Most people in the financial advisory business see it as parallel universes. In one there is the self-employed advisor who is either operating as an RIA or is affiliated with an independent broker/dealer. In the other, the advisor is the employee of a bank or brokerage firm. Yet these worlds are moving closer together all the time. Indeed, there is a growing trend toward registered reps moving out of the wirehouse environment--a trend invisible to most, but obvious to the country's leading custodians: they are actively wooing breakaway brokers.
TD Waterhouse (soon to be TD Ameritrade) and Schwab Institutional are at the forefront of this development. AIG, through its Transition Suite program, is also innovative in recruiting from the wirehouse world. Waterhouse introduced its initiative in early 2004 through the underwriting of a white paper, "Roadmap to Independence," Webcasts for those contemplating the move but wishing to remain anonymous, and a Web-based tool to help these brokers evaluate the economic implications of their decision. Schwab has followed this year with its Brokers Transitioning to Independence (BTI) initiative.
Brokers are responding in droves. Despite this groundswell, however, independence isn't necessarily the utopia it appears to be, and it's certainly not the solution for everyone. Before captive brokers take the plunge, or advisors at independent broker/dealers become RIAs affiliated with custodians, they should carefully consider their goals, their skills, their practices, and their finances. While the rewards are great if it's right for you, independence can be a heavy burden if you find it's taking you in the wrong direction. Sadly, our experience has found the independent advisory world littered with folks who undoubtedly would be much better off under a different model.
In the research that Moss Adams did to help TD Waterhouse develop its white paper on the transition initiative, we found three major reasons why advisors become independent. These themes were mostly gleaned from advisors who have already broken away from wirehouses or regional brokerage firms. While we were not at all surprised by the financial motivation (because the differences are dramatic), we were impressed by the number of "captive brokers" who broke away to build a more holistic, client-centric solution. Of course, many of those who went independent said that reality caught up with them no matter what their initial motivation.
1. Keep All the Fees. In almost every case, they said that the monetary advantage of independence should be carefully measured against the cost of establishing and maintaining an independent business. The expenses associated with independence (such as rent, compliance, research, technology, administration, and marketing) often offset the broker/dealer "haircut." It is not uncommon for advisors to find themselves taking home less after they become independent. While higher profitability is a goal of the independent model, it is contingent upon the ability of the advisor to create a firm that is productive and cost efficient. In other words, being a business owner has its rewards but it's not as easy as it seems, and it's not always rewarded by higher payouts.
2. Build Value. Most wirehouse reps do not have a transferable business--sometimes their employers may look the other way if they work out a compensation deal with a successor, but recognizing value in the client base would be admitting that the advisor owns the clients and not the firm. So going independent with profitable client relationships allows one to build value. But to realize that value, advisors must design their business from the beginning to reduce the firm's dependence on their own personality and time commitment. The design must incorporate systems and processes that institutionalize the business to ensure that the entire organization, not just the owner, will be attractive to future buyers. This is a very difficult cultural shift for "producers" who were told their value is tied up in the number of clients they control, not in the leverage they can obtain through teaming. What's interesting though is that most advisors who broke away were able to maintain relationships with the clients they wanted.
3. Customize Service to Clients' Unique Needs. Without wirehouse compliance, pricing, and product constraints, advisors are free to develop their own customized pricing and implementation strategies. The challenge is that without guidelines or standards provided by their parent, many will discount the fees and not have ready access to the full range of resources provided by their employer. The cold shock of having to manage the profitability and invest in infrastructure was confusing to revenue-driven people.
While each of these challenges was a surprise for the breakaway brokers, not one of them said they would go back. However, some did indicate that they probably should have considered joining an existing independent advisory firm so that they could have avoided so much initial trauma. Many of these newly independent advisors say that this is still a possibility.
This has been further validated in work we've done to help brokers evaluate their transition options. In one case, we talked to an advisor who had more than $500 million of assets under supervision--more by a margin than the average independent financial advisor--who said that even though his gross would go up by orders of magnitude, he had no desire to invest in or manage a business. He ultimately joined up with an independent firm and negotiated a new compensation arrangement rather than create his own business. As perplexing as this decision might seem considering the dollars involved, this clearly was an advisor in touch with his personal definition of success. Making more money wasn't his motivation, it was gaining independence to address client needs.
A less important factor in joining an existing advisory firm, yet a consideration for many, was the opportunity to become an RIA rather than continuing with an NASD affiliation, thereby reducing some of the oversight burden and the constraints that the B/D model often imposes on advisors. This is an area that the independent broker/dealers must wrestle with to remain a viable alternative for brokers transitioning out of wirehouses. The net income differential really becomes meaningful once an advisor reaches $1 million in annual revenue.
Before making any transition decision, I strongly recommend that wannabe independent advisors honestly consider each of the following questions. In fact, as I reviewed these recommendations that came out of the Waterhouse white paper, I couldn't help but think about their relevance to already independent advisors. Many in this business started out as technicians but evolved to become business owners without being truly prepared for the experience. It undoubtedly would be helpful for all advisors--independent and those about to break away--to resolve these key questions before trying to move to the next level:
Can you be a business manager? Advisors' revenues often stop growing once they go independent, as they become mired in a variety of operational and organizational issues. This results in mushrooming overhead and the erosion of profitability and quality of client service. The biggest challenge to advisors leaving a wirehouse is to discover and train the business manager within himself or herself. Unfortunately, most brokers (or independent advisors, for that matter) have never had this type of experience or training. To facilitate the transition, advisors should make full use of the many resources available, such as help from their custodian, peers, professional organizations, and other resources.
Can you manage people? The independent advisory business is driven by people--they are your biggest expense as well as your biggest asset. Advisors must decide if they are ready to manage people and help them become productive employees. If an advisor is inclined to deal only with clients and not spend time recruiting, training, counseling, and managing employees, it may be difficult to grow an independent practice beyond individual capacity. Also, without the leverage gained through support staff, the economic advantages of independence are greatly limited.
Are you comfortable with the risk? Independent firms face many risks, including financial, compliance, operational, legal, the economy, and the markets. Advisors should be emotionally prepared to address and mitigate the risks of independence while at the same time dealing competently with clients. The good news is that becoming an entrepreneur puts you on the same level of experience and respect as many high-net-worth clients. The downside is that many people are just not cut out to handle the inevitable bumps in the road to independent success.
What is your personal definition of success? Money is a powerful motivator for most people, but it is not the only one. Many advisors have ambitions that go beyond the next $100,000 of income--including building a business, creating a legacy, and serving their clients and their communities. Independence can enhance advisors' ability to achieve these and similar objectives. But it does not come without headaches and risk. If quality of life--time with family, regular hours, low stress levels--is more important to you than these other factors, then you might want to think twice about launching your own firm.
Is your practice big enough to be independent? Independence comes at a price. Those costs include rent, payroll, compliance, due diligence and reporting procedures, back-office duties, and marketing and sales efforts. Because many expenses are fixed, we believe there is a minimum critical income base necessary to successfully become independent. Based on the interviews and research, projected annual revenue of at least $500,000 is a reasonable threshold requirement, though hitting $1,000,000 makes the argument clear in favor of independence. If an advisor is not at this threshold, it may be wise to delay the transition until the practice can meet that requirement. Conversely, an advisor with a practice on the low end of this scale might consider outsourcing a significant number of back-office functions upon independence.
Mark Tibergien is a nationally recognized specialist in practice management for financial services firms, and partner-in-charge of the Securities & Insurance Niche for Moss Adams LLP, the 10th largest CPA firm in the U.S. You can reach him at firstname.lastname@example.org.