June 2, 2014
by Dan Jamieson, Financial Advisor
Running a smaller broker-dealer wouldn’t seem to be a promising venture these days. Growing regulatory costs, low interest rates and fierce competition for advisors make the business a challenge for any size firm, especially those with limited resources.
But small-firm executives say they can thrive by offering a level of personal service to independent advisors who detest the stifling bureaucracy of larger firms.
Broker-dealers “all do pretty much the same thing—process the business,” says Susan Woltman Tietjen, chief executive at Girard Securities Inc., which has about 250 reps and $52 million in gross revenue. “For the reps, it comes down to how good the people are, the culture, the service and the experience they have. That’s how we distinguish ourselves from the big boys.”
A midsize firm of $25 million or more in revenue can create a nice niche, says recruiter Jon Henschen of Jon Henschen & Associates LLC, which specializes in placing independent reps. “They’re large enough to be financially viable, but not so large that it’s a big bureaucracy,” he says.
Smaller firms cater to experienced advisors who don’t need much guidance, Henschen adds. “They just leave the broker alone,” which is what many reps want.
But small firms face some stiff challenges. Not surprisingly, regulatory pressures top the list.
There exists “a general hostility toward the investment business” on the part of regulators, says Arthur Grant, chief executive at Cadaret Grant & Co. Inc., which has about 770 reps and $150 million of gross revenue. B-D owners “are not enjoying the business like they used to,” Grant says. “Instead of running a business, it’s about compliance, supervision and tracking.”
Sure enough, the number of broker-dealers has continued to fall, from 4,720 five years ago to 4,142 as of March 2014. Many blame this long-term decline on regulatory costs and risks.
“For the most part, the independent midsized firms that are still standing today have survived because they’ve done a pretty good job of supervising their people,” Tietjen says. “The ones that have gone by the wayside are the ones who haven’t.”
Firms have no choice but to spend more on compliance—both for professional talent and for systems—observers say. “The beauty of the independent-firm business was that the primary expense was compensation to advisors, which is a variable expense,” Grant says. “But it’s to the point now where the regulatory environment has forced fixed expenses higher, and that’s not healthy.”
In particular, some industry execs worry about sales of non-traded REITs and business development companies, a staple at many independent firms. The products generate large commissions, but are illiquid and could cause problems with regulators and clients alike if yields falter.
Liquidity events among some non-traded products have created a “false sense from some advisors that these products are liquid,” says Russell Diachok, chief executive at Geneos Wealth Management Inc., which has 275 advisors and about $100 million in revenue.
In addition to regulatory risks, smaller B-Ds face a number of other headwinds. On the revenue side, low interest rates have dried up the income firms used to get from holding customer cash, and variable annuity sales are off from prior years as insurers pull back on sales.
In response, some firms are creating more in-house solutions for their fee-based business, which allows them to keep more of the administrative and revenue-sharing fees that are now kept by outside TAMPs and clearing firms—revenues that don’t have to be shared with reps. “The more people involved [with a fee platform], the less money there is for the broker-dealer,” says Tietjen, whose firm later this year plans to roll out its own internal fee-based service.
Geneos bought a managed money platform four years ago and has built assets up to around $600 million from $150 million, Diachok says.
Meanwhile, the recruiting environment has gotten more competitive. The bigger players are offering transition packages of up to 20% to 30% of 12-months’ trailing production. That’s something midsize firms can’t afford.
Ron Kovack, chairman of Kovack Securities Inc., recently lost an advisor prospect to a competing firm that could pay front money. The rep called and “told us we weren’t even in the ballpark,” he says. Kovack Securities has about 300 brokers and $50 million in gross revenue.
Since the financial crisis, many advisors are looking for bigger, well-capitalized firms, observers say. “The general [trend] right now is from smaller B-Ds to [the] recognized players that are going to be here” for the long term, says Mark Elzweig, founder of recruitment firm Mark Elzweig Company Ltd.
Some advisors also expect more bells and whistles from firms, such as practice-management consulting and coaching. But smaller firms can’t always afford to provide these types of services that advisors have gotten used to at larger firms.
B-D owners are waiting to see how continued industry consolidation impacts recruiting. Merger and acquisition activity among broker-dealers often causes advisors to evaluate their options. The announced acquisition of Cetera Financial Group by Nicholas Schorsch’s Realty Capital Corporation in January promises to change the landscape, but industry executives note that smaller deals also continue apace, such as Sterne Agee Group Inc.’s plan to purchase the midsize firm WRP Investments Inc. (a deal announced in April).
“We haven’t seen too much traction from [consolidation] yet,” says Tietjen about the recruiting environment. But the Cetera deal “is certainly changing the structure of this independent broker-dealer business.”
Financial stability, technology and pricing may be important competitive factors for B-Ds, but talk to executives at midsize firms and they’ll tell you it really comes down to offering a boutique, homey experience with personal service and the stability of a firm that won’t sell out or get too big.
New recruits joining Independent Financial Group LLC have nearly all come from other independents where they were not happy, says David Fischer, chief marketing officer at the firm, which has 550 reps and about $100 million in revenue.
Their situations were not what they enjoyed when they started in the business, he says. “Now they’re one of among 10,000 reps, they don’t know anyone in the back office anymore, or [service has] been outsourced to India.”
“There’s still an opportunity [for midsize firms] because not every advisor wants to be with a huge firm, or with a mom and pop B-D,” adds Mark Mettelman, chief executive of Triad Advisors Inc. “They really like a midsized firm where they have the resources for a rainy day, but still have the relatively small size.”
Triad, with 550 reps and $155 million in revenue last year, is owned by Ladenburg Thalmann Financial Services. Ladenburg has kept its three broker-dealers separate in order to preserve that unique feeling, Mettelman says. “Advisors still want to feel connected to the home office.”
Diachok, who co-founded Geneos with his father George and whose nephew, Ryan Diachok, serves as president, echoes that sentiment. “Advisors have to want to be part of the culture that we have, with our third generation of [family] management.”
At the end of the day, smaller B-Ds aren’t looking to add big numbers of advisors. As long as their reps are happy and turnover remains low, they don’t have to aggressively recruit and devote a lot of resources to transitioning new clients.
Add in the right mix of staff and technology, and “you can make it work,” Tietjen says.