In case you missed it, broker-dealer recruiter Jonathan Henschen posted an interesting blog for ThinkAdvisor on February 22 titled DOL Fiduciary Rule Will Accelerate Broker-Dealer Closings.
He starts by pointing out that between 2010 and 2015, the U.S. ranks of broker-dealers have shrunk by 544 firms, or 11.9% (from 4,578 to 4,034).
And he follows with this dire warning: “As discouraging as these statistics look, this could very well be the tip of the iceberg.” He then writes, “The DOL fiduciary standard will bring about a perfect storm if it coincides with a potential U.S. recession. Besides the lower revenue associated with a down market, a recession will put an end to Fed Funds interest rate increases, which will kill hopes of higher money market revenue for broker-dealers. The DOL fiduciary standard will also lower revenues for broker-dealers due to fewer product choices, lower commissions and higher rates of litigation.”
Yes, Henschen’s is another story about the doom and gloom that will prevail should the “crazy” DOL succeed in forcing brokers and BDs to act in their clients’ best interests when rolling over 401(k)s into IRAs. But like many stories of a similar ilk, it also offers interesting insights into the workings of the brokerage industry: reaffirming, at least in my view, the need for the DOL’s expanded fiduciary standard—and a similar standard for all retail brokers.
Although he talks about variable annuities and private placements, Henschen is primarily concerned about firms that sell mutual funds, and stocks and bonds. The problem with mutual funds is that: “Many broker dealers pocket 12b-1 fees as part of their profit center,” he write, and says that "following the track of regulators’ discussion leading to the DOL fiduciary rule both broker-dealers and advisors will no longer receive 12b-1 fees in [IRA] fee accounts.”
For stock- and bond-trading firms, the problem is that “the new [DOL] rules are expected to disallow commission-based trading of stocks and bonds in qualified accounts,” wrote Henschen. “This will force advisors to convert these accounts to a fee-based structure, which will result in substantially lower revenue.” How substantial? Henshen provides this example: “An advisor making $500,000 [per year] trading $25 million of AUM will see their income cut in half when going to a 1% fee model.”
Those of you who are confused: you’re not alone. For years, the brokerage industry has been arguing that commissions are less costly to investors than AUM fees. I guess reality has reared its often-ugly head in this case. But for Henschen, reality isn’t done yet. “Besides increased firm closings due to lower profits, it will make more sense than ever for smaller BDs to go fee-only due to increasing restrictions on commission products,” he writes. “However, the unintended consequence of broker-dealers going fee-only is less revenue for FINRA, with declining registration and FINRA assessment fees.”
Did you get that? It seems that FINRA, too, has a financial stake in commission revenues for BDs.
Just speculating here, but perhaps that’s influenced the SRO’s opposition to the SEC acting on its Dodd-Frank mandate to create a fiduciary standard for brokers.
And as if that’s not revealing enough, Henschen drops the other shoe like a hammer: “Don’t be surprised if FINRA insists on being the policeman for RIAs if the number of broker-dealers craters. Seeing the number of BDs dwindle down to 2,000 over the next three years may turn out to be an optimistic forecast.”
On second thought, maybe those high BD profit margins aren’t so bad after all...