By Dan Jamieson
March 3, 2014,Financial Advisor
Can Nick Schorsch really pull off his plan to create a new major player in the independent broker-dealer space?
The industry is watching intently as the firm Schorsch controls, RCS Capital Corp., begins the arduous task of putting together what will be one of the biggest players among independents—with more than 9,000 advisors and around $200 billion of client assets.
Publicly traded RCS Capital (RCAP) boldly staked its claim as a major independent firm in January when it agreed to buy Cetera Financial Group with its nearly 6,700 advisors and $145 billion in client assets, quickly followed by another deal, for J.P. Turner ($4.3 billion in assets and 325 advisors). Those acquisitions followed earlier purchases of First Allied Securities, Investors Capital Holdings and Summit Financial Services, all of which were announced in the latter half of last year.
Industry observers are intrigued with how RCS Capital will integrate its whirlwind of acquisitions and keep advisors happy at the same time. “A year ago no one had heard of Nick Schorsch unless they were into non-traded REITs. Now, he’s a dominant player in the marketplace,” says recruiter Larry Papike, president of Cross-Search.
Schorsch, who made a name for himself shaking up the non-traded REIT business at American Realty Capital, says the opportunity in the retail advice game is obvious, given that advisors are increasingly going independent. “There’s great scale and synergy” in consolidating broker-dealers, he says. “You’re talking about nearly $2 billion of revenue [for the combined RCS Capital firms] so with the economies of scale, as you get bigger, margins improve.”
Observers expect the highly acquisitive Schorsch to announce even more deals. Schorsch says he’s always looking for opportunities, “but we’re not going to do acquisitions for acquisitions’ sake. Our growth right now is organic.”
Using a high-margin asset management business to build scale in the low-margin broker-dealer business via a publicly traded company is not a crazy idea: Ameriprise Financial, AIG and others have followed similar strategies.
No one executed this strategy better than Eli Broad, who began buying annuity companies and broker-dealers in the late 1980s. Over a decade he built SunAmerica into an asset management company, an insurance carrier and a broker-dealer network with 10,000 reps. In 1998, he sold it to AIG for $16.5 billion. Significantly, Broad let all the separate brokerages keep a degree of autonomy, though he was a demanding executive.
Access to cheap capital provides for growth, and liquidity for shareholders results in higher valuations compared to privately held B-Ds. “It makes a lot of sense for a public company to make acquisitions of smaller non-public broker-dealers that are accretive to earnings,” says Doug Dannemiller, founder of consulting firm Dannemiller Analytics & Consulting LLC.
Size and scale help “with recruiting [and] adding the bells and whistles you need to compete,” he says. “It’s still early in the transformation of the small broker-dealer market, from a fragmented market toward [one] powered by larger firms that are more efficient and effective.”
Smaller firms must rely on outside vendors for critical support functions like clearing and technology, and they have more difficulty covering growing costs like compliance. Larger firms can negotiate better vendor contracts, revenue-sharing deals and sponsorships from providers, and maximize profits from customer cash balances.
“LPL is more profitable [than competitors] because it self-clears and has a trust company, so they keep it all in house, which is higher margin,” Papike says. LPL’s ticket charges, for example, go “straight to the bottom line.”
Self-clearing is “certainly something we will look at,” Schorsch says. “It could be dual clearing, or in partnerships with other firms. We see a lot of opportunities” to gain scale in the back office.
Beyond operations, Schorsch envisions building an integrated firm with investment banking, research and trading to go along with an investment platform focused on alternative products. RCS Capital’s wholesale product distribution business, Realty Capital Securities, run by industry veteran Larry Roth, will be the foundation for the investment platform. Roth will continue to run the wholesale business, Schorsch says.
Roth, the former chief executive of the Advisor Group, the four broker-dealers owned by American International Group, joined Schorsch’s operation last September to run the distribution unit. The move puzzled some observers who wondered why a well-regarded executive in the independent B-D space would make the switch to wholesale product sales.
Roth said at the time that the entrepreneurial culture at Realty Capital Securities was a new challenge. He is believed to be building out a platform of alternative investments that includes non-proprietary real estate vehicles, alternative mutual funds and other instruments.
Realty Capital Securities has been adding some ’40 Act funds to its arsenal, and is in the process of buying the Hatteras Funds Group, a boutique liquid alternatives sponsor. According to sources, the goal is to have about 40% to 60% of these investment vehicles managed by outside third parties, not Realty Capital Securities or any of its affiliates.
Roth was not available to comment for this article, but has told investors that he is consulting the firm on its B-D acquisitions. “It doesn’t make sense that you wouldn’t use [Roth’s] talent as a consolidator” of retail firms, Papike says. Many think it is more than a coincidence that most of the firms in the Cetera network were acquired by ING, which Roth ran until 2001.
Roth “understands independent broker-dealers as companies, he has a lot of exposure to advisors, and understands what products might resonate and where reps might push back,” says David DeVoe, managing partner at consultant DeVoe & Company LLC.
The bulk of the wholesale business is done through independent broker-dealers but the firm is looking to diversify into other distribution channels. “We’ve done some on wirehouse [platforms] and we’re doing a lot on the RIA platforms,” Schorsch says.
Unlike most rivals, American Realty and the distribution unit began offering no-load REITs to RIAs in 2009. That channel now accounts for about 15% of sales. Might RCS Capital get into the RIA custodial business? “I don’t think so,” Schorsch says. “That’s not where we’re focused.”
The plan is to add more outside offerings for the combined broker-dealers, especially alternative investments for retail investors who still own relatively few non-traditional products compared to the institutional market. Average investors haven’t had access to quality alternatives, Schorsch says. They have “missed out on the endowment model of investing,” which is popular among larger institutions that put large stakes into private equity, hedge funds and hard assets. And “advisors are looking for a place where they can get truly independent product and service their clients better with more diverse products,” Schorsch says.
Part of Schorsch’s game plan seems somewhat reminiscent of LPL, which also serves a “mass affluent” client base defined as those with $100,000 or more in assets. And LPL has its own high-end investment platform, Fortigent, which provides alternative third-party products among its offerings.
But Schorsch’s plan is not the LPL business model, says Derek Bruton, managing director at LPL. “The genesis of [Schorsch’s] business comes from a product background,” whereas LPL doesn’t have proprietary products, he says. “I don’t know where exactly he’s going with that” model.
Whatever RCS Capital’s strategy turns out to be, Schorsch will get the most out of his managers, says Dan Seivert, chief executive of consulting firm Echelon Partners. “He is what I would call a hard-charging manager, so he might manage these businesses harder than their previous owners,” Seivert says.
But “sometimes when you redline it, you get great results, and other times it produces collateral damage” with unmotivated staff and turnover, Seivert adds. “You have to get the right balance.”
All the talk from Schorsch about building out the investment platform hasn’t helped quell concerns that he may be following the old insurance company model of buying broker-dealers for purposes of selling product—in his case non-traded REITs from American Realty Capital, a $12 billion REIT manager that Schorsch co-founded and still runs.
“There’s some suspicion that he’s trying to set up a massive distribution system for his REITs,” says Ron Edde, director of advisor recruiting at Millennium Career Advisors. “That’s the only way [Schorsch’s acquisitions] make sense, especially for the prices he’s paying.”
But having sold nearly $9 billion in REITs last year, Schorsch doesn’t need more distribution, countered Papike. “All the firms he purchased are already doing tons of business through him,” Papike says. “His track record has been so good, it’s easy to sell that product.”
Schorsch makes the same argument, pointing to his selling agreements with an existing network of 370 broker-dealers. Pushing proprietary products simply wouldn’t work, he acknowledges. “We’re going out of our way to make clear that’s not the thrust,” Schorsch says. “We’ve done everything we can to distance ourselves from any affiliated product,” such as separating RCS Capital from American Realty Capital.
RCS Capital’s predecessor firm was spun out of American Realty Capital in 2012, going public last year in June. In 2013, Realty Capital Securities, the wholesale distribution business, raised $8.7 billion for non-traded REITs and business development companies, up from $3 billion in 2012. About two-thirds of sales are in American Realty products; the rest are non-affiliated, but Schorsch wants to flip that ratio over the next three years. That would mean outside products would constitute about 95% of the mix at his stable of broker-dealers, he says.
But simply focusing on the product side ignores the key growth strategy for Cetera, which is working with advisors to raise the bar on professionalism, says Steve Dunlap, executive vice president of wealth management for Cetera Financial Group. That means “paying attention to the practice management side, the human [employee] talent, client presentations, how they handle investment management, create portfolios, choose products and how they deliver information to clients,” Dunlap says. “It’s also the brand they’re building, how they market their practices and their own professional development.”
That kind of practice-management support may help organic growth, but RCS Capital may have trouble aggressively recruiting. If its own broker-dealers poach talent from customers of its distribution business, they risk disrupting those sales relationships.
It’s a scenario the industry has seen before. In 2007, in the midst of integrating three broker-dealers it bought from Pacific Life, LPL successfully leaned on Jackson National Life to get its B-Ds to back off of recruiting from LPL’s new firms. LPL’s leverage: a threat to yank Jackson National products from LPL’s platform.
It’s too early to tell how Realty Capital’s broker-dealers plan to recruit. But if those firms came after reps at Cambridge, “those discussions would definitely happen,” says Amy Webber, president of Cambridge Investment Research Inc., which sells some American Realty products.
What is clear is that so far Schorsch has preferred to acquire entire broker-dealers outright rather than negotiate with individual offices. It is believed that the owners of Cambridge and many other firms have received acquisition overtures. And the fact that only five B-D transactions have been announced to date doesn’t mean there won’t be more.
Dunlap, though, feels recruiting and retention were just made easier. Why? The sale to RCS Capital answers the one big question Cetera advisors and recruits had about the firm: When is Cetera going to be sold?
The deal “takes us straight to the end game,” Dunlap says. “In being owned by a private equity firm, it was clear a transaction was in our future at some point. Now we have a strategic [owner] with access to capital.”
Some advisor attrition won’t be avoided as RCS Capital takes over its newly acquired broker-dealers. That happens in any merger, observers say. The key thing is keeping the bulk of the top offices on board.
Schorsch is promising no major changes, at least for now, which should help convince advisors to at least give him a chance.
“Most advisors are fiercely independent,” Papike says. “If they feel the [new] broker-dealer is exerting too much control, like if [it decides] to self-clear, that’s going to be a problem.” In 2009, LPL reportedly suffered some attrition when it moved advisors who had been affiliated with Mutual Service Corp., Associated Securities and Waterstone Financial to its own clearing platform. The change ruffled feathers because LPL had initially promised to keep the existing clearing relationship with Pershing LLC.
All the broker-dealers RCS Capital has acquired also clear through Pershing, which Schorsch says should ease integration. But he hasn’t ruled out self-clearing at some point.
Another risk: evolving into a mammoth bureaucracy where advisors at the legacy broker-dealers lose their cherished culture. “I’m sure there will be some sort of consolidation that takes place … because you don’t want seven different compliance departments or trading departments,” Papike says.
“But how they do it will determine whether they stay as one of the major players” or lose large numbers of advisors to competitors, he says. “If they do what they say they’re going to do and keep everything separate and let them run on their own, that could be a benefit in that they can take the best of breed from each firm.”
Cetera, formed in 2010 following the sale of ING’s broker-dealers, has tried to keep its four platforms somewhat distinct. It rebranded its broker-dealers in late 2012, using the Cetera moniker for each firm, but kept separate management for each one.
Cetera Advisors (formerly Multi-Financial Securities Corp.) caters to individual practitioners. Cetera Advisor Networks (the old Financial Network Investment Corp.) supports advisor teams through a more closely managed branch network, while Cetera Financial Institutions serves banks and credit unions and Cetera Financial Specialists provides tax and accounting professionals with investment services. Schorsch says RCS Capital will use the Cetera platform as a “hub” for the parent company’s broker-dealers.
Dunlap says it’s too early to talk about specific plans for the firms, but the new owners “don’t want to change Cetera—they want us to stay as Cetera.”
Each of the Cetera broker-dealers “has its own leadership structure and its own resource-center people to deliver service that makes [the broker-dealer] feel like home” to advisors, Dunlap says. “They [advisors] actually use words like that—having a home.”
Operations are done in one central place. “We leverage where we can without losing individual capabilities,” he says.
“I think it’s a smart model,” says recruiter Jon Henschen of Henschen & Associates LLC, who recruits for Cetera Advisors. “Reps are happy with the service [and it’s] a less expensive way to do it … where some things are centralized and others are not.”
Can RCS Capital and Cetera retain the homey feel they want with an even larger and more diverse collection of firms under common ownership? “I believe we can,” Dunlap says. “I’ve seen that we can do it with 7,000” advisors at Cetera.
Schorsch echoes that thought. “The core culture [at the firms] is really the key thing. It’s probably the most important part of this business. … We’re keeping the cultures all separate, keeping the names, and the same management teams are in place.”
“Most of us are taking a wait-and-see approach,” says Mark Carruthers, an advisor affiliated with Cetera Financial Specialists. “We’ve been around this block before,” he says, when his prior firm, C.J.M. Planning Corp., was bought by Genworth Financial Inc. in 2005 and ultimately acquired by Cetera.
“Each time, we saw more money go into technology and helping advisors serve their clients,” Carruthers says. “We expect the same” with RCS Capital.
Observers warn that a consolidation of this size won’t be easy. If it hits snags, competitors will swarm. Integration will be “a lot more complicated than what [Schorsch is] talking about,” says Mindy Diamond, president of Diamond Consultants LLC, who recruits for competing firms. Cetera has gotten more bureaucratic as it’s grown, Diamond says. “It was not entrepreneurial before this [deal], and I expect that to get worse.” She expects Cetera to lose some of its top producers after the honeymoon period ends.
“There will be some advisors who don’t want to be with the next Merrill Lynch,” Webber says, recalling comments Schorsch made about becoming a Merrill Lynch type of integrated firm for the independent world. If that’s the case, “we’ll certainly be willing to talk to them,” she says.
LPL’s Bruton is thinking along those lines as well. “We’re watching [industry] consolidation pretty closely,” he says. “Consolidation always presents opportunities … because not everyone wants to join one of these consolidated firms.”
The Best Thing That Ever Happened To Schorsch
After Nick Schorsch was ousted from American Realty Finance Trust, a publicly traded REIT, he moved in 2007 from his hometown of Philadelphia to New York and started American Realty Capital, among other entities. In retrospect, getting forced out by friend and partner Lewis Ranieri may have been the best thing that ever happened to Schorsch.
Schorsch began raising money for his new non-traded REIT just as the real estate market was collapsing around the world. In contrast to giant rivals like Wells Capital that had raised billions earlier in the decade and were fully invested in 2007, American Realty Capital (ARC) found itself perfectly positioned to take advantage of a battered real estate market in 2009 and sell shares of easy-to-understand, single tenant net leases to companies like Walgreens and CVS.
Schorsch wasted little time shaking up the non-traded REIT business. He freely criticized competitors and slashed his own fees to help his deals achieve dividend coverage, something his rivals didn’t always do.
According to The Philadelphia Inquirer, Schorsch opted not to take ARC public four years ago and charge a percentage of assets like most publicly traded REITs do. In doing so, he walked away from $114 million in fees on one deal, telling his stunned accountants, “It’s the right thing to do.”
Don’t cry for Schorsch. He has become a billionaire by realizing that if the non-traded REIT business was going to survive in the post-crisis environment, real estate companies would have to change their fee structure and give investors a better investment experience. “He said if investors don’t win, no one wins,” says Robert A. Stanger & Co. managing director Kevin Gannon. ARC doesn’t take internalized compensation and doesn’t receive any fees until investors get a 6% return. Between 2011 and June 30, 2013, three of its unlisted REITs returned gains of between 22.5% and 33.6%, according to Gannon.
ARC also managed to monetize deals quickly at a profit, creating liquidity by merging private REITs with public vehicles and bringing other deals to the public markets. Historically, investors in non-traded REITs have waited years for liquidity events while sponsors rake in large fees.
Timing and luck have also worked in ARC’s favor. Schorsch is “smart, gutsy and lucky that interest rates have stayed so low for so long,” Gannon says. “He’s used a lot of leverage with variable rate financing, which he is in the process of fixing [interest on his debt] right now.”
As he diversifies into areas outside of real estate, the question is can he hold it all together.