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Nine threats to the RIA business and how they can be avoided

The fragmented 13,000-firm army is poised for great things but too much focus on expediency could bring its own problems

Monday, November 14, 2011 – 5:24 AM by Brooke Southall
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Brooke Southall: The RIA business needs to be alert to the danger of becoming something uncomfortably similar to the world of banks, brokerages and trust companies that it is trying to reinvent.

Brooke’s Note: If you spend any time here at RIABiz, you’ll know that I consider RIAs to be a largely unstoppable force. See: 10 things that show the RIA movement is really heating up in 2010: Part I. It is winning over both consumers and those who serve them as registered investment advisors. That’s a one-two punch in a free enterprise system. But any child can grow up and become exactly what they didn’t intend to be — a younger version of their parents. A close look reveals that as the RIA business passes through adolescence that it is hardly immune to this age-old process. As the critical mass necessary to take on Wall Street builds, the RIA business needs to be alert to the danger of becoming something uncomfortably similar to the world of banks, brokerages and trust companies that it is trying to reinvent.

1. Too fast, too furious

An overarching threat to the RIA business is just how determined its practitioners are to see it grow and grow fast — and to position their firms for future liquidation. See: What to make of Mark Hurley’s latest prophesy that most RIA firms will go out with a whimper.

People constantly ask me: What’s the next big thing is for RIAs? Translation: How do we get this old diesel freight-hauling engine to act more like a Japanese bullet train? If the RIA business currently wears a bit of a halo, it’s largely because it has grown so organically that it is the envy of all around it. Tim Welsh refers to the RIA business as “the rag tag army.” There’s a temptation to suit up advisors in slick, pressed uniforms and send them to military school to learn conventional warfare. Clearly, there are advantages to this and many advisors want to rise in the ranks. But there is also a risk that advisors could become so pumped up on hyper-growth and hyper-efficiency that they will become indistinguishable from the well-coiffed armies they are quietly vanquishing. See: Wall Street thriller 'Margin Call’ is a cautionary tale — even for RIAs.

It’s worth keeping in mind that, even with the massive efforts underway at asset custodians and elsewhere to create soft landings for breakaway brokers, there are still only a few hundred broker-dealer defectors making the move every year. There are also a fairly small number of firms that are growing at a rate greater than 20% annually. See: Six things to know about how and where RIAs are growing.

True grassroots movements don’t move at a pace that satisfies those with inorganic ambitions. Brokers leave their employers grudgingly. Clients leave their brokers in slow motion. And the other source of RIA growth — markets — are grudging in their returns, too.

The RIA business should and can get bigger and it will be disappointing if its assets haven’t surpassed those of wirehouses in 10 years. But attempts to make it move faster than it wants to go could result in a backlash — as the next two points better explain.

2. Corporate giant-ism

Many of the reasons that big broker-dealers have poisonous effects on investors — and in turn the brokers doing their bidding — can be traced to the caveat emptor-oriented rules that they play by under FINRA’s suitability standard. But these brokers are also tainted by the mere fact that they work for bloated too-big-to-fail — or, at this point, succeed — corporations like Bank of America and Morgan Stanley. In these behemoths, the rights and concerns of individuals are trumped by concerns for the success of the larger entity. It is as much this big-company underpinning as any regulatory factors that has made cross-selling of bank products and the sale of high-commission or questionable proprietary products so much the norm.

In the emerging RIA universe, strategic buyers, completion strategies, aggregators, wealth management platforms and various groups that form various umbrellas for groups of advisors, with or without ownership interest, run the risk of exerting a similar malign influence on RIAs. I won’t name any of these companies because it would suggest that I am specifically suspicious of the effects of their business models on the RIA industry. I’m not. Not yet. These companies certainly offer considerable advantages to RIAs that can, in turn, be conferred on the investors who work with those firms.

But as these companies get bigger and their ambitions to become public companies come to the fore, their leaders may be faced with an increasing number of decisions that pit corporate growth against what’s absolutely best for investors. As RIA businesses become corporations, each advisor and each client takes on a smaller significance to the organization as a whole. In the zeal to grow, the benefits conferred by existing fragmentation should not be forgotten and trampled on. Better management to assure consistently high-quality processes, better training, better funding, better technology and a better sense of office community is needed. The effluent of big-corporation-first attitudes needs to be guarded against.

3. The TAMP-ification of RIAs

Another way that RIAs are achieving scale more rapidly is by outsourcing larger portions of their businesses to other companies. The biggest area of outsourcing is of investments to turnkey asset management programs. Big and small TAMPs alike are booming — and for good reason. The benefits can hardly be doubted. The RIA knows that its investors are being handled by professional investment managers, which is good unto itself and solves a multitude of fiduciary concerns. It also frees up the advisor to spend more time with existing clients and prospects to build the business. Many TAMPs also offer high-level practice-management advice.

The downside of TAMPs is that somebody needs to pay for the giant burden of work that’s lifted from of the advisors’ shoulders — and that somebody is typically the investor. There can be layers of fees — not only TAMP charges but the underlying funds that the TAMP manages. On top of all that, the advisor charges a fee.

The question is whether the TAMP-ification of the RIA business will lead to higher and more confusing fees has yet to be answered. There is also the question of whether the portfolios used by TAMPs will always be customized properly for the client.

TAMPs have historically been used by IBD reps and, when the TAMP is compared to sales-based investing, it typically comes up a winner.

Will TAMPs also be able to show that clear bump in value as they penetrate and exert increasing influence on the RIA market?

4. The lack of a unified front

As it stands now, RIAs run the risk of not be able to properly unite when if threatened by hostile external forces. There are various organizations in which RIAs have good representation but none that can truly be called the RIA association. The FPA is big and RIA-friendly but counts plenty of brokers among its members and works to accommodate their concerns. NAPFA is more purely RIA but it is small. The IAA is pure RIA from a regulatory standpoint but it protects the interests of all RIAs — including mutual fund companies. This muddies its advocacy on behalf of RIA firms, per se.

The more powerful RIA associations in the industry are often the asset custodians — especially Schwab, Fidelity, Pershing and TD Ameritrade. The problem with relying on them as a unifying force is that— despite their leaders saying there is more that unites them than divides them — they not shown much of a taste for forming a united front. Fidelity Investments and Pershing LLC are hamstrung in that they don’t want to take actions that would be — or appear to be — working against the IBDs that clear assets through their clearing subsidiaries. Schwab doesn’t want to stand for anything that would harm its ability to give advice through brokers in its branches. And TD Ameritrade, Schwab and Fidelity are all wary of taking pro-RIA stands that could jeopardize their giant discount brokerage operations. Still, I believe that these custodians could take their united advocacy on behalf of RIAs to a new level and their inability to band together seems to leave an exposed flank for the RIA business.

A true RIA Custody Council would be a force to be reckoned with; one that lobbyists and legislators would think twice about crossing. See: Brian Hamburger answers the questions about an SRO future that has RIA stomachs in turmoil.

5. The rise of the robo-advisor

Another factor that could hobble the RIA industry is that there simply won’t be enough good people to do the job. There are multiple factors that bode ill on this front including: a current shortage, according to Mark Tibergien, of as many as 10,000 financial advisors at RIA firms currently; the fact that the average RIA principal will reach retirement age in the next decade; and the fact that it is difficult to produce an advisor worthy of a top-flight RIA firm.

It is troubling, too, that many of the older, more experienced RIAs have little or no succession plans. See: Favorite succession plan of RIAs remains the same: none at all. One big feeder of new advisors has traditionally been wirehouses, namely Merrill Lynch, but these companies are scaling back their training.

The good news is that a whole cottage industry of individuals, custodians and small companies cropping up to help established brokers go independent. Independent broker-dealers are also doing a good job of landing wirehouse reps and turning them into hybrid RIAs. See: 5 Reasons why the hybrid RIA model may be a bigger deal than ever. In turn, RIA custodians are re-poaching these advisors as their practices ripen. See: IBD reps are new wave of breakaways to the RIA channel, say some recruiters and custodians. (This approach is itself worthy of worry. See point No. 7.)

There are manifold potential ramifications of a dried-up labor pool for quarterbacking the wealth of complex clients. The costs of doing business are bound to skyrocket. Not only does this put the squeeze on owners of RIAs, but it makes it more likely that they will look for cheap substitutes. Will clients of RIAs come to find they are dealing with phone trees, call centers, clerk-like employees and keep-the-phone-call-short hourly rates to talk to experienced RIA principals? You laugh. But at a recent RIA retreat, there was serious discussion of making judicious use off robo-calls. See: Advisors talk over the future of financial planning at FPA Experience 2011.

6. The perils of 'harmonization’

Another obstacle to RIA growth lies in what many believe have been the misguided efforts to “harmonize” the fiduciary standards between B-Ds and RIAs. The danger here is that that independent RIAs could cease to exist as a truly distinct class of advisors from a legislative standpoint. An RIA, is by definition, registered with the SEC in a way that sets it apart from other types of firms. A leveled fiduciary playing field could create a watered-down fiduciary standard that would give brokers more accountability and credibility. It could also lower the bar for RIAs. FINRA purportedly has a more fundamentalist approach to the rules whereby you live by the letter of the law as much as by its spirit. The battle to distinguish a financial advisor from a broker would become more difficult than ever and no doubt the big brokerage marketing and advertising machine would exploit this lack of clarity to maximal effect.

Describing one of the downsides of a level regulatory playing field, Brian Hamburger, principal of MarketCounsel, said at the firm’s recent summit: “Who doesn’t like to be in harmony? But you should know what you’re being harmonized with.” See: The dark side of the 'good’ regulatory changes get scrutinized at MarketCounsel Summit 2011.

The “harmonization” that many in the RIA field have pushed for, could result in RIAs being lumped in with brokers — the firms you left or the ones you’re doing your best to disassociate yourselves from — because you believe you have a unique value proposition. See: What is the value proposition of a financial advisor — and how is a budding RIA culture upping the ante?.

7. Serving two masters

The fastest growing segment of the RIA business is the one built on hybrid RIAs, according to Cerulli Associates. The rise of this two-hatted group of firms that report to FINRA for transactional business and the SEC for advisory business has been a force in swelling RIA assets. Making the decision whether or not to give up transactional business altogether is overwhelming for some breakaways who are already wrestling with big changes associated with going independent See: Should I dump my securities licenses?.

Hybrid RIAs are nothing new but the industry’s ability to serve them with slick platforms that keep things looking uncomplicated and unified is creating boom times for this sub-segment. You could argue all day about whether hybrids constitute the best-of-both-worlds or sanctified schizophrenia. But it seems like wishful thinking to believe that an advisor sitting down with a client can be a fiduciary and a non-fiduciary all in the same meeting without causing some confusion. Is that confusion outweighed by the flexibility the hybrid label confers? The issue should continue to be raised as the RIA business continues to grow. See: A conversation between a wirehouse advisor and a senior citizen who seeks trust.

8. Technological homogeneity

The top custodians, including Fidelity, Schwab, TD Ameritrade and Pershing, are all deeply invested in creating incredible ecosystems of integrated technology. This looks like a great advancement for the industry as constantly closing in and out of apps and systems can hardly be considered efficient. Still, it seems to be creating two classes of consumers for technology. Wirehouse breakaways are being nudged toward using turnkey technology bundles. Existing RIAs tend to favor cobbling together best-of-breed third-party vendors. Will a turnkey-using RIA evolve into a less-customized advisor whose technology dictates what it does or doesn’t do for clients or will it actually leapfrog over the guy saddled with the 1990s-based system? Right now the most prominent software in the industry seems to be SalesForce. The CRM company’s product wasn’t even designed with RIAs in mind but has big custodians like Schwab, TD, Fidelity and LPL embracing it with ardor. This may be well and good but, to me, it’s a sudden sea change that bears watching in clinical trials. See: Purchasing too much technology has its own dangers for RIAs.

9. Losing the chip on your shoulder

A huge number of financial advisors have been fired by wirehouses or laid off from banks in the past few years. Others decamped because they felt marginalized by degrading cultures and changes in management. No matter what their mode of exit, having existed so long in such a world has left its mark and many newly established RIAs are aflame with a convert’s zeal to never be swept into such a world again.

I speak to breakaway brokers all the time, often shortly after they have left their former employers. Often, they express a sense of euphoria — even as they’re sitting on boxes of files in half-painted offices. It strikes me that this is a very healthy thing. For many advisors, it’s the enduring chip on their shoulders that fuels their determination to create a more perfect financial advisory practice. This passion shows up on no balance sheet, org chart or piece of legislation. But it may be central to the irresistible energy that emanates from this emerging industry, an industry that needs visionaries and leaders — and ones with long memories — to keep the flame burning. For dozens of case studies, see Breakaway Stories

Editor’s Note: About six weeks ago, I started asking of the RIA business: what could possibly go wrong? I felt like the guy they hire to write the 'weasel’ clauses in prospectuses — looking at every glass as half full to compile this list. I came up with a lengthier list than I expected. Still, I suspect I missed some points, and I hope people will share them here or e-mail me with thoughts at Brooke@RIABiz.com.

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Mentioned in this article:

National Association of Personal Finance Advisors
Top Executive: Geof Brown, CAE

Nexus Strategy
Consulting Firm
Top Executive: Timothy D. Welsh

CRM Software
Top Executive: Marc Benioff

Financial Planning Association
Top Executive: Lauren S. Schadle, CAE, Executive Director and CEO

Jeff Spears

Jeff Spears

November 14, 2011 — 2:28 PM

Great summary.

I would add that the success of the independent RIA business model is also based on the advsiors ability to customize solutions. Customization is NOT scalable (read IPO or PE roll-up) and a customized practice has real capacity constraints. Our research shows a high-end advsior can not effectively work with more than 25 families.

Bottom line – this is a relationship business that will fail if the “realtionship” becomes “the brand”. If we let that happen we will look like Wall Street and old school Trust departments.

Stephen Winks

Stephen Winks

November 14, 2011 — 8:39 PM


The advisory services industry has yet to achieve large scale institutionalized support for fiduciary standing largely because it has been a anathema to the brokerage industry and the trust industry is not greated to broad based distribution.

The nine threats cited are easily remedied by large scale institutionalized support for fiduciary counsel that is based on exper authenticated prudent process, advanced technology, work flow management, conflict of interest management and expert advisory services support which provides an unprecidented level of individualized investment and administrative counsel at a fraction of the cost of commission sales. The old brokerage business model is easily outdated and will be supplanted by the new faster, better and cheaper advisory services business model. Cerulli tells us by 2013, the majority of MSSB revenues will be derived from brokers who have control over the investment decision making process—the tipping point of brokerage obsolescence—rendering obsolete massive portions of overhead, that do not specifically add value.

No major institution will immediately or enthusiastically adapt because of the disruptive nature of the necessary advisory services innovation. The massive overhead of the old brokerage model that does not add value by industry design will be replaced by an authenticated prudent process which does. Harvard’s Clayton Christensen observes, the most common mistake made by established firms when faced with industry redefining innovation is to look at innovation in the context of its existing business model, when a new business model is required.

The question is will the brokerage industry adapt or an entirely new advisory services industry emerge which affords a preemptive advisor value proposition at a fraction of the cost?

It is actually easier to start from scratch than trying to fit a square peg in a round hole.

Look to Dynasty Financial and others for much needed market leadership, as wirehouses can not process the order of magnitude of innovation in store necessary to support fiduciary standing as their self interest gets in the way.

RIA rollups and custodians who fear being prescriptive in the advisory services support provided as it triggers fiduciary liability will be vulnerable to those firms which expertly support fiduciary standing. Why pay 60% of your gross revenues to a retail b/d that provides you with a permanently inferior competitive market position. Top brokers and advisors and most importantly their client’s know the difference in value proposition, scale, operating margins, earnings multiple, practice management, sales and marketing and productivity. The best interest of the consumer always prevails.


Mike Byrnes

Mike Byrnes

November 14, 2011 — 10:25 PM

Brooke, solid list. It is well thought out and on point!

When I do SWOT analysis business planning exercises with my clients the threats usually come down to this handful of items:
1. The markets / economy
2. Competition from non-RIAs and the increasing number of RIAs
3. Aging clients (and the younger generations that want to do themselves)
4. The loss of key personnel (a big problem for those without succession plans)
5. Regulatory changes

Mike Byrnes, President of Byrnes Consulting, LLC
www.byrnesconsulting.com @byrnesconsultin

Rick Ferri

Rick Ferri

November 15, 2011 — 2:29 PM

Great list, Brooke.

Rick Ferri
Portfolio Solutions, LLC

Elmer Rich III

Elmer Rich III

November 14, 2011 — 4:48 PM

This is good and tracks what we see with clients. We would also say a major weakness we see is disinvesting in the business.

We do M&A consulting with RIAs and find that, especially over the last few years, FUD (fear, uncertainty and doubt) have led partners in firms to stop supporting the businesses and actually take money out of the businesses for personal use of savings. Especially if the owners are nearing retirement.

This can backfire.

Businesses require steady investment, upgrades and maintenance to remain competitive and protect and build the equity in the business.

Business development, technology, people and skills, expert knowledge, etc. all these investments need to continue or disinvestment is happening, silently. Paradoxically, a “down” economy and market is the cheapest time to reinvest in your business equity. But, like your clients, it requires acting against your immediate feelings and FUD, and taking a long-term goal perspective.

We see the penalty when it comes time to sell the business or get a co-investor for continuity.

For a business to be a going concern in the future:

- Someone has to maintain the equity in the operations

- If there has been disinvestment, say the technology has been allowed to lag, the buyer will have to make-up the lost equity investment and spend to bring operations up to par.

- This cost will come out of the price the seller is paid, right now.

- Only if the equity in the business is adequate and kept maintained in the future will everyone optimize their benefits from the business — buyer and seller.

If there is not a suitable and continuous investment in the equity of the business returns to everyone will be sub-par — including clients. It takes discipline.

But the main mistake we see is not a problem or unexpected big costs, but a conscious disinvestment in the business for immediate personal gain.

We not saying that disinvesting, in particular situations, “right” or “wrong” — but it does have consequences.

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