From the February 2008 issue of Boomer Market Advisor • Subscribe!

Bypassing the broker/dealer -- What Charlie Farrell knows

Presidential candidates may talk about change, but in 2007, Charlie Farrell lived it. Besides relocating his business and family from Cleveland to Denver, he dropped a long-term relationship with a large broker/dealer, opting for a more direct route to the clearing and custodial firm.

"I wanted a firm that was independent and would be supportive of me and my practice both here and in Ohio," he says. "So I needed the infrastructure to be here and there at the same time."

For Farrell, Denver-based North Star Investment Advisors was the firm and Schwab was the clearing partner. With six advisors and 300 million in assets under management, North Star focuses on superior service with Farrell, in particular, focusing on tax-efficient distribution planning.

No small task; one that would cause other advisors to rely heavily on the compliance and product help broker/dealers offer. So why change now? How difficult is the transition? Is it cost-effective? How has it helped or hurt his business?

Farrell confidently answers these questions and more.

Boomer Market Advisor: What surprised you most about going independent?

Charlie Farrell: It forced me to focus on my core competencies. Without the outside support, it makes you look at what you do best. The cream rises to the top. "What's the best use of my time and what do I think I'm really good at." If you look at your client base and map them out, you'll probably find that there's a certain core of clients that you've attracted. That tells you what others think you're the best at.

BMA: What's been the biggest negative about going straight to the clearing platform?

CF: The data transfer from whatever performance reporting system you were on to what you're going to is tough. And who, exactly, owns the performance data is a little unclear. There was also a disagreement about what was necessary to do the conversion. Everyone was saying they were going to be helpful, but not everybody had the same opinion about how these things fit together. Set aside three to five months to get through the transfer process because the paperwork is overwhelming. I would also suggest the advisor draft a business plan and then discount it a bit so there are fewer surprises. It's the little revenue streams here and there from the broker/dealer that you'll have to do without.

BMA: It's a big step. Why did you discontinue your broker/dealer relationship and go directly to the clearing firm?

CF: You have to find a business model that fits who you are and the type of practice that you're trying to build, and this goes for everyone in the industry. Over the years, more and more of my business and my time was spent on the asset management side and fee-based advisory work. That became the majority of the investment work that I was doing. The broker/dealer side just didn't fit any more. I really wasn't doing much work in that area. Being regulated under both structures and carrying both licenses as a dually registered rep was too much of a burden. I think if your practice mix is such that you have a healthy mix between advisory and commission-based business, then the dual registration works. For what I was doing it really didn't fit. I had had pretty good conversations with the individuals at the broker/dealer whether it did fit. We came to the conclusion that well this was the model they were running and it fits for them. But it wasn't a good fit for me going forward.

BMA: A lot of broker/dealers jump at the fact that the industry is moving towards the fee-based and fee-only platform. Do you feel they're not moving fast enough to retain their top talent?

CF: One of the things you have to look at is the cost structure of dual registration. The way my practice was structured, it was relatively expensive. The question becomes, "Do you still need that type of overhead and assistance as you build your asset-base?" In the beginning it's quite helpful. But if you're primarily fee-based and you're pretty good at operating your business from an administrative standpoint, and you've got a good handle on technology, the cost structure may hold you back. The industry is more competitive and, you know, people are certainly more fee sensitive just because of public awareness and things of that nature and modest returns over the last seven and eight years. So I think that, you know, for certain people getting on a low-cost platform that provides you with access to a lot of technology to kind of leverage the stuff that you are focusing on, you know, it could be -- for me it was a good change. For other people it may not work because the scope of what they're doing may require them to still have a lot of access to broker-dealer services and also some of the support available through those networks. You know, I had a tax background and a law background so for me it wasn't as important to have, you know, a resource pool for some of that as it might be for some other people.

BMA: When you went directly to Schwab and National Financial, what did you have to then replace on your own that the broker/dealer previously provided for you?

CF: You'd have to have a compliance person, obviously. You'd have to have somebody who is skilled on the technology side, particularly the account reporting and performance. You have to have the ability to handle that internally or feel comfortable with outsourcing it. The outsourcing is getting easier; where you needed to rely on the broker/dealer for help, the outsourcing capacity is now really efficient. You lose some control and you'll have to be comfortable with that. A good broker/dealer does provide you with solid resources for retirement planning, IRAs and 529. They have specialists in those areas and for some people it's really helpful. For me I didn't need as much help because of my particular background. But I think if someone was going to make a move to the clearing firm, they've got to ramp up on all that expertise or have the ability to get it elsewhere. If you don't, you'll find that you're really frustrated. Many advisors are looking to comprehensive wealth management, not just investment advisory. They're touching on estate planning issues, gifting and education funding, qualified plans and maybe business exit planning. If you don't have some way to access needed resources, the institutional platform is just not going to provide you with much assistance. It's not what they do. That's one of the biggest challenges. If you have a good broker/dealer with good resources and in-house experts, you might not realize how good you had it.

BMA: What AUM level and experience level should an advisor have before making the change? What's the minimum to make this work?

CF: For somebody to be on their own, they have to have at least $50 million in assets under management. That would be the bare minimum. You need to hire the staff yourself; you need to outsource some suspects of the business, which is costly. Taking that into account, somewhere between $400,000 and $500,000 in revenue would be enough. But you've got to think about what happens if a bear market hits, and you AUM level is reduced, do you have enough cash flow to remain independent?

BMA: What are the value-adds that Schwab and National Financial bring?

CF: I think most of the systems are pretty good, whether it's Fidelity or Schwab, but it's all about trying to help you leverage your portfolio management structure. The more efficient you can be with your time, obviously, the more assets you can handle, the more advice you can give and the more time you can spend with your clients. It's about helping you take a look at running your practice more efficiently and bringing resources to your attention that you might have missed.

BMA: Do they have a specific packaged wealth management platform they offer you?

CF: We have a primary relationship manager who gets to know our practice. We have a team of service individuals that we access who are dedicated to our business and are very helpful.

BMA: We hear so much about how it's a stripped down relationship, but that doesn't necessarily mean that it's just a "nothing" relationship.

CF: Exactly. It is still a relationship. The only time I really got a visit from my prior broker/dealer was for the annual audit. Here, I've had a number of visits from operations. I would say, surprisingly, from that standpoint the relationship's been a bit deeper. We have a primary relationship manager for our firm. We also have a team of service individuals that help with administrative issues; custody, transfer and trading issues; all that operational stuff. The prior broker/dealer may say, "It was all there, you just had to take advantage of it." That may have been the case, but I just know I've had more visits since going with the clearing firm. Part of it may be because there's a large Schwab center here in Denver.

BMA: Is it cheaper to go with the clearing firm, and if so, by how much?

CF : The custodial relationship is not much of a cost, but the performance reporting will now fall to you. That might be 5 to 10 percent of revenue cost per account. Any trailing commissions you have at the broker/dealer go away. If you have your own office you have to pay your own staff and overhead on top of that. If you have a broker/dealer, you have payouts, but you also have fees to utilize their RIA services. If you're looking at saving 15 percent on a $100,000, it might not be that helpful. But if you're saving 15 percent on $500,000 that can really move something to your bottom line.

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