Financial Opinion and Insights

How to Recognize Investment Service Models

IFG BlogThe average investor can often have a difficult time understanding just how different investment professionals operate and who they’re really dealing with.

There are three basic service model environments where investment professionals can be found; but, what can make these environments even more difficult to understand is that it’s possible for two to be combined… or one can be masqueraded to look like something else entirely!   When you add to all that the alphabet soup of credentials and designations – some excellent and most meaningless – it’s no wonder the average investor has trouble figuring it all out.

While it would be impossible to address everything without writing a book, here’s an admittedly cursory overview of the three environments.  All have their selling points and negatives – and none is intrinsically better than the other –  but, since I’ve worked in all three, maybe I can help shed a little light on this and make them a little easier to understand.

1.      The Captive Registered Representative

This is how many, including yours truly, began their careers; and, in fact, many never leave!  The captive RR is someone you may know as a stockbroker, although the broker-dealer is actually the employer firm and the person you’re thinking of is a Registered Representative of the broker-dealer firm.   These firms can be the well-known large ‘wire houses’ with widely-recognized names or they can be smaller regional or even local firms.  In all captives, the RR is an employee of the firm and it is the firm that must sign ‘selling agreements’ with outside product providers if the RRs are going to offer anything other than in-house product.

I began my career in such a firm that provided all the services and infrastructure.  The job of an RR was is to generate revenue for the firm.  The hierarchy looked something like this:

What you may not know:  In the old days, these large firms made most of their money from their own packaged in-house proprietary product, including mutual funds, unit investment trusts (UITs), and other offerings.  I don’t know how true that is today – my guess is it’s probably much less so than in those days.   The reason I think this is because the wirehouse industry’s margins have been declining steadily over the years, indicating fewer proprietary product sales and evidenced by (1) a greater number of mergers that never seem to end, and (2) the fact that broker payouts – the percentage they pay their RRs on generated revenues – have been declining.  Brokers throughout the industry are having a tougher time ‘keeping their desks’ as margins have put pressure on RRs to increase revenue production.  This may be a reason why some, if not all, within that community are resisting the adoption of a fiduciary standard.

As I said, some RRs never leave the large wirehouses, for a variety of reasons, including the large in-house back-office infrastructure support, etc.   And, let’s face it, some may not be cut-out for self-employment.  For those who are, they often take the next step.

2.     The Independent Registered Representative

Some RRs who don’t want to remain ‘captive’ often want to set-out on their own and open up a private practice.  When a RR makes the decision to ‘break free’, they have to pay their own bills.  In my early days, that meant getting office space, phones connected, office furniture, supplies, and paying for my own insurance and a thousand and one other things; but, I could now select my own broker-dealer (BD) to function as my back-office and process all the paperwork through the various providers, etc.   

There are hundreds of BDs available to the independent RRs and they come in all shapes and sizes with different attributes.   Since my need was primarily for back-office processing, I wanted one that had (1) prompt and quality personal service, and (2) good relationships with quality custodians and other service providers.  Today, almost all can probably fit that bill.   While the RR is not an employee of the BD, the BD must still have Selling Agreements with product providers before the RR can access them for his/her clients.

One of the things about independence that independent RRs like is that the hierarchy can be flipped, which, to my mind, creates more of a ‘client first’ environment.

What you may not know:  An independent RR may be operating out of a small office in your local community; but, don’t let that fool you.  That independent likely has access to a huge array of institutional money managers and widely respected and recognized asset custodians and other service providers.   In fact, it wouldn’t be at all surprising if your local RR office actually had a wider menu of availabilities than the major wirehouse down the street, since many BD operations have provided their RRs with greater access to the marketplace.   An independent is far more likely able to provide you with a choice of custodians, etc., than a captive whose employer itself may want to be the custodian.

Something else you may not know:   Ever walk into your local bank branch and see the investment desk sitting somewhere in the lobby or off to the side?   When you sit down at that desk, you may think you’re still in the bank; but, guess again.  There’s no FDIC insurance there!  The likely scenario:  Some BD has signed a deal with the bank to private-label a brokerage service.  Not bad; you should simply be aware.

3.  The Independent Fiduciary Model:  The “pure” fee-only Registered Investment Advisor (RIA)

Some independent RRs finally decide to complete the process:  They want to drop all sales and commissions and gain access to the entire world of products and service providers, including those who don’t work through sales channels.  In my case, since I had already been in business in my own office for fifteen years, it was a simple process to register as an advisor and simply drop all the selling licenses.  An RIA must avoid conflicts of interest and operate under a fiduciary standard:  The clients’ interests must be paramount.

The model, however, looks much like the independent RR:

What you may not know:   Captive RRs and independent RRs both very likely work for or with a BD that is dually-registered, making the RRs also RIA representatives.  This allows them to work on a fee basis, as well as on commission.  Some will tout their fiduciary status during the planning stage; but, you should ask if they will operate under that status during the investment implementation stage.  It’s one thing to “adopt a fiduciary standard’ and quite enough to accept fiduciary status in writing.  From what I’ve observed, few, if any, BDs will allow their RRs to accept this status, whether they’re captive or independent.   That doesn’t mean they aren’t honest or that they don’t do good work; it’s just something you should be aware of.

Also be aware that some RIA firms provide investment management, asset custody, and portfolio reporting services all in-house while others prefer to work in a purely advisory capacity using third-party providers for the various services. 

Example:  In my own practice, most clients’ assets receive custody services from Pershing (owned by Bank of New York-Mellon).  All institutional managers are independent of the custodian and all portfolio reporting is provided by third-party services independent of the managers.  All parties are compensated by client fees only, as are my advisory services.   While it may sound like more fees, it’s often actually less.  All these services are usually ‘bundled’ by investment providers; I just unbundle them and ‘shop’ them individually, which can result in savings.

While this overview just scratches the service, it might give you some idea of the playing field.  In the final analysis, choosing an advisor is a personal choice.  You should find someone you’re comfortable with… and someone who will talk with you like an adult.  Avoid the ‘glad handers’ who tell you what you want to hear; find one that will talk straight and tell you what you need to hear, even if you think you’re an investment genius.  

Good luck!

Jim Lorenzen, CFP®, AIF®


Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 


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