Looking at the numbers in LPL's SEC filing for its IPO, Philip Palaveev, president of Fusion Advisor Network, says, "It's important for everyone to understand that LPL is a relatively unique firm—the sources of revenue for LPL are unique and almost no other broker-dealer other than perhaps Raymond James has this combination of revenues." However, Palaveev says that the filing also provdes "a glimpse of what the entire industry looks like at the custodian and clearing level."
Palaveev writes about Top Wealth Managers and practice management regularly for AdvisorOne.com.
Those numbers, he says, highlight the "magnitude and importance of secondary revenues to LPL's business, and by reference, to everyone's business. It shows us how important these revenues are for all broker-dealers and all custodians—for pretty much the entire independent industry."
In an interview on Nov. 18, Palaveev prodided these insights into LPL, and the industry.
AdvisorOne: Any surprises in the LPL filing?
Palaveev: What draws my attention is that here we get a glimpse of the economics that are driving the RIA side of the business and the broker-dealer side of the business.
What is important is the fact that, at net revenues of $2.75 billion, well over $500 million, about 20% of that revenue, belongs in this category of attachment revenue: asset based fees, transactions and other fees, and interest and other revenues. That's the revenue that is usually not in plain sight. This is the chunk of revenue that happens more behind the scenes.
AdvisorOne: So the asset based fees are custodial fees?
Palaveev: The asset based fees are fees that custodians generate and to some degree, broker-dealers as well.
AdvisorOne: The cash sweep fees?
Palaveev: Cash sweep, sponsor fees and record-keeping—those three. Cash sweep fees, generally speaking, are something that clearing and custodian firms generate—they may occasionally share some of that with broker-dealers. LPL, being self-clearing, has full access to that entire category.
Sponsorship fees are something that is driving custodian programs—custodian select manager and No Transaction Fee (NTF) programs are the source of such fees. Sponsorship fees are paid to basically belong to that program. Record-keeping is part of what brokers and custodians do. [LPL lists $273 million in "Asset Based Fees" for 2009 in its filing.]
The revenue clients pay advisors is the $2.182 billion ($1.478 billion in commissions and $704 million in advisory fees). For every dollar of commission or advisory fees, there's 12.5 [additional] cents of such asset-based fees that are generated at the clearing firm or custodian level. The two are mixed because the firm is both a clearing and custodian firm.
AdvisorOne: This is part of investing that clients don't see—I'm not saying it's nefarious, but these are things that they don't realize are part of the cost of investing.
Palaveev: It's not easy to see—this is almost a unique page that gives you a full view of the economics and it's not something that advisors often see themselves. I'm by no means suggesting that this is inappropriate—obviously if these revenues were not there these firms would not exist and they did not exist we would not be in business. I'm just trying to say we all have to realize that this is a very substantial part of the cost of investing for clients, and a cost of doing business, and it's a very big part of the economics of this business.
Advisors need to pay a good amount of attention to this—the economics that drive their relationship behind the scenes, whether that's a custodian relationship or broker-dealer relationship—because what happens in this category [of revenues] is going to drive the other categories.
LPL would not be able to offer the payout they are able to offer in the absence of these asset-based fees. Similarly, custodians would not be able to offer the custodian services they offer in the absence of these fees. This is a critical part of the economics of this industry. The payouts of the first category are about 90% and out of that they have to cover their operating costs. So a typical broker-dearer would probably not be profitable on that first category alone—advisor-driven revenue. The source of profitability of broker-dealers, if any—because not all broker-dealers are profitable—is in the asset-based fees and transactions and other fees.
