Ask Brad: Brokers Cannot Depend on Managing Assets
This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
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An advisor at one of the large traditional brokerage firms recently asked me if he could manage his clients’ assets on a discretionary basis if he transitioned his practice to the RIA model.
Having never been in the RIA model, it was reasonable for him to ask.
His reason for inquiring is a cautionary tale for advisors at the large traditional brokerage firms.
Advisors offer different value propositions for their clients. Some provide deep financial planning, others concentrate on a narrow investment focus, others choose from various additional approaches.
This advisor’s value proposition is based on his investment management of the client assets, which he provides on a discretionary basis.
He has been warily watching as his firm continues to make policy decisions that would suggest their end goal is to take discretionary authority away from him and other advisors at the firm. This elimination would not be due to the actions of an advisor. It is from firm-wide policy adjustments.
Such a change would destroy the value proposition this advisor has spent years, if not decades, explaining to clients and prospects.
Why might a brokerage firm eliminate this authority? Two reasons are supervisory purposes and economics.
Most “advisors” at large traditional brokerage firms wear two hats. They are a registered representative of the firm’s broker/dealer and an investment advisor representative of the firm’s RIA.
As a registered representative, the broker/dealer has a regulatory responsibility to supervise their broker’s actions. The firm also seeks to reduce liability risk.
If you oversaw compliance/risk at such a firm, would you rather your 10,000+ advisors: 1) be allowed to trade on a discretionary basis, with potentially bespoke portfolios for each client; or 2) force your advisors to invest client assets in firm-built models, and/or under the management of a narrow list of firm-selected money managers?
Narrowing the scope of how assets are invested makes managing risk easier. Never mind that the risk will be managed to the lowest common denominator of the 10,000+ advisors.
There are economic motivations as well.
Model portfolios and access to money managers typically come with layers of costs. Force advisors to invest client assets in such approaches, and you’ve added basis points to the revenue stream.
The motivations are there, but realistically would a firm renege on allowing their advisors to act with discretionary authority?
The brokerage firm’s 20+ page compensation plans teach us you don’t have to implement binary policy adjustments. You simply inflict death by a thousand cuts until your objective is met.
How might such a shadow ban on discretionary authority occur? Consider the potential for firms to slowly implement:
- Accounts under $X in size can no longer be managed on a discretionary basis. This change will be rolled out at a small account threshold, but as the sun rises in the east, it will increase with each comp plan revision.
- Qualified accounts must be invested via firm-provided models/managers. This will be communicated under the guise that as it is a qualified account, there are no tax consequences from adjusting the portfolio. There is no reason the accounts cannot be reconfigured.
- The payout on accounts managed on a discretionary basis will be X% lower than model/manager-invested account payouts. This will be implemented with a modest initial decrease but slowly expanded with time.
Think such an evolution is impossible?
In the small world I live in, I was recently speaking to a fintech executive from Switzerland. He explained that in his country, all financial advisors have essentially been converted to “relationship managers.” These RMs are forced to use firm-provided investment solutions and are tasked with maintaining client relationships, not managing portfolios.
I politely pointed out to him that referring to financial advisors in the United States as relationship managers would be met as an insult.
Yet aren’t traditional brokerage firms a few policy adjustments away from something similar? Reduce compensation, limit choice, add bureaucracy, and you are a relationship manager, even if not in name.
This is why the advisor contacted me to learn how discretionary management works in the RIA model. Death by a thousand cuts is not a fun way to go.
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development, to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.