The Pros and Cons of Independent B/D Styles
by Jonathan Henschen, CFS and featured in ProducersWeb
November, 2006:
It would be delusional to think a single broker/dealer can meet the needs of all advisors. Because we see such vastly differing needs among advisors, it’s fortunate there is such a wide variety…Following is a list of nine different styles of independent broker/dealers — along with the upsides and downsides of their business models.
- Small B/Ds — Fewer than 200 advisors
- Medium B/Ds — 200 to 800 advisors
- Large B/Ds — 800+ advisors
- Insurance/Bank BDs
- Stock, bond and institutional BDs
- Advisory focus B/Ds
- Alternative investment focus B/Ds
- Equity participation focus B/Ds
- Marketing and practice management B/Ds
- Small B/Ds — Fewer than 200 advisors
By far the most appealing qualities of small firms are flexibility and personal attention. It’s the big-fish-in-a-small-pond feeling that makes advisors feel significant and is conducive to building strong relationships with back office staff. Smaller firms are better able to mold to advisors’ individual needs than larger firms. For example, compliance bureaucracy is at a minimum, so approval of seminars and marketing materials is usually faster. The concerns with smaller firms tend to be over such matters as capitalization and breadth of services.
Pros
- Flexible on adding products
- Low bureaucracy
- Personal service
- Quick compliance
- Rep friendly and rep driven
Cons
- Limited range of services
- Capitalization
Medium B/D’s — 200-800 advisors
We do a lot of recruiting to medium-size firms. Our experience has been that they offer the best of both worlds: the flexibility of smaller firms but enough revenue to ensure that advisors don’t have to be as concerned with capitalization. Most medium-size broker/dealers offer a wider array of services than small firms, beyond just processing business.
Pros
- Flexible on adding products
- Low bureaucracy
- Personal service
- Greater financial stability
- More infrastructure than smaller firms
Cons
- Fast growth at this size can negatively impact service
- Not quite as flexible as smaller firms
- Slightly more bureaucracy than smaller firms
Large B/Ds — 800+ advisors
Large firms have their appeal. They offer a depth and breadth of services — such as financial/estate planning departments, practice management and marketing support — unavailable at most smaller firms. Larger firms are financially sound, with possible name-branding adding to their allure. Annual conferences and large-producer reward trips can be very high-end, with guest speakers like Steven Forbes or Rudy Giuliani inspiring the crowds at Westin or Four Seasons Resorts. However, these bells and whistles come at a cost, with higher fees for additional services whether you use them or not.
Pros
- Depth and breadth of support services
- Elaborate conferences and trips
- Financially secure
- Possible name branding
Cons
- Inflexible
- Higher bureaucracy — slower on compliance approval and more disclosure forms
- Higher costs
- Quality personal service can be hit or miss
Insurance or bank B/Ds
Insurance or bank broker/dealers have many traits of large, independent firms, but insurance and banks are more risk-averse. Upper management of insurance or bank broker/dealers serves two masters: the advisors of the broker/dealer, and management of the insurance company or bank. At times the needs of these two masters
clash, and the advisor is usually the loser. Insurance-based broker/dealers are also the least profitable broker/dealer model, with many of them losing money. Insurance companies usually can live with their losses, as long as they’re not excessive and the advisors are selling large amounts of the insurer’s proprietary products. Not to throw the baby out with the bath water, but we have uncovered a few insurance-based broker/dealers that cultivate a rep-friendly culture, while maintaining flexibility and profitability.
Pros
- Depth and breadth of services
- Elaborate conferences and reward trips
- Financially secure
- Possible name branding
Cons
- Inflexible
- Management serves two masters
- Service problems more than most other B/D types due to back-office consolidation and mismanagement
- Risk-averse nature of insurers and banks
- Risk of direct or indirect proprietary-product pressure
Stocks, bonds and institutional B/Ds
As many firms shun traditional stock brokers, a handful of high-quality firms remain loyal to servicing the transitional model. The needs for servicing these advisors is specialized, with their wish list including an experienced and efficient trading desk, the ability to have DVP accounts for institutional clients, the ability to do principal trades, block trading and the flexibility to negotiate on ticket charges, such as flat ticket charge on stock or bond trades. The downside to these specialized firms is the high risk of customer complaints from retail stock and bond clients, which adds to potential compliance liability.
Pros
- Specialized to service needs of stock and bond traders
- High-quality trading desk
- Flexible on ticket charges
Cons
- Capitalization concerns
- High-compliance liability with retail clients
Advisory focus B/Ds
Most broker/dealers offer advisory help, but a select few feature advisory issues as their primary focus. An advisory practice is predictable, experiences fewer compliance complaints, and is worth more when it’s sold. For firms focusing on advisory, flexibility is a key factor, including the ability to have your own RIA, add third-party managers, and work with outside sources such as Schwab or TD Ameritrade. Many of these firms have set up their own administration at bargain rates, (typically, five to 10 basis points), for platforms where the advisors direct the assets. These firms will also allow 12-b1 fees to flow through to advisors in both qualified and non-qualified accounts. Some also offer higher than usual payouts on the advisory portion of advisors’ business up to 95 percent.
Pros
- Flexible on third party and separate account managers
- Ability to have own RIA
- Lower administration fee on self-directed wrap platforms
- In-house advisory administration that can be plugged into Schwab or TD Ameritrade
Cons
- Larger advisory-focus firms may have less flexibility on third-party manager choices or ability to add managers
- Smaller advisory-focus firms may have capital issues
Alternative-investment focus B/Ds
With mutual fund and variable annuity choices increasingly commoditized, one way a firm can stand out on products is by being broadly based in alternative investments. Having just a few REITs and limited partnerships doesn’t cut it anymore — advisors need a firm entrenched in 1031 TIC offerings from a wide selection of vendors, with equipment leasing, oil & gas partnerships and futures funds filling out the needs of accredited investors. Other investment outlets — living benefits and medical receivables, for example — are also high on the list of many advisors seeking to meet their clients’ investment needs. Many firms have beefed up their alternative investment choices over the last couple of years, but only about 10 significant firms push the envelope by offering broad choices in this arena.
Pros
- Broader alternative-investment selections than most firms offer
- Timely participation in 1031 offerings
- Accommodate specific needs of accredited investors
Cons
- Higher-risk investments with less liquidity raise the risk of more customer complaints
- Higher reserves of excess net capital needed by firm as a safeguard
Equity-participation B/Ds
If you’ve been part of a broker/dealer that has been sold out from under you, you’ll relate to firms that stress equity participation. When a firm is sold, the president and perhaps a few others in management, make a fist full of dollars while the advisors are typically left out in the cold. Advisors who have experienced just that want to benefit financially if their broker/dealer is sold.
The parameters for how stock is received varies, with some firms giving stock options based on production, and others making stock available for purchase, or a combination of both. The amount of ownership varies greatly, with some firms making 20 percent of the firm under advisor and staff ownership, while others will go up to 100 percent ownership. Stock valuation can be complex. Some apply a value by an internal valuation matrix, or firms plan on going public to give value to their stock options. Others offer options that have value only if and when the firm is sold.
Pros
- Advisor has ownership in the firm
- Potential for large payday
- Can be motivating bridge-builder for staff and advisors
Cons
- Firm can go under leaving advisor with nothing (as happened to Integrated Resources)
- Some argue, why invest my money in a business that is marginally profitable when I could invest in a quality growth stock?
Marketing and practice management B/Ds
A growing trend among broker/dealers is helping advisors use technology to run their offices more efficiently and help them grow their books. Some firms commit substantial dollars and staff to support their advisors, while others outsource these support functions to companies specializing in this area. The rationale for providing these services is saving advisors time so they can spend more of their time in front of clients, thus increasing production. Ultimately, a broker/dealer’s investment in practice management and marketing support services pays for itself — and then some. Presumably, more firms will catch on to the value of these advisor benefits, but for now, only a few firms are deeply committed to them.
Pros
- Run office more efficiently
- Gather more assets
- More effective marketing
- More time for clients
- More time for family
Cons
- Some advisors don’t need marketing help and already operate their operations at peak efficiency
With all the choices advisors have, how is an advisor to know which of the over 500 independent broker/dealers is best for his or her particular needs? To cloud matters even further, every broker/dealer will tell advisors they have great service, technology and high flexibility. If you’re an advisor who wants to find a broker/dealer that best fits your style, temperament and needs, we can help you to do the necessary homework about the various types of firms out there so you can stay focused on what you do best: helping clients with their financial needs.