Our Broker/Dealer of the Year survey has come of age. Twenty years of change, innovation, regulation, boom, bust (and boom again) in the independent space. And for each of those 20 years, the September issue is one to which we look especially forward. Interviews with industry thought-leaders are always revealing, but put four in a room and the interaction and information gleaned is that much more exciting. The men whose firms won Broker/Dealer of the Year honors–as chosen by their own representatives (see “How You Picked Them” sidebar)–gathered together for an entire stormy day in Chicago with Editor John Sullivan and Group Editor-in-Chief Jamie Green to answer prepared questions, but the conversation often went into unexpected and interesting directions.
This year’s winners were David Stringer of Prospera Financial, Russell Diachok of Geneos Wealth Management, Eric Meyers of The Capital Financial Group/H. Beck and Eric Schwartz of Cambridge Investment Research.
With all that’s happening, each had a lot to say, and editing the transcript alone took a bit of doing. But all were surprisingly candid in their views of the recruiting environment, the recently passed financial reform bill and what broker/dealers (and advisors) are doing right–and what they’re doing wrong. Most important, they sound off on what needs to happen to ensure the recent market and business angst doesn’t happen again.
The 20th anniversary BDOTY celebration continues online at InvestmentAdvisor.com, where readers can find the full, uncut interview transcript (an excerpt of which is provided here), individual interviews with this year’s winners and behind-the-scenes video at the magazine’s photo shoot. We’d also be remiss if we didn’t acknowledge Commonwealth Financial Network’s unprecedented 10 BDOTY wins over the years, the most of any broker/dealer. We interview founder and chairman Joe Deitch in this month’s B/D Briefing about how the firm was built and what it takes to maintain such a high level of performance.
What Your Peers Are Reading
So enjoy the conversation in print and online on the present and future of the independent B/D model from the 2010 Broker/Dealers of the Year, and here’s to another 20 years of challenge and growth in the independent space.
RECRUITING: IS THE WIREHOUSE EXODUS TO THE INDEPENDENT CHANNEL BEGINNING TO COOL?
Eric Schwartz, Cambridge Investment Research: Almost every broker/dealer that I’ve spoken with had a banner year in 2009. We certainly did. Last year we recruited $71 million of new production. The prior year was a record year at $56 million. We’re going to be somewhere between $60 and $70 million this year. I would say the lead generation this year is about 30% down from last year.
What has happened is that some larger offices take longer to move. If you have 50 advisors and you’re doing $12 million in business, you don’t move over night. I don’t think the quality [of recruited reps] has changed or the size; those are two different things to a degree. I think we do fine with most independents and I’m interested to see what other people say in the room.
Most of us don’t get our recruiting from wirehouse firms, so even last year out of our $71 million I think somewhere around $9 million was from wirehouse firms. So that’s only about 12 to 14%. We get a lot more from other independents that are having difficulty, which was also going on in that time period.
Eric Meyers, Capital Financial Group/H. Beck: I agree with what Eric said, especially when it comes to quality versus quantity. It’s interesting; we’ve always had an emphasis on recruiting but we made a decision in January, February and March of 2009 to shift more of our activity and efforts to the recruiting process. While we did have a record year, and it appears this year will be unbelievable, you have to go back to take a look why. It’s because so much of the momentum we initiated back in the first quarter of 2009 really hit a crescendo as we moved into 2010.
You have to take a look at your asset base and your activities and decide, for the long term, what’s best for the organization. Enhancing our recruiting activities has worked out very well for us. It’s continuing this year. Our best fit is still the independent rep who wants to put his clients first and be able to call senior executives in the broker/dealer to create that special relationship.
Russell Diachok, Geneos Wealth Management: Recruiting has definitely improved this year. We had a ton of activity in 2009, but I think much of it was because of the other companies that were struggling–their advisors were in a panic. The quality of people that we brought on board is dramatically up from previous years. But not so much the quantity, which I think comes from our own desire not to change the model of our firm. We don’t want to be as big as Cambridge. We want to stay smaller and stay in Division II or Division III.
We’ve never recruited from the wirehouse world and probably never will. We don’t have the resources to convert that mentality. We’re getting people from smaller firms calling us and we’ve also had several producer groups approach us looking to be acquired. Those are the kinds of ongoing conversations that we’re having.
Schwartz: A lot of firms are injured because of their exposure to these Medical Capital and similar products. So you have to analyze the prospect’s exposure to those products and [determine] those that haven’t blown up yet. Due diligence from our side has to be a lot higher than in the past. If somebody’s sold $20 million of Med Cap he may not be in business in six months. So there’s exposure where they have four clients that each have $1 million of it or even if they have 20 clients that have $22,000 each. Our due diligence teams are part of our recruiting process more than ever before.
David Stringer, Prospera Financial: One of the things we’ve tried hard to do is stay small because it’s absolutely about quality, not quantity. We’ve had a strict vetting process for some time.
I like the word “like-minded” because we use like-minded in our practice. We’re looking for those advisors who are like-minded in our core values; putting the client’s interest first, not breaching their integrity.
We have a pretty selective process. We have a scorecard we track and obviously production and business mix is one side. But personality profile is on the other. We have a “no-jackass rule” at our firm. So our recruiting effort was big last year. We did have a number of wirehouse guys looking but they were really just tire kickers. It seemed like they were trying to get away from something instead of moving toward independence.
We did have a number of our advisors come to us from firms that had events of some kind. But big numbers for us is all relative to our scale. Our pipeline is still pretty full.
PRODUCT AND STRATEGY: WERE ALTERNATIVES REALLY ALTERNATIVES?
Meyers: For many years, up to about 1986, better than 50% of our business was in private placement and limited partnerships. We developed an expertise on the due diligence side of the equation over the years and it’s kept us out of trouble. That’s a big attraction to a lot of quality-oriented reps.
I do have concerns as to the [over all] increased litigation risks. Unhappy clients find it easy to go out and find attorneys who will put them in a “heads I win, tails you lose” scenario. You go back to the due diligence that you do on these vehicles; you have to be very careful as to what’s suitable and what’s not.
We’ve gone from better than 50% of our business in 1986 (and I realize that’s eons ago) being private placements to now about 7%. We still have a niche in the market. We’re going to keep our niche in the market. But it’s interesting to note that in this particular economic contraction as compared to previous economic contractions, the private placement, limited partnership side that serves to even out the market didn’t happen this time.
Diachok: Those non-correlating assets sure were correlated during this downtown.
Schwartz: What wasn’t correlated were the managed futures. In the year the market was down 40%, most of the managed futures were up between 20% to 30%. And then the next year when the market went up, most of them had one of their worst years ever. So those worked.
DUE DILIGENCE: ARE YOU A JACKASS?
Stringer: As I mentioned, we had one question on our recruiting form: “Are you a jackass?”
Schwartz: Each time you make a mistake, you have to add another item to your list of questions to ask.
Meyers: It gets longer and longer.
Schwartz: We ask for mixes of business for the prior five years because “Oh yeah, I don’t sell any private placement now.” But they sold nothing but private placements last week; it raises a pretty big red flag.
Meyers: It occurs to me that there is a new paradigm for performance-based suitability that we have to deal with. That’s part of the equation as well.
We’ve always had a definitive and intensive vetting process when it comes to bringing people onboard. We embrace the decentralized model, but on the other hand, you have to centralize as many of the compliance functions as possible. It’s interesting.
This new bill [the Dodd-Frank reform bill] is 2,235 pages long but will probably have 4,800 pages of unintended consequences. Picture the advisor who’s out there doing private placement, oil and gas deals, and has an accredited investor. He signs them up, overnights the check to us for processing and President Obama signs the law, which has a new definition of accredited investor. All of a sudden, by the time we get it the next day, it’s not suitable any more. Those are the unintended consequences that are going to happen.
Stringer: And we’ve been living under that [fiduciary] standard for some time. When you get taken to arbitration, they hold you to a fiduciary standard anyway.
Schwartz: Obviously, regulators have been holding us to a fiduciary standard for the last 10 years, at least on the broker/dealer side. The argument is always, “You sold them the more expensive product.” Well, it’s still suitable, but they’re saying that just because it wasn’t the cheapest, therefore it wasn’t a fiduciary-responsible course.
Meyers: So by selling the second best mutual fund out there, have we violated our fiduciary responsibility?
Schwartz: According to regulators, yes. And if you’re selling a $2,000 IRA can you possibly do it in a fiduciary way, which requires ongoing quarterly meetings and whatever else? So they’ve got six months to work the definition of fiduciary. The general feeling on the Street is that they’ll get an extension–[the regulators] can get extensions; we don’t get extensions.
Meyers: Have you violated your fiduciary standard if you sell anything other than a no-load mutual fund? I mean these are the kinds of things we’re going to be dealing with.
Schwartz: Well, certainly FSI and a whole bunch of other organizations are all over it.
EXIT PLANNING: AN ADVISOR AFTERTHOUGHT?
Meyers: The aggregate age of our producers, like the industry as a whole, is going up. One of the things we’ve done is initiate a program where we look for mentoring situations and then we provide financing for the sale of practices because you want to keep that business. If he sells it to someone else or he just walks away, we lose that business.
It’s like everything else; you have to look not 10 yards down the line but 50 yards down the line; five, six years or longer to see what you need to do to maintain your business model.
Schwartz: Any broker/dealer that isn’t getting into continuity planning better hurry up or they’ll be out of business. What most advisors want to do is sell their practice to their junior partners. They don’t want to sell it to some bank or some institution that’s going to lose everything and aren’t going to properly take care of clients.
But the problem is the junior partners don’t have the money. They can’t borrow from anybody because they don’t have the financial strength to support the borrowing.
Stringer: It’s like doing your will. Most people spend more time planning their vacation than they do their estate. We’re in the process of trying to get our guys all to sign a “guardian agreement” so that, at worst case, if they don’t have a succession plan or a named successor, they give us the ability to find a buyer for their practice. It allows us to find a way to get compensation to the heirs for the practice.
Being a small firm, we have enough capital so we could do a few deals and help provide a bridge of financing. I’m sure if we got to a scale where you guys are, it would be something where we have to look at it and say, “Boy, if we have a mass exodus here or a mass change of practices, we could be in trouble, so we better find another vehicle.” But it is important.
Schwartz: A few years ago we had a full-time guy calling up advisors saying, “Hey, do you have a plan if you die? What’s going to happen?” And 90% would say, “Not really.” So we said, “Well, why don’t we identify 10 people in a 50-mile radius that are a good match and maybe you guys can just have a buy-sell agreement. You can terminate it any time. But just do something so you have it and then if something better comes along, it’s not a binding long-term deal.”
We said, “Oh, that’s pretty easy, right? There’s no risk; all upside.” The guy worked for six months and got one person to make the deal. The reason was that, “If you’re dead and I haven’t even met any of your clients, your practice is only worth six times GDC.” Another guy thinks it worth 3.2 times GDC. So they don’t know each other and it gets really, really complicated. So they continue doing their own thing.
Meyers: Which is nothing.
Schwartz: Right. So we moved to something similar to [Prospera], although we don’t call it a guardian agreement, where we said, “Okay, we will be your succession plan.”
SUPER OSJ: THE FUTURE OF THE INDEPENDENT MODEL?
Schwartz: We have a number of what we call Super OSJs. These are OSJs of 20 to 150 advisors. This is a phenomenon that didn’t exist 15 years ago because they all would have been broker/dealers themselves. They tend to target reps that are somewhat smaller. It is hard to be a small broker/dealer. I think it’s a lot easier to be a 2,000-rep broker/dealer than a 200 rep one right now because of the pressures of compliance and all those other things.