The Financial Services Institute (FSI) is lobbying the Department of Labor over a proposed rule that could result in as many as a few hundred thousand dually registered advisors being reclassified from independent contractor to employee status.
Should the new rule be adopted, the reclassification could significantly disrupt the independent broker-dealer (IBD) industry by forcing affected brokers and hybrid advisors affiliated with IBDs to choose between becoming brokerage employees or forming their own RIA firms. In addition, the disruption could reduce investor access to professional financial advice, burden independent brokers and advisors with extra legal and business costs, and even push older independent hybrid advisors into retirement, according to a study commissioned by the FSI and submitted to the DOL for consideration.
“Independent financial advisors aren’t the focus of the rule in the proposal, but they would be significantly impacted if the changes were adopted,” said David Bellaire, executive vice president and general counsel of the Washington, D.C.-based institute, a member organization for independent financial service firms and independent financial brokers and advisors. “The statute would apply to all workers, and this only emphasizes the importance of clarity in this area and of getting it right.”
The DOL in October announced that it intended to reverse the 2021 independent contractor rule that reduced the criteria for classifying a worker as an independent contractor to two metrics—their control over their work and their opportunity for profit. In the past, the Internal Revenue Service has maintained jurisdiction over independent contractor status and used a test of more than 12 different economic factors—including which party (employer or employee) pays rent, utilities and benefits—to make a determination.
In the 1990s, a predecessor organization of FSI was able to convince the IRS that brokers and hybrid advisors affiliated with IBDs were indeed independent contractors, since they paid most of their own expenses and enjoyed wide latitude in the products and services they recommended and sold to their clients.
Instead, the DOL will return to what it calls a “multifactor, totality-of-the-circumstances analysis” to determine which workers are employees and which are independent contractors. A final decision on the change is scheduled for May, according to the government’s Unified Agenda of Federal Regulatory and Deregulatory Actions, although Bellaire said he thought that might be optimistic.
To have a better understanding of the proposal's impact, the FSI commissioned Oxford Economics, a commercial research arm of Oxford University’s business college, to interview and survey its membership. Currently, FSI represents about 85 member firms, including Raymond James, Advisor Group, Cetera, Atria and Wells Fargo Advisors, and more than 160,000 independent financial advisors. Other large firms, such as LPL Financial and Ameriprise Financial, are not members, so the universe of affected advisors is much larger than those represented by the FSI.
In general, the survey said, these advisors retain 90% or more of the revenue they generate and affiliate with the member firms for assistance with software platforms and compliance issues. The survey estimated this group represents more than 400,000 jobs in total, including office staff, and contributes $35.7 billion to the U.S. GDP.
“The reasons for choosing independence include better economics and greater autonomy. We asked interviewees and survey respondents how they expected financial advisors to react, were it determined that they should be classified as employees,” the survey noted. “The consistent response we heard in interviews, and which is apparent in the survey data, is that most advisors prefer independent status.”
In fact, 58% of respondents said they would start or focus on their RIA business and 19.3% said they would retire. Only 10.7% said they would become an employee of their broker-dealer affiliate.
If almost one in five advisors chooses retirement in an industry that’s already aging, it could have a detrimental effect on clients’ ability to find and access advisors and affect how much they would end up paying for services, Bellaire said.
“We’re very concerned. That finding confirms our worst fears that the rule proposal would result in a reduction in access to advisors and an increase in cost. When we reduce the supply, costs increase,” he said. “This decision to retire is heavily influenced by the fact that the universe of independent financial advisors is aging. And so rather than continue working in a career in which they can no longer participate the way they want to, they’ll choose to leave.”
For those that soldier on, there may be substantive changes in the services they offer, in the way they do business and in the way their clients pay them. And those changes will cost them: These expenses could be as much as $200,000 for those who start their own RIA, the report said.
And for the member firms who have to onboard their independent contractors as employees, the cost would run about $11,000 per employee for basic onboarding plus an additional $40,000 to $50,000 per employee if recruitment is needed to fill the hole created by independent contractors starting their own RIA. The ongoing record-keeping costs would be around $300,000 per year, the report said.
A number of large independent brokerages, including LPL Financial and Raymond James, offer brokers and advisors multiple employment and affiliation models, ranging from an employee model to affiliation as an independent RIA.
Bellaire said besides submitting the Oxford survey to the DOL, the FSI has sent it to the Small Business Association, which has been tracking the proposal and looking for information to understand the impact on small businesses.
“In addition, we’ve shared it with our members and intend to share it with members on Capitol Hill,” he said. “We supported the 2021 rule because it was designed to bring greater clarity to the test applied to the worker in order to find the appropriate classification. This proposal takes us backwards by eliminating the focus on the two core factors and opening classification up to six factors or more. Any evidence supplied under these six factors mean the worker should be an employee.”