Here’s a not uncommon scenario for independent advisors: Without warning, you discover that your independent broker-dealer has been unceremoniously dumped by its owners, often times a distant corporate parent.
The home office trading and operational staff you’ve relied on over the years to help serve your clients and accounts and to fix problems has been pink slipped.
Before you know it, the designated successor firm is touting its flawless platform and recounting the glorious synergies between the two stellar organizations. Once the specifics of the deal to stay are announced, usually you have only a few months to make your decision before the scheduled transfer of accounts.
Typically, 30 days prior to the merger, the new firm will notify clients directly that their accounts are being transferred over to the new firm. Departing advisors will need to leave beforehand to prevent any client confusion.
It’s a tough spot to be in, because you don’t really have enough time to thoroughly evaluate the prospective firm as well as the myriad of other IBD and RIA options. Also, your clients are depending on you to get it right.
What’s your strategy to forestall finding yourself in this predicament in the first place? Let’s look at some of the wreckage in the IBD world during the past two years.
In 2018, John Hancock handed off its 1,800 advisor network to Royal Alliance. Allianz is in the process of transitioning its 640 advisor group at Questar to Woodbury Financial Services.
Last year, Jackson National Life dumped its four broker-dealers comprised of 3,200 advisors and sold them to LPL Finanicial. Securian Financial Services unloaded its 700 advisors at H.Beck to Kestra Financial.
The razor-thin margins of the IBD business and the ever escalating overhead are prompting many firms to jettison their retail operations.
IBD Consolidation Is Happening, Big Time
According to the 2017 Fidelity Wealth Management Report, the number of IBDs has declined 28%, with 904 open for business in 2015, compared to 1,255 such firms that were up and running in 2005.
Some Cerulli Research data clarify what’s driving this trend: The return on equity of IBDs was 96 basis points in 2011. It dropped to only 76 basis points in 2016.
A veritable witches brew of factors is responsible. These include burgeoning technology and compliance costs as well as regulation, specifically the Department of Labor fiduciary standard, which likely was the nail in the coffin for many smaller firms.
Who wants to be in a business of shrinking margins and ballooning overhead?
As additional mergers take place among IBDs, more advisors will find themselves in this predicament. How can advisors in a contracting industry safeguard the practices that they’ve worked so hard to build?
1. Choose a firm wisely.
You should determine if the BD’s profits contribute a meaningful amount of money to the parent company’s bottom line? Is the BD a core business or an easily disposable side show?
If a BD is privately held, you need to consider the caliber of its salesforce as a clue to how well the firm is doing. Larger producers are of course more profitable. It’s a real red flag if a firm repeatedly hires advisors with major compliance issues either because they are strapped for revenue or ethically obtuse. Either way, it’s likely that their days are numbered.
If a firm’s financials aren’t publicly reported, you may need to sign a non-disclosure agreement to get that information. Excess net capital and profitability are two key numbers.
Some other questions to ask: Is the firm investing in needed technology and product upgrades? How do they compare in this regard to their peers? These expenditures are a sign of their commitment to the business.
In retrospect, the fact that foreign banks like Deutschebank and Credit Suisse were technology laggards that did not make ongoing investments to upgrade their technology and product suite foreshadowed their ultimate exits from the retail business.
2. Keep in mind that some firms require a higher level of due diligence than others.
Smaller IBDs demand a higher level of scrutiny because, as mentioned previous, the IBD business is a skinny-margin business. Most advisors are on payouts of 90% or greater, which is a challenge to firm profitability.
Compliance and technology costs continue to climb. Larger firms that enjoy economies of scale and smaller firms with well-heeled parent companies are in an advantageous position. It’s critical that prospective advisors do the extra due diligence to ensure that they are choosing a firm that can go the distance.
The future of insurance-owned broker dealers is especially problematic.
One reason that insurance companies originally acquired IBDs was that they viewed them as conduits for their products. But IBD advisors now have open-architecture platforms in which they offer clients a “best of the best” platform of third-party managers. Insurance is not a large part of the product mix of many independent advisors.
These factors combined with shrinking industry profit margins, mean that unless an IBD has stellar earnings, there may no longer be a compelling rationale for an insurance company parent to stay the course.
3. Advisors should set up a put option for their practices.
Advisors at smaller broker-dealers that lack a supportive parent company or those at insurance-owned BDs, especially, should consider setting up a put option for their practices.
Just as advisors set up strategies for clients to insulate their stock positions against sudden downdrafts in the market, they should do no less for their own careers. In fact asset allocation programs are driven by the identical rationale: finding the appropriate mix of asset classes to fortify client wealth across changing, unpredictable markets.
Independent advisors at potentially troubled firms should take the time to review their options with prospective firms and have a clear plan of action just in case things go awry at their current BD.
Due diligence on prospective firms is critical and should never be rushed. This way, in the event of a firm sale or other serious issue, advisors can get back to clients in a timely manner, confident that they’ve made the right choice on whether to stay with the new firm or transition elsewhere.
In my experience, advisors who devote the time to undertake a thorough due diligence process make the best decisions for themselves and their clients.
Mark Elzweig is president of executive search consultant firm Mark Elzweig Company, Ltd.