You know a trend is well on the way to becoming business as usual when “independent” broker-dealers start jumping on the bandwagon. That certainly seems to be the case for the movement toward increasing the independence of financial advice. Traditionally, independent BDs have been one of the most conservative elements in the independent advisory world. For instance, some of us will remember when Miles Gordon, then CEO of Financial Network (now ING) led BDs to petition the NASD (now FINRA) to outlaw the emerging practice of registered reps managing client assets for a fee. By the time the BDs realized that AUM fees might not be such a bad idea, Schwab advisors had nearly a trillion client dollars under management.
Today, the issue is truly independent advice. Despite the Financial Services Institute’s head-in-the-sand resistance to a genuine fiduciary standard for registered reps, a number of farsighted BDs are actively embracing a new level of advisor independence (including the fiduciary duty that goes along with it). Perhaps the poster kids for BDs’ change of heart is the independent industry’s largest firm: LPL Financial in Boston, through its hybrid RIA program, along with its largest hybrid affiliate, Independent Financial Partners. The success of firms like IFP and others, including HighTower Advisors (see “HighTower’s Continuing Success Suggests a New Model for Independent Advice” on AdvisorOne.com), raises important questions about the meaning of independent advice and its future.
Independent Financial Partners in Tampa, Fla., has been in business in its present form since 2000, but got a major boost when LPL launched its hybrid program in October 2008, which now boasts 146 RIA firms and $22.7 billion in custodied assets.
Today, IFP services 425 independent advisors, generating $80 million in revenues on $3.5 billion in client AUM. Last year alone the firm added some 140 advisors. The attraction of IFP is three-fold: It offers a broad range of services designed for dually registered advisors and reps, uses its economies of scale to keep its payouts high and, most importantly, works to maximize the independence of its advisors. “Our structure,” said IFP founder and CEO Bill Hamm, “is designed to give our advisors the ability to serve their clients according to their vision, not ours.”
IFP uses $35 billion it has under “advisement” at LPL, which includes the retirement and estate planning portfolios that aren’t included in its actual client AUM, to negotiate much higher payouts than most of its advisors would get on their own. For instance, LPL pays out 100% of client asset management fees, making its cut on the custody of those assets, and gives IFP 3% concessions on commissions generated, which, according to Hamm, the firm passes along to its advisors. Consequently, IFP advisors earn between 90% and 97% payouts, “with the average around 95%,” he said.
On the service side, IFP offers a “multi-custodial” platform, meaning that its advisors are free to custody client assets at Schwab or TD Ameritrade should they or their clients feel it would be advantageous to do so.
While LPL charges an additional 5% fee for the oversight involved, the ability to choose among custodians greatly increases the independence of the IFP advisors and those who affiliate with other hybrid firms such as HighTower.
“Unlike other custodians [that] compete directly with their advisors for clients,” said Derek Bruton, managing director and IAS national sales manager at LPL Financial, “the basic structure of LPL Financial’s relationships with independent advisors allows us to maintain a singular focus on supporting their needs [...].”
IFP offers a broad range of investment and risk management products, some of which are commission-based, which I’ve always been against due to the conflicts involved. But in recent years, I’ve come to believe that the benefits of having all a client’s needs met by one advisor outweigh the potential conflicts.
Of course, IFP’s menu doesn’t approach the level of sophistication offered by HighTower’s menu of hedge funds, alternative investments and principle trading, which is designed to attract breakaway brokers who are used to wirehouse-level services. Still, IFP’s lineup is more than you would see at many BDs and more than enough for most independent advisors. It’s a telling indication that the independent world is beginning to recognize the distance between its and Wall Street’s service levels—and the need to close that gap.
Another attraction of IFP and other hybrid firms is regulatory compliance. It’s now clear that the most tangible result of Dodd-Frank will be a major increase in the oversight of RIAs.
The result will most likely be major increases in compliance costs for independent RIAs and a major boon for hybrid firms such as IFP and HighTower, which can use their economies of scale to keep compliance costs down. It’s no coincidence that IFP is beginning to attract fee-only RIAs from outside LPL’s ranks, including some NAPFA advisors. (With their reduced compliance issues, LPL lets them take home 100% of their AUM fees.)
“For RIAs on LPL’s platform,” said Bruton, “we offer a full suite of value-added compliance tools and systems to support their fulfillment of SEC and other regulatory obligations applicable to RIAs.”
Traditionally, “independent” broker-dealers such as LPL are called independent because they allow their registered reps to own their own firms, and therefore, they are self-employed. Wirehouse brokers, in contrast, are W-2 employees of their brokerage firms. This affords the advisors at “independent BDs” a certain level of independence, but as registered reps, it’s still a far cry from the independence of many RIAs.
To increase the independence of its advisors, IFP enters into written agreements with them that clearly spell out that clients belong to the advisors: When the advisors leave, the clients leave with them. What’s more, IFP’s agreement makes clear to all parties that its advisors are free to leave at any time for any reason. “Of course, that’s perfunctory,” said Hamm. “But it creates the mentality that we’re here to serve the advisors and their clients, and not the other way around.”
Perhaps the most important way IFP differs from firms like HighTower is in the ownership of affiliated advisors. HighTower buys an equity stake in its advisory firms, and in turn, those firms acquire a stake in HighTower. While this arrangement gives advisors a measure of control over the conduct of their custodian, it also gives the firm some control over its advisors, particularly in their ability to move to another firm.
In contrast, IFP has no such ownership arrangement and no plans to institute one. “We don’t think ownership in our advisors is a good idea,” said Hamm. “This way, it puts the onus on us to do the right things for our advisors. It seems to be working: we have very little advisor turnover. They rarely leave.”
Which raises the question: Does partial ownership of advisory firms by their custodian or BD create more or less independence? Seems to me the litmus test should always be what’s in the best interest of the clients. Is it better for advisors to be able to take their clients and find a better arrangement should the need or opportunity arise? Or is it better that advisors have some actual control over how their custodian conducts business?
Personally, I’m leaning toward advisors having the ability to keep business execs in line. For advisors, it’s nice to have both models to choose from. Undoubtedly, time will reveal whether one model or the other contains enough serious flaws to make advisors and BDs move in the other direction.