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Secrets of Success

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Rough markets, rough times, and a catastrophe no one could have foreseen have driven much of the business world right into a maelstrom. The financial industry has been battered from stem to stern. Wirehouses have been laying people off for months. Stock trades are down. Portfolios are down. Broker/dealers are suffering.

Well, not all of them. Just as not all portfolios are down and not all businesses are hurting in a market that has been volatile, to say the least, some B/Ds have been doing very well in these turbulent days. Whether large or small, some companies have it together and are weathering the rough waters in fine style. How did they manage to do that? What worked for them that didn’t work for others? There’s no one-size-fits-all business plan; from the type of business they seek to the kind of technology they employ to the sort of rep they want to work with, B/Ds have varied strategies for success.

Running the Numbers

Each year, Investment Advisor Research Editor Liana Camporeale runs the numbers on the B/D industry to come up with our exclusive look at the state of the independents. Of the 70 firms responding to the 2002 survey, 43 have given us data for three years running. That information forms the basis for our picture of the industry.

Last year, gross revenues for the 43 B/Ds came to $2.71 billion, down 11.7% from $3.07 billion in 2000. But for 2002, the B/Ds foresee a sharp recovery, with revenues climbing 15.8%, to $3.22 billion. Only two of the 43 respondents think revenues will decline.

Thirty-nine B/Ds submitted three years of data for fee-based income. The big news is that the industry’s fee-based business is decidedly on the rise. Fee-based revenue for 2001 was $353 million, up 2.6% from $343.9 million the year before. But this year, the 39 B/Ds say fee-based revenues will grow 17.2%, to $426.2 million. Only three firms expect their fee-based revenue to drop in 2002. Last year, 14 noted a decline.

Even in the face of the most challenging investment climate in more than a decade, the industry is continuing to grow its rep force. The 49 B/Ds that gave us data on their reps for 2000 and 2001 reported that they had a total of 47,078 representatives at the end of 2001. That number is projected to rise by 0.7%, to 47,410, by the end of 2002. Four B/Ds plan to remain constant; 26 will add, and 14 expect to drop their total number of reps.

As for gross revenue per rep, it came to $138,194 last year. B/Ds think it will drop by a quarter this year, to $103,349. That’s not a rosy picture for individual reps, on average, despite industry expectations of increases in gross revenues. Yet for the B/Ds who are faring well, business remains brisk and recruiting continues. Indeed, gross revenue per rep is up at 34% of the firms reporting.

A Strategy That Works

If you want to see how a particular B/D is navigating around the shoals, take a look at Folsom, California-based Brecek & Young (BY). Its excess capital fell substantially in 2001, from $840,000 to $545,000, but that’s not a concern to President Roland Brecek. “We did lose money last year,” he concedes, “but the reason was the acquisition [Brecek & Young bought Donahue Securities last year]. Had we not had that, we would have been in the black. We’re expecting to make a reasonable profit this year.” Brecek explains that the acquisition and start-up phase, expensive in itself, was accompanied by expenses for technology, new employees, and an office building. “Not only did it bring down excess net capital, but it also hurt us on the cash flow side initially,” he says, noting that there was no revenue coming during the transition. In the fourth quarter of last year, however, he says, they did turn a “nice profit.”

In fact, says Brecek, “We’re having a lot of fun.” With $2.4 million in gross revenue, “April was fantastic; it was our best month ever,” he says. “I know that’s the opposite of what a lot of B/Ds are experiencing right now. A lot of our business is in retirement plans, and those plans are being funded every month regardless of market conditions. Tax-sheltered annuity accounts, 467 deferred compensation plans, and 401(k) plans [are funded with money] that employees have deducted from their paychecks every month, and it goes in regardless of market conditions. The amount of revenues we’re getting every month is actually increasing. We’re getting more and more under management, too–I can’t wait till the market rebounds.”

With gross revenue of $19.3 million in 2001 and an estimated $24.2 million in 2002, BY is still in expansion mode. Brecek expects to add more reps and increase revenues this year despite market conditions. The company is down by 70 reps–”A lot of firms have a lot of dead wood,” Brecek says–but BY is still looking to add more. “We’ll grow by a net of 100 reps,” he says.

BY devotes a lot of attention to reps, and that affects not only its recruiting strategy but its technology investments, expansion plans, and training. While BY’s minimum standard for producing reps is $20,000 annually, Brecek says, “we’re really seeking reps that do $100,000 plus. We normally don’t hire an inexperienced rep.” Yet having the $20,000 minimum allows BY to train a newbie with promise.

New reps’ concerns include technical improvements that allow reps to be paid weekly, and back-office customization that allows OSJ [office of supervisory jurisdiction] staff to customize how they pay representatives. “We have a lot of happy reps right now,” says Brecek. “I want our reps to feel that the things we’re doing are specifically to help them to build their business, rather than to help us build our business.”

To that end, he says, BY will do a private-placement stock offering to reps to raise $1.4 million over the next couple of months. The firm is also meeting with an advisory group of reps to determine future technology needs. Already BY has upgraded software to allow reps to look up “any client they’ve ever worked with and print out whatever they need” by accessing their client database online. The software will also fill out forms for reps. Training will begin on the software upgrades in June. Another thing BY has done for reps, he says, is make it possible for them to earn CE credits on the BY Web site.

Another Happy Camper

Although its 2001 gross revenue and 2001 gross per rep numbers were both down from 2000 figures, if you talk to Jim Putnam, national director of sales and marketing at LPL Financial in San Diego, business is pretty handsome there, too. Activity, he says, has increased since last year, and he predicts that the trend will continue.

Putnam acknowledges that last year left a bit to be desired. “When you look at LPL’s business overall,” he notes, “we were down 9%,” adding that “while you never like to be down, considering what happened to the rest of the industry, that was a tremendous achievement.

“We believe that advisors in the future are going to be managing millions more of their clients’ money,” says Putnam. “Our goal is to provide them with the tools, research, and efficiency to be able to do so in their businesses profitably. So what we continue to invest in is automation and technology.” In fact, LPL’s spending on technology to support reps hit an all-time high of $35 million in 2001. Says Putnam: “The fruits of that investment will be borne out in the next bull market, when our advisors have millions more to manage and they have the tools to manage it with.”

Fee-based business is continuing to prosper at LPL. “I really believe that it’s a bull market for advice,” says Putnam, “and one of the things we experienced last year was that we had 65% more new accounts opened in 2001 than in 2000. What this tells me is that because of market conditions, clients are seeking a trusted advisor more than ever. The number of transfers of accounts into the firm is up 35% over 2000. It was one of the best years to get new clients and assets.” That’s one reason he expects this year to be so much better. “We’re now beginning to see the effects of all the new accounts and all the new assets.”

Putnam says that the last year “validated the business model of the fee-based business. Our number of fee-based accounts was up 13%, while all assets under management were down 3%. What that tells me is that everyone wondered what would happen in down markets with fee-based accounts. Now we know clients want the advice, and are willing to pay for it.” Fee-based business has been the fastest-growing area of the firm, he says, for a decade. “Ten years ago it was probably 2% of our business,” Putnam remembers, “and today it’s closer to 35%.”

Of course, LPL is not alone in finding value in advice. Jaime Punishill, senior analyst at Forrester Research in Cambridge, Massachusetts, says that “the Internet injected a shot of kerosene on the fire–it said transactions were worthless. It said you can’t charge [huge fees] for transactions. It forced advisors to shift, and at some point it becomes a competitive issue. If you haven’t offered a fee-based price, your client will go somewhere else.”

But Punishill cautions B/Ds that adding fee-based programs “changes the model and services you have to offer, and it’s accelerated planning. You have to demonstrate value in a different way. It has to be around portfolio analysis and planning simulations and such.”

Indeed, Putnam says that LPL is actively seeking out consumers, especially wealthier ones, who thought they could manage their own portfolios and now are hunting for advisors. “What we’re providing our advisors with now are tools to do portfolio reviews and proposals for high-net-worth clients.” At the same time, LPL is “concentrating on research. Especially with the headlines about research today, the fact that our research is unbiased makes it even more important than ever before. The fact that we don’t make markets in stock, we don’t have proprietary products, and we don’t do investment banking means that when our research department issues a report or recommendation, it’s without any prejudice or bias.”

LPL has been adding reps, too, at a pretty good clip: 400 last year alone. And Putnam says his firm is still looking for “people who put their clients first, who feel comfortable owning and operating their own business, and who have a long perspective about helping people manage their wealth.” LPL’s new reps are coming from wirehouses, regional firms, and other independents, according to Putnam.

Declaring Independence

Even though their independence and lack of market-making in securities are factors in their apparent success, according to Matt McGinness, senior analyst at Cerulli Associates in Boston, the very lack of proprietary products can make it harder for LPL–or any true independent, for that matter–to survive in the current marketplace.

“LPL is different,” says McGinness, because “it does have proprietary managed account programs.” McGinness divides B/Ds into categories. There are the true independents, such as LPL and Cadaret Grant. There are firms that he characterizes as hybrids, such as American Express and Waddell & Reed, that “look like a cross between a wirehouse and an independent.” American Express, he notes, “has a big advisor force and a good bit of proprietary product on the mutual fund side.” A hybrid, however, “has a more diverse revenue stream than the true independent. That’s one of its strengths.” And then there are aggregators, such as SunAmerica and ING. Aggregators, he says, “know it’s a thin-margin business so they feel that scale is the only way to make it work.”

Regardless of the aggregators’ view of the business, says McGinness, “we’re not saying there’s not room for true independents. There will always be; successful advisors won’t work under any other model. LPL will be successful, and has been so far, but there’s a question as to how much room is left in that space.”

McGinness says that in general, B/Ds that are doing well look less like the traditional independent firm. “It’s difficult to run a traditional independent firm on thin margins inherent to that business model,” he says. “You give up a lot of things: no proprietary products, mutual funds, wraps, consulting. And also, true independents, or firms that don’t really attempt to pressure or encourage their rep force one way or another on products, have less ability to leverage asset managers and insurers for more lucrative arrangements–which wirehouses are able to do.” But some independents, he concedes, “have tried to forge relationships with asset managers and are doing quite well.”

When Putnam says of LPL that “Wall Street is moving more toward our way than we are their way,” he’s probably right. Says McGinness of B/Ds in general, “They are adapting. Most of the adaptation is occurring on the wirehouse side. Wirehouses are looking more like independents for autonomy, and more and stronger alternatives: fee-based and managed accounts, encouraging reps to transition to fee-based programs. The big question for the future of wirehouses is whether they will go so far at some point as to offer the multiple affiliation model that American Express has.” American Express, of course, not only has its own employees but affiliated offices as well; it both trains brokers and acquires them mid-career with their offices.

The Big Squeeze

Although many B/Ds are expanding despite the tough market, the industry in general is focusing keenly on costs in order to prop up the bottom line. The placement consulting firm Challenger, Gray & Christmas in Boston cites financial services industry layoff figures of 12,943 in January, 1,371 in February, 7,337 in March, and 8,648 in April. “It’s a harsh environment out there, and it looks as though it’s going to get worse before it gets better,” says CEO John Challenger. “Financial services cuts have been growing.”

While these numbers include not only broker/dealers but also banks and mutual fund companies, the trend is toward leaner and meaner throughout the sector. Echoing that view is Larry Papike, president of Cross-Search, a recruiting firm based in El Cajon, California, that serves broker/dealers, brokers, and recruiters.

The firms suffering the most, Papike says, are the transaction-oriented broker/dealers. “The firms doing more than 35% to 40% in stock and bond transactions are really having a problem,” he says. “Eisner Securities [which went into liquidation last November] did a lot of transaction-oriented business. The typical stock-and-bond business and independents concentrating in that area are off significantly. Packaged products and fee-based are still hanging in there. The broker’s revenue is down, and the firm’s revenue is down, too.”

When it comes to recruiting, this consolidation has made a difference in what reps are seeking when they look for a new B/D. “Registered reps used to call and want to talk about money and service,” he says. “What they really want to know now is about the stability of the organization. With firms going out of business, consolidating, and rolling up, they want to make sure that the name of the firm will be the same six months from now.”

Papike says that some firms are “stable and sound because they saw this thing [the trend in the economy] and they planned for it.” Revenues may be off, he says, but “it doesn’t concern me a lick. There’s still a continuous flow of people wanting to join the independent contractor environment.” And with the wirehouse firms continuing to increase production requirements and mandate product sales, he says, this “causes a movement to independent.”

Not everything has been rosy on the independent side, although there is hope for change. And results can be mixed within the same firm, as rising numbers of fee-based accounts struggle to stay afloat in a market that depletes the assets within them.

Mixed Bag

Texas-based Signal Securities, independent and small, with gross revenue of $3.9 million, has had its ups and downs over the last year. “Across the board,” says President Jerry Singleton, “people are tending to put their money in a coffee can and bury it in the backyard, as far as I can tell. People are afraid to make decisions. Hell, they’re afraid to get in a cab to go to the airport.” After a “horrible” March and April, “the jury’s still out” on what this year will bring. But Singleton is hopeful for the year, and pleased with the fee-based business his firm has done. “I’m still very positive on this market,” says Singleton. “We’re still looking for it to turn up before the end of the year. If you look, there are still more companies increasing dividends than cutting them; something like 65% of first quarter earnings estimates beat analysts’ expectations, and another 20% met them. So that’s only 15% of companies that didn’t meet earnings expectations. Given all that, and with this steady interest rate environment and no inflation, corporate earnings should follow by the end of the year.”

But to Singleton, the jury has already decided in favor of fee-based revenues. Compared with last year, they’re up, says Singleton, “and that’s simply because we’ve captured more assets and have more money under management. This year we have picked up $3 million to $5 million in fee-based accounts, which is small as a number but a big percentage for us, based on the fact that we only had about $10 million under management. People are recognizing the value of hiring an investment advisor. It’s an admission that they do need help; they can’t go out online and do it themselves. They’re willing to pay an advisor for good advice. I think for the fee-based side of the business, it’s a very good sign.”

“People are always out of sync with the market,” he adds. “The traditional flag-waving American out there is always buying when he should be selling, and vice versa, because he’s a trend follower, he’s always too late, and never has the bravado to make a move when he should. You buy when there’s blood on the street.”

“Average folks wait until 80% of the market moves before they jump in, and the market turns on them and they jump out,” says Singleton. “And five years later they repeat the cycle. That’s why people need investment advisors, to hold their hands and steady them out. I have one man who calls me about once a month. That’s where financial professionals are so desperately needed in this environment. That’s when you make clients for life.”

Although times are tough, Signal Securities is upgrading its technology to make its systems simpler and more user-friendly. Singleton is looking for “new software, whether it’s for searching for good equities or doing asset allocation. Some software out there is fantastic, but you’ve got to have a Ph.D. in computer skills to use it.” The easier it is for reps to use, the more of an attraction it will be. At the same time, Singleton is moving toward a paperless business. Signal has done away with paying reps via paper checks, for instance, even though “the old-timers are fussing and fuming and having a fit.”

Just A Technicality

Punishill of Forrester zeroes in on the issue of technology, saying, “Increasingly one of the big differentiators between independents and captives [wirehouses] has been the technology provision. You get a lot of technology at Merrill Lynch, and [at the independents] you only get as much as you’re willing to build yourself.” While Schwab and such companies as Advent and TechFi have “closed that gap,” he says, “the captives, now under pressure, are busy building next-generation workstations, and will be focused on integrating data across the platform and using CRM to provide help to advisors.”

It’s a “huge transformation to fee-based planning; the market environment is only accelerating it,” he says. A broker at a wirehouse trying to go fee-based now suddenly must think about “planning, and insurance, and estates that I may or may not be expert in or comfortable with,” says Punishill. “How will I get there when it was hard enough managing the assets? A challenge [for the independents] will be competing with systems that will help the captives sound a lot smarter.”

The system will automatically bring up screens to guide brokers, offering suggestions on what to tell clients and providing contact information for outside specialists: “The screens will say, ‘Here’s what you need to say, and here’s the expert to talk to,’” he says. “Captives are not sitting around waiting for the indies to eat their lunch.”

As wirehouses up the ante on what they expect from reps, and as more and more of those reps decide that they don’t want to deal with the pressure or constraints imposed by wirehouses, more gravitate toward independents. Mitch Vigeveno, president of Turning Point, a recruiting firm in Clearwater, Florida, says he had an inquiry for a rep to go from an independent to a wirehouse. “We chased down the deal and he decided he didn’t want to do it. He found it difficult to have someone looking over his shoulder.”

For some, it’s tough to go to a wirehouse, anyway. Says Vigeveno, “The wirehouses have all upped their antes; in terms of the people they can pick up, they want $500,000-plus guys.”

The Last Word

Although many B/Ds on the prowl for new reps are promoting themselves as advisory and planning firms, Punishill at Forrester notes that the same percentage of households is using advisors now as five years ago. Moreover, “as the markets go further south, clients go into ostrich mode. They don’t pick up the phone; it depresses them. They’re not talking to the advisors they’ve got.”

Try telling that to the B/Ds that are making a success of themselves in hard times. Via aggressive recruiting, hefty tech budgets, and other means, they are keeping costs down and, Punishill observes, using the Web and e-mail to “reach out to folks and bring them back into the fold.”

When the going gets tough, companies need new tactics to succeed. The top players in our annual industry survey are certainly showing that they are up to the challenge.


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