Q76 – Can I Accommodate Concentrated Stock Positions As An RIA?

Also available as podcast (Episode #76)

Apple  |  Android  |  Spotify  |  Amazon  |  Stitcher  |  Audible

Can I Accommodate Concentrated Stock Positions As An RIA?

A misconception I occasionally hear is when a financial advisor feels they need a broker/dealer affiliation (in addition to their RIA) in order to be able to accommodate concentrated stock positions that their clients own.  This is not accurate. There is a way to hold concentrated positions in advisory accounts that provides an experience for clients similar to if they held the positions in a brokerage account.

Found This Video Helpful?

Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice?  I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.

Full Transcript:

Can I accommodate concentrated stock positions as an RIA? That is today’s question on the Transition To RIA question & answer series. It is episode #76.

Hi, I’m Brad Wales with Transition To RIA, where I hope you understand everything there is to know about why and how to transition to the RIA model.

If you’re not already there, head to TransitionToRIA.com where you can find all the resources I make available. I have this entire series in video format, podcast format. I have articles, I have whitepapers.

And as I noted, if you are a podcast fan and you’re currently watching this on video, if you search for the “Transition To RIA Podcast,” on all major podcasting platforms, you will find it.

Again, TransitionToRIA.com has all the resources.

On today’s episode, we’re going to talk about solving for one of the pieces of the pie, if you will, of transitioning your practice to the RIA model.

Something I point out often is that in its simplest form, transitioning your practice to the RIA model is an exercise in asking: What is my current firm providing for me now and how will I replicate that on the RIA side? That might be things like technology, compliance, asset management solutions, etc. How can you replicate that, ideally at a lower cost, and with more flexibility?

An example of a piece that often must be solved for is if an advisor or team has some amount of remaining commission business. A big misconception is that you must be 100% fee-based to move into the RIA model. That is incorrect, as it can be solved for. I’ve done episodes explaining how.

When I’m talking with advisors that have commission assets, we discuss what sort of positions those are. A typical example is where clients have variable annuity positions. Maybe the advisor doesn’t have aspirations to do new variable annuity business going forward, but they have existing positions where it make sense for the client to remain in. And those positions are paying the advisor a trail.

Another commission-based example is 529 accounts.

On a recent conversation I had with an advisor, another example came up which I hear from time to time, and which is the topic of this episode.

The advisor explained they’re at an independent broker-dealer now, and they’ve been looking at options. He came to me to learn more about the RIA space.

I started by asking him where they were in their exploration process, which was by looking at other independent broker-dealer options. I then dove into their practice and came to learn they are overwhelmingly fee-based. They don’t have variable annuity positions, they don’t have 529 positions. The only thing that’s in a commission account at their current firm are concentrated stock positions. They have a few clients that have very large concentrated stock positions.

The advisors are not actively managing the concentrated stock positions. The clients also have more diversified assets that are in fee-based accounts that the advisor is managing those assets. But as an accommodation, they hold the concentrated stock for the clients (in commission accounts.)  With the understanding those positions might sit indefinitely as-is, or they might do occasional sales to diversify down the position.

That scenario is essentially the only reason they’re using commission accounts.

So, I asked him, “When you’re essentially almost all fee-based except for these concentrated stock positions, why are you looking at other independent broker-dealers? You’re effectively 100% fee only for the most part. Why are you not looking more at the RIA model?”  (Which he now was by talking to me.)

His answer though as to why he had been looking at independent broker-dealer options is because he thought he had to because of the concentrated stock positions.  He was under the impression that was the only way he could solve for those positions.

Today’s episode is to talk about how that can be accommodated in the RIA model.

We must start by considering why he is currently using commission accounts for these types of positions. The reason is if he were to move the assets into a fee-based account at his current firm, his firm requires a certain minimum fee be charged in fee-based account. While there might be discounting allowed, there is a minimum that must be charged.

As these are concentrated stock positions, with little to no activity involved, he doesn’t desire to charge on it (nor would the client likely agree to.) But if he were to move it into a fee-based account, he’s required to charge on it.

Another indie-B/D scenario with this is where the firm might charge a set basis points “platform fee” on all advisory accounts. If you want to put the concentrated stock position in a fee-based account, even if you wanted (and are able) to waive your advisor fee, there’s still the basis points that must be charged.

As a result of variables like this, the advisor is using commission accounts for the positions. And when an occasional trade is needed, he makes a commission, but that’s not a motivator for him. It’s because he can’t put it into a fee-based account where he is now.

So, he thought he had to do that exact same thing if he were to move to a different firm, and that’s why he was predominantly only looking at independent broker-dealer-type offerings.

There is a way to potentially solve for this in the RIA space and so I’ll give you an example of how it can be done.

As a starting point, this advisor who (except for the concentrated stock positions) is almost entirely fee-only. So, he could either start his own RIA or potentially join an RIA. I’ve done episodes on both approaches.

For discussion sake, we’ll assume he starts his own RIA. For the non-concentrated client assets, he opens fee-based accounts as usual. Then he opens additional, separate fee-based accounts to hold the concentrated positions. He’ll do two things with those accounts.

First, he’s going to mark the account as non-discretionary.

If you’re not already aware, in the RIA space you are allowed to have discretionary accounts and non-discretionary accounts. The overwhelming majority of RIAs have the bulk, if not all their assets as discretionary assets.

But you also have the ability to mark an account as non-discretionary, and is something you solidify in the advisory agreement with the client.

As an aside, you can look at the ADV of any RIA and see how much assets the RIA has in total, and then specifically how much of it is discretionary assets, vs non-discretionary.

As I noted prior, most RIA’s AUM is discretionary, but today’s example is a scenario where you might also want to have non-discretionary assets.

So, back to our example. You would open the second account, you would put the concentrated stock position in it, and you would make it clear to the client that it’s non-discretionary. This is important because the position is just going to sit there, you don’t want the client to retroactively one day try to claim you should have managed the position better, if for example the price of the stock declined. You’d want to protect yourself and make it clear the account is non-discretionary. So, that’s the first variable.

The second variable is simply don’t bill on it. As an RIA, you do not have to bill on an account. In fact, by default, when you open fee-based accounts in the RIA space, there is no fee. Unless you institute some mechanism to actually charge the fee to the client, by default it would otherwise just sit there.

So, in this example, the way you can solve for a concentrated stock position is: 1) Open a separate account, 2) Mark it as non-discretionary, 3) Mark it as non-billable. Simply don’t bill on it.

If the advisor does that, he has essentially created what he has now in the commission account where the asset just sits there and there might be occasional transactions.

Now, if the advisor does that, how will he be compensated for the concentrated stock position? Right now, even though it’s not a focus of his revenues, he gets a commission from the occasional sale of stock that might be occurring as the client diversifies the asset over time.

For starters, if desired, you could simply raise the fee that you’re charging on the client’s other assets you’re managing to make up the difference.

Or, because you have the creativity to do so in the RIA space, you could do something like charge the client a flat fee of (for example) $2,500 a year related to the concentrated stock position.  For that, you will help handle the occasional transactions that occur in the account.

Further, because most equity trades have gone to zero transaction cost at custodians, there’s not likely to be a transaction charge from it. It depends on how big the position is. If it’s a super large trade, that might be a little different. But as the advisor, implementing something like a flat $2,500 annual fee is available to you.

So, you have some flexibility if you still want to get paid. Or you might even say, “I assist with the concentrated position as an accommodation to my client. I make my revenue over here with their more diversified assets, so I don’t feel compelled to charge anything related to the concentrated stock position.” That is available to you. Again, you have that creativity.

Along the same lines, keep in mind what this means to the custodian as well.

If you have a concentrated stock position sitting on a custodial platform – and quite frankly, it’s the same at the broker-dealer – and it’s just sitting there, and it might be sitting there for years with at best occasional transactions, that’s essentially dead assets to the custodian. When they’re likely not charging a transaction fee, they have no way of generating revenue from that asset. It is just sitting there.

Now, they generally are willing to accommodate this arrangement if everything else you bring to the table makes it worth their while to have the relationship.

In an extreme example – we’ll just make up simple numbers – if you have $100 million in AUM and you go to a custodian that has a $100 million AUM minimum to work with them, but it turns out $50 million of your $100 million is one client’s concentrated stock position, the custodian will have to factor that into the potential relationship because they’re going to make no revenue off of that concentrated stock position.  (Unless the client perhaps borrows against it.)

As an aside, if you want to dive deeper into how custodians generate revenue, I made a separate episode on that.

If you are looking to get a clearing arrangement with a custodian, while you’ll do your due diligence on the custodian, the custodian will do due diligence on your practice as well. They want to make sure it’s going to be a profitable relationship for them.

They will ask for, among other things, a breakdown of your assets. If you have $500 million total assets and you have $30 million in concentrated stock positions, that’s likely not going to be an issue because the remainder of your assets are potentially very profitable for the custodian.

But again, extreme case, if you had $100 million and half of it is essentially a dead asset of concentrated stock positions, the custodian absolutely is going to factor that into whether it makes sense for them to have a relationship with you.

So, just something to think about from both sides. How you as the advisor might be able to generate revenue and what it means for the custodian as well.

To wrap up, this has been an example of the flexibility of the RIA model where unlike a large broker-dealer firm where you likely have stringent policies, you generally can be much more creative on the RIA side.

This is typical of the RIA model. Increased flexibility to make decisions regarding how you can accommodate clients. It’s one of the big advantages of the model.

With that, like I said, my name is Brad Wales with Transition To RIA. This kind of conversation is something I have with advisors all day long. What does your practice look like now? What services is your current firm providing you with, and how could you replicate that on your own, both cheaper and with more flexibility?

To get started, if you’re not already there, head to TransitionToRIA.com. You’ll find all the resources I make, the videos, podcasts, articles, whitepapers.

At the top of every page is a contact link. Click on that and you can instantly and easily schedule a one-on-one conversation with me to get started. Whether you want to talk about today’s topic or anything else RIA-related, I’m happy to have that conversation with you. Again, TransitionToRIA.com.

With that, I hope you found value in today’s episode, and I’ll see you on the next one.

Want To Learn More?

Schedule a Discovery call and lets begin a conversation.

Share this post

Read my free whitepaper!

Get instant access to my free whitepaper on "11 Ways The Economics Of The RIA Model Are Superior To Other Advisor Affiliation Options".
FREE WHITEPAPER:  “Steps To Take Now If You Anticipate Transitioning Your Practice To The RIA Model Anytime Within The Next 10 Years.”