LPL CEO calls out big RIAs that flunk 'core principles' and cuts ties with Merit Financial, which revealed fresh disclosures in it's June ADV regarding Fidelity as custodian

Brooke Southall: You had to wonder what and where a shoe was going to drop when even-keeled Dan Arnold spoke on July 25th with rare venom about clients soon to be cut loose from the LPL herd. Their crime: ‘Misalignment’ with ‘core principles.’ No sooner were those shots fired than Merit revealed to Citywire it was ending a 14-year affiliation with LPL. We suppose this not only might not be a coincidence, but also that there is more to the story. After digging into some interviews and carefully questioning Merit and LPL, some of the fog around this improbable divorce took shape. It was a classic power struggle, years in the making, but it has really heated up since March or April.

Dan Arnold talked down the ‘principles’ of two big RIAs on a Thursday and by Tuesday, the RIA business knew of one big firm out the door at LPL Financial. Fidelity Investments seems to have pole position on $8.8 billion in advisory, $2.8 billion in brokerage assets, and $253 million in assets under advisement, as of June 30, 2024.

"They were limiting advisors' ability to choose how and where they do business," said the LPL Financial CEO about the giant OSJs on the company's July 25 earnings conference call. 

“That posture is in stark contrast to our core principles of advisor independence, and as a result, we have resolved to separate from these relationships," he added. 

“… We see in some cases where I know OSJs may buy up their advisors' practices, turning them into more of an employee-based construct, and ultimately, because of that approach, it's more of a captive type of model at that point, which again, is very different from the principles of independence and providing flexibility for those advisors, [to] move those assets where they want to or go where they want to," Arnold explained. 

“And I think that's our point. As soon as they begin to lose the principles of independence within the model, we have a hard time with that sitting within our platform and within our ecosystem,” he added. 

Strategic move

By Tuesday, July 30, Merit Financial, founded in 1998, had revealed to Citywire it was parting ways with LPL after 14 years as partners.

Merit said in a statement to RIABiz that it wasn't sure which firms Arnold was discussing in his call. 

“However, Merit is committed to advisor choice. Every business decision Merit makes is focused on enhancing service offerings to our clients through our advisors. Merit is also committed to providing our advisors with the very best tools and resources to execute on this,” it said. 

Merit Financial Advisors CEO Rick Kent said he was "grateful for the many years of support and collaboration we’ve had with LPL Financial.

“As we look towards the future, we believe that this transition will better position us to offer innovative solutions that meet the evolving needs of our clients and ensure our continued growth and success for generations to come.”

Brian Hamburger, founder of MarketCounsel, which represents Merit, confirmed Merit's decision to leave LPL Financial.

“This strategic move is one of many that Merit has taken upon itself in support of its relentless efforts to enhance its service offerings and support its vision of creating a growth-focused enterprise for its team, clients, and new advisor partnerships.”

Puzzling divorce

LPL and Merit prospered as partners, making it hard to grasp what changed so much that one – or both – wanted out.

"It’s a bit of a head-scratcher why LPL would want to get rid of large OSJs," says Mike Wunderli, a managing director at Echelon Partners.

“But there could very well be a lack of control and the ability to adequately monitor them, which increases liability.” 

Merit, backed by private equity, would seem to benefit more from the divorce, Wunderli says.

Merit's team members own more than 70% of Merit, but private equity players, Wealth Partners Capital Group and HGGC, are each minority investors in Merit.

“Firms like Merit rely on acquisitions for growth, and the more acquisitions you make, the more flexible you need to become. 

"Flexibility generally requires a serial buyer to be multi-custodial in order to cater to the needs of the most attractive acquisition targets. It’s hard enough to compete as a buyer in this market,” Wunderli adds. 

Fierce independence

Merit's ADV, filed June 17, is more nuanced. It reveals warnings about LPL to investors via Securities and Exchange Commission (SEC) ADV brochure.

“We generally recommend LPL due to the relationship our representatives have with LPL… Clients should be aware that LPL charges Merit for any assets held away from LPL. 

"LPL has a wide range of approved securities products for which it performs due diligence prior to selection. LPL’s registered representatives are required to only use these products when implementing securities transactions through LPL.

"Clients should be aware that commissions charged for these products may be higher or lower than commissions that they may be able to obtain if transactions were implemented through another broker/dealer,” it stated. 

Merit also calls out LPL for not participating in the householding of accounts like Schwab, Fidelity and Pontera, a startup that allows RIA firms to manage 401(k) assets held away at other custodians. See: Pontera attracts yet another $45-million VC round for its 'held-away' 401(k) order management system and snags SageView, a $175-billion RIA, as a customer

Fidelity, Schwab and Pontera accounts can be under the same billing household. LPL accounts can only be under the same billing household as other LPL accounts and cannot be under the same billing household with Fidelity, Schwab and Pontera accounts.

Merit Financial, with 110 advisors and 38 locations, is showing a streak of fierce independence by doing more business outside the LPL ecosystem.

Fidelity connection

Merit Financial revealed in the ADV that it was entering into a more complex relationship with -- and receiving “transition assistance" from -- another RIA custodian, which the document identifies as Fidelity Investments. 

Merit declined to state if it would choose a new primary broker dealer, custodian or if it would become a pure RIA. The company said in a statement that it would reveal plans “at the appropriate time.” 

Merit's ADV, however, states that it uses Fidelity, Schwab and Pontera in addition to LPL.  

The ADV update added that Merit may also use “certain default cash sweep vehicles at Fidelity and [with] related conflicts of interest.” See: Fidelity reveals it switched its RIA sweep default to a much lower-yielding FCash product, on new accounts, during Schwab's very pre-occupied week; new yield still beats Schwab's by about 300%, but advisors are sure to be irked

OSJs at LPL are able to run their own RIA and allow advisors to hold assets at other custodians. 

Clamping down

LPL's relationships with these giant OSJs have been crumbling. The company tried to push restrictions on the OJS going back to 2017 when LPL initially didn't want these firms to use other custodians. See: Tensions build with OSJs after LPL Financial's 'about face' on held-away RIA assets and forced use of its corporate RIA

OSJs are big RIAs and brokerage branch offices that essentially buy LPL's services on a wholesale basis and perform many of the advisor-servicing and compliance functions in-house. 

These firms take on responsibility and provide many services to advisors, but at the same time, take a healthy cut of payouts – making LPL lukewarm on the model, says one former OSJ patrner.

“It makes sense, because, ultimately, LPL would prefer all the hybrids to be on its platform where the margins are higher,"  says Bill Hamm, CEO of Independnet Financial Partners, who also pulled $12 billion off the LPL platform, in 2018.

Since 2018, LPL has only clamped down further on firms like Merit to purchase other LPL advisors, 

“I know LPL has put restrictions on a hybrids' ability to buy other hybrids by instituting a right of first refusal on those purchases. 

"I have also heard that LPL has been purchasing a number of the hybrids which we kind of expected when we left five years ago," Hamm adds.

Veto rights

LPL also restricted a number of giant OSJs this spring. LPL sent letters to some OSJs alerting them to new terms that industry leaders have said could cause an exodus from LPL, Barron's wrote in late April. 

“LPL is requiring the targeted OSJs to notify it and obtain authorization before moving assets off its platform,” the article states.

LPL added a provision that would give it a first-rights provision in a sale of more than 10% stake, but the OSJ doesn't have to accept the offer and LPL doesn't hold any veto power if the OSJ decides to sell to another firm. Large OSJs like Merit have attracted private equity and have been purchasing other LPL firms. 

Hamm points out that when he was at LPL, his firm didn't employ advisors, and LPL was able to convince 50% of them to stay. 

“Had they been employees of IFP, 100% of that business would have moved to our new broker dealer since we essentially would have owned the collective book of business. 

So, having the employee model makes the hybrid more valuable, which leads to a greater probability of selling to another firm at some point without the aspect of LPL being able to make a play for those advisors.  

"Basically the hybrid employee model gives more leverage and power to the hybrid (versus the independent contractor model) which is typically not in LPL's best interest,” Hamm says. 

Future transaction

Wunderli says he understands why Merit would want to leave. 

“If you’re PE-backed, then you are ultimately preparing for a transaction of your own [either a majority sale to a strategic or swapping out PE ownership]. 

"With LPL as your sole custodian or BD, your prospective buyer universe will be much smaller and your transaction value lower. Hence, I’m sure their PE backers are actively ‘nudging’ them in this direction [away from LPL] as they look towards a future transaction.”

Arnold maintains LPL will be just fine without the OSJ/RIA assets it began 'off-boarding' last month.

“Collectively, these firms have roughly $20 billion of client assets, which began to off-board from our platform in July. At the end of the day, these separations will strengthen our overall ecosystem and position us to better serve the great partners on our platform.”

On its ADV, the company explains that in a unique tiered fee schedule, assets can be billed at more than one rate. For example, a $500,000 account would pay 1.5% for the first $100,000. The next $150,000 would be billed at 1.25%. Tthe remaining $250,000 would be billed at 1%.

In 2022, LPL purchased Financial Resources Group Investment Services, also headquartered in Fort Mill. The then-$40 billion office of supervisory jurisdiction (OSJ) – previously an IBD client – will become a hub to roll up OSJs nationally to further its retail strategy and grab more bank customers. See: LPL Financial prepares to enter the 'OSJ' channel -- this time as an owner, headed by a former executive whose staff advises $40-billion