What a remarkable time these last few years have been for independent broker/dealers. The markets have recovered from a bubble, a crash, a grinding bear market, investment industry scandals, and corporate debacles. An aging population has realized that big corporate–or public–pension plans are, in many cases, gone or at least eviscerated, and that they generally are on their own, saving and investing for a long retirement. Tremendous wealth has been created. Scads of investors have realized that they want–and need–advice about managing their money, whether from a local independent advisor or a representative of a wirehouse, bank, or insurance company.
Many of the challenges broker/dealers face are client-driven. Even many of the regulatory issues are, in a roundabout way, the result of client complaints or client demand. Savvy individual investors are demanding value, unbiased advice, and scrutinizing that advice more closely than ever. Yet broker/dealers are seeing their margins shrink, and for better or worse, regulations are changing the face of the investment business, sometimes in surprising ways. For instance, some reps may stop asking clients questions about their goals in the planning process, fearing being labeled a fiduciary under the SEC’s “Merrill Lynch” rule.
To take the industry’s pulse, we talked with some of the leading independent broker/dealer executives to get their views.
The Local Impact
“Demand for advisors has never been better,” says Mark Casady, president and CEO of Boston- and San Diego-based LPL Financial Services. He says investors are much more sophisticated than even five years ago, and very well informed about everything they buy, including investment advice. Part of the reason for that shift is that the majority of retail investors are Internet-savvy; before they buy, they check out everything–on the Web. They want to deal with a person in the community, and local advisors have become “true impact players,” according to Casady. Consumers are inspiring vast changes at broker/dealers; they are demanding more comprehensive service that includes product choice, unbiased advice, and a long-term relationship with a “trusted advisor,” typically someone recommended by a friend or relative.
One trend that seems especially positive for independent B/Ds is that investors don’t seem to be as influenced by the big branding and advertising campaigns of the wirehouses. Today’s client may possess a newfound healthy skepticism after the mutual fund stale trading, research conflicts of interest, and corporate scandals of the past few years. If a friend recommends a trusted advisor who happens to be at a full-service brokerage firm, fine, but if the recommended advisor is with an independent B/D in the community, that may be even better. “I think consumers are really smart and understand the difference between advertising and delivering a real relationship. I think they are going to go to the person that they see in their community as having a real impact, whether that’s an impact with a friend–in terms of achieving their financial goals,” or on a nonprofit organization or politically in their town, says Casady.
But what clients want out of that lasting relationship has been shifting too, because clients’ needs have changed and because they can more easily compare what is being offered to them. Joe Deitch, CEO of Commonwealth Financial Network, in Waltham, Massachusetts, says “financial advisors are a very highly valued commodity–all the people that I know who have substantial income or assets–what they need is someone to help them bring sanity to their life, and to be organized, so they can focus on working and enjoying life.” But Deitch has noticed an odd thing, “Most experienced, talented advisors don’t appreciate how valuable they are,” he claims. “When I speak with people who own businesses, I am often told that the luxury in their lives is to find a trusted advisor, whether it is medical, financial, whatever.”
Assets under management was always the sweet spot of financial planning, according to Deitch, and now there is a growing emphasis on wealth management. The wealth management model is “much stickier,” says Deitch, because it adds risk management, retirement planning, and estate planning to the relationship. While Deitch says that model is a “much more labor-intensive relationship to build, and it’s a lot more difficult to disengage,” if the client does have “a wealth manager, a financial planner, they don’t want to disengage. A talented wealth manager is anything but a commodity, and can in fact charge a premium for those services.” Rather than seeing more advisors switching to wealth management, what Deitch observes at Commonwealth is advisors adding more wealth management services to their asset management business.
The Regulatory Impact
To say there has been an emphasis on regulation in recent B/D history is an understatement. Regulators have fundamentally shifted the way B/Ds are made to conduct business, and in large part the new regulations have to do with conflicts of interest, including firms selling their own products and excluding similar products from other manufacturers that may perform better or have lower fees. There is “tremendous movement away from independent B/Ds owned by insurance companies,” most of which were bought between 1995 and 2000, according to Lon Dolber, president and CEO of American Portfolios in Holbrook, New York. Regulatory scrutiny of manufacturers is supposed to lead to more disclosure and less conflict of interest. “If the public loses confidence in the markets, we’re all doomed. If the goal of the regulators is to increase confidence in the markets, and if the public believes that the capital markets are fair–that’s a good thing, ultimately.”
The breakup of manufacturing and distribution is a huge trend. “Manufacturers that owned distribution traditionally relied on a high degree of their products being sold by their advisors, and that really isn’t as easy to do in this environment. If somebody had 60% or 50% penetration of their own products in their own system, those numbers have dropped pretty dramatically–probably in half over the last couple of years–as more disclosure and more open architecture of product has occurred. That makes distribution less economically viable for a manufacturer to own,” argues LPL’s Casady. He says that’s a key reason why they’re splitting up. When manufacturers bought outlets, they never really integrated them–and perhaps that wasn’t part of their game plan. The value of manufacturers buying distributors made sense at the time, even without integrating the firms. It was a good model for a number of years, notes Casady, but in addition to more cumbersome regulatory issues, the “demands of the end consumer for open architecture, plenty of product choice, and the desire for unbiased investment advice has changed the economic equation,” of manufacturers owning distribution.
He cites the closure of the deal between Legg Mason and Citigroup in early December, with Legg Mason transferring its advisors to Citibank’s Smith Barney. Legg Mason now will be out of the distribution business, but its manufacturing operations will grow, since Citigroup’s mutual funds will be brought under the Legg Mason umbrella. Insurance companies have been consolidating “massively” over the last 12 to 18 months because they need to integrate their manufacturing plants, and they need scale, according to Casady, pointing to the Jefferson Pilot-Lincoln Financial merger, targeted to close next quarter, and the John Hancock/Manulife deal that closed in 2004.
Along the same strategic lines, LPL has beefed up distribution by purchasing two broker/dealers from Hartford-based The Phoenix Companies: W.S. Griffith, also in Hartford, and Main Street Management in Wallingford, Connecticut. “We’re quite interested in purchasing distribution companies that may come up for sale, whether it’s in ’06 or beyond,” says Casady.
LPL isn’t just buying; it’s selling. The company announced the sale of a 60% stake in itself to two private equity groups in a deal scheduled to have closed by year-end 2005. Hellman & Friedman LLC and Texas Pacific Group will share equally in the majority interest. “This investment is so different from anything that’s come before it,” says Arthur Grant, president of Cadaret, Grant & Co., in Syracuse. Here are independent investment firms, “whose judgment was that LPL was worth investing in as a going business, instead of as a distribution arm or as an adjunct to an insurance company.” It’s a growing company with good earnings, and a standalone business, says Grant.
Not Asking Questions