Drama in LPL's house: What big OSJ besides Merit is leaving?

The unexpected announcement that two branches with a combined $20 billion in client assets would be leaving LPL Financial turned the company's earnings call last month into something out of a reality TV show.

Which offices of supervisory jurisdiction will be gone? LPL didn't reveal their identities at the time. A few days later, Merit Financial Advisors emerged as one of them. For now, though, LPL has the industry on a cliffhanger waiting to find out the second departing branch. 

Hundreds of hybrid registered investment advisory firms that act as OSJs — which manage compliance and other services as a third party, working with both LPL and networks of independent financial advisors — maintain complex, highly secretive and, sometimes, dramatic relationships with the corporate office. The disclosure of the rare loss of a big branch formed a notable contrast for a firm whose industry-leading financial advisor headcount reaches record levels every quarter thanks to recruiting and M&A wins. It's no wonder that the surprising twist caused the industry to grab the popcorn and settle in on the couch, awaiting any juicy details.

Many unknowns remain. The looming questions include the timelines for the departures, the extent of disclosure by any of the parties involved, the exact policy change relating to M&A deals that created the rifts with the large branches, and the degree to which LPL will seek to retain as many advisors and client assets as possible out of the departing OSJs. 

The answers to those questions will decide whether CEO Dan Arnold and other executives who have led LPL on its remarkable growth trajectory in recent years are correct in predicting that the two exits are isolated exceptions that won't lead to more future ex-LPL branches walking out the door. That uncertainty — combined with the poor performance of the company's stock this year — has altered the normally upbeat tone ahead of the firm's annual Focus conference next week.

Carolyn Armitage

"LPL doesn't lose very often," said Carolyn Armitage Consulting founder Carolyn Armitage, a former financial advisor and longtime industry executive who once led a team at LPL managing the firm's push-pull alliances with large OSJs and other big enterprises. "They've done a lot of things right. I do feel they will get over this hiccup. They will be successful. I think Merit's going to be successful."

READ MORE: $12B hybrid RIA firm Merit to leave LPL in biggest exit of past 5 years

The crux of the matter

Over the years, the growth of OSJs that can evolve into major players in their own right and tweaks to LPL policies affecting such expansion have led to some — albeit very few — high-profile flights from the firm's brokerage and custodian services by branches managing billions of dollars: Carson Group, Independent Financial Partners and Level Four Group. The differences simply come "down to the margin compression," because, "as these offices get larger, the margins get smaller" for LPL, Armitage explained. The company has said as much.

It has needed to explain its decisions to analysts closely watching the firm's stock, which has soared in value by 155% in the past five years as a whole but slumped by 14% so far this year. Most analysts have fixated, as they typically do, on the earnings impact of potential interest rate cuts by the Fed to cash sweep accounts at LPL. It and other giants of the industry are facing lawsuits filed by investors who argue low yields put the firms' interests above their customers.  

After Arnold disclosed the departures on the July 25 earnings call, an analyst asked "what the OSJ economics generally look like on an EBIT ROA basis relative to the firm-wide average." 

Chief Financial Officer Matthew Audette answered candidly with a level of negativity toward the outgoing OSJs that could raise eyebrows in an industry known for keeping as many competitive numbers private as possible and painting happy public faces at all times.

"When you look at our overall gross profit [return on assets] for the firm, it's in the low 30s [in basis points]," Audette said. "For the firms that we're talking about, this $20 billion, it's around two-thirds of that. So, think in the low 20s. So returns are lower. And then, from [an] organic growth standpoint, these folks weren't growing. They were actually a drag or reduction on organic growth. So I think lower-returning, lower-growing would be the headline on those firms."

LPL Financial

Merit hasn't responded directly to this jab connecting the Alpharetta, Georgia-based firm with $12 billion in client assets to an often overlooked reality across wealth management: that the industry is primarily growing through M&A and market appreciation, rather than adding more new clients or attracting more assets through existing accounts. 

Representatives for Merit noted that the company decided to transition away from LPL's brokerage and custodian — pushing back against any implication that LPL terminated Merit — but said that neither CEO Rick Kent, President Kay Lynn Mayhue or anyone else from Merit was available for an interview. The hybrid RIA's latest Form ADV brochure filing with the Securities and Exchange Commission lists custodial relationships with Charles Schwab and Fidelity Investments, but the firm's representatives declined to say what brokerage or custodians the firm will use after it leaves LPL.

Instead, Merit sent the prepared statements it shared when the company confirmed its impending departure, in which Kent said that the move "will better position us to offer innovative solutions that meet the evolving needs of our clients and ensure our continued growth and success for generations to come," and Mayhue said the company's staff is "committed to ensure that this transition will be seamless."

Representatives for LPL didn't provide any evidence supporting Audette's claim on the earnings call beyond email statements from spokesperson Kristin Petrick noting that the company defines organic growth "based on net new assets to our platform driven by recruitment of new advisors, growth of existing advisors and departure of advisors" and routinely discusses the metric "with each of our large enterprise partners to ensure we are aligned on a common goal of shared growth." 

The parting of ways began before LPL's adjustments to the rules of its contracts with OSJs earlier this year, Petrick noted.

"As Merit's business model has evolved in the last couple of years, it became increasingly clear that our interests were strategically misaligned," she said. "Despite extensive efforts to re-align our interests, we were unable to do so and ultimately agreed to separate. LPL and Merit have enjoyed a mutually beneficial relationship for many years, and LPL values the meaningful role we've played in Merit's impressive growth. We remain committed to ensuring a smooth transition for Merit advisors and their clients."

READ MORE: IBD Elite 2023: What the heck is an OSJ?

Who's the mystery OSJ?

As for the identity of the other departing OSJ, neither LPL nor any other firms are providing any hints. 

The largest hybrid RIA-OSJ firm that uses LPL's brokerage, Minneapolis-based Wealth Enhancement Group, with its 115 offices nationwide and $85.7 billion in client assets at last count, fits the profile of a quickly expanding, private equity-backed firm that makes frequent M&A deals. Representatives for Wealth Enhancement declined to answer when asked if the firm plans to leave LPL over the adjustments to the OSJ agreement.

"We enjoy a strong relationship with Wealth Enhancement Group, and they remain a valued client," Petrick, LPL's spokesperson, said.

The Wealth Consulting Group

Representatives for three other prominent hybrid RIA-OSJ firms — Private Advisor Group, Mariner Advisor Network and Integrated Partners — confirmed that they will keep their ties to LPL. A fourth, Las Vegas-based The Wealth Consulting Group, will be staying as well, CEO Jimmy Lee said in an email.

"Based on the collective feedback from large enterprises they did change many things that were issues that we didn't like in the original communication," Lee said. "I think the leadership at LPL is doing what they believe are the right things for their stakeholders. I know Dan Arnold personally and I believe that he is a man of good character and is trying to balance all of the needs of their clients and shareholders."

However, Lee noted that he has told "some of the leadership at LPL" that outside investors into the OSJs can serve as a method to drive earnings "without having to be 100% responsible for helping to fund their advisors' growth and succession." That can aid each side's bottom line amid the industry's ongoing succession challenges with upcoming advisor retirements, he said.     

"Valuations have gone up, and this is good for our industry," Lee said. "But, I think many transactions may fail if they are not supported with institutional capital. So, private equity and broker-dealers should be looking at each other as potential partners and not adversaries."

Other firms besides LPL have seen large enterprises leave as well. Over the past two years, Raymond James has seen Steward Partners and Tampa, Florida-based Concurrent Advisors leave its brokerage.

"Typically speaking, these changes are driven by a divergence of incentives and friction in pursuing new business opportunities," Concurrent CEO Nate Lenz said in an email interview. "Major platforms don't want to be held hostage by their OSJs from a pricing standpoint and OSJs don't want to be restricted in growth by their platform (whether that be in recruiting/M&A, technology spending, or in the opportunity to forge strategic partnerships). Furthermore, it's often difficult (but not impossible) to bring on outside capital while operating on a major platform, which at our scale became necessary to continue to execute our business plan."

READ MORE: How we built an RIA in 60 days — and convinced our teams to join it

The next steps to watch

In LPL's case, there is still some public murkiness about the specific terms of the OSJ agreements that preceded the departures. 

The new policies enacted this year do not "limit an advisor's ability to sell their business to a buyer of their choice or require LPL business approval for a transaction, outside of any regulatory obligations we have," Petrick said. And "no policies have changed regarding advisor M&A," she noted. 

As for the "misalignment" with Merit and the as-yet unidentified second departing OSJ, she said it "was not necessarily due to policy changes, but stemmed from strategic differences that have developed over time." Little else has shifted for the OSJs, Petrick added.

"It's important to clarify that there have been no changes that require OSJs to obtain LPL's approval before purchasing an advisory practice or team," she said. "The recent policy adjustments mentioned during the earnings call specifically relate to how enterprises can access LPL's recruiting capital to support their growth. We do not require approval or limit an advisor's ability to sell their business, including to an OSJ. However, for certain advisors on our corporate RIA or broker-dealer, there may be regulatory obligations." On the earnings call, Arnold had said there is "very little probability" that more OSJs will leave LPL over time because of "the alignment and the structure we've put around the program." He also called out M&A in particular as a key area of concern for LPL with its OSJs.

"We see in some cases where an OSJ may buy up their advisors' practices, turn them into more of an employee-based construct, and ultimately, because of that alignment, that approach, it's more of a captive type of model at that point, which again, is very different from the principles of independence and providing the flexibility for those advisors to move those assets where they want to or go where they want to," Arnold said. "As soon as they begin to lose the principles of independence within the model, we have a hard time with that sitting within our platform and within our ecosystem. So, that's an example of something that I think we were just trying to make sure we had alignment on and teased out, such that as we go forward, that foundational principle is in place across our collective ecosystem."

The mix of smaller practices that use corporate supervision rather than being part of an OSJ and large enterprises at LPL makes for "a delicate balance" between the firm and its big independent branches, Armitage noted. If the past is any indication, the exits of the two OSJs could start a recruiting struggle, she said. LPL has "the manpower to do so quickly as well as the means," while the OSJs will seek to fend off any outside suitors to retain advisors through the transition, and outside competitors are likely to try to pounce, too, according to Armitage.

"Sometimes those super OSJs get to a point that the flexibility isn't there that they need, and so, strategically, they feel they have to move on in order to continue to grow," she said. LPL has "been aggressive to retain other advisors when groups have left, and it would be prudent for them to do so as well. That normally is taken into account in a strategic move like this on both sides."