2017 Career Guide: Financial Services Explained

In response, NAPFA was considering changing its focus from “fee-only” to “fiduciary” advice, and asked a number of industry observers what we thought of the idea. (The NAPFA folks proved to be ahead of the curve when four years later, the Dodd-Frank Act popularized the concept of fiduciary advice; more recently, the Department of Labor made it a national conversation with its Conflict of Interest rule regarding the fiduciary status of advisors while giving retirement advice.) At the time, I told the NAPFA board that I thought the concept of a “fiduciary” was both too legal sounding and too complicated for most investors to grasp. Instead I suggested the term “independent advisor” to differentiate sources of truly client-centered advice.

While NAPFA did not take my suggestion, they did heed my advice (and undoubtedly that of many others) and passed on the fiduciary nomenclature. In the years since that meeting, a majority of brokers have embraced managing assets for a fee, making them fiduciaries when advising on client portfolios, but not fiduciaries when selling the investments that go into those portfolios. They have been able to co-opt this term in marketing and speaking to confused clients, just as they did “fee-only.”

That’s why I still believe that “independent advisor” is the best description to market truly client-centered advice. However, like most things in financial services “independence” isn’t quite as simple as one might think. To be clear, we’re talking about advisors’ financial independence from employers or other firms. As it turns out, some advisors are more financially independent than others. Here’s a breakdown of advisor independence, along with a breakdown of how client-centered advice can be affected at each level.

Employee Advisors. At the bottom of the independence scale are brokers at the large brokerage firms: Merrill Lynch, Morgan Stanley, Wells Fargo Financial Advisors, UBS. The brokers at these firms are W-2 employees, so there’s no confusion about whom they are working for. Their salaries, bonuses, forgivable loans, promotions, offices, staff support, entertainment allowances, client referrals and payout percentages (the portion that they get to keep of the revenues that their clients generate, which typically range between 25% and 50%) are all controlled by their employer.

Since the primary business of these firms is underwriting (creating) securities such as stocks and bonds, and investment vehicles such as mutual funds and hedge funds for outside client companies, the primary mission of their brokers is to sell these securities to investors. Consequently, these brokerage firms have considerable amount of influence over what — and how much of it — their advisors recommend to their clients.

Independent Broker-Dealer Advisors. On the next level of independence are advisors who affiliate with so-called “independent broker-dealers.” These BDs are called “independent” for two reasons.

First, unlike the big Wall Street firms, they don’t underwrite securities to be sold. Instead, they are simply conduits for their clients to buy and sell securities. The second reason is that instead of being employees, these brokers own their own advisory businesses.

They affiliate with their BD for regulatory oversight and for back-office services and technology that they couldn’t afford on their own. The BD can still exert some degree of control over their affiliated advisors: primarily by determining their payout percentages, which typically range from 40% to 90%. On $1 million in annual commissions and AUM fees, that’s a difference of between $400,000 and $900,000.

Even though these independent BDs don’t underwrite investments, they do have financial arrangements to market the products of mutual funds and other investment firms, all of which can render the advice of their affiliated advisors less than financially independent.

Registered Independent Advisors. Finally, at the top of the independence spectrum, we have registered independent advisory firms. These firms are advisor-owned RIA firms that derive their revenues solely from charging a fee on their assets under management (AUM) or flat retainer fees paid by their clients. Their clients have accounts at custodial firms such as TD Ameritrade or Schwab. These firms and their advisors are full-time fiduciaries under the ’40 Act, without affiliations with other financial services firms.

Industry observer Michael Kitces has pointed out that some of the custodial firms do offer technology support and other services at reduced costs to some of these firms, which can create conflicts of interest. Yet the dollar amounts of these perks appear to be quite small, and most RIA firms today work with multiple custodial platforms to get their clients the best pricing while reducing any outside influence.

As a result of this range of financial independence in the advisory world, and the confusion it might cause among investors should the notion of “independent advice” gain the same success that “fee-only” and “fiduciary” have achieved, it will be important for truly independent advisors to clearly differentiate themselves in a meaningful way.
I suspect that this can be accomplished more easily and effectively by RIAs than advisors at the other two levels. How? By simply stating that these financially independent advisory firms do not take revenues from any source other than their clients. Period.