with financial security. He is a 1976 graduate of Stony Brook University and a 1979 graduate of the University of Iowa College of Law. He has been licensed to practice law in Iowa since 1979, before the United States Supreme Court since 1994 and in Nebraska since 2000. In addition to his law practice, concentrating in civil litigation and estate planning, he has published or contributed to 14 books and many law journal articles on subjects ranging from insurance coverage litigation to employment discrimination and from managed care to software. David has been recognized by the American Bar Association, Who’s Who in Emerging Leaders, Who’s Who in American Law, Who’s Who in the Midwest, Who’s Who in the World and others. He can be contacted at 515 252 0777 or dleitnerlaw@gmail.com

April 2010

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Transitions Magazine

Beyond Reproach Ethics, Integrity and Trust

by David B. Loeper, CIMA®. CIMC®

I

Broken Beliefs and Uncertainty’s Heavy Hand

A Common Belief That Is Misleading – Small Cap “Return” Premium As an ethical objectivist, I’m not going to represent to you that I know whether or not for sure there is, or is not, a return premium for small cap stocks relative to large cap or total domestic equities. Most of you probably assume this is a given. It is generally accepted, and you might articulate this belief to your clients when you show them portfolio weightings that overweight small caps relative to their total market cap. Much of the information you have probably seen on this premise is likely to be sourced to someone that shares this belief and assembles very compelling evidence to demonstrate it. It is easy to do. Take something simple like the average return for small cap stocks from 1926 www.transitions-mag.com

April 2010

sEthics,

It is common in our industry to communicate beliefs with clients. Understand that most of these beliefs are just exactly that…something one believes in that may not necessarily be factual. If it was factual, we wouldn’t call it a belief, we would state it as a proven and irrefutable fact. Often advisors articulating their passion about a belief will cross this line and mislead clients leaving an impression that their belief is an irrefutable fact. With the uncertainty of everything we do with our clients and the uncertainties of the future, there are few things we can factually say other than things are uncertain. So where do we cross the ethical line when communicating with clients? When does explaining the rationale behind why we believe in something cross the boundary line of ethics into making misrepresentations or misleading our clients?

Integrity and Trust s

recently had the displeasure to have to terminate an agreement with an advisor we have been working with for the last year or so. I had to terminate him for ethical reasons, but he didn’t understand those reasons. You see, he had a “belief” that he steadfastly promoted without acknowledging the uncertainty introduced by his belief in his communications with clients. His preference was to defend his belief instead of simply acknowledging the uncertainty. Instead of objectively examining the circumstances where his belief would have failed to deliver the value he explicitly represented to clients that it “should” deliver, he focused only on data that showed it added value, ignoring contradictory data and evidence.

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through 2008. The average of all one year returns based on rolling monthly data (985 one year periods) for this time frame shows small caps having a 15.67% return relative to large cap with 11.58% and total domestic equities with 12.02%. You have probably also seen all kinds of charts with rolling ten or twenty year average returns almost always showing a higher average return for small caps.

I understand why the firms that show this “research” do this. Overweighting small cap is part of their value, and it is a lot easier to use the “average” function in your spreadsheet than to calculate future dollar values and write the formula to calculate the compound return.

To the believers in the premise, using average returns makes the decision to overweight small cap look like a no-brainer in their presentation. And to their credit, most small cap promoters accurately disclose the higher volatility. Unfortunately, they rarely show the impact of this higher volatility and often simply profess, “It is a risk worth taking for the higher return.”

Head In The Oven, Feet In Ice Water, But Comfortable On Average As advisors, we all know that simple average returns don’t mean anything in dollars because of volatility. After all, if you get a 100% return the first year, and lose 50% the next, we know that while you have an average return of 25%, your compound return is 0%. Two years later after investing $100 you still have $100 despite averaging a 25% return.

On a compound return basis (instead of average), there still appears to be a pretty good return premium for small cap stocks, along with higher risk. Looking at the 877 ten year time periods from 1926 through 2008, and using compound returns instead of misleading average returns, we observe that the average compound return advantage for small cap stocks for all of these 10 year periods was 2.18% versus domestic equities as a whole.

However, the compelling implied certainty of how frequently small caps will outperform becomes more 24

questionable when using compound returns. Small caps outperformed domestic equities in only 67.3% of all ten year periods. That’s not exactly “no-brainer” odds. In fact, there was a ten year period where small caps compounded at 4.86% LESS than domestic equities. Periods like this don’t show up as often when using average returns that ignore risk, and most small cap promoters won’t highlight this reality. The data still appears pretty compelling though, doesn’t it? Small caps averaged an excess compound return of more than 2%, with only a 32.7% chance of underperforming in any ten year period by no more than 4.86%.

Armed with this more informed perspective, we work with a client and determine that the appropriate allocation target considering risk tolerance, risk capacity and funded status of the wealth management plan argues for a 60% weighting to domestic equities, 24% to 5-year treasuries and 16% to longer treasuries. The average twelve month return for such a portfolio using 985 historical one year periods was 9.47% with a standard deviation of those one year returns of 13.41%.

When it comes time to actually construct the underlying portfolio, we want to capture some of the return premium of small cap but do so without introducing higher risk.

To accomplish this, we back into portfolio weights that match the standard deviation of the original portfolio yet significantly overweight small cap. The allocation that accomplishes this is weighted 20.4% small cap, 29.6% total domestic equity with the remaining 50% weighted proportionately in treasuries as we previously modeled.

The small cap weighting in this portfolio is almost four times the weighting of small caps in the original portfolio (remember, small caps are part of domestic equities).

This “improved” portfolio has the same 13.41% standard deviation of 985 one year returns and the average of those one year returns is 9.58%, 11 basis points higher than the original.

Knowing that average returns can skew things a bit, we

April 2010

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Transitions Magazine

Ethics, Integrity and Trust also want to look at the compound returns over all of the historical ten year periods just as we did when we were looking at our original compelling evidence to overweight small cap stocks. The average compound return of all ten year periods is 14 basis points higher.

The likelihood of outperforming drops from 67.3% of the ten year periods to only 57.7%. Compound returns over thirty year periods do not materially change these odds with the heavily weighted small cap portfolio outperforming in 57.3% of the 637 thirty-year periods.

What does this all have to do with ethics? It depends on what you are presenting to clients and sometimes even the questions that the client may ask you.

Compelling Small Cap Premium?

Look at Table 1 (below) to see if you are as confident as you may have been about the value of overweighting small cap stocks in your portfolio.

Perhaps these statistics make the decision to overweight small cap look like a no-brainer to you. Most statisticians

Table 1 – Where Uncertainty Lies In Our Beliefs – Balanced Portfolios With Like Risk

Overweight Small

Market Weight Small

Difference

13.41%

Magazine 9.58%

10.01%

13.41% 9.47% 9.90%

0% 0.11% 0.11%

877 10‐Year Periods:

Average Compound Return

25% ‐tile Return

50% ‐tile Return

75%‐tile Return

Worst Relative Return

Best Relative Return

% of 10 Year Periods Outperformed

9.28% 11.23% 8.87% 7.33% ‐2.00% 2.85% 57.7%

9.14% 11.55% 9.06% 6.64%

0.14% ‐0.22% ‐0.19% 0.69%

42.3%

15.4%

637 30‐Year Periods:

Average Compound Return

25% ‐tile Return

50% ‐tile Return

75%‐tile Return

Worst Relative Return

Best Relative Return

% of 30 Year Periods Outperformed

9.21% 10.43% 8.90% 7.98% ‐0.67% 0.69% 57.3%

9.15% 10.05% 8.95% 8.12%

0.06% 0.38% ‐0.05% ‐.14%

42.7%

14.6%

985 One‐Year Periods: Standard Deviation

Average One Year Return Median One Year Return

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would consider the small sample size and relatively tiny differences and say they are about statistical equivalents with nothing particularly compelling one way or the other. Others might argue to focus on the median (50th-tile) compound returns and conclude that there is no small cap premium but instead a discount. Still others might argue that there is a higher cost in small cap in expense ratios, trading costs of commissions to rebalance and bid/ask spreads… also that those costs are a certainty.

(The Russell 2000 IShares ETF has 21% turnover and Blackrock’s has 42%, while Vanguard’s Total Domestic Equity ETF has 5%.)

Regardless of what you might glean from this data or what it might cause you to believe, you have to acknowledge there is a significant uncertainty in the value of overweighting small cap stocks. This is where that advisor crossed the line. He made a statement that simply said that the overweighting to small caps was a risk worth taking. That statement doesn’t say it is a belief and doesn’t say there are uncertainties. It presents his belief as if it is an irrefutable fact. The ethical lapse in this case was even worse than being a bit over enthusiastic discussing his belief as will invariably unintentionally occur. This written response to a client was his answer to the client questioning the uncertainties of the higher risk and cost the advisor was proposing.

How hard would it have been to answer with a more honest response that acknowledged the uncertainties and cost? Or even better still, making the client more comfortable and offering him the choice of avoiding the additional risk and cost?

It is hard enough for us to be consistently and perfectly ethical in our actions just by our human nature and the inherent difficulty with differing communication styles. But if we cannot center ourselves to be honest and ethical when a client is greasing the skids for us and begging for clearer understanding, the question then becomes when would we ever be honest and ethical? How often are clients’ being misled? What 26

other ethical evasions are occurring and where else might they occur? If you accept any ethical lapse, you cannot answer this question with anything other than “too much”… at least not in a practice that is beyond reproach. uuu

David B. Loeper is the CEO of Financeware, Inc. which does business as Wealthcare Capital Management. An SEC Registered Investment Adviser with nearly 25 years experience, Loeper has appeared on CNBC and has been a featured contributor on Bloomberg TV and CNN. Loeper joined Wheat First Securities as vice president of investment consulting in 1988, where he served for 10 years. He was promoted to managing director of investment consulting, and then eventually to managing director of strategic planning for the retail brokerage division. He left his position at Wheat First Securities in 1999 to found Financeware.

Active in industry associations throughout his career, Loeper has been a member of the Investment Management Consultants Association (IMCA) for over 20 years, serving on the advisory council for more than 5 years, most recently as chairman. Loeper was also appointed by the governor of Virginia to serve on the Investment Advisory Committee of the nearly $30 billion Virginia Retirement System. He received his CIMA® designation in 1990 by completing a program offered through Wharton Business School, in conjunction with IMCA. Drawing on years of experience in financial services including serving as a fiduciary for all types of ERISA plans, Loeper has authored numerous whitepapers and books including the top selling book, Stop the 401k Rip-off! as well as The Four Pillars of Retirement Plans, Stop the Retirement Ripoff and Stop the Investing Rip-off.

April 2010

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Transitions Magazine

Book Review Preparing Heirs Through Philanthropy — An Excellent Resource for Financial Professionals— Title: Philanthropy Heirs & Values: How Successful Families are Using Philanthropy to Prepare Their Heirs for Post-Transition Responsibilities Author: Roy Williams & Vic Preisser Cover Price:$29.95 (hard cover, 164 pages) To order, click here.

Enter discount code AP488FF (case sensitive) for a 20% discount.

This easy to read book views philanthropy as a tool to improve the odds of post-transition success and explains the rationale behind family foundations and family giving programs. In it, the authors explore the hidden power of philanthropy to prepare heirs for wealth and responsibility. After interviewing 3,250 affluent families and examining nearly 100 family foundations, they disclose how successful families are suing philanthropy to teach their children values, to develop their appreciation for focus on a specific mission and to instill them with a sense of accountability.

In many cases, the family leadership's use of philanthropy as a teaching tool determined whether or not the family remained unified and financially successful in their post-transition period.

tool for financial professionals.

About the authors: Roy Williams has invested 40 years helping successful families with their post-transition planning. Skilled in guiding entire families (including heirs, spouses and children), his findings have proved to be an important complement to transitions pre-transition estate planning. His earlier books, preparing Your Family to Manage Wealth and For Love and Money, are widely used by estate planners, trust officers, lawyers and accountants. As a professional athlete, university trustee, leading researcher and an accomplished grandfather, Roy is the acknowledged dean of family coaching.

Book Review s

The authors have provided exercises, examples and checklists for each of 5 major age groups -- 5-10 (awakening years), 11-15 (exploring years), 16-20 (developing years), 21-30 (applying years) and beyond age 30 (mentoring years). This is a must have book for any family library and a great reference

Vic Preisser brings 40 years of experience in business, government and education to his partnership with Roy. A successful senior executive for Fortune 500 companies, he has also served at the State Cabinet level in positions with Transportation, Social Services, and at The White House. He was formerly the Resident Professor of Management and Director of the Family Business INstitute for the University of the Pacific.

He is co-author (with Roy) of Preparing Heirs.

Roy and Vic, both successful entrepreneurs, mentor clients as part of The Williams Group. www.transitions-mag.com

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Transitions Magazine

ADVISOR ADVOCATE "HIGH FIVE"

Nicholas Gudz (right) and Phil Flakes (left) have taken a unique approach to helping financial advisors find a broker dealer that best fits their business model. StarPoint Consulting was founded on two key operating principals; Trust and transparency. As an Advisor Placement firm that specializes in Broker Dealer and RIA transitions, they assume responsibility for the due diligence and negotiations with potential firms so that financial advisors can keep their focus on their business and clients. They research hundreds of independent, regional, bank, and wirehouse firms and look at variables such as technology, payout, culture, compliance, flexibility, product differentiation, and business development.

“In a forever-changing industry, its tough enough keeping up with the rules and regulations, products, and maintaining client rapport. It’s safe to say that advisors have a tough role and it certainly looks to remain that way in the foreseeable future. Starpoint paves the way for an easy decision when making a broker dealer change,” said Phil Flakes, Managing Partner of StarPoint. “We like to think of ourselves as a true partner and advocate to the advisor. Once an advisor lets us know what he or she is looking for, we begin the due diligence process to best align a few options for their business model. From there, we can start discussing payout and possible transition packages for firms that offer the option.”

The founders of Starpoint had a vision which encompassed “doing right” by the advisor and providing excellent support services to wholesalers. Aside from their advisor placement division, they also provide distribution support to investment companies and wholesaling teams. Their staff of Business Development Consultants helps to promote products by initiating strategic call campaigns and scheduling appointments.

“What makes us unique is the second side of our business, our distribution support. We work with many wholesalers and distribution teams, and are kept in tune with what’s going on behind the scenes at the broker dealer level” said Nicholas Gudz, Managing Partner. “This is an invaluable tool when doing our due diligence on broker dealers. Not only are we receiving feedback from advisors looking to transition, we’re now receiving feedback, both positive and negative, from wholesalers in the field.”

The philosophy behind what they do is simple. All too many times advisors get handed empty promises.

With a “do what you say, and say what you do” attitude, Starpoint is determined to align good advisors with good broker dealers. Their proven dedication to meeting and exceeding expectations and their understanding of the importance of relationship building is what drives their success. u

Advisor Advocate "High Five!" s

StarPoint Consulting Group, LLC

For more information about StarPoint Consulting Group, email Phillip R. Flakes, Managing Partner, at phillip.flakes@starpointnow.com, or call 866.431.4848 x 102, or email Nicholas Gudz at nicholas.gudz@starpointnow.com. www.transitions-mag.com

April 2010

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Sound Off!

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Outstanding Wealth Management Teams to feature in the 4th Edition of The Wealth Factor: A Team Approach This customized, hard-cover book provides an objective, third-party endorsement for you and your team.

It's authored by veteran journalist Sydney LeBlanc, and published by Financial Forum Publishing.

Books can be distributed to clients, prospects, members of your network, editors and writers at targeted publications. Call today for details and to see if you and your team meet the criteria for inclusion.

CONTACT: Stephanie at 435.750.0062 x3, or email stephanie@ffpublish.com *Fee includes 300 copies of the book and a complete marketing and PR package.

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April 2010

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Transitions Magazine

A Conversation with ..,

John Burns

Founder and CEO, Burns Advisory Group, Private Wealth Management

By Sydney LeBlanc

I recently had the pleasure of speaking with John Burns about his thoughts on the transition process, and his advice on the challenges facing advisors today, as well as the solutions.

LeBlanc: What are the basic steps an advisor needs to take in the transition process from wirehouse environment to independent advisor or RIA?

As an independent, whether you join a firm or start own, you will be compensated based upon actual profitability. In short, you need to move from the mindset of being an employee to the mindset of being an owner.

You built a franchise with enterprise value that will be worthless if you stay still. But if you port your business to an independent model, you instantly have equity that’s worth something to the market.

For practical purposes, the top considerations for an advisor preparing to make the transition are financial prep (equity value & income analysis), legal and compliance prep, client operations evaluation, client transition analysis (assessing risk) and business planning.

The financial preparation requires evaluating the upfront and ongoing capital investments you need to provide the necessary infrastructure for a viable business within the market you want to serve.

LeBlanc: How long does the process take, approximately, from start to finish?

Burns: I think advisors spend a lot of time doing what I call “getting ready to get ready” because they haven’t fully committed yet. Of course, many decide to stay because the tasks involved seem so daunting.

Once an advisor has committed to moving to an independent practice, it doesn’t take very long. It’s a matter of blocking and tackling very specific action steps. It should not take more than a few months to line up all of the resources you need to execute.

In the Spotlight

Burns: You have to begin the transition process by analyzing your business today and translating it into what it would look like recast in an independent model. A wirehouse advisor is used to receiving payouts based upon the job that they do for their firm. If he wins a client with two million dollars in assets and they pay twenty thousand dollars a year in fees, the advisor’s payout is somewhere around thirty or forty percent. He’s not responsible in the least for actually having a profitable bottom line.

The last leg centers on the client transition process. You’re not truly finished until you’ve gotten the clients to come over to your new business. Planning to engage clients on the transition and implementing the asset migrawww.transitions-mag.com

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Transitions Magazine

In the Spotlight

tion will have life cycles of their own. It could be two to six months or more before all of your clients who are willing to make the shift are going to come on board, so to cut down on your time commitment and client transition risk I would suggest prioritizing your clients in order of the immediacy with which you’ll have to meet them. Start with those who have the most assets and work your way down.

It is essential to the success of your transition to have a strategy and an emergency plan for these issues. The actual work does not have to take that long, but it really depends on whether you have a sense of urgency. I’ve spoken with advisors who say “Well, I’ve been working on it for two years.” Most of it is just battling inertia.

LeBlanc: How does an advisor choose the best model for their practice?

Burns: I’m reminded of a quote by Wayne Gretzky, who when asked what made him such a good hockey player replied, “Most players skate toward the puck. I skate to where the puck is going.” Choose a model that will support where you want to be, not where you are now. Decide what services and technologies you will need to serve your current and prospective clients, and then figure out what it will take to be the best in that space. For my clients, partners and myself, this pointed to the independent RIA model.

But it’s also Darwinian — “Adapt or be eaten.” Advisors realize their clients are changing. They are far more sophisticated than they used to be, and now the baby boomers are conscientious of every dollar they save, how it’s invested, and where it’s spent.

There is a lot we can do in the independent space, and one of our greatest advantages is the absence of the conflicts of interest inherent in the broker/dealer relationship. Whether that’s a big wirehouse or an independent firm, more and more clients and the public get it.

LeBlanc: What should an advisor look for if they are considering joining an existing RIA firm?

Burns: A lot of advisors are great at managing relationships, assets and emotions. But their skill sets don’t necessarily mean they’re prepared to run a profitable business 32

on their own. The fundamental question to ask yourself is do you want to be in the back office administration compliance business for a profit? Are you prepared to make the capital and human resource commitments?

It is impressive how many wirehouse advisors aren’t aware that joining an existing RIA firm is even an option.

There are a lot of independent RIAs that would be interested in having a successful advisor join their team.

If you’ve decided to partner with an independent RIA, you should only consider firms that match your needs. In the RIA world, there are as many different competencies as there are firms. If you’re a money manager and performance is how you’re measured, look at what kind of performance track records the firms you’re considering joining have over the past several years. If you operate an advice-driven practice, what kind of financial planning or advice platforms do the firms have? Work backwards from there and it should work out well.

You should also scrutinize their behind-the-scenes capabilities. What kind of investment have they made in infrastructure technology, money management systems, CRM systems, operations staff, compliance, etc.? These firms should have a developed back office solution to serve successful high net worth advisors. You want to find out what level of commitment the firm has made to provide the right tools.

Burns Advisory Group partnered with two advisors – Paul Hynes in San Diego and Tom McGuigan in Old Lyme, Connecticut – in 2006. Paul and Tom decided our firm would provide them with the capabilities they required to best serve their clients’ interests, which they did not believe was being fulfilled at their prior firms.

LeBlanc: Do you recommend the hybrid model?

Burns: There are two situations where the hybrid model would make sense. First, if you’re an advisor who wants to leave a wirehouse to start a firm and you have a high dependence on commissionable products that you plan to continue, then you need a broker/dealer model. Second, if you have some commissionable business and need a short term solution during your transition period, then you would

April 2010

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Transitions Magazine

In the Spotlight need some element of the hybrid broker/dealer structure. It all comes back to what you want your new practice to look like and creating a transition strategy that works.

Despite the public perception, I’ve found there are really very few transactional advisors left at the big wirehouses who rely solely on commissionable business. Certain advisors use a lot of alternative investments and structured products that may pose a hurdle if they move to a fee based compensation model. But consider that when you’re performing due diligence and making investment recommendations, you’re getting paid a fee for your work.

LeBlanc: What are a few of the most troublesome challenges when making the transition?

Burns: This depends on whether you go it alone or join an existing firm. If you go it alone, the most troublesome challenge is that you’ll find yourself wearing many different hats. From human resources to compliance and Magazine technology, you have a lot of responsibilities outside your purview that have to be seen through with careful attention to detail. This will keep you away from the work where you excel and actually drives profitability for your practice. The characteristics that make great advisors – client service and relationship skills, investment management expertise, prospecting – will initially be pushed to the back burner in favor of administration issues.

Advisors also have to overcome the challenge wirehouses will present once they decide to make the transition.

In many instances, the client identifies with the brand, be it Merrill Lynch or UBS, and the advisor has attributed a lot of his success to the firm. But it’s crystal clear in my mind that the value is created in the client-advisor relationship, not the brand. The big firms need advisors more than advisors need the firms.

Remember, once your firm knows you’re planning to leave, your clients will be getting calls from your branch manager and other advisors that are staying. They will paint a scary picture to the client, so you have to be prepared to overcome these sizeable objections.

You have to be clear when explaining to your clients why you’ve decided to go on your own. Let them know www.transitions-mag.com

you could have gone to another wirehouse that would have compensated you handsomely, but you’ve chosen to make a capital investment to create a practice structure that will truly be able to meet their needs. When you have that conversation with a client, they are going to understand your decision and respect you for it. The value proposition is the advisor that’s dedicated to serving that client’s best interests. That’s the whole story.

LeBlanc: Where can an advisor seek help with these challenges?

Burns: Choose partners that hold a position of strength.

If you’re making a transition and can explain to clients that you’re going to work with a custodian like Charles Schwab, then they will be much more likely to have a level of comfort with the move. High caliber custodians will also use their experience working with advisors to help you plan for and make the transition.

You will also want to engage experienced legal counsel early in your transition planning. You can not overestimate the positive impact they will have providing you with essential guidance at a point when you will not be able to manage the entire process by yourself. You will need an attorney to review your existing contracts to make sure you are not at risk of breaching a gag order once you offer your resignation, which would limit you from reaching out to your clients.

Also consider working with an M&A advisor who has experience with independent firms. They could prove to be a major asset in your search for the right strategic partnership.

Finally, consider talking to advisers who have already made the transition. They’ll be the most candid about the lessons they learned during the move, essential steps to take and pitfalls to avoid.

LeBlanc: What should an advisor look for when researching B/D or RIA options?

Burns: It goes back to the Gretzky quote. If you’re analyzing your options, you should have filters in place so you’re only considering those scenarios that will allow you to grow your business and serve the best interests of

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Transitions Magazine

In the Spotlight your current and prospective clients. Ask yourself what environment would be most conducive to your clients feeling valued, safe, and where trust would be engendered. In this era, it’s all about trust and security.

Remember, if you’re moving from a wirehouse to another wirehouse or an independent broker/dealer, you’re going to the same business model either way – it’s just a different wrapper. The new broker/dealer has the same goals and objectives that your old one had.

LeBlanc: Is transitioning an expensive process for an advisor?

Burns: It can be. Certainly, the time commitment is the most expensive element.

But if you are going to build an RIA firm with world class services and capabilities, you’re going to hit your hip pocket for a big number. When you look at the best RIA firms in the country, they’ve spent hundreds of Magazine thousands of dollars on technology and applications and commit tens of thousands more each year to the ongoing improvement of their operations.

If you’re not planning to grow your practice, you can probably do a nice job of transitioning your clients with an assistant and a relatively modest capital commitment.

But you’re not going to have the capabilities you would have if you’re planning for growth.

LeBlanc: Is it important to have a transitioning team in place at the prospective B/D or RIA? Burns: Absolutely, it’s critical. Part of your evaluation criteria should be the quality and experience of a prospective firm’s transition team. Consider asking if they’ve done this before with other advisors and for details about that experience. Assessing the quality of their transition process should be part of your analysis when determining which firm to join.

Any broker/dealer or custodian is going have a transition team to facilitate account transfers, which is essential and can take a lot of time. But the transition process runs much deeper than that. You’ll need an operations team on the ground working to integrate systems, which www.transitions-mag.com

is critical. It’s also important to have somebody with experience at the higher end of the transition to handle the softer client relationship issues. When you have a team that already has systems and experience in place, the transition can take place with precision so you’re able to move quickly and serve your clients.

You need to be prepared operationally prior to the actual transition. The longer it takes to complete, the harder it is to maintain your client base throughout the process. A turnkey transition and a sense of urgency will stave off the greatest potential cost, which is lost opportunity. I’ve talked with advisors who have gone independent and were still dealing with transition issues over a year after the initial move. This precludes them from being able to focus on serving clients, their core business, because they’re busy working out infrastructure details.

LeBlanc: Closing words of advice?

Burns: Ask yourself where you want to be in ten years.

It is becoming more obvious what the big firms have to do to stay in business because their model is clearly broken. They have to squeeze every dime out of their clients. If you weren’t working at your firm, would you have an account there?

When you’re truly able to put your clients’ interests first and you’re in that position every day, you will trip over more business than you could ever find at a wirehouse.

The opportunities are just tremendous. uuu

Burns Advisory Group is a private wealth management firm in Oklahoma City with offices in California and Connecticut. John Burns leads the firm’s strategic management, provides comprehensive investment management services to high net-worth individuals and serves in a fiduciary role for corporate defined contribution plans. John’s depth of industry experience has proven invaluable in his work transitioning his partners from their former wirehouse environments to Burns Advisory Group’s independent RIA platform. He also served as a founding member of Schwab Institutional’s Advisory Council for Advisor Transitions. The firm was recognized earlier this year as a Best Managed Firm by Schwab Institutional and as one the Fastest Growing Firms by Financial Advisor magazine in 2008.

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Transitions Magazine

Grin and Bear It!

A Touch of Humor s

TAX TIME Something got your funny bone?

Submit your jokes and cartoons to info@transitions-mag.com. Entries selected for "Grin & Bear It!" will receive a $10 gift card. www.transitions-mag.com

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Transitions Magazine

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