With the Advisor Rule looming and commissions dwindling, it may be time for some RIA/BD hybrids to take it to the next level: drop the broker-dealer license and register exclusively with the SEC as an investment advisor.  This week’s post focuses on what’s driving the downward trend in BD-only registrants and when it makes sense to abandon the hybrid model.

We’ve not included many images of hybrid vehicles on this blog, and for good reason.  They’re usually not the most aesthetically pleasing cars and therefore unlikely to generate good click bait for our readers.  They can, however, be extremely (fuel) efficient and practical in certain contexts.  The same could probably be said of hybrid RIA/BD firms, as the traditional broker-dealer model continues to lose ground to hybrids and fee-only RIAs.

According to the Financial Industry Regulation Authority (FINRA), the number of broker-dealers has dropped 24% over the last decade, from 4,891 in 2008 to just over 3,700 today.  The Credit Crisis is partially responsible as the entire industry’s reputation and financial viability suffered a huge blow, forcing many BDs to consolidate or go out of business.  The rise of online DIY trading platforms and low fee ETF products exacerbated this trend as commission income spiraled downward to stay competitive.  The rising expenses and nuisances associated with FINRA registration also pressured firms down the RIA path, and the recent overhang of the Fiduciary (now Advisor) Rule hastened this transition for many industry participants.

Many hybrids are considering dropping their BDs.  Should you follow their lead?  That really depends on a number of factors.

1. BD Income’s Overall Contribution to Your Total Revenue

If commissions and/or trading income represent less than 10% of your total revenue, then you should seriously consider dropping the BD license.  Your compliance and FA/broker expenses alone may well exceed what you’re taking in from the FINRA registration.  This seems simple and obvious, but many hybrids originally operated as a broker-dealer, and the transition to (RIA) exclusivity can be daunting and sometimes difficult to implement in practice.  The good news is that transition costs are one-time; whereas, the forgone compliance expense associated with dual registration is an ongoing benefit.

2. Top Line Exposure to Bear Markets

It’s been over nine years since we had a sustained market downturn.  We’re probably overdue.  Many hybrids have been transitioning toward the RIA model for quite some time but are reluctant to drop the BD license because it offers some cushion against falling advisory fees when AUM plummets with the market.  The asset-based revenue model has been great for FAs largely invested in equities since the Financial Crisis, but that won’t always be the case.  Commissions and trading income aren’t completely market proof but do offer some hedge against revenue declines from down markets.  If your firm manages mostly equities and primarily charges asset-based fees, you may not want to totally abandon your BD status just yet.

3. Emphasis Clients Place on the Fiduciary Standard Over the Suitability Standard

Many years ago most your clients probably didn’t know or care about the distinction.  Now your best clients, and particularly your best prospective clients, likely are not only familiar with these terms but understand the implications.  If your hybrid is not technically a fiduciary, you may want to change that before ditching your BD license.

4. The Costs (and Headaches) Associated with Dual Registration

I think most industry participants would agree that less is more when it comes to regulatory oversight, and several clients have told us that FINRA compliance is more burdensome than the SEC’s.  Devoting capital and resources to compliance matters can be a huge distraction.  Abandoning the BD license could be a quick fix if it’s not doing much for you in the first place.

5. Your Firm’s Identity

Do your clients and other stakeholders see the company as an advisory firm or broker-dealer?  Are you operating as a fiduciary for clients or selling proprietary products and/or executing trades on their behalf?  Either route may have served you well in the past, but it may be time to choose a path.  Acting as a fiduciary to some (but not all) clients could lead to conflicts of interest and confuse your role to prospective clients.  Picking a side would clarify this message and potentially land more business from investors looking for an RIA or BD firm but not necessarily both.  If, on the other hand, a hybrid culture has been instilled across the firm for quite some time, it may not be worth the hassle or cost to go the exclusive route.

Undoubtedly, there are other things to keep in mind if you’re thinking about going exclusive.  You can take some comfort in knowing that you’re not alone.  Industry consultants Cerulli Associates estimates that hybrids have grown to roughly 15% of the industry, up from 7% in 2004 as BD-only firms have declined in number while fee-only RIAs have grown more modestly in recent years.  Still, this trend is probably not sustainable with a looming Advisory Rule, so you need to be thinking about your options if you haven’t already done so.