Back on February 15, Michael Kitces posted an interesting think-piece called “Reinventing the Broker-Dealer Business Model to Survive a DOL Fiduciary Future.”  In it, as the title suggests, Kitces raises questions about the ability of BDs to adapt to a world in which all “advisors” only deliver investment advice to their clients. 

He concludes by stating (spoiler alert): “The bottom line… broker-dealers are facing a form of existential crisis, as the evolution of financial advisors from selling securities products to actually getting paid for advice raises the fundamental question of why it’s necessary at all for an advisor to affiliate with a broker-dealer intermediary to facilitate the distribution of those products…And while some broker-dealers may be able to make the ‘shift’ from product intermediary to a bona fide advisor support platform, it seems increasingly likely that many simply aren’t positioned to survive (much less thrive) in an advice-centric future.”

Michael’s analysis has some validity as far as it goes. His suggestion that the likely success of DOL’s new fiduciary rules, although they only apply to retirement accounts (specifically rollovers into IRAs), are a harbinger of the future of the whole financial services industry is probably correct. If the full force of the securities industry, along with its political and media allies, couldn’t stop the DOL, a fiduciary standard for all retail brokers seems inevitable. 

Yet I’d suggest that Kitces doesn’t go far enough, on at least three points:

  • The need for securities sales
  • the difference between wirehouses and independent BDs and
  • the effect of technology on independent advice.

Consequently, the future may look a bit different than Michael predicts. 

First, Kitces seems to have overlooked the real business of major brokerage firms: to raise capital for businesses by underwriting new issues of their stocks and bonds, and more recently, packaged products, such as mutual funds for fund companies. Because competition between brokerage firms to underwrite these lucrative offerings is fierce, a major selling point for potential underwriting clients is the speed with which a brokerage firm can “sell” a new issue of securities. That’s why brokerage firms have both retail and institutional broker forces. I’ve heard that a major brokerage firm, such as Wells Fargo Advisors with its 15,000 or so employee broker force, can “guarantee” selling out a new a stock offering in as little as one day. 

The point is that while sales is a very different activity from providing “advice,” it’s still a very important function. The raising of investment capital from institutions, mutual funds, hedge funds, and retail investors is an extremely competitive business—and consequently requires salespeople to “represent” each issuer.

Consequently, it seems very unlikely that the institutional or retail sales forces of major wirehouses will be converted to “fiduciary” advisers. It seems to me a more workable solution would be to legally separate businesses that “sell securities” from those that “provide investment advice” (not unlike the way the Glass-Steagall Act separated lending banks from investment banks).

That way investors would have a clear choice between a brokerage firm that will sell them securities or an advisory firm that will provide them with fiduciary advice. 

The so-called independent BDs are in a different business.

Rather than underwriting securities offerings, IBDs simply facilitate the sales of existing offerings: mutual funds, ETFs, insurance securities, real estate and, sometimes, stock and bonds. And instead of employees, their advisor reps are “independent advisors,” who primarily offer financial advice, and therefore will likely fall under the inevitable broker fiduciary duty. In this new world, broker-dealers’ challenge will be to justify the 10% to 40% of advisor revenue that they keep, as compensation for support services and regulatory oversight. 

“Broker-dealers are facing a form of existential crisis,” wrote Kitces, “as the evolution of financial advisors from selling securities products to actually getting paid for advice raises the fundamental question of why it’s necessary at all for an advisor to affiliate with a broker-dealer intermediary to facilitate the distribution of those products.”

While Michael is on the right track here, he appears to be unwilling to draw the obvious conclusion: Why in the world would a fiduciary adviser share potentially millions of dollars in AUM fees when he/she could move their clients to a custodian, and keep it all? The answer, of course, is that they won’t.

And that these relatively small BDs will be able to provide “support services” that are so much better than what custodians offer they justify a large portion of advisory revenues is unlikely, to put it mildly.

For the past 30 years, digital technology combined with the Internet has been rapidly increasing what independent advisors can do in their own offices and decreasing their need for BD support. Today, as far as I can see, the only reason for BD affiliations is that they are required by law.

If Kitces is right, that a fiduciary standard for all retail advisors will be the end of securities commissions, and I believe he is, it will also spell the end of non-underwriting broker-dealers.