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Industry Spotlight > Clearing and Custodial Firms

Choose Your Partner

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It’s not a question of any port in a storm — it’s the right port … in a tsunami. That’s what independent broker-dealers are seeking in a clearing partner: a safe haven from the tidal wave that has up-ended the entire industry.

Indeed, the landscape has changed dramatically not only concerning market turbulence, but the health and stability of a wide range of firms. There is no doubt that, across the spectrum, the financial services arena is faced with huge challenges.

But for the clearing segment, it’s business as usual — that is, business as usual ratcheted up to the nth power. As ever, firms are competing for clients — only harder; introducing products and services to help broker-dealers — only more of them; and helping to recruit advisors — only nowadays, with intensified initiative and vigor.

It’s a time of money in motion, advisors in motion and, to be sure, firms — re-evaluating their clearing relationships — in motion. The state of flux stems from prevailing uncertainty brought by the seismic financial and economic shifts that began in earnest in March of last year. And, for better or worse, in no way have clearing firms dodged the fallout.

“Who can I trust?” is the issue, says Anne Steer, executive vice president, relationship management, for National Financial, a unit of Fidelity Investments based in Boston and with more than 300 clearing clients. “Everybody is stepping back and analyzing all their relationships, even the pretty strong entities. The questions are there. I don’t think anybody is untouched.”

Seeking Stability

During the last several years, it was rare for the financial solvency of clearing firms to come into question. But with the 2008 rescue acquisitions of Bear Stearns by JP Morgan Chase and Wachovia Securities by Wells Fargo, for example, that is no longer the case. Clearing firms were part of both acquisitions.

Such events have “caused brokers and broker-dealers to rethink their clearing partners. It’s an enormous shift,” says Craig Gordon, president of RBC Correspondent Services, based in Minneapolis, with 170 clients among broker-dealers and registered investment advisors. “The turmoil has challenged the stability of the perceived big firm with the big reputation, and the next level down of smaller firms is really challenged because they didn’t have big capital to start with.”

As broker-dealers mull clearing relationships, many advisors, disenchanted with their wirehouse employers, are breaking away and setting up shop on their own. Clearly, this is a boon for clearers. “There’s been a tremendous amount of brand destruction — chaos among advisors affiliated with some of the big wirehouses.

So they’re looking to become affiliated with a firm that won’t be damaging to their brand and business model,” says Jim Crowley, managing director, Pershing LLC. With 1,100 BD and RIA clients, the affiliate of Bank of New York Mellon is the industry’s top clearing firm. And “we’ve been a [beneficiary] of this disruption. We have a full conversion calendar,” says Crowley, based in Jersey City, N.J. Plus, “our introducing broker-dealers are successfully recruiting not just accounts but advisors away from many of the large institutions.”

Just so, RBC’s Gordon reports that his clearing firm’s new-business pipeline is “larger today than it has been in the last two years.” RBC Correspondent Services is owned by the Royal Bank of Canada, which, according to Gordon, is Canada’s soundest bank.

Certainly in the United States, the industry is anxious to know to what extent the large firms that acquired firms with clearing arms are committed to that side of the business. JP Morgan Chase bought Bear Stearns, and its clearing unit has been turned into JP Morgan Clearing Corp. Bank of America acquired Merrill Lynch, with its clearing provider, Broadcort. First Clearing Correspondent Service is now part of Wells Fargo’s acquisition of Wachovia by way of its Wachovia Securities subsidiary.

In the past, these acquirers chose either not to be in the clearing business — JP Morgan, for instance — or sold their clearing entities — Wells Fargo, for example, whose buyer, about four years back, was RBC Correspondent Services. Bank of America had exited the business not long ago.

Now, BDs wonder: Will the clearing partner I have now be there for me in the future? To be sure, broker-dealers and FAs alike are taking a hard look at the financial stability and perceived goals of their clearing firms.

Relationships in Flux

BDs are “looking for a firm that will offer them stability in this turbulent storm. Safety, soundness, trust and confidence are values that are in the forefront,” says Crowley.

At First Clearing, “we’re seeing our firm attract financial advisors who may be interested in looking for an alternative from the traditional wirehouses,” says William Coppel, chief officer, Client Growth Group. First’s clients total 120. “We didn’t lose any in 2008 — we brought on a couple. And we have a couple more that are coming on. In the face of changes in the marketplace and the market, we continue to grow.”

First’s conversion of A.G. Edwards — which Wachovia bought in 2007 — was completed this past February. The firm last year relocated to St. Louis, where A.G. Edwards is headquartered. In light of recent events, many wirehouse FAs are leaving big firms and starting their own boutique shops. For both business and personal reasons, they are dismayed with their employers, some of whom, they say, have tarnished their brand.

“We see more and more opportunity for the former big-firm advisors to go out on their own either as independent broker-dealers or independent registered investment advisors,” says Gordon.

Going independent is always a risk, but for some FAs, given current circumstances, it’s a risk they must take. But perhaps no segment of financial services has a bigger focus on risk nowadays than the clearing sector.

“The four-letter word everybody is talking about is risk,” says Dan Weingarten, senior vice president and co-director of global sales and marketing at Penson Worldwide, the clients of which number 300-plus. “Evaluating and monitoring risk has definitely heightened; we want to make sure that our clients are doing the [kinds of ] business we expected them to do. So we [study] their ongoing profiles — not just a one-time risk profile” generated at the start, he says.

But when a broker-dealer partners with more than one clearing firm, the BD’s risk profile changes immediately.

“You don’t see the full picture of what they’re doing,” says the New York City-based Weingarten, because “you’re not seeing all their money and accounts.”

To ensure business continuity in the event of disaster, there has been a major push toward redundancy in operations and technology. That’s why some firms have gone to a dual-clearing model.

“True, there’s all this redundancy,” says Weingarten, whose firm serves some dual-clearing clients. “But for a lot of people, there’s a single point of failure. And that’s the clearing firm.”

Pershing, for one, does not see dual-clearing as a growing trend, though. “In this cost-conscious environment where people are trying to operate their businesses as efficiently as possible and, at the same time, mitigate operational and reputational risk,” Crowley says, “firms are picking a partner and staying with [them].”

One risk-centric change in the clearing space occurred this past winter when insurer Customer Asset Protection Company (CAPCO) announced it would not be renewing excess SIPC account insurance for client assets once its coverage expired on February 16, 2009. Many clearers that used CAPCO, including Pershing and First Clearing, replaced it with Lloyd’s of London.

With the number of BDs in difficulty, sources believe that CAPCO was worried about its exposure to risk. Further, two CAPCO members — Bear Stearns and Lehman Brothers — had exited. “I believe CAPCO may be in the process of dissolving” Crowley says.

According to Steer, “There were questions about the solvency of CAPCO. Obviously, if you have more claims, you get a lot of pressure,” she says, adding, “We’ve never seen as many questions about, ‘Where are my assets held?’ With all that’s happened, [end-clients] want to know exactly where things are.”

Cutting-Edge Clearing

Despite, and because of, the ongoing financial meltdown, clearing firms continue to come up with innovations to help existing clients and attract new ones. First Clearing, for instance, is rolling out a Growth Accelerator to help FAs develop their business through one-on-one coaching. First is also furnishing ongoing market information that enables advisors to engage in more of what it calls “courageous conversations” with clients during this tough time.

National Financial has launched a Business Process Management system for greater efficiency in handling company-wide workflow. Later this year it will broaden its platform to give high-net-worth FAs boosted support.

Pershing has set up an additional website, It helps on-the-move FAs link up with appropriate BDs and RIAs, all Pershing clients.

And LPL Financial’s Custom Clearing Services, which, in addition to LPL independents, clears for AXA Equitable Life Insurance Company’s AXA Advisors, offers what it touts as a “unique, air-tight” compliance regulatory system to help mitigate regulatory risk.

Regulators now require clearing firms to supply increased information about correspondent BDs’ businesses. Though this signals greater responsibility, clearers still are not obligated to supervise advisor business or conduct.

Nonetheless, firms “can’t turn a blind eye to any inappropriate activity,” says Gordon. “There have been some significant cases where clearing firms should have known there were bad things going on but didn’t act upon it and became very liable. Bear Stearns was probably the most famous case back in the ’80s.”

About clearers’ responsibility in general, Steer points out: “We all understand, at the end of the day, who is ultimately accountable for different risks. But if somebody learns something, the faster they share it, the better off we’re all going to be.”

Crowley adds: “It’s our responsibility to help our introducing broker-dealers discover things that we might have some suspicion of.”

As for clearing firms’ new-business initiatives for the rest of this year, they center on seizing opportunity. This means pursuing BDs that are concerned about the stability of their current clearing partners and wirehouse FAs opting to go solo.

“Many broker-dealers are feeling that ‘We’ve got a crack in our foundation, so we’d better change now before the house falls down,’” Gordon says.

For LPL Custom Clearing, headquartered in San Diego, Calif., the situation calls for patience until large insurance BDs — its target clients — loosen their purse strings.

“Until things get stabilized a bit with respect to market conditions and they feel more comfortable about spending money,” says Jon Eaton, Custom Clearing’s managing director, “we’re seeing people just sitting on the sidelines wringing their hands and waiting.”

Industry-wide, look for several BDs to shut down by year’s end. That, of course, spells contraction in the clearing client base.

Crowley warns: “A lot of people are going to have to reestablish themselves in the marketplace and stick to blocking and tackling — very fundamental things.”

With the predicted prolonged economic downturn, most clearers agree that their corner of the financial world will experience further consolidation before ’09 is up.

“It’s inevitable,” says Penson’s Weingarten. “We’ll see firms exit the business because it’s not core to their future goals. Everybody is ‘getting back to basics.’”

A continuation of both “activity and swirl” is what Atul Kamra, president of First Clearing, foresees.

“Firms are [contemplating] whether to stay in the business or tie up with somebody else and take advantage of more scale…. It is in these environments — where you have either revenue compression or people who have taken undue risk in the market — that folks rethink: ‘What business are we in?’

“I’ll leave you with that notion about consolidation,” he says.

Freelance writer Jane Wollman Rusoff is a Los Angeles-based contributing editor of Research and is the founder of Family Star Productions.