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The Curious Plight of the Independent Broker-Dealer

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What You Need to Know

  • The move toward being an RIA is changing the IBD space, which shrank 25% in the last decade.
  • Consolidation, and thus scale, has been key in the IBD arena.
  • Broker-dealers are responding to this evolution by offering more services to outside advisors.

With the emergence of the financial planning profession over 50 years ago came its companion: the independent broker-dealer. At the time, it was a quite an innovative approach for a financial professional to combine insurance and securities to help shape a client’s financial future.

In the late 1960s, you were either an insurance agent or a stockbroker, not both. To accommodate this financial planning movement, however, early innovators in the form of a handful of Midwestern insurance companies created product platforms for independent advisor contractors to operate their businesses in this manner.

Then along came the lucrative mutual fund and similarly packaged products, and it was off to the races for independent advisors and their broker-dealers.

In the go-go years of the 1980s and 1990s, non-Wall Street broker-dealers and insurance companies’ products finally had a distribution channel of their own that they could compensate and control to drive outsize profits. As a result, life was golden in IBD land, attracting all sorts of outside private equity investments and M&A to keep the party going.

The hidden challenge for IBDs with this model, however, lay in its sales-commission-driven structure, which not only tied advisors by regulation to their broker-dealers despite being “independent,” but also opened the industry to nefarious activities led by bad actors and fraudsters. These questionable characters introduced highly profitable packaged products, some of which were Ponzi schemes in REIT disguise, staining the reputation of the industry and putting some firms under.

Despite these inherent problems and bad PR, the IBD model was still so successful that it led to the creation of an entire financial services sector with more than 100,000 advisors, reaching its pinnacle in the early 2000s.

Consolidation Craze

Since then, the IBD space has been in steady decline as technology, low-cost product innovation, new operating models and a regulatory crackdown in the form of FINRA and state security agency fines combined to decimate this once-dazzling financial services segment. The industry shrank 25% in the last decade alone, according to Cerulli.

To compete effectively in the 2020s and beyond, this battered sector must deal with low-cost, huge-reach competitors, such as Vanguard, plus the online discounters offering direct, low-cost retail wealth management services. At the same time, they had to leverage their back-office operations in the form of RIA custodial platforms to support professional, fee-based, human advice competitors, which sapped what little profitability was left.

The result? Industry consolidation over the past decade has become the answer.

This is exactly what has been playing out on the big screen with more gargantuan deals, many of which have been driven by private equity investors’ inevitable need to exit, along with the realization by many insurance company owners that mutual funds don’t have the juice they had in the past.

Just last month, we saw Voya sell its IBD operations to Cetera, while Advisor Group has been on an acquisition tear of its own, rolling in several well-known IBDs in the past couple of years. At the same time, LPL is completing its tie-up with Waddell & Reed, and the list goes on. In a consolidating industry, scale becomes ever more important, and that is where the action has been.

Future Landscape

What will the IBD space look like going forward? Perhaps there are some clues to that future in how the most successful and fastest-growing segment of the wealth space — the independent RIA — has evolved.

RIAs are truly independent, meaning that their fiduciary models and compensation are not tied to any product or platform. They exist as separate entities, charge a fee for services rendered and are paid by the client, not any product. This has the double benefit of allowing RIAs to “shop the street” for the lowest-cost, highest-quality products and services from any provider they recommend to their clients.

By unbundling advice from a product transaction, all sorts of innovations in product structures, cost eliminations and business operations are happening, which are completely rewriting the wealth management playbook.

Most notably, when it comes to technology, RIAs can hand-craft their technology stacks to customize and choose the components they want to operate their businesses. And with RIAs’ outsized growth, there has been an amazing renaissance in the advisor technology segment, attracting investment from some of the tech world’s most successful and influential platforms to feed this growing demand.

In fact, one of the main drivers of the “breakaway advisor” movement has been for IBD advisors to seek out the superior technology they can access as an independent RIA, rather than making do with the “lowest common denominator” technology of their BD.

The result we will see is the “RIA-ifying” of the IBD industry and their platforms, and they will find growth opportunities and remain alive to sustainably support their advisors. Early efforts of the RIA-ifying movement manifested in most of the major IBDs creating RIA custody platforms. This was done as a defensive measure to persuade their breakaway advisors to at least stay with them in a custody relationship rather than move all their assets to one of the formidable RIA-custody competitors and lose the advisor and assets forever.

Game-Changers

But beyond just an RIA custody play, the new paradigm will require these IBDs to change the advisor-client experience they are offering to provide more open architecture, better technology, low-cost products and service models that are necessary for advisors to succeed in a much more challenging and competitive environment.

One example is Cambridge, one of the most respected IBDs in the industry, which recently launched its new advisor workstation and operating platform, Clic, to much fanfare. Leveraging cloud-native technologies to bridge the gap between the back-office systems and integrate those with the most popular RIA applications for financial planning and client portals, Cambridge is providing advisors with choice and flexibility in how they want to consume technology and run their businesses — the hallmark of the RIA model.

Along these same “RIA-ifying” lines, LPL has announced probably one of the bolder steps to invest in the support tools and business services that independent advisors need to stay afloat and offer them to outside advisors.

This is particularly important as the wealth space becomes even more competitive, with new digital players like Goldman Sachs and the impending launch of the Schwabitrade Death Star — soon to be operationalized and unleashed on both the retail and RIA custody stages.

Commonwealth, another respected IBD, also has launched business consulting services to help advisors run better businesses as well as increased the number of firms they support as IARs.

Because LPL and Commonwealth plan to offer these services to outside advisors as well, this is solid evidence that the IBD model does not have to be limited to antiquated, commission-based frameworks. IBDs finally can emerge from their legacy models to become true open architecture platform and technology providers, facilitating advisor success across affiliation channels.

This RIA-ifying movement portends brighter days ahead for this once-glorified but now embattled financial services sector. “Innovate or die,” Peter Drucker famously said, a key theme playing out in real time here in the independent wealth space.

Timothy D. Welsh, CFP is president, CEO and founder of Nexus Strategy, LLC, a consulting firm to the wealth management industry. He can be reached at [email protected] or on Twitter @NexusStrategy.

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