One year ago, small broker-dealers weren’t feeling particularly upbeat. With the implementation of the DOL rule looming, most were scrambling to re-engineer their businesses.

But in the 12 subsequent months, all signs point to a far less onerous regulatory environment than many anticipated. That, in turn, is making the independent brokerage business appear far more attractive than it has for several years.

One indication of a turnaround in the IBD space is the renewed interest of private equity investors. One year ago, two Morgan Stanley executives—Doug Ketterer and Eugene Elias —and Kevin Beard, former head of acquisition and recruiting strategy at AIG Advisor Group, formed Atria Wealth Solutions to acquire registered investment advisors and broker-dealers. It was backed by Lee Equity Partners.

Atria immediately acquired two California B-Ds, CUSO Financial Services, which serves credit unions, and Sorrento Pacific Financial, which works with banks and has an independent B-D as well. Then in April, it acquired Syracuse, N.Y.-based Cadaret Grant & Co. with 900 affiliated reps and $23 billion in assets under administration. Most industry observers expect Atria to continue looking for other acquisition candidates.

However, the biggest vote of confidence in the IBD space also occurred in April 2018 when one of LPL Financial’s largest super OSJs, Tampa-based Independent Financial Partners (IFP), announced it was leaving the mother ship and forming its own B-D. Only nine months before, the industry was expecting to see that strategy play out in reverse, with IBDs selling themselves to big firms and becoming super OSJs within those B-D networks.

IFP’s CEO Bill Hamm didn’t respond to calls from Financial Advisor, but his decision to take 550 reps with more than $50 billion in assets under management or advisement out of LPL stunned many B-D executives. Despite initial rumors that IFP was financed by its clearing firm, most B-D execs now believe it received private equity backing.

One analyst said it was a smart move if IFP is looking to create shareholder value, since an independent brokerage firm probably would sell for double the price of a super OSJ with similar financial metrics. Moreover, that’s factoring the decision of some IFP reps to stay with LPL, which is expected to make a compelling case to them to remain.

It’s also no surprise that 2017 was a good year, thanks to the bull market that helped draw reluctant investors back into the markets. Also helping some B-Ds recruit new reps is the ongoing consolidation that has caused some advisors at affected firms to affiliate with small firms for a more personal relationship.

Finra lost 109 firms last year, about the same number that disappeared in 2016. It’s part of a longer-term trend that has seen the number of B-Ds decline 25% from a decade ago, but the shrinkage has prompted many reps to reconsider their options.

“We had our best year ever last year,” said Robert Keenan, chief executive at St. Bernard Financial Services in Russellville, Ark., which serves 90 independent contractor reps. But the “costs for compliance go up every year.”

Although Finra is considering some relief for B-Ds from outdated rules, any relief will likely be limited given the size of the rule book and inevitable political backlash against moves to lessen regulation of Wall Street. Besides, Finra isn’t the only regulator firms have to deal with.

State regulators, for one, have gotten tougher, observers say. Massachusetts and New York are mentioned as particularly tough jurisdictions. “They’ve gotten too oppressive,” said Jon Henschen, who recruits independent reps.

“A lot of these state securities departments have decided Finra isn’t doing a good job,” Keenan adds. “Now I get a four-page [inquiry] letter from states when trying to register a person.”

And the requirement under the Dodd-Frank Act for financial statements to be OK’d by auditors certified by the Public Company Accounting Oversight Board has stuck in the craw of small firms ever since the rule went into effect in 2013. The requirement raised costs, forced some firms to find new auditors, and at least in the view of small B-Ds, shouldn’t apply to brokerage firms that don’t custody customer assets.

Small firms continue to work on a grass-roots effort to get an exemption from the PCAOB audit. All told, those regulatory burdens get the most blame for the long-term erosion in broker-dealer numbers.

True, new B-Ds are being formed, but at only about half the rate as firms throwing in the towel, Keenan said. “Among new [B-Ds], there are very few traditional firms with a clearing agreement,” Keenan said. Most are doing private placements or other types of business for which they need a limited-purpose broker-dealer, he says.

“We’re not seeing [new] small firms wanting to do a general securities business,” agrees Michael Brown, president of B/D Solutions Consulting, a compliance consultant in Atlanta. “That’s just a tough, tough business.”

What Finra is seeing are start-ups involved in blockchain-related deals and other private offerings. These specialty firms that want to be legitimate “are putting [deals] through B-Ds, just like any other offering, because they don’t want to be the first one the SEC clamps down on,” Brown says.

Finra chief Robert Cook seems to be attentive to the fact that membership is going down, Keenan said, and is undertaking a retrospective review of a number of existing regulations as part of an effort to ease the regulatory burden. “It’s a good start, but there still is a lot that needs to happen,” Keenan says.

Finra has recently requested comments on potential changes to rules covering outside business activities and private securities transactions, the effectiveness of its rule governing agreements with clearing firms, and rules dealing with suitability and churning.

Notably, Finra has proposed to drop a 24-year-old requirement for broker-dealers to supervise the independent RIA firms run by their registered reps. It’s been a challenge for firms to supervise independent RIAs they have no control over, and many are cheering on the proposal.

Robert Hamman, president of First Asset Financial in Salina, Kan., is one proponent of the change. The supervision requirement has “really been an impossible thing to do, but [it] leaves the B-D open to huge liability for something they do not get much money from,” he says.

How to handle hybrids will continue to be an issue. The hybrid channel has been the fastest-growing area in recent years, and that looks as if it will continue. In a March report, Cerulli Associates said that 25% of independent broker-dealer reps with $500 million or more in client assets seriously considered opening an RIA in the past year.

Reviewing rules is helpful, but Brown thinks Finra needs to focus on its own inefficiencies. He says he recently had to respond to eight pages of questions about one trade done a year ago by a B-D client.

“Finra has enormous amounts of data, but it doesn’t get shared,” Brown adds. “I’ve sent eight, nine pages of information to a district [office], then gotten the same inquiry from the Washington [D.C.] office.”

Given the compliance load, Henschen thinks firms with fewer than 100 reps will have a tough time surviving. “I hear this repeating chorus [from small firms] that the whole Finra thing has gotten out of hand,” he said.

Survival Strategies

Given that challenging background, one might think the small B-D model is dying. But small firms are finding ways to compete.

For one thing, larger competitors can’t always accommodate the way advisors and their clients want to do business. “I think we can give a little more personal attention, and can manage each portfolio more closely to the desires of investors,” Hamman said. “At large firms, they get dumped into a model, into one of 10 slots.”

“A lot of advisors are looking for a small firm that will take care of them,” said Stephen Kohn, founder of Stephen A. Kohn & Associates in Lakewood, Colo., which has 32 affiliated reps. “They’re not necessarily looking for a [high] payout, but a good, clean place to work.”

Small firms can be flexible, said Cathy Cucharale, chief operating officer and chief compliance officer at M. Griffith Investment Services in New Hartford, N.Y., with 22 employee reps. For example, some firms don’t allow direct business, but her firm supports it by taking on the task of tracking assets held outside of its clearing firm, Wells Fargo Clearing Services. And M. Griffith has worked with Wells Fargo to make DFA Funds available to its advisors, something larger competitors may not offer.

An advisor “can connect directly to our people, and facilitate getting a [software] program they want,” Cucharale adds.

Consolidation in the industry has increased frustration among advisors in many cases, small-firm execs say, which has helped them bring on additional advisors and teams.

Meanwhile, as the industry has become more commoditized, offering more robust financial planning services is seen as a competitive advantage.

“All our reps are CFPs, and do a lot” of planning, says Matthew Savery, chief investment officer at M. Griffith. Clients will question what they’re getting for a 1% management fee, and want more than just investment management, he said. “We work with accountants and tax advisors, and bring the whole financial picture together. We think we do a better job than the guy across the street.”

As firms seek to attract advisors and build revenue, protecting already slim profit margins is crucial to survival. An important part of Keenan’s strategy is a “relentless” focus on expenses. To save money, he prefers doing things in-house rather than outsourcing. “Half of small firms are under $500,000 in revenue [and] if they’re not watching their pennies … all of a sudden, they’re spending a lot of money.”

Don’t skimp on compliance, though, Brown warns. Regulatory problems, and the expense and time they eat up, can be a killer for a small firm. But don’t just throw money at compliance, he says. “Get a chief compliance officer who’s good at what they do, who’s thorough. You don’t need a lot of staff.”

At the end of the day, observers hope the small B-D space will survive. “What regulators forget is that [smaller] B-Ds bring the service element to a lot of small investors, particularly in rural areas like ours,” Hamman says.