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April 11, 2014 at 05:26 AM
This is the second in a two-part posting on how excessive compliance costs, in addition to other factors, place many smaller, generalist independent broker-dealers’ survival at risk. In part one, we set the stage for the discussion and suggested which broker-dealers will survive. In this posting, we look at which BDs are most at risk.
Which Small BDs Will Falter?
We’ve seen some other specializations fall flat over the years, resulting in broker-dealer closures. Examples include those who focus on internal financial planning and on fee-based advisors without having anything unique to offer. Without something to set them apart, the generalist broker-dealer is going to find that competing with larger firms is increasingly difficult.
Lacking up-front money, a broad array of services, leading technologies or deep pockets to offer financing help with succession planning or marketing expansion, the generalist broker-dealer has little more to offer than personal service and, for larger producers, the management attention that comes with being a big fish in a small pond. Besides recruiting competition from the large broker-dealers, we also see additional regulatory burdens impacting the small broker-dealer’s ability to recruit.
Risk Assessment Reports Affect Recruiting
Since 2008, the Financial Indistry Regulatory Authority has supplied broker-dealers with quarterly risk assessment reports. These reports let BDs know how their firm compares with industry averages on topics such as:
- Reps registered with three or more firms in the last two years
- Number of terminated reps
- Reps with one or more disclosures
- Reps with customer complaint disclosures
- Reps previously employed by a severely disciplined firm
For example, in a given quarter the industry average of reps with one or more disclosures may be 11.5%, and the broker-dealer’s average may be at 23%. The broker-dealer may wonder, “Is that a problem?” FINRA is usually quite vague on such matters.
If you are among the lucky ones, FINRA may hint that they’d like to see you stay under two times the industry average. Otherwise, you might simply need to guess. It stands to reason that FINRA would refer to these risk assessment reports when they are tailoring their inspections of firms. It is during and after such inspections that broker-dealers must quickly make a host of policy changes.
We’ve received feedback from small broker-dealers that they can no longer bring on reps with credit issues or compliance marks because their percentage on the risk assessment report is too high already. Some firms keep a list of severely disciplined firms handy in order to weed out candidates from those firms so their own average isn’t raised above a certain threshold.
In order to grow, smaller broker-dealers are usually forced to take on greater risk in the form of reps with higher frequency of disclosure events as well as lower producers in order to build scale. As these firms grow toward midsize level, they can then let go of higher-risk reps and low producers because they now have the scale to afford to do so. The risk assessment reports adds an additional dynamic that prevents small broker-dealers from being able to recruit because now “beggars have to be choosy.”
FINRA Tightens Thumb Screws on Small Firms
