Reality Check

As you might expect, on the productivity side, the wirehouse brokers do have a substantial advantage, at least for the present. While RIAs have steadily increased their productivity to $70 million in client AUM per advisor (compared to $61 million for dually registered advisors and only $18 million for independent BD reps), the wirehouse brokers average some $94 million in AUM each, fully 34% more client assets. And it’s more than even odds that their management fees are higher, too, generating significantly more revenue per advisor. Even though their market share of assets is falling precipitously, we also read media reports almost daily of wirehouse brokers who are breaking away to go independent or of mass layoffs at one firm or another. The net result of this corporate belt tightening may be that broker ranks will fall faster than the share of retail AUM, enabling some firms to maintain their high advisor productivity levels.

Yet, here’s a classic example of where the figures don’t tell the whole story. With their massive overheads, expensive regulatory compliance and top-heavy management structures, wirehouses need that high productivity to generate even mediocre profit margins on the retail side of their business. And with proprietary product sales not nearly what they were in the old days, the profitability of retail brokerage has become increasingly important.

Conversely, independent advice is a much more efficient business model. Advisors who own their own businesses have considerable incentives to manage their overhead and maximize productivity. While they don’t manage as much client AUM per advisor as their brokerage counterparts, they don’t have to in order to generate substantial free cash flow margins. The relatively high profitability of an independent firm is often hidden from the naked eye and from business consultants, as privately held businesses have no incentive to carry their revenues all the way through to their bottom lines. But as far as doing more with less, all one has to do is a quick visual inspection of a large brokerage office in a downtown high-rise versus a modest independent firm in a suburban office park.

Then, of course, there’s the cost of regulatory compliance. Despite the increase in SEC actions against RIAs in the past two years (in part, to offset its bad PR for having muffed the Madoff situation on seven separate occasions and to bolster its request for more funding to increase RIA regulation), the incidence of RIA malfeasance is miniscule compared to investor complaints against brokers. That’s because holding advisors to the standard of simply acting in their clients’ best interests is far more compelling than the rules-based suitability standard for brokers that is often more bureaucratic than client-oriented. Consequently, brokerage firms have massively expensive compliance departments to create defensive paper trails.

The net result is that brokers are far more costly to house, equip and supervise, which is why the brokerage industry—largely through SIFMA—is working so hard to “level the playing field” by dramatically increasing the regulatory burden on independent RIAs, both at the SEC and, if they have their way, through a FINRA takeover of regulation. It’s a last desperate attempt to salvage a top-heavy business model that can’t compete in the current marketplace.

That’s the reality, at least as I read the Cerulli tea leaves. The independent advisory channel has been steadily gaining market share for the past 30 years and recently got a shot in the arm when the big brokerage firms shot themselves in the foot with mortgage-backed securities. As further evidence of the emergence of independent advice at the center of the industry stage, Cerulli found that essentially half of all assets at independent firms are now at RIAs with more than $1 billion in AUM. It’s time for the financial services industry to face the evidence and admit that independent firms are simply a better, more efficient and more profitable way to deliver financial advice.