The U.S. Department of Labor’s final fiduciary rule may not be the death knell of small broker-dealers, but no one in the industry thinks it will help the little guys (defined by Finra as those with fewer than 150 reps), who are already struggling from regulatory and cost pressures.
Brokerage industry executives have been busy consulting with legal advisors and trade associations about what the DOL rules will mean, and what they might cost. So far, there are few clear answers. “By fall, we should have a better idea” about specific actions to take, says Robert Keenan, chief executive of St. Bernard Financial Services in Russellville, Ark., which has about 50 reps.
The DOL “did us a favor, [by extending the compliance deadline] so we’ve got time to digest this,” Keenan says.
Advisors, too, are concerned about the repercussions. The rule has scared many, says Jodie Papike, executive vice president of Cross-Search, a recruiting firm. “Their feeling is, ‘I don’t know what the DOL rule means, so I sure hope my B-D does,’” Papike says.
Recruiters say some of their prospects are leaning toward bigger firms, which are seen as better able to cope with the new regulation. “A lot of reps now definitely want a $100 million [in revenues] or larger B-D,” says recruiter Jon Henschen, of Henschen & Associates.
Observers see two main consequences of the DOL rule: a shift toward fee business, and a shift away from smaller accounts. The Financial Services Institute and other industry groups have warned about the potential impact on small investors if the compliance burden and liability make serving modest accounts uneconomic. The FSI in fact is now supporting a congressional effort to nullify the DOL rule.
Most small firms anticipate moving “a lot of business from the B-D space to the [investment advisor] space,” says David Martin, chief executive at Keystone Capital Corp. in San Diego, which has 20 reps. The movement to fee accounts has been occurring for years, but the new rule “has the potential to accelerate the process,” he says.
Growing Challenges
The DOL rule is just the latest among a barrage of new regulations imposed after the financial crisis that have squeezed the resources of smaller firms.
The demands and a more competitive operating environment have contributed to declines in the number of brokerage firms—at least according to industry observers—and more consolidation is expected. “Every single person I talk to has the same story—they’re being driven out of business” by cost pressures, says John Busacca, managing director of the Broker Dealer Exchange, which matches B-D buyers with sellers.
Martin recalls his own experience with regulators. “Over the past year and a half, we’ve had a regular Finra exam, a [Finra] cycle audit, and now an SEC audit. I’d much rather be out there making money.”
B-D officials say there are no signs regulatory pressures will ease, either. A potentially positive regulatory development for some firms, though, is a pending Finra proposal for a streamlined broker-dealer.
Finra’s “capital acquisition broker” (CAB) proposal would create a separate rule set for firms that just do mergers and acquisitions business and don’t handle retail clients. The proposal is pending approval at the SEC, following a comment period that ended in May.
The CAB option “is supposed to take a lot of the compliance burden off of firms” that shouldn’t have to comply with the full Finra rule book, says Karen Fischer, a compliance consultant at BG Strategic Advisors LLC. The change “may save a lot of B-Ds if it goes through,” Fischer says. “I have a number of small M&A firms now who are ready to drop out” of the business because of the costs of full Finra compliance.
“It will be interesting to see how many M&A firms jump” to the new CAB format should it be approved, says Martin. Costs for errors-and-omissions insurance, and assessments for SIPC and Finra, should drop, he says.
On the other hand, Martin says he might lose an investment banking group he picked up a few years ago if that unit can operate more easily under the CAB structure than within his regular broker-dealer, Keystone Capital.
On the advisor side of the equation, more services and support are expected of B-Ds, Papike says, and brokers who are recruited expect financial help from the new dealer when they make the transition. “Offering all of that is very difficult for firms without a ton of scale,” she says. “If they don’t have a way to recruit, it’s difficult to sustain” the business.
Another issue small firms have is finding an affordable clearing firm, Busacca says. A number of smaller clearing firms have been bought out over the years, allowing a dwindling number of survivors to raise monthly minimums and deposits, he says.
And just like their advisor ranks, many B-D owners are aging. As the challenges of running a small B-D grow, some are just getting out. “A few [older] guys like me will stick it out a bit longer, but eventually [many] will throw in the towel,” says Jed Bandes, 61, president of Mutual Trust Company of America Securities in Clearwater, Fla., which has 30 reps.
Owners of small firms with a good base of business and no regulatory baggage should have no problem attracting potential buyers or partners, though. Owners say they get inquiries all the time, and recruiters are actively scouting the market for small dealers who might be better off dropping the B-D license in favor of becoming an OSJ at a larger firm.