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As planners outgrow their roots, hard choices lie ahead

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As the financial planning industry nears a fee-only, fiduciary world, we are finally outgrowing our profession’s roots —and for the better. In the process, though, independent broker-dealers will face some important choices about their future business models.

First, some brief history. The financial planning profession was initially made possible by the emergence of the independent broker-dealer business model in the late 1970s and early 1980s, which suddenly gave brokerage representatives a new business option. They could move their licenses from the brokerage firm to the independent BD, operate their own offices and enjoy much more independence and freedom than they did in the bullpen under the supervision of the local branch manager. They could sell the products they wanted to sell, and more importantly, they could provide investment advice in the context of this newfangled thing called a comprehensive financial plan.

Fast forward to today, and it appears that the profession is outgrowing its original facilitator. A growing number of advisors are going fee-only and affiliating with institutional custodians like TD Ameritrade Institutional, Schwab Advisor Services, Fidelity Institutional, Shareholders Service Group and Pershing Advisor Solutions. Hundreds of fee-only firms now have more than $1 billion AUM. The Department of Labor’s fiduciary rule has only accelerated the trend, causing advisors to drop their Series 7 and forego commission revenue, or enter the business as fee-only from the start. Meanwhile, new mark-to-market requirements for non-traded REITs, a growing market of no-load annuities and a seemingly endless parade of new FINRA regulatory hassles are making sales activities less attractive and profitable.

Like it or not, the business model that helped the financial planning profession emerge is in danger of being left behind.

For independent BDs, it’s not hard to read the handwriting on the wall. The number of FINRA member firms has steadily fallen from 5,374 in 2002 to 3,835 in 2016, while the rep count has fallen from 662,311 to 635,902. Fees are clearly the future, and an all-fee planning practice doesn’t need some of the things that independent firms have traditionally provided: a place to park your license, access to commission-based annuities and non-traded REITs, and a compliance regime that fussily inspects every outgoing message to clients as if it may be a sales pitch. Why pay 10% to 12% of your top-line revenues for supervision that is no longer appropriate for your business model?

What to do? I think the independent broker-dealers face some important choices that will determine their future viability.

Their first decision is what kind of advisor they will cater to in the future. In my mind, there are two choices.

First, the firms who have increasingly emphasized fee business, like Cambridge Investment Research or Commonwealth Financial Network, could opt to secede from FINRA altogether and instantly become the equivalent of a national RIA. I talked with one broker-dealer executive about the idea, and he said that if FINRA was out of the picture, he could instantly remove more than 100 compliance staffers and drop home office overhead dramatically. That means a lower haircut for affiliated advisory firms. The national RIA model would attract advisors and brokers who want to be ahead of the fiduciary curve and still collect residual trail commissions. It would charge a monthly fee for practice management advice, national educational conferences, technology and wholesale custodial services, and that all-important sense of community, which may be the most important service that the best broker-dealers offer their advisors.

The potential disadvantages: lose reps who prefer sales, and have to compete on value vs. price with independent custodians.

The other option could be called a sales house: a FINRA-affiliated haven for the reps who are determined to remain in sales, and say “to hell with the fiduciary trend.” A broker-dealer network like Cetera Financial Group would specialize in servicing sales agents, and stock its shelves with the annuities and non-traded REITs that have been their bread and butter for decades. In the short term, this could be a huge recruiting bonanza from reps who are tired of being told they need to charge fees for their advice. The firm would provide a compliance overlay to keep the reps out of trouble, deliver excellent sales and marketing assistance and lead generation, and enjoy protected revenue margins from the independent custodial competitors.

The potential disadvantages: a diminishing market share as sales reps age out of the business, less predictable income and greater potential for arbitration claims related to unsuitable recommendations.

Whichever direction the broker-dealer chooses, there will be another branch in the decision tree. Much of the value of a home office lies in the technology that is made available to the affiliates. How these firms choose to add value with their technology suite would distinguish them in the marketplace perhaps more than any other service-related issue.

For independent BDs, it’s not hard to read the handwriting on the wall. The number of FINRA member firms has steadily fallen from 5,374 in 2002 to 3,835 in 2016,

I think there are two possibilities. One avenue is to create a proprietary technology suite, which would give the firm more control over the feature set, tighter integration of the CRM, asset management and financial planning components, and a certain stickiness in that it might be harder for advisors or reps to be lured away and have to start their tech stack from scratch.

But there would be disadvantages to going down this road: notably higher internal expenses to build and maintain the in-house system, and the possibility that the legacy software they build would fall behind the dynamic evolution of independent software solutions.

Follow the other branch, and the national RIA or sales house would commit to creating and maintaining superior integration of off-the-shelf technologies. This would certainly be a less expensive approach than the proprietary technology suite, and it would provide a potential recruiting (though not retention) advantage: it would allow the fiercely independent affiliated offices to make their own software choices.

But there would be disadvantages to this approach as well. How do you keep up with all the new emergent competitive technologies in the software space? Another, perhaps bigger disadvantage is that hanging your hat on great software integration would give you less differentiation from the independent custodial competition, who have all been offering off-the-shelf integration technology for years, and who have large annual budgets to apply to the issue.

I suppose the final option is to do nothing and hope the whole fiduciary fee-only movement is just some kind of passing fad. Anecdotal reports tell me that the independent custodians have recently been growing again, as they recruit affiliated advisors and reps from the ranks of the wirehouse firms—people who want to escape the restrictions on the products they can recommend and what advice they can give.

Sound familiar? The difference is that now the BDs are competing with increasingly large independent advisory firms for those brokers, and the fee-only firms have a better story to tell regarding where the future is going.

Like it or not, the business model that helped the financial planning profession emerge is in danger of being left behind by financial planning’s progress toward becoming a real profession. As we head toward an increasingly fee-only, fiduciary world, I hope I’ll see the independent broker-dealers making their contributions to that future professional ecosystem.

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