The narrow-margin independent broker dealer business is facing a huge challenge: the growth of the hybrid RIA model. This hybrid model has cut IBDs’ bottom lines and crushed profit margins for some of their largest advisory practices.

“IBDs are grappling with their ability to maintain profitability in supporting large OSJ and hybrid practices, and whether they can justify the ROI in retaining them,” said Dennis Gallant, president of GDC Research, which provides research and consulting services to the financial-services industry.

Hybrid advisors typically own their own RIA and custody many of their fee-based assets outside of their broker-dealer. They do commission business through an IBD and rely on it for technology and compliance resources.

However, more advisors are opting to place customer assets with outside RIA custodians instead of using IBDs’ costlier corporate RIAs, and that puts IBDs in a bind: Unless they offer their advisors an RIA platform, the advisors may bolt and set up their own independent RIA or join an existing RIA.

“RIA platforms at IBDs are primarily defensive in nature,” said Kenton Shirk, director at Cerulli Research and head of their intermediary practice.

Rise of Third Parties

Many of their largest and most successful advisors crave what they feel is the enhanced objectivity of using third-party custodians like Schwab, Fidelity, TD Ameritrade and Pershing. For others, this signifies that they’ve arrived as consultative, fee-based advisors who are not beholden to one platform.

Plus, most advisors feel that these RIA practices are worth more than those at IBDs, because there is a broader universe of potential buyers.

IBD practices often are sold within their broker-dealer so that the buyer doesn’t have to repaper their accounts. RIAs, though, can be purchased more easily by other using the same custodian. Banks or serial aggregators are potential suitors, too.

IBDs recognize these advisor perceptions and compete for them by touting the prowess of their RIA platforms. For example, Commonwealth Financial Network describes itself as “the largest privately held RIA independent broker-dealer.”

Yet reversing the advisor viewpoint that RIAs are paragons of unbiased advice as opposed to advisors who do both commission and fee-based business is a tough, uphill slog. Fee-based business has been awarded a halo by both regulators and by broker-dealers themselves.

Down, Down, Down?

Some data from Cerulli Research is instructive. The return on equity at IBDs was 96 basis points in 2011. It dropped to 79 bps in 2016. These numbers underscore the serious profitability challenges that IBDs face; the growth of the hybrid model may be but one factor.

Hybrid assets have grown in market share to 8.8% in 2016 from 6.2% in 2006. Once advisors become hybrids, they typically continue to shift more of their assets to outside custodians. Cerulli reports that in 2016, hybrids placed 60% of their assets with outside custodians, from 57% in 2012.

To counter this threat to profitability, last fall, LPL announced two new policies. First, new hires with less than $50 million AUM will be required to use the corporate RIA. Second, advisors who place assets with some outside custodians will pay a fee of 5 basis points.

(LPL says it had about 420 affiliated hybrid RIAs with some 5,200 advisors and $113 billion in advisory assets vs. $160 billion in advisory assets on its corporate platform as of Dec. 31, 2017.)

But another curve ball was thrown at IBDs by a recent FINRA proposal. It would no longer require IBDs to monitor assets their advisors place with outside custodians and would not allow them to charge for the compliance costs associated with these assets—representing a big potential hit to their bottom lines.

Still, it’s not all doom and gloom for IBDs. About 65% of hybrid practices plan to stay with their broker-dealer, because they are used to servicing clients with a mixture of fees and commissions. They also value the compliance support and technology provided by their broker-dealer.

These advisors don’t want to worry about audits or keeping track of required regulatory filings. In addition, they like access to turnkey technology and don’t want to spend time tracking industry innovations and weighing potential upgrades.

Concerns about cybersecurity also encourage advisors to tap into the resources of a larger organization. Advisors who leave to set up their own independent RIAs are typically those who want to be full-fledged fiduciaries and are willing to take on the extra responsibilities to make that happen.

What’s next? It’s clear that as more IBD advisor assets shift to the hybrid model, firms have their work cut out for them to ensure acceptable levels of profitability and advisor loyalty.

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Mark Elzweig is an executive recruiter who has worked in with advisors at wirehouse, regional and independent firms for three decades.