In response to my March 18 blog (The Gloomy Future of (Independent) Broker-Dealers) about his Feb. 15 blog (Reinventing the B-D Business Model to Survive a DOL Fiduciary Future), Michael Kitces sent the following email.
“I actually agree with you about the essential role that brokers (and sales people more generally) serve. I wrote last year that I’m strongly against a uniform fiduciary standard for brokers and investment advisors for that reason, and have maintained for years that the REAL choice is not suitable advice vs. fiduciary advice, but about actual advisors vs. salespeople who fulfill fundamentally different roles.”
Kitces concluded his email by writing:
“The issue here, though, is that because broker-dealers kept pushing their brokers into being advisors and abused the label, it seems increasingly likely that brokers really will be regulated as advisors, which obliterates their still-quite-relevant role as actual brokers to distribute securities in the process of capital formation. I agree with you that’s a bad thing. But the brokerage industry has left almost no way out for itself, to go back to just being called and acting like brokers, because the DOL fiduciary rule (and subsequent SEC efforts?) are becoming so expansive that no carve out will remain.”
Kitces is right that the current fiduciary issue is one of the brokerage industry’s own making. It's even more ironic that initially (back in the 1990s), the industry was dead set against brokers managing client portfolios. There was even one former NASD (FINRA) examiner turned BD top exec going so far as to file an action requesting the BD regulator to prevent brokers from managing client assets. He was not successful, which is why the industry is still wrestling with the resulting complications.
Despite the securities industry’s initial reluctance, the driving force behind its transition to managing client assets is that’s a better business model. Rather than having to continually find something “new” to sell their clients in order to generate new income, brokers who manage client portfolios start each year with ready-made income from existing AUM, and the prospect of a substantial raise should those assets grow, and/or new client assets added.
It’s the model that has created the largest banks, investment banks, private banks and investment management companies in the world.
But brokerage firm executives (being brokerage firm executives) were not satisfied with simply adding a new and better business line to their existing brokerage force which sells the securities underwritten by their corporate banking divisions. No, they reasoned that if managing client assets was a good business, imagine how much better it would be if their firms and their brokers also earned commissions on the funds going into those managed portfolios! And, better yet, what if they actually created some of those funds themselves and cut the mutual fund companies out altogether?
And that’s how the lines between sales and advice that Michael Kitces refers to got blurred. Is it a better business model? Absolutely: for the brokerage firms. They make money on the loads from their proprietary products, the sales of all products and on the management of all those assets.
Is it a better business model for brokers?
Well, yes and no. Yes, they now have recurring income from their AUM, in addition to their sales commissions. And no, they generally only take home between 30% and 50% of that AUM, while independent RIAs, who do essentially the same job, get to keep 100%.
And what about the clients? Well, they are getting more service in the form of ongoing asset management. But they are paying for it quite dearly: from what I can tell, most brokers charge over 200 bps, compared to under 100 bps for most independent RIAs. And, of course, they are also charge those sales commissions (and proprietary product loads) neither of which clients would pay if they used an independent RIA. Those would be the real costs of having a “part-time” fiduciary advisor.
Which brings us to the brokerage industry’s current challenges that Michael Kitces refers to.
It seems that some consumer advocates, regulators, lawmakers and even a handful of financial journalists, have come to the conclusion that perhaps the brokerage industry has gone too far. That perhaps adding asset management should have been enough, i.e., without allowing sales people to also be advisers for the same clients. And, yes, it’s not hard to believe that changing course at this point will probably cost BDs and their brokers.
Yet I can’t help but agree with Kitces that this problem is largely of their own making. Perhaps they shouldn’t have been wearing “two hats”—and earning the money for both—in the first place.
See additional Bob Clark blogs on this topic:
See also reporting from ThinkAdvisor's Melanie Waddell: