From the September 2017 issue of Investment Advisor • Subscribe!

Rock Solid: The 2017 Broker-Dealers of the Year

The leaders of the 2017 BDs of the Year rely on strong corporate cultures, flexibility & business acumen to build mutual success with their advisors

Meeting in Chicago on Aug. 7, executives from the four top broker-dealers traded views on everything from succession planning to fees, commissions, regulation, RIA issues and charitable giving. A significantly trimmed-down version of the animated dialogue follows. Their insights on other topics — such as technology trends and cybersecurity — and lengthier discussions from the meeting can be found online at ThinkAdvisor.com/tag/2017-broker-dealers-of-the-year.

Janet Levaux, Investment Advisor: What highly challenging issues are your firms and your advisors facing today?

Lon Dolber, American Portfolios Financial Services: We have a number of colleagues who have their own RIAs. When they find themselves being questioned by a regulator, maybe the SEC, and they need help and they need to get data, [it's a challenge]. It may not even be an outside RIA. It might be literally someone that has an arbitration. That's what we’re really there for. They know they’re not going it alone in that situation.

(Related: Destination Unknown: The 2017 Broker-Dealer Poll)

Amy Webber, Cambridge Investment Research: I would answer this question as it relates to … succession and acquisitions. We really hit that issue hard starting in 2010. … Many [advisors] believe they will live forever and/or leave while they’re still at their desks. It isn't an easy issue to talk about and to tackle.

It starts by simply getting them to think about it and talk about it. We have an emergency plan that we’ve implemented where we will buy the practice — which is not ideal. We actually want a long-term plan, but at least there's something.

Over a third of our advisors are solos and ensembles. … It just becomes really difficult culturally to find someone that will take care of their clients as well as they did.

The biggest obstacle is valuations. Part of our consulting [work] is really helping the buyer and the seller think about the fact that on every end of a succession is an acquisition. What is a challenge for one becomes a huge opportunity for another. We have spent a lot of time marrying those two [dynamics] and helping them mitigate through the valuation questions and the difficult scenarios that may happen in that environment.

The next big obstacle is funding. We’ve funded over $20 million in loans for succession and acquisition since inception. I think that's just an industry issue that's going to continue.

John Burmeister, Lion Street Financial: Many of our owners have corporations as clients. We have a top-five benefits firm that specializes in corporate-owned life insurance and plan administration. We have taken what this firm has done and white-labeled it, so all of our other owners can tap into the resources that the firm has.

Just a couple weeks ago, I had a firm on the East Coast introduce this firm to one of their corporate clients and offer solutions that he wouldn't have been able to [find] on his own. It's a very specialized marketplace.

Ryan Diachok, Geneos Wealth Management: Succession and the next generation of advisors in our industry is probably the biggest macro challenge that we all face. The smaller the firm, you maybe don't have as many pockets of advisors to be able to marry together. Frankly, a lot of times that doesn't work.

We’ve been encouraging our advisors to really start thinking earlier and earlier about that junior advisor setup.

The lack of training in this industry is a real problem. The reality is the training is now at the advisor level. The training is for the seasoned independent advisors.

If you put that aside for a minute, just how do we take this industry out for the next 20 years? That's a problem. We need new advisors [flowing] into our industry.

Partnerships don't always work. As a broker-dealer, you have to sometimes get in the middle of helping dissolve a partnership. In the past 12 months, we had a long-term partnership with two very successful advisors very amicably decide to part ways because the long-term transition plan was not going to be each other. It created a pretty unique set of challenges.

They had an outside RIA that they jointly owned and managed. Divesting the partnership and the RIA and coming under the corporate RIA was a much better solution for them. ... We were able to help [them] do that transition smoothly, amicably between the two of them and, from a high-level broker-dealer perspective, we were able to save the revenue and the asset base.

Webber: That's a great point because our retention of assets has run about 97%, whereas the retention of advisors is lower than that at 90%. That tells me that succession and acquisition is working, with retention of assets potentially being the key that we watch.

We also had a divorce occur, but it was with one of our largest offices. We wanted to utilize our expertise and funding to allow certain mechanics of the arrangement to make sense. Now we have two very successful $15 million branches instead of one with $30 million. But everybody was happy in the end and … came to the table in a very professional way because it was a transaction that we were all invested in.

Dolber: If you really dove deep at most independents, you would find that when it comes to succession planning, they may have programs, but it's a tough nut to crack. It may be more important to look at continuity planning. This might be the more important issue because you’ve got to maintain the integrity of the underlying accounts in the end. You have clients, and you’re responsible for them and their well-being.

Webber: The complexity, I suppose, is who serves them in the interim. I don't know if your continuity-planning program actually keeps the assets within the home office for long. We have a SWAT team. Of course, we’ll send the SWAT team out; not ideal because our ultimate goal is to then figure out … how to get the assets somewhere else to be served.

(Related: Amy Webber — Next-Gen Nurturer: The 2017 IA 25)

Dolber: To do a succession plan, typically, unless the company does it for you, you’ve got to find someone that you want to partner with. Partnerships are just tough.

Diachok: The industry as a whole recognizes [this], and there are avenues to get these deals done, but they are challenging.

Dolber: You know who does a good job of it? The P&C [property & casualty] firms. They have a thing called extended earnings. They don't wait for advisors to make deals with each other. They buy the book, they give the book to another advisor and they have an arrangement. They extend the earnings to the advisor who's leaving or retiring or, if the advisor has passed away, to the spouse. They take over. They take the book. They manage it, and they do a very good job of doing it.

Webber: Our super OSJs do that a lot, too.

Diachok: It's those isolated silos. Our business, our independent nature and the independent nature of the advisors just make [for] … legacy issues. A lot of advisors don't want to just hand it off to somebody. They want it to go to somebody that they know and trust. There's ego issues, and, frankly, the hardest part of any of these transactions is getting that price to one that they both agree on.

Burmeister: If you know that you’re looking for somebody who has a succession plan [then] you can go out and recruit someone into your firm to help with that succession planning.

Webber: It depends. Usually the broker-dealer that wins is the broker-dealer that the retiring advisor is at because the retiring advisor does not want to move as the last option. It can be a double-edged sword.

It is a recruiting opportunity. If you [have] younger advisors hungry for the business, we win them — but we have to work a lot harder to convince the retiring advisor that it's a good idea.

Diachok: We had an advisor unexpectedly die about a year ago and, classic story, had no [succession] plan. We sent in the SWAT team. With a local advisor who had worked with this gentleman before, we put together an after-the-fact transition plan so that the clients had people that they knew ... to step right in. But those are also things that we have really started to encourage our advisors to have — at the very least, that contingency plan in place because you hear of too many of those examples.

The DOL Fiduciary Rule

Levaux: We don't exactly know what will happen with the Department of Labor's new fiduciary rule, but in general, what's your take on the rule? Is there more uncertainty or less? (On Aug. 9, two days after this discussion, the DOL requested an 18-month delay of the fiduciary rule's Jan. 1 applicability date.)

Diachok: We think as a firm that there will be additional delays to the full implementation date. Geneos is in favor of a fiduciary standard. The problem with this Department of Labor rule is you can put — as we probably will do for the next 45 minutes — 20 securities attorneys or 20 broker-dealer executives into a room, and you’ll get probably 20 different interpretations.

Webber: I agree with that. That said, I don't believe we are un-ringing the bell. What we’ve found … is that advisors are going through what we refer to as the five stages of grief, but when they come out the other end ... of those five stages, it's not so bad. There is a lot of benefit potentially to the transparency part of what [the rule] is bringing to the table in terms of … the total internal expenses of a model portfolio.

What I have seen is, in the end, either clients are coming out the same or they are paying slightly more. It's just that revenue is moving into different pockets.

As the internal expense issue is spotlighted, the only thing that's going to happen is the custodians, the product manufacturers and the solutions firms like ours are going to be adjusting other pricing to offset that and make it more transparent.

Dolber: I laid out what I thought we had to do [to comply with the rule], and it started with transparency. For us, it was easier because all our technology is proprietary. I don't use anybody else's technology. We are prepared, come Jan. 1, to do exactly what the rule says. The advisors have to understand there is going to be change. They need to embrace this change or be a victim of the change.

Webber: One of the most productive things we’ve found, honestly, is boots on the ground. Last month, we had about 10 of our associates — the experts in this environment — go out and do face-to-face roadshows across the country. We did four in each region.

Those advisors that showed up came in freaking out — and that's a technical term — but by the time they left, a day and a half later, they had calmed down. They accepted what you are describing, Lon, which is that this is an opportunity. For those that survive, it is a huge opportunity. That said, they have to make behavioral and psychological shifts to the way that they think about this.

Dolber: Are [advisors] prepared to walk away from a revenue source? There's a book called “The Third Way” written by [AOL co-founder Steve] Case. They had a subscription-based model. It was generally, what, $25 million a month? How do you walk away from that?

Advisors are thinking, “How do I walk away from big, fat commissions?” We’re facing a different model, and we need to help our advisors see that and start making the changes they need to make to be relevant going forward so they can survive. I’m hoping some of that layers into DOL. I definitely feel it's the wrong rule, the wrong remedy and the wrong regulator.

Diachok: If you look at how some of the larger networks, and maybe private equity firms, [have prepared] for DOL, I think some have gone four steps further than the rule even takes it.

Webber: Don't you think they are using this as an excuse to make decisions that they would have made anyway?

Diachok: I think there is a lot of that going on. Geneos took a measured approach as this thing evolved, and come Jan. 1 or whenever that final applicability date is, we’re going to comply with the rule. We’re going to take the least disruptive approach as possible for our advisors.

Burmeister: We’re doing exactly the same thing. Where I differ from most of the people in this room is we have no proprietary technology. It's actually been more of a minimal expense because we haven't had to invest in any proprietary technology. We had to operationalize the rule and put the right forms and the right policies in place, but to us, it hasn't been that expensive.

Webber: Wish I could say the same — $20 million later …

Dolber: A big part of our budget is systems technology.

Webber: We would have spent that $20 million anyway on tech, it's just disturbing that we’re spending a fair amount of it [to comply with the rule]. It is distracting us from other productive innovation, in my opinion.

Diachok: One thing I find interesting is some of the technology companies jumped on DOL as a chance to get huge contracts with some of the larger BDs for, let's call it “financial planning software lite,” and they renamed it a DOL tool, which causes all kinds of other conflicts.

In some regards, firms are trying to use technology to get every piece of a client's financial picture [in order] to comply [with the best-interest regulation]; that creates a whole other set of potential pitfalls if you’re rolling it out across every client.

Levaux: How are you adjusting to DOL and any possible lost revenue and/or changes to investment products, fees, etc.?

Diachok: The firms that are well-positioned today are the ones that started making the shifts that are being forced by DOL long ago. The firms dependent on commissions and transactional-based revenues, if you’re in that position, you’ve either been acquired, you’ve gone out of business or you’re hurting pretty badly right now.

The firms, frankly the ones sitting around this table, are the ones that really started seeing the shift in revenue trends years ago and were able to create different streams of revenue to offset some of the changes that have happened because of DOL and some of the other changes in the industry.

Amy, I know your firm is right there at the top as far as percentage of overall revenues from advisory [fees]. We’re right there as well. We have consistently tipped up every year. We’re approaching 60% of our total revenues from advisory fees. That's up from 55% last year and 53% the year before.

It's not just advisory revenue. It's a much more macro question. Can the independent broker-dealer, as we see it today, even exist 10 years from now? I don't think it will. I think we all are marching toward much larger RIAs with a broker-dealer component.

How do we provide the services, the technology, the platforms as we talk about DOL and the never-ending shift toward the advisory-fee model? The firms that have embraced that and are creating those solutions and platforms for their advisors are the ones that are finding other revenue sources, finding asset-based revenue sources versus transactional-revenue sources.

We had a dip in topline revenue last year. From the prior year, our profitability increased with a 6% or 7% topline decrease. That's a function of some of those shifts that we started making years before, [such as] creating our own UMA platform, building all the technology underneath it to not be beholden to third-party technology and its cost. It has been extremely successful for us to create what we think is a very competitive managed-money, UMA, multi-manager, single-account platform at a lower cost than I think is available pretty much anywhere in the industry. Our advisors have really taken to that.

We’ve been able to take a shift in revenues — less transactional, less commissions — which drives that big topline number and may pull back a little bit, to embracing that shift, creating solutions, creating platforms that ultimately make the firm a little bit more money and revenue and profitability, while at the same time creating a less-expensive option for the investor and the advisor. If you can do both at the same time, you’ve found a pretty good combination.

Webber: It's the same thing we’ve asked advisors when they convert to advisory accounts; maybe [take] a few steps backward before you propel forward. With 63% of our revenues coming from advisory and another 22% from recurring revenue, that leaves 15% transactional.

That said, a lot of our innovation around the product side has been in the advisory space. I still don't believe transactional commissions are going away, at least not in my career, because there are just certain situations where an advisory account is not the most suitable for a client. I also do not completely buy into the “cheapest is best” scenario. The thing that gives me the greatest heartburn, honestly, are the DOL assessments around reasonable compensation.

Who should be determining it? There might be some outer bumper guards that need to be established from a regulatory structure, but the buyer and the seller should probably be determining that based on needs. Still, we do have to deal with what the rule is requiring us to do, so we are setting up reasonable compensation thresholds inside of each product category for that transactional side.

Then in the advisory space, all our discretionary retirement accounts will, by January, move into an asset-based pricing environment. Transactional fees are gone. All the clearing firm ancillary costs are gone. It is purely based on basis points. The clients are paying a programmed fee, just like they would in a UMA or a TAMP. In effect, our traditional asset-based platform fees that advisors pay are going away. They may use some of that to offset the clients’ overall fee.

The share classes potentially change. The revenue share goes away, and the clients pay a very transparent program fee. That's probably the biggest evolution I think that we’ve seen in the product space. It has been very well received after we get through the five stages of grief. We go through every account and figure out exactly what it means to every advisor.

This is eliminating some of the disparity between the way that our pricing works as opposed to the institutional platforms. This is exactly what an independent RIA is getting when they go to Schwab and ask for a wrap account … .

With us, they’re getting our recent pricing — which is similar to institutional asset-based pricing that could be around 19 basis points — for our advisory business instead of ticket charges, and this is, all in, highly competitive depending on the size of the practice, average size of accounts and number of households.

This thing that we’ve been struggling with forever, how to compete with that model, is where the ice might be starting to crack. We might have some opportunities here.

Diachok: Sure. It's driving assets away from the traditional TAMP model, which has traditionally been the most expensive model. With complete transparency on who's paying what, advisors are saying, “I can access the same quality managers in a more transparent model. I can save my clients money. I can do it for less.”

Webber: What do they hate the most? The nickel and diming.

Diachok: Exactly. I don't think in any of our lifetimes commission products will go away. There's a place in a lot of circumstances that a commission transaction is more appropriate than just opening an advisory account for every client. But, I think we as firms have to adapt and see where those revenue streams are going and be able to operate with ever-increasing expenses, compressed margins and everything else. We have to be involved in providing those solutions on the advisory side, so that we are participating in that revenue stream.

Webber: We’re not just broker-dealers. We consider ourselves a financial solutions firm, so we might lead, not quite as vehemently as Lon does, with “technology for an independent RIA.” Or we might lead with, “We’re a registered investment advisor. Our corporate RIA is huge.” Or “We’re a registered investment advisor with a broker-dealer attached.” Or “We’re a fee-only corporate RIA.” I think that's offering some opportunities.

Burmeister: We haven't talked about ... the product manufacturers. What share classes are they going to change? What fee structures are they going to change? It seems like they’ve been on the sidelines. I don't know about all of you, but [manufacturers] have been coming to us, asking for our opinion and guidance.

Webber: “What do you want?”

Burmeister: Because they don't know. We’re going to have to react rather quickly to make sure that we’re in agreement with what they’re coming to the table with.

Dolber: We came up with an idea that the decisions we make could have great impact on the advisors we serve. We didn't want to make product decisions very quickly, like some firms that decided they weren't going to allow commission-based IRAs. I thought, “Did they think about how that was going to affect their customers?”

Webber: They might be regretting that today.

Dolber: I think they are regretting that. I think also you could go to the end customer. The investing public should have choice.

I did not make a decision to tell advisors they couldn't do commission business. I still have a book of business — not as many clients as I did when I started, but I have about 100 clients. I could relate to the things that our advisors are telling me because I have to deal with my clients.

If a client calls in and says, “Lon, I want you to go see my kids. They want to start a $2,000 IRA.” I’m going to put that into a fee-based account? Really? The regulators and people from DOL have never been in that situation. I’m not going to do it.

They’re going to go into a mutual fund. They’re going to go into a mutual fund probably with a 4% load. Because am I going to sit in a client's house to make $10? This argument was made years ago. My dad brought me into the business. I remember he had to go in front of Congress to talk about why contractual plans made sense.

Webber: The share classes are insane. I’m not talking about what the compensation is necessarily, but we don't need thousands and thousands of different share class variations. If they do need thousands, then maybe they could all name them the same letter … and have them look the same across the product sponsors because one man's R shares are not another man's R shares or I shares.

(Related: New Share Classes in a DOL Fiduciary World)

It's really complicated because the amount of money that we must spend having human beings try to sort through our data to make sure that the right share classes are going through the right rules engines is obnoxiously inefficient.

As for T shares, I’m not a fan because if in fact we have to buy into the “cheapest is best” [scenario], there will come a time when T shares are no longer the cheapest. Then what do we do? Because there are no exchangeability or portability requirements for the client.

Then you go to clean shares, which, by the way, at least the ones we’re hearing are coming out, they’re not all that less expensive [in terms] of an internal expense than an I share. It's just one more complexity.

Maybe it makes sense on the advisory side, but for every broker-dealer to have to develop a commission schedule like we did 25 years ago on the equity side, where does reasonable comp begin and end? That brings no consistency, again. I’m harping here, but this is … something that we agonize over because we’re not solving the issues. We’re just bringing more complexity.

Social Responsibility and Good Citizenship

Levaux: What are your views on social responsibility?

Dolber: I think the corporation has an absolute responsibility to be a good citizen and to do good work in the community, and it starts with the internal community. For me, our value proposition is very simple — we put our employees first [and] customers second. That gets some arguments from some of my advisors, but I tell them, put your employees first and they’ll go to the end of the world for your customer. Chicken and the egg. Community and shareholder value.

What we do is we have initiatives on a corporate level, and then I will allocate funds for advisors for their projects. We allow advisors to call and say, “We’re working on something,” and, up to a limit, we’ll support them. We have core things that we stick with every year, like Virtual Enterprise, which is an internship program. We put high school interns into our offices, and we pay for the six-week program. It's a substantial commitment for us to do it.

Or World TEAM Sports, which I’m involved with, working with individuals that are physically challenged. I integrate these things into our culture where employees get involved, advisors get involved, people in my community get involved.

Webber: Happy associates make happy clients. Part of that, on the giving back side, is taking care of your own. If one of our employees is experiencing — and we have 736 — a health problem or an accident or their house burns down, it is amazing to watch how quickly our organization pulls together as a family. That's a part of our culture.

We take care of each other, and then the board matches. They’ll do fundraisers. They’ll do whatever it is that they do, serve lunches, and then we match what they raised for that cause.

We created the Cambridge Foundation several years ago. We have associates who feel that this is a satisfying activity for them, and they can suggest that they want to be on the board of the foundation, so it isn't just the senior leadership. It can be other employees. We look at hundreds and hundreds of requests every year.

Part of our core values is giving back to our local community. Every city that we go to and have our national conference in, we have significant fundraising efforts, and we’ve given thousands and thousands of dollars at our national conference. We also have what's called the Cambridge Community Kindness Matching Gifts [initiative] and Dollars for Doers … for employees and for advisors.

Dolber: We have a full production studio at our office, so we produce content all day long and incorporate this, the social fabric, the CSR, into what we do. I think advisors have joined us because of it, quite frankly. A lot of the advisors are in their 50s. They’re making money, but they’re at a point where they want to do something more than make money. They want to give back to the community.

Diachok: The question about culture and what makes each of our firm's culture unique, it's pretty evident there's a clear, common theme of why the four of us are sitting here today as winners of this years’ Broker-Dealers of the Year. We all share very common themes on culture — family culture amongst your employees, amongst your advisors.

I’m a third-generation family member, so we have true family running ... through our organization. That's been one of the key cornerstones of our firm from day one, and that's really attracted a lot of the advisors to us, as it has to your firms. At the end of the day, these independent advisors are out there a lot of times on an island, and they really are just looking for true partners.

They get caught up in acquisitions, as we’ve talked about, forced transitions, and all the things that they’ve had to do. When they find a firm that has that real culture — not a manufactured culture, but a real sense of belonging, a sense of family starting at the employee level and translating down to the advisor level — I think that's the most critical piece for all the people that look at and ultimately join our firms.

We decided to do away with any type of plaque or any type of recognition from that perspective, and instead, we created a program for the top 15 advisors and top five branches. We set a pretty significant dollar amount and donate to their charity of choice in their community. At our conference, we give them a chance to come up and talk about it to the group.

Burmeister: What you have put together, I’d mirror that as exceptional. I went out to our advisors and said, “What charities do you work with?” and I was blown away. You talk to the advisors, and they do charitable-organization work where they’re helping the charities themselves save money, whether it be through insurance planning or wealth management planning. The one that we have multiple employees in Austin involved with through a committee, as well as some of our owners, is the City of Hope Foundation.

Webber: One of our fastest-growing solo [advisors] was in last week. He said one of the best things he did — he's in Texas, Austin, actually — was to create a client advisory board. The clients drive where his charitable dollars go.

--- Read Helping Clients Be Charitable Is Good for Advisors’ Business: Foundation Source on ThinkAdvisor. 

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