Q62 – Should I Join An Independent Broker-Dealer First Or Should I Go Straight To The RIA Model?

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Should I Join An Independent Broker-Dealer First Or Should I Go Straight To The RIA Model?

I have a lot of conversations with advisors that are in the wirehouse W2 type model, who want to move into a more independent model. Sometimes the default reaction they have is, “Maybe I should go into the independent broker-dealer model first and then move into the RIA model later.” The phrase I sometimes hear is, “Maybe it’s a step too far to go from this employee model I’m in now, all the way to the RIA model.” I challenge that by asking, “Why is that? Why do you feel you need a stepping stone to get to where you eventually want to get to?” On this episode I go into some of the reasons that I am given as to why some advisors feel they think they should go to an independent broker-dealer model first before they get to the RIA model.  And why that way of thinking is usually based on misconceptions.

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Full Transcript:

Should I join an independent broker-dealer first or should I go straight to the RIA model? That is today’s question on the Transition To RIA question and answer series and it’s question #62.

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.

If you are not already there, if you head over to TransitionToRIA.com, you can find all the resources I’ve put out.  This entire question and answer series in video format, or podcast format if you prefer. I also have whitepapers. All kinds of resources to help you better understand the RIA model. Again, TransitionToRIA.com.

On today’s episode we’re going to be talking about if you’re in the employee model now, the wirehouse model now, and you want to make a move to an independent channel, should you go to an independent broker-dealer or should you go to the RIA model?

I recently did an episode you might’ve caught about the differences between the wirehouse / W2 model and the RIA model. I went through several variables with that. I encourage you to check out that episode as well.

So, I thought, maybe I should also do one along the same lines of what’s the differences between the independent broker-dealer model and the RIA model? That’s what we’re going to be talking about here.

I have a lot of conversations with advisors that are in the wirehouse W2 type model, who want to move into a more independent model. Sometimes the default reaction they have is, “Well, maybe I should do the independent broker-dealer model first and then move into the RIA model later.”

The phrase I sometimes hear is, “Maybe it’s a step too far to go from this kind of captive employee model I’m in now, all the way to the RIA model.” I challenge that by asking, “Why is that? Why do you feel you need a stepping stone to get to where you eventually want to get to?”

So, on this episode, I’m going to go into some of the reasons that I am given as to why some advisors feel they think they should go to an independent broker-dealer model first before they get to the RIA model.

“I have commission business.”

The first one is the commission piece. If you look at your book of business, how much is advisory assets and how much is commission assets?  There is a point where it might make sense to go to the independent broker-dealer model not just initially but maybe forever.

A big misconception, and I’ve talked about this on a number of episodes, is the thought that you have to be 100% fee-only to go into the RIA model. That is absolutely not the case. I’ve done all kinds of episodes on this.

One episode I explained the “hybrid” approach. The most recent episode I did was on the different solutions you can use to accommodate commission business in the RIA model.

That said, the fee-based part of your business needs to be the main part of your business. There is no hard line in the sand where if you have at least X percent, then it makes sense (to go RIA) because every advisor’s situation is unique.

If I had to give a ballpark number though, it makes more sense to be around 70%+, give or take, fee-based to make that move. You can go up and down that scale a little bit.

An extreme example, if you are 30% fee-based and 70% commission, you can still thread the needle in the RIA model and there is a way to accommodate that. But the reality is, your practice is primarily commissions. Arguably an independent broker-dealer is better suited to support the needs of a practice like yours.

However, if it’s the inverse, if you’re 70% fee-based and 30% commission, or some increasingly fee-based variation of that, the RIA model becomes more appealing.

So, one decider is what is the breakdown between fees and commissions in your practice both now and then going forward?  Per the latter, I don’t recall ever having an advisor tell me that they hope to increase the commission piece of their practice, and decrease the fee-based. That trend is only going in the other direction.

If you are maybe 60% fee-based and 40% commission now, it’s still worth looking into the RIA model, if your plan going forward is to convert more of the commission business into fee-based.

So that is a consideration. If you don’t have any desire anytime soon, if ever, to give up a large part of your practice as commission-based business, the independent broker-dealer model is perhaps best for you as opposed to trying to jump directly to the RIA model.

“It’s too risky.”

The next counterpoint I hear from advisors is that they (erroneously) think that moving to the RIA model is riskier than the independent broker-dealer model. I challenge them on this.

Under both the independent broker-dealer model and the RIA model, you will be independent. You will have more responsibilities than you likely have now if you’re at a W2 employee type firm. You will likely pay for your own office, pay for your staff, you’ll be a small business owner.

That does bring with it additional risk.  I’m always a straight shooter, independence is not for everyone. There are some advisors where it’s always going to be a better fit to be in a W2 type environment. But for those that are willing to take on the responsibilities and challenges of being in the independent model, then you have to ask, “Is it really any more risky in the RIA model than the independent broker-dealer model?”

The counterpoint I make is to ask, “What’s the worst that could happen?” You have a client sue you?  In the independent broker-dealer model, that risk is mitigated by your errors and omissions insurance, E&O insurance.

Guess what? In the RIA space, you have E&O insurance as well. While it’s not necessarily required, it’s a best practice, many custodians are now requiring it, and some states might be as well.

Assuming you follow this best practice, you will have E&O insurance in the RIA model as well. So why is that riskier? It’s not. You must be able to cover your deductible, but that is the same whether you are in the independent broker-dealer model or the RIA model.  So that extra “risk” off the table.

Another potential risk is what happens if you have a rogue employee that steals from the practice or clients somehow?

If that issue arises, it’s not going to matter what model you are in. That is going to be a serious problem for you and arguably there’s no greater risk associated with it in the RIA model than the independent broker-dealer model.

Even in an employee model, it likely would create very significant challenges for you if one of your team members ended up doing something very bad like that. This is a black swan type risk (i.e. very rare), but the risk of it is no greater in the RIA model, than elsewhere.

I challenge you to consider why the RIA model would be any riskier for you as an advisor than the independent broker-dealer model. Each advisor situation is unique so maybe I shouldn’t paint a broad brush with it, but by no means default to assuming that it’s less risky or safer in the independent broker-dealer space.

I’ll give you a counterpoint on how it’s maybe riskier in the independent broker-dealer space.  You hear this a lot with entrepreneurs or the idea of entrepreneurship, “Someone’s going to leave a job at a corporation and go out and start their business and, oh, that’s so risky to go be an entrepreneur because it might not work out.”

The counterpoint is, the entrepreneur has some control over their destiny.  They hopefully build multiple clients over time and if they ever lost a client, hopefully that’s not going to put them under because they’ve got all these other clients as well.

Whereas if you’re an employee of a corporation, all your eggs are in one basket. If that corporation decides to do layoffs or just fire you or whatever the case is, you’re done, you’re out. You don’t have any say in that.

So, is entrepreneurship riskier when in today’s day and age, there is no loyalty by companies to their employees? They could let you go on a whim’s notice.  There’s risk there as well.

How that ties back to our industry is if you are at a broker-dealer, and particularly one with (for example) 10,000+ advisors, if that broker-dealer feels you now present too much of a risk for them for whatever the reason may be, they will have no problem terminating their affiliation with you. Sometimes with immediate affect. Other times might be on something like 30 days’ notice. Either way it is going to seriously jeopardize your career trajectory.

There was an example in the news recently. I won’t name the firm but there was an advisor who went into a smoothie shop up in New England somewhere, I think it was. He directed some horribly distasteful comments towards the employees. They caught it on tape. The guy seems to be a very bad guy. I’m not defending the guy at all. He made horrible comments.

His broker-dealer, who he had been with for over 20 years I believe, fired him I think within 24 hours. Less than 24 hours after this news came out, they had already fired him.

The guy’s a horrible guy in my opinion. He likely deserves to be terminated for what he did. I don’t know all the details but I understand if that ended up being the final result.

The fact they termed him in under 24 hours is what is concerning though. How much time did they really have to gather all the facts and think things through before making that decision?

In the firm’s mind, “No one advisor is going to give us a bad name or a bad look. We don’t care how long they’ve been with us, we don’t care how much revenue they make, we don’t care how human that person is.”  They just let that advisor go in under 24 hours.

Even if they considered that the advisor might in turn sue them for the termination, the firm has way more resources to ride out any sort of litigation and pay for legal costs than any one individual advisor has.

Again, I’m not defending the guy. If you’ve seen the story, he probably deserved to be fired. The fact they did it so quickly though, demonstrates firms have no problem kicking you to the curb if they feel you present an unnecessary risk to them. Or possibly also someone in management that oversees your territory. If they feel you might become a liability and they think it will personally hurt their career trajectory, they might decide to let you go as well. You don’t have much recourse on that.

I know 99% of advisors don’t come close to something that could become a terminable offense, but over the years I’ve been exposed to a lot of scenarios – much less than this crazy smoothie shop incident – that it was more of a judgment call and was the advisor actually maybe trying to do the right thing, or whatever the case is, and the firm says, “Too much risk,” and they let that advisor go, sometimes with immediate effect.

So, there’s always risk there, arguably maybe even more risk in the independent broker-dealer model from the perspective of controlling your own destiny as an advisor.

“I’ll have to pay for compliance.”

Sometimes I hear the argument of, “I don’t want to go directly into the RIA model because won’t I have to pay for my compliance or do my own compliance?”

I’ve done a lot of episodes on this topic. There are things I always point out when anyone says, “Won’t I have to pay for my own compliance in the RIA model?”

For starters, you’re already paying for compliance now. I don’t care what firm you’re at or what affiliation model you are with, whether W2, independent broker-dealer, RIA, whatever, you are paying for compliance. You just might not get an itemized bill that shows you exactly how much you’re paying for compliance.

If you’re at a wirehouse, W2 firm, you’re paying for compliance. It’s just buried in your payout, the portion your firm retains. A piece of that is to pay for compliance. So, don’t think you’re not paying for compliance already.

Some people also think, “I’m going to have to do compliance. I don’t know how to do it. I’m not a compliance person. I don’t want to be a compliance person.”

Well, there is a defined process for how to manage the responsibility. I’ve done episodes on this as well. There are specialty compliance consulting firms that you hire to help you fulfill the responsibility. That’s their sole focus, the sole thing they help you with. Thousands upon thousands of RIAs successfully do this every single year. They rely on these consultants to help them with this process.

Yes, you will have to pay them, but again, you’re paying for your compliance now. One of the big differences if you have your own RIA, you are the client now of the compliance apparatus. If you’re in a big firm now and you have a question about something for compliance – whether you can or can’t do something or you need something approved – if they don’t get back to you right away, or you get conflicting answers, you don’t have much recourse. You can complain about it, you can try to escalate it but at the end of the day you don’t really have any control over it. The only control you potentially have is to leave the firm altogether because you’re so dissatisfied with it. But other than that, you don’t really have any control over it.

Whereas in the RIA model, you are the client of the compliance consulting firm. If they are not responsive to your needs, if they are not willing to think through solutions of how to solve for things you’d like to do with your practice, well, guess what, you can fire your compliance consulting firm and hire someone else.

Now, I always point out, you need to listen to these folks. You’re paying them to have them help you stay out of trouble, to stay within the rules of the road. But, to the degree they are not providing good service, they’re not responsive, or any of those sorts of things, you have control in the RIA model to replace them with someone else. They must work to retain your business.

How many of the compliance people back at the home office of your large firm – which by the way, in the early years of my career, I was one of those folks so I’m not trying to knock anyone – how many of those folks think of you as their client?  Are they thinking, “If I don’t get back to someone, if I don’t return their voicemail or email quickly, the client is going to be unhappy.” Unfortunately, that’s not the culture, that’s not the mentality.

Lastly, if this responsibility still concerns you, you always have the option to join an existing RIA. I did an episode on why you might want to join an RIA versus starting your own. Part of the reason you might join one is because you want to outsource the compliance responsibility to them to manage. So, just know that is an option as well. To the degree you don’t want to manage it yourself, you could outsource it to someone else to do on your behalf.

“I must build everything myself.”

There is also the operational, administrative tasks of running an RIA. That’s things like setting up and maintaining a tech stack – I did an episode on that –  your client fee billing, those sorts of things. Putting the resources together to be able to provide the needed services to your clients. You might thing, “I don’t want to have to piece that together.”

One of the benefits if you start your own RIA, is the flexibility to build out the needed resources however you want to. However, with that, comes the responsibility of having to piece it together. Which is doable. That’s something I help advisors with all the time, “Let’s build this out, what are the pieces and who are the vendors and why you might pick one over the other.”

But to the degree you say, “I don’t want to do that myself, and the independent broker-dealer model does all that for me,” well, the RIA model has evolved to the point where there are solution providers where you can bundle up a lot of these “middle/back office” tasks and go to one provider that does a lot of those non-client-facing tasks for you. So, know that that whole apparatus exists as well.

So, the thought that, “I don’t want to go RIA. I should stop short and go independent broker-dealer because I don’t want to do all that stuff,” there’s a way to accommodate all of that in the RIA model as well. Don’t let that be a deterrent of why the independent broker-dealer model should be your starting point because you think it’s not possible to have those solutions in the RIA model.

So, that’s a couple variables to consider. I can go on with other ones as well, but the idea is I want to give you some things to think about of why you shouldn’t assume, “It’s a step too far to go to the RIA model and I should stop at the halfway point of the independent broker-dealer model.”

Again, for some of you, it depends on your circumstances, that might be the best fit. But for many of you, you should take that final step. It’s usually misconceptions about how it all works that gives people pause.

If you’re at wirehouse W2 type firm now, and you want to move into an independent model, the exercise you want to mentally go through – I have a checklist on this. If you’d like to see the checklist, reach out to me. I’m happy to share it with you – but the exercise of going independent is to say, “What does my current firm provide for me now and how will I replicate it on my own?”

That involves things like technology, E&O insurance, a custodian to hold assets. If you’re at a W2 firm now, they’re providing all those things for you. So, the exercise is, “How do I replicate that on my own?”

Ask yourself if your business is primarily fee-based, 70%, 80%, 90% plus fee-based, and it’s only going to increase. When you consider the options in the independent world, are you better off leaning on firms or affiliation models that were primarily built with a broker-dealer commission mindset and they’re now trying to adapt to the fee-based wave that continues to grow, or do you want to look at solutions that from the very start were built to accommodate the fee-based advisor?

Independent broker-dealers, literally by the name that we still call them, historically were primarily commission solution providers. They continue to evolve to the point where they now have more in fee-based assets than commission assets, yet we still call them independent broker-dealers.

Their legacy technology, their legacy knowledge at the home office, is based on decades of a commission FINRA broker-dealer mindset. They’re now having to adapt to more of a fee-based world.

Or would you rather go straight to solutions that were built to do thing from the start, support the fee-based advisor. It’s something important to think about.

My final thought on this topic – I wrote an article on this a little while back – it’s going to be increasingly difficult for independent broker-dealers. The typical advisor – the stats show this – are going more and more fee-based with their practice.

As I just mentioned a little bit ago, most all large independent broker-dealers now have more of their assets in fee-based accounts than commission accounts. That trend continues to shift, yet we still call them independent broker-dealers.

I’ll give you a perfect example. I was talking recently to an advisor that’s already at an independent broker-dealer firm. His practice it roughly 98%, 99% fee-based already. Because they’re already independent, they’re already running their own local P&L. They’re already responsible for their own office, their own staff, all that stuff. They already manage that responsibility and they now find themselves 98%, 99% fee-based.  (This is an extreme example, you don’t have to do that much already in fee-based.) He asked me, “Why should I still be in the independent broker-dealer model?”

There really isn’t a good reason for him to be. Why still be attached to FINRA? Why still play by broker-dealer rules?

Independent broker-dealers are going to have a hard time in the years to come answering that.  How do you explain – again, this is an extreme example – to an advisor that is 98% fee-based why they should continue to stay in the broker-dealer FINRA world? Where they have a payout on both their commission assets, and fee-based assets?

I don’t know of a good explanation for an independent broker-dealer to tell such an advisor as to why they should stay put. That’s why there is a continued migration of such advisors into the RIA model.

I will give you two examples, though, of where I think independent broker-dealers are trying to manage that. I won’t name names to protect the innocent, or I guess the guilty for those not doing it.

There is one large independent broker-dealer that no longer calls their “independent broker-dealer” channel by that name. Which historically they had for decades. They now refer to it as the “corporate RIA”.

It’s not that all advisors under that channel are 100% fee-only. They’re acknowledging that well more than 50% of the assets on the channel are now fee-based assets, not broker-dealer assets, so why keep calling it an independent broker-dealer?  They are primarily now an RIA and the commission assets are an accommodation alongside that.

I think it’s forward thinking of them to think of it this way. They are putting out their offer and saying, “We have a corporate RIA. We’d like to tell you about it, what our value proposition is. And by the way, to the degree you still have some commission business, here’s how we can accommodate that with our broker-dealer here on the side. But we think of ourselves as an RIA first.”

I give them credit for that. I think most independent broker-dealers will eventually fall in line with that. That’s not the case currently though.

The other example I want to give is you see independent broker-dealer firms rolling out, as they say, IAR-only offering. “Investment Advisor Representative-only” offering.

Consider the advisor example I gave a moment ago, regarding the heavily fee-based advisor at an independent broker/dealer.

Some firms are saying, “As opposed to going to the RIA model, how about we let you drop your 7, so you’re not tied to our broker-dealer, but you can stay under the corporate RIA. We call it IAR-only. You can get the benefits of an RIA model without having to go anywhere, we’ve got it right here.”

I think that’s better than not doing anything. I was talking to an advisor recently though who had made that move at her firm. I won’t name firms, from she moved from their traditional independent broker-dealer channel into the firm’s newly established IAR-only channel.

I asked her, “Have you really noticed much difference from a flexibility standpoint, from a compliance standpoint, anything like that? Because you’re no longer tied to FINRA, you’re not tied to the broker-dealer.” Her response was, “Not at all.”

The firm’s intent is to make the IAR-only channel more flexible because you don’t have FINRA involved anymore, you don’t have the broker-dealer involved anymore. But the firm was historically built on a commission apparatus, they have a FINRA legacy within it.

The compliance that’s been built out, which you still need compliance in the RIA world, but it’s most likely the same department, the same people that are trying to manage both channels.  They have a legacy mindset of things you can and can’t do because of some FINRA rule, a broker-dealer situation or whatever.

In this advisor’s case, yes, it is an IAR-only channel. Maybe she doesn’t have to do FINRA continuing ed and all that, but from a flexibility standpoint, she feels there hasn’t been any difference at all.

I think these offerings will continue to evolve. Hopefully that’s not the answer we hear about that in the future.  But as it stands now, it is. So, to the degree you’re looking at that, I encourage you to compare that to what options are available in the standalone RIA space and see which one might be the best fit for you.

The main takeaway here is don’t assume, “If I’m in an employee model now, going all the way to the RIA model is a step too far.” Again, I hear that from time to time. It’s generally always based on misconceptions.

Hopefully this episode has helped you realize that for some of you the independent broker-dealer model will be the best path. For many more of you, though, the RIA model will likely be the better fit.

With that, like I said, my name is Brad Wales and this is the sort of thing I help advisors with all day long. Advisors tell me what their current practice looks like, and what they’re looking to do going forward. I talk through these options and how they all work. I do that all day long with advisors. I’m happy to have that conversation with you as well.

If you’re not already there, head over to TransitionToRIA.com. You can find my videos, podcasts, whitepapers, etc. At the top of every page, there is a contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me to talk about today’s topic or anything else RIA-related. I’m happy to have that conversation with you. Again, TransitionToRIA.com.

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

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