Late last week, the SEC announced its Examination Priorities for 2013, which provides some guidance on what the SEC views as the greatest issues for concern and focus, especially amongst its Investment Adviser-Investment Company (IA-IC) program that is responsible for examining nearly 11,000 Registered Investment Advisers (RIAs) along with 800 Registered Investment Companies (RICs, e.g., mutual funds). In addition to a usual array of focus areas, from monitoring the safety of assets, conflicts of interest, and marketing (especially regarding performance marketing), this year's announcement was notable in one other regard: the SEC specifically cited dually registered IA/BD advisors (i.e., "hybrid" advisors) as a new and emerging risk area, especially regarding how advisors make a determination of whether to direct a particular client to the brokerage account versus an investment advisory account.

Notably, the SEC cited a particular concern for not just dual-registered advisors, but those who have a broker-dealer relationship and an outside unaffiliated RIA of their own, which means the broker-dealer's compliance and oversight processes will not extend to reviewing the RIA's business activities. In point of fact, that's precisely why many firms choose to keep an outside RIA - to avoid the scope, and especially the cost and hassles, of the broker-dealer's compliance department. Yet the SEC suggests that the lack of oversight may be concerning, noting for this hybrid-BD-with-outside-RIA model in particular:

This business model presents multiple conflicts. Among other things, the staff will review how financial professionals and firms satisfy their suitability obligations when determining whether to recommend brokerage or advisory accounts, the financial incentives for making such recommendations, and whether all conflicts of interest are fully and accurately disclosed. In addition, the staff will review dually registered firms’ policies and procedures to understand if such policies and procedures provide guidelines for when a financial professional makes a securities recommendation to a customer with a broker-dealer account versus an investment adviser account.

- New and Emerging Issues, SEC Examination Priorities For 2013

As the SEC notes, there is concern regarding the different financial incentives involved for typical BD-based vs RIA-based accounts, given the types of investments that are typically implemented. For instance, an advisor might implement mutual funds in an A-share fund with the broker-dealer, versus an ongoing AUM fee with the RIA - how does the advisor determine which clients get which recommendation, given the material difference in compensation? Similarly, the conflict might even be present when comparing the client cost and advisor remuneration involved with a broker-dealer's fee-based wrap account versus the RIA's AUM fee, or even a mutual fund C share versus the RIA's ongoing compensation. Additional conflicts may be involved if the BD requires a certain minimum amount of business to maintain a contract - an additional incentive to steer clients in one direction or another for the benefit of the advisor, rather than the client - and notably the SEC separately expressed a rising examination focus on conflicts of interest related to "shelf space" and other compensation arrangements that could be an indirect further conflict for hybrid advisors.

Of course, the reality is that many of these conflicts are not really unique to dually registered BD/RIA advisors. In point of fact, advisors working for a broker-dealer have long faced potential conflicts of interest regarding the decision to recommend a client towards A shares versus C shares, or to recommend loaded mutual funds versus fee-based wrap accounts with lower-cost alternatives. The only distinction in this context seems to be the outside RIA structure in particular, where there's not necessarily any comprehensive compliance process that looks at both sides of the business at once (at least with a hybrid advisor working under the BD's corporate RIA, the organization can oversee all activities of the hybrid advisor), which may be especially concerning given both the potential conflicts of interest between the two sides of the business, and also the fact that they're held to different regulatory standards.

And notably, the SEC's rising scrutiny on hybrid advisors is coming at a time where the ranks of hybrid advisors themselves are growing rapidly - in fact, according to Cerulli's recent data, hybrid advisors experienced an even greater growth rate (of assets) than RIAs in 2012, and while in the past many advisors became hybrids simply as a waypoint towards full RIA status, some are now being encouraged to view the hybrid advisor approach as an endpoint, where the wider array of available investment adviser and broker-dealer offerings makes it easier to serve a wider range of clients profitably. Given the rise of hybrids, though, it's likely no coincidence that the SEC's exam focus is shifting here; if this is becoming a priority, it's likely because the SEC has discovered some abuses are already happening.

Nonetheless, in my experience most advisors are not adopting hybrid models in some kind of greedy attempt to maximize revenue in every situation by steering clients to whichever side will net them the biggest conflicted paycheck. Instead, the primary purpose for the otherwise-independent RIA to maintain a BD relationship seems to be: 1) keeping access to certain products that simply aren't available for independent RIAs (e.g., most variable universal life insurance and many variable annuities); 2) having a way to do commissioned business with clients whose accounts are simply too small to meet the RIA's minimums (and who would likely end out doing business with another commission-based broker anyway). In other words, the purpose of the dual-registered broker advisor with an outside RIA is really more like a dual-registered RIA with an outside BD relationship, where the latter is simply there to provide for a few select needs that the RIA simply can't manage on its own.

Ultimately, I suspect that the issues the SEC is raising here are still occurring amongst a small minority, albeit one numerous enough to merit further SEC exam attention. But the potential for greater exam scrutiny may be a shot across the bow for hybrid advisors to at least establish clearer policies and protocols about which clients end out in which types of accounts and why - after all, we're not talking about outright illegal activity here, but simply the potential for improper recommendations due to the conflicts of interest that are present. And if this new initiative gains momentum, expect to see a lot of broker-dealers place a renewed emphasis and insistence that they must be allowed to oversee outside RIA activity - with all the attendant costs as the broker-dealer takes a slice of the RIA pie. This in turn may put a lot of pressure on some firms who truly view their RIA business as primary and their BD relationship as secondary to question whether it's still really worthwhile to maintain that outside BD relationship, especially if it's only to offer a narrow range of products unavailable in the independent RIA environment or to have a way to be compensated for working with clients below the RIA's minimum anyway.

In the meantime, though, the bottom line seems clear: if you're working with clients across multiple regulatory lines and subject to different regulatory standards, you'd better have a clear justification for why each client ends out with the recommendations they do.


  • Bill Winterberg

    It’s hard for me to imagine that there is a definitive way regulators can measure and evaluate the conflicts inherent in dually registered environments.

    I see this reducing to a subjective opinion based largely on the SEC examiner’s willingness to aggressively investigate the details of where the money flows. Are load funds favored under the broker-dealer model? Or are flows directed into the RIA’s advisory accounts and charged an annual fee? A blend of both?

    An easy thing dually-registered advisers can do is not only document how client funds are allocated and invested, but document *why* funds are allocated the way they are.

    It’s like adding comments to programming code. Code is the how, comments are the why.

  • Stephen Winks


    This view of the SEC argues for a well documented, expert authenticated prudent investment process with an audit path to objective, non-negotiable fiduciary criteria of statute, case law and regulatoty opinion letters, that would alleviate any fears of violation of fiduciary duty.


  • Tanya Carson

    Great reading. Thanks for putting this up.

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  • Derek

    I know this is somewhat of an older article now, but I came here after reading the recent InvestmentNews editorial on the same topic.

    I’m very supportive of the RIA-only business model, but it seems strange to me that the focus is only on hybrid advisors here. Why should hybrid advisors be scrutinized for directing business towards an RIA (while maintaining a BD relationship for a narrow set of situations), if RIA-only advisors aren’t being scrutinized for directing 100% of their business towards an RIA model? The RIA-only advisor seems to have an even greater incentive to recommend an inappropriate RIA solution when it might not be the best for the client.

    • Michael Kitces

      The issue is the other direction. The regulators are concerned about what circumstances an advisor decides to direct business away from the RIA. For instance, when does an RIA “decide” it would be better to get paid upfront in an A-share mutual fund via the B/D instead?

      • Derek

        I can see that concern, but it also seems like abuse could happen in either direction. For a buy-and-hold client who isn’t seeking ongoing planning and has over $1 million in assets, A-shares may make more sense, but an advisor may have a large financial incentive to seek a 1% annual AUM fee versus a 1% front-end load and a 0.25% trail. Whereas the hybrid advisor would at least have some incentive to recommend the A-shares if the circumstances warranted doing so (i.e. they could still be paid, though it would be less than through the RIA), the RIA-only advisor would have no incentive to do so.

        • Michael Kitces


          Placing clients in an “unnecessary” advisory account is also a concern from the SEC. See for some of their recent focus on “reverse churning”.

          That being said, there is somewhat less concern about brokerage clients being “steered” towards advisory accounts since it wouldn’t be a violation of brokerage suitability. There is more concern about steering advisory accounts towards brokerage because that could/would be a violation of RIA fiduciary obligations.
          – Michael

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