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Is it possible to keep some of my legacy commission business?

A common misconception advisors have when considering the Registered Investment Advisor (“RIA”) model is that they have to already be 100% fee-based before they could make such a move. Such a belief is entirely inaccurate.  There are a number of solutions available for (RIA) advisors to either continue being able to offer/receive commission products – typically trail revenue, and/or there are available solutions in which the advisor can formally move away from the commission arrangement, but not jeopardize any other part of the client relationship in the process.

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Full Transcript:

Is it possible to keep some of my legacy commission business if I were to transition to the RIA model? That is today’s question on the Transition To RIA video series, it is question #30.

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

On today’s question we’re going to talk about something that comes up in many conversations I have with advisors and I would tell you, a lot of advisors simply don’t realize this is even an option. It’s certainly worth a video to talk this through.

As an advisor right now maybe you already are 100% fee-based at whatever firm you’re at. Maybe you’re at one of the large traditional wirehouse type firms and you have over time converted your book to where you are literally 100% fee-based. That’s a perfect scenario to move into the RIA model.

But maybe you’re not at 100%. Most people aren’t at a full 100%. Maybe you’re at 95%. If so, there’s reasons you might want to consider this. It’s actually worthwhile – part of what we’re going to talk about on today’s video – anyone in that 60%, and certainly more so 70%, or higher that are already fee based, it’s worth still having a conversation to understand your options with the RIA model.

You might only be 70% fee-based or 80% fee-based, there’s a misconception out there that….”unless I’m 100% fee-based there’s no option for me in the RIA world.” That is absolutely incorrect. If you’re even as low as 60%….but call it, 70%, 80%, it’s absolutely worth that conversation. Which then leads to “what would I do with that remaining 20% or so that’s commissions?”

This is a typical example of an advisor I might talk to that he’s maybe doing (for example) $800,000 in fee-based revenues coming in, and they have about $100,000 in commission revenue. For an advisor that’s really made the move to more fee-based in that capacity, usually that commission piece at that point is not so much new business, it’s mostly trails coming in on legacy positions. That could be C share mutual funds. Maybe it’s a smaller client or smaller account and at the time it certainly made sense to put them in a C share and they’re content, and everything is fine there. And the C shares are still paying a trail out to the advisor.

Or maybe it’s variable annuities. Maybe the advisor doesn’t have any desire to necessarily do any more new variable annuities, but there is a good amount out there that are paying trails. In my example, it might be that advisor is $800,000 already fee-based, the $100,000 is mostly trail type situations.

That can be hard to walk away from. If it was $800,000 in fee-based and $8,000 in commissions – for a whole host of reasons that I help advisors think through, in that case – you do need to put a lot of thought to….”I probably should walk away from that $8,000. If I can’t convert that to some sort of fee-based arrangement – the lion’s share, the $800,000 is fee-based.” $8,000 by itself is not worth necessarily trying to work through a solution, that I’m going to talk about today. In some cases it won’t even be an option.

I realize that your level of commission business can reach a point where it’s not some simple no-brainer to walk away from. Even if you don’t want to do any new business – or maybe you do, maybe you do want to have that as an option – but to the degree you have a sizable amount of legacy commissions, it’s usually trail business coming in. I realize you might want to say….“What are my options?” That’s what we’re going to talk about here.

What I would say a lot of advisors don’t realize is that there is a pathway here of how to do this. Let’s use our example of that advisor that’s about $900,000 all in. That’s $800,000 fee-based and $100,000 (mostly) legacy trail commissions.

An option for that advisor is to go ahead and set up their own RIA. They’ll move the $800,000 under the RIA, the fee-based assets. Then for that remaining $100,000 – which we could argue is certainly large enough to not want to walk away from, and certainly the advisor probably feels that way – so one of the options out there is there are entities that are set up that are often referred to as RIA-friendly broker-dealers.

These are broker-dealers that literally this is their business model. They established their broker-dealer with the idea that they want to partner with RIAs. With our advisor, the $900,000 advisor, that solution for them (the RIA-friendly B/D) would be to say….“advisor, you go ahead and start your RIA. We’re not going to have anything to do with that and you put your $800,000 in fee-based production under that RIA. You then can separately become a registered rep of our broker-dealer. It’s essentially a limited purpose broker-dealer, we’re going to do that $100,000 in commission business with you. Our whole existence as a firm is to accommodate this exact situation.”

Now, when you’re set up that way and you have your RIA here and your broker-dealer here….as the RIA, everything is generally the same. All of the topics I’ve talked about on all these videos. You will see 100% of your advisory fees on the RIA business. And over here, it is more of a typical broker-dealer type arrangement. Usually with payouts similar to independent contractor type broker-dealers. They usually are not employee models that have this accommodation.

For the commission business, you will get a payout on that, in this case that $100,000. They usually have traditional payout grids for that. If you’re only going to bring them $50,000 business that’s different than $300,000 of business. So there are payouts….but it’s usually more on that independent contractor type payout range of, call it 80% or higher, depending on the size of your production.

A lot of advisors don’t realize that they can put this together where it’s….”I can essentially get 100% on my fee-based business and I can still get my commissions, and I can get a pretty healthy payout on that.” As yes, it is a payout. The broker-dealer will retain some of that because obviously, they need to cover their costs. They are a for-profit businesses, so they need to have margin built into there as well.

This is absolutely a solution available to advisors though to go ahead and set this up. Like I said, there’s specialty purpose broker-dealers – I’m more than happy to help walk you through who some of those players are. There might also be other broker-dealers out there that on a one-off basis might be willing to make this accommodation as well. But just know there are these RIA friendly broker-dealers, they exist out there in the marketplace.

That’s the option at a high level. I wanted to go through a couple of specifics on it though. First one of note, and this is more of a technical thing, but it’s something to be aware of. If you set up this arrangement, know that the commission activity has technically nothing to do with your RIA. Your RIA will still be a standalone RIA in the traditional sense of providing only fee-based business. It will be the broker-dealer under which you will be offering the commission-based business.

In that set up, you’re wearing two hats. Sometimes it might be one hat with a client, maybe it’s the RIA hat with a particular client….and the broker-dealer hat with another client. Then in some client’s case, you might have a need for wearing both of those hats.

When you’re opening a fee-based account you are wearing your RIA hat and you are opening that up under the RIA. When you open a commission account, even if it’s for the same client, if you open a commission account, you are formally wearing your registered rep hat of that broker-dealer. You would have your Series 7 with that broker-dealer. So to be clear, it is a complete separation of those two. Your RIA is not offering commissionable products. It’s not the RIA that is providing that, it’s the broker-dealer at that point.

This is a classic example of what you often hear of as a “hybrid” set up. The tough thing with the word “hybrid” is I’ve seen that used in so many different capacities. I’m of the belief there’s not one true definition of hybrid.

If anyone starts talking to you about a “hybrid solution”, or you’re seeing an advertisement for some firm….”we offer hybrid solutions for advisors,”….you have to dive into that and ask….”what exactly do you mean by a hybrid solution?” One could even argue that if you’re at a wirehouse firm now and you have fee-based and commission accounts, because you’re technically under the corporate RIA of the wirehouse and you’re under the corporate broker-dealer of the wirehouse, that some people could argue….“well, that’s a hybrid solution.” You can offer fee-based and commission.

By default though, that is not the “hybrid” scenario most people are referring to. They’re more referring to this idea of having your own RIA and you keep 100% of that, then you have a broker-dealer solution. But the “hybrid” term is used a number of ways. I would always caution you if someone starts talking about hybrid, make sure you understand fully what they’re describing. This is an example of a hybrid set up that you might hear about out there.

The other point I’d make before I get into some pros and cons of all this is these RIA-friendly broker-dealers, they do generally have minimums. So that example I gave at the beginning, if you have $800,000 in fee-based and only $8,000 in commission business – normally my advice would be you need to find a way to walk away from that. I’ll give you some examples of how to do that.

But for some reason if that was you and you wanted to hold on to that, these RIA-friendly broker-dealers are not going to accommodate you for $8,000 a year in trail production. If you think about it, they’re only going to take, give or take, call it 20% of that, 80% payout. That’s not worth their while. That’s too small of a relationship. They do generally have minimums. That’s something I help advisors think through.

Not only do you want to make sure this is worthwhile to set all this up for your own situation, it has to be enough to make it worth the while of the broker-dealer as well.

Now, we’ll jump through a couple pros and cons on this. There’s no perfect answer. This is a wonderful solution for some advisors….”this sounds great. I could make more money doing this.” And for a couple other reasons – I’m going to go into the cons as well – you might say….”This is not for me. I don’t want to do this. I want to be solely RIA.”

Each advisor has to look at their own individual circumstances and how might this look and would this be worthwhile doing, and how would this work. That’s one of the main things I help advisors think through is all of these logistics.

I did want to go through some pros and cons of this set up. So a couple pros. Obviously, if you do have that $100,000 trail commission, you get to keep that $100,000. It will go through a payout grid, but that is a way to still retain a healthy amount of revenue coming in each year.

It is an option which a lot of advisors that start thinking about this RIA option have no idea this is even a possible solution. They think they have to walk away from it. So know it is a possible solution to be able to keep your – it’s usually trail revenue that’s coming in.

The next pro, because you have that arrangement with the broker-dealer, they don’t prohibit you from doing new commissionable business. So for instance, maybe there are – a typical example might be variable annuity situations where it does make sense for a particular client that doesn’t currently have a variable annuity to go into a new variable annuity.

I did a whole separate video on this. As an RIA, you can indeed offer insurance. However, it depends on the type of insurance. So as an example, a variable annuity requires both an insurance license and because of the variable nature, a securities license with a broker-dealer as well. In that capacity – I did a whole video on this, if you have any interest in it, look at the video, I go through all kinds of details – but in that capacity, the variable annuity would not be done under the RIA. It would be done on the broker-dealer platform. That’s certainly doable, it’s not for a trail revenue coming in. That’s typically what it is, but you do have the option to do new business as well.

Another example of where that could be – maybe you have a large client that has a large concentrated position and wants to slowly sell that over time over many years. Maybe it doesn’t make sense to charge them (for example) 1% to sit on that particular asset. If you have this “hybrid” set up you at least have some flexibility. Whether you like this idea or would want to do this, but when you have that broker-dealer arrangement you could perhaps say….”We’re going to put the concentrated position over here, and every quarter or month, or whatever it is we agree to, I’m going to sell positions and I’m going to make a commission every time we do a sale until we whittle it down. And after we liquidate the position, we move it over here to the fee-based account and then I manage it for the typical 1%” or whatever it may be. It gives you some optionality as well by having both of these solutions.

That’s some of the pros. Let’s be fair and go over the cons as well. You would be a registered rep of a broker-dealer. That means you still would be under FINRA regulation. A lot of advisors that want to go to the RIA world, they basically want to get away from FINRA, or not necessarily get away from FINRA, but get away from having two regulators.

If you are at a traditional firm now and you’re offering fee-based accounts, and commission accounts, you’re technically under two regulators. The SEC regulates the fee-based portion of that and sets rules; FINRA sets the broker-dealer rules that go with that. You’re as I say, a “slave to two masters”. Some advisors want to get away from that and want to focus on one regulator, one set of rules.

In the case of an RIA, and if you’re above $100 million it would be SEC that is all you have to worry about. So just know, if you do set up with this hybrid solution, you still will have two regulators you’re dealing with. FINRA is obviously on the BD side.

I talked about how the broker-dealer will take a payout on the commission business. Some of these broker dealers will also – not all, but some will – want to take some basis points on the fee-based assets as well. There’s different interpretations of how broker-dealers – these RIA-friendly broker-dealers – apply this. Some consider your RIA as solely an outside business activity that’s completely arm’s length and they do little, to no supervision of it.

Others are more in the middle and say….”We’re not going to get in the weeds (of your RIA), but there are a couple things we want to be aware of. Because you have your Series 7 with us, we feel we have an obligation not only to supervise your commission business, but with some sort of oversight of the RIA business as well.”

There’s two parts to this particular “con”. One is that there is that look from the broker-dealer side into your RIA world. And then for that, some of these broker-dealers will charge you something on your fee-based assets as well. Some do, some don’t.

You shouldn’t necessarily assume though….”I should default to the one that doesn’t charge anything,” because it all comes back to the value that broker-dealer is providing. If whatever they’re going to charge you from a payout and maybe some basis points, if the value they in turn provide makes that worthwhile, that might be better than the value perhaps a broker-dealer that doesn’t charge you anything on the RIA business provides. This is something I walk advisors through to help them understand all this.

The next “con” is this does make it a little more complicated for the client to understand. We’re in the industry ourselves, so talking about RIAs, and broker-dealers, and custodians, and registered reps, and Series 7s, that’s vernacular that we know, we understand how this works. But arguably the investing public out there is not nearly as well versed on this as we are.

If you’re solely an RIA, the only thing you have to make sure your client understands is….what are RIAs, why you’ve started one, why the custodian is separate from the RIA, and that the custodian holds the assets. That’s a fairly simple explanation.

If you want to do this hybrid solution, you explain that and then you also have to explain….“so that I can still offer commission products,” or however you want to position it, “I also have a license (Series 7) with what’s called a broker-dealer over here, and they as well use a custodian,” which may or may not be the same custodian that your RIA is using.

It adds a little complexity to the relationship and how it works with the client. The client would get in that case – if it is different custodians – would get a statement from one custodian for the fee-based business and a statement from the other custodian for the broker-dealer business. To the degree this is meaningful and important to the client to be able to have, it’s certainly doable. There’s a reason to maybe go down that path. Just know there is some extra complexity as a result of it all.

The next “con”, is the additional disclosures needed. This is not necessarily a hard thing to accommodate, but there are more disclosures. As your RIA, you would have to put in your ADV that you have this other affiliation with a broker-dealer so that your clients or prospective clients could understand that and be aware of that. That’s something your compliance consultant – that you’ll be working with – will help you get set up, but just know that there are additional disclosures required if you have this set up.

The last piece of this – I did a whole video recently on as an RIA, you’ll have regulatory exams. I’ve actually done two videos. One about what the frequency of those regulatory exams will be, and then the other one is about what can you expect during that exam. To add to that – and I talk about it in those videos – what dictates in part the frequency of how often you might be examined is how the regulators score your RIA from a risk perspective.

A typical example would be a billion dollar RIA will arguably be scored higher than a $100 million RIA. There’s more on the line with a billion versus $100 million. So they perhaps might examine the billion dollar one a little more frequently than the $100 million one. That’s an example.

In the case of this hybrid solution, it does add extra complexity to your practice. Does that arguably score you a little higher in the regulator’s perspective that….”it’s not solely an RIA, they also have a BD affiliation, and so there’s some more complications there.” Does that score you a little higher? I don’t know. It’s ultimately up to the regulators, but it is conceivable that they would. However, even if they do though, it might not be deemed to be much more of a concern and so maybe it really doesn’t move the needle. Nonetheless, something to potentially be aware of.

Basically, there’s no perfect answer with this. I know I downloaded (on you) a bunch of cons about it, but the reality is all of those are manageable. There are a lot of advisors doing this. This is not a fringe thing that advisors set up. Quite a few advisors out there have this arrangement where they have an RIA and they do have this broker-dealer affiliation. It’s absolutely doable. There’s absolutely a process for it. The compliance consultants will help you get it set up.

There’s no perfect answer. It’s more what makes sense for you individually. To drive that home, I realize it’s easy for someone like me to sit here and say….”Mr. or Mrs. Advisor, this would make your life easier and cleaner if you walk away from all that trail business and just do your RIA,” because I’m not the one with the skin in the game. Now if we’re only talking $8,000 in production (for example), I would tell you, you probably do need to walk away or find a solution for those assets. It’s not going to be worth your while. But that number will reach a point where that’s not such a clear cut decision.

I’ll give you an example. I know of a specific advisor, and this was a couple of years ago, she walked away from about $200,000 a year in trail commissions. Obviously, there would have been a payout on that so not all $200,000 would have gone to her pocket, but you can do the math. It would still be a very healthy amount, yet she was so ready to not be wearing two hats and under two regulators. She wanted to be solely an RIA, entirely on her own, did not want anything to do with a broker-dealer relationship, and literally walked away from $200,000 a year in trail commissions.

It’s a personal decision. That (the example I gave) is a little rare. Usually you see people walking away at something much less than that, but know that it does happen at all levels.

The last piece on that is there are firms now, if you say to yourself….”I want to walk – say it’s $30,000 in commission business – it’s not worth me doing all that, but what do I do with that $30,000?” Where that gets especially tricky – if you have a client now at your traditional wirehouse type firm and the only business they do with you is that commission account, that’s a simple solution. If you’re not going to continue with commission assets going forward, you basically simply leave it behind. You don’t try to move it with you when you start your new firm.

There is a typical scenario though where maybe you have a client that has a $1million IRA in a fee-based account that you manage – and you’re absolutely intent on continuing that under your RIA – and they have a $70,000 variable annuity. For whatever reason that VA came to be years ago and they’re happy with it, there’s no reason to change that. The question is, even if you’re comfortable walking away from the trails on that, if you leave the variable annuity behind, the problem is your prior firm will pounce on that client and they will try to then win the rest of the relationship and win the $1million account, and bring that back. You generally don’t want that competition.

There are now a few firms popping up that essentially raise their hand and say….”move that $70,000 variable annuity to us. We will technically be the registered rep on it, we will technically have ownership of that position. But we will commit to you, advisor, to not solicit the client for any of their additional business. We will absolutely honor and respect the fact that you are the primary advisor on that, you have the million dollar relationship. We are basically housing this asset.” And for that, they’re going to sit there and generally make a trail from it. It’s a good thing for them and it’s a good thing for you.

So be aware there are some solutions like that where you could walk away from the business without jeopardizing the client relationship. I’m more than happy to walk you through what some of those solutions are.

Bottom line, this (a hybrid solution) it’s absolutely doable. Do not think you need to be 100% fee-based already to consider the RIA model. You could be close and willing to walk away from some amount of commission business. Or you could be in that – you probably need to be in the 60% plus range (fee based) at least currently to even be considering these options. Surely 70% or higher, it’s absolutely worth thinking through the different solutions available to you.

It’s a common misconception, advisors think….”I have to be 100% fee-based or I can’t do this.” That’s not the case at all. There is a solution like I talked about here and I’m more than happy to help walk you through how it might apply to your specific situation.

With that, like I said, I’m Brad Wales with Transition To RIA where I help advisors just like you understand everything there is to know about why and how to transition to the RIA model.

Today’s question obviously, a perfect example of that profile. That conversation I’m having with an advisor where they say….”I’m 80% fees, 20% commissions, what are my options?” This is the sort of thing I help advisors think through. How does it work, what’s the structure like, who are the players involved in these RIA-friendly broker-dealers, why might I consider one versus another? I’m happy to have that sort of conversation with you as well.

If you’re not already there, head on over to TransitionToRIA.com. I have plenty more videos posted. I have some whitepapers. The easiest thing is right there at the top is a contact link. If you click on that, you can instantly and easily schedule a specific date and time for us to connect, have a conversation.

Whether you want to know more about today’s specific question, or you want to begin more of that macro conversation of….”Here’s where I am now in my career, and here’s the type of firm I am at now. I hear a lot about this RIA model. What might that look like for me?” I’m more than happy to begin that dialogue with you.

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

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