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September 01, 2008 at 04:00 AM
In this, the 18th year that Investment Advisor readers have chosen Broker/Dealers of the Year, it’s not easy to be any kind of broker/dealer. On the one hand, it seems that the rich are getting richer–that size and scale are being achieved by the few at the expense of the many. One of the casualties along the way is the intimate pas de deux between the independent contractor rep and the independent broker/dealer that has long benefited rep, B/D, and client. Perhaps that’s as it should be. After all, larger firms are able to devote the resources necessary to provide a broader range of wealth management services to clients whose advice needs can be as complex as their financial and family lives. However, there’s more to providing good advice than the mere size of the organization doing so, and having a unique vision for your firm, and supporting quality reps providing that advice, is more important than the number of reps providing it. Moreover, while growing competition, an aging rep force, thin margins, the trend of reps forming their own RIAs while still demanding the latest technology and the highest payouts, the continuing albatross of compliance, a seemingly bottomless market, and an economy that may have been in recession already for several quarters might cause the leaders of independent B/Ds to despair, that isn’t the case at all. “I would suspect every year we’d have almost the same list” of troubles, says Eric Schwartz, the founder, CEO and chairman of Cambridge Investment Research, Broker/Dealer of the Year in Division IV, the largest of the four divisions in which awards are given.
Nick Sondel, founder and president of Harbour Investments, which won Broker/Dealer of the Year in Division I, the smallest of the four, says “it’s surprising that it’s not worse.” Schwartz reports that “most of our reps are not that much off this year and some are still growing. The most successful ones, the million-dollar ones with mostly recurring revenues, they’re up 10% to 15% this year. People that are smaller, more transactional. . .they’ve backed away and they’re off maybe 30%.” The leader of the winner in Division II, Ralph DeVito of The Investment Center, notes that he’s finding the same dynamic at work: “The majority of the reps are not that worried per se. They don’t like the markets, but their clientele is pretty secure.”
The shared sentiments of the four winners could be summed up by Barry Knight, president of NEXT Financial, which won Broker/Dealer honors in Division III. “Difficult markets like we’re experiencing, it’s really a great time for good broker/dealers and good reps.” Knight points out that “fee-based revenues are down in relation to the size of the markets being down,” but adds, “I have to say I’ve been surprised by how calm our reps, and their clients, are.”
Spending an afternoon in a Chicago hotel conference room with these four men on a day when a tornado touched down in Cook County reflected the current turmoil of the independent broker/dealer universe. Buffeted by forces outside their control, with different ownership structures and with independent-minded rep forces that run the gamut from less than 200 to more than 1,200 and based in different parts of the country with different compensation models, these are leaders who put their differences, and their shared principles, to work for their firms, reps, and clients.
“We’re all independently-owned firms, all focusing on similar kinds of clients,” Schwartz said during the four-hour roundtable meeting on August 4 with Investment Advisor Editorial Director Jamie Green, with individual and group photo sessions that same day directed by IA’s nonpareil art director, Scott Valenzano. “The independent model is best served, in my admittedly very biased view,” argued Schwartz with his trademark candor, “by independently owned broker/dealers who still have the passion and can relate to reps on a one-to-one basis.”
Knight positions it a bit differently: “I talk a lot about moving from being a purely entrepreneurial organization to an enterprise organization, while still maintaining the heart of an entrepreneur,” while Sondel says he’s “sure there’s something else that we have in common: no or low attrition, because we listen to our reps.” DeVito phrases it neatly: “It’s knowing who it is you’re dealing with,” in referring to the reps in his relatively small B/D, “how they fit with your business. We have guys who have been with us since we started–for 22 years–we almost never lose the top guys.”
These top guys took the best part of a stormy Midwestern day to share their insights into their own firms, why their reps gave them their highest scores in the B/D of the Year balloting (see sidebar on how the firms were chosen by readers, page 60), and how they and their firms hope to remain on top. We’re taking up 10 pages of this issue to share those thoughts with you, along with the other gems we learned from the nearly 5,000 broker/dealer reps who took the time to vote this summer. This cover story is followed by a three-feature special report on the present and future of independent broker/dealers, and the alternatives. Please read on.
On the Wirehouses and Recruiting
The leaders of the four winning independent broker/dealers of the year spoke candidly–with a touch of tongue-in-cheek humor–on how they differ from their wirehouse cousins, and why they’re not in the same financial and regulatory hot seats–particularly related to the credit crisis.
Schwartz: We don’t do enough clever stuff to have those kinds of problems; it’s a self-protective mechanism.
Knight: When you operate on the kind of margins we all do, you never get quite so aspirational.
DeVito: I was talking to a very high-end fellow at one of the wirehouses recently. I said why do you do this? Do you actually make enough money? As a product gets driven by one firm, then at the shareholders’ meeting they ask, “Why aren’t you making money on it?” and they all follow suit. We would never do it because we have the liability. We think far enough ahead and say, “If we sell this, some years down the road, it’s going to cost us this much!”
Schwartz: If they can make a $30 million bonus this year, they’re not worried about what the company’s going to make 20 years down the road.
Knight: Absolutely. It’s short-sighted greed. But we still haven’t seen the mass migration that’s been predicted from the wirehouses. We keep saying that it’s bound to happen as people want to monetize their practices, and we’ve seen more than we’ve seen in the past, but I think that’s because we’re more of a mature firm.
Green: But you have seen people move from the wirehouses, especially recently?
Knight: I think about 17% to 18% of the reps who’ve joined us in the past year came from the wirehouses–that’s on a GDC basis, not on a rep basis.
Schwartz: I would expect that a few years ago that percent was close to zero.
Knight: Right. Part of that is that we’re larger, so if you’re in a wirehouse you’d be more comfortable with a larger firm.
DeVito: We’re seeing that, too, even with 300 reps. We’re seeing them come without the gripe, without having to sell them as much on the process.
Schwartz: The ones that are going, you don’t have to convince them that independent is okay, at least the ones who are calling us. They’ve already figured that out, now they’re going to choose a broker/dealer. In the old days, it took them five years to get up the courage to go independent.
Of course, there are a lot of things the wire firms do to keep people there. There are 200% signing bonuses every five years if you want them. There are also certain lines of business that don’t transfer over here as easily. If someone is managing money themselves in either a commission or a fee account, they’re way ahead when they get over here cash-flow wise, as well as the equity in their practices, but if they’re doing separate accounts . . .
DeVito: . . .it’s almost not worth it.
Schwartz: The thing about us in this room is that we’re not really looking at those guys anyway. But the guys in the wirehouses have been trained that separate accounts are the way to go, and it’s not by accident that they’re also what’s most profitable for the wire firms. Where they have more of a golden handcuff on them is because the pricing is so competitive. Out here you’re paying 70 to 100 basis points, even more, for separate accounts, and there they’re paying 40 or 50. Even with the differential in payout, it isn’t as advantageous when it’s their main course of business. We’ve even had some people change their main course of business in order to go independent. They wanted to go independent badly enough that they stopped using separate account managers for the most part and shifted their business. But performance of separate accounts hasn’t been that roaring. Many mutual funds have been very competitive with them. If the price differential on separate accounts wasn’t the way it is, I think we’d be seeing many more [wirehouse brokers go independent].
On the Markets and How It’s Different This Time
When it comes to dealing with a difficult market, the leaders are a bit more sanguine about long-term prospects, pointing out that reps and clients learned their lesson during the last market contraction, though there is some concern about market manipulation.
Schwartz: I think what happened from 2000 to 2002 gave [clients and reps] a level of pain way beyond what they’re experiencing today. Back then, the market had gone straight up for 10 to 15 years, and obviously the tech stocks had gone totally crazy, then tech stocks went down 80%, and many reps had overweighted in that area. Today, at 20% off the absolute, absolute peak, they’re not happy, but it’s nowhere near what that was. Now, if we’re talking here 12 months from now and the market’s down another 20%, then I think you’ll be hearing a very different story.
All in unison: Absolutely.
Schwartz: But if we’re at the bottom now and flattening out and we end the year this way, and then we’re up 5% to 10% next year, then it will be a relatively minor . . .
Green: Sorry, did you just say that we’ve hit the bottom? “Eric Schwartz has called the bottom of the market!” I want to make sure I’ve got that quote right . . .
Knight: That was our prayer, not a statement of fact.
Sondel: People have not forgotten how the markets were then, and they have to be very, very careful. Our investors are more careful, our reps are more careful, we’re using projections that are much more realistic. We don’t take clients who want 12% income, unless they’re willing to sign a suicide letter and they have to be very accredited or something. We’re being very selective and watching ourselves to make sure we’re realistic. Right now the 10-year numbers are terrible, and investors are looking at reality–you could be in the markets for 10 years now and not make money, so what other strategies do you take?
Schwartz: Expectations are so important. People used to expect 20% a year back then; now they’re thinking of a number more around 7% to 10%.
DeVito: Or zero!
Knight: Anything positive will be fine! (laughter all around)
Schwartz: Allocation models are better now–it’s more balanced. So people aren’t down the 20% that the market’s down, while back then the market was down 40% and they were down 40%, or even 60%. There’s one other thing: I was at my national conference and one of my reps said, “This is what I get paid for!” Business is pretty easy in down markets–but now, this is what we’re getting paid for. This is when people need us most, and that’s the challenge, but also the opportunity. This is where we earn our keep.
Sondel: I’ve been through so many cycles now, it’s a time for the good reps to shine. To grow their practices; get more aggressive; calling their clients more often, asking for more referrals, because now is the time that people are thinking, “Maybe I should be talking to another broker.” These down markets are really great times for reps who are more aggressive and will be the stars in the long run.
If the regulations keep getting worse and the markets keep returning under 10% for long periods of time, then the smaller brokers are going to have a tough time.
On Compliance and the Future of Regulation
The issues of regulation and compliance are never far from the minds–and pocketbooks–of independent broker/dealer leaders. There’s also concern that RIAs will continue to feel the burden of greater regulation, and that’s not a bad thing, the leaders say. So how do they feel about regulation?
Schwartz: I think we’ve gotten used to it. Regulation is at the highest level it’s ever been. It ramped up substantially after problems arose that we had nothing to do with–like Enron and so forth–but the rate at which it’s increasing has slowed down considerably. There was a time when it seemed there was a Notice to Members every three days or so, with some new thing they were working on. The SEC and the NASD have gone through just about every major category of business that we do–mutual funds, variable annuities, A shares, B shares, as well as all the different ways we give information out–in the last five years and have adjusted regulation or made new regulation in that regard.
I think that as a member of the FSI Board of Directors–I’ll be chairman next year–there’s still plenty more for us to do, it’s not like they’re not going to give us any new regulation in the next five years–but there were so many things coming out so fast over the last few years, that you needed two years just to come up with the systems to comply with it all. Now most B/Ds have caught up and are complying.
DeVito: I just hope it doesn’t happen again, in reaction to the bad market and bad decisions of some of the players out there, I hope they don’t ramp up again.
Knight: As Eric [Schwartz] pointed out [regarding the markets], the change that we saw after 2000-2002 when so many client assets were lost and then the regulators came in with great increases in staffing to go after these issues, and the huge public finance sector issues they went after even recently–they’ve handled most of the big issues and I don’t see it increasing. It’s this thing that we’ve had to absorb and digest.
Sondel: They often don’t understand the kind of firms that we have and they come into our offices like it’s their first day on the job–not always, sometimes we have good regulators who come in and realize we’ve been in business for 21 years and we haven’t gotten in trouble and things are going pretty well. But a lot of times they’ll come in and not know what’s going on, and they’ll do something like subtract our rep payables from our net capital and say, “Oh, well, there goes $2 million,” or whatever it is.
I follow a lot of individual stocks, and I think that’s where the regulation needs to go. When I watch individual stocks, it just seems like a rigged game all the time. The same thing is happening with oil–it’s very predictable that we’re going to have a crash in oil. The speculators get together, and it’s a small kind of collusion that goes on with the stock–especially smaller stocks with the market makers–you can just see stocks being driven up beyond any reasonable value for no reason only to fall well below what the value should be for no good reason. It leaves you standing there wondering what to do. You can buy a bargain but how long is it going to be held down artificially until the other investors are driven out and the big boys hold all the stock?
Schwartz: I think on some individual stocks, certainly the smaller ones, that kind of thing goes on, but when you see how these high-level hedge funds crater and major firms crater, they certainly don’t know where the top and the bottom is. The system does allow, especially in markets where there is less liquidity, for things to run away.
We’ve seen boom after boom here over the last years, especially oil, which is not sustainable at $150. It could go to $250 before it goes down to $80 again, but it’s certainly not sustainable.
Sondel: The regulators should focus more on that kind of stuff rather than people like us who are just trying to make an honest living taking a sliver by introducing products to the market.
Knight: All of these things are so predictable. Whether it’s manipulation of individual security prices or whether it’s the credit or mortgage markets–maybe it’s just a function of having a few gray hairs, but did any of this not seem predictable? It’s just like the oil thing. Oil is obviously going to come crashing down at some point–it may go higher before it does–but was money too loose a few years ago? You think, maybe? Geez, it’s shocking. And I’m not sure what the regulators do about that.
Green: Are they not only not focusing on the right thing, but are the right regulators doing the focusing? If you look at the Treasury Secretary’s blueprint for regulatory reform and you look at how active the Fed is lately, it seems that the SEC is the odd man out. Is there a turf war shaping up–will FINRA be regulating RIAs?
