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Many advisors have concluded there’s a better life on the RIA side of the regulatory spectrum. Nevertheless, most advisors remain tied to the apron strings of broker-dealers.
This attitude is changing.
According to FINRA, the number of registered representatives stood at 637,669 in 2019 (the last year for which information is currently available). This represents a drop of only 3,782 from the prior year. Meanwhile, according to the Bureau of Labor Statistics, although the number of “personal financial advisors” in 2019 was only about 263,000, the number is projected to grow 4%. And before the COVID shutdowns put a blanket on activity last year, average breakaway AUM in Q1 and Q2 was on pace for another record year. Still, even amid the uncertainty caused by the pandemic, the number of breakaways topped any other year save for 2019’s record 12 months, according to an ECHELON RIA M&A Deal Report.
There remains a sense of the unknown for reps who are thinking about breaking away. The most significant concern is whether they can earn enough in advisory fees to offset their commissions absent a registered rep license. Notwithstanding this trepidation, the ability to be your own boss, access to a more diverse set of investments, and become a true professional advisor to clients, rather than a simple order taker, offers clear advantages. The decision ultimately comes down to many factors, both personal and regulatory.
An evolving landscape
Twenty years ago, registered reps were sacrificed to their broker-dealer as firms tried to minimize their liability from the latest “hot investment” that crashed and burned. Despite the regulatory authorities cracking down on the systemic problems in the industry, such as conflicts of interest arising from sales contests, the pressure to sell the broker-dealer’s own products remains. Moreover, the view that most registered reps are expendable, and all but the highest producers are replaceable cogs, endures.
Back then, the conventional wisdom held that the independent investment adviser couldn’t compete with the big wire houses because they didn’t have the access to the research or the products necessary to properly serve their clients. If you wanted to go independent, you had to have significant capital behind you and could only service a handful of high-net-worth individuals. That has all changed dramatically in the last two decades.
In the years since, the availability of advanced client and portfolio management software and the growth of the internet has leveled the playing field. Research is abundant and access to sophisticated investment products are available to even the smallest advisory firm. As the industry moves toward more technology solutions to help with trading and performance reporting, it has become easier to compete with larger firms and aggregation software can offer “soup-to-nuts” solutions that allow RIAs to focus on true wealth management. And as the pandemic lockdowns demonstrated, you don’t even need an office to serve clients as an investment adviser.
The break-even question
Whether to give up your registered rep license, however, is never black and white. The decision is driven as much by your personality as it is by the regulatory requirements. Breakaway RIAs are entering the market with a compelling value proposition in the form of old-fashioned white-glove service. But by maintaining your registered rep license, you’re creating unnecessary hurdles that can pose challenges down the road.
Typically, the reluctance to give up a brokerage license stems from the unfounded fear that without a connection to a broker dealer the advisory fees won’t make up for the loss of commissionable income. Keeping that connection, however, comes with costs, both financially and emotionally, in the form of two sets of compliance obligations.
Most registered reps have not served in the role of chief compliance officer. It is difficult to appreciate the time commitment necessary to absorb these responsibilities. In addition to the required oversight obligations, there are also numerous “best practices” state and federal examiners will expect to be in place. Maintaining a registered representative license in addition to your investment adviser registration effectively doubles the workload. In most cases that shouldn’t be necessary.
Anecdotally, these decisions can seem like a no brainer in hindsight. One adviser who was frustrated with his broker-dealer noted they were monitoring his email communications continuously and chiding him for any recommended investments not on their approved list. Because this brokerage firm also acted as an investment adviser for certain types of accounts, the representative could only recommend the “unapproved” investments for clients who were not in the broker-dealer’s advisory programs. When I suggested that he drop his registered rep license, and move all his clients to the independent channel, it was a revelation.
There are several compliance obligations that become moot without a Series 7 license. In the last few months alone, FINRA has issued regulatory notices regarding options account supervision and margin requirements; published updates to the interpretations of the margin rule for day trading; provided guidance on certain sales-charge discounts and waivers; and amended its equity trade reporting rules.
The more rules and regulations, the higher the chance for error. In April alone, FINRA sanctioned nearly 50 individuals for various rule violations. Moreover, registered reps face continuing education requirements, an added responsibility not imposed on investment advisers.
Recently an adviser contacted me in a literal panic when he realized he had not taken any continuing education courses in over a year. I double checked his license status and reminded him that he and his partner had dropped their Series 7 licenses two years prior when they became investment advisers, eliminating the threat of a possible suspension. The relief in his voice was palpable.
Would you sleep better knowing you no longer have to answer to FINRA? I would imagine so. The benefits for investment adviser representatives who drop their registered rep licenses are obvious. With the right business model, you should find that the advisory fees more than offset the lost commissions, while eliminating many regulatory obstructions that get in the way of helping your clients.
Subjecting yourself to additional regulatory burdens is simply counter-productive to becoming truly independent. Do your homework, of course, and run the numbers just like you would for any client considering a new investment. In the vast majority of situations, cutting those registered rep ties will provide the freedom you’ve been seeking.
Alan J. Foxman, Esq. is a managing director with Foreside and has been a member of the Florida Bar since 1988. Alan is a past chairman of the Government and Regulatory Committee of the former National Association of Investment Professionals (NAIP).
Read more articles by Alan Foxman
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
