More than half of all independent financial advisors say they would cut ties with their affiliated brokerages if the only other alternative under a proposed federal rule is to become a direct employee.
So suggests a
The DOL's proposal, scheduled for approval on May 6, is meant to ensure that people who, in fact, should be classified as direct employees are not being improperly deemed independent contractors. It's driven primarily by a concern that workers at "gig economy" companies like Uber and Lyft are being deprived of federally mandated minimum wages and overtime pay.
But as groups like the Financial Services Institute warn, it also threatens to disrupt the business models of the more than 300,000 financial advisors. Many of these people are hybrid advisor-brokers who work as independent contractors of large firms like LPL Financial, Raymond James and Cetera Financial Group.
The Financial Services Institute had Oxford Economics, an advisory firm originally affiliated with Oxford University, survey 614 financial advisors and 14 independent financial service firms between Dec. 7 and Dec. 20. The main question: "If DOL enacts the rule and affiliated financial advisors are required to become employees of their broker-dealer or investment adviser firm, what is your likely response to the change in employment status?"
Of the respondents, 58% said they would hang up the brokerage side of their businesses and start their own RIA or join an existing RIA. Only 11% said they would become a direct employer of a large brokerage.
At a time when advisors are
The Financial Services Institute was among roughly
Damian Lo Basso, the managing partner and chief financial officer of the RIA Journey Strategic Wealth, said the DOL's proposed rule seems to overlook the freedom that people in many industries like financial services already have to work as direct employees if they choose. Every advisor on his staff, he said, has filled out a W2, the IRS document required for all direct employees. So it's not as if advisors who want to work as direct employees are stuck being independent contractors, Lo Basso said.
"Unlike in ride-sharing, where you often don't have a choice, in this space you do have options," he said. "They may not be perfect, but there are alternatives. Most individuals who want to work as direct employees would be able to make that happen."
The Financial Services Institute study notes that many independent advisors started their careers as direct employees of large firms and later went independent because they wanted to. Those who do choose to work as independent contractors, the survey results suggest, do so because they see advantages. Asked why they liked working as independents, 39% cited their ability to own their own firms, 34% their ability to work clients better, 14% their ability to set their own hours and 5% their ability to choose their clients.
Lo Basso predicted the DOL proposal could disrupt the industry in several ways. On the employer's side, it would mean the need to withhold Social Security and Medicare payroll for every direct employee. Those costs would most likely be passed on to clients. On the advisor side, the DOL proposal could give rise to ownership concerns over books of business.
To many independent advisors, one of their most prized possessions are these lists of existing clients, which often take years to build. Under the independent model, advisors are allowed to take these books of business with them should they leave an affiliated broker-dealer.
Lo Basso said he and his colleagues have taken steps to smooth out this possible point of contention with their firm's direct employees by making them the contractual owners of their books of business. But for advisors who are now without that protection, the DOL rule could cause some unwanted anxieties.
"I understand where the administration is coming from in their attempts to protect workers," Lo Basso said. "But the issue that's clearly arising is that they are taking too broad a stroke and not thinking critically about this on an industry-by-industry basis."
In another eye-popping result, the Financial Services Institute's study found that 19% of independent advisors — nearly 1 in 5 — would prefer to retire than be forced to become direct employees. David Bellaire, the executive vice president and general counsel of the Financial Services Institute, acknowledged the surveyors did not ask how many of the advisors who said they'd retire before becoming direct employees were considering retirement anyway.
Retirements are already common in the industry.
"It's no secret that the population of independent financial advisors is aging," Bellaire said. "But whether this is through accelerating people's decision to retire or otherwise forcing them to take a different career path, we think the end result is the same."
The Financial Services Institute's report further warns the DOL's proposal could give advisors additional incentives to work only with the wealthy. Many of the institute's clients are hybrid broker-dealers and advisors. That means they can make money as brokers by charging commissions for, say, individual stock sales and as advisors by charging fees that are set at a percentage of the total amount of money they have under management.
Bellaire said commissions tend to work well with clients with relatively few assets and a corresponding need for relatively few transactions. Fees work better for clients with large amounts of money that need to be managed throughout the year.
If more advisors give up the brokerage side of the business and become RIAs, they'll have an incentive to seek out only clients who have the largest sums to invest. Many advisors might also consider increasing both their fees and the minimum amounts they'd require clients to hold in accounts they manage.
And advisors who had to start working under the umbrella of a large broker-dealer might be deterred by in-house policies from pursuing anything but standard investments.
Of the possible unintended consequences of the DOL's proposal, roughly 78% of the survey respondents cited higher account minimums, 77% higher fees, 64% reductions in service, 59% losses of customers and 47% reduced investment options.
"Through overall attrition, the number of smaller accounts served will decrease, disproportionately hurting those with lower wealth levels, including younger, minority households and those in rural areas," according to the study.
The DOL's proposed rule would replace a Trump administration standard that many critics contend makes it too easy to have people who should be treated as direct employees instead classified as independent contractors. The Trump rule places great weight on two considerations: how much control workers exercise over their work and how much they stand to profit or lose from their own activities and decisions.
The DOL proposal instead would rely on a "totality of the circumstances" and look to factors such as the amount of skill required for a certain type of work, the permanence of a given working relationship and whether whatever work is being performed is just one part of providing a particular product or service.
Groups like the Financial Services Institute say they like the current standard because it allows for little ambiguity over who can be classified as an independent contractor. Bellaire said it's now clear, for instance, that a company is not acting like a direct employer simply because it tells its independent contractors they're expected to abide by the law. The new rule would erase that bright line.
Bellaire said another result is that advisors would have to spend more to make sure they are staying compliant. Of the respondents to the Financial Service Institute's survey, 24% said they'd probably have to retain outside legal counsel should the DOL rule be adopted. Among the financial services firms surveyed, nearly half said they'd need outside counsel. The average projected cost of those services was $20,000 for advisors and $100,000 for firms.
Advisors who choose to start their own RIAs would also be faced with substantial costs. Respondents to the survey pegged the average cost of starting an RIA at $200,000. Other projected expenses included costs associated with bringing former independent contractors on as direct employees ($11,000) and costs for keeping records on direct employees' wages and hours worked ($300,000).
One of the Financial Service Institute's fellow critics — the National Association of Insurance and Financial Advisors — contends one of the biggest flaws is that it's so ambiguous that no one can really know for sure what the effects will be.
"I don't think we can truly understand the impact until after it's instituted," said Mike Hedge, NAIFA director of government relations. "The actual examples of how people are driving out of business — I don't know that answer because I don't think the DOL does."
