Why the Breakaway Broker Exodus Hasn’t Happened
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A number of industry observers, including me, have been predicting a wave of defections from the brokerage model. For years, we’ve expected that captive brokers who are employed by larger wirehouse organizations will, in droves, flood the independent world like refugees seeking independence.
In my book, The New Profession, I predicted that this flood of ex-brokers (what the trade press calls “breakaway brokers,” and the brokerage firms have characterized as “rogue brokers”) represents one of the biggest growth opportunities for independent advisory firms. If you can help these people acclimate to a non-sales culture, they can bring significant existing business plus valuable marketing skills to your business environment.
This mass exodus hasn’t happened, much to the chagrin of us prognosticators, and I know why.
The brokerage firms have done a terrific job of characterizing independent advisors as rogues who are trying to evade the FINRA compliance regime, and convincing their reps that they will go broke if they leave the comfortable marketing umbrella of their wirehouse brand. Beyond that, these firms provide brokers with a comfortable office, sometimes a staff, and an integrated suite of software capabilities. Leaving that environment entails a lot of complexities like finding your own custodian, creating your own tech stack, hiring staff, renting an office and setting up a phone system.
There is, of course, a support network of custodial transition teams who will help brokers figure out those things. But those teams are experts in their own firm’s solution.
The missing ingredient, until now, was a holistic source of unbiased advice about all various options.
I’ve been reading over a white paper written by independent consultant Brad Wales, entitled, not-totally-catchily, “11 Ways the Economics of the RIA Model Are Superior to Other Advisor Affiliation Options.” Wales spent 18 years with Raymond James giving practice management and strategic advice to advisory firms around the country before going independent himself. Today, his TransitionToRIA firm offers exactly that holistic consulting that the marketplace has been missing. Wales has taken a stand: The independent fee-only RIA model is the best landing place for brokers who are looking for greener pastures.
It isn’t surprising that brokers are not sophisticated about their options outside their member firms. “Imagine that you’ve been an advisor for 20 years with Morgan Stanley or Merrill Lynch,” says Wales. “You could be a fantastic financial advisor, but unless you’ve taken the time to look at the mechanics of how a different affiliation option works, you're not going to be expert enough to know if it’s a real opportunity for you.” Wales lists the typical questions he hears, and has created videos on his website to answer them:
Would I have to be 100% fee-only?
How big do I have to be to start an RIA?
Would it be possible to keep some of my legacy (trail) commission business?
Why should I consider starting my own RIA?
Won’t I have to pay for doing my own compliance as an RIA?
What level of bottom-line income can I expect to earn as an RIA?
The white paper addresses this last question in some detail and the analysis is interesting. Wales asks brokers what they’re currently earning, and they immediately cite their payout grid: 45%, or 40% of whatever they take in. But then he shows that most professionals working in the employee model are earning meaningfully less than that. They may be getting 0% on all accounts below $100,000 or $250,000 (the number varies from firm to firm), and chances are that threshold number has been incrementally growing throughout the broker’s career. How long before it reaches $500,000 or $1 million?
In addition, many compensation plans don’t pay anything on the first 3% of production every month. Other plans say that if the broker doesn’t have a financial plan with a particular client, those revenues go on a lower grid rate. Brokers might be required to refer X number of banking products to their clients, or provide X number of leads to the banking team. If not, it will pull the numbers down.
On the other side, there might be a few extra percentage points added for things like retirement plan contributions the firm is making on the broker’s behalf. The point is that the actual percentage is much harder to calculate than the simple published payout grid rate.
After you read the fine print, you find that your percentage payout is lower than you thought.
Is the RIA model any better? One of the videos on the website says that many RIA firms can buy all the services that the brokerage firm provides – the office space, the computers and tech stack, perhaps an office assistant and all the compliance oversight – for between 35% and 40% of the total revenues the firm is collecting. The “payout,” in other words, jumps to 60-65%. More importantly, this is largely under the control of the new RIA owner. He or she can rent a fancy office or work out of the home. He or she can buy a fancy tech stack or go with software that offers fewer features.
RIA firms can deduct business expenses, while brokers cannot. They can set up their own retirement plans, with higher contribution limits than could be offered under the employee model. An independent firm enjoys operating leverage, which means the office and salary costs are largely fixed. If you grow your revenues by 20%, your expenses will go up, but not by 20%.
When the broker starts her own RIA, she is creating business value which can be monetized at or before retirement, in a succession plan or outright sale to an outside buyer. These payments will be taxed as capital gains rather than the ordinary income a broker receives under a typical “sunset” arrangement.
Finally, the white paper addresses the marketing limitations imposed by brokerage firms under FINRA sales-oriented regulations, which Wales says will come up frequently in conversations with his frustrated broker clients. “I was talking with an advisor at a very large firm,” he says, “and he wanted to create YouTube videos for business development reasons, to demonstrate his expertise.”
The firm decided not to allow it. “This is a perfect example of the lowest-common-denominator approach to compliance,” says Wales. “They didn’t necessarily have any concerns with him, specifically, doing it. But they felt they had no way to get their hands around thousands of advisors doing it.”
The service that Wales provides starts with a lot of listening, so he can fit the broker into the best of four possible models. The first is to stay put. “I have talked with employed advisors who are netting $500,000 a year,” he says. “I can show them that they could be making $700,000 a year through their own RIA and have all kinds of additional flexibility. But then they might come back and say, ‘You know, that sounds great and all, but at the end of the day, I’m making a wonderful living. I show up at 9:00 AM and leave at 4:00 PM, and I don’t want to deal with all the headaches of running a business.’”
Despite all the predictions from pundits like me, Wales says that there will always be brokers who prefer the employee model. Because there are talented advisors who prefer that somebody else handle the business end of things, the employee model will never go away completely.
What are the other options? “They could start up their own RIA,” says Wales, “and work with someone like me who will help them figure out the various vendors they need: the right custodial fit, the technology and compliance.”
But Wales also finds, in his initial conversation, that some advisors are looking for a softer landing. “Suppose you don’t like the idea of having a lot of responsibility for back-office or middle-office functions,” he says. “That’s where I might bring a Dynasty into the conversation. Maybe they should partner with one of the bigger firms that provides those services as part of the affiliation.”
And then there’s the softest landing of all: wrapping their book of business into an existing independent RIA firm. Wales notes that some of these firms are enterprise-sized, and would view this tuck-in as a routine part of inorganic growth.
Who does he recommend there? “I have talked with some of the bigger ones,” says Wales. “Mariner is in the marketplace with an intriguing offer. But there are smaller ones, still in the multi-billion range, like Goss Advisors down in Louisiana. WealthShield has an interesting solution. But the reality is,” Wales continues, “that there is not a single growth-minded RIA where, if I said, ‘Hey, would you be interested in me introducing advisors to your firm and maybe having them bring over their book of business,’ that they would turn me away.”
Trails and accounts
What about some of those other questions? What if a broker has a significant amount of trail commissions? Is there a way to keep that revenue while still running a fee-only RIA?
“There are ‘RIA-friendly broker-dealers;' that's what they call them in the business,” says Wales, “You can partner with them and keep that trail commission business.”
Such as? “Purshe Kaplan Sterling Investments may be the most well-known for that model,” says Wales. “They say, ‘Bring your trail commission business to us, set up your RIA at arm’s length, and we will consider it an outside business activity. We might do some degree of oversight, but if you aren’t doing any new commission business, it will not be nearly what a typical independent contractor in the independent BD relationship would be getting.’” He also mentions Private Client Services in Louisville, KY as a similar option.
Alternatively, the broker could divest herself of those commissions gradually over time. “Johnstone Brokerage will take you in in that capacity when you set up your RIA,” says Wales, “and they will buy out your commission trails. They’ll give you 18 months of trail payments as the purchase price, spread out over the 18 months, and they commit to servicing those assets and clients.”
The servicing promise addresses another reason why a broker might want to hang onto those trails: Johnstone pledges not to do anything to try to get any wallet share from the broker’s clients. “If you leave the variable annuity behind at your former firm,” says Wales, “it will get reassigned, and someone will try to poach the rest of the relationship.”
Another issue to consider is whether the assets that the broker is managing can be transferred, intact, to one of the independent custodians. Suppose, for example, the broker has recommended a lot of separately-managed accounts that the firm has been pushing, because it has revenue-sharing agreements.
“With mutual funds and ETFs, nine out of 10 times the same investments will be available on the other platform,” says Wales. “But with SMAs, that’s a typical part of your due-diligence process. You could hit roadblocks.”
When Wales brings a broker to a custodian or an RIA, the custodian (or the RIA’s custodian) will evaluate the investments that the broker’s clients are holding, a process that Wales describes as a ”scrub.” Normally, this will turn up minor problems like the brokerage account fund share class might be different than what the custodian is handling, which might lead to taxable sales and repurchases. Alternatively, the fund company might permit a share class exchange.
If there are a lot of SMAs in the mix, then the transition could hit a roadblock. “But typically, you can find a solution,” says Wales. “You could use a third party like Envestnet that has a huge universe of SMAs.” If the money is with a proprietary manager or an in-house SMA, the broker could quietly begin repositioning the assets into more mainstream ETFs or funds before making the move to independence.
Compliance and technology
Wales also addresses the often-asked compliance question in his consulting work with brokers. “A lot of times, there’s the fear of doing your own compliance and of not having it provided by the broker-dealer,” he says.
Interestingly, Wales says that most of the people he’s talked with are motivated to leave the FINRA compliance regime and go completely fee-only, and that is the niche situation that he concentrates on. But they have only a hazy idea how much more liberating it is when you aren’t assumed to be a salesperson in all your interactions with the public, and when you can finally talk with your clients like an adult. Wales will offer advice on who to select as an RIA compliance consultant and the things that the new firm can expect in SEC examinations.
“There’s a certain anxiety about the incremental cost of compliance,” says Wales. “Do I have to pay for my own compliance? I remind folks that they’ve been paying for it all along; the firm just hasn’t ever given them an itemized bill for it.” He adds, “A lot of times I find that they’re paying for more compliance than they need. For example, any large firm has enormous anti-money laundering (AML) teams, so if you want to open an account for a foreign client, there are all these safeguards and steps to take. But what if you never want to work with any foreign clients? You’re still contributing to that pot that has nothing to do with you. When you start your own RIA, you can tailor compliance specifically to the services you’re offering and the clients you’re serving.”
This takes the conversation back to which of the three RIA options a broker might prefer. “I’ve had people tell me, I don’t want the SEC to be knocking on my door,” says Wales. “I want them to knock on Mariner’s door.”
Wales also walks brokers through their tech options, and this, too, helps narrow the choices. Some will be easy; if they fold into an existing RIA firm, the tech stack is there and waiting for them. If they affiliate with one of the national RIAs, they may have choices: Orion or Black Diamond, Redtail or Salesforce.
Some brokers want to go independent, but still have an all-in-one solution like what they’re accustomed to working with at their larger firm. “If they’re used to plug-and-play technology,” says Wales, “then there are some fully-integrated tech solutions available on some of the platforms.”
His former firm, Raymond James, will provide custody services to fully-independent RIAs. “And part of that proposition is that they offer a fully-integrated tech solution,” says Wales. “It is the same tech solution that is available to the employee and independent contractor advisors.”
Still others view that kind of arrangement with a high degree of suspicion. “I talk with people who say, ‘I don’t care how great that technology is, I just don’t want my technology to be wedded to a custodian,’” says Wales.
Wales will help brokers who are setting up a new RIA sort through the most popular choices in each tech category. In his experience, the ex-broker will start with client performance reporting software, and then add on CRM, planning and other programs depending on whether they’re compatible with the custodian that was selected. Because these ex-broker RIAs tend to be larger than the average independent RIA firm, Wales will often recommend the larger name brands – Orion, Envestnet/Tamarac or Black Diamond – for an interesting reason.
“These [new RIA] firms might want to become multi-custodial down the line, for a variety of reasons,” he says. “And that’s really easy for them because Orion pulls it all together.”
How does Wales get paid for his services? “It’s the typical recruiter model, where everything is free for the broker,” he says. “If I guide someone to a custodian or an existing RIA or middle-office provider, and they end up joining one of those firms, that firm pays me a referral fee.”
Pointedly, Wales does not take referral fees from software vendors or compliance firms, which helps preserve his objectivity. “You don’t necessarily have to use a particular kind of technology, or use a lender to borrow money or hire a compliance consulting firm,” he says. “If I was paid by any of those, there could be a bias in me suggesting they consider them.” Taking fees from the firm the broker joins is different, he says, because every broker that leaves the employee model has to go somewhere. “I only get paid by the platform you end up on,” says Wales. “And I try to be transparent about that.”
Some of us pundits and observers would like to know when our predictions are going to come true, when brokers will start leaving the employee model in numbers significant enough to justify our aging predictions.
“I think the wave is picking up speed,” says Wales. “The industry trends are going more and more to the RIA model. I believe there is a market for independent advice to walk brokers through to a solution that works.”
And he thinks that growth-oriented RIAs and custodians will find value in this eventual wave of successful brokers looking for greener and more independent, objective and lucrative pastures. “It will serve the advisor and custodial community to have somebody independent and agnostic about any one solution bringing these people into their world,” says Wales. “So far, the advisors I have connected with seem to appreciate it.”
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