Other Voices

Uniform standard may not be a win for RIAs

By Mark Elzweig
July 29, 2012 6:01 am ET

It is likely that retail investors soon will have more difficulty telling the difference between wirehouse brokers and registered investment advisers. That isn't what RIAs were counting on when they lobbied so hard to force brokers at least those who dispense investment advice to become designated as fiduciaries. They had other things on the agenda. That is what happens to interest groups they focus too much on internecine competition without really thinking about how it looks or feels to outsiders. But the stakes feel big to the adviser community on both sides of the retail-asset-management divide. Main Street is ever so wary of Wall Street and its representatives but is also dying for decent advice. Both RIAs and traditional brokers are seeking to find an edge but in the process are looking more and more alike to the people they are trying to woo. It looked as if the two brands were about to become almost indistinguishable, thanks to a law wending its way through Congress that would have made the Financial Industry Regulatory Authority Inc. the regulator for broker-dealers, the overseer for RIAs. The Bachus-McCarthy bill is on hold as lobbyists thumb-wrestle over whether the Securities and Exchange Commission can remain the RIA regulator if and this is a really big if Congress endorses implementing user fees to increase the barely there SEC inspections of RIAs. Ironically, RIAs have only themselves to blame for losing their marketing edge with clients. One catalyst was the shrill campaign launched by self-described RIA advocates for the adoption of a uniform, harmonized fiduciary standard that would cover both RIAs and those broker-dealer representatives providing investment advice. It is hard to fathom the logic of why RIAs lobbied so hard to dilute their own unique value proposition. Perhaps they thought that wirehouses and regional firms wouldn't be able to comply because the rules seemed to mean that firms with an in-house bond inventory or stock syndicate desk wouldn't be able to meet the fiduciary standard. That might embarrass traditional brokers and put them at a disadvantage.

LITTLE CREDIBILITY
Maybe the RIA advocates felt that somehow they were advancing the interests of investors. Either way, it blew up in their faces. It should have been obvious that Finra would become the regulator of choice. The SEC has little credibility in Congress. The Bernard Madoff and R. Allen Stanford fiascos didn't exactly enhance the SEC's reputation. More important, the SEC acknowledges that it examines only 8% of RIAs annually, while Finra examines about 55% of broker-dealer practitioners each year. It seems as if Finra was the no-brainer choice. But I can understand why RIAs prefer the SEC. It is a less confrontational regulator.

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Some attorneys used to advise newly minted independent breakaway brokers to become RIAs in part just to get rid of Finra. That was part of the attractiveness of the RIA model. Finra's reputation is that of an adversarial bounty hunter, not a collaborative partner. Last year, the selfregulatory organization levied $63 million in fines, retaining $40 million for its own budget. The SEC initiated 113 enforcement actions last year, compared with 1,488 for Finra. It oversees 12,000 RIA firms, while Finra oversees more than 300,000 advisers. The 12,000 RIAs will be trimmed by more than 25% as those with less than $90 million in assets under management shift to state supervision. Despite the fact that the business models of broker-dealers and RIAs look a little more alike these days, important differences remain. Most of the differences are behind the scenes and not top-of-mind for investors. Here are some of them: How they get paid. RIAs advise on virtually all types of securities and typically receive a fee based upon assets under management. They don't accept commissions or fees from product providers. They are under no pressure to make changes in a portfolio in order to generate income. They can advise on the purchase of insurance, derivatives contracts and limited partnerships but don't directly receive commissions. Although wirehouse advisers are restricted to using some 1,000 outside managers that have been vetted by gatekeepers, RIAs can have multiple relationships with custodians, each of which offers its own lineup of 3,000 or so managers. Wirehouse advisers can receive sales commissions from their firms and other payments from product manufacturers and can also charge clients both fees and commissions. Wirehouse advisers like the compensation flexibility of their model. RIAs think that not accepting any compensation from product providers gives them the moral high ground. Wirehouse advisers typically keep anywhere from 38% to 45% of revenue. RIAs retain 100% of revenue, less their overhead. Technology. RIAs have the most freedom to choose their technology and how much to spend. They typically can select from multiple outside software vendors for portfolio management, portfolio accounting, customer relationship management and client reporting. Although many wirehouses have poured huge sums of money into technology in recent years, wirehouse brokers must rely upon the technology provided by their firms. Compliance/social media. Christopher Winn, managing principal of AdvisorAssist LLC, noted: The frameworks are vastly different. RIAs have a principles-based framework, and reps have a review-based approach. There are pros and cons to each. The chief compliance officer or outside compliance consultant are the go-to guys to formulate policies and procedures for RIAs. This gives RIAs a leg up in getting seminars and mailings approved quickly. They also have more latitude in formulating social-media campaigns. Wirehouse brokers must rely upon in-house compliance departments for guidance. Succession planning. Wirehouse programs typically allow retiring advisers to keep anywhere from 150% to 200% of gross commissions over a three- to five-year period. Lucrative succession-planning deals are a major selling point of the RIA model. RIAs are free to craft their own deals and, upon completion, pay taxes at the capital gains rate as long as they have owned their practices for more than one year.

Mark Elzweig Company www.elzweig.com 212-685-7070

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Big-bucks recruiting packages. Wirehouses win hands-down here. Although custodians sometimes lend breakaway brokers modest amounts of startup money, the stratospheric 250% to 300% deals remain the specialty of household-name wirehouses. So which group will investors choose? Investors will continue to choose advisers in the same way that they always have. They will select advisers they like and trust as long as they possess the investment skills that they require. It will always be all about the caliber of the adviser and never primarily about the business model.

Mark Elzweig heads an eponymous national executive search firm that provides recruiting services to the retail brokerage and asset management communities.

Mark Elzweig Company www.elzweig.com 212-685-7070