Ask Brad: The Super-OSJ Model is Doomed
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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The economics behind the “super OSJ” brokerage model are unsustainable. Those firms are destined to transition to RIAs.
To understand why this is the case, imagine you operate a hotel.
John, a business traveler, comes to town frequently, booking a room once a month. He’s a great customer: he visits often and pays the full room rate.
John eventually starts booking two rooms for each visit, as he now brings a co-worker. That’s two rooms every month at full room rate. We love John!
Business keeps expanding for John; he now brings four co-workers with him each month, each needing their own room. Now up to five rooms total, John asks for a discount on the room rate every month. Knowing he’s a valuable customer, you oblige and offer him a 10% discount. Everyone is happy.
Business expands again for John; he now books 20 rooms a month. Knowing he got a 10% discount at five rooms, he comes back asking for a deeper discount now that he books 20 per month. You feel a little uncomfortable, but 20-room nights each month is a wonderful customer to have! You again oblige and give an even deeper 20% discount.
Before you know it, John is now up to 100 rooms a month! He got a discount at five rooms and a deeper discount at 20 rooms, so guess who comes knocking on your door? Knowing how many rooms he books each month, he ups the ante and not only asks for an even deeper discount on the room rate, but he now also wants late checkouts, waived parking fees, and guaranteed room availability.
You initially push back against John’s request. He politely references the hotel down the street that would love to accommodate his business.
It is now even more uncomfortable. John generates significant revenue for your hotel each month. But with the discounts and perks, your profit margin on his business continues to decline (though it is still meaningful income for your hotel.)
What do you do? When does the cycle end if you agree to John’s request yet again?
This is the love-hate relationship that broker/dealers have with their super-OSJs.
An office of supervisory jurisdiction (OSJ) is a FINRA term describing an office identified by the broker/dealer as having supervisory responsibilities for a set of brokers.
A “super” OSJ is an unofficial name for an OSJ, generally in the independent broker/dealer model, that serves dozens, if not hundreds, of brokers.
Most super-OSJs were born from the same humble beginnings of our business traveler, John. They might have originally consisted of a small handful of brokers, slowly adding more. Their growth benefited the three parties involved:
- The broker/dealer benefited as they pushed certain compliance and operational responsibilities to the OSJ, thus resulting in better economies of scale. The OSJ generally also performed its own recruiting.
- The super-OSJ benefited as its increased scale gave it negotiating power with the broker/dealer regarding payouts, service levels, flexibility, etc. The super-OSJ passed along some of the better economics to its brokers while retaining a “scrape” of the savings for themselves.
- The broker benefited as it was provided with more localized support, less direct compliance/operational responsibilities, and a better payout than it could achieve on its own.
This three-part harmony worked wonderfully right until it no longer did. While polite words were surely expressed publicly, broker/dealers increasingly found themselves squeezed, ala our hotel analogy.
This is not a one-sided challenge, though.
Super-OSJ firms are increasingly finding themselves at a disadvantage to standalone RIA offerings. Super-OSJs are typically constrained by proprietary broker/dealer technology, limited custodial choice, increasingly hostile broker/dealer relationships, etc.
The same constraints on the super-OSJ apply to its affiliated brokers.
What is the likely outcome?
Several super-OSJs have transformed into standalone RIAs. The typical evolution involves retaining the broker/dealer as the RIA’s friendly broker/dealer solution while also retaining the broker/dealer’s custodial channel as its initial custodial relationship (which will assuredly be complemented with the eventual addition of other custodial options as the newly unshackled RIA becomes multi-custodial).
All remaining super-OSJs of size will eventually transition to their own RIA. They will either be forced by the pressures of competing RIA offerings or because the status-quo of their existing broker/dealer relationship is no longer tenable… for anyone involved.
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.