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Independent Broker Dealer, Financial Industry News, Broker Dealers

Independent Broker Dealers: A Sound Choice for the Financial Advisor

Article written By Shawn K. Smith

Small Broker Dealers Tarnished by Private Placements . . .

There has been much noise around Independent Broker Dealers (IBDs). The Small Independent Broker Dealers (SIBDs), who have less than 500 advisors, have received much of the negative press. Some SIBDs shut down in 2011 and 2012 resulting from the sale of private placements, REITs, and TICs that had gone south: Medical Capital, Provident Royalties, and DBSI, Inc. created sanctions and fines causing about 50 IBDs to go out of business as reported by the Investment News. This has caused financial advisors to become especially wary of all of the IBDs, especially the SIBDs, as the public has “thrown the baby out with the bathwater.” We recently spoke to a team of advisors who decided to put their move to an independent broker dealer on hold, due to the recent “stability “concerns they had heard about smaller broker dealers.

The Truth Behind the Numbers . . .

The decrease in number of IBDs follows suit with the decrease in the number of financial advisors. There were 79,802 independent financial advisors in 2011, down almost 14% from 92,727 in 2010. If you count dually registered advisors then the decrease is only 11% from 2010 to 2011. This compares to all financial advisors that decreased from 323,566 to 316,109, a 2% decrease.2 The independent financial advisors rate of decrease is much higher than those of all advisors. The independent advisors who were lower producers left the business as a result of the 2008 meltdown, or retirement, while others may have gone RIA, or possibly into the bank channel. The pace of the advisors leaving the wirehouses has also decreased since 2008 due to recruiting and retention bonuses.3 There are currently 4,380 brokerage firms.4 In the first quarter of 2012, 93 broker-dealers closed, compared to 137 firms during the same period in 2011. Only 44 new B-Ds opened during the first quarter of 2012, while 57 broker dealers started up in the first quarter of 2011.5 In other words, there was a net decrease of 80 broker dealers in first quarter of 2011 versus a net decrease of 49 broker dealers in the first quarter of 2012. The rate of reduction of broker dealers seems to be slowing. If the IBDs finish 2012 at the same rate of losing a net of 49 broker dealers per quarter in 2012, they will lose 196 broker dealers or 4.5% this year. This is about twice the rate of the number of advisors leaving the business. It was reported by Investment News that about 50 broker dealers went out of business from the failed alternative investments i.e. Provident, Medcap, and DBSI. This would explain the uptick in failed broker dealers in 2011.

There were also mergers in 2011 involving larger broker dealers, who have over 1000 advisors, which contributed to this decrease. The major ones were: Ameriprise Financial who sold off Securities America to Ladenburg Thalmann; Wells Fargo sold H.D. Vest Financial Services to Parthenon Capital Partners; Lovell Minnick Partners acquired First Allied from Advanced Equities; Pacific West Securities closed down and moved its reps over to Multi-Financial; and Allied Beacon Partners absorbed Workman Securities’ reps. This year Cetera Financial acquired Genworth’s broker dealer, LPL Financial purchased Fortigent. In the regional space, Raymond James bought Morgan Keegan6.

Accounting for Non-Retail Broker Dealers . . .

Out of the 4,380 broker dealers, about 3,100 broker dealers have 150 or fewer financial advisors (71%), 2,650 have fewer than 25 representatives (61%) (micro broker dealers) and 450 have between 25 to 150 representatives. We have recently done research and found that about 40% of the micro broker dealers are not retail broker dealers but are set up to transact many other types of business such as: investment management, mutual funds, institutional business, private placements, REITs, investment banking, foreign business, trading, and mergers and acquisitions.7 In 2010, out of the 20 broker dealers, reported to have gone out of business, 9, or 45% had no retail reps8. When referring to broker dealers closing down, these firms should be segregated from the data to show a more accurate picture of the retail broker dealer landscape and to help us better understand how the retail IBDs are doing. This would greatly reduce the reported number of IBDs, on the retail side, who have exited the business.

We have recently done research and found that about 40% of the micro broker dealers are not retail broker dealers but are set up to transact many other types of business such as: investment management, mutual funds, institutional business, private placements, REITs, investment banking, foreign business, trading, and mergers and acquisitions.

Profit Margin Compression . . .

In the past few years, many IBDs have gone through profit margin compression from decreased revenues as well as increased costs. There are several reasons for profit margin compression: 1. Increase in costs associated with compliance and accounting costs as a result of the Dodd-Frank regulations, 2. Decreased trading volumes from the 2008 financial meltdown, 3. Revenue lost from margin loan interest and money market fees, 3. Increase in competitive pricing, i.e. payout to the financial advisor, as a result of competition between IBDs, and 4. Cost of implementing technology. Profit margin compression has been more bothersome for the smaller and micro retail broker dealers, who do not have scale to offset the increase in expenses. This has caused some net capital issues, especially with the micro broker dealers. In response to margin compression, some of the small and micro broker dealers have looked at several options: 1. Do nothing and weather the storm, 2. Sell their firm to larger broker dealer, 3. Merge with a similar sized broker dealer, or 4. Close up and let the representatives joining multiple broker dealers. However, we are speaking to most small broker dealers where it is business as usual, and a few that are exploring their options. They are watching costs, and recruiting new financial advisors to increase revenues.

At many of the micro broker dealers, the owner or one of the partners of the firm is usually involved in other corporate functions, such as compliance or the back office operations in addition to being a producer, in order to be profitable. The majority of these firms are continuing to weather the storm without any plans to close up shop.

In most cases, the small and micro broker dealers are working in standard securities, and insurance products, steering away from alternative investments, as well as other products which may pose compliance risk. This has been their norm for years and they will continue to deal with FINRA’s increase in fees.

Break Away Brokers . . .

When a wirehouse advisor leaves a “Wall Street” firm we usually see a higher comfort level in joining a large broker dealer (greater that 1000 advisors) which frequently coincides with increased brand recognition, and more robust wealth management platforms and technology than the SIBD. Since the wirehouse broker is coming from an environment where they are benefitting from a brand, and they have wealth management platforms, and decent technology, the natural progression is to go to a larger IBD. Many of the large IBDs have some brand recognition, financial strength, and have bulked up their wealth management platforms so the wirehouse broker can ACAT their clients to similar third party mangers . We see the “break-away” brokers becoming more comfortable with the larger IBDs or are in some cases, going to IBDs who are specializing in large producers (aggregators). They may also consider starting their own RIAs. We usually see a wirehouse advisor going to a hybrid firm where he can either use the corporate RIA or set up his own RIA as opposed to going directly to the pure RIA model. This coupled with the possibility of FINRA overseeing RIAs, may further decrease the wirehouse advisor’s desire to go pure RIA. The “break-away” broker focuses on how his clients will perceive the new broker dealers since the wirehouses have good branding with their clients. However, those who are comfortable with the small broker dealer and the larger clearing firm “story” will join a smaller firm.

According to Cerulli data cited by Envestnet, the number of independent advisors is expected to grow to 164,560 by 2014, up 25% from 2008, while the number of advisors at wirehouses is set to shrink to 48,919 in 2014, down 10.8% from 20089. The IBDs should enjoy some exceptional growth in the coming years.

Independent Advisors Switching Firms . . .

More recently, as some of the independent firms are getting larger (1000’s of representatives) we are seeing more advisors considering leaving the larger independent firms for smaller independent broker dealers. We are hearing that the financial advisors aren’t getting good service from some of the larger firms that have not adequately added staff to support their advisors. The ratio of back office support to the financial advisor may fall, with high growth and the level of service from the back office support staff will drop, executives in the home office can’t be reached or don’t return calls. In short, the financial advisor sometimes does not feel like a valued part of the organization, when in fact they are the “customers” of the broker dealer. A financial advisor of a larger broker dealer recently mentioned to us that the people in his home office were getting more confrontational and treat him like he is a “subordinate”. He further mentioned that he should be getting “Ritz Carlton” white glove service since he is “buttering their bread”. We are hearing more of these types of statements as reasons why some financial advisors desire to join smaller broker dealers. Their observations are that the smaller firms are: more specialized for their practice; have more personalized service, lower expenses, and higher payout by having direct home office supervision. These advisors are also drawn to the potential ownership, “family culture”, and lower production requirements that an ISBD may offer. In short, they want to feel like they are a customer of the broker dealer, and a valued member of the organization.

Small Broker Dealer Value Proposition . . .

While many of the IBDs have merged and gotten quite large through both organic and growth through acquisition, there are also many small, “boutique” broker dealers, usually with less than 500 representatives who are also doing very well. They have sound financials and have stayed away from many troublesome alternative investments that have put other firms out of business. Their service models are sometimes superior to the larger firms, offering more personalized service in a “family type” culture.

Many times, we hear from our candidates that they “feel like they are a number” at their current firm. The smaller broker dealer’s culture is very appealing. Many of the smaller firms offer similar platforms and more “personal” support from the home office and are usually more flexible with terms of their agreements with the financial advisor joining the firm. In many cases, the first or second conversation that a prospective broker has with the firm is with the CEO or officers of the broker dealer. They want to speak to each candidate individually to get to know the advisor, before making a decision to hire them. The fact that the advisor can pick up the phone and contact the officers of the firm is sometimes the reason that an advisor chooses to join a smaller firm who can provide a “family type” of environment. It is appealing that the advisor is not a “rep number”- when they call into the small broker dealer, and they usually know him on a first name basis.

In many cases, these smaller firms have the latitude to customize their offers to the FAs as their management structure is flat. Many of these broker dealers offer payouts without a “grid”. They offer high payouts, and in many cases lower costs, and lower production requirements than their larger counterparts. Many of these “boutique broker dealers” also specialize in certain types of business such as: fee-based, wealth management, financial planning, RIA “friendly”, commission equity business, packaged products, discretionary business, retirement plans, fixed income, options or alternative investments. The smaller broker dealers are not large enough to be “everything to everybody”. By specializing in certain types of business, the financial advisor may feel more of a synergy with a firm that is playing in the same “sand box” as he.

Most of the small broker dealers clear through a big well known clearing firm such as Pershing, National Financial, J.P. Morgan, RBC or First Clearing. The client’s assets are held safely at one of these clearing firms. If for some reason, the BD went out of business, or they decided to switch firms, they could simply find another BD on that clearing platform or switch to another clearing firm, to continue their business. Broker dealers are more interchangeable in the advisor’s mind, when they switch to another broker dealer within the clearing firm.

We will continue to see a good movement of financial advisors to the independent space. From what we can see, IBDs as well as the SIBDs will continue to benefit from revenue growth with higher growth rates within the SIBD space. The IBDs are here for the long Term.

1 tough-market
2 Ibid
3 Ibid
7 Financial Advisor Placement Services Research, April 2012 to August 2012.