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Succession Planning Strategies

A sound plan will ensure continuity for your practice.

By Richard Ford

As a growing number of independent commission and fee-based financial professionals contemplate retirement—or their mortality—they’re increasingly signing contracts with broker-dealers to sell the rights to their lucrative trail and advisory fee commissions and even bequeath them to spouses and children. As financial professionals age, it’s becoming more apparent that they are moving into the asset-preservation business because there is value in recurring residual revenue.

Business-succession planning forces a financial professional to consider several unpleasant facts: his or her own death or disability and the fact that a practice that produces a good income may not have substantial value. Succession planning for people in the financial services industry is further complicated by the regulatory environment and the third parties involved. These include custodians, insurance companies and broker-dealers.

At stake is control of billions of dollars in annual payouts-some $6.8 billion in mutual fund 12(b) 1 fees alone last year, according to Lipper, Inc. The best way to address this issue is to ask and answer some of the most common questions. Here are a few examples:

What happens to my securities clients upon my death, disability or retirement?

Most broker-dealers will assign them to regional directors/ offices of supervisory jurisdiction (OSJs) to handle on a case-by-case basis. Most broker-dealers have a direct obligation to take care of the client upon the death of one of their representatives to safeguard the client’s mutual funds and securities. The National Association of Securities Dealers (NASD), through Rule IM-2420-2 (Continuing Commissions Policy), offers an exception to paying 12(b) 1 advisory fees or other transaction-based compensation to a nonregistered entity. Commissions can be paid to an advisor’s widow or beneficiary as long as a bona fide contract exists while the representative is registered. In particular, the rule recognizes the validity of contracts that vest in the associated person and his heir’s right to receive continuing compensation upon retirement and to designate such payments to the associated person’s surviving spouse or other beneficiary designations.

Retired financial advisors who are no longer registered (or their unregistered widows or other beneficiaries) can continue to receive what are meant to be “service fees” under the NASD rule, so long as the advisor specifies the details in a contract while he is still registered and active. In no event can a nonregistered representative receive compensation on new sales activity. This rule has existed for years but is more important now as financial professionals transition from commission- to fee-based practices.

Does your broker-dealer offer any help in dealing with the issue of succession-planning options? If so, what are the requirements?

It is no surprise that many broker-dealers use former representative or advisor accounts to recruit new representatives or reward star producers. Other broker-dealers will assign them as house accounts, leaving the heir with no remaining split on ongoing advisory or trail commissions. Few broker-dealers offer any assistance with the issue of succession-planning options or requirements. It appears that most independent and full-service firms and discount brokerage houses do little to help advisors retain the value of their practice and what they have worked hard to create. Most of the big wirehouse brokerage firms decline to comment on the subject of business succession.

With a commission-based practice, there is little long-term value for the representative. With a fee-based business practice, you align your interests with those of your client and create more long-term value. Financial professionals now find themselves with the residual income that creates value with their books of business, whether they are sold or passed on to new servicing representatives.

Do you have a buy/sell agreement in place with your broker-dealer? What is your business worth?

A $100 million agency book of business might gross $1million each year at 1 percent. Subtract $150,000 for replacing the owner with a paid employee and another $200,000 for overhead expenses and you are looking at an operating income of $650,000. Taxes after deductions might run $250,000, so you have a net of $400,000. This means the agency practice is worth approximately $2 million to $3 million. But this may not be the case if your clients and their assets get absorbed by your broker-dealer. The best way to prevent this depends on how you do business. Independent advisors affiliated with a broker-dealer face somewhat different issues. Probably two of the nation’s leading authorities on practice valuation are Mark Tibergier, CFP, in Seattle, and Donald L. (Larry) Morrison, CBA, CMA, CLU, ChFC, in Portland, Ore.

What are the differences among independent advisors affiliated with a broker-dealer, someone who has given up his securities licenses in favor of operating his own RIA, and representatives who do business under an RIA owned by their broker-dealer?

Under the Investment Advisers [sic] Act of 1940, an advisory contract with a client cannot be reassigned without the client’s consent, but client agreements don’t have to be re-executed. Custodians like Schwab or Jack White will worry about their liability if they learn of an advisor’s death and don’t inform his clients, unless a buy-sell agreement is in place. If you are a
registered representative working through an RIA owned by your broker-dealer, you can work out a cross purchase agreement as long as the representative is associated with the broker-dealer. No consent is needed from clients to move the accounts to another servicing representative as long as the RIA remains unchanged. The Securities and Exchange Commission (SEC) requires that change be disclosed to clients.

Grooming your successor
In the coming years, many financial professionals will think of retiring or selling their practices. The best way to find someone who can take over your practice when you retire, die or become disabled is to groom your own successor. When you retire or if you die prematurely, a trusted partner can pay you or your beneficiaries on an earn-out basis, ensuring continuity for your clients and providing value for your loved ones.

All of us will die—and many will become disabled before planning an orderly departure from our practice. Each financial advisor owes it to his clients, his employees and his family to make adequate succession plans. Why wait until you’re three cars behind the flowers?

(This article is intended to provide general information only. Please seek the advice of professional legal and tax advisors for details regarding your particular circumstances.)

Richard Ford is senior vice president of business development for PlanMember Securities Corporation. He can be reached at 800-874-6910, ext. 2400, or by email at richardf@planmember.com. PlanMember Securities Corporation is a registered broker-dealer, investment advisor and member NASD/SIPC.

    


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