From the January 2005 issue of Investment Advisor • Subscribe!

Broker/Dealer Special Report: The Financials--The Right Fit

A successful 2005 is likely for both independent broker/dealers and their reps. Luckily, there are still different styles for reps to choose from

For most broker/dealers and their representatives, 2004 was successful: new clients were added, assets under management grew, and revenues were up. That meant that in most--though not all--cases advisors' take-home pay was higher. While it will be a few more months before we can statistically confirm the success of the independent broker/dealer industry for the full year, at the beginning of 2005 we think that advisors and their broker/dealers have even more reasons to be excited about the future. Here are some positive developments that industry leaders and their reps should capitalize on.

In our mind, the best news for advisors is the fact that independent broker/dealers are focusing plenty of resources to help their advisors become better business managers and improve the profitability of their practices. In recent research, Moss Adams LLP found that since 1999, advisors have experienced an average decline of 18% in personal compensation. At the same time, average revenues grew by more than 50%. The challenge of creating a bigger practice involving multiple practitioners and leveraging staff and overhead seems to have overwhelmed many firms. We believe that the foundation of the problem is the tricky transition from advisor to business manager that successful advisors must overcome. With growth in number of clients and AUM, most firms need to hire, motivate, retain, and manage more people, but few are prepared to accomplish the process smoothly.

The need for more and better practice management tools and services has consistently been voiced by the independent advisory community. For the last three years, it has been the area with the lowest score of satisfaction in the FPA Financial Performance Studies produced by Moss Adams (see Unsatisfied Reps at right).

Despite that dissatisfaction, the good news is that many broker/dealers have recognized this need and have created innovative and practical programs that allow advisors to increase their skills as business managers, get better information on their own businesses, use templates and structured approaches to address common management functions, and find outsourced solutions to many problems. As an example, Tower Square Securities offers what it calls a Business Health Check to help its advisors assess their operating performance from client management to practice succession. Securities America has made its Client Audit tool available to help reps systematically elicit feedback from their clients. It also provides a custom benchmark to help reps measure their practice's performance. National Financial Partners (NFP) and Linsco/Private Ledger (LPL) provide their advisors with access to internal and external business consultants. Raymond James and Western Reserve Life provide manuals on succession planning for their advisors. The ability to acquire and deliver proven tools to enhance the practices of their advisors has helped these B/Ds evolve from vendor to partner in the relationship with their representatives.

Growing Larger = More Resources

The start of 2004 was marked by the acquisition of WS Griffith by LPL, taking the largest broker/dealer closer to $1 billion in total revenue and fueling anticipation that it will go public in the near future. That possibility, along with the prominence of already-public NFP and Raymond James, is getting the independent B/D industry not only more recognition on Wall Street but also more capital resources that translate into better technology, product platforms, and other capabilities. Many of the top 20 firms are also divisions of large public companies.

Larger and better-capitalized broker/dealers can only be good news to their reps. Ultimately, advisors should recognize that their competition for the best clients is not other independent B/D reps as much as it is the large investment firms like Merrill Lynch and Smith Barney. The continuously improving technology, products, and support that the larger broker/dealers can provide will help independent advisors be more successful in the marketplace.

Naturally, there are advisors who view this trend with skepticism, afraid that as their B/Ds grow larger they will lose the personal touch and attention to their needs, and that the indie B/Ds will start looking and behaving like the large brokerages that many advisors left in order to be independent. Fortunately, there are still many broker/dealers that focus on this model and welcome advisors who need more personal attention and a smaller-firm environment. The challenge for advisors who want the benefits of a small firm may be that they have to affiliate with a number of broker/dealers in succession as each follows the same path of growth and leverage.

By contrast, for the B/Ds themselves, recruiting remains their biggest challenge, though compliance with new regulations is in second place (see B/Ds' Biggest Headaches chart above).

Innovative Models

Competition is always a driver of innovation, and in 2004 broker/dealers introduced new affiliation choices and compensation models for their advisors. The most notable trend is toward closer affiliation between the advisor and his broker/dealer. For years, advisors have moved from closer affiliation models like banks and wirehouses toward fully independent platforms. Now we are seeing some firms experimenting with more involvement of B/D management in the business of individual advisors. The performance of those models will be interesting to follow.

The trend is very logical. Both advisors and the broker/dealer find that they need:

Better lead generation and consumer awareness. In the fully independent model, neither side has the margins or the size to create a consumer brand, but closer affiliation helps solve the problem.

Operational efficiencies. These usually begin with standardizing processes, something that the independent channel generally finds difficult to accomplish.

Standardization of service delivery to the client. This is made necessary by increased compliance and regulatory oversight.

Better business management. Long a challenge for independent firms, the promise of a quasi-parent firm managing many internal functions appeals to many advisors.

Most independent broker/dealers hate the term "franchise broker/dealers" used by the NASD to describe them because it is factually incorrect and does not accurately reflect the relationship they have with their advisors. At the same time, we are now seeing some firms that are focusing on developing a franchise-like system.

Some of the most successful broker/dealers in the industry specialize in supporting particular types of advisors. Firms like 1st Global, supporting CPA advisors; Cambridge Investment Research, supporting fee-based firms; and specialized bank-oriented firms like ProVest and Uvest are creating a unique fit for the specific needs of their affiliated advisors.

The specialization should not stop at vertical niches such as CPAs or bankers-- practically all advisors can find one type of service or one type of support that's most important to them. Chances are good that there is a broker/dealer firm specializing in what you need (see Custom Made above).

Streamlined Compensation

Finally, compensation in the independent B/D industry is becoming more streamlined and "unbundled." With the pressure on revenue-sharing arrangements, most broker/dealers have taken a serious look at their pricing structures and are charging more fees to the representatives. Counterintuitively, this a positive development for advisors because the pricing structures are becoming more like a menu of options rather than a prix-fixe dinner. Under this model, advisors have a chance to decide which services they want to use and purchase them accordingly, rather than have everything bundled together. This creates more customized, better-fitting support models for the advisors while producing more stable and sustainable economics for the broker/dealer.

There are many reasons to be excited about the independent B/D industry in 2005. There are bigger and better firms, more flexible affiliation models, and a strong competitive environment that should combine to give advisors excellent support and choice. It's important to remember, however, that choice is only good if you know what you want--otherwise it's just a state called confusion. Independent B/D reps still need to design their strategies for success, but the good news is that their business partners are becoming more focused on their needs and better equipped to provide for them.

Philip Palaveev, a senior manager with Seattle-based Moss Adams LLP, manages the benchmarking studies of broker/dealers and advisors for the firm, and leads its broker/dealer consulting practice, with a special emphasis on strategy. He can be reached at philip.palaveev@mossadams.com.

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