This article delves deep into the business model of the Registered Investment Advisor, exploring what should be its defining qualities and some of the associated controversies. It is part of a series of analyses from the UHNW Institute.
As part of a continued series from the UHNW Institute, the organization takes a detailed look at the main wealth management business models of the North American industry. With so much debate about the advantages or disadvantages of each, it is particularly important to get a detailed outline of how they actually work. This article is from Maria Elena Lagomasino and Michael Zeuner, managing partners – WE Family Offices. For more detail about the Institute, see here.
In the first installment of this series, Jamie McLaughlin makes the case that there are four distinct regulatory regimes in the wealth management arena: commercial banks; broker-dealers; registered investment advisers (RIAs); and trust companies. This installment provides a deeper dive into the RIA regime.
For purposes of this article, RIA refers to a wealth management firm that is registered with the United States Securities and Exchange Commission as an investment advisor(1). Registration with the SEC imposes a unique and distinct regulatory burden on a firm to adhere to the key tenets of the Investment Advisers Act of 1940, which, according to the SEC website (2):
“prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business. As a fiduciary, an investment advisor owes its clients undivided loyalty, and may not engage in activity that conflicts with a client's interest…”
In addition, a registered investment advisor is uniquely required, under the Advisers Act, to:
“deliver to each client or prospective client a Form ADV Part 2A (brochure) and Part 2B (brochure supplement) describing the advisor's business practices, conflicts of interest and background of the investment advisor and its advisory personnel.”
These two core requirements of the Advisers Act help set Registered Investment Advisors apart from the other types of firms mentioned above. Even more importantly, they also form the basis of the prevailing culture in the RIA industry: a strong fiduciary culture of putting clients’ interests first, and an emphasis on the utmost transparency.
That said, this distinction is important, but not enough to help ultra-high net worth families determine whether an RIA is “right for them”. Few families make regulatory status the primary driver of their decision in hiring a wealth management firm. Instead, we would argue that a more important distinction is between business models available in the wealth management industry, and would pose this question: Is the firm built on a provider model or an advisor model? (Note: See discussion of manufacturers versus distributors in Jamie McLaughlin’s article, The Skinny on UHNW Wealth Management Models, the first in this series.)
Advisor vs provider
This distinction makes all the difference. If the firm is a provider, its core role is to sell or distribute financial products or services to clients for a fee. If the firm is an advisor, its core role is to help the family determine which financial products and services and providers are best suited for their needs.
Everything about the two business models is fundamentally different:
• Regulatory framework: Generally, RIA for
advisors; bank, broker/dealer or trust company for providers,
though many such firms are dually registered or operate
separately regulated subsidiaries in tandem in the
• Compensation: Asset-based fees generally for advisors, though flat fees or service activity-based fees are beginning to catch on; management or asset-based fees and transaction fees for providers; and
• Client experience: a holistic, comprehensive, integrated relationship based on a complete picture of the family’s overall wealth for advisors; compartmentalized, transactional relationships centered on a piece of the family’s wealth for providers
Nearly all families work with multiple providers for understandable reasons: different providers have different specialties and areas of expertise; different providers bring a diversity of perspectives; concern about telling a single provider “everything” for fear that the information will be used to try to cross-sell a range of financial products and services.
The challenges for families who work with multiple providers raise these questions:
• Who’s keeping track of it all?
• Am I getting the highest quality financial products and services that are right for me?
• Who’s connecting the dots across everything I’m doing to be sure it’s done in sync with my objectives and to see I don’t have any overlaps or underlaps in financial products and services? and
• Who’s keeping me updated on the “big picture” and my overall wealth map?
This is where the advisor can come in. Because an advisor can sit on the same side of the table as the family, his or her role becomes one of a financial quarterback: In that role, the advisor will be able to understand the “big picture” and help them to buy, integrate and manage without the conflict that comes with having to sell financial products and services. In all cases, wealthy families need an ecosystem of providers (banks, lawyers, accountants, brokers, custodians, investment managers, trustees, etc.). The key question is do they also need an objective advisor to help them source, research, integrate and manage that ecosystem of providers?
While nearly all firms in the wealth management space will call themselves “advisors”, we would argue that the only way a firm can act in an advisory role is if they are completely disconnected economically from the provision of financial products and services. In other words, they receive fees from the families they serve to help them source the right providers, and that is the only source of fees for the firm. They don’t receive any incentives from providers of financial products and services as this represents a fundamental and detrimental conflict affecting their capacity to advise with impartiality.
This, in our opinion, is the essence of the distinction between registered investment advisors and all other business models. An RIA is hired by families, and paid only by families, to represent their interests, and no one else’s. It’s not just about the regulatory duty of putting their interests first, it’s about serving ONLY their clients’ interests, and no others.
It’s also clear to us that some registered investment advisors and their affiliates do take fees from multiple sources, but as an RIA these fees must be disclosed in the ADV and it’s relatively straightforward for a family to discover that a particular RIA may not be fully acting in an advisory capacity. Here’s a real example (with the name of the firm disguised) of a disclosure in an RIA’s ADV:
To the extent that advisory clients of XYZ Advisors invest in third-party investment vehicles for which XYZ’s affiliate is acting as placement agent, XYZ’s affiliate will typically receive a placement fee from the third-party investment vehicle in connection with such an investment. In addition, XYZ Advisors will also typically receive its agreed upon advisory fees from its advisory clients with respect to the investment. The payment of the placement fee to XYZ’s affiliate creates an incentive for XYZ Advisors to recommend third-party investment vehicles for which its affiliate acts as placement agent to its clients instead of other investment opportunities. To mitigate this conflict, XYZ Advisors discloses when its affiliate is acting as placement agent, performs due diligence on such offerings, and evaluates the suitability of prospective investors for such third-party investment vehicles.