Stretched

 

For broker/dealers who are already stressed, dually registered advisors are a challenge being met in varied ways

 

From Investment Advisor Magazine: June 2006 Issue

 

By Kathleen M. McBride

 

June 1, 2006

 

Broker/dealers today are feeling the pull of many masters.  On one side, what B/Ds can charge customers for services seems to continually decrease.  Tugging at least as hard on the other side, compliance costs are up- way up- twice as much, on average, in just two years, according to the Securities Industry Association.  On the revenue side, the way B/Ds operate is vastly changing in response to representatives demanding new ways to do business, and their clients who are demanding more comprehensive brokerage, and perhaps even investment advisory services. At the same time, regulators are demanding that broker/dealers must supervise any activity that a representative does—whether is it deemed “securities” business or not.  So if a B/D has reps that also are practicing investment advisors, that B/D is on the hook to supervise those investment advisor activities.

 

What is a broker/dealer to do? Perhaps the solutions is not whether, but how, to add investment advisor practices- and the fiduciary relationship that goes along with them- while maintaining the ability to do commission business when it is appropriate for clients.  Larger independent B/Ds may be in a better position to adapt to this brave new world of the dually registered advisor.  For one thing, they are already using their systems and technology platforms to supervise representatives’ activities.  The compliance processes large independent B/Ds have in place may be readily adapted to support the activities of investment advisors.  They may already be providing research and recommendations for the brokerage side of the business.  With their scale, brand recognition, and relationships with regulators, large independent B/Ds may be poised to make the most of dual registration.

 

The effects of moving to what Moss Adams called the “hybrid model” in a study commissioned by Pershing, Dually-Registered Advisors: Opportunity Knocks, are being felt by the firms, their representatives, and customers.  While some independent broker/dealers have made investment advisory services part of their business model for more than a decade, others added IA businesses much more recently.  Early in the game, B/Ds may not have captured a share of revenue from, or even supervised, representatives with advisory practices, but how they certainly do supervise these advisors, and it is rare that they don’t share in revenue.  The B/Ds we spoke with for this article all provide a very high level of support to dually registered advisors including billing, statements, research, various investment and transactional platforms, performance measurement, and compliance.

 

Quite a few broker/dealers mentioned that fees are the fastest-growing part of their business.  Their revenue models include commissions plus fee-based brokerage, and/or fee-based advisory.  Some have flat fees for planning along with fees for assets under management, a model that may work well even when retirees start to withdraw from their retirement accounts.  This recurring fee model can also be more accurate than a commission model when valuing a firm for sale.

 

Many of the dually registered advisors are among the senior, higher-assets-under-management, better producing registered representatives at their B/Ds.  They are not only taking on the responsibilities- including fiduciary duty- of being an investment advisor, there is a contingent that also is licensed to sell insurance. 

 

How successful are hybrids? “In general, if you compare the average advisor who is not a hybrid to the average advisory who is, the hybrids are less profitable than the average,” says Phillip Palaveev, senior manager at Moss Adams and an author of the Moss Adams/Pershing study on dually registered advisory (IA) business through the B/D’s corporate RIA or have their own individual RIA.  That’s about 29% of the NASD’s roughly 660,000 registered representatives. There are 9,022 RIA firms that are registered with the SEC, according to the Commission.

 

 

One of the pioneers in the dually registered world is Cambridge Investment Research, Inc, based in Fairfield, Iowa.  “In the late ‘80s I had a B/D, we were doing about $2 million of business a year, and a lot of it was our two largest offices.  Back then we didn’t supervise that [RIA] business- and we didn’t get paid on it,” says Cambridge’s president, Eric Schwartz.

 

“It’s all relative- 55% of our revenues come from fees, [while] most of our competitors are still in the 10% and 15% range, [though] there are some in the 20% and 30% range, so it is still relatively early,” “more responsive broker/dealer,” but what he discovered was that, “where people needed the more responsive broker/dealer was on the fee side.”

 

They would “call me up and say’ I want to do fee business; I want to manage money at Schwab, and my broker/dealer won’t let me.’ I heard that two or three times, and I went to my lawyer and said, ‘Can I allow that? What are our requirements?”’ This was after NASD Notice 94-44 [which told members that they were still responsible for their reps’ RIA business] came our, notes Schwartz, and “we discovered we could do it, as long as we figured out a way to supervise it, and as long as charged something so we made a profit on it.” He started offering a 95% payout on RIA business done at Schwab, because, “when reps had their own RIA at Schwab we didn’t actually have to process any of the business, we just had to do the supervision of it- so we could give a higher payout on that than we do on our own platform.”

 

That was “a huge breakthrough” for Cambridge.  It formed its own corporate RIA, and “allowed reps to use all our platforms. They can use our RIA or their own; they can have discretion or not have