From the July 2007 issue of Boomer Market Advisor • Subscribe!

The added value of dually registered reps

More advisors are establishing their own RIAs, yet retaining their NASD licenses. What are the benefits of doing so? The trend in dual licensing -- as both a registered representative and a registered investment advisor -- continues to grow. By combining both business models, financial professionals are better positioned to serve the complex needs of their clients.

Dual registration has its roots in the late 1990s. At that time, stock market performance was so bullish registered reps saw an opportunity to increase their revenue by shifting investments to fee-managed products. Not all dropped their Series 7 license, but many moved to pure RIA platforms on the belief the markets would continue to rise, as they had for much of the previous decade. They then did not have to share their increased revenue with broker/dealer firms, which prompted many broker/dealers, especially large independents, to add advisory accounts under their umbrella organizations.

"But no forethought was given to a bubble occurring in the markets," says David Goad, ChFC, president of Succession Planning Consultants of Newport Beach, Calif. In the aftermath of the dot-com bubble's explosion brokers and advisors realized that a flat hourly amount or percentage fee for their services would prove difficult as a viable, long-term business model.

For the most part, those who maintained dual licensing were better able to weather the recent downturn due to the income stream generated by recurring commission products. Goad says that many fee-only financial planners who were planning to retire in 2001 "are still working to make up for lost revenues."

David Peterson, president of Denver-based Peak Capital Investment Services, agrees. "The fee-only model just doesn't work. There's too much that an RIA does that the client doesn't see, and when you bill them for three hours they say, 'Our conversation didn't take that long.'"

Shift happens

Despite Goad's and Peterson's comments, a October 2006 study by National Financial Services reports that 23 percent of brokers and advisors say they prefer to be paid using asset-based fees exclusively, whereas only 5 percent are actually paid in this manner. So are the fee-based and dually registered trends running parallel?

"The trends can conflict but they can also work hand-in-hand," Peterson says. "The dually registered advisor can offer more comprehensive services to clients," such as certain oil and gas investments and non-publicly traded REITs. And an NASD license is required to offer these products. RIAs who dropped their registration would have to sit for Series 6 or 7 again -- not an enticing prospect, according to Robert Enright, a founding partner with Burton/Enright Wealth Management in San Francisco.

"Most people would rather have a root canal without the Novocain," he says. "There are some products an RIA just can't access. But they convince themselves they don't need those products [or] tell their clients they cannot accommodate these [investment choices], and refer the client to someone who can."

The variable annuity market is one area of opportunity on which the fee-only advisor likely will fail to capitalize. According to Tiburon Strategic Advisors, as baby boomers retire, some $467 billion will transfer each year from corporate plans to IRA rollovers by 2010. While Peterson believes a tax-deferred IRA within a tax-deferred annuity makes little practical sense, "like going out in the rain with two umbrellas," some clients are attracted to the living benefits that variable annuities provide.

"We can invest a portion of client money very aggressively and insure that portion with a living benefit such as a guaranteed minimum income benefit and a guaranteed minimum withdrawal benefit," Peterson says. "You insure your home or car, so it makes sense that more and more retirement fund money will be placed in annuities."

But others believe the insurance feature is too costly. And while the insurance industry has been creative in launching new, lower cost products to take advantage of changing client needs -- and may soon promote fee-based annuity products -- Enright says RIAs can customize a payout program appropriate for the individual's risk tolerance and time horizon under a fee arrangement.

Compliance and regulation

The recent controversy over the courts' handling of the SEC's Broker/Dealer Rule highlights compliance conflicts for dually registered reps. An RIA has full fiduciary responsibility for his clients, while a broker is charged only with making suitable investment transactions (seen by some as a lower standard), which is a source of potential confusion for advisors and clients alike. Many brokers who migrated to a fee-based model before the tech bubble implosion now regret the increased regulatory oversight associated with becoming an RIA, while at the same time lacking a broker/dealer relationship to help with compliance support under what is now a more strict set of rules for fiduciaries.

"We know there's still growth in the fee-based RIA marketplace," Goad says. "What's new is the regulatory issue on top of that."

Goad says this will slow the fee-only movement, as smaller and mid-size reps find they can't afford to outsource compliance to a consultant or take the function in-house.

"This has always been a benefit of paying a broker/dealer concession," he adds. "[It's] to get support that you don't get in the RIA channel."

Enright agrees that regulation and supervision are the hot-button issues.

"I've always asked myself how the SEC can supervise these thousands of hatrack RIAs, the guys who hang out a shingle that says I'm a registered investment advisor," he says.

To Enright, the R in RIA stands for registered with the state, not the SEC, earned simply "by paying a $200 fee and foregoing an exam" to prove one's qualifications, a situation he says won't last. Enright believes that, eventually, broker/dealers and RIAs will fall under the same regulatory jurisdiction, with the NASD helping to alleviate some of the supervisory responsibilities of the SEC.

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