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Outgrowing The Series 7

Outgrowing The Series 7

When the 7 becomes more of a burden than a benefit.

In April, LPL Financial lost its second-biggest advisor team. After 17 years as dually registered advisors with LPL, Cleves Delp and his brother Brad took a final step on the route to independence — they transferred the majority of their $1 billion in client assets to Schwab Advisor Services, dropped their Series 7 licenses and became fee-only financial advisors. There was no bad blood, no tension and no hard feelings with LPL. In fact, “out of respect for LPL” the Delp Company, of Maumee, Ohio, will likely custody some fee-only assets there, says Cleves Delp. As for the broker/dealer relationship with LPL? Well, that's something the Delp Company had decided it didn't need any longer.

There is a coveted cohort of dually registered advisors who are dropping their Series 7 licenses and leaving their b/ds behind. These advisors are often veterans of the business; they have a hundreds of millions in client assets and cater to high-net-worth clients. Most of them of them already focus heavily on fee-based business, and have been converting to fees from comissions for years. As the share of revenue they get from commissions dwindles into the single digits, they begin to reconsider the value of the Series 7 license.

There are no official figures that show exactly how many dually registered reps drop their Series 7 licenses and opt to go fee-only, but consultants and industry executives say it tends to happen when the license becomes more of a burden than a benefit to the business. Cerulli Associates projects that 24 percent of dually registered reps who plan to move to a different channel will drop their Series 7 and move to the RIA-only channel in 2010. Scott Smith, associate director at Cerulli, says, “For advisors on the high-end of the spectrum, the dually-registered model tends to be more of a transition than a permanent home.”

What's A 7 Worth?

Dave Hansen is another one of those advisors who is transitioning from hybrid to fully fee-only. He earned his Series 7 license about fifteen years ago and added the 66 in 2005 to become dually registered. His firm, Yellowstone Partners, manages over $400 million in client assets and less than $10 million is in commission-based investment products. Meanwhile, revenue from the commission business makes up less than five percent of the firm's total revenue. This October, Hansen plans to convert fully to fee-only, break ties with his b/d Crown Capital Securities and let his Series 7 license expire.

Hansen says he was hesitant to drop his series 7 at first, but his compliance attorney told him it was only adding to the firm's regulatory burden. “There are lots of hoops you have to jump through when you are a registered broker,” Hansen says. “The broker/dealer has requirements including continuing education classes about anti-money laundering and annual face-to-face meetings with the b/d's compliance department.” Hansen ultimately decided the commission revenue he was getting was not worth the effort required to keep the license — not to mention, he'd now have one less regulator to comply with.

The biggest issue was figuring out what to do with assets in existing variable annuity and insurance products that would be difficult to convert to fee-only products. Hansen decided to make a Series 7 advisor at Raymond James (which serves as his RIA custodian) the so-called “agent of record” for those assets. “So I don't get the revenue on those products but I still get to see the positions in those accounts and what's in there,” Hansen says. He also points out that he can still buy and sell stocks for clients without his Series 7. Hansen says he can set up a fee agreement for any client who holds individual stocks. “I charge the client a flat fee of $1,000, for example, for overseeing it or making any trades,” he says.

In fact, the only products you can't sell without a Series 7 license are those with upfront sales charges. John Furey, principal and owner of Advisor Growth Strategies in Phoenix, says this typically includes insurance products and certain alternatives.

Meanwhile, there are plenty of downsides to keeping a Series 7 license. Some hybrid advisors feel that they are subsidizing other broker-dealer services that they do not use themselves when the b/d takes a cut of their commission business, says Dennis Gallant, principal, Gallant Distribution Consulting in Sherborn, Mass. For example, Delp says his b/d might spend more time and resources on annuities or financial planning software. “We do little or none of that kind of business but that is what a lot of the other advisors in the network are looking for,” he says.

The money Delps was giving to his b/d he now directs to products and services that directly support his business. “One thing we've purchased is technology that allows us to buy individual bonds without a markup, or at least close to the net price,” he says. “Also, we now have access to better research on passive management which is what we focus on in our practice.” He wasn't getting that from LPL.

Meanwhile, Hansen's b/d was taking a 15 percent cut of that $10 million in commission revenue and charging him a fee for his advisory assets held away. “Believe me, it wasn't very easy giving up the Series 7,” he says. “But what I ended up picking up from not sharing revenues with anyone else was far greater than anything else. I found out that I could basically have my cake and eat it too.”

An Interim Step

Dual-registration often serves as a stepping stone to full independence for many advisors. Breakaway wirehouse brokers in particular will choose to join an independent b/d that is “RIA friendly” and allows them to custody advisory assets outside of the IBD. “Over time, as they continue to move more and more of their assets to the fee side of their business, they start thinking about dropping the Series 7,” says Tim Oden, managing director at Schwab Advisor Services.

Through June 30, 2010, Schwab has moved 20 former dually registered IBD teams to the RIA-only channel. That's double the number of teams in the same period last year. The teams are also larger with average assets under management of $124 million — more than 10 percent higher than those who went RIA-only in 2009. “We've seen that the larger a practice becomes and the more assets they move over to us, their need for the b/d affiliation gets smaller. They tend to outgrow the b/d and do more on their own.”

Fidelity and TD Ameritrade do not track how many of their dually registered reps become fee-only RIAs each year. But Fidelity Institutional Wealth Management's Scott Dell'Orfano, executive vice president and head of sales and relationship management, says the reason the dual-registration channel is one of the fastest growing channels is primarly because of the wave of wirehouse breakaways who are unwilling to give up their Series 7 licenses right away. “When they first leave the wirehouse, their commission business makes up a significant portion of their revenue. No one really wants to give that up so quickly, especially when making such a big jump,” Dell'Orfano says. Over time though, that advisor — especially if he's been allowed to custody assets away — is likely to make the full push to the fee-only RIA channel.

The Fee-Only Challenge

Independent b/ds are aware of the incipient trend. “You better believe the IBDs are aware of the number of advisors who might be looking to go fee-only,” says Smith. “Not that the move would go as far as to destroy the independent b/d business model but no one wants to lose an advisor with hundreds of millions in assets.” But what exactly are they doing to keep from losing top advisors whose assets are primarily fee-based? That depends on the firm.

Cambridge Investment Research, Raymond James and LPL already have a solution to the possibility of advisors going fee-only. All three firms allow advisors to operate their own RIAs rather than using the firm's corporate RIA, even though this complicates compliance. Cambridge and Raymond James have had this option available for over 20 years, while LPL just rolled its platform out in late 2008. (Delp says he chose not to custody exclusively with LPL because the offering was immature compared with Schwab and Fidelity when he converted to fee-only.) The problem is most IBDs are still wary about allowing reps to operate under their own individual RIAs. Those IBDs would rather the reps use the corporate RIA where they can keep a better eye on the advisory activity, and possibly collect fees for doing so. That's a dealbreaker for some independent reps, Gallant says.

Take Kathleen Miller, for instance, of Kirkland, Wash. In 2006, after over 20 years as a dually registered advisor with Raymond James, she decided to move to the fee-only channel. With the majority of her $130 million in assets already on the fee-side of the business, Miller decided it was in the best interest of her business to become a fiduciary advisor with no commission business. In fact, the mere existence of her Series 7 made some of her professional contacts hesitant about doing business with her. “I do a lot of work with attorneys and they knew I had a conflict of interest because of my brokerage business. I didn't act on those conflicts of interest but it was easier to just drop the commission business,” she says.

But Miller didn't have to leave Raymond James all together to go fee-only. She dropped her Series 7, and about 80 households, which she passed on to a fellow Raymond James broker, and moved all of her assets onto Raymond James' RIA platform. Miller points out some of the same benefits that Delp and Hansen did. “I can now buy bonds at the institutional level without the markup,” she says. “Before I had to go through the b/d. If there is a local or regional investment my clients want to make, I have discretion to do that without needing to the get the approval of the Raymond James compliance office. And my revenue is greater because I'm not sharing it with the b/d.”

Miller says she would have made the move to the RIA-only world with or without Raymond James as a custodian. “We spent a year looking at our options and analyzed every revenue source we had on clients. It was just time to drop the commission business and the [Series 7] license,” she adds. Why didn't she try one of the other RIA custodians? “I'd built good relationships at Raymond James and like their research,” she says.

But not all IBDs are going to command such loyalty. “At some point, every largely fee-based rep with a big book of business is going to wonder if he needs his b/d or not,” says Dan Inveen, principal and director of research at FA Insight in Tacoma, Wash. “They want to feel that the b/d they are giving up some of their revenue to is providing them with some greater good. IBD executives need to ask if their firms are a business building partner for their top advisors. Are they staying ahead and anticipating those advisors' needs while coming up with solutions? Those are questions every b/d should be asking if they want to stay relevant,” Inveen says.

Philip Palaveev, president of Fusion Advisor Network, in Elmsford, NY, says IBDs must provide benefits to an advisor's practice outside of just regulation and compliance oversight. “That's not enough anymore. Reps who stay with their IBDs after thinking about leaving have decided their IBD provides them a level of scale they can't get on their own. And they're getting resources they wouldn't get on their own,” he adds.

If they're not getting those resources, however, RIA custodian executives are ready to step in and show them the fee-only option. “We know once a practice reaches a certain level of scale the principal of the firm is going to start wondering about the cost benefits of the b/d relationship,” says Tom Nally, managing director at TD Ameritrade Institutional. He adds, “He might be wondering if the firm is better off having one regulator instead of two. We're ready to tell them that TD can provide the white-glove service and technology they need that's more cost effective than their broker/dealer.”

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