Financial Professionals Should Consider their Available Employment Options, Including Going Independent

Are you a financial adviser, investment adviser, wealth manager, registered representative or similar financial professional? There are many different names for those who render investment advice. Have you ever wondered how your clients’ situations might improve by changing your employer or business partner? Have you ever considered how your own personal financial well-being might improve if you changed your employer or business partner, joined a new firm, or started your own independent investment adviser (RIA)? This article is designed to illustrate the options that exist as you explore your current situation, and ultimately tries to convey how forming and operating your own RIA may be the best choice of all.

I.                  Employee of “Wirehouse”

The term “wirehouse” is an antiquated term that generally refers to Merrill Lynch, Morgan Stanley, UBS, and Wells Fargo—that are among some of the largest companies in the country.

For current employees, there are numerous reasons why remaining at a wirehouse might not be the best fit for your business. Below is a discussion of some of those reasons why you might want to consider your current affiliation.

1.     Name Recognition – Once upon a time, working for a wirehouse was the best form of advertising. These companies carried great name recognition with Americans of all age groups. However, in light of recent regulatory events, scandals and enforcement actions, the original luster of these companies is beginning to fade. The culture at these companies is being exposed for what they truly are—for profit companies that are most concerned with their shareholders.

I performed a Google search using the following keywords “Merrill Lynch SEC enforcement” and uncovered 5 settled enforcement actions in 2018 and 2019 alone between the U.S. Securities and Exchange Commission and Merrill Lynch. Using the same search methodology, I uncovered 1 for UBS and 2 each for Morgan Stanley and Wells Fargo. This doesn’t contemplate any of the trouble these companies have faced from their other regulators such as FINRA and the Consumer Financial Protection Bureau.

2.     Conflicts of Interest – Wirehouses tend to have more conflicts of interests than other firms, especially financially related conflicts of interest. They receive payments from the vendors and products that they recommend, they sell affiliated investment funds and bank sweep products, they direct trades to exchanges where they have ownership interests, and the list goes on. All of these conflicts of interest ultimately lead to higher costs and lower returns for your clients.

3.     Overhead Expenses – The wirehouse model has historically, and continues to have, some of the lowest payouts in the industry based on financial adviser revenue. One source has suggested that payouts at wirehouses are anywhere between 32-42% of revenue generated. These payouts are the lowest in the industry, because these firms have such expansive overhead. They have massive real estate complexes in most major cities, they have thousands of employees and need to fund their retirement packages, they have highly compensated executives, and they have a stable of professionals with niches that you might never need—annuity, banking, insurance, marketing, corporate, estate planning, IPOs, microcap, structured products, and the list goes on.

4.     Lack of Succession Options – When you are employed by a wirehouse, the dynamic is employer-employee. You likely do not have a meaningful equity stake in your employer and you don’t have much flexibility in monetizing your goodwill that you have created by doing your job over the years. At best, you might be able to locate a more junior adviser who will pay you to introduce you to your clients and eventually take over managing those relationships. With an ownership in an independent investment adviser, you have many more options for potential buyers such as other RIAs, which helps you to recognize the true value of your goodwill.

5.     Client Ownership – In a practice that has become more prevalent in recent years, wirehouses are treating employees like the wirehouse owns the client relationship, when we all know that no one can “own” a client relationship. Wirehouses include restrictive covenants in their employment agreements that prevent employees from soliciting and servicing their clients upon their departure. Both Morgan Stanley and UBS left the broker protocol in recent years, which makes it more difficult for advisers seeking to leave these firms and to take their clients to new firms. However, it is definitely not impossible and we have counseled numerous clients through this process.

6.     Restrictions on Freedom of Investment Universe. While employed by a wirehouse, you will likely be restricted by investment, operations, and compliance policies. You may be forced to keep client portfolios within certain managed strategies, You might also be required to purchase affiliated mutual funds. Further, you might be prohibited from managing a client’s outside assets such as their 401(k) account. All of these things might be to yours and your client’s detriment.

If you are just starting out, you might think that those posting on LinkedIn or other job sites to take part in a financial adviser training program is a great launching point into a career in the financial industry. If it is with the “wirehouse” model, you are probably wrong. According to one source, the Practice Management Division of Merrill Lynch had over a 90% failure rate for new employees. If you are serious about your future in this industry, you may want to explore other options.

II.               Join a Hybrid Model

There are many different types of hybrid models for investment professionals. On one end of the spectrum, an advisor can join an independent RIA that has an affiliation with a friendly broker-dealer (e.g., Purshe Kaplan Sterling Investments, The Investment Center, APW Capital). On the other end of the spectrum, an adviser can join a separate operating division or company of a wirehouse such as Wells Fargo’s Finet. This provides these advisers with higher payouts and access to many products to recommend their clients on a commission basis including variable annuities. Many of the same items addressed above can haunt advisers in hybrid models. For example, hybrid firms might be more likely to face regulatory scrutiny. Also, an adviser in a hybrid model might not be entirely free to determine his or her client’s investment policies and security selection. Depending on the firm, they might also not receive the maximal payouts. 

There are benefits to these models, however. Making transitions to a hybrid model can present less risk and less time time in addressing operational issues. For example, a person making the decision to go hybrid won’t have to consider registering an RIA and implementing a compliance program. They won’t need to locate office space and enter a lease or purchase real estate. All of these things should be considered in making a decision on what works best for you.

III.            Own and Operate an Independent Investment Adviser

While I might be a bit biased, I truly don’t see why anyone would ignore this option. I represent many clients with as few as $25 million under management who are profitable at operating RIAs. The economics of the decision are very compelling. Below is a chart explaining the total revenues generated from different levels of assets and advisory fees (75, 85 and 100 basis points). 

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This chart only reflects the annual, recurring revenue that one could generate operating an RIA. It doesn’t contemplate what one could earn as part of the sale of their business. RIAs are legal entities and can be sold just like any other company. They have relatively high values compared to other business. Their value fluctuates based on numerous factors (e.g., asset levels, age of clients, location, and expenses). The multiple that we have witnessed in this industry over the last several years is anywhere between 1.5 and 3.5. So for the business referenced on the bottom of the diagram, that owner could expect to achieve anywhere between a $1.5 million and $3.5mm payout when he or she sells the business. This is a very compelling reason alone to consider forming an RIA. 

There are numerous other reasons to consider the RIA path. Below are some of the reasons that our clients take the leap:

1.     Independence –As a business owner, you have the freedom to dictate how to operate your business. You get to decide who to hire, what investment philosophy you want to adhere to, where your office will be located, whether to manage outside assets, and even more granular details like website and logo design.

2.     Legal Standard – RIAs are held to a fiduciary standard when they render investment advice. Under current rules applicable to broker-dealers, they operate under a different legal standard. While it is technically called a “best interest” standard, it does not live up to the RIA standard.

3.     Expense Control – Obviously, there are expenses involved in starting your own business—office space, technology, administrative support, legal, and compliance. However, these costs are all controllable and an RIA has lots of control over these variables.

4.     Create Your Own Brand – Many clients that I work with are eager to become true entrepreneurs. They express that they have largely felt that way since they started their careers in wirehouses. One of the common refrains I hear is that they were predominantly responsible for the growth of their business. Given that fact, why not continue that trend outside the purview of your prior employer?

IV.            Conclusion

If you are considering making a transition away from a wirehouse or from a wirehouse to another wirehouse, I would be happy to have an introductory discussion with you at no cost. I try and offer prospective clients an honest assessment whether going independent is for them. If it is not the right option for you, I have ample experience assisting advisers with negotiating lift outs, bonus compensation and succession plans. 

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Twitter: @AdviserCounsel



California Assembly Bill 5 and the (Non-)Impact on the Financial Services Industry

California Assembly Bill 5 (the “Bill”) was passed in Senate on September 9, 2019 after passing the Assembly back in May. According to reporting by the New York Times, it is expected that California Governor, Gavin Newsom, will sign the bill.

The Bill changes the status quo on the classification of employees and independent contractors. As the preamble to the Bill makes clear, California courts currently follow the common law rules for determining whether an employer-employee relationship exists or whether a person is an independent contractor. That test has numerous parts, but one of the important elements for a person to be considered an independent contractor is that the person must be free to control the performance of their work.

However, the Bill provides a greater likelihood that a person would be classified as an employee instead of an independent contractor, which means that the employer would be required to make payments for “payroll taxes, payment of premiums for workers’ compensation, Social Security, unemployment, and disability insurance”. Ultimately, the Bill would provide greater protections and benefits to persons previously classified as independent contractors and now classified as employees. It would cost employers more to employ these individuals and the employers would be subject to added liability.

Under the Bill, “a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates that the person is free from the control and direction of the hiring entity in connection with the performance of the work, the person performs work that is outside the usual course of the hiring entity’s business, and the person is customarily engaged in an independently established trade, occupation or business.”

Under this test, most independent contractors in the financial services industry in California would be classified as employees absent an exemption. Section (b)(4) of the Bill exempts both broker-dealers and investment advisers and their agents and representatives that are registered with the U.S. Securities and Exchange Commission or the Financial Industry Regulatory Authority from this new test. Instead, the Bill makes it clear that these employers and individuals will continue to be subject to the framework outlined in S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341.

Top 10 Considerations for Starting Your RIA

The following are the top ten considerations to make for starting an investment adviser:

1.     You will want to develop and complete your firm’s business plan. You will need to decide on your resignation date and begin to develop your vision and strategy. It may be helpful to consider your existing clients, your strengths, your desired future, and competitive market demographics.

2.     You will want to review your current employment agreements to determine whether you are subject to any non-compete or non-solicit provisions. You may want to consider engaging employment lawyers that are well versed in this area of law and familiar with Broker Protocol compliant transitions and non-Broker Protocol transitions.

3.     You will need to decide on your firm’s business entity structure (for example, corporation (Corp.), S-Corporation (S-Corp), limited liability company (LLC), etc.) and domicile. You may want to consider engaging legal counsel and tax experts to advise on the business formation requirements and tax implications of varying business entities across jurisdictions.

4.     You may want to engage the assistance of legal counsel or compliance experts to assist with licensing and registration requirements at the state or federal level. As part of this process, you will want to evaluate your firm’s initial regulatory assets under management to determine whether your firm will require registration with the U.S. Securities and Exchange Commission or with similar state regulatory authorities.

5.     You will want to develop your firm’s business operations and select your firm’s physical office location and move-in date. In setting up your business, you may want to consider engaging an insurance carrier to ensure you have the appropriate insurance policies in place such as an errors and omission policy (E&O) policy.

6.     You may want to hire an external information technology vendor to evaluate, assess, and implement your firm’s technological needs for services and software including, but not limited to, Customer Relationship Management (CRM), reporting, billing, and archiving.

7.     In preparing client agreements, you may want to consider enlisting the services of legal counsel.

8.     You will need to create and implement your firm’s compliance program. You may want to consider engaging legal counsel or compliance consultants to assist in drafting your firm’s legal and compliance documentation including, but not limited to, your firm’s policies and procedures manual and code of ethics.

9.     You will need to enter into a custodial agreement and set-up your firm’s custodial platform. You will need to prepare documentation for the transfer of client accounts with the custodian. You will also need to assess what assets that will be converted onto the custodian platform. Once you have entered into proper arrangement with your custodian, you may want to consider employee training in an effort to bolster your firm’s familiarity with custodial operations and compliance issues.

10.  You will need to announce your formal resignation. Once you are officially resigned, you will need to complete your transition in by transferring your clients’ assets and continuing to provide ongoing management of your clients’ assets at your new business.

Twitter: @AdviserCounsel



An Introduction to AdvisorCounsel

AdvisorCounsel is a blog discussing issues relevant to the investment adviser community. While the focus is on issues pertinent to investment advisers to separate accounts (more specifically, wealth managers), this blog will address issues that extend to institutional managers, private fund managers, advisers to registered investment companies, and roboadvisers. AdvisorCounsel is a compilation of the thoughts and analysis of Max Schatzow, an attorney with the law firm of Stark & Stark, PC. The content of AdvisorCounsel does not necessarily reflect the expressions of Stark & Stark, PC or any of its clients.

Max advises investment advisers and broker-dealers on a range of financial regulatory matters. Max advises private investment vehicles, financial institutions, and other market participants on structure and operations, regulatory guidance and interpretation, investment adviser compliance and controls, and internal and regulatory investigations. He also advises these same entities through examinations, administrative proceedings, and enforcement actions. Max previously practiced law with one of the largest law firms in the world in its New York City office, where he advised investment advisers and broker-dealers on regulatory compliance.