As the RIA model continues to charge ahead, Investment Advisor spoke with him about how the business of advice is changing and what lies in store for RIAs and advisors.

Can you describe the growth of the RIA channel both across the industry and for Pershing specifically?

The business of financial advice is going through a significant change, as financial professionals continue to move away from being professional sellers to being professional buyers, from being product advocates to being client advocates, from a commission structure to a fee structure and overall, away from a suitability standard toward a fiduciary standard.

Most of this is the shift from brokerage to advice. The model has been in place since at least the Securities Act of 1940, but it wasn't until the 1970s and ’80s when the financial-planning movement started to take root that the current model was conceived.

Up until then, most RIAs were pure money managers investing in stocks and bonds on behalf of institutional clients and wealthy people. Typically, these RIAs would trade with the big brokerage firms in return for research, something we call “soft dollar.”

Charles Schwab conceived the idea of offering his discount brokerage platform to retail-oriented RIAs to execute transactions and hold assets. Banks were the primary custodian, but Schwab led the effort to disintermediate them on this service as well.

Now there are about 30 firms that offer custodial and execution services to RIAs from boutique providers such as Shareholders Service Group to the big four that include Schwab, Fidelity, TD Ameritrade and Pershing.

The RIA model now represents almost a quarter of the assets managed by financial professionals in the U.S. According to Cerulli Associates, the independent RIA and hybrid RIA channels grew marketshare of advisor-managed assets from 14.8% in 2006 to 22.7% in 2016. At the end of 2015, there were 17,245 RIA firms registered in the U.S. That's up from just over 12,000 in 2005. In 2015 alone, 648 new RIA firms were created, mostly breakaway firms from wirehouse brokers and private banks as well as transitions from the IBD channel.

Pershing's growth has mirrored the industry's growth, perhaps [moving] even a bit faster. As a company, we serve RIAs in multiple ways. First, through Advisor Solutions we focus on RIA firms who tend to be much larger than those at our competitors. As an example, the average RIA we onboarded last year had assets of $750 million. Our assets under custody in this channel grew from $30 billion six years ago to $200 billion today, and the growth in this business continues to compound at a double-digit rate.

We also have a growing base of corporate RIAs. This is a big untold story but significant for the industry. In order to respond to the movement away from transactional business, broker-dealers invested heavily in the corporate RIA model under which their advisors would register as investment advisor representatives (Series 65). This allowed their advisors to do financial planning and act as fiduciaries when consulting with their clients.

This was a great solution for financial professionals to set up their practice as advisory rather than brokerage. As the largest securities-clearing firm in terms of the number of broker-dealer clients in the U.S., we have seen dramatic growth in corporate RIA assets, growing from 5% of our total in 2008 to 47% of our total assets under custody today. Currently, Pershing custodies just over $650 billion of RIA assets and that trend continues unabated.

Can you comment on what factors have been driving this growth and what has been interesting to you as you have observed this trend over the years?

Several factors are driving this growth. The first catalyst was the creation of financial-planning designations — CFP and ChFC. This helped individuals move away from being investment-forward product salespeople to planning-forward client advocates.

Second, the rapid growth in the independent contractor broker-dealer model away from employee-oriented brokerage firms allowed for a more open approach to doing business and gave way to a more entrepreneurial mindset among financial professionals.

Third, their supervising broker-dealer required the unbundling of services where advisors no longer had to limit themselves to proprietary investment products, technology or even custody. Now, RIAs can shop for the best set of solutions that align with their business model and their clients. There are literally scores of providers eager to serve them, which puts them much in demand.

The fourth catalyst was the overt promotion of the fiduciary standard by organizations such as the Financial Planning Association (FPA) and the National Association of Personal Financial Advisors (NAPFA), which caused many in the industry to think more clearly about how they would like to be perceived. This has resulted in more than 100 universities in the U.S. conferring degrees in financial planning, which is introducing thousands of new students into the advisory side of the business every year.

The most recent catalyst was the reputational damage that big investment banks and brokerage firms suffered following the 2008 market collapse. The fastest growth in the RIA segment is coming from very large breakaway teams like 6 Meridian (Wichita), Summit Trail (New York, Chicago, San Francisco) and Halite (Columbus, Ohio), who are setting new firms up with billions of dollars of assets under management.

Has that growth surprised you — why not? And in what ways?

As I said, the RIA movement is not a recent phenomenon. Momentum has been building for 30 years or so. Now that consumers are beginning to appreciate the difference between an advisor and a broker, and that financial professionals want to be seen as client advocates versus product advocates, the growth is continuing to gain momentum.

That's not to say brokers don't add value or aren't acting in the client's best interest. But the shift to a more professional standard of conduct just puts an exclamation point on the way these folks want to practice.

I think what surprises me, and sometimes annoys me, is that the industry and regulators allow for a confusion in terminology between broker and advisor. Consumers have the right to know what type of practitioner they are dealing with.

If I have a sore back, I want to know if I am seeking the help of a massage therapist or an orthopedic specialist. If I’m seeking help with my taxes, I want to know if I’m dealing with an Enrolled Agent or a CPA. If I’m trying to buy a new condominium, I want to know if I’m dealing with an independent real estate agent or a representative of the building I’m interested in.

I don't mean to diminish those who deliver basic services, but if my expectation is that I’m dealing with a professional who must adhere to certain standards, then I’d like evidence of that in their disclosures and their relationship with me. If the consumer wants to be transactional in their relationship, this should also be clear to them.

You’ve said this trend started way before DOL's fiduciary rule. Can you elaborate on this view?

The DOL [Conflict of Interest] Rule mandates that anyone advising on retirement plans adhere to a fiduciary standard as defined by [DOL]. This focus is only on a certain type of account and not on the entire relationship. On the other hand, the Securities Act of 1940 stated that those acting as advisors must adhere to a fiduciary standard in all of their dealings.

In the case of the DOL, it's a rule with the threat of litigation. In the case of the RIA fiduciary standard, it's a principle or standard of conduct, and is what those who are established as RIAs understand they must adhere to in their total relationship with the client.

Clearly, the growth of the RIA segment of the business has been exponential for many years before [DOL's rule] was even conceived. I perceive that the regulators and their advocates felt that by requiring brokers to step up their standard of conduct, they would put all clients on a level playing field regardless of what type of financial professional they worked with.

I’m sure there are many within brokerage environments who are saying if they have to adhere to new rules, they might as well go all the way to RIA, but this has not yet been a boost to the RIA side of the business. Meanwhile, the DOL rule is forcing broker-dealers to invest more in their approach to serving clients, including more robust corporate RIA platforms, more relevant technology and a stronger focus on cost and benefit.

Would you say that the DOL fiduciary rule is good for RIAs and growth of the channel? And where do you see DOL going given the present political climate?

DOL may be the final shove that some registered reps need to become RIA only. At some point, the complexity of acting in the best interest [of clients] on certain types of accounts but not on others becomes too risky from a compliance and litigation standpoint and too onerous from a management standpoint. But there are other factors likely to drive the RIA movement.

What does the growth of the RIA channel mean for independent broker-dealers, employee BDs and other players?

As this industry continues to evolve, I think more broker-dealers will view themselves as financial service firms, not product distribution companies. There are 1,400 fewer broker-dealers since 2008, and we are aware of at least 20 broker-dealers filing BDWs (broker-dealer withdrawals) to go RIA only.

But I think it's a mistake to blame this stress on the growth in RIAs. The real pressure is coming from how consumers want to interact with their financial professionals, how technology is changing the advisor-client dynamic and how regulators are making it more difficult to operate profitably.

Regardless of the business model, financial professionals of all stripes need to be clear on who their optimal client is, what their client experience will be, how they are structured to support this experience and how they manage to profitability. If I were running a broker-dealer today, I would try to answer the key strategic questions around why I exist in financial services, regardless of which regulatory structure I operate under.

What does all this change mean for clients?

Clients clearly benefit from greater transparency, a lower cost of doing business and higher standards of conduct. There still is too much confusion as to what type of practitioner they are dealing with, so the onus is on them to do their homework.

But now, consumers have a clear choice.

On the downside, most RIA firms are small businesses. They have limited resources, limited capacity and in many cases, limited capability. Working with a lifestyle practitioner without a command-and-control structure can be as risky to consumers as working with a pure-product advocate. RIAs are not audited by regulators frequently, and there is not a lot of funding to change this.

Consumers still need to be careful not to accept all practitioners as equal regardless of their business model or their professional designations. Deciding to work with a fiduciary is not a panacea to one's financial challenges. It's a great threshold question, but not the final question.

What does all this change mean for advisors overall?

For young people contemplating a career, the business of financial advice is very compelling: It's intellectually stimulating, you have a degree of independence, you are well-rewarded financially and you can profoundly impact the lives of others. Plus, there is an oversupply of clients seeking advice.

For others trying to build a business with transferable value, there is nowhere to go but up. There will be normal business pressures, but the opportunity for meaningful growth in an industry with so much potential is truly compelling. There is a reason why so much private-equity money is coming into this space.

What's next for the RIA business?

I am hardly an oracle, but I do see some patterns from other professions such as accounting, law and engineering that could apply here. There is a desire for many firms to get to critical mass. There is a need to create a better process for developing and recruiting talent. Most firms are limited in their growth because of a lack of human capacity to serve clients.

As a result, I expect to see more large firms emerge. It would not surprise me to see 10 to 12 national RIA firms and 50 to 60 super-regional firms in the next 10 years. I think we will also see a growth in local-market dominators as firms begin to consolidate.

How will new technologies like robo-advisors, AI, social media and mobile tech affect RIA growth?

I don't see digital technology displacing advisors. I do see this technology enhancing the advisory experience. In a sense, mutual funds [and] then ETFs were a form of robo back in the day. Each innovation, whether in this business or not, ratchets up client expectations about how [advisors] will interact with you.

One challenge is how the regulators will keep up with technology. I’m not sure that their original intent anticipated how social media, smartphones and the internet would transform how people interact.

What does it mean for consolidation, and what is the future of large vs. small advisory firms?

There will always be lifestyle practices, but consolidation is inevitable. Two models are unfolding: private-equity-backed roll-up firms seeking a financial play or a liquidity event; and strategic acquirers, existing owner-operated firms that are attempting to grow into large regional or national firms. My next column in the November issue of Investment Advisor will get into this extensively.

When you look at the RIA channel's growth, what predictions can you make about it — say 10 and 20 years out?

I think less about it being the “RIA channel” and more about an operating model for how financial services will conduct business going forward.

There will always be transactional firms because many consumers prefer it. Discount brokers and the like seem to still attract a certain type of client. As I said before, I think broker-dealers will continue to adapt to this orientation, and some of them could emerge as the national or super-regional firms that I predict will unfold.

However, this segment has its challenges:

• There is an acute talent shortage, and there are very few firms big enough to become known as the employer of choice with a people-development plan.

• RIAs have not really experienced any price compression, but other providers have; this dynamic will soon change.

• It is difficult to tell the difference between advisory firms, so distinct branding will be required for those committed to growth.

• Regulatory standards for establishing and maintaining an RIA will also likely be raised, which will put additional pressure on the owners of these firms.

Are there any more thoughts to share on the topic or related industry trends?

The shift to advice away from brokerage is not unique to the U.S., even if the term “RIA” is uniquely American. We see the growth in this model occurring in the U.K., the Netherlands, Singapore and Australia. We see rumblings in India and Japan and throughout Europe.

The question is whether the movement will occur as it has in the U.S. with a profession fueled by entrepreneurs rather than giant organizations.

I do have a concern that the organizations upon which RIAs are dependent for technology, custody and investment management have all experienced serious margin compression. At the same time, RIAs are demanding more from their providers.

At some point, there will be a reckoning that could change this dynamic and make it harder for the entrepreneurial firms to ride on the coattails of their larger, well-funded providers. I think this is a scenario worth watching.