Three Hidden Broker-Dealer Profit Centers Exposed

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Independent channel broker-dealer recruiter Jon Henschen writes about three areas where broker dealers could be more transparent with their reps.

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Jon Henschen

The shell game needs to end with a new era of broker-dealer transparency.

In his recent article “Three Hidden Broker-Dealer Profit Centers Exposed,” published in the March 2015 issue of Investment Advisor, broker dealer recruiter Jon Henschen of Henschen & Associates notes that as the financial services industry pushes for greater transparency, one area that remains largely opaque is broker-dealer profit centers.

Henschen states that while there's nothing wrong with broker-dealers being profitable, it is how those profits are obtained that could use a good dose of disclosure. He continues by noting that representatives deserve to know that what they are paying is a true cost and what they are receiving is the best possible commission from a vendor.

Henschen’s article starts by looking at the profit centers that are relatively obvious to reps, such as the spreads broker-dealers receive from payout grids, and two other primary sources of broker-dealer profit: revenue sharing and markup. He notes that while representatives recognize markup charges on clearing firm costs as a profit center, it may not be apparent how much the markups are, or how extensively the costs incorporate overall costs.

After accounting for revenue sharing and markups, Henschen digs in to the three profit centers that remain well hidden, with reps unaware that they are paying additional costs or missing out on additional commissions.

The first area discussed is third-party money manager markups. Frequently, reps are unaware that they may be paying management fees that are 10 to 15 bps higher than what the fund manager actually charges. Even broker-dealers’ own recruiters often are clueless that their firm marks up the manager's fee.

According to Henschen’s research, about one-third to one-half of independent broker-dealers are imposing markups on third-party managers. Small and midsized broker-dealers tend to do little if any markup, while larger broker-dealers will charge as high as 25 bps.

The second hidden profit center is variable universal life insurance (VUL). Henschen notes a shift away from VUL to universal life since 2009, but adds that there are still representatives who do substantial amounts of VUL. For these reps, it's all about receiving not only target premiums, but also additional backdoor allowances that can raise their commission on premium from a target of 80% to 90% or more. Often, BDs may have negotiated backdoor allowances with product vendors, but they pocket the added premium and only pay the base target premium to the representative.

The third hidden profit center, according to Henschen, is fixed index annuities (FIA). Since the legal battle between Investors Capital and the state of Massachusetts (which held the broker-dealer liable for the FIA product their reps sold over a multiple-year period with a $1 million fine imposed in 2006), broker-dealers quickly started to require their reps to run their FIA product through one of the insurance marketing organizations (IMO) that they networked with in order to supervise FIA business and avoid a similar legal quagmire.

Henschen also identifies the trend toward broker-dealers requiring index universal life to be run through the broker-dealer because the product has the word “index” in it. If your broker-dealer has such a policy, consider verifying whether you are getting additional backdoor allowances.

Henschen concludes his analysis by noting that if a broker-dealer has a strong value-added proposition, reps don't mind sacrificing a portion of commissions or paying markups on third-party managers. However, he calls for increased transparency so that reps are aware of these added costs or pocketed commissions so that they can make an informed decision that will best serve themselves and their clients.

Jon Henschen is President of Henschen & Associates, an independent broker dealer recruiting firm located in Marine on St. Croix, Minnesota. With more than 20 years of industry experience, Jon is a staunch advocate for independent financial advisors, and is widely sought after by both reps and broker dealers for his expertise and advice on independent broker dealer topics.

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