Both TD Ameritrade (NYSE:AMTD) and Charles Schwab (NYSE:SCHW) are mostly known for their retail brokerage operations. However, these two firms also have significant institutional divisions, which provide brokerage and custody services to registered independent advisors (RIAs).
To get a feeling of the size of these divisions, consider that the institutional division of Charles Schwab had around $895 billion in client assets at the end of Q1 2013, which is nearly 43% of the total client assets held at the company.  TD Ameritrade does not provide a frequent business-wise breakup, but it seems that its institutional assets crossed the $200 billion mark at the beginning of this year  while its total client assets surpassed $500 billion in Q1 2013.  That means the proportion of institutional assets for Ameritrade is also close to 40%.
In this article, we discuss the basics of the institutional businesses of the two firms and understand how they attract advisors and assets from large brokerage firms like Morgan Stanley and Merrill Lynch.
Where Do The Assets Come From?
The institutional divisions of Schwab and Ameritrade have been growing rapidly since the Great Recession and have contributed significantly to their respective companies’ asset gathering figures by primarily attracting as clients the financial advisors from firms like Morgan Stanley, Bank of America-Merrill Lynch, Wells Fargo and UBS Americas.
These four firms own some of the largest full-service brokerages in the U.S. and are often referred to as “wirehouses”. Collectively, these four brokerages control around 40% of all the client assets in the U.S. wealth management market and employ around 46,000 financial advisors for managing those assets. 
The financial advisors at these large brokerages maintain a close relationship with affluent clients and work with them to develop their financial plans. The clients usually become loyal to their advisors due to the high level of personal interaction involved in the process of financial planning, and are likely to eventually follow the advisor if he/she switches firms. The process is legal if the advisor follows a set of rules called the breakaway protocol.
Due to this reason these advisors are in great demand and are often recruited by competitors. Some advisors also look to open their own wealth management firms by going independent.
Why Do Wirehouse Financial Advisors Go Independent?
While there could be multiples reasons for a financial advisor to seek independence, we can broadly categorize them into three categories:
The lure of independence: Starting one’s own wealth management firm turns a financial advisor into a business owner. Not only does it provide flexibility in the way they handle business operations, but it also gives him or her an option of selling the business for a premium whenever they wish to retire. As an employee at the wirehouse they would not get these benefits.
The charm of independence is especially strong because most good advisors who go independent are actually able to retain most of their clients. This reduces the business risk in the transition and allows an advisor to own a business without having to build a client base from scratch again. (Related article: Schwab: Most Clients Follow Advisors Who Go Independent)
Frustration at wirehouses: Another major reason that drives advisors to independence is their low level of satisfaction when working at wirehouses. According to J.D. Power & Associates, the average satisfaction level of employee advisors (695 points out of 1,000) remains much lower than those in the independent channel (794 points out of 1,000).  The most prominent reasons for frustration at these companies are:
- Integration Issues: Following the financial crisis, we have seen a consolidation among the largest wirehouses as Merrill Lynch became Bank of America-Merrill Lynch, Smith Barney became Morgan Stanley Wealth Management, and Wachovia became Wells Fargo Advisors. However, the acquisitions created multiple cultural and integration issues, which has caused many advisors to leave these companies. Specifically, Morgan Stanley is still in the process of taking complete ownership of Smith Barney and was struggling to integrate the technology systems until last year. You can read about the integration issues at Morgan Stanley here.
- Pressure to cross-sell: After being acquired by large banks during the Great Recession, wirehouse advisors are under pressure to “cross-sell” the asset management products and mortgage loans created by their parent firms. While this generates additional profits for the firm it may not be in the best interest of an advisor’s clients. It is also unhealthy for the advisor-client relationship because the advisor can be perceived as being “pushy” by clients if they frequently try to sell products rather than providing financial advice. Hence, many financial advisors loathe this practice and look to go independent whenever such pressure increases. You can read more about this factor here.
Layoffs: Some advisors may also opt for independence once they are fired from one of the wirehouses. Such advisors usually have a book of business that is too small for the wirehouse to care about them, but large enough for surviving in the independent channel. For example, Charles Schwab accepts advisors as clients even if they have clients assets worth $10 million. Such an advisor however is likely to be considered very small at a wirehouse. According to Cerulli Associates, an average wirehouse advisor manages around $93 million in client assets. 
How Does It Benefit Schwab And Ameritrade?
The institutional divisions within the two firms serve independent advisors by providing them the necessary back office support and custody services in exchange of an asset-based custody fee (fee as a percentage of assets held in custody).
In addition to earning an asset-based custody fee, the two companies also benefit from this business indirectly because they can generate net interest revenue on the client assets brought in by the independent advisors. Similarly, they generate trading commissions whenever their independent advisor clients trade on behalf of their customers.
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- Trading Commissions Drive Ameritrade’s Earnings As Low Yields Subdue Interest Revenues
So What Does The Future Look Like?
Industry research firm Cerulli predicts that the wirehouses are likely to cede another 7% in market share by 2015.  This is likely to happen as more advisors leave these firms – either voluntarily or because the wirehouses asks them to.
In either case, the assets that move to the independent channel along with the advisors end up being at custodians like Schwab and Ameritrade. This is one of the reasons why we predict a continued growth in client assets for the two firms.Notes:
- Q1 2013 SEC Filings, Charles Schwab, April 15, 2013 [↩]
- TD’s custody business tops $200B in assets, Investment News, January 27, 2013 [↩]
- TD Ameritrade Client Assets Surpass $500 Billion, TD Ameritrade, March 11, 2013 [↩]
- Wirehouses Seen Losing 7% Market Share By 2015, Financial Advisor, October 2, 2012 [↩] [↩]
- 2013 U.S. Financial Advisor Satisfaction Study, J.D. Power & Associates, April 11, 2013 [↩]
- Wirehouse Advisors Most Receptive To Asset Management Pitches, On Wall Street, June 5, 2013 [↩]