The RIABiz list of winners and losers in the wake of the SEC's fiduciary study
The race is on as laggards adapt to new vision of the future
A week ago yesterday, the SEC endorsed a single fiduciary standard no less stringent that the one that has long governed investment advisors.
Good news for investment advisors, bad news for broker-dealers, case closed.
Not exactly. A closer look reveals that the list of winners and losers in the wake of last week’s fiduciary study is long and riddled with footnotes. The chief uncertainty remains how and when the SEC proceeds with developing the actual rules. Conceivably, future rulemakings might not follow the study or might create so many loopholes that the fiduciary standard is no longer a fiduciary standard.
As an optimist, however, he and others believe that the SEC will go forward to impose a new regulatory regime on broker-dealers and advisors, one that includes a fiduciary standard for brokers and more stringent regulations for advisors.
List of winners and losers
RIABiz developed this list of winners and losers on the idea that the SEC would indeed use its study as a sort of long-term outline for rule-making. Thanks to many industry thinkers and executives who helped formulate the ideas.
I’m going with the losers first, because it’s the loss of business from the losers that is going to drive the growth for the winners. Just a reminder here of the number of advisors in each segment of the industry (stats are from Boston-based Cerulli).
Insurance broker-dealers: 96,000
Regional broker dealers: 38,000
RIAs: 33,000 – 34,000
Dually registered advisors: 14,000 (counted both as RIAs and in their broker-dealer category)
Introduction: Those whose business models are based on selling overpriced and/or proprietary products have the most to lose. In a fiduciary world, a proprietary product is – presto — an instant conflict of interest that must be disclosed. Overpriced proprietary products will put sellers into an even worse position.
Advisors who work for insurance broker-dealers make up the second largest segment of advisors. About half of them can’t sell anything but proprietary insurance, says Bing Waldert, a consultant with Cerulli Associates. Their business models appear to be the furthest from transitioning to a fiduciary world.
One particular kind of insurance agent stands to lose the most, said Barbara Roper, director of investor protection for the Consumer Federation of America.
“The insurance agents who call themselves financial advisers or financial planners and sell a few high-cost variable annuities and mutual funds have the most to lose. State and federal regulators have been struggling for years to use the tools available to them under the suitability rules to rein in abusive sales of variable annuities, but imposing a fiduciary duty would give them a whole new set of enforcement tools to bring to bear.”
“The four wirehouses are the largest sponsor of managed accounts,” said Waldert. “They are well on their way to a fiduciary model.”
Still, wirehouses will be hurt, to the tune of billions of dollars, says Adolf, listing three ways the damage will play out.
• First, he says, the new regulation will cause even more brokers to question staying at the wirehouses. “What the broker is ultimately asking is: Why I am I paying the 60/70% tax to the wirehouse? I’m not getting anything for it. Now, I’m no longer held to the suitability standard.”
• Second, wirehouses will lose profits because it will become harder to distribute proprietary products, which are probably generally more profitable. Waldert agrees with this and notes that wirehouses will be hurt on a second, related front, as their ability to make proprietary trades of existing inventory is compromised.
• Third, wirehouses will be hurt by new disclosure requirements, Adolf says. “The traditional smoke-and-mirrors that drive the brokerage industry is going to be impossible. They are going to be facing a fundamental challenge to their business model.”
IBDs, especially small IBDs
Like wirehouses, IBDs may face more defections as brokers begin to ask questions about whether a higher payment to the IBD is worth it, if they are no longer able to operate under a suitability standard. Like smaller RIAs, smaller IBDs may be especially vulnerable to higher compliance costs as a result of more regulation.
Small- to medium-sized RIAs
Compliance costs are set to rise as regulation increases. It may not be by huge amounts.
“I doubt compliance costs will really go up that much,” says Zachary Gronich, president of compliance firm RIA In A Box. “Say people have to start taking CEs, they’ll just find a way to take the cheapest, easiest CEs, like they do in any other professional area.”
Yet, how much is too much for any given firm? Many RIAs with less than $100 million in AUM are already facing higher compliance costs as a result of the switch to state oversight, which is likely to mean complying with multiple sets of regulations. (See: What advisors should know about the next sweeping change: the switch from SEC oversight to state regulation).
Regulations developed by the SEC may or may not apply to those RIAs under state oversight, but it’s a safe bet that at least some of them will – driving costs up even more.
Introduction: One hallmark of the companies that will end up winners will be the speed at which they adapt. The SEC’s actions are important and powerful – but they will merely speed up a process of market transformation that’s been under way for a while. All of the industry is entering a time of risk brought about by rapid change.
“Losers will let legislation lead them,” said Dan Inveen, principal of FA Insight in Seattle, Wash. “Winners will be led by the marketplace.”
Consumers will have more clarity about their investment advisors and the incentives driving those advisors. It won’t be a perfect world – but investors will have a better chance of making good decisions.
As One-Man Think Tank Columnist Ron Rhoades wrote last week, “If properly implemented, a 'uniform fiduciary standard’ adopted and applied both to investment advisers and to certain activities of broker-dealer firms, will enable consumers to discern when their financial and investment adviser is truly acting in their best interests.”
The RIA world
RIABiz chronicles a fast-growing but still nascent industry, made up of RIAs, custodians, tech companies and myriad other service providers. That industry as a whole just got a huge shot in the arm, as the SEC essentially said: ‘You’ve been following the right business model all along.’” No, clients aren’t reading the SEC’s web site – but the shift of thinking in the industry will trickle down.
The Investment Adviser Association and other advisor advocates have long made the case that what’s good for consumers is also good for RIAs. A healthier market in which there are fewer scandals related to “bad advisors” will benefit RIAs.
“We are looking for an effective regulatory scheme that protects investors,” said Neil Simon, government relations vice president for the IAA. (Top RIA lobbyist says insurance foes have been 'more effective’ in fiduciary battle but urges patience).
Larger and well-prepared RIAs
Along with imposing a fiduciary standard on broker dealers, the SEC says that RIAs should be held to higher regulatory standards. Eventually, those may look somewhat like the rules-based model that broker-dealers operate under. For instance, RIAs might have steeper licensing requirements.
All RIAs will pay the cost of those higher regulations (see Losers: small RIAs), but the large ones will be better able to bear those costs, giving them a competitive edge. In addition, large RIAs may be in a position to acquire those small firms that decide that being independent just isn’t in the cards anymore. “The time for the mom and pop RIA has passed,” said Mindy Diamond of Diamond Consultants.
Custodians and aggregators
As the flow of brokers increases from the wirehouse and IBD worlds, custodians will obviously benefit. So will the companies that have set themselves up as professional acquirers, like Focus Financial, HighTower, United Capital and Sanders Morris Harris Group. (See Sanders Morris Harris Group, serious competitor to the big roll-ups, launches bid from Texas).
Adolf says the growth at Focus, which now has $40 billion in AUM, is coming from two places: clients leaving the wirehouses, and brokers leaving the wirehouses. “A broker cannot look his client in the eyes any more and say it’s better for you if I go from Merrill Lynch to Morgan Stanley.”
The degree to which different custodians and aggregators have built strong fiduciary platforms varies, though, points out Don Trone, CEO of consulting and compliance firm Strategic Ethos.
Some TAMPs and other service providers
Some companies have already been positioning themselves as companies with the platforms that enable advisors to outsource some of their fiduciary obligations. Envestnet, for instance, has built in a fiduciary component of its technology platform. An example, says Jim Patrick, managing partner: an advisor making an investment decision for a client might be prompted to enter the fiduciary rationale for such a decision, establishing an (electronic) paper trail. The number of advisors on Envestnet’s platform grew to 19,620 in the third quarter from 13,542 in the year-earlier quarter; assets under administration grew to $126,350 billion from $85,198.
SEI and genworth have also gathered momentum as TAMPs, partially because of the wholesale switch of so many IBD reps to fee-based business (For more on TAMP growth:SEI turns a big corner but Genworth is still the big asset gatherer).
A fiduciary emphasis means more pressure on keeping fees and expenses low, says Trone. That’s bad news for service provides who aren’t efficient, but good news for those that are.
Longstanding advocates of the fiduciary standard
Associations like FPA and the National Association of Personal Finance Advisors, that promise education and a fiduciary stamp of approval will benefit, as well as designations, such as the CFP, which already require a fiduciary standard of care, says Trone. Some money managers, including Thornburg, Columbia, and Calvert, will also bask in the reflected glory of being on the right side of the debate, early. Among the custodians, TD Ameritrade, which came out vocally in favor of a fiduciary standard, is already winning kudos from advisor groups.
The SEC has finally taken action to elevate the standard under which broker-dealers operate. Moreover, it doesn’t need to wait for Congressional approval to start issuing rules (though it’s not clear when the agency that has a host of new obligations under Dodd-Frank financial reform will get around to building out the new regulatory regime it has envisioned).
Yes, the SEC last week issued a report that seemed to prefer user fees to pay for more SEC regulation of advisors rather than a new SRO or FINRA, causing celebration among those who consider FINRA as the devil.
The fiduciary study may have the more important – and trickier implications. If the rules that govern investment advisors and broker-dealers are harmonized, and both are operating under the same standard of care, it naturally begs the question of why two different regulators would be needed.
Some in the business believe the SEC is playing a very deep game to shift oversight to FINRA. I think it’s possible, which is why I include FINRA on the winner’s list.
“The SEC is lining up all of the facts so that later on the conclusion becomes painfully obvious (that they can’t regulate advisors with their current resources). Then comes the budget shortfall. It’s genius, what they’re looking to do, but it’s incredibly transparent,” said Brian Hamburger, CEO of legal and compliance firm MarketCounsel.
Compliance firms and lawyers
This is obvious.
Elizabeth’s note: Two people for whom I have a lot of respect view the fiduciary study as unalloyed bad news for independent advisors of all sizes and stripes – but they are in the minority among those I interviewed. They are Trone and Hamburger. Their argument basically boils down to one thing: in the past RIAs were different from broker-dealers. Under the new regulatory regime envisoned by the SEC study, they will not be. They’ve lost their marketing edge – on top of having to enter a world of increasingly complicated regulation.
“Independent RIAs have now lost one of their competitive advantages (that they are a fiduciary, and the broker is not), plus the time and expense for additional compliance is going to be considerable,” said Trone. “In addition, there are a considerable number of RIAs who have acknowledged fiduciary status, but don’t actually have a defined fiduciary process in place; now with increased oversight, they’ll need to have a process.”
Hamburger agrees: “We are basically succumbing to one class of financial advisor,” he said. “Independent advisors were rather ill-equipped to pick this fight. They have won the battle but are quickly losing the war.”
I’m interested to hear what readers think about our list of winners and losers.
With RIA valuations ticking down and successions ticking up, Focus Financial deep sixes 'drunken sailor' pause, forgoes buyback plan and adds a CEO
CEO Rudy Adolf sees a 'softening' in multiples after a couple of frothy years when CI Financial dominated headlines and big RIA deals
August 13, 2022 – 12:39 AM
Robinhood gets 'brilliant' upper manager -- and a spare CEO -- by nabbing TD Ameritrade's ex-thinkorswim top exec, hopefully to throw a lifesaver to Robinhood's sinking stock
The Menlo Park, Calif., firm nabbed Steve Quirk as first-ever chief brokerage officer to 'bridge the gap between academia and reality.'
January 6, 2022 – 10:33 PM
Oisín's snippets: Charles Schwab brand goes up on Omaha's TD Ameritrade stadium, home of college baseball world series • Interactive Brokers lands an RIA custody insider, Charlie Latimer, to climb the custodian ladder
The TDA brand lives on until the techies figure out how to make two systems into one, but change is in the air in Omaha, while Interactive Brokers gets a leg up in the custody business with a new hire.
December 27, 2021 – 9:58 PM
Looking past Covid-19 pandemic, Louisiana RIA buys $1-million building after hitting $1 billion in AUM and hiring the town's mayor
Summit Financial Wealth Advisors was sold to Focus Financial in 2014, growing its assets by $400 million since then but keeping staffing about the same
December 17, 2020 – 3:02 AM
See more related moves
National Association of Personal Finance Advisors
Top Executive: Geof Brown, CAE
Top Executive: Kurt Cerulli
MarketCounsel | Hamburger Law Firm
Consulting Firm, Compliance Expert, Legal Services for RIAs
Top Executive: Brian Hamburger
Top Executive: Tom Nally
Financial Planning Association
Top Executive: Lauren S. Schadle, CAE, Executive Director and CEO
Top Executive: Mindy Diamond
Focus Financial Partners, LLC
Top Executive: Rudy Adolf
RIA in a Box
Top Executive: GJ King
Barbara, I understand that your constituents want you to hold their advisors to the highest possible standards. But you are suggesting that, instead of separating these two industries by removing the broker-dealer exception from the Advisers Act, we should instead give in to consumer confusion and remove any distinctions between them. The movement for independent investment advice was harmed when brokers were permitted to dress up like advisers. Your suggestion relegates that costume to a permanent uniform.
Barbara raises a good point: the public, at large, has not been able to discern the difference between a fiduciary and suitability standard. On the other hand, a fair percentage of individual advisors have been able to distinguish themselves as fiduciaries with certain individual clients, and with other professionals, such as attorneys, accountants and retirement plan service providers.
Ben Baldwin III
2008 study conducted for the Securities and Exchange Commission by the RAND Corp.
Ben Baldwin III
The entire concept of a fiduciary standard originates if I recall correctly 4 or 5 years ago, perhaps more, time flies, with a study conducted (I beleive SEC sponsored), in which it was determined that consumers were confused about what ehtos their advisor was bound by and what it meant. Namely, the question of whether the advisor selling as a broker or agent or advising as a fiduciary was one they determined in the study the client could not answer. The consumer was confused about the implications for them of the differences. I was aghast at the study’s conclusion at that time and found it so ludicrous as to be laughable and not even worth thinking about. The conclusion of the study which found that consumers didn’t know the difference between a broker and a fiduciary advisor was not to educate the consumer, but to create a new definition of fiduciary which was essentially NO LONGER a fiduciary at all but could be a broker or a fiduciary advisor so long as they did things in accordance with certain specific rules. No longer would you have to put your assets on the line and keep the clients BEST interest FIRST. The solution was to degrade the value and ethos of the fiduciary advisor to look like a broker or agent. The idea was and still is crap. There are no rules that can ensure a individual keeps their clients interest first, there is only the contract between the advisor and the client, and the traditional standards of fiduciary that principally, define the liability of the fiduciary who fails to behave as one.
Making sales people follow procedures to look like fiduciaries does not change the heart of the matter or clarify any definitions. Are you beholden to the client for your income or to the product manufacturer?
Thank goodness for the DOL’s Phyliss Borzi who is holding firm on the traditional understanding of fiduciary duty. Every broker who is doing a great job for their clients is acting in a fiduciary capacity.
There is the fiduciary standard of care required under ERISA based on 800 years of English Common Law and objective, non-negotiable fiduciary criteria of statute, case law and regulatory opinion letters. The brokerage industry has had every opportunity to support the fiduciary standing of its brokers and had instead decided to oppose their brokers being able to act on behalf of their clients in the client’s best interest, fulfilling the brokers fiduciary responsibility to act in the consumer’s best interest.
It is self defeating for the brokerage industry to support anything less than the traditional understanding of fiduciary duty. The brokerage industry would self select itself to permanently afford an inferior broker value proposition rather than support its brokers acting in the consumer’s best interest. There is no secret why the consumer has lost their trust and confidence in the brokerage industry. The industry has lost its ethical bearings and Dodd-Frank affords the opportunity for the industry to reset its moral compass.
By ignoring its fiduciary responsibility to support its brokers to act in the consumer’s best interest—the brokerage industry openingly acknowledges its obsolescence. There has never been an occassion in a free market where the best interest of the consumer has not prevailed.
It is not possible for the brokerage industry to take short cuts in a free market. Transparency and disclosure will not allow the industry to confuse fiduciary standing regardless how clever the industry may be. Enterprising advisers working in a free market, in the context of an authenticated prudent process confirmed by expert opinion letter, who are acting in a the client’s best interest, will prevail every time.
Bring the brokers on. They are not ready to compete and their words and actions counter to the best interests of the consumer will haunt them. At some point the industry will have to explain to brokers why the broker is paying their b/d 60% plus of their gross revenues and getting inferior advisory services support.
The industry has a vision and know how deficite that must be resolved, otherwise the broker becomes a high cost low value added alternative to advisors subscribing to a fiduciary standard of care.
Indeed, the Rand Study confirmed the consumer’s confusion on the role and responsibility of the broker. Advisors will make it clear that brokers are not accountable for their recommendations after they are executed, and have no ongoing responsibility to act in the consumers best interest base on objective non-negotiable fiduciary criteria of statute, case law and regulatory opinion letters. This can be made crystal clear to the consumer in highly understandable terms.
The brokerage industry maintains brokers do not render advice, they simply make the client aware of their investment alternatives. It is up to the consumer to determine investment merit on their own, regardless how limited the consumer’s investment knowledge and experience may be. What the consumer thinks is a broker recommendation, is not only not a recemmendation but the industry insists that no investment advice is implied or rendered. This is the industry’s principle defense against fiduciary liability as there is no liability if no advice is provided by the broker. By extention, if no advice is provided, no value is added by the broker and thus the role of the broker is simply the clerical function of trade execution services as confirmed by mandatory arbitration proceedings managing client disputes.
The fact is brokers are neither accountable or responsible based on the industry’s present business model—which has lost the trust and confidence of the investing public. This has required an act of Congress (Dodd-Frank) to protect the best intereast of the investing public.
The ball is in the brokerage industry’s court to properly provide the prudent processes, statutory documentation, advanced technology, work flow management, conflict of interest management and expert advisory services support in the consumer’s best interest.
We are about to see who the good athletes are and who has been peddeling down hill.
The sophistication, or the lack there of, of the brokerage industry is about to be exposed and there is nowhere to hide.
After reading Barbara Roper’s comment, there is certainly progress in the right direction. Though if there is no ongoing duty of client loyalty and care after a recommendation is executed and the broker is paid, isn’t the impied fiduciary standard not remotely close to the traditional understanding of fiduciary duty. Further, doesn’t disclosure of conflicts simply perpetuate conflicts rather than requiring them to be managed on behalf of the consumer in the consumer’s best interest.
We assume that the brokerage industry will lead in the best interest of the consumer to win market share, yet as Barbara Roper points out—nothing in the past 25 years would support that thesis.
My disappointment is, unlike the FSA in England, the SEC is very passive in their recommendations. If the industry will not lead and the SEC is passive, where will the required market leadership come from?
Where will the vision, leadership and resources come from that will make advice (fiduciary standing) safe, scalable and easy to execute, as it is viewed as heresy within many firms to suggest that advisers need to be properly resourced to fulfill their fiduciary duties when previousily fiduciary standing was not even acknowledged. Doesn’t this represent a significant challenge for the industry? Is the industry taking the fiduciary standing of its brokers seriously or is its tact to simply waterdown what is required so not much is changed? If there is a different fiduciary standard for retail advice than institutional advice which seems to be emerging, then isn’t it self defeating for retail brokers?
There are a lot of questions that require principled leadership. Legitimate fiduciary standing for brokers is in the broker’s best intererst. If it were up to brokers, the difficult decisions would be made in support for fiduciary standing. But the industry has largely been insular to the best interest of the consumer as Barbara Roper has found. In order for Dodd-Frank and the intent to hold brokers to the fiduciary standard of care to be effective—it presumes the industry actually has an identity of interest with the consumer—this is the Elephant in the room. It is faster, better and cheaper for the industry to support the traditional understanding of fiduciary duty than permanently cripple retail brokers with the perpetuation of conflicts of interest through disclosure and the broker’s absolution of ongoing responsibility for their recommendations.
I see one key flaw in the argument attributed Brian Hamburger and Don Trone that advisers will lose an important competitive advantage if brokers are subject to a fiduciary duty. How can advisers’ fiduciary duty be a valuable competitive advantage when investors don’t know the difference between brokers and advisers, can’t tell whether they are dealing with a broker or adviser, and don’t recognize that they are subject to different standards? I think this argument would have been valid if the SEC had ever prevented brokers from misrepresenting themselves to customers as advisers, but that is water under the bridge.
Brian, You are absolutely right. Having fought fruitlessly for 25 years to get the SEC to enforce the distinction between brokers and advisers, I am bowing to the inevitable. When they allowed brokers to offer financial planning and investment planning outside the protections of the Advisers Act, allowed them to call themselves financial advisers outside the protections of the Advisers Act, and allowed them to advertise that “advice is at the heart of our relationship” without questioning whether such advice was “solely incidental” to their brokerage activities, the SEC effectively removed all meaningful distinctions as far as the investing public is concerned. We opposed every single one of those decisions, and we lost every single time. In an ideal world we would draw a clear line between these two functions, this is not an ideal world. So, while the approach of extending the fiduciary duty to advice by brokers is far from perfect, it is the best option that is politically feasible and will extend important protections to investors who need them.