Schwab offers revenue sharing to get hybrid assets

The Charles Schwab Corp. is offering revenue-sharing incentives to National Financial Partners Securities Inc. and other independent -broker-dealers…

The Charles Schwab Corp. is offering revenue-sharing incentives to National Financial Partners Securities Inc. and other independent -broker-dealers to persuade them to work with fee-based registered investment advisers who want to retain commissions on deferred annuities and other products, according to several sources.

The incentives include a piece of the fat fees that mutual fund sponsors pay Schwab for “shelf space” on its well-publicized fund supermarket platforms, as well as a piece of the revenue generated by cash balances that custodians glean from RIA client accounts, industry sources said.

An official in Schwab’s strategic-business-development group, Catherine Davies, referred calls to Schwab spokeswoman Alison Wertheim, who declined to comment.

The incentives address a continuing challenge for RIA custodians such as Schwab Advisor Services and TD Ameritrade Holding Corp.’s institutional division that don’t have correspondent-clearing businesses with networks of broker-dealer clients.

Rivals with such networks, such as Fidelity Investments and Pershing LLC, can induce their broker-dealer clients to accept the typically low-profit business of hybrid advisers through concessions on securities-related pricing and services.

Schwab in the past has tried to craft alliances with small independent-brokerage firms such as Cambridge Investment Research Inc., but the arrangements have largely disintegrated because of the brokerage firms’ assumption of responsibility for the hybrids’ compliance, low revenue potential from fee-oriented advisers and fears that Schwab would try to convert the independent firms’ reps to fee-only advisers, industry observers said.

Cambridge houses about $30 billion of assets from hybrids but hasn’t been expanding the business through Schwab.

Lindsay Tiles, a Schwab spokeswoman, said that the company has relations with 100 independent broker-dealers who work with nearly 1,900 hybrid advisers. She declined to elaborate on the nature of those relationships.

Schwab in recent months has been offering bottom-line money to broker-dealers but at the same time has asked for a list of the firm’s registered representatives, said the head of one independent brokerage, who asked not to be identified.

“Schwab is a good, quality firm with great service and systems, and they’ve recently attempted to create a deeper relationship with us on the advisory side, but we’re still a little cautious,” said Arthur Grant, president and chief executive of Cadaret Grant & Co., an independent- brokerage firm that works primarily with Pershing.

One of the problems for independent broker-dealers is that unlike custodians, they assume supervisory responsibility for all aspects of an RIA’s business if they house any part of the hybrid’s commission business. That heightens potential liability and can require the broker-dealer to invest in technology linking them to a custodian.

These constraints often lead the broker-dealers to demand a share of a hybrid RIA’s advisory fees, or offer a lower-than-usual payout on its brokerage commissions. And that can lead to a standoff.

“When I accept an independent RIA that also wants to be a registered rep, I have to be willing to take on compliance risk and extra work for something on which I am going to get very little payment,” said Ed Cofrancesco, president of International Assets Advisory LLC, an independent-brokerage firm that clears through Pershing.

Schwab’s incentives go beyond the goal of attracting the burgeoning number of breakaway brokers who are leaving traditional securities firms for independent fee-oriented practices.

The custodian giant also is trying to capture new assets from the RIA units that independent broker-dealers have established to accommodate the fee-based inclinations of their existing representatives. Many independent brokers require their affiliated brokers to use their internal RIAs, or assess penalties on them if they hold assets in custody elsewhere.

Under the Schwab incentives, the brokers would have reasons to send some assets to Schwab Advisor Services and perhaps split some of the incentives with their affiliates.

Indeed, Schwab’s arrangement with National Financial Partners was engineered in large part by Fusion Financial Group, a coalition of insurance agents and financial planners with a bias toward fee-based revenue, according to sources.

Fusion conducts securities transactions through NFP Securities, a broker-dealer and RIA that clears most of its business with Fidelity. Fusion has been pressing NFP for more platform choice and custodial fees.

“NFP Securities has recently renewed its long-standing custodial agreements with both Schwab and National Financial Services [Fidelity’s clearing division], and NFS continues to be our primary custodian,” said Jane Simmons, a spokeswoman for NFP.

Philip Palaveev, president of Fusion Advisor Network, declined to comment on details of the RIA custody relationship but said that the growth of the fee-based channel and custodians’ revenue justifies greater benefits for advisers.

“In an industry on the rise, there’s enough profit for everyone to collaborate and cooperate,” he said.

Indeed, Schwab isn’t the only custodian cutting revenue deals with independent brokers and their affiliates.

TD Ameritrade expects to an-nounce affiliations with three or four independent broker-dealers by the end of the quarter. The firm will offer those broker-dealers and others marketing and revenue-sharing opportunities if they agree to share some of their RIA custody business, said Jeff Zabel, director of TD Ameritrade Institutional’s Advisor in Transition sales group.

James Crowley, the managing director in charge of large brokerage firms at Pershing, said that over the past year, the firm has been offering brokers who set up RIA relationships with its custody unit “the opportunity to share in the economics” of the custody business.

RIA COMPLETE

More than 20 brokers have joined the program, dubbed RIA Complete.

“We are non-threatening,” said Mr. Crowley, noting that Pershing doesn’t operate a direct-brokerage business that competes with its clearing or RIA custody clients.

“We have a strong practice- management offering, a strong technology proposition, depth and ex-perience on the broker-dealer and advisory side, and if you wrap all those up and put a nice bow on it, we have a story,” he added.

Stephen Austin, a Fidelity spokes-man, wouldn’t comment on specifics but said the firm has helped “hundreds of brokers and advisers establish and manage dually registered businesses over the years” and exceeds all competitors in size, scale and capability. The firm attracted more than 180 breakaway brokers to its clearing and custody platforms in 2009 and continues its 12-year relationship with National Financial Partners, he said.

Schwab, however, has an ace in the hole with its industry-leading fund supermarket and the revenue that that service generates, according to brokerage firm executives, who say the firm is making some tempting offers.

What Schwab risks with the hybrid offer is offending hundreds of fee-only advisers whose business model it has long championed. The firm’s executives clearly understand the dynamics, some observers said.

“There are more advisers in motion today, and they need a place to house their commission business,” said Bill Crager, president of Envestnet Asset Management, which offers portfolio management services and technology tools to independent brokers and advisers.

“It’s hard to remain fully fee-based in today’s world,” he said. “That’s the lesson we all learned last year.”

E-mail Jed Horowitz at [email protected].