From the January 2005 issue of Investment Advisor • Subscribe!

Broker/Dealer Special Report: Clearing Firms--Closer Ties, Fewer Players

More regulation from Washington and B/Ds' greater expectations have led clearing firms to invest more in technology and to more consolidation in the clearing business

Consolidation has been a major trend in the clearing business for a few years now, and it doesn't show signs of abating. Clearing firms have been forced to devote huge sums of money to technology in order to comply with a deluge of new regulations, and some firms can't afford to pony up the cash. In addition, it's safe to say the Securities & Exchange Commission won't stop issuing new rules anytime soon. "Regulators are ambitious," says Rich Brueckner, CEO of Pershing, the big clearing firm based in Jersey City, New Jersey. "There will continue to be consolidation" among clearing firms because adhering to regulations requires new technology. Firms that offer clearing services "on the side," and not as a core business, are suffering the most, Brueckner says.

Over the past year alone, clearing firms have added new technology to provide more disclosures on mutual fund breakpoints, to get up to speed with anti-money laundering procedures, as well as to comply with the SEC's books and records rule. Now, Brueckner says he's particularly interested in how the SEC's revised Regulation NMS (National Market System), which would modernize rules for the U.S. stock market, will play out.

Brueckner says he "supports" the SEC's efforts to strengthen the market structure, "particularly those initiatives that will benefit retail investors and their advisors." He notes, however, that "any SEC mandated market structure changes must be done within a framework where competition between markets can continue to thrive."

The SEC reissued the proposal for a 30-day comment period on December 15.

Technology to Stay Competitive

Linda Van Oosting, VP at Raymond James Correspondent Clearing, says complying with the National Association of Securities Dealer's (NASD) disclosure rules on mutual fund breakpoints has required a huge amount of technology. The NASD claims that broker/dealers and mutual fund companies have failed, in some cases, to give the proper discounts to clients on purchases of mutual funds that are sold with front-end sales charges. Raymond James has developed technology, she says, to not only coordinate "efforts among our own firm's systems, but work with collecting information from the mutual funds." As a result of the breakpoints rule, "We need to look at how we can disseminate the information in the most practical manner not only to our sales force, but to our introducing firms in a way that's meaningful to them." Before any new technology can be implemented, however, senior management has to be willing to "allocate the resources" needed to support it, she says.

Donna Morris, executive VP of product management at National Financial, Fidelity Investments' Boston-based clearing business, agrees that consolidation will continue for some time (hastened by Fidelity itself, which announced a deal Dec. 16 to acquire Fiserv's clearing business: See Acquisitive Fidelity sidebar at right). Morris believes the increasing demands from broker/dealer clients for more products and services are also fueling consolidation. "The core capabilities of a clearing provider are really only a fraction of what clients want from firms like National Financial," she says. "It's not only the [technology] investment required to stay competitive in the clearing market, but it's the investment, expertise, and resources that it takes to build out an offering that meets the demands of B/Ds."

To stay competitive, clearing firms must help B/Ds streamline their operations, and offer technology platforms that can be easily integrated with the B/D's technology, Morris says. "For a firm like Fidelity, one of the things we're most focused on is integration." When Fidelity partners "with a best-of-breed provider, how do we take that product or service and integrate it onto our platform so that it's easily usable and deployable to our [B/D] clients?"

Building a Better Workstation

B/Ds are also looking for "a state-of-the-art workstation," she says, as well as access to products like managed accounts to help B/Ds build a fee-based business. "The expectations of the B/D community are far greater than they were 10 years ago," Morris says. "B/Ds are looking for a partner to help them grow their business, not to just execute their trades and custody their assets."

To address B/Ds' changing needs, National Financial has "made significant enhancements" to StreetScape, the firm's browser-based tool used by the home office, representatives, and consumers. It's now easier to navigate through StreetScape, Morris says, and brokers can also access market data from Reuters Plus. More research from firms like Prudential Financial and Lehman Brothers is now available on the StreetScape platform. Plus, StreetScape for Windows, "a client server application that was developed to meet the needs of reps that are managing a book of business," is now in the pilot phase, she says.

National Financial also had to make "a lot of enhancements to support" President Bush's tax bill, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), Morris says. Moreover, National Financial "continues to make investments" to comply with The U.S. Patriot Act.

One of the biggest trends now, says Brueckner of Pershing, is broker/dealers' business moving toward fee-based products. "Advisors and commission brokers are overlapping more and more," he says. That's why Pershing is now focusing on serving the needs of investment advisors by offering managed accounts, and is enhancing its technology platform to "allow advisors to do commission and fee business."

Trusts and Continuity

Since its merger with Bank of New York last year, Pershing has also been busy integrating BNY's trust platform with its own. The merger should be completed in the first quarter. "Trust services have been the No. 1 requested services from investment advisors," Brueckner says. "They want to provide a more complete suite of services to the higher-net-worth clients," and be able to compete with bank trust departments. Pershing has also teamed up with BNY to offer mortgage products, he says.

Raymond James has been busy putting the finishing touches on its "data warehouse program," says Van Oosting, which will allow broker/dealer principals and managers to access data, create customized reporting, and get up to speed on the latest compliance issues. To help broker/dealers comply with anti-money laundering rules, Raymond James continues to enhance its funds disbursement system, she says, "which automates not just the disbursement of funds to client accounts, but also runs wire [transfer] checks" and tracks other account activity.

"We've spent a lot of time and effort on reports in the anti-money laundering area, and we will continue to do that," pledges Van Oosting, noting that for the last three years, Raymond James has shared its anti-money laundering (AML) continuing education program with its correspondent firms.

Another focus area for Raymond James has been business continuity planning--not just for itself, but for its correspondent firms as well. "We've gotten a lot of calls from our correspondent firms asking for ways we could assist them if they should have an interruption" to their business, Van Oosting says.

Maintaining the Wall

Van Oosting says that when it comes to regulation, she wonders how any future SEC rules--or amendments to existing ones--will address "maintaining that traditional wall between an introducing B/D and a clearing B/D as far as the responsibility for monitoring client accounts." The clearing B/D, she says, is a vendor of services, whereas the correspondent or introducing B/D ultimately has the relationship with the client. So the introducing B/D "is responsible for know-your-customer rules, compliance, and supervision of account activity." Take the anti-money laundering rules, for example, she says. Raymond James monitors its own accounts, she says, and also includes the accounts of its correspondent B/Ds in its reports. "Is that appropriate?" she asks. "At this point in what we know about the [anti-money laundering] regulations, we believe it is appropriate. That doesn't relieve the introducing B/D from [its own] AML responsibilities." As regulations change, she wonders, "are we going to continue to have the delineation between the two" types of firms? As a clearing B/D, Raymond James provides clearing and trade execution, and is helping correspondent firms "to grow and make the most of their time and resources," Van Oosting says. "But I don't have relationships with their clients, and I don't feel that those are responsibilities that [clearing B/Ds] should have to take on."

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

Reprints Discuss this story
This is where the comments go.