In our second IBD Report Card, we examine the grades advisors gave their firms, and offer a look at one major trend that will shape the indie landscape in the next few years: consolidation.

Despite a tough market environment and a squeeze on profit margins, plenty of IBDs large and small are doing an excellent job of keeping their financial advisors happy, Registered Rep.‘s 2012 Independent Broker/Dealer Report Card shows. Just look at the grades the firms at the top took home. (See page 42, “The Grades are In.”) But analysts and executives predict the landscape is going to change dramatically in the next three years as the buying and selling of firms accelerates. 2011 was a busy year for deal-making and offered a taste of what is to come. A number of major independent broker/dealers got hitched, which meant a lot of upheaval for financial advisors. FAs need to examine their career aspirations and prepare for a potentially turbulent future, analysts say.

First, a look at the coming shakeout. Dealmaking has been ongoing in the brokerage industry, but it really got rolling last year. To name a few of the major transactions, Ameriprise Financial sold off Securities America to Ladenburg Thalmann; Wells Fargo made a deal to sell H.D. Vest Financial Services to Parthenon Capital Partners, a private equity firm; 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 made a recruiting deal to absorb Workman Securities’ reps. So far, 2012 has started off with a bang, with Cetera Financial’s acquisition of Genworth’s broker/dealer, LPL Financial’s purchase of Fortigent, and Raymond James buying Morgan Keegan, a regional firm.

In fact, if you look at the list of 20 firms that responded to Registered Rep.‘s survey, 40 percent of these firms or their parent companies were bought, acquired another firm, or experienced a change of ownership last year. Industry analysts, M&A consultants and broker/dealer executives say M&A activity in the IBD space will pick up even more this year and continue for the next three to five years, at which point the number of acquisition targets will have dwindled. In the end, the larger players will get larger, the mid-sized firms will thin out, and a handful of smaller firms will continue to grow organically, they predict, leaving the industry in a barbell shape.

David Alsup, director of business development for The Compliance Department Inc., foresees the b/d universe shrinking from 4,555 firms today to 4,000 by 2015, with the majority of the buying and selling happening among IBDs. Some of that will come from firms exiting the business altogether — at a net rate of about 16 per month — though Alsup says this rate will slow toward the end of the five-year period. Already, the number of firms in the business has declined to 88 percent of 2005 levels while the number of reps in the business has only dropped by 3.11 percent. He says this is just further proof that the large firms are swallowing some of these disappearing firms, while some of the orphan advisors may be heading to the smaller firms.

Srini Venkateswaran, partner in Booz & Company’s wealth and asset management practice, also says the consolidation trend will continue for the next three to five years, with, on average, a transaction every working day for the next year, including divestitures, acquisitions, demise of a firm, or some form of ownership change. And Chip Roame, managing partner with Tiburon Strategic Advisors, agrees that consolidation will accelerate in 2012 and continue for the next three to five years. He predicts we’ll see over 50 deals of all sizes in the IBD space in 2012, and he expects 10 of the top 30 firms to sell.

Buyers and Sellers

Firms that are known to be on the acquisition trail include LPL Financial, Raymond James, AIG Advisor Group, Ladenburg Thalmann, and some insurance firms, such as Metlife. Analysts also say there are several private equity firms looking to put capital to work in the IBD space, including Lovell Minnick, Parthenon and Lightyear Capital, which owns Cetera.

“The only barrier to more deals is the absence of targets,” says Philip Palaveev, president of Fusion Advisor Network.

Firms with a lot of fee business are in demand, says Aite Group’s Alois Pirker. Another potential source of acquisition targets could be insurance-owned independent broker/dealers, says Palaveev. Many of the insurance companies that bought the b/ds six to 10 years ago now want to wash their hands of them because it’s more difficult to distribute proprietary product and the profit margins just haven’t lived up to what they expected going into the deals, says Roame. Some divestitures have already happened. Pacific Life sold its b/ds to LPL; ING sold its b/ds to Lightyear; and most recently, Genworth sold off its b/d.

Scott Smith, senior analyst with Cerulli Associates, says the consolidation will be more like a slow trickle than a sea change. “I think it’ll start building because you’re not going to see 50 of these entrepreneurs who own IBDs do it overnight.”

Margin Pressure

So why are independent b/ds jumping into bed together? First of all, IBD margins are incredibly slim and getting slimmer, squeezed as they are by shrinking revenues and rising costs. Jim Nagengast, CEO of Securities America, says revenues are struggling under the weight of competitive pricing and low interest rates. Low interest rates put pressure on cash spreads, a large part of IBD industry revenues, he adds. Low rates also make CDs, money market funds and short-term Treasuries unattractive for retail investors, other sources of revenue for many IBDs, says Darlene DeRemer, partner in New York investment bank Grail Partners. Anemic mutual fund trading volumes and slow proprietary trading are also to blame for revenue weakness, she says.

And then there’s cost. According to Palaveev, IBD expenses typically take about a 10 to 15 percent bite out of revenues. With competitive payouts to brokers at about 90 percent or more of revenues, there’s a pretty narrow wedge for profit. On top of that, you have rising technology and compliance expenses.

“It’s extremely challenging to be a small broker-dealer today,” says Larry Roth, president and CEO of Advisor Group. “To succeed for the long-term, you must be financially strong and well-capitalized. You have to be able to make large investments in technology, compliance, and other services, all while offering a flexible platform to advisors.”

The changing regulatory environment is expected to put further pressure on b/ds because of the higher compliance costs associated with a raft of new rules, including Dodd-Frank reform, cost-basis requirements, FINRA Rule 2111 governing suitability, new 401(k) fee disclosure rules, and new fiduciary standard regulations. Many smaller firms simply won’t be able to afford the additional spending for compliance supervision and staff, says Jonathan Henschen, president of recruiting firm Henschen & Associates in St. Croix, Minn.

The demand for high-end technology is also driving consolidation, says Venkateswaran. “You have to think that the bigger firms have deeper pockets and can take on bigger capital expenditures in technology, and that’s a big deal these days,” Venkateswaran says.

Venkateswaran says deals are being done at a fairly good price for buyers because of all of the challenges facing small firms. If you have some kind of distinct asset or capability, such as Genworth with its tax and accounting professionals, you can command a premium, he says. DeRemer says the valuation really depends on a firm’s product mix and the buyer’s ability to retain reps.

Career Moves

In this new world order, advisors are going to have to rethink their career strategies, say analysts.

Larger firms may have greater resources and better technology, but an advisor is more likely to get lost in the crowd. At a smaller firm, there’s a better chance of being heard but greater risk that the firm could run aground or get picked up by an acquirer. Either way, reps will have to think about what resources they really need to run their practice successfully and choose accordingly.

While there are many small firms that are struggling to stay afloat, there is room for small firms that are nimble, focused, or have some niche market, says Pirker. Some producers simply aren’t happy at a larger firm, he says. Henschen says he works with many small firms that are doing just fine. They’ve got their overhead in check; they’re tight on compliance; and they have better relationships with their reps because of the family-like culture of the firm.

Reps may also want to be careful about relying too heavily on their b/ds since ownership could change, and often. This is where reps will have to use their management skills and be careful of what they keep in-house and what they outsource to the b/d. “I think advisors sometimes have a tendency to think of broker/dealers almost like these mountains in the landscape; they’re always going to be there,” Palaveev says. “They’re not mountains. They erode; they build up; they change.”

Broker Report Card: Rankings and Results

Registered Rep.‘s survey saw high satisfaction rates at both ends of the spectrum — small and large. The top-ranked firm, for example, was Sigma Financial, which had 650 FAs as of June 2011; VSR Financial Services, number three on the list, has 278 reps. But some larger firms took top spots as well, including Commonwealth Financial Network, Raymond James Financial Services, and Cambridge Investment Research. The 300-pound gorilla, LPL Financial, which boasts 12,799 reps, however, ranked 14 on the list with an overall score of 8.6.

The second annual survey was fielded in December 2011 and early January 2012, and yielded 4,271 responses. This time around, we partnered with Cerulli Associates to conduct the research. In our coverage of the survey, we only used data from firms that had 50 or more advisor respondents. The b/ds we chose to profile are among the top performing firms, and we feel they have a good story to tell. We chose not to profile Sigma, Commonwealth, and Cambridge, which ranked first, second and fourth, because we already profiled them in the first annual survey last year.

Ann Arbor, Mich.-based Sigma Financial took the top spot again this year, with an overall rating of 9.8 out of 10. Commonwealth, which tied with Sigma last year for first place, came in just a hair behind Sigma with an overall rating of 9.7. VSR Financial Services ranked third with an overall satisfaction rating of 9.5. Raymond James Financial Services moved up a couple spots this year to fourth place, while Cambridge dropped from fourth to fifth on the list. The firm that registered the biggest jump was SagePoint Financial, whose rating climbed to 9.1 from 8.2 in last year’s survey.

Sigma scored particularly high on sales and service support, receiving a 10 out of 10 for its helpful home-office support staff. Reps also like Sigma’s timely payout of commissions and fees and the ability to choose a mix of commission and fee business, which both received 10s. Commonwealth scored highest on its management, with a 9.8 rating, followed by sales and service support at 9.7.

In general, advisors seemed to be pretty happy at their current firms, with 86.7 percent saying it was very likely they would still be affiliated with their firm in two years. About 6 percent said they were somewhat unlikely or very unlikely to still be with the firm in two years.

Overall across all firms, advisors seemed least satisfied in the technology department, which took the lowest average category rating of 8.3. Cerulli’s Smith says the top complaint he hears from reps is that technology is not integrated enough. A larger firm, he says, will likely have more integrated systems, so advisors are rekeying data less often. In our survey, 47.1 percent of respondents said technology was the most important factor in causing them to look for a new b/d.

IBD advisors are not entirely thrilled with pay, however. Compensation and benefits received an overall rating of 8.5, with the sub-category health and retirement benefits getting a low score of 6.5. Reps are more content with their firms’ product offerings and management, which each took a score of 9.

Our survey shows IBD advisors are continuing the move to fee-based business. On average, respondents said 44 percent of their income comes from asset-based fees, with 49 percent coming from commissions. On average, respondents said they expect asset-based fees to make up 55 percent of their business three years from now. Commissions are going to be less of a focus in three years, with respondents expecting it to account for 36 percent of their business by that time.

Greener grass, expiring deals, calmer market will open gates

More brokers should shift to the independent RIA channel this year as markets stabilize and retention deals wind down.

That’s the prediction of custodians, for whom last year was a mixed bag as flat but volatile markets made it difficult for many advisers to make major career changes.

Schwab Advisor Services welcomed about the same number of breakaway brokers as it did in 2010, bringing in 166 teams. Breakaway assets fell slightly to $12.1 billion, from $12.6 billion the year before.

“Movement seemed to slow in the fourth quarter,” compared with the prior nine months, said Tim Oden, senior managing director of business development.

He thinks that more movement will happen this year.

THE WAIT AT WIREHOUSES

Advisers seem to have delayed moves “until another tranche of their retention package wears off” early this year, Mr. Oden said.

“It all looks very positive,” he said.

Schwab provides custody services to nearly 7,000 advisers who manage $679 billion.

TD Ameritrade Institutional enjoyed more momentum, with a record 348 new advisers coming aboard during the fiscal year ended Sept. 30.

That momentum carried through in the fourth quarter, when the firm landed another 100 breakaways, up 14% from a year earlier.

“We see that trend continuing,” said Thomas Nally, managing director of institutional sales at , which holds about $160 billion in custody for more than 4,000 advisers.

Pershing Advisor Solutions LLC brought in $7.3 billion in breakaway assets last year, up 24% from $5.9 billion in 2010, according to Jim Dario, managing director of business development.

The company has just over $19 billion “in active [registered investment adviser] opportunities in the later stages of our funnel,” Mr. Dario wrote in an e-mail.

The firm holds $94 billion in custody for 650 advisers.

Fidelity Institutional Wealth Services won’t disclose numbers, but 2011 “was another strong year for breakaways,” said spokesman Steve Austin.

“Our pipeline is strong, with more scheduled [transitions] over the next three months than we have ever seen in the past,” he said.

The firm holds $475 billion in assets on behalf of 3,300 advisers.

Wirehouse advisers are frustrated at the bureaucracy and managements of their firms, retention deals are wearing off, “and at the same time, firms in the independent space have come up with lot of solutions for advisers,” said Mindy Diamond, president of recruitment firm Diamond Consultants LLC, who agrees that 2012 should see more breakaways.

Observers said brokers have been waiting for portions of post-crisis retention and recruitment deals to be earned off this year, especially in the first quarter.

BOFA RETENTION DEAL

Bank of America Corp. gave Merrill Lynch & Co. Inc. brokers a retention deal in January 2009, followed by the newly combined Morgan Stanley Smith Barney LLC. At the same time, UBS Financial Services Inc. was recruiting aggressively.

“If [wirehouse] guys are in the latter years of a retention package [and] it’s the last move of their careers, they’ll probably go independent,” said Matt Cooper, managing member of Beacon Pointe Wealth Advisors LLC, an aggregator firm.

“They’re not going to sign [a deal for] another nine years,” said Mr. Cooper, who expects to add four to six adviser/partners this year, in addition to two partners added last year.

A report from Cerulli Associates Inc. this month predicts that the wirehouses’ market share of assets will drop from an estimated 43% last year to 35% in 2013.

At the same time, custodians continue to pick up representatives from independent broker-dealers.

Some independent broker-dealers have been forced to shut down due to problems with failed private placements and high regulatory costs, leaving reps looking for new homes.

“More things could come out” at the independents, said recruiter Jon Henschen, founder of Henschen & Associates LLC.

Brokers at the smaller broker-dealers will want to be hired by larger firms with more financial backing, he said.

“The hardening-up on compliance — that’s one factor” driving breakaways, said Fred Tomczyk, chief executive of TD Ameritrade Holding Corp.

“When you’re running a bigger firm, you have to take into account what the bottom 10% are going to do. Many of those routines are cumbersome,” he said.

And of course, a better market environment would help the custodians.

With the global equity markets hitting an apparent bottom in October, prospective breakaways will find it easier to jump ship.

“Turmoil may cause some [advisers] to pause” before moving, Mr. Nally said. “Advisers don’t want to approach clients during a period like we had last year and say, “Hey, we’re moving.’”

Still, despite the favorable factors this year, RIA custodians won’t exactly have easy pickings among their competitors.

The big firms may not care so much about market share, and instead seem intent on keeping their top advisers, according to Cerulli Associates.

Wirehouse refugees could be concentrated among lower producers who have suffered from recent cuts in pay.

Observers also noted that the custodians overall can expect to grab maybe 400 to 500 wirehouse reps each year — not exactly a flood, in any event.

And the surviving independent broker-dealers could prove to be increasingly tough competitors.

“They have smart people running these [broker-dealer] organizations,” said David DeVoe, managing partner at DeVoe & Co. LLC, a mergers-and-acquisitions consultant.

“I expect they’ll continue to invest and think more creatively about how to retain their reps,” he said.

2010 was the year of going nowhere. 2011 was much better. What does 2012 hold for broker-dealer recruiting?

When changing broker-dealer, transition time is typically brief—only one or two months. Yet often, Financial Advisors place the weight of the world on this early part of the relationship, the “honeymoon period.” They are enticed by what appears to be a sweet offer, and end up making a compromise that undoes their reasons for making the change in the first place. That compromise is usually in the form of upfront transition money.

Upfront Transition Money Doesn’t Always Pay Off

Making the right choice when switching to a new broker-dealer is crucial in terms of retaining clients during the transition. We encourage our clients to set their sights on the long-term goal because ultimately, it’s the whole package that they have to live with in the coming years that should capture their attention—not a lump sum of money at the beginning of a relationship. Still, we see human nature rear its ugly head as advisors become blinded by an offer of a forgivable note.

Here are a few examples of how reps have compromised their goals when changing broker-dealer:

• going with a firm that offers to cover $20,000 of initial expenses when in fact the rep would earn over $30,000 per year more at a firm offering a higher payout
• taking a 10% forgivable note when another firm would save them more than that amount each year through lower ticket charges
• accepting a large forgivable note even though the rep’s original intent was to achieve lower administrative fees on their Advisory accounts (the new firm would have netted them around 85% while the sign-on bonus firm netted them 65% on Advisory business, which equated to $40,000 more per year with the firm that netted them 85%)

Instant Gratification: Going for the Marshmallow

This irrational human nature is well illustrated by an experiment done in the early 1970s by American psychologist Walter Mischel at his Stanford University laboratory. The experiment was simple: invite four year olds to eat marshmallows. Mischel would make each child an offer. They could eat one marshmallow right away or, if they were willing to wait for a few minutes while Mischel ran out to do an errand, they could eat two marshmallows when he returned. Initially, nearly every child decided they wanted to wait so they could get two marshmallows. Who doesn’t want more sweets?

Before Mischel left the room he told the child that if he or she rang a bell, Mischel would return and the child could eat a marshmallow. However, by ringing the bell, the child would forfeit the second marshmallow. Not surprisingly, most four year olds couldn’t resist the sugary treat for more than a few minutes. Comically, several children covered their eyes with there hands so they couldn’t see the marshmallow while others would start kicking the desk or pulling there hair in order to restrain themselves. Most of the children lasted less than 1 minute, while only a few were able to wait up to 15. Some of the children ate the marshmallow as soon as Mischel left the room, not even bothering to ring the bell.

Results from the marshmallow experiment demonstrated that some individuals were better at managing their impulses than others. Tracking these children to adulthood revealed some interesting trends. Children who rang the bell within a minute were much more likely to have behavioral problems later on in life. They got lower grades, struggled with stressful situations, were more likely to abuse drugs and had quick tempers. SAT scores were also lower on average than for those kids who waited several minutes before ringing the bell. The children who were able to wait before ringing the bell loved sweets and wanted the marshmallows just as much. However, they were better at using reason to control their impulses. These children went on to get higher SAT scores. They got into better colleges and had, on average, better adult outcomes.

Two Types of Advisor Personalities

The personality differences demonstrated by the children tempted with sweets can also be seen in the Advisors seeking our consult. Speaking in general terms, an Advisor that is an active stock trader tends to be more emotionally wired, thus more likely to be motivated by transition money. A Financial Planner on the other hand looks at investing as a discipline and relies less on emotion when making decisions. This type of Advisor is less likely to let transition money skew the decision. They generally don’t like the idea of being beholden to a broker-dealer for four to six years for the sake of a bit of money paid at the beginning of the relationship.

The Dark Side of Forgivable Notes

Forgivable notes come with issues rarely brought up but can become a nightmare for unsuspecting advisors. A 10-20% forgivable note will typically be forgiven over a five-year period. The advisor needs to maintain 80-100% of his trailing twelve months production (for which the note is based on) for the first year at the firm. That amount increases 10% per year for the following years. What happens if production drops below those requirements? Likely scenarios include:

1. extending the note for another year or two
2. charging interest on the note
3. calling the note, asking for what is owed to be paid immediately

Another Word of Caution

Advisors also need to be cautious of the wording in the note contract. Some notes don’t forgive the note one-fifth per year but rather bunch up the forgiveness toward the end of the five-year period. For example, let’s say you want to leave after two and a half years. On the surface you’d think you’d owe half the money back. However, with some contracts you could end up still owing 80-90% of the money. 2008 was a big problem year for many firms giving out forgivable notes, with many of those notes now underperforming loans. Imagine being a $500,000 gross dealer concession producer at the beginning of 2008. You change your broker-dealer and get a 15% note ($75,000) paid upfront. Market conditions turn south and you produce $250,000 in the next couple of years. Result? Your note is extended several years in length, you’re paying interest on the loan or they ask for the money back. The other question that reps fail to ask themselves is what if they become ill for an extended time? It’s for reasons like these that you need to look at the good, the bad and the ugly of accepting any forgivable note money.

Take the Upfront Incentive Only When All Things Are Equal

The marshmallow experiment was a test of self control for four year olds. Upfront sign-on bonuses are a test of self control for advisors. If you’re down to the choice of two firms, and all attributes seem equal with one firm offering a generous transition money package, then there’s nothing wrong with going with the firm offering more. The key here is all things being equal. Often, when the forgivable note is dangled before you, it’s easy to start to rationalize and minimize your original criteria. Your focus becomes fixated on the short-term honeymoon rather than the long-term marriage to the broker-dealer. Making this choice, you become the kid taking the marshmallow without even ringing the bell. Focus on the long term and you’ll likely get the sweeter deal.

Jonathan Henschen, CFS, is President of Henschen & Associates. Henschen & Associates contracts with more than 70 independent broker-dealers and 15 producer groups. He can be reached at http://www.findabrokerdealer.com, (888) 820-8107, (651) 433-3501, or jon@henschenassoc.com.

Once the dominant player in the industry, carriers seeing reps exit; consolidation puts squeeze on

Independent broker-dealers owned by insurance companies, once the dominant players of the industry, will continue to dwindle in size and importance over the coming decade, unable to keep pace with more nimble competitors that invest in, and increase, investment advisory services for reps.

That’s the assessment of some industry executives.

To underscore that point, one leading group of advisers formerly affiliated withTower Square Securities Inc., which is owned by insurance giant MetLife Inc., left several months ago to work with a leading broker-dealer for fee-based registered reps, Cambridge Investment Research Inc.

In total, 87 registered reps — including some support-staff members with securities licenses — who produce more than $10 million in gross revenue, left Tower Square from July to November to become affiliated with Cambridge, said David Duncan, chief executive of Atlantic Financial Group LLC.

Atlantic Financial, a full-service general agency based in Richmond, Va., with offices in the Mid-Atlantic and Southeast, is the branch that left Tower Square.

“While we have a strong, long-standing relationship with MetLife and Tower Square, our business model is evolving into an RIA, and we wanted to work with a leader in that space,” Mr. Duncan said. “And Cambridge is one of those.”

A spokeswoman for MetLife, Jessica Ong, confirmed that the advisers left Tower Square but added that more than half of the reps decided to stay.

The MetLife broker-dealer group has “experienced significant growth in our fee-based advisory platforms,” she said. “Between both the platforms, we have almost $8 billion in assets under management. These platforms give advisers a wide variety of options in providing fee-based solutions for their clients. Additionally, we also have a number of offices that have well-established independent RIAs.”

Eric Schwartz, CEO of Cambridge Investment Research, declined to comment on the recruiting coup of adding 87 advisers from one team.

In general, however, Cambridge had another strong recruiting year, achieving a net increase of 400 reps and advisers, the firm’s biggest single-year gain ever, he said.

The newcomers generated close to $66 million in annual fees and commissions, known as gross dealer concession, at their previous firms, said Mr. Schwartz, who added that the figure was close to an all-time high for the firm.

Cambridge now has more than 2,000 registered reps and advisers.

“One segment we did well from was insurance broker-dealers, and we typically do well from those,” he said. “The insurance companies don’t seem to be interested in committing the resources to compete.”

In the 1990s, insurance carriers such as ING Group and American International Group Inc. rushed into the independent-broker-dealer channel, snapping up such firms or companies that already owned them. The goal was to broaden the platform to sell insurance products.

While consolidation in the securities industry has occurred over the past few years with numerous small firms, Mr. Schwartz believes such consolidation will occur among the largest broker-dealers, too.

And insurance-company-owned broker-dealers will feel the squeeze, he said.

“In 10 or 12 years, there will be only seven or eight broker-dealers doing 80% of the business, and insurance companies will own only one or two,” Mr. Schwartz said. “That type of consolidation happens in every industry.”

More erosion seen

One industry recruiter agrees.

The ownership of firms by insurance companies “will continue to erode in the broker channel,” said Jonathan Henschen. “Insurance companies make more money on products than on the broker-dealer,” he said.

The shift away from insurance-company-owned firms is now so great that private-equity funds now dominate the market, Mr. Henschen noted.

In 2010, private equity manager Lightyear Capital LLC bought three independent broker-dealers that ING acquired more than a decade earlier.

To be sure, insurance-company-owned broker-dealers are not all cut from the same cloth. Some are vigorously competing in the registered investment adviser market. Others, however, remain tied to a model that emphasizes selling insurance products, industry observers said.

“In the past, independent insurance broker-dealers could offer 100% payout on proprietary insurance products, or have a percentage requirement of proprietary product sales,” Mr. Henschen said. “But those days are gone.”

Multi-Financial Securities signs recruiting agreement for Pacific West reps

If you find yourself in arbitration, following these steps can improve your chances of a decision in your favor

Tampa, Fla.-based Calton & Associates, an independent broker/dealer with over $2 billion in assets, has recently ramped up its marketing and recruiting efforts after flying under the radar for the last 25 years. The firm plans to build itself up through mergers and acquisitions with smaller b/ds as well as by bringing on new reps and RIAs.“The regulatory requirements for a $250,000 b/d, like we are, just continue to mount,” said Dwayne Calton, president and CEO of Calton. “If you’re not growing, you’re dying; you just don’t know it yet.”

To solidify its plans, Calton recently formed a recruiting and marketing agreement with John Simmers, who co-founded IBD Financial Network Investment Corporation, which eventually became part of the ING Advisors Network, and Scott Sherwood, who co-led Investacorp from 1980 through its acquisition by Ladenburg Thalmann. Simmers and Sherwood are both licensed with Calton and will be in charge of synergistic relationships, Sherwood said.

When the firm was founded in 1987, it had 18 shareholders, including Calton and his reps, who simply wanted to create a “safe” work environment for themselves. The firm never advertised; it grew over the years through word of mouth. Also, the group did a lot in the municipal bond space at the time, Calton said. But now, the firm’s business model has changed, with only five of the original shareholders left and about 200 total reps, doing all sorts of investments, including equities, corporate and government bonds, mutual funds, insurance and options. In addition, things have changed on the regulatory front, with greater regulatory fees and requirements facing IBDs, Calton said. All of these factors added up to now being the time to get out there and grow more aggressively.

“It’s a very very expensive business,” Sherwood said. “If you’re not growing and securing quality agreements and securing the knowledge to avoid some of the minefields, it’s a dangerous place to be.”

“I have seen these ‘let’s reinvent ourselves, and bring people in that are good at recruiting and good at repackaging the story, making some tweaks here and there to make the firm more attractive,’” said Jon Henschen, a recruiter with Henschen & Associates, who likened it to the growth of Ausdal Financial Partners in Davenport, Iowa. “So I’ve seen it done.

“It is increased expenses for b/ds, and one way to raise your profitability is to raise your revenues, and economies of scale can help.”

Simmers and Sherwood are tasked with growing the firm, and are also making a few changes to make the firm more appealing to potential reps.

For example, while Calton used to clear only through Southwest Securities, they recently added National Financial Services to its list of clearing firms. New reps that join the firm will also get equity-like participation, as Sherwood calls it. This is not equity shares of the company, but rather a share of potential profitability as a component of their compensation so reps are tied into the success of the firm. Calton also added new technology for consolidated reporting.

Sherwood said they don’t have any quotas as far as new advisor headcount or revenues, but he’s confident they’ll grow steadily.

“There will be spots where, or points where we may grow more rapidly than other points, as other firms maybe lose sight of the things that are important to quality advisors,” Sherwood said. “Sometimes there will be large blocks of folks available. As long as we can provide excellent support for them, and they’re good quality people, we want to be their home.”

Calton is not looking for advisors with any particular niche, except for those with larger practices that should be national in scope, Sherwood said. These are advisors who have more business than they can properly support, such as a radio or TV personality or an FA with a special in with a company. Sherwood said Calton can help these FAs achieve national exposure.

The new effort will also involve mergers and acquisitions with smaller b/ds. The firm is currently waiting for FINRA approval on one b/d asset acquisition of about 35 to 40 FAs, Sherwood said. Other potential deals range up to $28 million.

“Hopefully it’s not so much taking advantage of what’s blown up as it is helping to provide a lifeline of sorts to firms that realize that going it alone, if you don’t have the size, if you don’t have the ability to grow, that there are some alternatives,” Sherwood said.

At Investacorp, Sherwood helped grow the firm from 15 reps and $150,000 in commissions to 500 reps and $65 million in commissions. Simmers grew ING Advisors Network (now Cetera) from zero to over 8,500 advisors and $1 billion in revenue.

Conflicts of interest contributed to insurers’ loosening grip

From 1990 up until a few years ago, insurance companies dominated broker-dealer acquisitions in order to gain greater control over insurance product distribution. In case you haven’t noticed, there’s been a steady flow of insurance companies getting out of the broker-dealer business and focusing on their core business: insurance products.

To be certain, private equity firms are now the dominant players in broker-dealer acquisitions, in part because broker-dealer prices have been driven up to rates that insurance companies aren’t willing to pay. Paying 30% to 40% of revenue was the old pricing model. Today, 50% is increasingly common. When Multi-Financial was originally sold to ING, they fetched a price of 40% of revenue, which at the time was considered a very good offer.

Proprietary Product Dominance Evaporating?

Pricing is only one reason we are seeing less acquisition activity from insurance companies. Another is the fact that these companies’ ability to directly manipulate their reps into selling proprietary insurance products has largely evaporated. This is due to FINRA’s attempt to level the playing field with its edict that broker-dealers not have product mandates or pricing advantages that favor particular products. In the past, independent insurance broker-dealers could offer 100% payout on proprietary insurance products, or have a percentage requirement of proprietary product, but those days are gone.

With these manipulative measures gone, tactics used to sway reps to sell proprietary products are more subtle, but still effective:

• Heavy wholesaler contact on proprietary products and restrictions on competing wholesalers’ ability to initiate contact
• Saturation of proprietary products on broker-dealer website
• Domination of proprietary products at annual conference, reward trips and regional meetings

The conference domination of proprietary products was made evident to me when I attended a Multi-Financial conference (when they were owned by ING). My observation to management that two-thirds of the product vendors were blue and orange (the ING company colors) was quickly rationalized: You will rarely, if ever, see a competing variable annuity vendor in attendance at an insurer-owned broker-dealer conference. If the insurance company also owns money managers, you can bet that competing third-party managers will be few to none. Insurance companies claim their broker-dealers have a level playing field on product, however, this is only true in part. In spite of higher sales of proprietary products from their own reps, the allure of insurance companies to own broker-dealers continues to erode.

Litigation Eroding the Bottom Line

Insurance-company-owned independent broker-dealers have seen a substantial increase in litigation and arbitrations in recent years, which have eaten away at their bottom lines. Client market loss, inappropriate investment sales, lack of supervision fines and problematic alternative investments are a few of the liabilities that have given insurance companies regret, causing them to either consider selling their broker-dealer or be sold, as we’ve recently seen with Securities America.

Financial Upheaval and Politics

The financial upheaval caused by variable annuities that promised too much in living benefits temporarily crippled many former Rock-of-Gibraltar insurance companies. The economic turmoil of 2008 was enough to cause ING to shed all but one of its broker-dealers to help shore up losses in Europe. In good times, insurance companies like to branch out, but when times get tough, they sell outside businesses to focus on their core profit centers.

Besides business cycles, politics with competing non-insurance broker-dealers have given insurance companies additional concerns. In 2008, Jackson National broker-dealers aggressively recruited Pacific Life BD representatives who had been recently bought by LPL. At the time, they were offering unusually high forgivable notes to entice reps to come their way. According to industry insiders, LPL threatened to pull their Jackson National product sales agreements in retaliation. The profitability losses from such a move would dwarf any potential profits from their broker-dealers. The threats resulted in immediate changes in management and recruiting personnel at their lead broker-dealer. According to former recruiters, to this day, Jackson National broker-dealers do not recruit representatives from either LPL or Raymond James Financial.

Company politics aside, new regulations threaten to add to insurance company potential conflict with broker-dealer ownership. A uniform fiduciary standard imposed on brokers by the SEC could become a headache for insurer-owned BDs. Under a fiduciary standard, advisors must put the interests of their clients before their own. A fiduciary standard is most likely to affect captive insurance broker-dealers, but independent insurance-owned broker-dealers could still see substantial downward pressure to their product sales.

Representatives will be caught in a mental tug of war: “Do I offer my clients the best product or do I offer them my firm’s product?” We might see some reps motivated to avoid sales of any broker-dealer proprietary products, wanting to steer clear of any potential perception of inappropriate bias. If the uniform fiduciary standard pushes through, we may be looking at an increase in sales of insurance-company-owned broker dealers going forward.

Ladenburg Thalmann said that it planned to pay Ameriprise Financial $150 million in cash for Securities America in late August. In addition, the Miami-based broker-dealer says it will pay up to $70 million in 2012 and 2013 in so-called earn-outs, as the firm explained in an SEC report. Plus, Ameriprise continues to be responsible for any costs related to the sale of certain private-placements.

News has also been reported about the size of retention bonuses being offered to Securities America’s 1,700 advisors, who are led by Jim Nagengast. (Ladenburg Thalmann says it cannot comment on matters other than what is said in the 8-K filing.)

As for the additional $70 million being promised to Ameriprise, this amount is generous, several sources say, as it pushes the total price tag to about 50 percent of Securities America’s yearly revenue.  “I see this as a large amount,” said Chip Roame of Tiburon Strategic Advisors in an interview. “That’s substantial.”

Others agree. “I thought the initial $150 million was a reasonable price (worked out to around 34 percent of trailing revenue), but any more for a firm with their history etc., would be more than I feel is reasonable,” said Jon Henschen of Henschen & Associates in an interview.

While Henschen says that adding another $70 million is “overly generous, it also depends on what kind of production hurdles they’ve set [for the earn-outs], and if they are realistic. Ameriprise may see little if any of that $70 million,” the recruiter explained.

Overall, says Roame, the arrangement seems to be “a fair price range,” with a caveat. “The price is low if Securities America has rep attrition and cannot get the kicker. The price is average to high, if they keep their reps. It seems like a fair deal all around.”

Litigation Coverage

In its recent filing, Ladenburg Thalmann explained, “Ameriprise has agreed that, following closing of the transaction, it will indemnify Ladenburg for … any and all losses arising out of substantially all claims pending.” This clause includes claims related to the sale of certain securities issued by Provident Royalties and Medical Capital Holdings, which prompted Ameriprise to take a $77 million charge in the first quarter and put Securities America up for sale.

These provisions are earning the acquiring firm praise. “Ladenburg was wise to shield themselves from future liability of those particular products,” said Henschen.

“This is great for Ladenburg Thalmann,” shared Roame, “and it’s literally a perfect agreement. For Ameriprise, though, it’s risky. They know the claims they have on the table now, but maybe more claims will come. I am sure Ameriprise did lots of due diligence on this risk, though, and knows what might happen.”

Retention Bonuses

To help stem any further attrition of advisors, Securities America is said to be offering bonuses to FAs that agree to stay on of about 15 percent, according to Roame. “This seems low, though the cash component is 75 percent, which seems high.”

Culture shock is the top reason advisors look for a new BD

Several years ago I wrote about what motivates advisors to change their broker-dealer. Much has changed since then, so it’s time for an update. This time, rather than basing the reasons solely on our own recruiting experiences, we sought out the feedback of various broker-dealers for greater objectivity. Also, this review focuses on the perspective of advisors who are already at an independent broker-dealer and looking for a new one. We didn’t bring wirehouse advisors into the mix, as their criteria for change are somewhat more static and narrowly focused.