DAN ARNOLD, THE NEW CEO of LPL Financial Holdings Inc., is making bold moves to increase profitability at the nation's largest independent broker-dealer, and while he's pleasing Wall Street, some LPL affiliates and advisers are questioning how they fit into his vision.
Less than a year into his tenure, Mr. Arnold is in the midst of integrating the largest acquisition in LPL's history, while at the same time instituting a new policy to make sure advisers joining LPL park their fee-based assets on the firm's corporate RIA platform. While both moves are widely seen as enhancing the firm's future earnings, he runs the risk of alienating many of LPL's affiliates and advisers who produce those earnings.
Mr. Arnold, 52, has risen steadily through the executive ranks over the past 10 years at LPL. He joined the firm in 2007 after it acquired Uvest Financial Services, a large broker-dealer focused on reps and advisers at banks and credit unions. In 2012, he became LPL's chief financial officer and three years later was promoted to president. He became CEO at the start of 2017, a few weeks after LPL's former CEO, Mark Casady, said he was retiring.
Known for his attention to detail and a keen sense of numbers and analytics, Mr. Arnold has already impressed Wall Street. Since he took the reins at LPL, the company's share price has risen 49.0%, compared with a 13.4% gain for the Standard & Poor's 500 Index. And since Aug. 15, when LPL announced it had bought the assets of the four broker-dealers that make up the National Planning Holdings network, its shares have increased 14.0%, compared with 2.9% for the S&P 500.
In announcing the acquisition, LPL said it could add as much as 40 cents a share to its earnings by the end of next year, or almost 20% more income than the company reported in 2016.
[The] LPLA/NPH merger checks all the boxes — accretion, structure, price," Steven Chubak, an analyst with Nomura Securities, wrote in response to the news of the acquisition. "This announcement only further reinforces our bull case for LPLA shares."
Getting LPL's rank and file to fall in line may prove more difficult for Mr. Arnold.
LPL's revenue is based primarily on assets from two sources: brokerage and advisory. At the end of the second quarter, LPL reported $305.2 billion in brokerage assets and $236.8 billion in advisory assets.
While brokerage revenue is funneled through the firm, LPL is missing an opportunity to capture potential fee revenue from advisory assets that its advisers hold in custody at Schwab Advisor Services, Fidelity Clearing & Custody Solutions and others. LPL has a corporate RIA, but some LPL affiliates allow their advisers to hold their advisory assets at these external custodians.
These affiliates, especially the larger ones, say that allowing advisers to do so has helped their recruiting. That's because advisers can negotiate a payout from external custodians that is 10 to 12 basis points greater than the payout they would get from putting their clients' assets at LPL's corporate RIA, sources said.
Two weeks after announcing the NPH acquisition, LPL said that in the future it would require advisers who want to have an RIA outside of LPL to put at least $50 million of advisory assets under custody with LPL first. LPL does not report the amount of assets its advisers hold at outside custodians, but affiliates say it could be at least 10% more profitable for LPL to have adviser assets with its own corporate RIA rather than at a competitor such as Schwab or Fidelity.
The new policy, which does not affect LPL's current advisers but applies only to recruits, will undoubtedly estrange some of the larger LPL branches that have benefited under the old policy, and there could be defections to other broker-dealers, according to Dennis Gallant, an industry consultant.
"But at the same time," Mr. Gallant said, "no one is nonprofit in this industry. Firms need to really think about where they make money. The branches need to realize they are taking money out of the pocket of LPL when they work with Schwab and the others. And other firms have said the margins get very thin when you are not the custodian of assets."
In an interview, Mr. Arnold downplayed the change in the RIA custody policy, saying that the overwhelming majority of advisers' assets are already on LPL's corporate RIA platform.
The economics and regulation of the securities industry have changed in the past decade, and policies about where LPL advisers custody assets in the future needed to be updated, he said.
"The change in policy doesn't surprise me," said Jodie Papike, executive vice president of Cross-Search, a third-party recruiting firm. "What will be interesting to see is if this change affects their recruiting. I'm sure LPL has evaluated this and is betting that any missed recruiting opportunities will be made up with higher profitability per adviser and continued opportunities with acquisitions."
"Because it's self-clearing, LPL is best-suited to acquire larger firms like NPH," Mr. Gallant said. "For profitability, the company needs to grow assets on its own RIA."
Some observers are quick to note that LPL, an industry bellwether with more than 14,000 reps and advisers, is facing the same problems as its competitors, forcing Mr. Arnold's hand. With increased regulation pressuring profits, broker-dealer operating margins dropped from 12% in 2006 to just 3% in 2016, Firms are spending millions of dollars to comply with the Department of Labor's new fiduciary standard, a rule that the Trump administration may eventually kill.
There is no doubt that the DOL rule has hurt profits at LPL and other broker-dealers. Sales of high-commission products like variable annuities and nontraded real estate investment trusts have dropped precipitously. Five years ago, LPL reported $1.82 billion in commission revenue, exactly half its total sales. In 2016, it reported $1.74 billion in commission revenue, or 43% of its total.
A potential burden
LPL's new RIA policy could prove to be a burden not just for existing affiliates, but for the 3,200 reps and advisers who make up the National Planning Holdings network, whom Mr. Arnold still needs to convince to join LPL.
LPL paid Jackson National Life Insurance Co. $325 million for NPH and promised it up to another $123 million in the first half of 2018, depending on the number of advisers and amount of revenue that eventually move over to LPL. The four broker-dealers that make up National Planning Holdings are Investment Centers of America, National Planning Corp., Invest Financial Corp. and SII Investments. Together, they account for $120 billion of client assets, and according to InvestmentNews data, generated $909 million in revenue in 2016.
Some NPH advisers privately told InvestmentNews they would not go to LPL. Pointing to the change in policy about housing a new adviser's first $50 million in advisory assets, they said they were not happy with any notion of limiting the choice of where clients' assets are held. Another sore point was LPL's move to deal directly with advisers at some large NPH branches rather than communicate with them through branch managers, who in some cases have built up those networks over decades.
Other NPH advisers were more sanguine about the acquisition.
"I think it's a fair deal," said John Horseman, whose eponymous firm is one of the largest at NPH and manages $640 million in client assets.
"It looks like a smooth transition and the least amount of disruption to our clients. Instinctively, I like a smaller firm, but with the DOL fiduciary rule and Dodd-Frank, can a small broker-dealer exist?" asked Mr. Horseman, who was referred to InvestmentNews by LPL. "If larger is inevitable to me, LPL would be the first choice and is at a level we had at National Planning."
NPH advisers, as well as third-party recruiters and former LPL executives, predict that between 50% to 70% of NPH advisers and assets eventually will go to LPL. Securities America Inc. and Cetera Financial Group are particularly attractive alternatives at the moment for some NPH advisers, those same sources said. Many NPH advisers are likely to move to LPL simply because of inertia.
In the first part of the transition, clients of advisers at National Planning Corp. and Investment Centers of America are receiving what are known as negative consent letters about the move this month and next. If those customers simply don't respond to LPL's missive, they have essentially agreed or opted in to moving assets to LPL.
LPL executives say that they are trying to make the merger as easy as possible for reps. They stress that when an NPH adviser moves to LPL, there is no messy paperwork that involves clients but rather an electronic movement of assets. NPH advisers who have cash in deferred compensation accounts will also not be taxed on that money when they move to LPL. If they move elsewhere, it becomes a taxable event.
Mr. Arnold said that over the past two years, LPL has been taking a "balanced approach" as it attempted to boost its profitability. The firm's emphasis is on the experience of its advisers, its financial results and risk management, he said.
"The focus is to be a better partner, and the balanced approach is the much better model," he said, adding that LPL was working to create "meaningful partnerships" and not "playing hardball" with NPH advisers.
"When we move NPH people over, the new guidelines [about assets] still apply, but if an adviser has $100 million in custody at Schwab, we are not going to require moving that to us," he said.
"The adviser will be charged an off-platform fee which is consistent" with those already charged at NPH, Mr. Arnold said.
"Ten years ago, advisers created RIAs and made certain assumptions [about] cost to operate the regulated entity," Mr. Arnold said. "That cost has changed. Now, the adviser has the risk and is not getting any economic benefit. They are coming back to the corporate RIA. That's what we are trying to accomplish with the policy change."