LPL Financial Holdings Inc (LPLA) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the LPL Financial Holdings third quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions). As a reminder, this conference call is being recorded.

I would now introduce your host for today's conference, Trap Kloman, Head of Investor Relations. You may begin.

Thank you, Nicole. Good morning and welcome to the LPL Financial's third quarter earnings conference call. On the call today is Mark Casady, our Chairman and Chief Executive Officer, who will provide his perspective on our performance. Following his remarks, Dan Arnold, our Chief Financial Officer will speak to our financial results and capital deployment. Following the introductory remarks, we'll open the call for questions. We would appreciate if each analyst would ask no more than two questions each. Please note that we have posted a financial supplement on the Events section of the Investor Relations page on lpl.com.

Before turning the call over to Mark, I'd like to note that comments made during this conference call may include certain forward-looking statements. This may include statements concerning such topics as our future revenue, expenses, and other financial and operating results, improvements in our risk management and compliance capabilities, future regulatory matters, growth and trends, our business strategies and plans as well as the other opportunities we foresee. Underpinning these forward-looking statements are certain risks and uncertainties. We refer our listeners to the Safe Harbor disclosures contained in the earnings release and our latest SEC filings to appreciate those factors that may cause actual financial or operating results with the timing that matters to differ from those contemplated in such forward-looking statements.

In addition, comments during this call will include certain non-GAAP financial measures governed by SEC Regulation G. For a reconciliation of these measures, please refer to our earnings press release.

With that, I'll turn the call over to Mark Casady.

Thank you Trap, and thank you everyone for joining our call. Today I'll comment on our third quarter performance, which will cover our fundamental growth drivers, including advisor productivity and headcount growth. I'll then provide commentary on our efforts to resolve outstanding regulatory matters and investments to enhance our risk profile.

Starting with our financial performance, in the third quarter revenue grew 3% year-over-year to $1.1 billion and adjusted earnings per share declined 15% to $0.48 per share. Investors remained engaged and our advisors were productive this quarter, leading to strong asset growth of 12% year-over-year to $465 billion. This asset growth was fueled in part by the addition of $17 billion in net new advisory assets over the last 12 months, including a record $5 billion in the third quarter. Much of this growth can be attributed to the continued success of our hybrid RIA solution in attracting new advisors. Year-to-date, approximately 65% of our advisors have joined our RIA platform and we now have 303 firms with $84 billion in assets as of quarter-end.

While asset growth was strong, year-over-year revenue growth was lower primarily due to two factors. First, interest rates continued to be a headwind, as cash sweep revenue declined by 14%. Second, as expected given changes in the market cycle, advisors focused investment activity on conventional asset types such as mutual funds, providing additional exposure for investors to equities and fixed income. This contrasts with last year in the third quarter when there was elevated reinvestment in alternative products driven by an unusually high number of liquidity events. Outside of these two items, the remainder of our revenues grew approximately 9% year-over-year.

Turning to advisor headcount, over the past four quarters, the firm has added 347 net new advisors, including 70 advisors in the third quarter. This result includes the successful conversion of 91 advisors from Financial Telesis. We completed the transaction -- transition process in October and have attracted $12 million in trailing production.

In looking at the recruiting environment more broadly, we feel positive about the quality and size of the advisors that we're attracting and the opportunities in our pipeline. Our recruiting results vary quarter-to-quarter given the volume of advisors we speak to and what is typically a multi-quarter sales cycle.

Specifically inside this quarter, our net new advisor growth was influenced by our focus on the migration of the Financial Telesis advisors and outsized attrition of low producing advisors. While the small producer attrition had a disproportionate impact on our advisor headcount, we continue to achieve strong production retention levels, maintaining 97% of our advisor production year-to-date.

Turning to regulatory matters, we had $23 million in charges in the third quarter, representing the estimated costs of resolving and remediating matters of significance, including fines and restitution, into which we currently have line of sight. The $23 million in charges are separate and distinct from our continued investment and risk management and compliance capabilities, which are captured in the remainder of our core G&A.

The root of many of these matters stemmed from a prior period of rapid growth as the complexity of the business increased, and our requisite investment in systems, policies, procedures, and staffing were not maintained at an adequate pace. As we shared last quarter, we committed to a period of up-weighted investment that began in 2013 to reengineer and enhance our compliance capabilities. By expanding our personnel in legal, risk, and compliance functions by over 40% in the last two years, we are increasing the layers of supervisory and compliance review, particularly around more complex products and manual processes. We are making progress implementing our new systems, having completed a number of our projects and that work will continue in 2015.

Over the next few quarters, we're working to derive the full benefit of our enhanced compliance and risk management capabilities to reduce future regulatory costs. As we manage through this process, we remain committed to serving our advisors and positioning them for continued success in building their businesses. The power of our independent business model, the benefits of our scale, and the strength of our fundamental growth drivers provide sustained opportunities for future growth.

With that, I'll turn the call over to our CFO, Dan Arnold, who will review our financial results and outlook in greater detail.

Thanks Mark. This morning, I'll be discussing four main themes. I'll start by addressing the fundamental drivers behind our revenue growth in the third quarter, including details on advisor production and activity in our cash sweep program. Next, I'll provide insight into our progress in managing core G&A expense. I will then discuss our consolidated results and conclude with an update on our capital management activity.

In the third quarter, revenue grew 3% year-over-year to $1.1 billion. Total annualized production per advisor grew 1% year-over-year to 248,000, driven by the strong growth in our advisory assets and market appreciation, which were offset by the decline in alternative investment sales. Annualized advisory production increased 11% year-over-year to $98,000 and the annualized commissions per advisor of $150,000 declined 4%, in line with expectations. Excluding the elevated portion of alternative investment sales from the prior year, annualized commissions per advisor increased 4%, primarily due to strong growth in mutual funds and trail revenue. On a sequential basis, annualized commissions per advisor decreased 3%, which is consistent with the typical seasonal slowdown in commissionable activity.

As we look ahead to the fourth quarter, we typically experience mid-single digit sequential growth in commissions per advisor as a result of seasonality and we expect the strong level of advisory asset flows to be maintained. With recent market volatility, we are monitoring its potential influence on commissions and market sensitive revenue in the fourth quarter.

Turning to our cash sweep program, balances grew as expected throughout the quarter, increasing sequentially by approximately $1.2 billion to $24 billion. At quarter end, cash represented 5.2% of total assets, which remains below the historical average of approximately 6%. We expect balances to continue expanding over time as our business grows and as the cash allocation within client portfolios reverts to its historical average.

Year-over-year cash sweep revenue declined 14% to $25 million, primarily due to the bank spread fee in the ICA program declining by seven basis points. With respect to ICA pricing in 2015, we affirm the incremental 13 basis-point step down and expect the majority of the re-pricing to occur in the first quarter. The upside from a rising Fed funds rate would help to offset the effects of contract re-pricing and contribute to EBITDA growth.

I'd like to now shift our focus to expenses, including our payout rate and trends in our core G&A and promotional expenses. Our third quarter payout rate was down 103 basis points year-over-year to 87%. 64 basis points of this decline occurred within the base rate related to mix shift primarily due to corporate advisory growth outpacing commission growth. Most of the remaining reduction was due to a decrease in non-GDC related expense, driven by the mark-to-market of the advisor equity compensation plan due to the decline in our share price.

Turning to our operating expense, for the third quarter core G&A grew 15% year-over-year to $186 million, including the $23 million of regulatory charges, which was $18 million higher than expected. Excluding this $18 million, core G&A costs were a $168 million, rising 4% year-over-year and declining by 2% on a sequential basis.

Expenses other than regulatory charges generally represent over 95% of our core G&A costs and over the last five quarters, this expense trajectory has flattened out between $160 million and $165 million. Excluding the elevated regulatory charge in the third quarter, we remain focused on managing core G&A to the 7% growth rate for all of 2014, if regulatory charges do not exceed $5 million in the fourth quarter.

The nature of these matters makes it challenging to quantify potential regulatory charges, particularly in this environment. We will report any future regulatory charges separately to assist in the understanding of their impact on our overall core G&A growth rate.

Year-to-date, we have recorded $32 million in expenses related to these matters, which is approximately twice the level of charges we had in the prior two years combined. We do not believe the 2014 run rate level of spend represents a structural shift in our risk profile. These enhancements we have been making in our legal and compliance capabilities support our work to reduce the number of regulatory matters and their related costs in the future.

As we previously shared, we estimated a $20 million charge for regulatory matters for 2015. The nature of these matters and the environment we are in makes it difficult to predict the potential for future regulatory matters and related charges and therefore actual results may vary.

Turning to promotional items, as expected, expense increased sequentially by $7 million, primarily due to conference spend related to our annual advisor national training and education Conference in August. These additional expenses were partially offset by approximately $5 million in incremental fee revenue generated from this event. For the fourth quarter, we are anticipating an $11 million decrease in promotional expense related to conferences and a corresponding $5 million decline in fee revenue. Looking ahead to our 2015 conferences, our Summit and Masters events, which occurred in the first and second quarter of 2014 respectively, are both scheduled to occur in the first quarter of 2015.

With regard to overall results, we generated $109 million in adjusted EBITDA and $0.48 in adjusted earnings per share in the third quarter, which included $0.11 per share for the elevated regulatory charges. Margins declined by 1.4% year-over-year due to these charges, as well as the decline in cash sweep and alternative investment revenue. We do not foresee these three factors as permanent headwinds to our business and believe our fundamental growth drivers will generate future margin expansion.

I will conclude with comments on capital management activity, which demonstrates our commitment to return excess capital to our shareholders. In the third quarter, we allocated $24 million to capital expenditures, paid $24 million in total dividends and conducted $25 million in share repurchases buying back 500,000 shares.

As we did in 2013, we're taking advantage of favorable market conditions and low interest rates to create additional flexibility in our capital structure and position ourselves to generate further value for our investors. On October the 1st, we successfully completed the refinancing of our term loan A and revolving credit facilities, upsizing our existing revolving credit facility by $150 million in the process. Concurrently our Board authorized an incremental $150 million in additional share repurchase capacity.

As a result, in October to-date, we have spent $50 million to repurchase an additional 1.1 million shares at a weighted average price of $43.99. As of October 29, we have $168 million in remaining share repurchase capacity.

With that, Mark and I look forward to answering your questions. Operator, please open up the call.

(Operator Instructions) Our first question comes from the line of Chris Shutler of William Blair. Your line is now open.

Chris, this is Mark Casady here.

It looks like he's just disconnected.

All right.

Our next question comes from the line of Chris Harris of Wells Fargo. Your line is now open.

So a few questions on the regulatory charges, I guess I'm just curious, maybe you guys can elaborate on a little bit, what exactly are they related to? And more specifically wondering why these charges tends to be so much of a surprise? What is it about the process that kind of results in these unexpected surprises on a kind of an annual basis?

Well, I think we have to recognize that we're in a highly elevated period of regulatory issues. So I'm not trying to characterize them as an annual basis. If you particularly look at the history of our fines and restitutions, this is significantly higher than we historically have seen over the past two years. So I do want to make sure we're characterizing that the way that we see it.

And the second part of it is that they?re enormously hard to predict as to when they'll come into our view and be to a position where we feel comfortable that we can accrue for them. In fact, I would describe these as mainly post-quarter activities that became clear to us in the process of negotiating with a number of regulators about a number of issues that are known to us and then which we've been working very cooperatively with them on.

We obviously can't talk about specific items. We want to recognize and respect the regulator's ability to control the process of announcement and discussion. And we aren't completed yet in these matters.

What we felt was a good thing for us to do is to try to get all the things that are known to us that we can account for, and obviously the classic accounting accrual standpoint, get those into a charge that obviously is quite significant, and try to really earn back credibility starting with the fourth quarter.

I certainly would describe that we've had surprise amounts that have been in sort of the one or two penny range against EPS in a number of quarters that have been related to these regulatory activities. We felt it was better to try to take a substantive charge and see if we can't get the majority of this behind us over time.

Now, we can't predict the future. And so I also want to caution that the one thing that we need to also do is to not to try to predict things we can't predict. And we can't predict new issues that will come up. We can't predict the regulatory environment. What we can predict and control is our own expense profile, our revenue growth, our recruiting. The fundamentals of the business remain strong and that's what we need to talk to you about on a going forward basis.

So again, these are a substantive charge related to issues that are known to us and obviously something we can take from accounting charge and our attempt from this point forward is to regain the trust of our shareholders and perspective shareholders, and are regulators in terms of getting on the right foot, we will call it that way, going forward.

Thanks Mark. That's helpful. Just maybe one point of clarification. On the settlement this quarter, is that going to result in any higher incremental cost related to kind of hiring of staff that you guys might have to do as a result of that? So in other words, you have a charge this quarter, but theoretically maybe your expense base is a little bit higher than you might have thought given incremental hiring you might have to do?

Well, I don't think we can again talk to specific items within this particular charge. I just want to stress this isn't a settlement. This is an accounting charge. Settlements are still to come. What is in our G&A is quite clear, which is that we've increased our headcount substantively, 40% over the last two years. That's obviously making its way through the P&L. It's important to note that we have a significant amount of spending that's coming to the Company in 2014. We anticipate continued heavy spending in our run rate.

And so as we've profiled G&A for fourth quarter, which is all I'll speak to today, is that our discussion of that percentage includes the run rate costs that you're identifying. And those are well known to us, and those are well known programs of improvements in our processes. So it might be, for example, setting up a much larger complex product review group that would be an example of run rate cost that's now in but will continue to grow.

Another example would be replacement of systems in our risk management group, or the addition of systems in our legal team. The increase in our internal audit function has about doubled in the last year, for example. So those are all in the run rate and not in this charge, and that's a very important distinction to make. The charge is really fines and restitution. The rest is in our core G&A, which again we have good line of side on and a good way to talk too.

So Chris, they didn't trigger any new investment in our core G&A, it was just part of our plan.

Got it. Thank you, guys.

Thank you. Our next question comes from the line of Alex Kramm of UBS. Your line is now open.

I'm going to come back to the topic that was just discussed and hopefully you can add a little bit more. But I guess the way I would look for incremental color from you is when you look at whatever charges regulatory fine settlements are contemplated here, and you look at changes that you've made in the business so far, I mean is there any confidence you can get, when you look at this, this is where the problems are, this is where the problems were, and now we've changed so much of our processes that really some of these things shouldn't reoccur?

Or is this really a reflection of what it is, just the environment that we are in? And it is going to be things that are going to come up, that are going to be out of our control, or are you getting to that point? Again, I'm probably asking the same thing that was asked before, but are you really getting to the point where you say, you know what, I think we've made a major change here and I think it should be a little bit of a different business environment going forward?

Yes. So I think you're asking the question of hope, right, and the question of a way of thinking about how we can contour our expense profile, both from its core G&A standpoint and from a fines and settlements. And I just want to stress, I'm not going to talk about what I think those will be going forward as I don't think we know well enough to give you that confidence. That doesn't mean that we're not confident in the work we've done. We've done incredible work in improving our risk profile and doing things the way that need to be done in order to run a safe and profitable environment for financial advice and counsel.

I'd stress that our level of complaints per number of advisors has stayed very true to what it's been historically. And I'd stress that a lot of the processes that underlie already announced settlements as well as those coming are processes, which have undergone major revision. But what I do think is important is this is a work in progress. I've characterized it to our regulators as that we're about 60% away through the process. And because it is, a multiyear process of change and transformation and the way that we approach risk management and compliance oversights.

So I understand everyone's desire to know with certainty, what's going to happen, the one thing I know will be true is this is a fine business. It's going to produce good results for investors in terms of their financial security and safety. We're going to continue to grow businesses with the addition of new bank programs, new trust assets, new retirement assets, new advisors and we're going to do that in an environment that is much better controlled than historically has been the case.

What I can't predict is what that's going to mean in the near-term which I would describe is over the next 24 months as it relates to actions that are ultimately fines and settlements, and potentially up-weighted costs or down-weighted costs as it relates to ongoing G&A that's just not possible to do at this point.

Okay. I'm going to stay on the topic, sorry. And I guess two things as a direct call of one and I didn't ask before is when you look at the regulators or that you're talking to is different states and I guess and so forth. I mean at least do you think you've not cut all of those and no more now about new issues versus the same issues side? And then related to that when you think about what's driving these fines and settlements, or whatever they are all, it sounds to me and maybe correct me if I am wrong that they are related to at least some products more particular than others.

So when I think about it from a bigger picture and longer-term perspective, your business is moving towards more advisory, right, new -- more and more advisory assets, and when I look at the advisory, the RIA business that to me just appears to be a much, much cleaner business that should require a less oversight. But then you also still have a lot of legacy products that like non-traded REIT, VAs whatever that might involve a lot more manual processes you've hired, a lot of people over the last year.

So when I think about it, is there a point in the evolution of the company where you're shifting significantly to advisory. That's just a better business to be in. It's a higher margin business, it's a higher -- it's a cleaner business, maybe a better business for -- and investors. And you can actually say like, you know what, we're going to deemphasize this other side of the business; we can actually take out regulator cost.

Yes. Why don't you let me give you my presentation of that.

Yes. Sorry about the verbal diarrhea. I think you know why I'm trying to get that.

I think I know exactly what you're trying to get at. The difference between products is not their underlying efficacy nor their correctness for an investor. And I'm happy to explain that in ad nauseum detail as to why that's the case. The problem is those things, which are manually processed versus those things, which are done automatically. A mutual fund settles through a very well known automated process in which review of risk, review of activity is very straightforward and it's been routinized for the 30 years I've been in the business roughly, maybe a little less than that.

If you look at alternative investments, if you look at variable annuities they are all manually processed. And they are in different states of automation. In variable annuities, there is a variable order entry system, which is put in place a few years ago that has definitely helped the environment, but it hasn't made it perfect. If we look at alternative investments, it's all literally checking out, a piece of paper has to be reviewed that the customer sees, the advisor sees, we see in multiple ways. We're going to an automated system there. Again, it will help, but it won't improve it.

So I want to distinguish products that are good or bad that's not the distinction. The distinction is products that are manually processed versus those that aren't manually. You can imagine that in a manual process and humans doing a human review, they are going to have a human error rate. So if you looked at volume of transactions in any particularly settlement, I for example they come remarkably close to essentially what one might expect in the human run process as opposed to an automated process. So that's the distinction I would make between those two.

There is a cyclical nature of products, which is that alternative investments particularly non-traded REITs are cyclical in nature. We've just finished one of the greatest up cycles in real estate that we'll probably see in a period of time, I don't want to predict, but certainly, it's been very strong. That cycles what went out, cap rates are very low levels. And therefore, those products will be less popular and less appropriate going forward.

So that's the important thing for us to think about in terms of why the environment is the way it is and why certain activities might be elevated or not. What we stand for as a firm is the independent model. And we know that when we have a complex free environment where we're not producing products and we offer, literally in our case, thousands of choices of products that is better for the investor that is better for the advisor.

What it does introduces complexity and we have been on roughly a two-year journey across the entire organization to reduce that complexity not by reducing choice, critical to understand, but by increasing automation and increasing controls across the environment, it's a hard journey. I certainly apologize to all shareholders for the bumpiness of the ride financially, it's not at all what we aspire to and not what we will stand for going forward, but we have to recognize the things that are within our control that we're going to manage and those things that are outside of our control that we're going to have to manage in a different way, but not be predictive about. So I want to make that distinction quite clear in the way that we think about it.

I think the other part of it is that we've worked hard with our regulators who -- we have a lot of -- we have exactly the same goal in mind, we want investors to get to their financial outcomes that make them secure. For somebody who is a middle-income consumer, products they're trying to replace, the pension plan they don't have any longer. Therefore, a product that gives them a yield that essentially acts like a pension payment is very important to them that's why non-traded REIT works in that portfolio and why it is why it needs to be held for number of years.

Secondly, they're trying to create protection against inflation; they're trying to create protection against downside in markets that's why variable annuities work within their portfolio, an appropriate percentage of portfolios and appropriate levels and activities that are there. That's also why diversified portfolios are a darn good thing and why that can be done both in a brokerage account and an advisory.

And the last thing I'd say is it's about consumer choice. I know a number of consumers who are clients of advisors who are -- we all have friends who are more middle income oriented or even merging affluent. And sometimes people like to pay the cost of getting advice through a commission and sometimes they like to pay on an ongoing basis. And it matters a lot to a clientele that's middle income to have that choice. And the number of times I've heard those clients say no I'd rather pay myself charges in the brokerage relationship be done with it. I have a sort of once every few years check in on the financial plan, but there is really no need for ongoing advice at the level that person particularly has.

So it's really about the model that's appropriate for the investors and it's really about making sure that we're aligned with our regulators on what a safe environment looks like and adhering to those standards, which we are absolutely committed to doing.

All right. Thank you for the very long answer.

It's all right.

Thank you. Our next question comes from the line of Bill Katz of Citibank. Your line is open.

Okay. Thank you so much. So staying on the topic du jour. Maybe to Dan, as you think about sort of what I heard on the call here is you're sort of 60% of the way in. You've got another two years of this. You're still sort of back filling the -- some of your infrastructure to catch-up. So as you think about your core G&A outlook into 2015, I was sort of wondering what might be a reasonable run rate, obviously, adjusting for what you don't know on the regulatory side at this point?

Yes. So Bill, as part of the planning process, we always start with the trajectory of the business and then create that expense framework that will support the level of investment to support the growth in that trajectory, as well as then balancing that with delivering margin expansion. And so we have not finalized our plans for 2015. So it would be premature to speak to that. But we'll update you probably in December, on our next public update on sort of how we're thinking about 2015. But that's the right framework of which to think about how we're planning.

Thanks. Second question is just on the FA dynamics. You mentioned that you sort of had a better mix although it impacted the aggregate level of FA. So can you quantify how many sort of lower producing FAs you lost? And then the bigger question what might have still the pipeline where you are sort of weeding out some of underperformers. But the bigger question is just given the ongoing regulatory dynamic, how are you thinking about the impact on production and incremental recruiting? Is it having any structural impact on the business?

Let me start with your second question, maybe Dan you take the first one, is that the changes we have made in the way that we oversee product sales, complex products those things are in the system today. And so those activities to the extent that they affect production would have shown that effects by now, Bill would be the best way to think of it. I would argue based on the data that I see having run this business for a dozen years is that I see it is relatively minor which would make sense to me given the behaviors that I see by advisors working with investors anyway. And so I don't -- I see it as at the margin slightly impactful. And by that, I mean it's just a mix shift from one to the other.

Many of you will recall, and maybe Bill you'll recall as well that we at the gross margin level account for mix shift changes. In other words, the way we pay out by product line is adjusted for the relative economic strength of that particular line. So a VA pays differently than a mutual fund pays differently than an equity trade for those same reasons as we want advisors to be able to have essentially free rein from our standpoint to do what's right for their clients and for those clients to have plenty of choice to do what they need to do to save for retirement or whatever their goal is.

And so we do a business design to try to neutralize the impacts of switches from one product type to another at the gross margin level. So that's just important as part of that same conflict free advice structure that we've created. So I think that's probably the best way to think about it is the extent of how to shift is already shifted at this stage in terms of mix of products that are here.

But I do want to make sure that we all understand and then of course, a broker-dealer and an advisor are subject to whatever is going in the marketplace, right? You tell me whether fixed income is good or bad to buy. You tell me whether rates are going up or down. You tell me whether equities areover or undervalued, right? But an advisor and a client have to think through what are my long-term goals and what's the right mix of exposure in the market for me with the money that I'm investing. And that's going to be affected heavily by relative valuation levels and by relative opportunities in each line. So real estate is going to be less interesting today than it was five years ago or three years ago, that's just the cycles going through we see in any investment in the world.

Yes. And Bill, let me ask you a question, if I don't get it exactly right, it's only because I forgot exactly what you asked. So I think you were asking about the sort of the net new advisors and the impact, the sort of the outsized proportion of small advisors that were transitioned out of the business over the last quarter. And so, I think if you look at the quarter, and inside any one quarter, obviously net new advisors are impacted by the gross number that we recruit less those that attrition out.

And I don't have the exact number of small advisors that were transitioned out. I think one good barometer to think about is that the average production per advisor that transitioned out was about half of typically what we might see in a quarter and that's another good just reference point and indicator of why the number of advisors that transitioned out inside the quarter didn't have an outsized impact on what we would retain as a percentage of overall revenue.

We do still feel good about the different channels that we recruit into, so your traditional independent space certainly the hybrid solution, as well as in banks and institutions and retirements. And we're continuing to have success in seeing advisors pursue the independent model, as well as transitioning over from other independents.

The tailwinds of going independent are as strong as they've ever been. And I think it's important that as we talk to perspective advisors or perspective bank programs, they understand the tremendous investment we're making and creating an operating environment that gives them certainty around the safety of their practice that's the same thing they want, they want that.

These are certainly painful activities that are going on. We're not at all happy with the results we've caused. But it's important to understand that they see the investment that we're making and understand that that creates an environment in which doing their business is going to be, is really second to none as it relates to this topic in addition to our normal things that we do to help practices grow and prosper.

And just one last one, thanks for taking all my questions today. I know it's a busy day. Just as you think about the infrastructure spend, do you think you have the right management structure setup in place at this point in time to help ring fence some of the pressure you might feeling from the regulators or from your external shareholders in terms of that reflecting on the stock price?

Well, I think we've very clearly said over the last two years, we have changed our management team to operate in this new environment. Part of it is our team did well in the IPO and part of the team wanted to retire. Part of it is that people make different decisions about what they can do and part of it is we need different skills.

So out of the eight top executives of the company two years ago, six are new to the company. And that's an important change that we've been talking about for a number of quarters, but I just want to make sure and draw your attention to. And that was the company doing what I've done three times in the 12 years I've been here, which is making sure that the team is the team we need for the next leg of the journey and for the next leg of growth this business has.

We have tremendous capabilities, particularly around two individuals I'd point out; David Bergers, our General Counsel who joined us just about a year ago, and Michelle Oroschakoff, who joined us just about a year ago who runs our GRC, our Risk Management Group. Tremendously talented individuals. They've brought additional team members in and joining a staff that is very strong here as well.

We obviously just needed more staff to make sure that we're getting the processes done where they needed to be. That's the 40% increase in headcount, but it is important to note that we've already gone through the management changes that let us take the business forward in the way it needs to be taken forward, and what we're trying to do is clean up these issues that are in our past.

Thanks for taking my questions.

Sure.

Thank you. Our next question comes from the line of Alex Blostein of Goldman Sachs. Your line is now open.

Hi, good morning guys. Believe it or not, I have one along the same lines. So the way you've talked about these issues in the past and I totally appreciate the fact that you don't want to get into specifics, you can't, there is regulatory issues involved why you can't specifically talk about different matters. But the way you've described this in the past essentially was an issue of allocation limits across different states and you essentially had different states having different limits on how much you can allocate to alternatives and you guys tripped those limits because you didn't have certain systems in place. It sounds to me that there is obviously more than that and there is other matters that are involved here. So can you describe generically what these matters are?

No, we can't describe generically what these matters are. What is well known to you is exactly one that's one issue of many, which are the complexity of running a broker dealer and a large advisor. So in any given day, running an organization of this size and complexity and looking at any of our competitors for the same information, you're going to have something that doesn't work right, either because humans didn't perform the way we wanted them to and they're going to have a human error rate or because the system was working on day one and it isn't working on day two, that's the normal course. You might see a certain number of those at any point in time.

The point that I think is important here is we're really trying to systematically go through this period of under investment that we had in systems and people just to name two and essentially make up for that time. And there is a large body of work to do that's going to create a number of issues that we need to go to our regulators to and talk to them about and get resolved.

I think what's important culturally is we're trying to do that on as transparent basis as possible in a very complex environment with a very complex set of issues, which are much more numerous than alternative investment limits in a particular state and are complex. They are really hard to understand or systematize and what we're trying to do is be as transparent as we can about that where we're trying to understand how to make that environment better.

I think the team has done an enormously good job, which is awfully hard for anybody to see on the outside, so I apologize for that. But -- in which they have systematically gone through and looked at processes that we have and any number of our groups of risk management and compliance groups under issues that we know we need to change going forward or we already have changed and then talking about that with our regulators.

I can understand our regulators will be concerned about those issues because they're numerous. And that's really what leads them to these fine and restitution amounts they get us there. What I do think is important is that we are making sure in engaging our regulators around those issues and trying to make sure that investors aren't harmed in activity that should have been overseen in a different way and therefore that's where the restitution comes and then obviously the regulators have every right to then decide what the fine is that's appropriate for the behavior. And that's an important thing.

But I do want to stress to you and to those on the call that we're 60% of way through that, that's not a 100%. So there can still be other things that we'll find and still the other issues that need to be resolved. What's important is that we'll resolve them and make sure that investors are well taken care of, make sure advisors taking care of. That's the value proposition we have as a firm. And we're trying to do that in the context of controlling our other G&A in order to allow us for shareholder purposes to not unduly harm the shareholders.

Hard to say that after the charge we just took and again sorry about that. But that's how we're trying to think about 2015 for example, how we're trying to think about the fourth quarter of 2014 is one of the different levers we can control within our controllable G&A to make sure that we've made room for these other activities that we're not quite through yet.

Okay. And then shifting gears little bit to the nuances of the quarter and the forward I guess. The compression in ICAs that Dan you highlighted, the vast majority, I guess of the 13 basis points hits us in the first quarter of 15? How should we think about the 22 basis points in 16? Is that still heavily weighted towards the first quarter?

It would be, that would be exactly right. Most of those contracts re-price at the beginning of the year and that's the trigger point from the impact occurring in Q1.

Got it. And just one clarification, I think you guys -- when you talk about commission, I'm assuming you guys didn't highlight anything unusual with respect to alternative sales in the quarter. So is it fair to assume that it was kind of more of a normal $40ish million type of commission in the alternatives this quarter?

That's correct. I think we've been sharing our view at least all year that we would see a more normalizing level of activity and that's what occurred in the quarter.

Got it. Okay. Thanks.

Thank you.

Thank you. Our next question comes from Steven Chubak of Nomura. Your line is now open.

So the first question I'll start off with is one that doesn't pertain to the regulatory environment, and just wanted to dig into the other income line where the number was a little bit lighter than we expected. My understanding is the bulk of those revenues are attributable to higher marketing fees relating to non-traded retail, and since alternative commissions rebase to, as you noted in Alex's question, a more normalized level, should we assume that that $8 million per quarter other income is the appropriate run rate going forward?

Well, you've got the right on a year-on-year comparison. Clearly, you're missing that. The marketing dollars associated with the non-traded REIT sales at an elevated level. So at a more normalized level, you would expect more of that consistent run rate associated with that other income line.

Okay, understood. And Mark, I was still hoping to clarify one item relating to the 60% number that you threw out there. It sounds as though 60% of the investments that need to be made are largely completed. And I was hoping you could potentially clarify whether your reserve for all of these matters at this juncture to the extent that you have sufficient visibility? And on what percentage of the items that you're currently working through, are they continue as estimable and probable, which I assume is still the threshold, the other criteria that you still need to use?

Yes. So that's certainly the criteria for accounting, right? So that hasn't changed in the world, so that's the same. Obviously, the other things that are known so that are estimable, there are other things that might be known to us that aren't estimable, or we certainly are in early days of understanding. And again tomorrow is a new day, right? So who knows what's going to happen next week or next month, next year.

So I don't want to characterize, the future run rate at all. I think we've been probably crystal clear of that issue. But we can certainly characterize what's happened. I think just to make sure we're clear that charge is fines and restitutions, it's not the ongoing run rate. And the 60% of our journey isn't necessarily about the investment we're making, it's about where we in the process. And it's a characterization; it's my assessment of where we are, it's not a scientific number. And what I mean by that is I know that about half of our systems and GRC or risk management compliance group have been replaced some are all fully up and running, some are still going through their testing cycles as they go through, but they get there and some are in design.

So that's an example of where you are. So we know we're going to replace the other ones mainly in 2015. Some may dribble into 2016 even. And so I want to make sure we're clear about the characterization. It's really about where we are in the process of change, just because there is a lot to do in these areas.

I understood. It's actually really helpful. So I appreciate the color there and maybe just one quick follow-up. Can you at least disclose which regulatory agencies you're currently working with?

I can't, sorry.

Okay. Fair enough. Thank you for taking my questions.

Absolutely.

Thank you. Our next question comes from the line of Devin Ryan of JMP Securities. Your line is now open.

Hey, good morning guys. Most of my questions have already been asked, but I guess just coming back to kind of the budgeting process for next year and just expectation to me, it sounds like you guys will be employing some changes that you are thinking. And so, just wanted to maybe get some additional detail around how you guys are maybe building in more of that costs, unknown factor, or items that are difficult to estimate. Are you just waiting to kind of get more clarity or are those going to be in the budget whether it be regulatory or otherwise?

Well, they'll all be in the budget to the extent we know them because that's the way we run with our Board. And the Board has to oversee the goals and budgets and approve them on behalf of the management team. So I want to make sure we're clear. What we mean is we're going to stop trying to predict what we think the regulatory charges, the fines the restitutions are going to be that's what different. We know how to control G&A outside of that. We're incredibly good at it. It's awfully hard to see that and the results that we've had to-date, but one of the things we're trying to do in this release is make sure the world is clear about where expenses in the non-regulatory fine and restitutions are and they're spot on where we have said it would be because those are things we can control and this is a team that can manage those expenses well.

What I was trying to highlight was given what we know about the environment one might choose to do a dozen things in a given year. And those things might be balanced in some way across the portfolio of activities without getting into kind of detail. Obviously in this environment and our particular journey we need to stay focused on good risk management, better compliance, good oversight and that's where the majority of our things are and we probably need to do a little less than we might otherwise have done in a given year in order to make sure that we've got the organization's attentions focused on the thing that is most uncontrollable. That's what I would want as a shareholder because that would tell me that the team is focused on the thing that's the most difficult and therefore we're going to make progress against it in an intelligent way. So that's what we meant by that if that's helpful, Devin.

Yes. I appreciate that, Mark. Then with respect to I guess the follow-up on the recruiting environment. It sounds like the momentum there remains quite strong. We have seen some of the other call it large competitors getting more aggressive in the market recently. So I just want to get some perspective if you're seeing any change to the competitive landscape I know it's been very competitive, but is there any change more recently that you would characterize the environment is being different or is it just as competitive as normal?

I think it's as competitive as normal, but it's not surprising. The advisor practices are incredibly valuable. And we think we have a very solid value proposition for advisors, which is why we finish so well versus our competitors and even in a difficult environment for our business. The reality is that we're doing quite well vis-a-vis attraction. And if you look at our cost of recruiting it's materially less than those headlines or articles that one reads, Devin, about what other competitors are doing. So we're not having to pay up to the level they are having to pay up because people who are joining us get the value proposition and they are joining us and generally putting us in the number one and number two position for recruiting historically and based on the data that I can see, I'm characterizing that.

So that tells you a lot about the desire of practices to be here. The 97% retention tells you a lot about their desire to stay. And those are I think two strong operating metrics to focus on in terms of the strength of the business.

Got it. Great, thanks. And then just lastly with respect to the thought process around industrial loan charter, I know that was something that you guys have been at least exploring. Is there any update there, I mean is this off the table at this point or how should we think about the potential for that?

Yes. So I think great question. Part of it is that we've certainly been looking to try to understand what our optionality was around a bank holding company structure and industrial loan structure. Basically, an industrial loan structure doesn't exist any longer. There are industrial loan banks, but for somebody that's starting one or buying one they essentially have to go into a BHC type structure. And we know as we said before, we can't make a return for shareholders in a BHC structure, so therefore we wouldn't do it.

We found plenty of places to put the cash in the banking system and I'd characterize the banking system is healthier today than it was a year ago in terms of wanting deposits at rates that are slightly better than they were before.

Our headwinds and our rates are important to understand, it's historical. It's basically these really good long-term anchor bank contracts we've had coming off all the way through 2016 and actually putting us at a market rate by the end of 2016, which says that we're above market rate in aggregate here in 2014 and obviously in 2015. So that's I think important to understand. So that's what we -- I'd say it's off the table, just hard to see industrial loan charter being something that would get approved by the regulators and is something that would if were approved would have the characteristics of a BHC and that would mean that we can get a return.

Great. Thanks for the update.

Absolutely.

Thank you. Our next question comes from the line of Ken Worthington of JPMorgan.

Ken?

Couple of questions. First, there seems to be an unusual amount of money in motion with Gross' departure from Pimco. Is this having a positive and/or material impact on activity levels in 4Q for you guys?

No. Certainly say that we believe that Pimco has put a good team in place, supportive of transition that's going to occur at some point we all grow old andwe all change jobs at different times. So that we see there is sort of normal activity in that regard and our view is that the new team at Pimco will do perfectly find job, although we do watch it, we put the equivalent watch list on the product. And we certainly are watching what Janus does in terms of new products there and helping our advisors work with their clients around activities and information related to Pimco.

I think the other part of it is that given that we have thousands of products characterized by many thousands of them in the mutual fund space and particularly in fixed income, there is plenty of choice here. So whether it's new dollars going into an investment profile or whether it's somebody does want to make a change, there is plenty of choices to be made and we certainly don't have and overdue concentration of Pimco anymore than we have a concentration of any other fine manager like a Blackrock or other. So it really will be very marginal effect overall.

Okay. Thanks. In terms of the service value commitment, where is LPL in terms of investing to achieve those goals? You had 10 million of restructuring charges this quarter. I saw a portion of that is for the service value commitment, how much is left to spend to kind of achieve your value commitment goals?

Yes, I'll take that one. So you're correct. Inside the quarter, we had $9 million to $10 million of charges associated with the SVC project or program. We are drawing to a close and the majority of that spend will be completed over the remainder of the year which I think is roughly in the $10 to $12 million range in terms of what's left to spend. There may be a little bit of spillover into 2016 only because of the timing associated with the execution of some of the initiatives within it -- sorry into 2015, that's what I meant. Sorry about that, not 2016.

And that would be a very small amount. Just to characterize, the 30,000 fee, what we said was we're going to take a fairly significant amount of investment in order to lower our run rate and the characteristics of that are still true and therefore helpful to the business.

Okay, great. And I assume the savings targets are still similar to what they have been in previous discussions. Nothing is changed.

That's right. It was in the $30 million range. And we're continuing to track towards that number.

Okay. This is not new but transaction revenue growth seems to be fairly sluggish, it's the slowest growing kind of revenue line. Why is that not kind of keeping up with the growth you're seeing like in commissions, why so slow?

Yes, so there is a couple of things that drive that line item. One is fees that are charged to advisors, so the driver of a portion of that revenue would be more correlated with the change in the number of advisors. So if the number of advisors were up year-over-year 2.5%, which is directionally correct, I think those fees were up roughly in the 2% range. So there is a correlation in a piece of that line item that is directly reflective.

So just a different driver than market activity. And then there is the transactional activity. And inside the third quarter, just the number of trades, or trading activity that occurred was down. And so on a year-on-year basis and that's where you get just a slightly divergent level of trading activity as opposed to our commission growth which could be a function of or overall revenue growth which could be a function of assets under management as an example which is a big driver.

Thanks. And don't you raise prices periodically on some of the services that you charge for and are you due for any of those price increases?

We typically look at that on an annual basis and review and assess that. We don't see, we announced them a couple of months ago and they're not a large number of changes going into 2015. One that typically does change is always the review of the overall expense associated with the E&O policies for our advisors and that is one area that is changed. You will also get some benefit of the new service, remember that we talked about it goes into effect, or did this year but we start charging for it next year which is our home office supervision associated with some of the expanded compliance value proposition that we're delivering.

Okay. And then lastly on regulation. Is the worst over based on the activities that have been the source of the charges. Is the worst over in terms of fines and restitution or could it be that the worst is yet to come?

Again, Ken, we're not going to characterize where we are in the journey. Again, what we've done in this charge is to recognize what we know, ????they do mainly pertain to history. There is wide variety of regulators and it's our attempt to try to get as much of that behind us as we can, but we're not able to predict or characterize in the way you'd like us to where we are in the journey.

Okay. Let me ask it differently. What portion of regulators do you have line of site on? So you've got federal and state, not all states have these rules and regulations that you've fallen outside of, but many do. You try to put a lot of them into Q3 charge. What portion?

I'm not going to characterize, Ken where that is. I can't, sorry.

Okay. Thank you.

Absolutely.

Thank you. Our next question comes from the line of Chris Shutler of William Blair. Your line is now open.

Hey guys, sorry for the issue earlier.

Sorry. The mute button is a bear.

What's that?

The mute button is a bear.

Yes, exactly. All right. So first Mark maybe a little bit different angle on this, just curious what your outreach efforts have been to date with existing advisors and FI clients. To explain what compliance issues you've been having, explain where you're going? And then what kind of inbound inquiries have you received recently? Just trying to judge how proactive you are actually being in messaging to your advisor base?

Very proactive. So we did a significant co-op campaign as part of the announcement that was a public announcement that you saw earlier this week. And basically to call out to our top bank programs or top clearing client our top producers to make sure and tell them what we could tell them about it, make sure they understood that we were in a position of making investments essentially on their behalf and our behalf in terms of creating the kind of operating environment that they would want for their business that we want for our business. So we've been very proactive.

If anything I'd say, I'd characterize as we've got a lot of show of support. I've received several emails from advisors both in empathy and sympathy. And also in terms of understanding that the company is really standing up to do what's right for an investor and to work with the regulators to create the environment that needs to be created. And so the kind of support that I've seen from them personally or Dan might have, I know Robert Moore has as well has been about factor they see us making the investment, that they know it's significant, and is something that needs to be done.

And that's the reaction I'd like to see from our clients. And makes me feel good about our proactive communication and also makes me feel good about what I know are good practices and good businesses that they run.

All right, thanks Mark. And then just one quick one for Dan; you mentioned that you're monitoring the impact of market volumes on commissions; I know trading is up pretty nicely at the online brokers. Can you give us some sense so far in October what you've been seeing from commission's perspective? Thanks.

Yes, sure. And I think it's important to always reinforce the fact that what drives volatility that drives activity perhaps in some of the custodians is not the same driver here. In fact, volatility would usually have some type of impact on investor engagement or concern that may lighten up the new dollars being gathered or being put to work across either advisory or commission platforms.

And so that's what we reference in terms of monitoring it. I think up to this point the early reads in the quarter, we haven't seen it, but that's because the volatility just began in October so you wouldn't begin to see it flow through until probably the November or December timeframe as that investor engagement might have been impaired. So it's just too early to call right now. And it's something that we're monitoring and can give you an update in December.

All right, makes sense. Thanks a lot.

Thank you.

Thank you. And our next question comes from the line of Joel Jeffrey of KBW. Your line is now open.

I apologize for asking this, but I got on the call a little bit late. But I just want to make sure I'm kind of clear on this. Sort of taking away the fine you paid this quarter and taking out potential restitution you have to pay going forward, are you still looking for a core G&A growth rate in that sort of 4% to 6% range?

Yes. For this year 2014, I think we had targeted just to give you a number that folks are familiar with, 7% number for the full year excluding the $18 million of sort of up-weighted regulatory charges in the third quarter. And so, we're still targeting that 7% for the full year if regulatory charges in the fourth quarter do not exceed $5 million.

Okay. I mean going forward in the 2015 is the 4% to 6% still a good long-term growth rate?

Yes. I think what we had shared earlier with folks that we've got at any case when we're doing plan review we look at the trajectory of the business and then create an expense framework that will support certainly the growth in that business, but also trying to manage to balance the desire for margin expansion. And then as Mark also added on, we always have a series of choices with respect to investments that we make in any one year and they will continue to be heavily weighted and allocated to our investment and enhancing our risk management capabilities for 2015. And what was finally said is, we just haven't finalized the plan for next year. We'll give you an update in December.

Okay. Thanks. I appreciate that. One other question from me, I know you discussed sort of the contribution that alternative investments gave in the commission line. Can you give us a sense for how much variable annuities contributed during the quarter?

Yes. I think in the variable commissions line we continued to see good trends associated with variable annuities, ie consistent trends, but you've got to realize that throughout the full year there has been a step down in overall production in VAs just as the ten year treasury has created -- the level of the ten year treasury has reduced the number of new products that are coming on to market that create more opportunity in the VA space for our advisors. And so there has been a sort of a consistent headwind throughout the entire year associated with variable annuities. But inside the third quarter, I think you saw year-on-year about 2% growth compared to Q3 of last year.

Okay, great. And then just lastly from me, just looking at the growth in the independent RIA assets, it looks like it was up about $5 billion during the quarter and then total net new assets were up $4.8 billion. Just wondering if you saw some weakness in any of the other advisory inflows?

No. it's been a very strong quarter for advisory asset flows.

Great. I appreciate you taking my questions.

Thank you.

Thank you. And I am showing no further questions at this time. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may now disconnect. Have a great day everyone.