Q101 – What Is The Difference Between A Hybrid RIA And A Hybrid Broker-Dealer?

Also available as podcast (Episode #101)

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What Is The Difference Between A Hybrid RIA And A Hybrid Broker-Dealer?

There is no official definition of the word “hybrid” in our industry, and thus it is often used in a number of different ways.  Adding further complication is the differences, but also similarities of a “hybrid RIA” versus a “hybrid broker-dealer.” Adding even further complication is that many solution providers will tout some sort of “hybrid” solution, where their offering may not at all be what you assume they are referring to.

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Full Transcript:

What is the difference between a hybrid RIA and a hybrid broker-dealer? That is today’s question on the Transition To RIA question and answer series. It is episode #101.

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’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available from this entire series in video format, podcast format. I have articles, I have whitepapers, information on how to contact me.

Again, you can find all of that at TransitionToRIA.com.

On today’s episode, we’re going to talk about, what is the difference between a hybrid RIA and a hybrid broker-dealer?

For starters, always be careful when you hear the word “hybrid” used in the marketplace. Another word you might have heard me talk about similarly is the different ways the word TAMP, Turnkey Asset Management Program, is used in the marketplace. I did an episode on what is a TAMP.

The point being whether it’s the word hybrid or the word TAMP, you must be careful because for better or worse, in our marketplace, in our industry, both of those words are used in several different ways alluding to several different kinds of solutions. It doesn’t necessarily equate to exactly what you might think it is equating to.

So, part of what we’re going to talk about on this episode is what exactly is a hybrid, and then the difference between a hybrid RIA and a hybrid broker-dealer.

For starters, I’ll give a quick explanation of what hybrid is. I’ve done a separate episode on what is a hybrid if you want to do a deep dive on it.

There is no universal definition for what a hybrid is, and it’s used in several different ways. But it’s commonly accepted, and there’s different variations, different flavors of this, that it refers to a financial advisor that’s essentially wearing two hats. And for most financial advisors in the marketplace, this is the case.

If you are at a wirehouse firm or an independent broker-dealer firm, typically, you are wearing perhaps two hats. You have your Series 7, which makes you a “registered representative” of the firm’s broker-dealer. That’s what enables you to offer commission-based solutions to your clients in a brokerage account on a commission basis.

You might also be wearing, which many of you are, the hat of an “investment advisor representative” under your firm’s RIA. That enables you to offer fee-based services and open accounts on a fee basis for your clients.

Those two hats involved different regulatory bodies that govern them, and you are wearing two different hats.

Now, you might have some clients that are only commission clients. You might have some clients that are only fee-based clients. Or you might have some clients that have one of each type of account. Regardless, if you are operating under both of those worlds, that is arguably a hybrid relationship, meaning you are not only able to offer fee-based solutions, you’re able to offer commission-based solutions as well.

It’s tricky because with wirehouses, regional broker-dealers, independent broker-dealers, we generally refer to them as “broker-dealers.” And there are some that that is all they are. They are a broker-dealer. They’re not duly registered as an RIA. They don’t have an RIA on the side. They are solely a broker-dealer.

But for most of what we think of as traditional financial advisors in the marketplace, if they’re at some sort of “broker-dealer,” that broker-dealer itself is not only a broker-dealer but also an RIA.

If that is you and you’re wearing those dual hats, you are arguably already in some sort of “hybrid” solution. That’s why this is tricky is someone could say, “come join our hybrid solution.” Most financial advisors are arguably already in some flavor of hybrid now. It’s just not necessarily thought of that way or referred to that way.

I’ll give you an extreme example where “hybrid” was sort of tossed around in a buzzy fashion. This was 10 years or so ago. At the time, “hybrid” was sort of a sexy word to say, “look at our great hybrid solution.”

I recall there was an independent broker-dealer, we’ll protect the guilty and won’t name them, but they were offering what we would think of as an independent broker-dealer solution. Which for the right advisor is a good solution.

They were like, “This whole hybrid thing is being talked about and we’re losing advisors to these so-called hybrid solutions.” So they tweaked part of their payout and economics a little, and then slapped the fancy word “hybrid” on it and put all kinds of press releases about their great new hybrid offering.

The reality was though, nothing changed except for a little tweaking of how the economics worked. The advisors were still under the firm’s broker-dealer. The advisors were still under the firm’s RIA. The advisors were still using all the same technology, relying on all the same compliance people.

It shows though why you must be careful. It’s very easy for someone to tout a “hybrid” solution. But is it anything different? Is it better than what you have now? Is it what you think they are referring to? Certainly some things to think about.

The reason many of these firms are jumping on the hybrid bandwagon is because many of those firms were traditionally and solely started as a broker-dealer.

Go back a few decades and the average “financial advisor” was a “broker”, a registered representative. That was the only hat they were wearing. For the services they provided their clients, they made their revenue on a commission basis, whether from selling a variable annuity, selling a mutual fund, a commission on a stock transaction, fixed income, whatever the case may be.

The large firms of today were started as broker-dealers. Slowly over time, as fee based accounts became more and more popular, these firms ended up either duly registered or added an RIA, often referred to as a corporate RIA. I did a separate episode on corporate RIAs.

These broker-dealers have had to evolve after perhaps decades of building technology, personnel, policies and procedures based on a broker-dealer world, a broker relationship, a commission-based relationship. Then they added the RIA to it because there was an increase in demand from their brokers to also wear the two hats and do more fee-based accounts.

The market has now evolved to the point where with most of the large firms, more than half of the client assets held at the firm are now on the fee-based side of the firm, not the broker-dealer commission-based side of the firm.

And so it’s interesting that we still refer to these firms as “broker-dealers” when in reality they’re now predominantly RIAs and the broker-dealer part is a smaller part of the business. But as we’ve been referring to them as broker-dealers for decades now, the verbiage is hard to shake.

Those firms are now trying to reinvent themselves as more predominantly an RIA because that’s where the advisor and the client demand has pushed them to go. Keep that in mind, and what that might mean for you as your own practice continues to evolve as well.

Circling back to the definition of hybrid, and with this prior context, the truest definition, or the most maybe commonly accepted definition, if you will, of a hybrid relationship is where you have your own RIA, and you still have some amount of commission business, often referred to as legacy commission business.

The legacy business is oftentimes variable annuities that make sense for the client to hold onto. They might still be paying a trail, and it could be a sizable amount of revenue for the practice. And often, those same clients might also have fee-based accounts with you.

If you were to start your own RIA and you needed a way to accommodate those commission assets, there are solutions for that. For example, you could work with what are often referred to as an RIA-friendly broker-dealer. They say, “We understand you’re going to have an RIA. We’re going to consider that an outside business activity. We’re not going to take an override on those fees that you generate. But we realize you have that commission piece still, and we will play our part of being your broker-dealer for that piece of it.”

Hence you have created what is arguably the purest definition of a hybrid solution. You have an RIA and there’s some sort of broker-dealer solution to accommodate the commission assets.

As I talk about frequently, that sort of arrangement is generally available to you. You do not have to be 100% fee only to potentially transition to the RIA model. Now the reason I say “potentially” is most solutions have minimums.

How much fee-based assets do you have? Does it make sense to start an RIA? Will custodians work with you at your size? It’s the same thing with RIA-friendly broker-dealers, do you have enough meat on the bone to make it worth their while? I don’t want to paint a picture that it works in every situation because the details matter, but the format, the structure is there and is available and has been for quite some time.

There are also an increasing number of solutions being introduced in the marketplace – I’ve done episodes on these – where you can potentially still accommodate existing VA positions that are paying a trail, without formally having to affiliate with a broker-dealer as a registered rep. But you can still protect the client and all the things you’re generally looking to do with that subset of your practice.

And in that case, you might not even need a hybrid solution at all. You might not need a broker-dealer. Won’t have anything to do with FINRA. You are a fee-only RIA that has solutions for that remaining part of your practice.

With these new solutions in the marketplace, I think we’ll continue to see less need for some sort of hybrid solution. But just know that the hybrid solution still exists if it makes sense for your practice.

With that context, what is the difference between a hybrid RIA and a hybrid broker-dealer?

Let’s start with the hybrid broker-dealer. As I noted, traditional “broker-dealers” that we think of in the marketplace were started solely as a broker-dealer. For decades, they built proprietary technology to support a commission-based solution with commission-based clients. They built up policies and procedures from a compliance perspective, from an operational perspective to support that kind of client. They often have employees that have worked at these firms for a very long time, and there are some wonderful people, but they now have perhaps decades of a mostly FINRA broker-dealer mindset.

These firms, because of demand from the marketplace, are having to reinvent themselves to be more of an RIA. And, again, when you look at the stats, many fundamentally are more of an RIA than they are a broker-dealer at this point (based on their client assets.)

But, it’s not easy to unwind decades of institutional knowledge by team members, institutional policies and procedures, and ways of doing things. Decades of proprietary technology they’ve built. They’re having to try and reinvent themselves.

I would consider those firms as hybrid broker-dealers. Now, they wouldn’t want to call themselves that, but that’s essentially what it is. It’s a broker-dealer reinventing themselves into a hybrid relationship where they can support you wearing both hats.

Some are doing it better than others. Some are forward-thinking and are fully embracing it. They’ve realized they have this legacy, but they’re much more forward-thinking in how they’re adapting versus some other broker-dealers in the marketplace.

That is what you should think of as a hybrid broker-dealer. It’s something that’s a hybrid solution, but was predominantly broker-dealer at heart, broker-dealer by origin first, and then becoming an RIA.

Now flip that over to a “hybrid RIA.”

You could have your own RIA, like I talked about, and attach some sort of broker-dealer solution to it. Or if you were looking to join a “hybrid” RIA – there are several reasons you might consider joining an RIA versus starting your own, I’ve done several episodes on that as well.

But the idea is there are hybrid solutions in the marketplace that were started initially as an RIA. That is their origin. They weren’t started as a broker-dealer. They were started initially as an RIA where they could go out in the marketplace and say, “What are the best solutions, technologies, tools, everything to support the fee-based advisor? Let’s start fresh from what’s solely focused already on the fee-based advisor. But because we realize there are a number of advisors that have some legacy commission assets still, we have gone to the marketplace and found a solution for that.”

These firms were born as RIAs. They are predominantly an RIA. The broker-dealer commission side is essentially an accommodation for advisors that still have a need for that type of solution included.

So that’s how I encourage you to think of the difference between a hybrid RIA and a hybrid broker-dealer. What were they originally? What are they perhaps being forced to evolve to, or were they started from the jump with whatever you already might be most attracted to based on your specific practice?

There are two takeaways from this I’ll leave you with.

First, as the expression goes, don’t let the tail wag the dog.  Consider how your practice looks.  If you have a large portion (most?) of your assets in commission relationships, the traditional broker-dealer firms are going to be your best bet. That is what they were built for. That is what they were started for. They have decades of experience and proprietary technology to support you. That’s the path you should go to.

If you’re closer to 50/50, it becomes a little more gray area, a little more blurry.  Even at this split, a broker-dealer, perhaps an IBD (Independent Broker-Dealer) are often still going to be a better solution for you. They’re working to evolve more to an RIA model, but they have that deep background with the commission-based advisor.

If your practice is predominantly fee-based or you’re increasingly moving in that direction, whether you’re 70%, 80%, 90%, 100% fee-based, if you’re looking at firms to potentially join, look at firms that were built to support that sort of practice to start with.

Find a firm that doesn’t have to reinvent anything, but who has solutions for the remaining part of your commission assets. Don’t let the tail wag the dog. If you’re predominantly fee-based, why go with a firm that historically has been predominantly commission based?

I don’t want to dunk on all of them. Some have done a better job than others on evolving. They deserve credit for that. Some haven’t though. And you need to be aware of that.

Again, don’t let the tail wag the dog on what kind of solution might be best for you.

And then second, as I said at the top, anytime you hear a solution provider talk about their hybrid solution, take a pause, and don’t assume that what you’re thinking they are referring to, is necessarily what they are.

There are different flavors of the hybrid definition. It’s oftentimes the sexy marketing thing for firms to say, “Look at our hybrid solution.” They might have a good solution they’ve built, but they might also just be using the buzzword. Their solution is maybe not a lot different than if they hadn’t used the word. Be careful about who’s using the term.

If you want to have a conversation with those folks, that’s fine, but make sure you understand what version of hybrid they’re touting. Is it the same thing you are thinking of what they’re referring to? If there’s a disconnect, you’re not going to be speaking the same language, and the conversation is not going to progress as it should.

So, those are my suggestions. Don’t let the tail wag the dog. Careful anytime you hear the word hybrid.

With that, as I said at the top, my name is Brad Wales with Transition To RIA. This is the type of thing I help advisors with all day long. Helping you understand how the marketplace works in the RIA model and what these “hybrid” solutions are. How you could start your own RIA under a hybrid umbrella, or if you wanted a hybrid solution to join. That is a typical conversation I have. I’m happy to have that conversation with you as well.

First things first, head to TransitionToRIA.com where you’ll find all the resources I make available to help you better understand the RIA model. Again, this entire series is available in video format, podcast format. I have articles, I have whitepapers.

At the top of every page is a Contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me, 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.

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