It’s a question that caused even former Securities and Exchange Commission Chairwoman Mary Jo White to scratch her head: Why are the number of broker-dealers dwindling?
White told members of Congress during her tenure as SEC chief that the agency was probing the likelihood that broker-dealers were shifting to the advisory world to avoid inspections by the Financial Industry Regulatory Authority — their primary regulator — so they could face a less frequent exam schedule by the SEC.
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Indeed, Brad Bennett, former head of FINRA’s enforcement division, told me in a recent interview that it does “appear that some brokers are transitioning to investment advisors as a kind of regulatory arbitrage to minimize their regulatory burden.”
The regulatory obligations of a broker-dealer “have not been reduced. It is difficult to comply with the broad array of compliance responsibilities if a broker-dealer does not have scale,” said Bennett, who’s now a partner at Baker Botts in Washington. “There is no doubt that the regulatory burden is more manageable from a business perspective if you are an investment advisor.”
As of April, the number of broker-dealers totaled around 3,900, said David Alsup, director of business development at Fishbowl Strategies, which compiles a monthly snapshot of FINRA member brokerage firms’ comings and goings from the business. The number of firms is “going to go down to 3,500,” he told me recently. There’s a “net loss [of indie BDs] almost every month.”
FINRA examines the vast majority of large and high-risk firms annually, Bennett said. The SEC, which is also under a risk-based exam regime, covered 11% of advisors last year through its exams.
In April, there were 131 new RIA firms. “Brokers are looking at the constraints of making investments for their customers and they are going to the advisory side as opposed to the rep side,” Alsup said. “That’s why you’re seeing the surge in RIAs. … I don’t see any lessening of new RIA formations.”
The 131 new RIAs “branched off out of existing BDs and decided not to do securities business,” opting mostly for mutual funds and insurance, Alsup said.
Indeed, the number of SEC-registered RIAs continues to rise, with 12,172 firms registered with the SEC in April, compared to 11,847 firms as of the same time last year.
As it stands now, there are at least 1,000 IBDs with under 10 reps, Alsup said, “and they don’t have the capability to bring in a full-time compliance officer.” The “whole aspect of the way that the securities industry” operates is changing, he continued. “The stock jockey is all but dead.”
Chip Roame, head of Tiburon Strategic Advisors, agrees the number of IBDs are dwindling “for many reasons, most of them logical competitive business issues.” Those include: “the movement to fee-based investing, higher compliance costs associated with FINRA, and more financial advisors going fee-only, not requiring a broker-dealer.”
Financial advisors who stay with IBDs “will have more of their assets on the advisory platforms of those IBDs,” Roame opined. “The surviving IBDs will look more like custodians.”
What Does All This Mean for FINRA?
“One of the most troubling developments for FINRA is the migration of assets from brokerage accounts to advisory accounts resulting from the [Labor Department's] fiduciary duty rule covering retirement assets,” Bennett said.
That’s troubling because FINRA “does not have primary jurisdiction over advisory assets and thus its mission gets smaller because there are fewer assets under its direct regulatory control. A firm that is in the BD space is overseen by the SEC and FINRA. Advisory firms are only examined by the SEC,” he explained.
The shift of assets away from FINRA’s jurisdiction raises the question: What does this mean for FINRA’s self-regulatory structure? “The fact is that the vast majority of registered reps work for the 20 largest firms,” Bennett said. “If the fiduciary duty rule has the effect of shifting a significant portion of the assets that [BDs] service to fee-based accounts, this is not a positive development for FINRA.”