On Advice

LPL right to eliminate 'self-supervision'

By Bruce Kelly

Jul 28, 2013 @ 8:31 am (Updated 9:12 am) EST

Over the past decade, chief executive Mark Casady has built LPL Financial LLC into a 13,000-rep behemoth through two tactics: buying broker-dealers and aggressively recruiting registered representatives and financial advisers, many of whom were solo acts working in single offices and acting as their own supervisors. LPL Financial has 2,200 such reps and advisers, or 17% of its sales force.

Those advisers are absorbing the news that the company, bowing to coming changes in regulation, no longer will allow them to supervise themselves. Instead, beginning in 2015, LPL will charge them a percentage of gross fees and commissions or a flat $4,800 fee for outside supervision, either from LPL's home office or a regional office of supervisory jurisdiction.

The securities industry at times appears to be built on such brain twisters as “self-supervision.” And the brokerage business often gets itself into trouble with widely accepted business practices that make no common sense.

Indeed, a prominent example of such thinking was former Merrill Lynch star analyst Henry Blodget's putting “buy” ratings on technology stocks that, in truth, he didn't think worth buying.

Self-supervision, which is heading toward extinction as regulators rewrite their rules, is another such instance.

The average investor would likely ask, “Hey, what do you mean my broker can supervise himself? How can anyone objectively do that? That sounds kind of crazy, doesn't it?”

And that investor would be right.

The Financial Industry Regulatory Authority Inc. filed a proposed supervisory rule change last month with the Securities and Exchange Commission that attempts to fix this “self-supervision” conundrum.

According to the Financial Services Institute Inc., the new rule “clarifies that a registered principal assigned to an OSJ cannot supervise his or her own activities if he or she is engaged in business activities other than the supervision of associated persons.”

Now the principal in the solo office — a “Series 24” — will be under the supervision of a registered “senior principal,” according to the FSI.

The translation? A broker no longer can be in charge of reviewing his or her own communications, approving new accounts or ensuring the suitability of the management of client accounts, a bedrock function of the securities industry.

Mike Sharples, a solo LPL adviser in Durham, N.C., said that one question he has about the new policy is how it will better protect investors.

Advisers “will generally do the right thing, but there will always be crooks in the industry,” he said.

Fee hikes

A problem for LPL is introducing the policy and fees after two consecutive years of fee hikes for its advisers.

Remember, LPL last fall increased its errors-and-omissions fee for each rep by $250 annually to $3,000. A year earlier, LPL raised its E&O charge by $250.

It also raised its monthly “resource,” or “affiliation,” fee to $175 per broker, regardless of the number of reps in the broker's office.

At the same time, LPL cut into the payday of its branch managers, telling them that they would no longer receive bonuses for recruiting brokers until those reps produced $250,000 in fees and commissions.

Also, while other independent broker-dealers have decided over the past few years to no longer allow brokers to supervise themselves, they have absorbed the cost in other ways and haven't been guilty of the poor timing that LPL has shown. LPL already has had a turbulent year after being hit by regulatory fines due to compliance and oversight issues.

“We have no such thing as a self-supervised office,” said Adam Antoniades, chief executive of First Allied Securities Inc.

“Our big branches in the old days would hire a Series 24, but the problem was that [the adviser] would sign the paycheck, so he could tell [the supervisor] what to do,” he said. “That creates a conflict, particularly if the hubby hired his spouse as supervisor.”

When LPL announced the increases in fees last fall, Bill Dwyer, its managing director and president of national sales and marketing, said that the firm gave the advisers with $150,000 to $200,000 in annual fees and commissions the best deal on the Street.

'Best value'

LPL “still offers the best value in the business for anyone less than $300,000,” he said at the time.

Such advisers are LPL's sweet spot in the business

Mr. Dwyer has since left the firm, but spokeswoman Betsy Weinberger said that LPL managing director Derek Bruton reaffirmed Mr. Dwyer's comments about the firm's value for advisers with $150,000 to $200,000 in annual fees and commissions.

“We believe our single-person offices will have the benefit of continued robust supervision, coupled with a support team to assist with reporting and monitoring,” she said in a statement. 

“We recognize the difference in the cost structure, but we are adding services that will make it easier and simpler to manage their practices and focus on deepening client relationships. Furthermore, our cost for providing this additional service is in line with the rest of the industry,” Ms. Weinberger said.

Recruiting during the first half sputtered for many independent broker-dealers, including LPL, as advisers stayed to enjoy the good times created by the stock market rally.

Will the new supervision fee result in LPL losing potential recruits to other broker-dealers, such as First Allied, that charge no such specific fee?

“If we went out and charged $5,000 [for supervision], we would lose them,” Mr. Antoniades said.

LPL is placing advisers' and investors' interests first by its steps to eliminate self-supervision. The firm, however, may lose some reps in the process. 

The growing pains at Mr. Casady's behemoth continue.