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How to Fix Schwab

By Roger Nusbaum – Updated Nov 16, 2016 at 3:56PM

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A former employee offers advice on how to fix the former powerhouse.

There has been a significant shake-up at Charles Schwab (NYSE:SCH) since I first wrote about my former employer in the spring. CEO Dave Pottruck was asked to resign after a 20-year stint at the firm. He played a major role in the complete metamorphosis of the investment industry, and I believe he was a driving force behind the innovation that occurred during the 1990s.

My colleague Nathan Slaughter wondered whether the Pottruck firing was the catalyst I was looking for to turn Schwab's stock around. I view last week's events as more of an acknowledgment of all the poor decisions of the last five years illustrated last week by Bill Mann. Now management needs to figure out what to do next.

A lot of the coverage I have read has addressed options about what Schwab must do to regain leadership, but BusinessWeek was the only one I read that touched on what I think is the most important area of focus: Service to Investment Managers, also known as Schwab Institutional.

SIM, for short, provides trading desks, software, custodial services, and anything else an independent investment manager would or could ever need. This has been a wildly profitable division for Schwab. In my time on the SIM equity desk, the average trader would execute more trades than an entire team in the retail division. For some reason, in the late 1990s, Schwab began to try to get into the asset management business. There were many advisors that felt like Schwab was competing with them for clients. Pottruck repeatedly dismissed that accusation, but his words fell on deaf ears. I know of one multibillion-dollar advisor that Schwab lost over this issue.

Schwab should work to attract as many independent investment advisors into SIM as it can. This division is a once and future gold mine if Schwab would just get out of the way. Many brokers at firms like Merrill Lynch (NYSE:MER) and Morgan Stanley (NYSE:MWD) will strike out on their own in search of a better way to do business. Schwab is a logical destination for new independents to house their assets.

In the retail division, I think Schwab needs to simplify its service model, although everyone has said that. Specifically, management needs to focus on always striving to provide the bread-and-butter do-it-yourselfers new and improved tools needed to become better investors or traders.

I also think it needs to scrap the letter-grade stock analysis. It relies too heavily on backward-looking data. A big chunk of last year's rally was led by "low-quality" stocks, and Schwab's stock-grading system lagged the market. Lastly, Schwab needs to sell US Trust, which has added nothing to Schwab's mission.

So the road to restoration of a great name will have to occur without Pottruck. He had a lot of ideas on how to grow and change, but perhaps the best plan of all for Schwab would have been to stick to its roots and keep things simple. That's good advice for any Foolish portfolio, too.

Charles Schwab is a Motley Fool Stock Advisor recommendation. To learn more, subscribe and receive a six-month money-back guarantee.

Fool contributor Roger Nusbaum is an investment manager and wildland firefighter in Prescott, Ariz. At press time his clients owned none of the stocks mentioned. He does own shares of Morgan Stanley.

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