RIA vs Wirehouse
Much has been written recently about the fiduciary standard. Boiling down the hundreds of articles, op-ed pieces, official statements and professional debates, what the issue really comes down to is fairness. And culture. And billions of dollars in unfair fees and commissions coming out of investors’ pockets. But beyond the particular issues of industry oversight and ethical business practices, what the public debate has highlighted is that there are choices available to savvy investors, and that they are extremely important to understand. Central to the discussion is the comparison that can be made between differing business models for wealth advisors. In addition to traditional large broker-dealer firms, otherwise known as wirehouses, there are registered investment advisors (RIAs) and also smaller, regional broker-dealers.
There are other options out there, also. Another model picking up steam in recent years is the hybrid RIA model, which combines both fee- and commission-based registration and oversight. In addition to the fee-based financial advisor services offered by RIA’s, these firms earn commissions processing business as registered representatives of a broker-dealer, although most of the time, hybrids will act either as an RIA or a broker-dealer, but not both at the same time. Another growing model, aimed squarely at the very wealthy investor, is the Multi-Family Office. While these businesses are RIA’s, they are structured to serve families with a net-worth usually over $50 Million, providing every kind of financial service, and in some cases managing lifestyles, household services and even providing concierge services for their clients. The model provides a high degree of sophistication and capability geared to such families, but is too costly even for many high-net-worth individuals, to appeal to broader markets.
There are many variations and subtle differences between individual firms, and, of course, there are talented and ethical advisors working within every form of regulated wealth advisor business. It is likely that for many investors, personal relationships trump business model, oversight, accreditations and other factors. We do business with those we like and trust. But we typically also want a fair price for a quality service, we want plain dealing, and no one wants to pay unexpected fees and commissions. And no one expects that their trusted advisor is making recommendations that benefit his or her firm at their own expense or risk. Which brings us back to the different business models, because they actually play a major role in what investors should expect from their advisors, even beyond the issue of the now-famous fiduciary standard.
The wirehouse model dates back to a time when a “private telephone wire” was a major competitive advantage. Back then, before the internet, the cell phone and the computer, wirehouses thrived by connecting hundreds of offices around the country – and the world – to share information and present investors with the best and most timely access to financial markets, products and services. Independent contracting was almost unheard of during those years. Instead, advisors were employees of the wirehouse, as they still are today. As the businesses matured, they offered more products
and services, capturing more “wallet-share” of their clients. Trading of stocks and bonds lead to the selling of insurance, retirement planning products, mutual funds, tax advice and many other products and services. When every conceivable investment vehicle, financial product and financial service was being sold to their clients, the businesses found other ways to continue to grow revenues, sometimes through increasingly complicated commission and fee structures. Throughout most of the last century, the business model was a huge success, and lead to the growth of the multi-trillion dollars of assets under management (AUM) that today’s wirehouses still control. But it also lead to today’s ethical issues, and, some now argue, to a slide from absolute dominance into troubled waters.
A few key facts illustrate that the wirehouses are going through some challenging times. According to global analytics firm Cerulli and Associates, 25% of wirehouse advisors are expected to “go independent” by 2019, as reported by ThinkAdvisor on October 8, 2015. Statements published in the same report indicate that a major reason for the shift is dissatisfaction with the employee model, as well as a desire to avoid conflict-of-interest issues when dealing with clients:
“[A] recruiter shared that ‘[those] folks who truly go RIA are tired of big firms, tired of employee model, [and] want a non-conflicted type of environment.’ He added that those who do move are rarely unhappy with their decision.” –Cerulli and Associates, 2015
Another Cerulli report found that between 2007-2011, the wirehouses lost 2.5% of their advisors, from 56,900 to 51,750. By 2013, wirehouse advisors accounted for only 16% of the financial services practitioners. By 2017, Cerulli predicts that advisory firms will shed 25,000 jobs.
This is not to say that the wirehouses will become extinct any time soon. They still dominate the market, although they have steadily been losing market share for years, according to the 2016 study by Aite Group titled “New Realities in Wealth Management: A Bump in the Road”. As reported by wealthmanagement.com on September 30, 2013, another research firm that watches the industry, Tiburon, reported that wirehouses lost $90 Billion in 2012 alone. But these firms still control over $5 Trillion in assets, a far larger sum than all the independents put together.
Perhaps more telling than all the data and the flight of advisors to other models is the simple fact that the big four US wirehouses, Bank of America’s Merrill Lynch, Morgan Stanley Smith Barney, UBS and Wells Fargo, have all been fighting for years to prevent being held to the above-mentioned fiduciary standard. Instead, they’ve been held to the so-called “suitability standard.” This arrangement allows them to sell their services and products to their clients, regardless of who benefits the most from the transaction, as long as the product or service is deemed suitable at the time.
It is widely reported, and has been stated by government regulators for years, that the suitability standard has resulted in billions of dollars a year in unfair billing, inappropriate investments and many cases of conflict-of-interest. A recent white house statement, titled FACT SHEET: Middle Class Economics: Strengthening Retirement Security by Cracking Down on Backdoor Payments and Hidden Fees puts the number at $17 Billion per year. The fact that the wirehouses are actively engaged in protecting this unfair status-quo reveals their ultimate weakness – a culture that is increasingly viewed as being predatory.
When an advisor is restricted to his or her firm’s approved slate of products and services, and is compensated based on selling them to clients, regardless of their performance, and is often pressured to sell one item over another one, it is inevitable that such a conflict will arise. Ultimately, this model serves the firm’s interests over the investor’s. No wonder smart investors have become more than a little wary.
Dating back to the financial legislation of the 1930’s and ‘40’s, advisors registered with the Securities and Exchange Commission or a state’s securities agency, known as Registered Investment Advisors, have a business model built around the fiduciary standard and the corollary benefits that come from helping clients succeed. Most RIA compensation comes from fees. Hybrids, as discussed above, earn fees and also commissions. Fees can be assessed as a percentage of the value of AUM, or on an hourly or fixed-fee basis.
Because RIAs are generally compensated for giving advice, not for selling products and services, they are motivated to give good advice. To do otherwise would likely result in a dissatisfied client, and the loss of revenue. For this reason, many RIAs choose to be compensated based on the value of AUM. The arrangement is such that an advisor’s compensation is more directly tied to a client’s financial performance than to the sales of any particular products. In this respect, the interests of advisor and client are in alignment.
Aside from the benefits and protections of the fiduciary standard, there are several other major differences between RIAs and their larger wirehouse competitors. For one, wirehouse advisors are generally employees, while RIAs are often independently owned businesses. Many RIA advisors own their own businesses – but not all. Individual advisors within an RIA business can, of course, be employees of that business. But that RIA employee is less likely to suffer conflicts of interest if he’s working within a model in which the sales of products are immaterial to compensation – other than how they impact performance. Many RIAs don’t sell products, only advice and related services.
Another key difference is that RIAs can choose their own products without the limitations placed on many wirehouse advisors. With an agenda to do well for the client and not to sell products, an RIA is generally free to hand-pick the right products and services to recommend to a client. This is generally not the case at the wirehouses, which often promote their own products and services. This model restricts advisors to a limited menu of options, taking some options off the table that otherwise might be the best for their clients. Add to this the temptation to sell products which are profitable to the firm (or to the advisor, who may be compensated to sell), rather than the absolute best option for the client and you have a potential conflict of interest. One of the stated reasons that many advisors give when they leave a wirehouse is that they desire a free hand to pick the right products and services for clients.
Another, more subtle, difference is that many RIAs can structure themselves, choosing where to do business, how to set up their offices, what services to provide – and to whom – and so on. This is often not the case for many advisors at the large wirehouses. This RIA flexibility yields a variety of businesses, each with its own character and culture – and it’s own set of services and capabilities. From an advisor’s perspective, this is another attraction of the RIA model. From an investors’, it means a greater variety of options are available, with a greater likelihood that the right match to their particular needs is out there waiting to serve them.