There is growing concern that private equity ownership of a business that advises on wealth and retail investments is by nature a conflict of interest between business owners and clients, according to some industry observers.

Every time private equity makes a play for a wealth management firm, both supporters and detractors of such deals come out with their respective arguments about the impact on advisors. One big concern is whether or not ownership by private equity that is designed to make a profit is at odds with the advisor’s fiduciary obligations.

Shirl Penney, CEO of Dynasty Financial Partners, believes “there’s clearly a significant conflict that exists” in the private ownership structure for RIAs.

“I think advisors who want to operate as fiduciaries need to be really careful about how they answer the question of who they work for,” said Penney.

Explaining why he thinks the conflict exists, Penney said private equity firms and private equity funds “are designed to make a profit for the underlying investor and the underlying client of the advisor is a way [to make that profit]. And the amount of revenue generated off those relationships is how you enhance and drive the profit.”

There are others who agree.

“Shirl is 100% spot on about that, because there is a stakeholder in the organization that might not be completely aligned with the fiduciary responsibilities,” says Jay Coulter, a consultant at Resilient Advisor.

But private equity firms vehemently deny this premise.

Shirl Penney

Brad Armstrong, partner at Lovell Minnick Partners, which recently acquired an RIA, Pathstone, and has in the past held positions in RIA aggregators such as Mercer Advisors, dismisses the notion and calls it ironic.

“We and other private equity firms are registered investment advisors — who have a fiduciary duty. I find the statement incredibly ironic and I frankly don’t agree with it. I think as an industry we pride ourselves in having strong and good governance. We hold our management teams accountable. And we do take a long-term approach and have a long-term time horizon — especially when compared to too many other ownership models,” says Armstrong.

The year gone by has seen multiple private equity deals in the wealth management industry, especially where PE players have swapped ownership such as Reverence Capital’s acquisition of Advisor Group from Lightyear Capital, OakHill Capital’s Mercer Advisors buy from Genstar, and TA Associates’ purchase of Wealth Enhancement Group from Lightyear Capital.

Why the brouhaha over PE ownership?

Those that argue against private equity money point out the short-term nature of the investment, the potential for cutbacks on services and expenses, and loss of control as among their objections.

“Private equity certainly has been entering the space, but it’s temporary capital. There is usually very little value-add, if any, outside of a financial transaction. And there’s always some element of a loss of control or perhaps a complete loss of control,” said Lenny Chang, co-founder and managing director at Focus Financial at the firm’s investor day in November.

The notion of private equity being short-term capital is disputed by PE players who give the example of a rising number of deals where wealth management firms change hands between multiple private equity owners.

“I think what’s different about private equity, while any one ownership group may change in the course of, say, five or seven years ... is that there’s enough sustained interest from the [PE] industry that you’ve seen companies trade hands among private equity firms. And so private equity as an ownership model has become long-lasting and firms can stay under private equity ownership for multiple different ownership time horizons,” says Lovell Minnick’s Armstrong.

Private equity firm Warburg Pincus acquired Kestra Financial earlier this year from a prior PE owner, Stone Point Capital, which continues to hold minority interest in the firm. Kestra’s CEO James Poer says advisor misgivings about private equity are often created by competitors or the media.

“I would dispel the myth altogether. I don’t think advisors have a lot of challenges with private equity. I think there’s other sources in the ecosystem that like to create a storyline around it. Sometimes it's competitors, sometimes, respectfully, it’s the press looking for a story,” Poer told FA-IQ in a prior interview.

But taking sides for and against is also not an easy choice to make.

“It’s a tough question and you can’t really come down on both sides, because I do agree with Shirl Penney, that private equity money really muddies the water. My concern is that upon exit, what does it look like for the advisors and clients or the firm?” says Coulter. “And I think that leads to what matters most [is] potential bad client outcomes as a result of the advisors not being happy.”

Mark Casady, founder of Vestigo Ventures and former LPL Financial CEO at a time when 60% of LPL was private equity-owned, told FA-IQ in a prior interview that there are risks to PE ownership.

“One thing you have to be careful of is debt, right? If you look at Cetera, when it was first purchased, it was purchased by a strategic acquirer with lots of debt. They went bankrupt, and then the debtors owned Cetera. They held them for a few years, and then now have resold them to pay back the debt. So, there is real risk in those financial transactions when you leverage your company,” said Casady. But he added that advisors should be prepared to ask tough questions before making their judgment.

“I do think what’s important is to ask the tough question, is to say ‘You’re now the ownership group -- how are you going to improve our services? Our capabilities as a business? What are your plans for reinvesting? How are you going to help me grow my practice?’” said Casady.

“It’s a highly competitive business of providing support to financial advisors. There’s lots of choices. So, the reality is while it's painful to move, financial advisors can move their business if they don’t see the actions they’d like by the new owners,” Casady added.

Can PE ownership be beneficial to advisors?

“The influx of new capital is helping the industry solve for one of its biggest challenges today, which is succession planning. And the capital that’s come into, you know, companies like Pathstone or Mercer or many others has enabled those businesses to absorb other companies and provide a succession plan for those employees and owners,” says Armstrong.

James Poer

Some of that can be seen in firms like Kestra’s Bluespring Wealth and Cetera Financial offering to buy out books from advisors for retirement and succession planning purposes, driven by the financial strength derived from their private equity owners.

“We’re looking to make sure that we can fast track our Bluespring Wealth business, which is acquiring and creating succession for really successful wealth management businesses,” said Kestra’s Poer when asked where the firm would be deploying capital from the Warburg Pincus deal.

Cetera’s head of business consulting Richard Whitworth told FA-IQ that in its initiative to buy out books, the firm “would provide financing to facilitate that transaction through our partnership with Genstar, because Genstar has been very excited about this program, because it’s a great use of their capital to help us attain books of business.”