B/D or RIA? The Case for the Flexible B/D

The financial services industry has changed radically in the past 20 years. By foreseeing the rise of fee business and building a model to accommodate it, the firm of which I serve now as founder and chairman, Cambridge Investment Research, was able to ride the wave of that change. We grew from $500,000 in revenues 15 years ago to over $250 million in revenues today by leveraging one really good idea: being the fee business experts in the independent broker/dealer space. Rep advisors can accomplish a similar outcome in the next 10 to 20 years if they see the industry clearly and build the right model. But how can you find your “Blue Ocean Strategy,” as W. Chan Kim and Ren?(C)e Mauborgne described in their book of the same name (Harvard Business School Press, 2005), in that uncertain future–one that separates you from the competition and makes growing your business easier and more fun and rewarding?

Developing a compelling model that separates you from the competition requires a clear vision of the future, or of at least one meaningful trend, and a focused strategy to take advantage of that trend. Where do the future opportunities lie? Why do 95% or more of companies run by bright people either fail to see the trend, ignore it, or go in the opposite direction and end up anywhere but in the “Blue Ocean” of huge, largely uncontested opportunity? Before we can answer these questions, we must first identify the trends on our horizon.

Trend 1: The Fee Trend Grows Even Stronger

Fees may have been a secret when Cambridge jumped on them 15 to 20 years ago, but not any more. Most industry experts agree that fee business is an important model, and many think it may soon be the dominant model. Within the next 10 to 15 years, it certainly would not surprise me to see fee revenue accounting for an average of 50% to 80% of total revenue for all independent broker/dealers.

The fee explosion continues for many reasons. Quality rep advisors actually make more money in a more predictable manner over the long term and their practices are worth more when they focus on their fee business. Clients can get better advice and clearer disclosure, and the regulators also seem to prefer fees for their own reasons.

With fees widely acknowledged as a major part of the future, they are no longer a true Blue Ocean strategy. Continued competition will drive down pricing, and customers will demand more value-added service. Also, as regulation follows the dollars flowing into the fee business, it will seriously impact the profitability and ease of doing fee business. However, fees will continue to be king, creating opportunities in the industry.

One obvious opportunity is for rep advisors to become fee experts. They can carve out a niche in which they do fee business better than everyone else in their area. To be a world-beater in this one area, I suggest you outsource or partner with individuals or companies who are world class in other areas such as managing money, performance reporting, or management of staff.

Your broker/dealer may be a good place to start looking for outsourcing opportunities. If your B/D is not world class, then part of your journey may be finding a better broker/dealer. I believe that in the next 10 to 20 years, numerous fee-based rep advisors who make the right choices will have practices valued at anywhere from $10 million to $100-million plus.

Trend 2: Lines Blur Between Vertical and Horizontal Channels

Over the last 30 years, channel blurring has already occurred, but that was just the warm up. Thirty years ago, retail financial rep advisors basically consisted of stockbrokers, insurance agents, banks, and CPAs–all in their separate worlds. Today, independent rep advisors typically have insurance, securities, and RIA licenses and many are CPAs. At an ownership level, many wire firms, regionals, and independents are owned by banks or insurance companies. On the product side, there is more overlapping as well. Joining the early wave of variable life, variable annuities, and index annuities are principal-protected, structured products, and separately managed accounts with downside protection (i.e., insurance).

Just as the lines between horizontal channels will continue to blur, so will the vertical lines between rep advisors, independent broker/dealers, clearing firms, and custodians. Already, some broker/dealers have acquired or “rolled up” advisory practices. LPL is a broker/dealer, a clearing firm for other broker/dealers, and is planning a fee-only institutional platform to compete in Schwab’s world. Pershing and Fidelity’s National Financial are clearing firms for broker/dealers, institutional platforms for fee-based rep advisors, and are also retail firms. Schwab, Pershing, and National Financial all have recently created hybrid models to serve the commission and fee-based rep advisor.

I believe that in the next 10 to 20 years, these lines will continue to blend and the leaders of the next generation will be the companies that offer the most integrated, value-added global solutions to rep advisors and their clients. These will be firms who best integrate the vertical and horizontal opportunities to create a unique, value-added proposition to their partners/clients. This does not mean being all things to all people. It does mean assembling the right pieces from across these vertical and horizontal structures in a unique and integrated way to create their own Blue Ocean strategy and culture. Rep advisors have a unique opportunity today to be a part of this restructuring rather than being on the outside looking in. The future belongs to those who see and participate in the trend.

Trend 3: Regulatory Consolidation and Levelization

As the distinctions between stockbrokers, insurance salespeople, and advisors disappear, the regulatory and licensing side will follow suit. Regulation follows business trends, though usually five to 15 years after the fact. A major consolidation of the over 100 current regulators of financial services in the U.S. is likely. The Financial Services Authority (FSA) in the U.K. serves as a model of consolidated regulation often cited by U.S. regulators and politicians as worth considering. This consolidation trend is well in motion today with the merger of the NYSE and NASD to form FINRA. The next step is likely to be the merger of the Commodity Futures Trading Commission (CFTC) with FINRA. The failure of regulators to prevent, or even seem to notice, the subprime problem until it was too late will accelerate this trend.

In 20 years, I believe a financial rep advisor may well have just one global license that covers insurance, securities, and other investment business, be it fee or commission-based. A few regulatory bodies could oversee one reasonably unified regulatory structure. Companies and rep advisors offering integrated solutions to financial planning, wealth management, investments, banking, and insurance should benefit from this development because such a trend would substantially reduce complexity and cost of regulation for companies currently struggling to comply with multiple regulatory bodies. However, for RIA-only rep advisors, this could be a negative as they are currently “under-regulated” compared to other financial firms, which brings us to our next foreseeable trend.

Trend 4: New Wave of RIA Regulation