The RIA Space Defined

Defining The Independent Space

The purpose of this paper is to define the characteristics of different RIA and/or independent channels.

Over the last few years we have seen a consistent migration of clients and advisors moving from the Wirehouse Model towards “independence.” Broker dealers (Wirehouses) have not sat idly by watching client assets and advisors walk out the door. Many broker dealers have created new firms that are marketed to look like RIAs but in reality have almost identical characteristics as the parent company.

It is probably easier to understand by defining each model as we go:

Registered Investment Advisor (RIA): Depending on the size of the firm they are regulated either by the SEC, (assets above $100mln) or the state in which they reside (under $100mln). RIAs provide advice and act as fiduciaries to their clients and receive a fee from the client to do so. RIAs are expected to select the most suitable and efficiently priced investment and/or custodian(s) for the client.

Investment Advisor Representative (IAR): Someone who is directly affiliated with a registered investment advisor (RIA). Typically this person is required to have a Series 65 and/or 66 license. IARs must always work under the fiduciary standard.

Fiduciary Standard: A standard where advisors must select the most appropriate and best priced investment for a client, for example when the IAR receives compensation only from his clients he must put the best interests of his client before his own. The advisor cannot accept client commissions for selling products, nor do the product vendors compensate the advisor for selling their products or services. RIAs act under a Fiduciary Standard and are regulated by the SEC under The Investment Advisors Act of 1940.

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Broker Dealer: Regulated by Financial Industry Regulatory Authority (FINRA). FINRA is a private corporation that acts as a Self-Regulatory Organization (SRO) and is ultimately overseen by the SEC. Broker dealers make money by charging commissions, making principal (proprietary) transactions (marking prices up and/or down), trading their own accounts and selling vendors’ products.

Wirehouse: (Also called NYSE “Member Firms”) A large Broker Dealer. (i.e. Morgan Stanley, UBS, Wells Fargo, Merrill Lynch). Also FINRA regulated.

Stockbroker: A person who acts as an agent for someone else (typically one who works at or for a broker dealer). We rarely hear the term stockbroker these days but registered representative, financial advisor and investment advisor are the terms B/Ds have created to confuse the issue. Typically this person is required to hold a Series 6, 7, 63, 65 or 66 license. Stockbrokers normally work under the Suitability Standard.

Suitability Standard: The process of determining an appropriate investment for a client. Brokers act under the suitability standard and are regulated by FINRA under the Investment Company Act of 1940. Even with a suitability standard, a broker has no specified duty to act in a client’s best interest. Usually (some Qualified Plan Consultants can be fiduciaries to the plan ONLY, not to individual clients) a broker (a W2 employee of a B/D) can operate only under the suitability standard because he is paid by his employer and not paid directly by his client.

Independent Broker Dealer: A smaller, regional broker dealer. Many “clear through” (place trades through) larger B/Ds. Typically IBDs also make money by charging commissions, making principal transactions (marking prices up and/down), trading their own accounts and selling vendors’ products. Some self-clear like LPL or Raymond James, and some clear through other B/Ds like Commonwealth or First Allied (NFS/Fidelity), FiNet (First Clearing/WFC) or Independent Financial Group (Pershing/BONY). IBDs are FINRA regulated. These platforms typically are not open architecture.

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Friendly Broker Dealer: Same as above accept they provide services to non-captive RIAs. It is a separate line of business distinctly segregated from the RIA. This B/D doesn’t share in the RIA revenue and the RIA doesn’t share in the B/D revenue. It is distinctly defined to RIA clients (usually in the Client Account Agreement) as an outside business activity. Non-captive RIAs can have more than one B/D relationship.

RIA Custodian: A third party custodian that provides B/D services to RIAs that charge significantly lower fees than traditional brokerage firms but offers less in investment advice. (Fidelity, Schwab, TD Ameritrade, Pershing, etc). Non-captive RIAs can have as many custodial relationships as they wish. (Captives are usually restricted to just one).

Hybrid: A firm that offers an in-house RIA known as a Corporate RIA and B/D services bundled together to advisors. Typically hybrids make money by charging commissions, making principal (proprietary) transactions (marking prices up and/down), trading their own accounts and selling vendors’ products. Usually Hybrid product offering is limited to a pre-approved list of vendor products on which the B/D can earn an additional fee. This is usually termed a “captive” platform.

Captive Platform: Generally speaking the type of relationship where an Advisor is allowed only to have a single relationship with a corporate RIA and the in-house B/D (who also acts as the custodian for corporate RIA assets). The advisor can recommend only a limited list of products to their clients. This is almost exactly the same environment as a Wirehouse or IBD.

Corporate RIA: An RIA offering on a captive platform. The advisor must normally custody through the in house B/D and therefore only has a limited product offering. Usually the advisor is restricted from going outside of his B/D for products or services. Advisors doing business through the corporate RIA must adhere to the Investment Advisors Act of 1940.

Open Architecture: An RIA that offers non-restricted custodian and open product choices.

RIA Aggregator: An RIA that offers an open architecture environment to advisors branded in their name and/or DBA.

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1. Silo RIA: An RIA where all IARs act under their individual brand (DBA) and have a contractual relationship with the RIA.

2. Ensemble RIA: An RIA where everyone within the firm works as one brand. The IAR is typically a W-2 employee of the firm.

Now that we have the terminology loosely defined, it should be fairly evident that the players (mainly B/Ds) have done their very best to make this as confusing as possible to everyone. If it were easy to understand, most people (advisors and clients) would leave the obvious conflict of interest in the wirehouse and go to the nearest fiduciary / low cost provider. But with effective marketing campaigns, most advisors and most clients stay put until the light goes on. Obviously this may never happen.

Who’s Selling You?

It is very important for advisors and clients to understand where advice is coming from. If advisors are being solicited by recruiters (I recently met one who was cleverly disguised as a “consultant” who had advisors complete elaborate questionnaires and surveys just so he could refer them to a captive platform that would pay him a handsome referral fee), they must realize that this person would never recommend they move any place that wouldn’t pay them a fee. I certainly can’t begrudge anyone from making a living but please don’t expect to get unbiased advice from someone whose compensation is at stake.

This doesn’t end with recruiters. I recently sat in on a web seminar with a roundtable of RIAs and consultants who discussed the RIA space. Only trouble is the main sponsor was a Captive Hybrid who, over and over again, presented himself as an open architecture platform. When one of the audience asked the question, “Can I hold client assets at other custodians” the answer was a muffled “Well, no”. Complicating the issue seems to be the most effective marketing tool they have.

Know Before You Go

The point I want to make here is simple. If you want to be in control of your business and have 100% transparency and unlimited investment options, you can only do it as

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an RIA, not a corporate RIA, not as a Hybrid, and not at an IBD. You have to be an RIA FIRST and then select your custodians. Then find a friendly B/D for your transactional business (if you need it). Then YOU are in control, not someone else telling you what, when and how you are going to do it.

The Competition

When you’re in a captive environment your competition is the firm you work for. You compete against the profit centers: the trading desks, against the layers of management, the productivity managers and the proprietary products of the firm.

When you are in control of whom you do business with, you force the street to compete for your business. You create the leverage for better pricing, better terms and better service. Your clients will quickly realize what an advantage it is to do business with you. Your business will grow by referral, and you will make more money, and your practice will be worth more, it really is this simple.

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