Whether you are moving dealers or exiting, Beware of the Buyer!

The offer of signing bonuses is often the most tempting form of inducement for a wealth advisor. But they have also become very confusing and deceptive.

Many broker dealers still provide a traditional offer containing two elements. They offer fair market value for his practice. In addition, a traditional transaction offers the advisor the ability to choose the advisor who will be his successor upon retirement. The dealer recognizes the advisor as the rightful owner of his practice and sole decision maker regarding the transition – inheritance of that practice.

Every buyer has motives. But those motives are not all the same. Here are three reasons why the Investment Advisor-Portfolio Manager should be very wary about what they are:

A) An increasing number of broker dealers are offering attractive signing bonuses because they are purchasing the book for the firm itself, ie, it will be the owners property of the firm not – another advisor. In effect, the advisor loses the right to choose his successor.

First, the reason the firm is willing to pay up for the advisor’s practice, is because by assuming ownership and control of the client portfolio, the profit margins are far different. By owning the book, they can have a Salaried based advisor. This instantly eliminates commission-based revenues. A game changer for profit margins.

Second, the firm also de-risks the possibility of client exit, since the client relationship is now with the firm’s advisor rather than an ‘independent’ advisor. Very often the book will be sold back to one of the firm’s owners, reducing the possibility of an independent successor-advisor leaving (with the practice).

B) Another major conflict is the fact many broker dealers are not only distributors but product manufacturers.

First, by purchasing advisor books for the firm, the firm now have control over the construction of those portfolios and exactly what product can go into a client’s portfolio: ie, the dealer can now put the client into proprietary product. This again changes the economic equation as the dealer now makes a profit on the product itself while also earning a ‘management fee’ managing the portfolio. Another classic conflict of interest. Most clients are not familiar with this.

While this is all perfectly legal, it represents an obvious conflict of interest for the advisor and his client. Proprietary product always puts the advisor in the spotlight. Is he really representing the client’s best interest when a) he’s selling proprietary product vs the best available product on the market and b) why should he earning commissions on both ends.

Second, once the advisor has retired, the dealer will often convert the client portfolio into a proprietary product-based portfolio. A portfolio that is often very different from its original form. This becomes the classic misalignment of the client interests versus those of the dealer.

In many cases, the new portfolio does not resemble the one which the original advisor had specifically structured for the client and managed accordingly. How does this serve the client’s best interests? The advisor needs to ask himself; “Is the new firm really looking out for my client’s interest or is it trying to maximize its own distribution revenues through product manufacturing?”

We have a litany of examples of banks and large asset managers (being big product manufacturers) putting tremendous pressures on investment advisors to buy internal product: not for the client’s best interest-but because the asset manager needs to remain a separate, profitable revenue entity. It is often the very reason why banks asset managers buy small boutiques and Independent Advisors: Precisely because they become a significant additional distribution channel for the asset manager. In most cases, small or large asset managers who carry proprietary product are mere replicating what banks already do. They are no different from the bank. And with an ever-increasing number of independent dealers becoming product manufacturers, they now behave in the same fashion. It becomes impossible to differentiate them from the bank.

Last, by selling his practice directly to the firm vs the individual advisor, advisors are essentially disenfranchising themselves (and their fellow colleagues) by bypassing the free market system. He is eliminating the free market practice of selling the advisor practice between/among investment advisors. In effect, he is contributing to the demise of advisor-based ownership, to one where dealers now become the warehouses of client accounts. They own the client-assets.

While this change of ownership is an economic game changer for the dealer, the transfer of client assets does not necessarily serve the client’s best interest. The two are often not aligned.

This poses the ultimate contradiction: The Investment advisor is often viewed as an entrepreneurial centerpiece, the bastion of independence and self-ownership. The very practice of bypassing fellow advisors and selling the practice itself to a firm (vs the advisor himself) is perceived as the ultimate betrayal and contradiction of his own identity, ie-everything he was and represents.

Warning to the Advisor!

Not all broker dealers are equal, and neither are the assets they hold.

For many investment advisors, whether he is simply making a transition or looking for a retirement exit; getting the best deal on the market is a fair, reasonable goal. But that doesn’t mean he has to sell it to a firm. Nor is the firm’s offer in the client’s best interests.

The Advisor is perfectly able to have his cake and eat it too.

With a plethora of dealers hunting for fee – based advisors, he is able to make choices that not only benefit him-but those of his clients too.

The best way to ensure the client will have smooth continuity of his managed portfolio – is by effectively managing this transition to an advisor who best reflects his own investment style.

In order to best facilitate this, it is imperative that he maintains the free agency market, by making an advisor-to-advisor transaction rather than advisor to firm.

This highlights the underlying paradigm shift he must now avoid. When he’s ready to make the transition, it best preserves the character and sanctity of the advisor-client relationship.