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2014 Broker-Dealers of the Year—Scenario 3: SEC Imposes Fiduciary Standard on Reps

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In the in-person roundtable featuring the leaders of Investment Advisor’s 24th annual Broker-Dealers of the Year, we asked them to respond to four common scenarios faced by independent BDs.

Here’s how David Stringer of Prospera Financial, Doug Wright of The Investment Center, Kevin Bachmann of Questar Capital and Eric Schwartz of Cambridge Investment Research responded to the third scenario on how broker-dealers should respond if the SEC were to impose a fiduciary standard on broker-dealer reps.

Scenario 3: SEC Imposes Fiduciary Standard on Reps

Following the lead of the Department of Labor, the SEC mandates that all financial advisors must adhere to the fiduciary standard mandated by the Advisers Act. The RIA custodians have made a concerted push to attract your top producers to the RIA model, offering financial incentives and marketing support. How do you respond?

Doug Wright, The Investment Center: I know [SEC Commissioner] Gallagher said some pretty interesting things about that. He said you may see some movement right before the election on it. I’m talking this fall’s election, not the presidential.

Then you see the back and forth: It’s off the table; it’s on the table; it’s next year, the DOL may be coming out next year with it. It’s all over the place.

Jamie Green, Investment Advisor: I’ve been paying attention to this particular issue for a while, but I’m always interested in what’s going on in Washington. I guess it’s not law, but I guess it’s by custom that the SEC is always half Republican, half Democrat, and then you’ve got the chair at the top who’s obviously appointed by the president, so it’s going to be a member of that party.

It seems like there’s a fair amount of—what shall I call it?—partisan bickering among the commissioners, which I don’t remember seeing before.

Eric Schwartz, Cambridge Investment Research: It may have to do with how much bickering is going on in Congress.

Green: Eric, you already said that you asked a similar question at your national conference. Just about everybody there said they already feel [they have a fiduciary standard].

Schwartz: Yes, I don’t think most advisors in my world, and again, my advisors are a little more fee oriented, a little more mature, perhaps, in their careers than maybe the average [rep, but] it seems like most advisors don’t go, “Oh, okay, I’ve got this fee client, so I’m going to be meeting a fiduciary standard with him. Over there, I’ve get this commission guy, I’m just going to give him a suitability thing.”

The suitability role is enforced by FINRA to be the fiduciary rule right now. When they sue you, they don’t say, “Well, this wasn’t suitable.” They say, “It wasn’t the best investment.” They say, “You should have done this.” In many ways, we’re in a fiduciary world already. The advisors, 98% of our advisors, think that they’re acting in a fiduciary manner for all their clients right now.

The key is how ‘fiduciary’ is defined. There are lots of different definitions of fiduciary and so it depends on which one [is used] and what is going to be the mechanism under which it’s enforced or kept track of that has been the issue.

One of the issues has been, ‘How do you, on a fiduciary basis, do a one-time transaction like putting $2,000 into an IRA where you’re not going to talk to the client for five years?’ Under many definitions of fiduciary, that doesn’t meet the rule. You have to not take them in the first place.

I think the main concern of broker-dealers and of FSI is how they’re [the SEC is] going to define fiduciary and how that’s going to translate to another blizzard of paperwork where people are filling out all kinds of things to show they acted in a fiduciary way.

No one in the industry’s going to get up and say, ‘Well, I really don’t think we should take into consideration doing what’s best for clients.’ It’s a given that everybody wants to do what’s best for clients. But how do you create a law and then put together paperwork that supports that? What does it do to business procedures?

David Stringer, Prospera Financial Services: Yes, how do you codify it?

Schwartz: That’s the big issue that’s really going on. The Department of Labor has one definition of what’s going on and the SEC’s trying to come up with their definition. That’s different than your previous question where you were asking, what if [the SEC did impose a fiduciary standard]?

Green: Yes, that’s what I’m saying.

Stringer: We’re past all that, we’ve figured all that out. Now what?

Green: “Now what?” Or, is it “So what?”

Stringer: I would say that’s it’s probably “So what?” because I think about the services that we provide to our advisors. They look to us for some of these value-added services that are more than just processing a business.

We have a virtual sales assistant program that we offer that’s outsourced services like that. Whether you’re a broker-dealer or you’re an IA, they’re looking to outsource some of these capabilities to a firm like us. We do a lot of back-office support for them.

I just spoke with Amy about HR Essentials, because we have an HR person, who we’re trying to find out how we can support our advisors using and leveraging our…

Schwartz: That’s Amy Webber [president of Cambridge]. We have an HR program for our reps.

The Changing Roles of Broker-Dealers

Stringer: We’ve got some money management programs that we’re doing for our advisors, where we’re taking the signals and we’re providing some tactical money management capabilities for them. There are things like that we do whether they’re an IA or with the broker-dealer. I think what they’re looking for is, “Hey, can you help me run, grow and protect my practice?”

Some of these guys were going to the IA [route] because they were trying to do a regulatory arbitrage. I think that the playing field, over time, will level out. Some of those guys are not going to want to deal with some of the compliance activities.

They’re in this business because they want to support and help their clients achieve their financial goals. They don’t want to do some of the compliance work that we do, no matter what fence they’re on. I would just say, for me, [impostition of a fiduciary mandate) is more of a “So what?”

Kevin Bachmann, Questar Capital: I totally agree: “So what?” from our perspective. I mean, I think the advisors treat their clients the same, as Eric said. They don't put on different hats. They do what's in the best interest of the client, whether that's a commission or that's a fee.

I think they've confused the issue a little bit with the whole “Is it education versus investment advice?." Now the advisors are trying to figure out, “Well, how can I just educate them without crossing that line into investment advice?” That's going to be an issue.

As David said, a lot of [advisors] were going RIA-only to get away from regulation. I think that’s a bigger issue right now. I think they should focus on ‘What are you going to do with these small RIAs that are out there that basically gave up their securities licenses to do that with very little regulation?’ I think that’s a bigger issue.

Green: In terms of the public being protected?

Bachmann: Correct. Whether or not fiduciary versus non fiduciary or suitability standard. I mean, really, [the issue for the SEC is to] get your arms around the independent RIA space.

Green: You mentioned the line between education and advice. Isn’t there something in ERISA about that; that people can provide education, but if they provide any kind of advice, then they’re a fiduciary under ERISA?

Wright: They’re a fiduciary and then they come under ERISA on ERISA accounts.

Green: Of course.

Wright: Education’s broad; advice is to the individual person. You can advise the plan, but once you get down to providing individual advice…

Schwartz: You can have a meeting with 100 people and you can say, “This fund is more aggressive, this one’s more conservative.” That’s education. Advice is when I say, “Well, based on your age… .” Coming back to the other part of this question, we have competition from other independent broker-dealers, [but] we also have competition from the fee-only side of things. That’s been true for a long time.

I’ve been in the middle of that more than most because we’ve been 50% fee-based for 20 years, and we have a lot of assets that were sitting at Schwab and so on, so we’re right in the middle of that.

Regulatory Arbitrage?

Schwartz: An advisor can look around and say, “Gee, I could get rid of my broker-dealer and not have to deal with FINRA. Why don’t I just take the next step?” There’s certainly been a regulatory arm charge, where there’s a reasonable number of advisors that are fee-only to get out from having the heavy regulation on the broker-dealer side that doesn’t exist on the RIA side. As we talked about earlier, 40 some odd percent of all RIAs have never been audited. I can tell you that 40% of my reps have been audited every year [laughs]. It’s a different story.

I think [for] all broker-dealers that is another legitimate [source of] competition that we shouldn’t ignore. Now, some, depending on your business model, may be losing very few or very many to them. We lose somewhere around half a percent to sometimes a percent of our reps a year to fee-only [firms]. That’s a pretty small percent. They tend to be ones that are above average in production, because to go fee-only, you’re not doing $60,000 of business, you’re doing a larger amount of business.

It is a legitimate competition that we have to build a value proposition around as broker-dealers to compete [against], just like we do to compete with each other. I think what you’ve seen in our space is building robust fee platforms, but also building value adds that the RIA platforms don’t offer like Dave and I have both talked about: value adda such as virtual assistants, where you’re doing work for them that wouldn’t normally be done. You’re actually answering their phone or whatever.

In our case, we’ve done a lot of succession planning. We have this Continuity Partners Group, a sister company that 150 of our reps own along with us. Basically, we provide financing and help structure their succession plans, so we’ll finance their junior partner to buy them. We’ll also provide funding to buy practices.

These are things that, again, make you valuable to your advisors to justify why they should pay you, call it 10%. One [reason] is that they don’t have to form their own RIA and deal with that audit from the SEC. If there is a problem, it’s our neck on the line, not theirs. 

If this rule came down to be fiduciary—or say when it comes down; somewhere along the way it’s going to come down—if it took a form that was particularly negative on commissions, which is what the people over at Department of Labor [want], they would like to make it virtually impossible to do any kind of commission product in any kind of qualified money, including IRAs, which is the real big point on that.

If they totally wipe that out, that would give one less reason for some advisors to stay with a broker-dealer because 30% of their business was IRAs and they used to always do American Funds or whatever it may be, and now they’re going to have to go to a fee-only model. Somebody that was 50% commission, 50% fee is now suddenly 85% fee, they have a little less reason to be with a broker-dealer.

Broker-dealers have to work to make sure their value proposition is ready for that.

Let’s face it, anybody who has their model from 20 years ago and are still following that, are already out of business. The good broker-dealers, just like the good advisors, figure out how to evolve and change. Clients still need service, advisors still need somebody to work with. We just have to make sure we are thinking ahead so that we have what they need if some of these things happen.

Even if these things don’t happen, obviously, fees are very important. Any broker that isn’t building compelling fee programs and strong technology to back it up, they’re going to be in trouble whether this happens or not over time.

What Reps Want From Their BDs

Green: Most advisors don’t really have much in the way of a retirement plan for themselves other than they assume that at some point they’ll sell their practice and that will be their retirement plan.

Is that the role of something like an FSI to perhaps come up with those kinds of value adds, some of which maybe you couldn’t supply because you’ve got a 1099 business? We ask reps [in the annual balloting for Broker-Dealers of the Year], “What would you like most from your broker-dealer?” that they’re currently not getting. Retirement, 401(k)s, are something that comes up an awful lot.

Schwartz: You want me to withhold it so you don’t get your hands on it. Is that what you’re saying?

Green: I also know, they want help with, say, marketing, which it sounds like you’re sort of doing as well. You’re independent broker-dealers. You’re not employers. It’s not like you can offer them a lot of services.

Wright: You can offer a lot of services, it’s what they take.

Schwartz: Obviously, you can’t do the 401(k) thing. We’re doing an ESOP, but we can’t include them. They’re not employees. There’s things that you can’t do. But most of the things that advisors want, we can do if we have the budget.

Wright: Which is one of FSI’s things, too: keeping us independent.

Stringer: That’s right. But third-party discounts would be something [we could offer]. Maybe on their own they’re going to get a certain price for FedEx or UPS, but they get better pricing…

Wright: Partner discounts.

Stringer: Third-party discounts, those kinds of things. I think USAA’s probably a leader in that area, where they just provide purchasing power. Maybe FSI has a little bit of the ability to do some of that in the future. They’re not doing it now, but in the future, that might be something.

Schwartz: I suspect some broker-dealers are doing it. I think we have a number of our reps on our FedEx program…

Stringer: We offer a number of discounts…

Schwartz: It’s pretty significant.

Stringer: I’m sure if we went in there and got the pencils sharp and looked all the little places where they can save money because of an affiliation with a group like ours, it might be a pretty meaningful number.

Bachmann: We have a spot where they can go on our website and look at the third-party arrangements that we’ve set up. We’ve got probably a little bit more purchasing power than they do. We’ve let them dovetail into, like [the others] said, FedEx, UPS, Verizon, those types of services.

There are also some firms that will bundle some various benefits. They’re always looking for health insurance, DI, dental insurance. There are a couple of organizations that we refer them to that allow them to purchase it. We’re not providing it, but we’re referring them.

Schwartz: There’s also industry stuff like Morningstar or various things where they get some discount if you work it through our system.

Succession Planning (and M&A) Help for Reps

Green: It sounded like all of you have, as far as financing, [programs] helping reps buy other reps’ practices. Am I right in assuming you all have something like that? Not necessarily financing, but playing matchmaker?

Stringer: My folks, we actually do some financing.

Green: You do. You do the financing yourself, then?

Schwartz: We set up this separate company that did it, as I mentioned before, Continuity Partnership. Right now I think we have about $8 million outstanding on loans for financing for succession plans, acquisitions and business development loans, as we call them.

Deals with the members of that group, if we looked at all the succession plans because they all have succession plans now, the total amount we will be financing if we estimate over the next 15 years would be like $200 million. But some of that’s going to be the same money coming back, because it’s not going to be all one day that we loan all that out.

The thing about financing is you can do it for your few very select advisors. But it is something important. To try to do it on a broad scale for most of your advisors, there’s only so many brokers that are going to be able or willing to commit to that kind of amount.

Our revenues are going to be about $650 million this year. Probably the value of those practices is one and a half times, about a billion dollars. Obviously, if all those turned over tomorrow, that’s a lot of financing. We’re not going to be able to do that. LPL would need $8 billion and they don’t have that either.

We have a double incentive. We’re making money on them as an advisor, and we’re helping them with this. We’re not really doing the loan to make a profit. We would hope that the few bad loans will be not so much as to offset the principal and the interest we get on the good ones.

It’s really about maintaining their businesses, having a great story to tell advisors as to why they should stay or join us, and to solve a problem for them. I do think that that’s going to be a bigger and bigger thing over time in the industry, simply because it’s, we know the demographics.

Obviously, it’s not something that every broker-dealer is going to be able to do, because you only have limited resources. That’s why we set up a separate company, which is self-funding, so that we don’t tax Cambridge so it can’t spend the money it wants to spend on all the advisors that aren’t selling a practice that week. There’s only so many dollars in the pot.

Look for the Broker-Dealers of the Year’s thoughts on “Scenario 4: The Aging of the Advisor Work Force” next week on

Visit the 2014 Broker-Dealers of the Year home page for more coverage. Click here to view the complete rules for voting in the Broker-Dealers of the Year.