Wearing Two Hats

Or else limiting it. Apart from imposing compliance restrictions and taking a cut of revenue, the B-D may also restrict the RIA's ability to recruit other professionals. Such is the case at Advisors Alliance where, says Taylor, allied registered reps must work with the firm's affiliated broker-dealer; they can't partner with their own.

This complication notwithstanding, Advisor Alliance's dual registration has worked well for the firm to date. But Taylor acknowledges that the firm has been solicited by broker-dealers offering to fold the practice's investment advisory services under their own RIA. For now, the company is choosing to remain independent.

"To get us to switch, the broker-dealer would have to offer extremely valuable resources–performance reporting, marketing, referral assistance, and RIA platform assistance–that would replicate what we've built internally, but come at a lower cost to our firm," says Taylor. "The cost differential would also have to compensate for the flexibility we would lose in not being able to establish relationships with other 401(k) and mutual fund providers."

For other advisors, the key issue is not whether to dispense with their own RIA in favor of a broker-dealer's, but whether to affiliate with a broker-dealer at all. One potential turn-off is the broker-dealer's restrictions on the RIA's business. On this point, Scott Morgosh, principal and founder of 10 Star Asset Management, Carlsbad, Calif., echoes Taylor's concerns.

"As an RIA, I don't have to seek approval from a [broker-dealer's] compliance department to develop customized marketing literature," says Morgosh. "That's the main difference. I want to be able to present my services the way I want to market them."

David Simon, principal of SimonDavis Asset Management Inc., Denver, Colo., says he severed his B-D relationship 5 years ago–and thereby lost also the opportunity to sell variable insurance products on commission–to operate as an RIA only. The reason: He saw commission- and fee-based sales as incompatible due to the differing standards that govern the client engagement.

Registered reps for a broker-dealer, he says, are obligated only to recommend a product that is "suitable" for the client. But investment advisor reps under an RIA are held to a higher fiduciary standard, requiring them to act in the client's best interest. Simon adds that a fee-only practice is more in tune with the fulfillment of client objectives.

"As a fee-only advisor, I'm financially motivated to retain my clients," he says. "If their accounts grow, I make money and if they shrink I lose money. Previously, I would make a 7% or 8% commission on a product sale, whether I told the client to take a hike or provided the greatest service."

Simon adds the loss of commissions is a non-issue because his practice has grown to a point where he can live comfortably on fees, though he concedes the lack of commissions is often an issue for advisors just starting out.

Warren Forest, founder and president of Forest Brokerage Advisors and BrokerDealerPlace.com, Casselberry, Fla., also sees a potential conflict of interest in the ability to charge a commission or a fee. Some advisors, he suggests, might be tempted to shift, say, a $1 million deposit from a fee-based platform on which they would receive a $10,000 cut to a variable insurance sale on which they might earn substantially more in commission.

Temptations aside, advisors can address perceived conflicts, says Forest, by practicing full disclosure: telling the client when they're acting as investment advisor and when acting as a registered rep, and making clear the implications of each. Forest questions, however, whether many broker-dealers would be as amenable as clients to the advisor wearing dual hats.

"If you were a broker-dealer, I would tell you not to affiliate with an independent RIA," he says. "Unless the RIA can be expected to bring in a lot of money, I would think it's not worth the hassle in terms of regulatory oversight and the potential liability that result from the RIA's activities."

Because of cost savings to be achieved, AFA's Reiff similarly believes that dually registered advisors would do better to affiliate with a broker-dealer's RIA than to operate their own. But he acknowledges that an outside RIA may make sense for advisors who desire to create an independent brand.

"Under the broker-dealer's RIA, you lose the ability to build your own brand," Reiff. "And this may be important if you to want to have a highly saleable business. The brand, on top of the client accounts to be sold, may add value to the firm."