From the September 2010 issue of Research Magazine • Subscribe!

Towers of Strength

Amid regulatory and market flux, reliable clearing firms are more prized than ever.

In the aftermath of dreadful 2008 and 2009, staunch, stable clearing firms are not only being appreciated but touted by financial advisors to clients.

Indeed, with asset safety now a top-of-mind issue among investors, the strong clearing firm has become a value-added many FAs are boasting about.

"People want to know, 'How am I not going to be like a client of Bernie Madoff?'" says Craig Gordon, director of correspondent and advisor services, RBC Correspondent Services, based in Minneapolis. "Five or six years ago clients were concerned only that their investments performed well. Now they're very concerned that their assets are held with a financially stable third-party custodian."

Moreover, he notes, advisors are stressing that point. "They're explaining the clearing firm as a benefit to the relationship and how it provides checks and balances, as opposed to a firm that has client money under the same roof as the advice-giver," Gordon says. RBC serves about 200 correspondent clients.

To be sure, nowadays there is heightened awareness among advisors as to just what a clearing firm is and the function it performs.

"Safety of assets is a huge topic with our correspondents and their brokers," says Bobbi Masiello, executive vice president, relationship management at Fidelity Investments' National Financial, in Boston. The company clears for more than 300 clients. "A lot of our broker-dealers are asking us to provide a document of how assets are insured through the firm. We've been meeting more and more with them: they want to get an understanding of who the clearing firm is and who's behind it. The big banks and insurance companies also need to be aligned with someone who's going to be there next week -- and next year."

Regulatory Scramble

Right now clearing firms are revving up to help clients deal with new rules and regulations that the financial overhaul law -- intended to hold all industry participants to a higher standard -- is expected to bring.

"Clearing firms are right in the center of adapting to this," Gordon says. "Between that and the [fallout from] the economic crisis, it feels as if we're starting all over again -- like we're turning the Etch-a-Sketch [screen] upside-down, shaking it and saying: 'Draw the future of financial services'."

Likewise, Atul Kamra, president of Wells Fargo's First Clearing, based in St. Louis with 108 clients, believes that "the world has changed. The industry has to reset its processes and mindset, and come to grips with the reality that risk has a different meaning in the minds and hearts of clients. What is good advice has been called into question. It all starts with 'What does an end client expect of an advisor and what impact does that have on how we do business, and on our people and processes?'"

At Pershing, an affiliate of BNY Mellon and, with more than 1,150 clients, the largest clearer, Michael Row, managing director, notes: "I wouldn't say it's a complete throw-everything-out and start over. But I do believe it's prudent to look hard at the things you're doing and reconfirm your commitment to them and your clients."

While responsibility and liability still reside with correspondent firms, clearers, increasingly, are being drawn into the business of their customers. And that can be a double-edged sword.

"The wall between the introducing firm and the client is not as solid as it used to be," says Robb Combs, director of correspondent clearing at Raymond James & Associates, in St. Petersburg, Fla. "Clearing firms are being brought into more litigation than ever before because of our resources, the customer data we're privy to and our handling of transactions that are processed through our systems."

The consequence, he says, is that "people are looking at our level of responsibility as being more now than it ever has been before. But I wouldn't say that's a problem. It's an opportunity to shine and show the quality services we provide." Raymond James, with 38 clearing clients, is putting greater stress on serving bank-owned B-Ds in a program that furnishes banks additional sources of liquidity.

Broker-dealers need tools to properly supervise and manage given the expected heavier oversight en route from the SEC and FINRA. This is where the savvy, forward-thinking clearing firm comes in.

"The breakdown has often been when firms have not had [supervisory] capabilities and a view into their own businesses, which resulted in an advisor doing something inappropriate," says William Coppel, First Clearing's chief client growth officer. "Broker-dealers will require more support to meet the new requirements, and clearing firms will dramatically aid them to monitor what's going on."

Penson Worldwide's Dan Weingarten, senior vice president and co-director of global sales and marketing, says that if brokers are to be held to a fiduciary standard, which will "add liability to the broker-dealers and increase the 'know-your-customer' obligation, we'll find ourselves providing solutions to help them operate in the new rule set."

Row, based in Jersey City, thinks the new regs, in general, will be "a lot more work for [the industry] but a tremendous opportunity to increase the value of services we provide by solving our customers' business challenges that will be absolutely inherent in the new regulations."

And that of course is good news for all clearers. "There will be greater dependence on clearing firms on the part of broker-dealers to perform their role as astute leaders of their businesses," Kamra says.

Cost Controls

Further, the new rules will mean rising costs in running a B-D. Notes Coppel: "Firms will be asking themselves, 'Where will our capital be best deployed? Is it better to own or rent?' Self-clearing firms will re-assess their situation. So this is a keen opportunity for clearing firms. In a lot of ways, the market is moving in our direction."

At National Financial, Masiello says that broker-dealer overhead-cost reduction "has become more and more of a driving force."

At the same time, clearing firms -- operating amid historically low interest rates and with market volume generally unfavorable to processing -- are concentrating on cost-cutting too.

"These are the times when you focus on strengthening your core business, taking a hard look at fixed costs and looking for opportunities," says Weingarten, based in New York City.

Penson uncovered a major one with its June acquisition of Broadridge's Ridge clearing unit. The purchase was partly about cost reduction, with Penson leveraging Broadridge's back office for a number of functions it had conducted in-house. Further, the acquisition brought Penson's client count to about 400.

In other M&E activity, RBC has closed on its purchase of J.P. Morgan's investment advisor services group; and BNY Mellon has acquired bank company PNC's Global Investment Services Group -- a managed-account solutions provider -- which broadens Pershing's platform.

And the business likely will continue to consolidate, as investments required for tighter controls plus ongoing margin compression will simply push smaller clearing firms out of the game.

Consolidation is "a good thing for the industry because it will lead to stronger, more stable and committed firms," comments Row.

According to National Financial, in 1995 there were 150 clearing firms; now there are about 20. Muses Masiello: "It's amazing when you consider the firms that are no longer here."

For those remaining, consolidation presents another important way to boost business.

"It's an opportunity to talk to new firms that may want to review their clearing relationship," Combs says. "When their clearing firm is sold to another firm and new management comes in, the introducing firm doesn't know what their future will hold."

As clearers beef up partnerships with clients -- as opposed to being mere vendors -- they are helping B-Ds in a variety of ways; recruiting assistance, for example. Raymond James serves up nationwide software databases of financial advisors for B-Ds to prospect. It also conducts home-office visits in which FA prospects can see the systems employed to process their business.

National Financial tallies more clients seeking the firm's consulting services. For instance, the clearing company is advising acquisition-minded B-Ds that want to increase their efficiency. In other instances, clients that have made deep cuts over the past year want advice on how to take better advantage of who and what they have. "This is brand new to the clearing industry," Masiello says.

"They're also talking to us about consumer tools that in the past they never would have mentioned, such as front-end websites for marketing purposes," he points out. "Firms are seeing that they can get more from a clearing [company] if they work very closely with us.

First Clearing, according to Coppel, continues to "add capabilities around the less traditional clearing [aspects] to make firms more competitive and help them grow. We're well positioned to help them navigate through this period."

Growing Importance

The strong trend of brokers leaving wirehouses, post-economic crisis, to go solo continues. In fact, Masiello notes, that "for us, it hasn't really slowed down." A record 191 broker teams joined the Fidelity and National Financial platforms in 2009. In 2010's first half, Fidelity helped about 95 individuals and teams become independent.

"The role of the clearing firm will continue to grow and be more important as advisors break off to be independent brokers and investment advisory practices," RBC's Gordon says. "They no longer have to be associated with a big firm to deliver sophisticated, well-suited investment advice and services. And that's new. The independent industry has the potential to be the platform of choice for high producing financial advisors."

Clearing firms' new products and services include Penson's foreign exchange offering: a global desk for assisting managed futures executions; RBC's enhanced wealth station; Raymond James' Albridge Wealth Solutions all-in-one management and portfolio tool; Pershing's user-simplified recruiting website www.advisorintranstion.com; National Financial's Web-based "Insight & Outlook" service, where advisors can earn continuing education credits; and First Clearing's College of Advisory Practices, with training on how to dispense appropriate client advice.

Pinpointing what he believes has set off the profound changes in financial services, Coppel says: "The sea change hasn't been caused by the regulatory environment or by Congress. The catalyst is investors -- they're driving the dialogue because they bought into a value proposition that didn't pan out precisely the way they anticipated. Therefore, going back and doing business the way we did before and expecting different results is the equivalent of Einstein's theory of insanity."

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