A new study by Moss Adams claims that dual registration--which means advisors who are registered with both the SEC and the NASD, and are collecting both fees and commissions--may be the model of the future because it not only allows the advisor to offer clients more choice, but it turns out these hybrid firms also tend to be more profitable.
The downside (there always is one): the burden of complying with both NASD and SEC rules.
The study, Dually-Registered Advisors: Opportunity Knocks, which was released in February and presented at the Financial Services Institute conference, challenges the popular notion that advisors must choose between fees and commissions to be successful and illustrates that "it's the advisor that is fee and commission that is the most attractive space in the marketplace today," says Jim Crowley, managing director of Pershing, the big clearing firm based in Jersey City that sponsored the study. John Iachello, managing director of Pershing Advisor Solutions, adds that "Pershing is a mirror image" of the dually registered market because while it's the clearing firm for 1,100 independent broker/dealers (the largest in the industry), it also custodies assets for 300 RIAs.
The hybrid market is big, Crowley says, with 5,612 hybrid firms (RIAs) with $716 billion in assets under management (representing one in eight of all broker/dealer firms), and $6 billion in revenue. By contrast, there are 9,000 fee-only RIAs with $602 billion in AUM; there are 25,888 independent B/D firms with $2.52 trillion in AUM, according to the report.
Good for Advisors and Clients
Philip Palaveev, the Moss Adams analyst who auth-ored the report, says that if it wasn't for the cost and burden of complying with both NASD and SEC rules, "every advisor would choose to be dually registered." Advisors, he says, "love the flexibility to open accounts on the brokerage and custodial platforms, and [to offer] all types of financial services and products."
Indeed, Crowley adds that being dually registered is more appealing to clients because they "can consolidate their investment relationships with one advisor." Advisors under this model benefit because they can offer a more flexible menu of investment, technology, pricing, and operational support, the study says. The Moss Adams study also shows advisors of all stripes are competing for high-end clients. The hybrid model also allows the advisor to broaden his relationship with the client, according to Crowley. An advisor can say to their high-end client, "We've had this fee-based relationship, I know you have other related accounts, maybe your children's accounts, maybe it's a rollover 401(k)--I can work with you and serve those relationships as well." It's a win for the broker/dealer, too, because regardless of whether the advisor is SEC registered or is a Series 7 broker, the B/D is responsible for overseeing all of the advisor's activities, Crowley says. Under dual registration, the B/D has the "advisor's and broker's activity in one place--inside the B/D under one custodial relationship," he says.
Larry Papike, president and owner of Cross-Search, an executive recruiting firm in California that helps brokers find the right independent broker/dealer, says most advisors have felt the need to become dually licensed so that they could launch their own RIA. However, since the majority of B/Ds themselves--about 90%--have an RIA, "there isn't that big of a need" for advisors to have their own RIA "because they can do all of the same things through the B/D's RIA," he says. Because of this trend, Papike says he's noticing that most dually registered advisors are contemplating getting rid of their securities license and "going to a fee-only practice so they don't need a B/D." Dually registered advisors who are doing more fee-based business than commissions are also shedding their NASD license so they can avoid paying their B/D. Even though an advisor may have his own RIA firm, which is considered an outside business, the B/D is still responsible for supervising it, Papike says, so the B/D "is going to take a piece of the [RIA's] gross." So "if an advisor is doing 90% of his business in fees, but he's paying his B/D $100,000 a year and they're really not doing a lot, then he's going to give up his NASD license."
Don Schreiber, president and CEO of WBI Investments in Little Silver, New Jersey, decided to drop his dual license last year because his firm's commission business had dwindled to only 3% of its revenue, and he just couldn't justify maintaining the NASD license. Plus, he says, juggling NASD and SEC rules became unbearable. "The NASD and SEC have different rules for advisors trying to practice a business, whether it's financial planning or a fee-based one," he says. "So you end up with twice the compliance headaches. Over the last couple of years, I've gotten a migraine every day from this." Schreiber says he's noticing more and more dually registered advisors moving toward building fee-based or other recurring revenue business models that are less dependent on commissions. Schreiber's business is now fee-based, and not having to comply with NASD rules has saved his firm an extra $5,000 per year, he says. Plus, he now doesn't have to carry such hefty E&O coverage.
Darla Main, a planner with Main Advisory Inc. in Pittsburgh, is one such advisor that is contemplating dropping her NASD license because the majority of her business is advisory based. "We could just eliminate a lot of this paperwork if we dropped the [NASD] license," she says. "I'm at that crossroads; I feel like I need to evaluate [dropping the license] more closely than I would have a year ago." Especially now that she's trying to figure out how to comply with the SEC's so-called Merrill Lynch rule, also known as the broker/dealer exemption rule. She's trying to understand how her firm's RIA "plays into the guidelines being established" by her broker/dealer, Multi Financial Services in Denver. (For more on the compliance issues faced by all advisors, see cover story, p. 56) Main says she believes the Merrill rule--which became effective January 31 and requires hybrid advisors to fully disclose to clients in which capacity they're operating (as broker or advisor)--will ultimately create a compliance atmosphere where "few advisors will be able to remain dually registered." Broker/dealers, she believes, "will force the reps to be registered under the broker/dealer's RIA, and eliminate the ability for reps to have their own--some B/Ds are already requiring that." To her chagrin, B/Ds will then, in her mind, start dictating which software packages reps can use.
Planner Schreiber agrees with Palaveev that if the compliance burden wasn't so great, the majority of advisors would choose to be dually registered. Schreiber says many of his dually registered friends complain that they're "astounded by the amount of time and the cost it takes to comply," with both sets of rules. Over the past two years, Schreiber says advisors have had to spend 25% more time on compliance. Even the large brokerage firms are struggling with their own "compliance nightmares," he says, and are pushing more and more compliance onto the OSJ, or Office of Supervisory Jurisdiction. "If you're a large producing OSJ, basically you've become the outsourced compliance department for your broker/dealer," he says.
The Hybrid Hydra
Palaveev of Moss Adams says while the regulatory costs associated with being dually registered are substantial, operating a hybrid practice is actually a more daunting task. The costs incurred by complying with two regulatory agencies include such items as the incremental costs of bookkeeping, recordkeeping, review, and consulting help. The more "serious" cost, he says, is working on two different platforms--the custodial and brokerage--because "very often you have to use two different systems in terms of trading software and portfolio accounting software." Plus, the hybrid advisor must "generate reports from clients, and very often that's difficult to do if the client has accounts in both systems," he says, so the advisor has "to consolidate information for analytical and reporting purposes." Then there's the cost of training staff to use the clearing platform and the custodial platform, he notes. The good news, however, is that broker/dealers can "help advisors integrate their office--it doesn't matter what side of the business they work on."
When implemented properly, the hybrid model can be very profitable, according to the study. The top 25% of hybrid firms have average revenue per active client of nearly $7,000; an operating profit margin of 21%; and a pre-tax income per owner of about $508,000, which is more than double the industry average, the study says. Palaveev says the Moss Adams study found that a significant number of large firms--those that have made Bloomberg's list of the top 500 wealth managers, for instance--are dually registered.
Despite no growth in 2004, more hybrid firms exist today than four years ago, the study says. Palaveev believes that while the "direction of the dually registered market will depend on regulation, and regulation-related moves by B/Ds and custodians," the hybrid market "will continue to be a very significant portion" of the advisor profession. He predicts the hybrid market will continue to grow because many wirehouse advisors who leave full-service institutions migrate to dual registration. Also, as advisors near retirement, they are attracted to the idea of opening their own RIA because "they have the perception that the RIA will give them more options and maximize their value in retirement," he says. However, "it's not necessarily true that the RIA maximizes value and gives advisors more options," he says. "I think advisors are confusing the fee-based business with the RIA. But, nonetheless, many advisors are doing it."
Melanie Waddell, Investment Advisor's Washington Bureau Chief, can be reached at email@example.com.