'Affiliation arbitrage' is a bad reason to go RIA

Compliance and opportunity costs are just two reasons why trying to sidestep brokerages may not be in the best interests of advisers and clients

Nov 16, 2017 @ 5:20 pm

By Rich Whitworth

The past several years have witnessed a surge in the number of independent financial advisers who have established their own RIAs – often motivated by the desire to achieve a form of "affiliation arbitrage." By sidestepping broker-dealer and corporate RIA affiliation fees, the thinking goes, independent advisers who choose to set up their own RIAs can maximize their profit margins.

Certainly, there are valid reasons for advisers to try this. For example, having your own RIA makes perfect sense for groups that manage a substantial amount of fee-based assets, since they would likely have the necessary resources to support that effort. Other good candidates include advisers whose value propositions are principally rooted in their ability to conduct proprietary research, select stocks and put together portfolios that can outperform the market, as well as firms that may only do business in one state (though that's a rarity).

Otherwise, those who approach this decision from purely an "affiliation arbitrage" perspective may be surprised by some of the hidden financial and opportunity costs that come with setting up their own RIA. In particular, think about the following three things:


How will you manage added compliance and regulatory responsibilities? RIAs have heightened regulatory responsibilities, and managing this effort takes up a great deal of time and requires vast compliance expertise – two things that are generally in short supply. Even if advisers could take on this role, it would limit the number of meaningful interactions they have with clients, which defeats the purpose of going the RIA route in the first place.

Another seemingly viable alternative is to outsource compliance functions to a third-party vendor. That is costly and leaves it to the RIA to implement any directive the vendor may have, which can be tedious. The least sensible alternative is to hire a chief compliance officer. Qualified and experienced professionals in this field earn annual salaries of well over $100,000, which few advisers could afford.


Can you affordably implement, integrate and maintain technology solutions? Perhaps the trickiest part of establishing an RIA is developing a technology infrastructure that is the right mix of platforms and solutions that enable the best possible client experience and mimics that of an 'enterprise solution.'

Beyond the basic portfolio management, rebalancing, CRM account aggregation and document management systems needed to run a successful firm, advisers need to consider compliance, email/social media surveillance and identity protection software. The challenge of negotiating vendor agreements, integrating these systems into one collective tech "stack" and managing an ever-changing landscape over time only adds to the difficulty.

(More: Morgan Stanley advisers feel burned by broker protocol exit.)

Some firms may be able to get away with not having to invest in a dedicated chief technology officer to take care of these responsibilities. But that still leaves enormous start-up costs, exacerbated by the fact that most early-stage RIAs can't negotiate as a large pricing bloc, and thus fail to enjoy as much pricing power with third-party tech providers as larger groups.


What are the "soft" opportunity costs associated with breaking off a traditional affiliation agreement to start your own RIA? As some advisers get older and their businesses mature, it's only natural for them to downsize the number of clients they work with in favor of managing their staff and overseeing important strategic initiatives.

For others, however, working with clients and constructing portfolios is a passion, and they would be less likely to relinquish or scale back. Many independent practices could not maintain that advisory workload while still devoting enough time to managing the compliance, operations, technology and administrative workflows associated with having one's own RIA. This could lead to the substantial additional human capital costs of hiring a CEO or COO.

(More: What to do when your broker-dealer gets acquired.)

Moreover, commission-based business probably will remain relevant. Retiring Baby Boomers can benefit from fixed insurance, variable annuities and income-oriented retail alternatives. They also might benefit NextGen clients who lack enough investible assets for fee-based accounts. So RIAs will still need brokerage capabilities.

Once all these issues are taken as a whole, many advisers discover how costly and time consuming running their own RIA can be, and they realize that it may not be worth the effort.

Rich Whitworth is head of business consulting at Cetera Financial Group.


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