There's a point in every movie that screenwriters sometimes refer to as the part where "the bad guys close in." It's the point when the antagonists, stunned at first by the hero's actions, regroup and get in some blows of their own. Call it The Empire Strikes Back.

And the broker-dealer industry has its share of antagonists striking back, including their brokerage rivals, who are trying to hold on to advisor talent, and the huge legislative and regulatory apparatus lined up against the entire financial services industry.

After a cool-down period last year for high recruiting bonuses, headhunters say companies like Morgan Stanley and Bank of America/Merrill Lynch are once again throwing down the gauntlet and offering big checks to hold on to their prized advisor talent and keep it from going to independent broker-dealers and RIA firms.

"Three or four months ago, Merrill Lynch raised their deal to 300%," says recruiter Mindy Diamond, who works with both wirehouses and broker-dealers. In other words, the company was, for a few weeks anyway, offering bonuses of three times the broker's last-12-month production. "As a result," she says, "this forces deals up everywhere. Morgan is paying 330% for 'quintile 1' advisors and 280% for 'quintile 2' advisors. These were ultra-aggressive. We've never seen deals like this."

The main trend is that brokers are still leaving to go independent, she says, but it's become harder for the top talent to ignore these huge payouts for the sake of setting up their own shops-a choice which can bring a raft of nettlesome small business hassles. Not everybody has the entrepreneurial gene.

Also pushing back against the industry are the G-men. After years of indulging an environment of rampant deregulation, Washington is reasserting its authority over financial services with thick reams of bills and amendments wending their way through the paper canals of Congress. Indeed, on December 11, the House of Representatives passed a sweeping reform bill its authors called the most ambitious since the reforms of the Depression. Among other things, the House bill establishes a consumer financial protection agency, tightens regulations on financial instruments like asset-backed securities and offers regulators more scrutiny over financial companies so big their collapse could bring the economy to its knees. If that weren't enough, the bill could bring a bit more personal pain to broker-dealers, as it demands that they bring their standard of client care into tune with people giving advice in different service channels (such as registered investment advisories).

Operational Woes
Just in terms of doing business, 2008 was a bittersweet year for the B-Ds. Though the turmoil on Wall Street offered many firms the chance to snatch up new talent and bring in their prized accounts, companies such as TD Ameritrade, Raymond James, LPL and Commonwealth saw their bottom lines sag with the plunging asset values in the market. The chill in the markets, which didn't begin to perk up until last March, forced these companies to streamline operations. Some consolidated and slashed staff. Others cut pay.

"When the market price of the assets go down and the value of the account goes down, then obviously the amount of fees that you charge goes down as well," says Chet Helck, COO of Raymond James Financial. "And so you know that your revenue stream is going to be down similarly to what asset values are down, and that happened for us."

Also falling at Raymond James, he says, was transaction business, as skittish investors sat on the sidelines with cash. Interest income declined as well at a time when short-term rates fell to almost zero.

Those issues are hardly unique to Raymond James. TD Ameritrade said in its recent 10-K that its asset-based revenues fell 26% for the year ending September 30-to $1.10 billion from $1.49 billion the year before. Those figures include losses in net interest revenue, insured deposit account fees and investment product fees, though better transaction revenue due to intraday trading helped the company's bottom line. LPL Investment Holdings, meanwhile, saw declines in commission revenue, advisory fee revenue, asset-based fees and interest income for the nine months ended September 30 from the same period the year before. Total revenues for the period were off 17%.

One response to the turmoil has been to cut staff, a tack taken by both TD Ameritrade and LPL Investment Holdings. Meanwhile, in its effort to streamline operations, LPL consolidated three of its affiliated broker-dealer operations-Associated Securities Corp., Mutual Service Corp. and Waterstone Financial Group and brought them onto its LPL Financial platform.

"When the world kind of fell apart in October [2008]," says LPL's Bill Dwyer, president of national sales and marketing, "we were able to do a step back and say, 'What's the opportunity set going forward?' Top-line revenues were going to drop. We wanted to be prudent about spending-more importantly, what we saw were opportunities to grab market share-so we made strategic moves to streamline the organization and [move] resources to existing advisors."

After past downturns, companies could take advantage of the many baby boomers rushing back into the market and reinvesting to position themselves for growth, Dwyer says. But now these boomers are poised to retire, and will likely take more conservative positions in low-yielding assets. This, too, will hurt the broker-dealers' bottom lines. He stresses, though, that he thinks it will be harder for smaller broker-dealers than for larger firms like his own.

"For many firms," he says, "just operating profitability will be a challenge as you look at consumers paying less for advice [and look at] less asset growth in client accounts. Clients' risk tolerance should be down, so their returns are less. You're just going to see that the opportunity to operate profitably is going to be challenging for many firms."

John Rooney, a managing principal at Commonwealth, a private company, said that the owners of his firm took pay cuts this year in response to declining asset levels. But he said that the firm was able to avoid staff cuts.

"We took a material cut in pay but we did that because we wanted to avoid laying off anybody. We take bonuses; we still match 401(k)s. But benefits haven't changed a lick, and frankly my head count has grown this year because I took advantages of layoffs at some of my competitors."

While some of the figures may look glum, the outlook for independent broker-dealers may be sunnier than first appears. Because the accounts new advisors are bringing over into this independent channel have likely been beaten down by the bear market, they haven't shown their true potential yet in broker-dealer earnings.

A case in point is Raymond James, writes Morningstar analyst Jason Ren. "We don't expect robust growth from [the company's] investment advisory fees or investment banking, but we think that its growth in financial advisor headcount, up 8% year over year, wasn't reflected in its 2009 earnings due to general market declines and skittish clients."

B-Ds in general have managed to maintain a profile of independence free from the stains of Wall Street sin. Nonetheless, firms such as TD Ameritrade and Raymond James were hurt by auction-rate securities, the long-term, variable rate debt instruments that froze up in 2008 when the Dutch auction mechanisms they use stopped working. Some $330 billion in these supposedly cash-like instruments suddenly became traps, and many institutional and high-net-worth investors found themselves unable to get their money out.

The SEC and state attorneys general stepped in and settled with several firms that had sold these securities, including TD Ameritrade, which agreed to redress clients (it had received tenders for some $271 million as of October 26). Charles Schwab and Raymond James, however, were notable holdouts against settlement, claiming that they were not responsible for the underlying failure of the ARS market. Raymond James still had $750 million in ARS sitting on its books at the end of the year (from a high of $2.2 billion in 2008), and repeated its claim in its SEC filings that it didn't have enough capital necessary to pay clients back their money immediately.

"The number outstanding in client accounts have gone down dramatically but still it was way more than we wish it were and we're trying everything we can to get clients restored to liquidity," Helck says. "It remains a problem until all those clients have 100% of their money back and we're working hard to make that happen."

The Regulatory Burden
As broker-dealers try to bounce back from a poor market that's sapped revenue, they meanwhile face a chilly regulatory environment as lawmakers scramble to curb the rampant abuses that led to the credit crisis and the Great Recession. A lot of these changes, say industry advocates, are going to pinch smaller broker-dealers the most, who they complain had little to do with Wall Street venality.

David Sobel, a director at the National Association of Independent Broker-Dealers, puts it this way: "Do you remember the Billy Joel song 'We Didn't Start the Fire'? Well that's about it. The small and medium size firms didn't start this debacle, and yet it's the small and medium size firms that are going to end up paying for it with overregulation, with additional expenses. All of these things which should have been done with a surgical strike rather than a Hiroshima kind of strike. They're killing small firms."

He notes that the fees B-Ds have to pay to help fund regulation are spinning out of control. In March, the Securities Investor Protection Corp. (SIPC) markedly increased assessments it charged to members from a flat fee of $150 a year to a whopping one-quarter of 1% of net operating revenues. FINRA, meanwhile, has doubled its personnel assessment fees. Firms with one to five registered reps and principals have to pay $150 for each person, double the amount from the previous $75, while firms with six to 25 reps now pay $140 per, and those with 26 or more pay $130 each.

Meanwhile, last summer new legislation emerged that could stop employers from designating their employees as independent contractors, a move that's mainly meant to attack abuses in other industries but one that could have unintended consequences for the broker-dealer world.

"In our world we have tax professionals that own their own tax practices," says Roger Ochs, president of broker-dealer H.D. Vest. "What that would mean would be that all the firms out there that have independent contractors ... those folks would be recharacterized as employees and that would totally change the dynamics of the whole industry."

And then there is the fiduciary issue. The Wall Street Reform and Consumer Protection Act of 2009 that passed in December calls for, among other things, a harmonization of fiduciary standards for financial advice providers, requiring all of them, whether they are RIAs or broker-dealers, to be held to the same standards of care under the Investment Advisers Act of 1940, even if they sell on commission. (Similar language was included in a Senate version.) When a broker-dealer rep sells proprietary products, he has to serve notice to each retail customer and obtain his consent or acknowledgment.

Broker-dealers have balked at having to adhere to a fiduciary standard that they say has several definitions under different laws and that doesn't respect their business model. They say being held to the same standard as their RIA cousins isn't fair because they are already well regulated (by FINRA).

The Financial Services Institute, a membership group for broker-dealers and advisors, had come out against the House bill before it passed. Dale Brown, the institute's CEO and president, says that raising broker-dealers to the '40 Act standard will favor one form of business compensation over another and have the unintended consequence of eliminating client choice or making some pricing out of reach of the smaller investor.

"For a single uniform standard to be effective, it's got to work for all client situations and across all business models," Brown says. "It cannot favor one form of business compensation method over another. In other words, it cannot have the unintended consequences of eliminating client choice or restricting or making pricing out of reach of the small investor."