Since 2008, we’ve seen a steep and consistent drop in the number of broker-dealers. As reported by data aggregator Fishbowl Strategies, we were down to 4,578 BDs in 2010. By February of 2014, that number was down to 4,181. We ended 2015 with 4,034 broker-dealers, with the largest segment of firms closing by far being equity trading firms. September 2015 turned out to be a false flag of hope where we had 14 new firms admitted and only 5 firms withdrew. Nevertheless, fourth quarter results continued the downward trend.
Looking at the fourth quarter of 2015, we had 16 new firms that were admitted and 53 firms that withdrew. Of the 53 that withdrew, 32 were equity trading firms, 12 were private placement firms and 5 were mutual fund firms. Of these 53 firms closing, 37 of them had fewer than 10 reps.
As discouraging as these statistics look, this could very well be the tip of the iceberg. The DOL fiduciary standard will bring about a perfect storm if it coincides with a potential U.S. recession. Besides the lower revenue associated with a down market, a recession will put an end to Fed Funds interest rate increases, which will kill hopes of higher money market revenue for broker-dealers.
The DOL fiduciary standard will also lower revenues for broker-dealers due to fewer product choices, lower commissions and higher rates of litigation.
Variable Annuity Revenue
Variable annuities in qualified accounts will likely have two options: either a 2% to 3% upfront commissions with a trail option, or a no-load VA as the only option for ERISA accounts. VA volume has been fading since living benefits have been made more realistic for insurance company profitability; so more representatives are doing fixed index annuities. There is definitive talk that fixed index annuities and index universal life will likely need to fall under FINRA scrutiny. This would cause legions of fixed insurance reps needing to get their securities licenses in order to sell indexed products.
This potential influx of new reps into broker-dealers has mixed appeal because these types of products, along with the reps that sell sizable amounts of these products, are perceived by many broker-dealers as the red headed stepchildren of financial services.
Stock and Bond Trading Firms
Since 2008, by far the largest percentage of firms closing has been the stock and bond trading broker-dealers in the retail channel. The DOL fiduciary redefinition under ERISA will quicken their demise, as the new rules are expected to disallow commission-based trading of stocks and bonds in qualified accounts. This will force advisors to convert these accounts to a fee-based structure, which will result in substantially lower revenue.
For an advisor making $500,000 trading $25 million of AUM, they will see their income cut in half when going to a 1% fee model. During a recent conversation with a stock transactional BD president, I explained to him that his reps would need to convert to an advisory model on their qualified accounts. He responded, “they don’t do fee based.” He has no clue what lies ahead.
Private Placement Firms (REITs, BDCs, Alternative Investments)
We see two issues for firms focused on this product segment. First, the DOL fiduciary standard won’t allow illiquid investments in qualified retirement accounts. Second, FINRA Rule 15-02 requires these products to lower commissions paid to advisors and for the pricing on statements to reflect actual values, i.e., mark-to-market pricing.