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.
Making A Go Of It
In spite of all the challenges, B-D owners remain optimistic about staying small and finding a way to compete.
“Business has been good,” says Keenan. Like many independents, St. Bernard Financial caters to smaller producers, some of whom may engage in the securities business alongside an insurance agency, CPA firm or other enterprise.
“Smaller producers want more freedom,” Keenan says. “They don’t want a supervisor pushing them to be more productive.”
Smaller firms may also be able to survive by specializing. “We’re in good shape,” says Jim Johnson, president of Washington Securities Corp. in Chevy Chase, Md., a 13-rep firm with a focus on bonds and preferred stocks. “We have a great business, with not a lot of problems.”
Can he compete with larger firms? “Absolutely,” Johnson says, adding that his clearing firm, RBC Correspondent Services, keeps him in the race technology-wise.
Washington Securities isn’t looking to become a huge player, but Johnson says he can pick up a smaller wirehouse rep every now and then. “The kind of broker we’re interested in is a stockbroker,” he says. “If we’re able to find an older [wirehouse] broker [who] can’t keep up the pace there, we’ll accommodate them. The issue with the big wirehouses is that the pace is incredible.”
“We thrived during the financial crisis,” says Bandes at Mutual Trust Company of America Securities. He insists his firm continues to do well. As of April, he’d recruited $2 million in production so far this year.
The secret? His small size gives him the flexibility to support reps the way they want.
“If you [the advisor] go to the big outfits, when you send advertising in [for approval], who reviews it? Probably an ex-Finra examiner [who] could care less,” Bandes says. “If they send it to me, I may tell them they can’t send it out, but here’s a way to change it, make it sound better [and] it will be compliant at the same time.”
Bandes doesn’t buy the idea that advisors are looking for larger dealers—at least not advisors who are already at large firms. “They want to exit the big firms and come to small firms,” Bandes says. “If you come in as a client [at a large firm], you come out usually with a managed account of some sort. If [an advisor] leaves, it’s easy for the client to stay.”
Bandes calls the homogenized nature of the bigger players the “Walmartization” of the business, which he thinks is unappealing to sophisticated advisors and clients.
So to those who think the small B-D niche is headed to extinction, think again say small firm owners. “Yes, we can survive, but we have to make changes in what we’re doing,” Keenan says, such as improving efficiency and watching costs.
“You need to look at each rep and make sure you’re comfortable with what they’re doing,” he says. “You might not be able to take a chance like you used to on lower producers” whose revenues may not justify the costs of supervision and management. “There will always be a place for small shops,” he concludes.
The compliance responsibility that small firm owners take on can be a challenge, Johnson says, but at the end of the day it’s worth it. “You’re not held to the constraints of some management dictate put out by a bunch of guys who aren’t licensed,” he says.
For owners of small independent firms, that would be a worse fate than anything Finra or the DOL could throw at them.