Published June 7, 2017
“Parking” a license at a broker-dealer when you are not performing any brokerage functions for the firm has been a long-standing, albeit illegal, practice on Wall Street. Financial firms have used under-the-table agreements as a way to retain and attract new talent by promising to keep reps registered when they are no longer acting in an actual registered rep capacity. And while this illegal sponsorship has been an open secret for years, it still exists in some circles. However, friendly broker-dealers have legally served advisors in the RIA space who wish to hold onto their securities licenses and conduct brokerage business. In light of the impending Department of Labor (DOL) Fiduciary Ruling and a certain shift to advisory business, what will happen to the friendly broker-dealers?
What Defines a Friendly Broker-Dealer?
A friendly broker-dealer does not engage in the illegal action of “parking” licenses, but it can hold the licenses and execute brokerage business (commissionable) for advisors who have their own Registered Investment Advisor (RIA). The RIA uses a custodian for all of their other business; therefore, the friendly broker-dealer is only taking revenue on the commission business that the advisor conducts however they are responsible for overseeing all of the RIAs business, even if it is not run through their platform.
An RIA would have to still be collecting trails or executing brokerage business in order to leave licenses at a friendly broker-dealer. If the RIA does no commission business, it doesn’t make any sense for him or her to continue to hold a license, which becomes more of a nuisance than an exception. And yet, many advisors still fear dropping their licenses. Tim, one of our PAG advisors told me “I do almost 100% of my business in advisory, however, in the rare instance I need to use a brokerage product for one of my clients, I want to be able to do so.” This sentiment may be shortsighted on the part of the advisor. The compliance requirements and the fees associated with keeping licenses doesn’t make it an attractive option unless the advisor has a real reason to keep the license.
Why the Death of the Friendly Broker-Dealer Is Imminent
In my opinion, the death of the friendly broker-dealer will occur for a few reasons. The first, and most documented, is the continued trend for advisors to conduct advisory business and move away from commissionable business. Advisory business is transacted through a custodian where advisors typically charge a fee to their clients for their advisory or financial planning services. For instance, a common charge would be 1% of assets under management. For an advisor who has a client with $1 million in advisory assets, the advisor would receive 1%, or $10,000 to manage that client’s assets. Operating a fee-based business as an advisor is an attractive option as it allows the advisor to focus on building a successful, sustainable advisory business. Why? Because the fee the advisor charges is recurring revenue, the advisor doesn’t have to stop and think about what else to sell the client, and receive commissions for doing so. It inherently removes the conflict of interest and allows advisors to manage their cash flow and business more effectively.
The second main reason the friendly broker-dealer may cease to exist includes the enormous cost of compliance and risk management the broker-dealer takes on in this capacity. The DOL’s current legislation that would elevate all forms of retirement planning, sales, and advice to fiduciary status may mark the beginning of the end for the suitability standard, which is what brokerage business is held to. This legislation will also likely drive a large number of advisors, particularly those who work solely on commission, out of business, or at least force them to invent a completely new business model. Pricing may become completely transparent along with full disclosures of any possible conflict of interest. Therefore, the friendly broker-dealers will be receiving less of the revenue they have been due, because of the decrease in brokerage business overall and the increase in oversight and technology enhancements to properly do this.
This oversight is required by FINRA for any broker-dealer. Recently, a popular friendly broker-dealer, Purshe Kaplan Sterling Investments (PKS), received a $200,000 fine for failing to properly review its broker’s OBAs and allowing them to market to the public in a non-compliant way. Small broker-dealers simply do not have the capital to invest in the technology and the manpower to deliver that type of oversight, especially with shrinking profits.
Does Your Broker-Dealer Have What It Takes?
Advisors who leverage friendly broker-dealers to hold onto their licenses should be thinking about whether or not they have faith in the firm and its ability to invest in the enhancements required to remain compliant and in business. Serving independent advisors as a hybrid requires our team at PAG to invest heavily in people, processes, and technology just to manage the compliance. This enables us to serve advisors well in spite of the changing legislation. Many of the friendly broker-dealers must do the same, and more, to remain relevant and compliant.
The next 12 to 24 months will divide the financial industry into winners and losers. Investment News speculates that those who are able to adapt to changes in the market and truly be a partner to advisors will come out on top.
As a financial advisor, whether an independent broker-dealer representative, a hybrid advisor, or an RIA, you should be taking a closer look at the broker-dealer you have chosen to conduct your brokerage business with. Do they have the capital to invest in the technology required to help you with your business practices? Are they thought leaders creating the future of the brokerage business and products that will survive the post-DOL world? If not, it may be time to reevaluate.
For more information about partnering with Private Advisor Group, the largest hybrid RIA on the LPL platform, reach out to Charlie Latimer.