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Interesting Times

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Sweeping changes are whirling across the independent broker/dealer landscape in 2007, with major changes at, and coming from, the NASD, SEC, and potentially, Congress. Although broker/dealers may have a fair amount of direct and indirect input as to how a newly combined NASD/NYSE self-regulatory model with a unified set of rules will play out, some other changes may take longer to coalesce. When these changes are combined with the morphing demographics of the investing public, increasing global competition and global investing, and continuing margin compression, the stage is set for interesting times.

As these changes create opportunity–and uncertainty–executives at independent B/Ds seem, for the most part, to be optimistic about the industry, their representatives’ prospects, and their ability to serve the investing public. One touchstone of the changes of the past 12 months for independent broker/dealers is the new leader at NASD, CEO Mary Schapiro, who will also be CEO of the super-SRO when the NASD/NYSE Regulation deal closes, sometime in the second quarter. Her leadership and the unified rulebook that comes out of the new SRO will have a vast influence on how B/D executives structure and conduct business at their firms–probably for a very long time.

However, perhaps nothing has more potential to change how B/Ds do business than what happens over the short and long term at the Securities and Exchange Commission, particularly in the wake of the March 30 ruling by the U.S. Court of Appeals in Washington, D.C. that vacated the broker/dealer exemption rule. The SEC announced on May 14 that it would “not seek further review” of the decision, but did request a four month stay to allow “investors and their brokers to respond in light of a court decision affecting an estimated one million fee-based brokerage accounts.” The overturn of the exemption rule, also known as the Merrill Lynch rule, will undoubtedly create enormous changes at some B/Ds, but not so much at the independent B/Ds. In fact, according to a new element of the annual IA Broker/Dealer Directory this year, the inaugural IA Presidents’ Poll, in which 72 independent B/D presidents provided their opinions on a range of B/D issues, 90% said they did not expect that doing away with the rule would significantly change the structure of their firm (see sidebar “Voices of Authority” for more on the Presidents’ Poll).

In this Special Report on the state of the B/D world, we will consider the state of the independent B/D industry: giant changes in rules and regulators; how some firms are coping with margin pressure; and the opportunity for B/Ds to address the changing demographics of their customers. (The Special Report includes the annual IA Broker/Dealer Directory, online at, and a report on recent B/D technology developments.)

As for regulation, for the most part there seems to be a simultaneous, collective sigh of relief among independent B/D executives indicating that having a single rulebook will be easier–and less costly–to comply with, but the executives also seem to be holding their breath to actually see how the new rules are defined and enforced. Compliance is still a very big issue for most independent B/Ds, with firms spending an average of 10% of their gross revenues on compliance, according to a white paper, Independent Broker-Dealers: Building a Culture of Compliance, published in April by the Financial Services Institute (FSI).

One issue that may have a dramatic effect on B/Ds is the SEC’s ongoing study of financial professionals and their functional relationships with the investing public. Chairman Christopher Cox announced May 14 that he “has approved additional emergency funding to accelerate an ongoing outside study of the marketing, sale, and delivery of financial products and services to investors in this area.” That study, being conducted by the Rand Corporation, is to be “delivered to the Commission no later than December 2007, several months ahead of schedule.”

Regulatory Insight

For her part, NASD’s Schapiro has stressed in public speeches and private interviews that the NASD is moving away from “one-size-fits-all rulemaking,” and toward more risk-based examinations, a change that likely would be welcomed by B/Ds of all kinds. In order for broker/dealers to have the flexibility to innovate and grow their businesses, and to allow rules to cover firms of all sizes, the NASD has been adopting some alternative ways of making–and enforcing–rules, and that may make some B/D executives uncomfortable. They include “principles-based regulation,” “tiered regulation” based on a firm’s size, and distinguishing more clearly the rules for institutional versus retail investors, according to remarks by Schapiro at the compliance conference of the Securities Industry and Financial Markets Association (SIFMA) in March. She also stressed then the importance of the NASD being more proactive instead of reactive, and not automatically responding to “emerging issues,” by simply writing new rules. Schapiro argues that, “in addition to or in lieu of rule-making,” the NASD “must consider a range of options, including best practices, guidance, education, and task forces,” to understand and address new industry issues.

Schapiro is well aware of the balance necessary to encourage innovation at B/Ds, the impact of global competition, and especially, demographic changes in the U.S. surrounding retirement for the bulge bracket of boomers. Those preparing for retirement are “very much on their own, given the declining defined benefit plans, the rising healthcare costs, the questions about Social Security; the length of their retirement periods,” and the power of the B/D industry to influence how well many Americans are prepared to retire, she told IA. Her message to broker/dealers with clients in that position is that a “focus on doing what’s right for the client takes you a long way; it’s not enough just to focus on that, but what a great start, and you’re nowhere if you don’t at least start there. Making sure your interests and the client’s interests are absolutely aligned is one of the best ways to ensure that investors are well protected and that the relationship is an honest and fair one between the broker and the client.” However, Schapiro also had advice for regulators, especially when it comes to such hot potato products as equity-indexed annuities, where jurisdiction can, at the very least, be ill-defined. For example, investors have been confused because variable and equity-indexed annuities appear to be similar. When it comes to investor protection and who regulates these investments, why would it occur to an investor that there is national regulation for one but not for the other? “I’m increasingly of the view that regulators need to think about what they do, standing in the shoes of the investor, and annuities are a great example where we’ve absolutely lost the investor in our process of thinking things through.”

“This is a historic opportunity to revisit the whole business of regulation and enforcement,” says Raymond James Financial Services (RJFS) Chairman and CEO Dick Averitt, “not necessarily to take the load off of the financial advisor or the firm, but to ask yourself: If our job is to protect the investing public, what rules should we have? For example, why should insurance agents be able to sell equity-indexed annuities that are horrific, and to do so with impunity, because there’s no national regulatory body to supervise that?”

FSI: Relevant and Powerful

Independent B/Ds and the 105,000 representatives–35% of all registered reps–that are affiliated with them, according to Cerulli, still have something of a hangover from several years of fast and furious new regulation, and what the chairman of the FSI, John Simmers, calls “rule-making by enforcement” which the FSI argues on its Web site “undermines self regulation.” Simmers, who is CEO of the ING Advisors Network, is also an NASD governor, giving him a unique perch from which to view the industry. “The opportunities are tremendous: You have society changing, you have regulators changing, and they’re all looking for what’s next–and we’re actually participating in those panels, as an industry.” His view on the overturn of the B/D exemption rule is that “it turns the clock back and lets us do over.”

The FSI itself has become the most influential entity for independent B/Ds, in advancing the firms’ agenda with regulators and lawmakers as well as educating the powers that be in Washington about the independent B/Ds’ point of view, according to the IA Presidents’ Poll. On a scale of one to five, with one being the most important, 76.1% of the presidents responded that FSI is the most essential entity in advocating for independent B/Ds, while 21.4% say it’s the NASD. SIFMA was the choice of 13.5% of presidents as most essential; the Financial Planning Association was selected by 9.3% of participants.

Opportunities and Knotty Issues

Even with all of the issues that are up in the air, there is a great deal of opportunity. The chance to provide a home for reps that want to go independent and/or bring a fee-based book of business to an investment advisor platform at an independent B/D is one that has been duly noted. In recruiting, there has been a move to higher “numbers of people coming from wirehouses, regionals, and banks,” according to Barry Knight, president of Houston-based NEXT Financial. There is also opportunity to campaign for the reform of rules, related to recruiting, that would seem to not be in the client’s–or rep’s–best interests, such as Regulation S-P, which affects a rep’s ability to take her clients with her if she leaves one B/D for another. “It’s kind of a Catch 22; if you provide information in advance of your departure, you might be violating your own firm’s Reg. S-P policy, and if you’re the receiving broker/dealer, you might be aiding and abetting that advisor, according to the SEC,” Knight reports.

Independent B/D representatives and management also note the opportunity to help prod industry manufacturers to come up with more sophisticated, relevant products–outside of annuities–for clients that need not only retirement distributions from equity gains and dividends, but also the type of capital appreciation that many experts are saying will be required for a comfortable and longer retirement. “The whole issue of income distribution is becoming the subject du jour of our industry, ” says Averitt.

“I think everyone sees the need, and it certainly is a lot more talk today than substance,” as Brian Murphy, president of Woodbury Financial Services, puts it, but “I don’t even think they’ve begun to scratch the surface on a whole new genre of products to address this issue.”

Still, there are knotty issues that remain. Margin pressure is being felt universally by independent B/Ds, and to cope, different firms take divergent paths. While most firms are capitalizing on the efficiencies technology can offer, Mark Casady, chairman and CEO of LPL Financial Services is, in addition, taking advantage of scale, with acquisitions in 2006 and 2007 of firms that complement and diversify LPL’s capabilities.

Averitt says RJFS is finding efficiencies “as we continue to attract larger offices–there are efficiencies there.” Under the investment advisory side of the firm, Averitt points out, “we do a lot” of fee-based business. The firm is also “rebuilding our entire recruiting structure,” decentralizing so that instead of having the recruiters all at the home office,” where they were stationed in order to understand the RJFS culture, the new structure is a regional one that matches RJFS’s regional supervisory structure. It’s a work in progress, he says, with so far 15 recruiters, “teams all over the country…where our advisors are, and where the potential advisors are.”

Putting the Investor First

The new deal in regulatory rules represents an opportunity for B/Ds to put investors first. If they don’t, Schapiro warns B/Ds that the consequences could be serious. “Frankly, if we have an enormous blow-up in the market for selling products to retirees and near-retirees, there will be tremendous Congressional attention, and tremendous regulatory attention,” she says, adding, “I think firms really need to understand that there’s going to be a tremendous focus on how they are handling this business and whether they’re treating people fairly.”

It also makes for some interesting bedfellows, Averitt observes. “To me the NASD and the SEC and our firms all should have the same agenda to the extent that the investors’ interests are involved; all of us want the investor treated fairly, and we are all, also, investors. All of us want the bad guys out of the business. We’re getting back around to where everybody recognizes that,” Averitt says. “We went through a little regulatory competition at the beginning of this decade; I think some of that got lost in the heat and steam of the moment where it seemed more about getting scores in enforcement than about protecting the investor. Today I believe that they are back to a focus on what’s right for the investor and let’s not let the bad guys stay in the business. To position ourselves as on the same page as our regulators is not a common concept, but it is, in fact, where we all are. Our interests are aligned to the extent that we want to protect the investor, and the people whose interests aren’t there, we want out of the business.”

Contact Senior Editor Kate McBride at [email protected].


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