As Americans turn to more fuel-efficient hybrid vehicles, a trend toward hybrids in the financial services industry is also emerging. Increasingly, firms, advisors and brokers are establishing practices that manage both commission—and fee-based businesses.

Not long ago, brokers handled investors' commission-based needs, while their registered investment advisor (RIA) colleagues managed their fee-based needs. But in recent years, that distinction has blurred as the two business models, in some cases, have begun merging into one: the dually registered, or "hybrid," market.

Fastest Growing

The hybrid market is one of the fastest-growing segments of financial advisors and firms in the U.S. Nearly three-quarters of all brokers and advisors manage some combination of commission- and fee-based business, according to the 2007 National Financial Broker and Advisor Sentiment Index.

We believe there are multiple causes of this transformation, including the need of brokers, advisors and firms to generate more consistent revenue streams and grow their businesses. In addition, we are seeing a simple, common denominator: to help clients reach their financial goals.

One firm that has successfully adopted a hybrid strategy is Triad Advisors, Inc., an independent broker-dealer that works closely with advisors. "I think the use of a hybrid model in the independent marketplace is in its early stages," says Mark Mettelman, president and chief executive officer of Triad. "We have three to five years of dramatic growth ahead of us on the fee side, especially with new advisors coming into the marketplace."

The dissolution of the Broker-Dealer Exemption Rule (also known as "the Merrill Lynch Rule") has further contributed to the hybrid market's expansion. Originally proposed by the Securities and Exchange Commission (SEC), the exemption rule enabled brokers to function like RIAs—provided that certain conditions were met—without making them subject to investment advisor regulation. In 2007, however, the U.S. Court of Appeals rejected the ruling, and broker-dealers who wished to provide fee-based services were required to register as RIAs.

"The rejection of the exemption rule has helped to define and formalize the hybrid market," says Alois Pirker, senior analyst for Aite Group, an independent research and advisory firm in Boston. "Broker-dealer and advisory firms are much harder to distinguish from one another. It's conceivable that these historically distinct types of wealth management firms will evolve into a single retail investment advisory industry governed by the same regulatory body."

As with any solution, of course, there are challenges to meet and opportunities to seize. While challenges vary depending on the firm or individual, there are some common obstacles that we've seen working in the hybrid market for more than a decade.

Making the Call

The first challenge lies in making the actual decision to go hybrid. This is not as straightforward as one might think.

From Fidelity's perspective, there are three hybrid models that fall between the traditional 100% commission-based and the 100% fee-based models:

• Broker-dealer with Corporate RIA. The broker/dealer has a corporate RIA registration so its representatives can conduct commission- and fee-based business.
• Broker-dealer with an Independent RIA. The broker/dealer supports independent representatives who are RIAs and who conduct commission- and fee-based business.
• Independent RIA using a custodian and a broker-dealer. An independent RIA works with a broker-dealer to support commission business and a custodian to support fee-based business.
  

Complete Spectrum

Whether seeking to establish a practice or join an existing one, which model is best for a given individual or firm depends on a number of factors. Some of the more important considerations are the degree of independence one desires, the level of support needed, the current mix of business and the level of client assets.

We've seen a complete spectrum of business situations in our 25 years of experience in helping brokers, advisors and firms. Among these situations are brokers with sizable books of business establishing an RIA while aligning themselves with a broker/dealer for their commission-based products and needs. Others have preferred to leave day-to-day ownership decisions to someone else and join an independent broker-dealer with a Corporate RIA.

"The biggest challenge in adopting a hybrid model is educating the brokers and advisors, teaching them to be more entrepreneurial and develop customized solutions for their evolving practice," says Triad's Mettelman.

Challenges also lie in managing commission- and fee-based business simultaneously. This means efficiently managing accounts and client relationships involving both types of businesses.