As markets swooned and interest rates surged in 2022, at least one industry was likely quietly rejoicing: Broker-dealers, which have been facing combative regulators and fighting trench warfare with the RIA space, got a big reprieve last year.

Higher interest rates mean millions of dollars in revenue that go directly to the bottom lines at independent B-D firms, all due to the client money they hold in cash sweep accounts. If you’re a company like LPL or Raymond James, that’s major moola amounting to tens of millions of dollars on the left side of the balance sheet. Just take LPL’s 2022 results, for example: The firm’s interest income jumped to $77.1 million for the year, according to its SEC filing, an eye-popping 170% improvement over the $28.6 million it scored in 2021. Raymond James said its net interest income and third-party bank fees from the Raymond James Bank Deposit Program amounted to $723 million during the company’s first fiscal quarter, ending December 31. That’s a 253% increase from the previous year’s fiscal first quarter.

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The good news is that many companies will reinvest that money to woo advisors—getting them better technology with more bells and whistles. With lots of advisors looking to retire, broker-dealers fear losing their reps’ clients. Consequently, more B-Ds are offering advisors money to move over or for buyouts or for succession plans. Broker-dealers are even taking equity stakes in larger groups of reps blossoming into enterprise businesses.

The bad news, of course, is that swooning markets, bank runs, pandemics and other Malthusian chimeras don’t do much more for investor confidence than plagues of locusts. (LPL’s and Raymond James’s stock prices defied the 2022 bear market, only to tumble in mid-March after the implosion of Silicon Valley Bank.) Financial relationships have likely become more tenuous in the last couple of years, and when markets settle down, people are likely going to get itchy feet to move their assets.

The upheaval of Covid has for now slowed advisors’ movement among firms, says Scott Posner, the executive vice president of business development at LPL. The largest broker-dealer by gross revenue by far, LPL has become an aggressive recruiter and serial acquirer. “Over the past few years, overall advisors [changing firms] used to sit around 6.6%, 6.7% or 6.8% of the total financial advisor population,” Posner says, pointing to stats from Discovery Data. “That has come down quite a bit. It’s now sitting around 5.7% or 5.8%, depending on which trailing-12-month period you’re looking at. That’s post-Covid.” But he adds that LPL saw a lot of activity and curiosity among advisors in the first quarter of 2023.

Now throw demographics into the calculations. Financial advisors are getting older as a group, and the recent pandemic likely accelerated a lot of their plans to pack it in.

“With the pandemic, more and more advisors, just like everyone in the world, have taken the time to reflect on their life and say ‘What do I want to be doing?’ Just like we saw in 2008 and 2009 when the market corrected. … Many advisors decided to retire at that time too,” says Becca Hajjar, chief business development officer at Commonwealth Financial Network.

Mark Contey, senior vice president and head of business development at Chicago’s LaSalle St. Securities, agrees that Covid-19 might have pushed more advisors to consider leaving the business—which will cause more confusion about who is going to eventually take over that business. “Some advisors are saying, ‘Life’s short and I’ve been doing this for 30 years and I want to make sure I capture some retirement years as well and want to change my lifestyle and move to Florida. … Instead of servicing their clients for another 10 years, it’s another four or five.”

That’s a key problem. Broker-dealers don’t want to lose those clients in five years. They want to hold on to them for maybe the next three decades.

How will they get closer? The best way is to forge closer bonds with imminently departing reps—possibly by acquiring part or all of the practices. This is a new development in the independent space.

Shrinking Pool
The Finra-licensed rep population as a whole has shrunk. According to the Financial Industry Regulatory Authority industry snapshot from last year, the total number of Finra-registered firms shrank from 3,726 at the end of 2017 to 3,394 at the end of 2021. Finra said the total rep count fell from more than 630,000 to over 612,000 in the same period.

There could be any number of reasons—brokers are likely shedding their Finra licenses and adopting RIA models, or they might be retiring. Simple economics might be squeezing out smaller firms, since fee compression gives them less wiggle room to reinvest in the business when they have to pay out so much to their advisor force. Jodie Papike, the president of recruiting firm Cross-Search in Encinitas, Calif., says she’s even seen some smaller and midsize firms do the unthinkable and cut those payouts.

If too many advisors leave the space, a giant talent vortex is likely going to yawn open behind them, and that again raises questions about who’s going to take over the assets the reps are currently shepherding. Are broker-dealers going to be tempted to create direct-to-consumer brands? Perhaps slap their names on stadiums?

Stay Close
Again, courting the advisors and somehow staying close to their business is crucial.

That means firms have to go beyond raising payouts (already at nosebleed levels, reportedly even at 99% of gross dealer concession in the most extreme cases). Most of the big B-Ds have also already created attractive corporate RIAs structures so their advisors can shed their Finra licenses (if they want). Or they’ve adopted company models, fostering W-2 paycheck positions so their advisors can become employees, perhaps selling their practices back to the broker-dealer as they come on board. That means monetization for the advisor (good) and the company now takes all the client revenue (better).

Broker-dealers were already moving into the RIA model, including fee-only business, for some time. Cerulli said as much in a report last year: “To unlock the RIA channel’s success formula and protect against advisor movement to independence, broker-dealers are increasingly developing independent affiliation options, promoting financial planning, and creating more opportunities for advisors to conduct fee-based or fee-only business. By 2023, 93% of advisors across all channels expect to generate at least 50% of their revenue from advisory fees.”

That’s led some of the biggest firms to even start chafing at the very name “broker-dealer.” Commonwealth Financial Network has said specifically that with all the fee-based business it does, it operates more like an RIA. Hajjar says 200 of Commonwealth’s advisors, roughly 10% of its force, have gone fee-only and dropped their Finra licenses.

“A little over 80% of our revenue is advisory business,” she says. “That doesn’t mean 80% is fee-only, but our advisors are predominantly running their business as fee-based business.” LPL’s management is making similar statements. Posner describes a variety of options advisors have at the firm, including the corporate RIA and employee channel.

The applecart has also been upset by regulators, who for more than a decade have looked askance at the independent contractor model broker-dealers use with their reps (ask FedEx what happens when you misclassify workers). In October of last year, the Department of Labor said it wanted to narrow the definition of an independent contractor further, and the Financial Services Institute, which has been fighting this battle for years, released a study saying 20% of reps would rather retire than be classified as employees.

Amy Webber, the president and CEO of Cambridge Investment Research, says such a change would affect the industry’s entire model.

Getting Hooks In Enterprises
Larry Roth, a private investment and M&A consultant with RLR Strategic Partners (he’s also a former CEO of both Cetera and Advisor Group), says one interesting trend he sees is that big broker-dealers are using sharp elbows to grab minority investments in their affiliates’ enterprise businesses (what are sometimes called super-OSJs, or offices of supervisory jurisdiction). Consider LPL’s move last November to acquire one of its own branch offices, the Financial Resources Investment Group, a Fort Mill, S.C., firm with $40 billion in assets and 800 advisors.

“With LPL we’re noticing that if someone attempts to recruit someone away from LPL or someone attempts to acquire an interest in one of their large enterprises, they’re stepping up and matching or topping the offer,” Roth says. “It’s part of a broader strategy to own the client eventually.”

Several other big advisors are buying enterprise stakes as well. That includes Cetera, which in February announced it had bought a minority stake in Kansas City-based Prosperity Advisors, a firm with $1.7 billion, following the purchase of a stake in CCR Wealth, a $2.5 billion AUM firm, last October.

Cambridge’s Webber speculates that some firms are buying into enterprises because it’s another way to (almost) have your own client-facing advisors on staff—the next best thing to having your own W-2 employees.

Partial Book
Can LPL get closer to clients than that? Yes it can.

Consider an innocent-looking press release from the company in February, when the firm said it was offering to take over partial books of business from its advisors. That made some industry watchers prick up their ears. Was the country’s biggest broker-dealer now saying it wanted to work directly with clients? It’s a touchy subject. Advisors jealously guard their client relationships and don’t want to compete with their affiliates’ back offices.

Derek Bruton, a senior managing director at Gladstone Group who counsels RIAs and broker-dealers, says, “For some reason, the tolerance for this competition by your own provider seems to be lightening up.” As a result, B-Ds are buying more firms directly, he says, or purchasing stakes in them. “There’s a big trend right now … of B-Ds kind of focusing inward and saying ‘Why don’t we just buy up these elderly advisors and make their business our own W-2?’”

If advisors on the ground are more tolerant of that attitude from corporate, that might be because the aging workforce is thinking about monetizing their life’s work, and actually coasting to retirement on a company paycheck.

The broker-dealer, of course, brings the revenue in house and keeps the 100% payout in that case, Roth says. If an advisor is amenable, it works out for the client. “The client isn’t being charged more, but the revenue from the customer relationship will stay at the broker-dealer and not be put on the grid where they’re paying 90% to the advisor. So it dramatically improves the economics for the broker-dealer and it allows the advisor to monetize part of their business.”

For a $3 million business, say, the advisor could get a check for $1 million for a third of it. Roth compares it to hospitals buying up doctors’ practices. “Economically, if they’re already on the platform, LPL can easily price the value of that because there’s not going to be any breakage. It’s not like a recruit where you hope they bring the assets. They’re already there.”

There’s a perception that advisors want to go fully independent by starting their own RIA firm first because it gets commission business off their plate and improves their valuation. Papike says such maneuvers are harder than they sound.

“I talk to advisors who have $50 million in assets and they are thinking, ‘Oh, I’m going to set up my own RIA and it’s no big deal and I’ll just run it,’” she says. But then the advisor has to find a chief compliance officer, set up an ADV, maintain it, etc. They find out that getting to the 100% payout is pretty expensive and carries a lot of liability, she says.

It’s another reason people might want to work under the broker-dealer’s umbrella in one of the many different channels available. Jodi Perry, president of the independent contractors division at Raymond James Financial Services, says her firm has been financing buyouts of practices, especially in helping younger-generation advisors buy in. She points to her firm’s matchmaking software that allows firm buyers and sellers to find each other.

“It’s a seller’s market at this point, so we haven’t gotten into the business of buying practices,” Perry says. “We’ve been able to find advisors for all the practices. If someone doesn’t have a succession plan, we’re actively working with them to at least make sure that they have a [catastrophe plan] in place.”

Last June, Commonwealth launched a program called Entrepreneurial Capital to help advisors buy practices. The firm offered loans before, but this program offers both traditional loans and financing, including capital investments of up to 40% of a firm’s valuation, Hajjar says.

Posner likewise says that LPL’s programs can help advisors better monetize their business before they turn them over to successors. LPL’s partial book approach can help an advisor cash in some chips, while the company holds a stake and the successor gets trained. That’s one way to help an advisor’s children take over if they are otherwise not ready, says LPL’s Gary Carrai, executive vice president of the advisor business lines strategy.

Carrai notes that the partial book purchase program is about creating transitory bridges like that—and also for buying clients that aren’t strategic to advisors in the first place. He stresses that it’s not about competing with the company’s own advisors. “It’s not that LPL is creating a direct-to-consumer business,” he says.

Greg Cornick, the president of advice and wealth management at the giant broker-dealer network the Advisor Group, says his firm doesn’t have a W-2 channel, but might have to confront the demand sooner or later, because advisors are asking about it. “It’s not a massive strategy point, but it is something we have to have on our radar because we are hearing that feedback from advisors.”

Another way of getting closer to advisors is offering them company equity. In early March, Contey said LaSalle St. had offered a “significant percentage” of its equity to the affiliated rep force of 325 advisors using its platform. The firm has $12 billion in assets.

Commonwealth is not only buying up advisors’ commission business (if it’s already small) but once the advisors are fee-only, Hajjar says, the firm is now charging a lower platform fee starting at 5 basis points on assets and moving down after that (that fee was slashed from 12 basis points, and that covers trading costs, compliance and IRA maintenance fees, she says).

Manish Dave is the senior vice president of business development at Ameriprise Financial, No. 2 in gross revenue in this year’s broker-dealer survey. Dave tells advisors not to go to a place with only one channel. “A big part of what is dictating movement in the industry is driven by demographics for advisors who may not have a succession plan or they’re looking at figuring out how to monetize their business or set up their business in the best way to execute a succession plan, whether it’s vertical or a horizontal buyout.” Dave says better technology and more integrated data have made it easier to switch firms.

Bank channels are another way to get close to that all-important client relationship. Advisor Group last year took out $500 million in loans to buy American Portfolios, an IBD with 850 reps, and Infinex, a bank client advisory channel. The bank channel is important because that’s where many people make their first contact with financial services, says Cornick.

“Because we’re private, we’re not subject to the quarterly rigor that goes along with being a public company,” Cornick says, pointing to the company’s ownership by private equity firm Reverence Capital, which acquired it in 2019. “Just that flexibility of not having to do a quarterly earnings cycle is always nice.”

Bruton at Gladstone says the euphoria about higher interest rates in the industry has been dampened somewhat by costs: All broker-dealers have had to pay higher expenses to both attract and retain advisors and give them the holistic, comprehensive wealth management experience they demand. They’ve got to put that money into service and tech, things that can prompt advisors to leave firms if they’re not done properly.

“Salaries are going up, and the cost of maintaining a high-quality service organization or recruiting organization, those costs are going up,” Bruton says. “These rising costs across the board are eating up a lot of the excitement that the B-Ds had from the interest rate rise.”