Barnett and Company

Schwab, TD Ameritrade Meet at the Altar

In the financial services industry, consolidation is the name of the game. To wit: 2 of the biggest players catering to individual investors and independent advisors have finally consummated a marriage announced a year ago. Charles Schwab Corporation has completed its acquisition of TD Ameritrade in a $22 billion deal. The merger closed on October 6, with the integration process slated to roll out over the next 18 months.

Size and scale are increasingly necessary in a business where fees are dropping and competition is fierce. But what makes this merger interesting is the dominant role it will play in the corner of the brokerage business catering to independent financial advisors. The combined entity will now control over half of all the assets managed by Registered Investment Advisors, or RIAs.

Individual investors must utilize an intermediary in order to buy or sell a stock or bond. These intermediaries or brokers execute trades on behalf of a client and collect a fee or commission as compensation. For 180 years until 1975, the commissions charged by brokers were regulated and uniform, generally at nosebleed levels. Once commissions were deregulated, a spate of so-called “discount brokers” like Charles Schwab began slashing fees, making stock investing more accessible to smaller investors.

Coinciding with the democratization of the brokerage business and discounting of fees, a new breed of investment professional began to emerge. Rather than work as agents for a brokerage firm, these independent advisors act on behalf of their clients to manage portfolios but do not execute trades and don’t work for firms that hold the clients’ stocks and bonds. RIAs act with designated authority of their clients to place trades through the clients’ brokerage firms. Registered Investment Advisors report to a different regulator than brokers (either the US SEC or state securities regulators) and are held accountable to a higher “fiduciary” standard of care.

Some of the early discount brokers like Schwab, Waterhouse Securities, Jack White & Co. and eventually TD Ameritrade saw an opportunity to create dedicated platforms catering to this growing segment of independent advisors, offering discounted custody and trading services as well as specialized technology solutions. The confluence of independent advisors and dedicated advisor-oriented custody firms has revolutionized the investment business. Today, the independent RIA model is the fastest-growing segment of the financial services industry and currently encompasses around 20,000 firms. Interestingly, as commission have fallen, most of the traditional brokerage firms are adopting fee-based alternatives that resemble the RIA model.

Much like the traditional brokerage business, the advisor custody sector has seen significant consolidation. For the most part, Charles Schwab has grown organically, but Schwab’s marriage partner TD Ameritrade is the culmination of numerous mergers and acquisitions reaching back to the late 1970s and subsuming both American and Canadian firms.

The new Schwab-TD combination will new control about $6 trillion in assets, placing it well within the top tier of all brokers. But among independent RIAs, the firm holds about $2.5 trillion or 51% of the market, far ahead of its nearest competitors, Fidelity and Pershing. The rest of the industry is highly fragmented and appears ripe for further consolidation as well.

In addition to being the biggest RIA custodian, Schwab also owns one of the largest banks in the US measured by deposits, revenues from which allowed the firm to eliminate trade commissions entirely last year. TD Ameritrade reluctantly followed suit but depended much more heavily on commissions and was ultimately forced into the arms of its frenemy Schwab.

While significant uncertainties remain regarding the integration, RIA clients should benefit in the long run. Some TD Ameritrade applications were widely regarded as superior to Schwab’s, and advisors are hoping the best of the two will survive. On the downside, most current TD clients will likely be required to complete new account paperwork as the platforms are merged over the coming months.

As in any industry, consolidation has its plusses and minuses. But the trend toward lower fees and expenses is immutable and can only be accommodated by seeking economies of scale. In the end, the clients are likely to benefit from the combination.

Christopher A. Hopkins, CFA

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