Across the country, registered rep employees of national broker/dealers daydream of chucking it all — the scripted days, the morning squawk box — and going off on their own. But how far do you go? You can become an independent contractor rep by affiliating with an independent b/d (IBD). You run your own business and clear through a b/d — and keep a higher percentage of your production — but you still have to follow general rules of conduct, and are limited to the products and services offered. Or you can go all the way — become a registered investment advisor (RIA), earn advisory fees and keep everything beyond what you pay out in expenses.
But which is right? How independent do you want to go? And which is the best model for keeping the most of what your business generates? Obviously, with independence come a host of burdens — regulatory, financial and psychological.
“The key decision you need to make is whether to go as an RIA versus working with a b/d,” says Philip Palaveev, a senior manager at Moss Adams, a consultancy. “The latter has a better safety net, as you get more support, more compliance management, more turnkey solutions — a greater variety of technology and know-how.” The RIA model, by contrast, “has a lot more flexibility. Being an independent advisor means having full control over client relations, and it means having a full stake in owning the bottom line.”
Reps thinking of taking the RIA route “need to ask whether they are really entrepreneurial-spirited — do they have the wherewithal to run their own business?” says Michael DiGirolamo, head of financial services at Raymond James Financial Services, which provides clearing and custodial services, as well as financial products, to planners, money managers and advisors with fee-only businesses. “What type of services are you going to need from your custodian?”
You can break down independence into two broad categories. The first is aligning with an IBD (such as a Commonwealth Financial Network, Royal Alliance or LPL Financial Services). Advisors at IBDs act more like traditional reps — licensed to sell financial products of all kinds, and are paid by commissions and fees on those transactions. They hold a Series 7 license, must be affiliated with a b/d and are regulated by the NASD and the SEC. Strictly speaking, these reps are only allowed to offer financial advice that is “incidental” to their client transactions.
“Independent” advisors can actually become employees of the IBD, deriving earnings from a mix of fee-based and commission-based revenues (the breakdown is typically 60 percent fees and 40 percent commissions, according to Moss Adams). The drawback is that by aligning so tightly with an IBD, an advisor does not have a complete say in what products to offer and, more critically, the IBD will keep a percentage of an advisor's production, albeit much less than what a traditional b/d would charge.
The other category is more purely independent — becoming a RIA and registering with the SEC (filing Form ADV). RIAs actually cover a wide range of investment professionals, from money managers who control billions of dollars in assets to one-man advisory firms, dispensing investment opinions to individuals and (often working out of their own living rooms and garage offices).
Can You Say Fiduciary?
RIAs do not broker the sale of individual securities and cannot charge clients for a transaction like a Series 7 rep would (although many retain their 7s). RIAs, while sometimes picking individual stocks and running a client's portfolio on a discretionary basis, are compensated for their services on a fee basis. Of course, they can assess fees in different ways, like hourly charges or an annual fee based on the size of the client's portfolio. RIAs are hired to give advice, and while they may manage money or trade on behalf of or buy products for clients, they, as the cliché goes, “sit on the same side of the table” as their clients. RIAs, then, are often totally independent, with many allowing their Series 7 licenses to lapse. They are, therefore, unaffiliated with any b/d. RIAs generally have one of two licenses: a Series 66 (for RIAs who still hold Series 7s) or 65 (without Series 7s), and are regulated by the state and/or the SEC, depending on their size.
There is a sense that ranks of RIAs are on the upswing after a period of stagnation in the early 2000s. One reason: A growing number of high-net-worth clients are now favoring RIAs. A survey by the Spectrem Group in 2004 found that high-net-worth households are now more likely to use an RIA than use a wirehouse, a dramatic change from just three years before. In 2001, more than 35 percent of high-net-worth households used a wirehouse, while only 30 percent used an RIA. In 2004, about 45 percent used an RIA, compared with about 30 percent using a wirehouse. The past few scandal-plagued years for Wall Street's key brand names have sown disillusionment — about 25 percent of the affluent investors that Spectrem surveyed have moved a portion of their assets out of their financial services firms in the past two years, due to “lack of trust.”
That said, there is a wide variety of stops along the way from being essentially a commission-based employee of an IBD to a purely fee-based RIA. Raymond James, for example, offers a host of points along the indie spectrum for advisors to choose from. An advisor can choose to become a full-blown employee, an independent employee working off-site, an independent contractor or a fully independent RIA, using Raymond James primarily for filing paperwork.
Randy Carver, a Mentor, Ohio-based advisor who has been affiliated with Raymond James for 15 years since he left Edward Jones, likes the variety of choices. “Raymond James has all sorts of flavors of affiliations,” he says. “You need to find a model that makes sense.”
The Big Question
The main question for many a rep is simple: Can I achieve the type of volume and payouts that the top wirehouse brokers do if I go independent? After all, Registered Rep.'s annual list of the top 50 advisors tends to be dominated by pros from the wirehouse side.
DiGirolamo, for one, thinks that more RIA groups are going to infiltrate the top tier in the next few years. “I think that's where the trend is going. We are seeing more large advisors [who are] thinking of going independent now looking at the RIA side.”
The path to higher payouts in the independent spectrum is straightforward — the more truly independent you go, the more revenues you keep (though you also have to deal with more expenses. About 45 percent on average of an RIA's revenues are eaten up by overhead costs, according to Moss Adams, which recommends that RIAs try to cap expenses at 40 percent). The less independent you go, the fewer expenses you have, but the tradeoff is that your b/d will get a larger piece of the payout.
To get a sense of the payout difference, Moss Adams was commissioned by Schwab, the top RIA firm, to compare the average revenues and expenses of the IBD and RIA models with those of a typical wirehouse (using Morgan Stanley's publicly available asset-based payout information as a basis model). The findings seem to indicate that an RIA takes a far greater chunk of the revenue than his wirehouse counterpart, and that while the IBD model is relatively comparable to RIAs on the low end of the scale, it becomes less lucrative the larger the practice.
For example, in a $500,000 practice at a wirehouse, an advisor would only keep 38.5 percent of the total revenues — netting roughly $192,500 (see table on p. s12). By contrast, an RIA would net $274,242 from the same total, and an advisor at an IBD would net $267,016. All that a wirehouse has going for it in this model is much lower expenses — where overhead is $221,008 for an RIA, and $178,709 for an advisor at an IBD, it is a mere $5,000 for someone ensconced in a wirehouse.
The payout difference is even starker in a higher-volume example. In a $3 million practice, a wirehouse rep would only take home $615,000, compared with an IBD-affiliated rep's $868,267 take. Here is where the IBD and RIA models begin to diverge: In this scenario, the RIA takes home a whopping $1,009,507 net.
It's a compelling argument in favor of becoming an RIA for Schwab to make, and the firm has a large stake in increasing the RIA market further. According to Boston-based Cerulli Associates, Schwab has the largest part of the $1.6 trillion U.S. RIA market, with $353 billion in assets under management by fee-based advisors in 2004, compared with Fidelity Investments' $128.6 billion.
In some cases, getting a bigger chunk of the payout can make a huge difference. Take the Golub Group, a San Mateo, Calif.-based RIA with $240 million in assets under management. Co-founder Michael Golub had been working for Hoefer & Arnett, and his team was grossing more than $1 million in revenue from $180 million in assets under management. However, Hoefer & Arnett was taking the lion's share of the revenues. Golub and his team became RIAs in December 2003, and 15 months later they increased client assets under management by over 30 percent. More importantly, Golub and his partners, not Hoefer & Arnett, now get to keep the revenues. The comparison is skewed, wirehouses point out, because RIAs and other indies are responsible for everything from advertising to hiring a computer guy to paying your employees — stuff the wirehouse pays for.
Not So Stark
It's not that stark a difference between the IBD and RIA channel, some analysts and advisors say. Paul Lally, at financial advisory firm DAK Associates, who focuses on wealth planning and portfolio management, says the distinction has blurred over the past few years. “There is a lot of noise in the independent channel, and it's hard for an advisor from the wirehouse world to decipher what would be the best fit for his practice,” he says. “When everybody is relatively the same, how do I differentiate?”
Raymond James' DiGirolamo says he has seen advisors move across the spectrum after going independent. “People come in with the idea of migrating,” he says. “When you are at a wirehouse, you may feel you need compliance support and for part of your book to be commission-based. But I've seen advisors thinking, ‘I'm mostly fee-based now and in three to five years I'm going to be totally fee-based.’ Then you might migrate to other parts of our platform.”
Each stop on the spectrum has its drawbacks. For example, if an advisor flees a wirehouse to avoid merger-related politics, he is still not immune from the effects of consolidation. Rob Wright, at Schannep Investment Advisors in Tucson, Ariz., went independent and joined First Allied. But in January, Advanced Equities acquired First Allied and has been integrating the firm into its financial services group, which also includes Round Hill Securities, a California-based independent b/d. The experience has not been ideal, Wright admits.
“We're suffering through some facets of the merger,” he says, and what concerns him is that Round Hill's policies, in some cases, are different from First Allied's, and if Schannep doesn't want to contend with this new regime, it could prove costly and a huge time commitment to move client accounts.
Many advisors who moved to IBDs say they are happy they did. “The key is support. The more I get, the better I look to clients,” says Lynn Allen, founder of Atlantic Investment Management, an Annapolis, Md.-based firm affiliated with LPL. “I ended up with LPL because of their technology and research. I want to make things more seamless to my clients. You have to ask what kind of support is being offered. Does it ever stop? That relationship needs to be ongoing.”
Research, for example, is of a far higher caliber than Allen could have provided on her own. “I'm not a CFA — I'm the conduit between the client and the CFA,” she says. Rather than presenting her client with her own research, Allen says she can call on LPL's chief investment officer, and President Reagan's former economic advisor, Lincoln Anderson. “I like having the ability to call up Lincoln Anderson if I need to. It's very powerful to be able to tell clients that,” Allen says.