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Broker/dealers today are feeling the pull of many masters. On one side, what B/Ds can charge customers for services seems to continually decrease. Tugging at least as hard on the other side, compliance costs are up–way up–twice as much, on average, in just two years, according to the Securities Industry Association. On the revenue side, the way B/Ds operate is vastly changing in response to representatives demanding new ways to do business, and their clients who are demanding more comprehensive brokerage, and perhaps even investment advisory services. At the same time, regulators are demanding that broker/dealers must supervise any activity that a representative does–whether it is deemed “securities” business or not. So if a B/D has reps that also are practicing investment advisors, that B/D is on the hook to supervise those investment advisory activities.

What is a broker/dealer to do? Perhaps the solution is not whether, but how, to add investment advisor practices–and the fiduciary relationship that goes along with them–while maintaining the ability to do commission business when it is appropriate for clients. Larger independent B/Ds may be in a better position to adapt to this brave new world of the dually registered advisor. For one thing, they are already using their systems and technology platforms to supervise representatives’ activities. The compliance processes large independent B/Ds have in place may be readily adapted to support the activities of investment advisors. They may already be providing research and recommendations for the brokerage side of the business. With their scale, brand recognition, and relationships with regulators, large independent B/Ds may be poised to make the most of dual registration.

The effects of moving to what Moss Adams called the “hybrid model” in a study commissioned by Pershing, Dually-Registered Advisors: Opportunity Knocks, are being felt by the firms, their representatives, and customers. While some independent broker/dealers have made investment advisory services part of their business model for more than a decade, others added IA businesses much more recently. Early in the game, B/Ds may not have captured a share of revenue from, or even supervised, representatives with advisory practices, but now they certainly do supervise these advisors, and it is rare that they don’t share in revenue. The B/Ds we spoke with for this article all provide a very high level of support to dually registered advisors including billing, statements, research, various investment and transactional platforms, performance measurement, and compliance.

Quite a few broker/dealers mentioned that fees are the fastest-growing part of their business. Their revenue models include commissions plus fee-based brokerage, and/or fee-based advisory. Some IAs have flat fees for planning along with fees for assets under management, a model that may work well even when retirees start to withdraw from their retirement accounts. This recurring fee model can also be more accurate than a commission model when valuing a firm for sale.

Many of the dually registered advisors are among the senior, higher-assets-under-management, better-producing registered representatives at their B/Ds. They are not only taking on the responsibilities–including fiduciary duty–of being an investment advisor, there is a contingent that also is licensed to sell insurance.

How successful are hybrids? “In general, if you compare the average advisor who is not a hybrid to the average advisor who is, the hybrids are less profitable than the average,” says Philip Palaveev, senior manager at Moss Adams and an author of the Moss Adams/Pershing study on dually registered advisors. “The most successful hybrids, however, [the top 25%], are very, very successful, much more so than the non-hybrid advisors.” The report says that revenue per professional in the top 25% of hybrid firms in 2004 was $391,957, compared to $334,630 at other retail advisory firms.

So how pervasive is this dually registered advisor model? As of May 1st, of a total of 211,044 investment advisor-registered individuals (including SEC and state-registered RIAs), 188,344, or 89%, were registered representatives as well, according to the NASD. They may do their investment advisory (IA) business through the B/D’s corporate RIA or have their own individual RIA. That’s about 29% of the NASD’s roughly 660,000 registered representatives. There are 9,022 RIA firms that are registered with the SEC, according to the Commission.

There at the Beginning

One of the pioneers in the dually registered world is Cambridge Investment Research, Inc, based in Fairfield, Iowa. “In the late ’80s I had a B/D, we were doing about $2 million of business a year, and a lot of it was our two largest offices. Back then we didn’t supervise that [RIA] business–and we didn’t get paid on it,” says Cambridge’s president, Eric Schwartz.

“It’s all relative–55% of our revenues come from fees, [while] most of our competitors are still in the 10% to 15% range, [though] there are some in the 20% and 30% range, so it is still relatively early,” asserts Schwartz. Back in 1992, Schwartz’s advertisements to recruit reps stressed “higher payout” and “more responsive broker/dealer,” but what he discovered was that, “where people needed the more responsive broker/dealer was on the fee side.”

They would “call me up and say ‘I want to do fee business; I want to manage money at Schwab, and my broker/dealer won’t let me.’ I heard that two or three times, and I went to my lawyer and said, ‘Can I allow that? What are our requirements?’” This was after NASD Notice 94-44 [which told members that they were still responsible for their reps' RIA business] came out, notes Schwartz, and “we discovered we could do it, as long as we figured out a way to supervise it, and as long as we charged something so we made a profit on it.” He started offering a 95% payout on RIA business done at Schwab, because, “when reps had their own RIA at Schwab we didn’t actually have to process any of the business, we just had to do the supervision of it–so we could give a higher payout on that than we do on our own platform.”

That was “a huge breakthrough” for Cambridge. It formed its own corporate RIA, and “allowed reps to use all our platforms. They can use our RIA or their own; they can have discretion or not have discretion; they can use stocks, bonds, mutual funds, or options in some contexts. We started figuring out ways to say yes to things that most of our competitors were saying no to, in particular what you would call the hybrid model where they have their own RIA.” So how do they supervise such an open architecture? “It isn’t easy by any means,” says Schwartz, but, “of the 50 largest independent broker/dealers, a far as we know, we have the cleanest regulatory history of any of them.”

Schwartz says his top criterion for allowing dually registered advisors to do business on another firm’s platform is whether Cambridge can get a daily download of data as it does on the brokerage clearing side from National Financial and Pershing, to feed through his compliance programs.

Investment Advisory Revival

“Interest in investment advisory activity peaked in the late ’90s, went to sleep for four years, and now it’s coming back,” says Arthur Grant, president of Cadaret, Grant in Syracuse. “In the late ’90s it seemed that more people were actually changing the nature of their relationship with clients–and that there seemed to be more of an outflow of people leaving their Series 7 licenses behind.”

Grant says that at his firm now, and he thinks at other independent B/Ds as well, there are fewer people leaving the brokerage side of the business, and he attributes this partly to the availability of non-proprietary products. “If you are at a wirehouse, you may feel a desire to change the way you do business, and you may look at the RIA business as a way of giving up the yoke,” he says. “In the independent firms, people already feel independent; they don’t feel that yoke pain around their shoulders,” because it’s their own business, and they can run it the way they want to.

Valerie Brown, president of Atlanta-based ING Advisors Network, agrees that fewer dually registered reps are giving up their NASD licenses right now. Dual advisors “with significant assets under management,” have reconsidered, because they are concerned that if they drop the NASD licenses, “there are cases where there is product that is commission-based, that is the right thing for my client, and when I go totally fee-based, I take that option away,” she says. Instead, what Brown is seeing is “true demand from clients for advisory-based relationships where the rep moves into a fiduciary role, and it becomes a fee-based, contractual relationship,” noting “we don’t do fee-based brokerage–we do advisory.” Not only does this make clients happier, according to Brown, but “from advisors’ business point of view, the recurring revenue is attractive, too.”

One Who Got Away

There are times, however, when a dually registered person must strike out on his own. Jeff Bernier, managing director at his RIA firm, TandemGrowth Financial Advisors in Roswell, Georgia, has successfully made the transition from B/D representative to independent RIA. He was a career rep with an insurance-based B/D, but began doing fee-based business and financial planning in the mid-1990s. He made the transition to RIA in two steps, first going from his original B/D to a smaller B/D, Triad Advisors in Norcross, Georgia, a firm that, he says, “really impressed me,” and that embraced the hybrid model. While there, his business went more and more toward fees until only 5% was commission business. At that point, in December 2004, Bernier moved to his own firm and dropped his NASD licenses.

Bernier uses a fee for planning plus a percentage of AUM compensation model, and says he feels “liberated” that now, “I’m serving clients the way I want to be served.” (For more about dually registered advisors breaking away, please see Melanie Waddell’s March 2006 IA column “The Playing Field: Here, There and Everywhere,” available in the Web Extras part of the home page).

The Regulation Issue

When it comes to regulating investment advisory activities that are undertaken by B/Ds’ dually registered representatives, the NASD is customer-centric. “Our job is to protect the customers,” NASD Executive VP Elisse Walter says. “The firm should make it its business to know as much as possible about what else the [representatives] are doing, and I would say that’s true even when you’re going outside this area, and something that’s outside the securities area. For example, a firm may not be legally responsible for an insurance policy that is not a security that someone sells, but they may end up being morally responsible or being found responsible despite that.” Walters adds that B/Ds need to act “prophylactically” in order to “ward off trouble, to ward off litigation–even if they win the litigation. That’s what they should do, and you know, it helps the investor, so it makes us happy.”

The independent B/D giant LPL Financial Services, based in Boston and San Diego, takes a different tack when it comes to dually registered reps and custody. Advisors can either operate through LPL’s corporate RIA, or have an RIA-to-RIA relationship with the firm, according to LPL’s CEO and president, Mark Casady, but “we don’t allow [representatives to custody away] as a matter of policy.” Advisors must keep assets at LPL. He says it is much more complex to supervise what is being done with assets that are custodied away. “If you are licensing the securities part of [an] advisor’s business, and then he or she has assets held away, you are required to supervise those assets held away,” he says.

LPL is unique in the independent broker/dealer world in that it is self-clearing, so keeping assets at the firm and capturing the transaction side of the asset management business is part of the LPL business model, whereas it would be an added expense for other B/Ds. Casady notes that the vast majority of its representatives’ advisory business is done under LPL’s corporate RIA, though some advisors move in with their own RIA and then convert to LPL’s.

The Payout Grid

One place where B/Ds have different models is in the payout of IA business. At Mutual Service Corporation, based in West Palm Beach, Florida, and Scottsdale, Arizona, the fee-based business is growing so fast that the firm has added a long-term program called “The System for Fee Based Success,” which has proved so popular that it was oversubscribed three days after it was announced, at a cost of $10,000 to each participant.

“Our institutional advisory firm’s ADV is structured around activities that take care of a client from a management-of-their-assets standpoint, not estate planning, not the full-blown financial planner,” says John Poff, Mutual Service Corporation’s CEO and president, and the current chairman of the Financial Services Institute, the association of independent B/Ds. About half of the firm’s dually registered advisors have their own RIA, and the rest use the firm’s corporate RIA. “If that’s a strong component of a representative’s offering, we allow them to register their own investment advisory [firm]. We do all the supervision of their ADV and make sure they’re on the up and up with client-handling,” boasts Poff, but he says the firm is not interested in sharing the independent RIAs’ revenues.

At Omaha-based Securities America, they’ve taken the money issue off the table, says Janine Wertheim, president of Securities America’s RIA. “Whether they are an independent RIA or an IA rep of ours they are treated the same way from a pricing standpoint,” she says. Often, she notes, “an advisor will want to be their own independent RIA because from a perception standpoint they feel they have more of their own identity–even though as an IA Rep for Securities America Advisors you still can use your own dba. More advisors than not operate under a different name than Securities America–with the appropriate disclosures.”

Most advisors think that as far as compliance goes, “by far the easiest, from a regulatory and compliance standpoint, is to come under the corporate RIA,” according to Wertheim. “They use the corporate Form ADV, compliance manual, client advisory agreements, Form ADV Part II, and disclosure brochures.” This saves time and potentially many thousands of dollars in fees that individual RIAs would pay to outside counsel to draft and support these documents. Securities America offers this service to their affiliated representatives who want to have their own RIA. “We would actually be their IARD service provider. Securities America charges $2,400 per year for this service, and it includes their audit.”

One thing dually registered advisors need to bear in mind if they think flying solo would be a better option than staying with their B/D is that, “It can make sense to affiliate with a larger organization,” says Cadaret’s Grant, “that can help interpret the rules, that has access to regulators, that has access to the good lawyers to deal with regulatory matters.”

Moss Adams’ Palaveev says where the best dually-registered firms excel is, “they have a focus on the client relationship that allows them to offer multiple products and services to the same client.” In addition, dually registered advisors can capture clients–including small ones–that RIAs generally would pass on. “Where pure RIAs sometimes fall into a trap is, because the pricing is asset based, they equate how good a client is with how much assets they have. The relevant measure is revenue per client, as opposed to assets per client, because at the end of the day, the firm receives the revenue, not the assets.”

Staff Editor Kate McBride can be reached at [email protected].


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