4 Factors That May Cause a Flood of Broker-Dealer Sales

With 9,500 Cetera Financial Group reps, 470 NEXT Financial Group reps and 4,925 AIG Advisor Group reps looking to “get bought,” we may be headed for a flood of broker-dealer sales as prospects for their future profitability fade.

The current motives to sell are unique to these particular firms, with Cetera needing to partially or fully sell its broker-dealers to generate revenue to cover its debt load; activist investor Carl Icahn wanting AIG to split up into three entities and focus on core business; while NEXT Financial, a rep-owned broker-dealer, is looking for a liquidity event.

When firms look out over the next five years, many may determine that the risk-reward model has the risks pulling ahead, with the question becoming not whether they can maintain current profit levels but rather how much their profits will decrease.

Trends we are witnessing today will only be exacerbated by the Department of Labor’s fiduciary rule over the next five years. Marketplace dynamics such as insurance company trends, the strong dollar and the inherent profit potential of the independent channel will all have influences on whether owning independent broker-dealers makes sense.

Factor 1: A Profits Hit From DOL Rule Implementation

You can easily argue that BD profit levels are as good as they will get and it will be a struggle to maintain current profit levels for the following reasons:

• The DOL’s new fiduciary standard negatively impacts an advisor’s ability to prospect for new clients.

• Restrictions on nonliquid products in retirement accounts (Since 2008, large portions of broker-dealer profits have been via REITs/BDCs and alternative investments, along with the revenue-sharing arrangements with these vendors, so this will be a substantial profit hit for many firms.)

• New labor-intensive requirements for what must be disclosed on websites regarding who and what gets paid through commission product sales.

• Restrictive product choices, such as presenting a client with A-share mutual funds with breakpoints versus a variable annuity with a 5% commission; the client may not have a variable annuity as an option under the DOL’s best interest contract exemption (BICE) or will only be available under strict restrictive criteria.

Couple these factors with more advisors practicing the advisory model in an already crowded space and low-cost robo-advisors, and you get price compression that requires more AUM to make the same amount.

Additional FINRA tracking and documenting has been an ever-increasing burden as segments of Dodd-Frank have been piecemealed out, which has already been a tipping point for many broker-dealers. Now, with new fiduciary rules getting rolled out over time, what was a tipping point for firms under $10 million of revenue could reach to firms under $25 million or higher. As a recruiting firm, we’ve already been focusing largely on firms with $75 million-plus of revenue as a safe haven of scale and profitability.

Factor 2: Small Firms Drowning in FINRA Rules

An advisor recently shared with me his personal dilemma with our industry, which mirrors what is happening to small BDs. “The ground we are standing on is constantly shifting and breaking apart,” he said. “We have to be in a full sprint to stay ahead of the collapsing ground. It would be great if government and FINRA helped foster stability to give us some certainty in our business but instead, we’re trying to advise clients while we are wondering if our broker-dealer will make it. Some of us are wondering if we can grow fast enough to get the size and scale needed to keep up with the expensive regulation that never slows down.”

As an example, he pointed out that the time and effort it now takes to schedule an appointment, prepare for it, generate the paperwork to open an account, “explain what we are doing to the client, get the client the proper disclosures, document the meeting and follow up with any mistakes with the paperwork is extraordinary. My assistant and I work together on the paperwork, yet many times we spend the next couple of weeks redoing things that were not perfect.” This individual said, “My OSJ said that what they are looking for is ‘precision,’ but ‘precision’ is killing me. I’m drowning in things that must be done to make my clients successful.”

The “precision” required at the rep level is even more stringent at the BD level because a lack of precision on tracking and reporting results in steep FINRA fines. The irony for this advisor is that he is with a large broker-dealer that has good technology, practice management and marketing tools. Imagine advisors with smaller broker-dealers that don’t have these tools.

LPL has been through the ringer with FINRA over the last few years and has warned our industry that what they’ve been through will trickle down. Tracking and reporting are areas that many firms fall short on during audits, small firms being the least able to survive the FINRA fines that are imposed.

Since 2010, we’ve seen many small broker-dealers merge into larger ones and become super OSJs that hand off the duties they hate to a larger entity. Going forward, it is very likely that we’ll see an increase of firms with under $25 million of revenue go the route of super OSJs or merge with other small BDs.

Factor 3: The Strong Dollar Makes Sales of Foreign-Owned BDs More Attractive