(Dow Jones) The lingering downturn is slimming the ranks of smaller and less sound regional and independent broker-dealers.
Like other industries, the broker-dealer business is experiencing "a low-end washout," says Bing Waldert, a director at consultancy Cerulli Associates. "Tough times are tough on those who aren't financially sound."
While no one tracks the number of regional or independent broker-dealers that have gone out of business, analysts who track the industry say that at least a dozen have closed their doors due to insufficient capital or issues with complex investments like private placement in just the last six months.
Overall, the industry has shrunk, but much of that has resulted from consolidation. The Financial Industry Regulatory Authority oversaw 4,676 brokerage firms in May 2010, down from 5,005 in 2007, according to the regulator's web site. Those numbers include various types of brokerages.
Among the struggling firms is Jesup & Lamont Inc., which said Tuesday that it would terminate all non-essential personnel with the exception of a few executives and some other limited staffers. Finra ordered the small investment bank and brokerage firm, which has 200 total employees, to cease conducting a securities business, other than liquidating transactions, because of its failure to meet net capital requirements.
Another small broker dealer, Chicago Investment Group, is merging with Newbridge Securities Corp., said Bob Acri, a former president of the firm who stepped down about a year ago. The issues facing the company-which had about 60 advisors a year ago-were similar to those Jesup & Lamont faced, Acri said. "There was a requirement to boost up capital," he said, "and the merger was the best way to do it."
Acri now is president of Chicago-based Kenilworth Asset Management, a registered investment advisor. He believes a combination of factors is putting pressure on smaller broker-dealers, including the economic downturn, an increased focus by regulators on broker-dealers' net capital positions and more coordination between regulators.
His firm just had its first audit by Finra and about three-quarters of the time was spent on documents related to the company's net capital, he said.
A Florida-based broker-dealer, GunnAllen Financial Inc., was shut down by Finra earlier this year after it fell below mandatory net capital requirements. The firm later filed for bankruptcy. Great American Advisor, a subsidiary of Cincinnati-based Great American Financial Resources Inc., a member of the Great American Insurance Group, has also said it plans to exit the retail broker-dealer business next month to focus on its core insurance and annuity operations.
Some of the firms were operating close to the bone, with advisors managing as little as $4 million-hardly enough to draw a payout to live on, let alone cover firm expenses. "This isn't the cream of the crop we're losing here," Waldert said. "These aren't the big registered adviser firms shutting down."
Alois Pirker, an analyst at Aite Group LLC, a Boston research and consulting firm, says, "What's happening in the market right now is that, on all levels, there is a little shifting of market share."
"Some folks are getting stronger that have used the crisis to beef up, and others that weren't as lucky-and the capital situation is probably a good reason for it-are actually having troubles," he says.
Some broker-dealers have run into problems selling private placements that later turned out to be fraudulent. In one case, a court-appointed trustee last month sued more than 45 broker-dealers, several of which are now shut, to recover at least $251 million in damages plus interest and seek the return of all commissions received for the sale of Provident Royalties LLC private placements. The deal, which supposedly involved oil and gas royalties, was later exposed as an alleged fraud. The broker-dealers "permitted a massive financial injury to take place to debtors and thousands of individual investors," the suit says.
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