Independent registered investment advisor practices tend to charge lower fees on managed assets than dually registered RIAs, and the former also tended to hire fewer advisors with investment-related Securities and Exchange Commission violations, according to a new report from advisor digital lead generation firm Zoe Financial. The analysis illustrates and highlights ongoing differences between the services hybrids and indies offer clients.
“The Unbundling of Wealth Management” examined information and data derived from Form ADVs of SEC-registered RIA firms. Of the 13,825 RIAs registered with the commission, Zoe Financial excluded RIAs based in other countries, as well as those that do not work in wealth management, leaving 6,845 RIAs. Of these, 2,381 were hybrid RIAs, with 4,464 independent RIAs (1,350 of which were fee-based and 3,114 fee-only).
According to Zoe Financial founder and CEO Andres Garcia-Amaya, the analysis charted the benefits and drawbacks of “bundled” versus “unbundled” services, and he wanted the report’s methodology to be as direct as possible in order to highlight what he argued were disquieting signs about hybrid RIA services.
“It was to try to add data, because otherwise people would say we were just saying it, that it was not systematic. This is something that is systematic,” he said. “If an advisor is incentivized in any way by selling an investment product, they’re no longer just working for the client. Over time, that will show up in the numbers, one way or the other.”
According to the report, 3.05% of dually registered RIAs had some kind of investment-related violation, compared with 0.85% for independent RIAs and 0.80% for fee-only RIAs. The report also cited the research of Nicole Boyson, a Northeastern University professor studying conflicts at dually registered RIAs.
According to Boyson’s research, hybrid RIAs tended to charge higher fees than independent RIAs for similar services. The fee difference for high-net-worth clients (more than $1 million in assets under management) was 1.39% for hybrids versus 1.02% for indies. The contrast for retail clients with less than $100,000 AUM was even more striking; hybrid advisors charged an average 2.19% fee for such clients, compared with the 1.15% average fee offered by independent RIAs. According to Boyson, the divergencies illustrate a conflict that hasn’t been sufficiently addressed to date by regulatory oversight and is unlikely to be addressed by the SEC’s new Regulation Best Interest.
“Just because they’re fiduciaries doesn’t mean they always want to act as fiduciaries,” she said. “If we want to turn all the brokers into fiduciaries, and they all behave in this manner, I’m not sure that’s a huge improvement over where we are now.”
Garcia-Amaya does acknowledge that Zoe Financial is largely invested in the fee-only independent investment advisor space by supplying their clients with digital tools to match them with curated fee-only financial planners. But Garcia-Amaya asserts that the SEC data speaks for itself.
“A hybrid may say ‘you have skin in the game, and you’re talking your own book.’ We’re absolutely talking our own book. I quit my Wall Street career because I want skin in the game,” he said. “We think it’s going to continue in this direction because that’s what people want.”
According to Boyson, the research that culminated in the release of her working paper “The Worst of Both Worlds? Dual-registered Investment Advisers” began with questions about why money was flowing out of broker-sold mutual funds and into institutional share classes. As she details in the report, a 2007 victory by the Financial Planning Association against the SEC vacated the so-called “Merrill Lynch rule,” meaning brokerage firms charging asset-based fees had to register with the Commission as investment advisors.
However, regulations concerning commission-based accounts remained largely the same, leading many brokerage firms to transfer fee-based clients into subsections of the firms that would register with the SEC. But this did not negate the inherent conflicts that already existed (and continued to exist), according to Boyson. Additionally, retail clients were hit particularly hard because so few independent RIAs offer and market services to those clients. The resulting surge in both fee-based and hybrid RIAs continues to this day; according to the Zoe Financial report, the percentage of advisors that were RIAs jumped from 12% in 2005 to 38% last year, while asset market share rose from 15% in 2006 to 27% last year.
However, Ronald Rhoades, the director of Western Kentucky University’s Financial Planning Program, cited numerous reasons hybrid RIAs may find difficulty in the transitioning industry space, including the burden of FINRA oversight, the lack of clarity clients have in regard to their advisor’s status (or lack thereof) as a fiduciary, and the reticence hybrid RIAs may feel about making that clarification clear.
“It’s a highly regulated model, there’s a lot of traps and any time you have a lot of conflicts of interest with a client, that’s likely to come back and bite you at some point,” he said. “They don’t mind paying fees, but they want the advisor to be on the same side of the table with them. I’m not saying fee-based advisors have no conflicts, but (clients) want their advisors to have a minimum level of conflicts. And I think advisors want that, too.”
Garcia-Amaya said that the "fee-only" space remained fragmented and was still in its relative infancy, calling it a veritable "cottage industry." But he still hypothesized that the fee-only approach could eventually grow to become the preferred industry model.
“If you compare them to the wirehouses that still run over a trillion dollars, there’s still a ton of small players, which is what usually happens in a niche and growing market,” he said. “It may not take four decades to achieve consolidation, but I think it’ll play out over the next decade. I think there’ll be more transition from independent broker/dealers into the fee-only space.”
But Boyson was less optimistic. Though she acknowledged she anecdotally saw a “groundswell” of younger advisors interested in mitigating potential conflicts, she did not see a way in which regulation could curb the issues with dually registered RIAs.
“Dual registration is inherently flawed, but there’s no way to change it,” she said. “There are so many dollars and powerful people behind keeping the status quo, that I think that while we can eat away at it and improve it, I don’t see a sea change coming in and improving it.”