From the January 2004 issue of Investment Advisor • Subscribe!

Looking for Mr. Right

The brokerage or custodial affiliation that you choose can have a dramatic impact on the success of your practice

I've been working in and around the financial services industry since the early 1970s. In my experience, the advisory practices that have been most successful are the ones that have a clearly defined strategy, that pay attention to management, and that effectively leverage other people and organizations.

Perhaps the most important strategic relationship that the majority of advisory firms have is with their custodian or broker/dealer. Ironically, far too many advisors take a very narrow view of this relationship. If you look closely at the firms that support independent advisors, you will find they each have a singular value proposition, a unique culture, and a specific attitude about how they support their advisors. That's not to say that one is necessarily better than any other; they are just different. But in order to maximize the efficiency and the potential of your firm, the selection of a custodian or broker/dealer should always be made in the context of your strategy: you need to find the organization that best supports what are you trying to accomplish.

Affiliation Models: An Overview

One thing that I've noticed is that advisors often allow their backgrounds to dictate their affiliations, rather than making a conscious choice about what would be best for them and for their practice.

Many advisors came into the business through the traditional securities brokerage or general agency system as salespeople. We refer to that platform as "Complete Control." Brokerage firms such as Merrill Lynch and Morgan Stanley best represent this model, as do general agency systems such as Northwestern Mutual, and bank financial services networks as exemplified by those run by Wells Fargo or Wachovia.

There are a number of good examples of advisors who have built dynamic practices within this environment, leveraging the brand that these parent firms provide. The primary advantage of this approach is the cocoon it offers that enables advisors to focus on their clients, and defer most business issues to their parent firms. There usually is a high level of support and quality control, and the firms typically have a significant identity and presence in a local market. The downside that comes with this approach is usually a significant limitation on how these advisors run their business affairs, the available products, and sometimes even how advisors can interact with clients. Moreover, the portion of the revenues that the advisors get to keep is also often quite a bit less than they'd get under other affiliation models. Most importantly, under the complete control model, client relationships are "owned" by the parent firm and advisors have limited availability to build and realize value in their practices.

Of course, there's a good number of advisors who have migrated to one of the next three levels of affiliation: regulated local autonomy (typical for insurance B/Ds); supervised independence (independent B/Ds); and total independence (the RIA model). There are pluses and minuses to each of these models. The payout is usually higher the farther you break away from a completely controlled environment; but advisors in these other platforms are also more responsible for their costs, their infrastructure, and their technical support. In other words, independence carries a cost.

A good example of this migration is the Minneapolis-based American Express Financial Advisors system. AmEx offers three affiliation platforms that mirror typical industry models: Platform I is "Complete Control," under which the advisors become employees of the firm; Platform II is for the statutory employee who is now responsible for her or his own business expenses; and Platform III is for the independent contractors who no longer operate under the American Express name but who are still supervised by that firm.

Raymond James, based in St. Petersburg, Florida, is another example of a once-traditional broker/dealer that now crosses three of the possible platforms. In Raymond James's case, the mix is slightly different, offering relationships with its captive brokerage firm, its independent broker/dealer, and its totally independent institutional services platform.

In the early 1990s, discount broker Charles Schwab in San Francisco changed the broker/dealer model with its then-revolutionary institutional services division. Many advisors discarded their broker/dealer affiliation, in some cases even relinquishing their NASD licenses, and set up custodial relationships with Schwab. Companies like Fidelity Registered Investment Advisor Group in Boston, T.D. Waterhouse Institutional in New York, and DATAlynx in Denver have also become significant players in this market. They offer their advisors total independence in product selection, business affairs, and client relationships, and (in most cases) 100% of the revenues those relationships generate.

In addition, there are also turnkey providers of asset management services such as SEI, Buckingham Asset Management, and the Frank Russell Company that, in some respects, have also replaced their affiliated advisors' need for a broker/dealer. It is also not uncommon to see an advisor use both a broker/dealer and a custodial or turnkey platform simultaneously, assuming their broker/dealer permits this.

A more recent evolution has been in the creation and growth of independent trust companies, which a number of fee-based advisors look to as a place in which to custody client assets and clear securities, at lower costs to their clients, and without the perceived threat of competition from their affiliation partner, whether that partner is a custodian or a broker/dealer. This trust company model also holds the potential to fall under the jurisdiction of banking regulators rather than securities regulators, which some believe can provide a higher degree of client comfort.

The Implications for Advisors

Any one of these four approaches can be an appropriate choice, depending on an advisor's individual business strategy. In some cases, being a local representative of a national brand is an effective way to attract and serve clients without the requirement of a large investment in a business infrastructure. This has proven to be the traditional way most advisors enter the business. There is a cost, of course. The payout is not as high as in the alternative channels, and there may be more pressure to advocate for the company's own products, or outside products in which the parent company has an interest in distributing.

The Regulated Local Autonomy model also is an appealing platform for those who are looking for some of the best characteristics of a wirehouse or General Agency cocoon, but with some degree of independence regarding product, service, and brand name. Payouts are typically higher in this environment than under the "Complete Control" model, but not at the same level of "Supervised Independence." The simple reason for this is that most independent broker/dealers cannot afford to provide as much infrastructure and still sustain their high payout to advisors. The simple rule of thumb is that the more support you need, the less payout you're going to get to keep.The Supervised Independence model holds a lot of appeal for independent advisors, providing they have the ability and interest to manage their practices and resources effectively. It also requires a practice to reach a critical mass of revenues that will support its own office. The average payout for an independent broker/dealer is 82%, ranging between 70% and 90% (with minor exceptions at either end). This platform tends to offer fewer controls on its advisors, but really only works if an advisor is emotionally and managerially ready to grow his own business without a safety net. This is also an appealing option for advisors who have grown their fee-based business, but still have a substantial amount of trailing commissions from mutual funds sales that they would be reluctant--or economically unable--to discard under a total independence model.

The Total Independence model provides a great amount of flexibility for advisors who operate in the fee-only environment. In addition to legally collecting fees in a wholly-owned business entity (NASD rules prohibit commissions to an entity that is not registered as a broker/dealer), advisors collect 100% of what they charge. If they are effective in managing their practice, are comfortable asking for appropriate fees, and are willing to take full responsibility for their own compliance supervision, this model can be very compelling.

Relevance to Practice Management

The firm that an advisor picks as a business affiliate will impact his strategy, compensation, personnel choices, and financial results. Each platform has appeal depending on what the practitioner feels he or she can do well, what they need a partner to do, and what the advisors' personal goals are.

As you develop your strategy, it is important to determine which model will best suit your business. If you don't have the time, money, and management capability to undertake an initiative on your own, consider how each of these firms would help you to fulfill your goals. They are sources of products, technology, advanced planning education, contacts, acquisition and succession assistance, client referrals, and more.

For some practices, payout may become the overriding reason to affiliate with one firm over another. But this is often a short-sighted approach: Keep in mind that the higher the payout, the fewer dollars the partner will have available to invest in infrastructure to support you. There are many opportunities to leverage the resources of larger organizations to build your business today, and reap greater rewards in the future. It all depends on what you need and where you want to go. The key is to make sure the tradeoffs you make are the right ones for you.

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