Affiliating with an Independent Broker Dealer: Evaluating Your Options – Part 1

Affiliating with an Independent Broker Dealer: Evaluating Your Options – Part 1


Evaluating All Independent Broker Dealer Options


Published December 12, 2018

Advisors going independent have various options to consider when affiliating with an independent broker-dealer (IBD). One option is to start their own RIA, where the IBD serves as both custodian (for advisory business) and broker-dealer (for brokerage business). This is typically referred to as a “hybrid” platform or structure and in many ways, is the most complicated form of affiliation since the advisor, owning the actual RIA, has to appoint a Chief Compliance Officer and manage an entire, never-ending, resource-intensive compliance regime (regulatory exams and all). Solving for a costly, integrated, technology stack is another major consideration.

Another path of consideration is to affiliate directly with an IBD’s corporate RIA, where the advisor simply outsources compliance supervision to either the IBD’s home office compliance department or to one of its many branches or OSJs (Office of Supervisory Jurisdiction). While this is certainly much easier than operating a standalone, hybrid RIA, there is yet a third option which has gained notable, if not remarkable traction over the years. That option is for the advisor to align with an established RIA that is already affiliated with the given IBD. This hybrid structure (as noted above) provides the best of both worlds for advisors who have any combination of advisory and brokerage business. That is to say, on the one hand, they benefit from the IBD’s vast operational chassis, technology, and servicing platform, while also benefiting from the outsourced compliance services provided by the RIA. In this arrangement, the RIA provides a unique boutique-level experience and a community of advisors who collectively bring scale, advocacy and outright buying power that the advisor alone would never be able to attain. While the revenue mechanism of this affiliating structure is bifurcated with the advisor’s advisory revenue flowing through the RIA and their brokerage revenue flowing through the IBD, it is nonetheless seamless and transparent.

Affiliating with a Hybrid RIA/OSJ

Carrying on then, while each option has differing benefits and considerations, for purposes of this writing, let’s focus on the last option, affiliating with a hybrid RIA/OSJ. To that end, outlined below are five due diligence best practices advisors should carefully consider in selecting their long-term RIA/OSJ partner since there’s much more involved than just economics. While seeking the highest payout is human nature, following a lower cost RIA/OSJ model means that you are going to get what you pay for. That is, such RIA/OSJs typically make ongoing compromises in their operations, which are not immediately obvious and may introduce business risks that materialize over time. On the other hand, overpaying could mean you may well be subsidizing a one-model-fits-all structure, where you are essentially subsidizing services and features you don’t want or need. Right in the middle lies the ideal model where the payout is maximized, compliance is covered with the highest degree of expertise and any add-on services you may want are optional on an a-la-carte basis.

Questions to Ask when Choosing an RIA/OSJ Partner

  1. What is the level of turnover with the firm’s compliance staff, and particularly with the Chief Compliance Officer role?
    Compliance should be the core competency of every RIA/OSJ and should be completely stable and predictable. Compliance staff turnover is a red flag, even more so if it is evident in the CCO role. While CCO’s can be terminated for not doing a competent job, they can also voluntarily resign over any practices they fundamentally don’t agree with, or a compromised culture they cannot overcome; factors that pose risk to the business and their reputations.
  2. Has the hybrid RIA ever been audited by the SEC and what was the result?
    Every advisor should ask this question plain and simple. If the answer is “yes,” you want to know more about the scope of the audit, how the RIA managed themselves and the final outcome. An RIA/OSJ that has never been audited may be a red flag as this demonstrates that the firm’s policies, practices, procedures, and documentation have not been put to the test. Accordingly, any “questionable” practices or activity in the grey area may create unforeseen risks not only to the RIA/OSJ entity itself but to all of their affiliated advisors as well. If you’re going to buy an airplane, the first thing you want to see is the service log books. An airplane without logbooks is a red flag of the worst kind and can be bought for over 50% off. Just because the airplane has an engine and wings and can get off the runway doesn’t mean it can stay in the air for long, especially in bad weather!
  3. Does the RIA have any conflicts of interest or disclosures on their Form ADV part 2a filed with the SEC (aka brochure)?
    Not many advisors are even aware that adverse disclosures are revealed in an RIA’s ADV. Just like an advisor’s disclosure history is transparently maintained on Brokercheck, so is an RIA’s history and conflicts of interest in their ADV. Advisors could be missing key disclosures and red flags if they don’t do a simple check on the SEC’s website: adviserinfo.sec.gov/IAPD
  4. How long has the RIA/OSJ been in operation and what is their reputation like?
    An RIA/OSJ’s overall experience is an extremely important attribute to consider. Firms that manage hundreds of advisors and have been around for decades are much more attuned to the risks that advisors face and how to protect them. You want to align with an RIA/OSJ that has “seen it all,” having endured the test of time, having navigated successfully through up and down markets, including “hot button” regulatory issues and has the vision to proactively skate to where the regulatory puck is headed. Such firms know how to keep their advisors safe and always ahead of the compliance/regulatory curve.
  5. How does the RIA/OSJ manage cybersecurity threats?
    Advisors should ask their prospective RIA/OSJ partner if they (including any of their advisors and end clients) have ever been hacked. One of the more resource intensive and outright expensive line items in operating an RIA/OSJ is the effective management of cybersecurity. Advisors should ask their prospective RIA/OSJ partner what they are doing to protect them and their clients. The RIA/OSJ should be able to produce a formal, documented cybersecurity policy (FYI, it’s an SEC requirement) and more importantly, how it’s executed. Are they conducting penetration testing at least annually (costing $50k or more per year), regular vulnerability scans and other defense measures? Getting hacked is no longer a black swan event since data networks and systems are under constant attack. It’s no longer a matter of if a breach will happen, but when. The question is how will resilient will the RIA/OSJ be in limiting the scope and impact of an attack. Needless to say, if you’re an affected end-client, you may very well choose to find another advisor. Not surprisingly, the SEC, FINRA and the various state bodies have made cybersecurity a top priority in their 2019 exam initiatives!

In closing, advisors face several choices when taking their practice private and affiliating with an IBD. A lack of understanding of how to evaluate these options creates confusion and uncertainty and is only mitigated by knowing what to ask as part of a comprehensive due diligence process. It goes without saying that advisors hate surprises and not having their expectations met, so each option should be evaluated on an apples-to-apples basis. While this path of discovery is typically led by economic considerations (even if advisors don’t admit to that), the importance of long-term stability, ease of business, ongoing vigilance and shelter from the evermore scrutinizing regulatory landscape cannot be underestimated. There exists a subtle balance where such myriad factors come together in a complete, optimized package, where strong compliance and strong economics coexist in harmony! Imagine that! For that reason, the model of affiliating with an RIA/OSJ personally excites me the most! Stay tuned for Part 2 of this piece. Best Wishes and Happy Holidays!!!