Transition Forgivable Notes
Last year, our recruiting firm was approached by a broker-dealer owned by an insurance company. The B-D boasted about its generous transition packages to advisors who joined, and said it paid more forgivable note money than most competitors. But there is no free lunch. We did some digging and found the firm charged an advisory administration fee that tiered around 18 to 28 basis points, a very high cost for clients to incur when much better values were available.
We did a formalized cost analysis comparing a fiduciary-focused option (in other words, one with a low administrative fee) to options that paid substantial up-front note money—along with a high administrative fee.
In most cases, it was the clients who paid for the advisors’ up-front note money, more than three times over during a seven-year note period.
For our analysis, we took a real-world advisor with $90 million in assets: $40 million of that was in stocks and ETFs; $30 million was held with a third-party manager; $20 million was in mutual funds and variable annuities. The advisor had $900,000 in gross dealer concessions and 250 brokerage accounts. To transition to his new firm, the advisor was given a $315,000 forgivable note payable over seven years. This firm charged 30 basis points in administrative all-inclusive wrap fees (the assets were managed at Pershing). There was also a 15 basis point markup on third-party money manager fees.
The advisor’s clients ended up paying $1.155 million in advisory administrative fees over seven years to service that $315,000 note.
We compared what would have happened to him in a hypothetical situation at a fiduciary-focused broker-dealer RIA. This time, there was no forgivable note. There was a flat $50 annual service charge per client account. He got 2% to 5% in trailing GDC. The advisor’s transition expenses were covered, and there was another $30,000 paid in incidentals.
Those clients would have paid only $87,500 in admin fees over the same seven years.
This particular analysis compared two different broker-dealer RIAs, but an independent RIA can offer even greater cost savings to clients. Forgivable note money makes it clear whether a CFP is putting his clients’ interests above his own—or if he’s taking a large amount of note money at his clients’ expense.
Advisory Administration Fees
Broker-dealers warn advisors about future fee compression, yet no one seems to be discussing the elephant in the room, which is broker-dealer RIA expense compression. Many broker-dealer RIAs charge 10 to 15 basis points in administration fees on advisor-directed advisory assets for billing and performance reporting. But a growing number of fiduciary focused broker-dealer RIAs and producer groups are charging flat fees of $50 to $75 per account annually, which substantially cuts the clients’ expenses.
Independent turnkey RIAs are going one step further, as they bundle everything (the 100% payout, compliance, operations, the technology stack, E&O insurance, advisory billing and performance reporting) into a single cost as low as 10 basis points on client assets. If there is one thing that gives broker-dealer RIAs an arrhythmia, this is it.
Markups On Third-Party Money Manager Management Fees
Broker-dealers use markups on third-party manager fees to help themselves pay for their large forgivable transition notes. But this costs clients dearly. The markup (which the firm may refer to as a “marketing reallowance”) can overrun the original manager’s charge by as much as 10 to 50 basis points. Advisory departments may claim the charge is for ongoing due diligence on the money manager, but the reality is that it’s all profit. The markup, after all, is not charged on the firms’ proprietary asset management platforms—only on non-proprietary ones. And that’s a conflict of interest. Not all broker-dealer RIAs do it, but an increasing number have added the fees, which are more pronounced at larger broker-dealer RIAs.
Advisors are often unaware of these extra fees—sometimes they find out about it through happenstance. One advisor told us he was exploring Fidelity IWS as a custodian. He asked Fidelity out of curiosity if it contracted with a particular money manager and what the management fee was. He discovered he was paying 20 basis points more for the money manager’s management fee than what Fidelity IWS was quoting.
It’s hard to adhere to a fiduciary standard when dealing with such opaque costs. You don’t know what the large checks being waved in your face represent—since how they are being paid for is muddled at best. You don’t know what your alternative options are in the marketplace. But it’s imperative to know what the conflicts are if you want to adhere to the standard, especially if you are a CFP with a legal obligation. That standard has been required by the CFP Board for client investments since June 2020, and those who run afoul of it risk disciplinary action by the board. In the future, you must be hypervigilant about these conflicts and the better options available to you and your clients.
Jon Henschen is founder of Henschen & Associates, a recruiting firm placing advisors to independent broker-dealers and RIAs.