For a growing number of advisors, a hybrid or dual practice that combines brokerage and traditional advisory services at a single firm can seem like the best of both worlds.
Dually registered advisors can provide fee-based advisory services through the RIA wing of the practice while also offering clients a galaxy of commission-based products. Many RIAs like the option because they don't have to send clients elsewhere to purchase insurance or a variety of other products; broker-dealer reps find they can differentiate themselves by offering more fee-based services. (Independent B-D network Advisor Group recently found that its dually registered reps were 25% more profitable than those who were registered reps alone, CEO Erica McGinnis told Financial Planning.)
"It really depends on the client," says Jane Ott, president of North South Capital in Chicago. "It's always good to have choices too. Let the client decide how they're going to pay for their financial advisor."
Yet the dual-registrant model also invites a set of regulatory and compliance concerns that have federal authorities on alert.
"I tell [advisors] that having the ability to offer your clients a wide array of options is both a blessing and a curse," says Jason Thackeray, vice president and director of compliance at Raymond James Financial Services. "It is a blessing because it gives you the flexibility to work with a wide array of clients in numerous different situations. But it also places a burden on you to make sure you're accurately documenting your conversations with those clients about why you chose to work with them in the way you did."
The SEC has put the financial world on notice that it has dually registered investment advisors and broker-dealers in its sights. Alarmed at the convergence of what once had been distinct segments of the industry - governed by two separate statutes - the SEC warned early this year that dual registrants can expect increased scrutiny from its examiners this year.
The agency had already identified dually registered investment advisors and broker-dealers as a "new and emerging" issue in outlining last year's examination priorities. This year, the commission named dual registrants as one of the "most significant initiatives" its National Examination Program would undertake.
"The convergence among broker-dealer and investment advisor representative activity continues to be a significant risk," the SEC cautioned.
An SEC spokeswoman declined to answer questions on the record about the commission's concerns about the dually registered business model or its ability to increase oversight at a time when its resources are stretched thin.
In addition to setting its examination priorities, SEC officials have been making the rounds at public events to talk up their focus on dual registrants. At an industry conference in late January, Kevin Goodman, the national associate director of the SEC's broker-dealer examination program, explained that the commission is "looking for the outliers" - dually registered firms "that are consistently guiding people to the wrong space in terms of what's in their best interest."
STEEP ASSET GROWTH
The SEC scrutiny reflects the growing convergence of the advisor and broker-dealer spaces.
According to research firm Cerulli Associates, dually registered advisors held nearly $1.1 trillion in assets under management in 2012, the most recent year data was available. Those holdings are still overshadowed by the nearly $1.6 trillion independent RIAs oversaw in the same year - but on a percentage basis, dual registrants' AUM grew at nearly twice the rate as assets in the independent sector.
"The dual registration channel won the most net assets in 2012, surpassing even the RIA channel," explains Cerulli's associate director, Kenton Shirk. "The channel has historically been viewed as a stepping stone for IBD advisors before moving to a pure RIA model," Shirk adds. "Yet Cerulli's research has found that two-thirds of dually registered advisors plan to continue serving their clients with a mix of both fees and commissions, which suggests that the dually registered channel has staying power."
The question of fees versus commissions is at the core of the SEC's concerns about conflicts of interest associated with dual registrants. Those advisors are in a position to steer clients into either an advisory account or a brokerage account (or both), with different cost structures and - notably - different standards of care for the client.
"This influence may create a risk that customers are placed in an inappropriate account type that increases revenue to the firm and may not provide a corresponding benefit to the customer," the SEC warns.
In practice, there are significant regulatory distinctions between the two models. RIAs are bound by a fiduciary duty to provide investment advice that is in the best interests of clients. By contrast, broker-dealers, who are required to register with FINRA, must make recommendations deemed suitable to their clients - a determination that can be based on a variety of factors such as age and risk tolerance.
By the letter of the regulations, brokerage accounts and advisory accounts are held to different standards. In theory, then, a client holding both types of accounts with the same firm could receive a different standard of care regarding one set of assets than another. For some dually registered advisors who consider fiduciary the gold standard of care, that distinction is moot.
"We're also CFPs, so we consider ourselves fiduciaries no matter what," says Linette Dobbins, president and chief compliance officer of McGee Wealth Management, a Raymond James office in Portland, Ore. "I don't really have the variations because what I do is take it to the highest standard - so whatever the standard is on either side, we take it to the highest standard."
One particular area of regulatory concern: Are fee-based clients getting enough service to justify high asset-management fees? In particular, the SEC has expressed concern about so-called reverse churning: the practice of parking assets that will only be traded infrequently in a fee-based advisory account.
In its reviews of dual registrants, the SEC has signaled that examiners will take a close look at accounts placed in the advisory wing of the practice to evaluate whether investors are in fact receiving enough financial services to justify the fees assessed.
Advisors acknowledge that the threat to investors is real. "I let a guy go for that. I had an employee who I fired because he wasn't talking to his clients," Dobbins says. "You're collecting a fee and you're doing nothing for it."
Because clients in a commission-only brokerage account aren't paying a fee on assets, the SEC has taken a particular interest in the decision to place a client's assets in a brokerage or advisory account. Although compliance experts stress that evaluations of account selection run on a case-by-case basis, an examiner might look at an account with low activity (other than periodic rebalancing) and question why an advisor placed it in the fee-based side of the practice.
As a result, compliance experts say the fee accounts could become a red flag for examiners who might challenge an advisor to demonstrate the additional financial planning services such as estate planning or cash-flow analysis that they offer clients to warrant their fees.
"That's where the advisor or financial planner needs to say, 'Here's what I do for the client,'" notes Duane Thompson, a senior policy analyst at fi360. "If it is apparent that they are offering financial planning services and not just portfolio management, then hopefully the SEC is going to agree with this dual registrant that it's appropriate to charge this 1% fee."
SEC officials have also been warning that consumers don't generally understand the technical differences between RIAs and brokers, particularly when the advisors are operating out of the same firm and advertising their services under the generic label of a wealth manager or financial planner.
"Oftentimes, and this is the thread that runs through all of this, the client - the customer - comes to them, they may fill out a brokerage account, they may fill out an advisory account, but they don't know the difference," Thompson says.
To address the regulatory discrepancy between the models, the SEC has been considering whether to move ahead with rules to establish a uniform fiduciary standard that would apply equally to advisors and broker-dealers. But passage is far from assured; such a proposal has long been anticipated, but it could be months or longer before it even materializes.
In the meantime, compliance experts stress that dual registrants should take the time to detail their business models - and the regulatory obligations each entails - to new clients as they work through the decision of what type of account is the best vehicle for their assets. And, regardless of where the assets land, those conversations should be well documented.
"Disclosure and documentation - those are the two big ones," Thackeray says. "It's a question of how you make that disclosure, and I would caution people that putting it in your [Form] ADV is not the only place that you should be making those disclosures," he adds. "At the very least, you have to tell the client that options exist."
Of course, some SEC watchers think the agency's tough talk might be just that. Questions remain about how much heightened scrutiny the commission will be able to bring to bear, considering its limited resources and a long list of other examination and enforcement priorities - running the gamut from retirement rollovers and fraud detection to cybersecurity and advisors who have never been examined.
"This will certainly be a challenge for the SEC, due to the inadequate number of investment advisor examiners they currently have on staff," says David Bellaire, executive vice president and general counsel of the Financial Services Institute. "Increasing the frequency of dual-registered advisor exams will require redirecting these resources from other examination efforts. I anticipate the SEC will put together teams of broker-dealer and investment advisor examiners to perform holistic exams of dual-registrant firms."
The SEC has acknowledged that its examination staff is stretched thin. Last November, the commission's Investment Advisory Committee cited an exam cycle of 13 to 14 years, and noted that more than 40% of advisors under the SEC's purview had never been examined.
Members of Congress have floated proposals to help address the examination gap, including giving the SEC the power to collect user fees from advisors to fund reviews. Bellaire's group has been lobbying to establish one or more self-regulatory organizations - in all likelihood, FINRA - to begin overseeing advisors.
It remains to be seen how the SEC's plans to enhance oversight of dual registrants will play out. But at least one recently departed SEC official cautions advisors to take the commission's warnings to heart.
"If a client were to ask me about this, I would urge them to pay attention to this issue," says Bob Plaze, a partner with law firm Stroock & Stroock & Lavan who previously served as deputy director of the SEC's Division of Investment Management and now represents advisors and other financial sector players.
If commission leaders agree that dual registrants are as much of a concern as their public statements indicate, the SEC will likely marshal the resources to increase scrutiny of the sector, he says.
"There's a tendency now in the commission to say these things ... and maybe a year later enforcement cases start to come down," Plaze says. "Often, these warnings are precursors."
Kenneth Corbin is a contributing writer for Financial Planning in Washington.
- For RIA Compliance, When Size Matters
- SEC, FINRA to Host B-D Compliance Events
- RIAs Warned of Heightened SEC Scrutiny
Register or login for access to this item and much more
All On Wall Street content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access