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Industry Spotlight > Broker Dealers

Small Broker-Dealers’ Secret Weapon

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What You Need to Know

  • Thriving smaller firms have an area of specialization, such as alternative investments.
  • Smaller firms with high-quality advisors have fewer compliance issues because they know their advisors better than larger firms.
  • Profitable smaller firms typically have low staff turnover, so competency is high, resulting in correct answers and quick response times.

This article may run counterintuitive to many industry voices when it pertains to smaller broker-dealers, and by small, I’m referring to broker-dealers with under 200 representatives.

One example of industry voices is LPL’s recent comments, on the back of a very successful year of recruiting, that they would be focused on acquisition of small BDs going forward.

In spite of the doom and gloom portrayed about small broker-dealers, there are smaller firms that are not only surviving but thriving and growing. How can this be?

You would think the chips would be stacked against them, since they lack the substantial scale that brings more profit, are unable to compete on transition money like the larger firms offer and lack the resources for a stable of proprietary services.

Granted, there are certainly smaller firms that don’t know what they are doing and operate on razor-thin margins, and their compliance and due diligence teams are laughable. These will be the target of firms such as LPL, and this is especially true for smaller firms that are generalists, failing to set themselves apart from larger BDs.

Smaller Firms’ Success

The smaller firms that are thriving have an area of specialization that they do very well with —  for example, alternative investments. Sales of alternative investments and real estate investment trusts require high-quality due diligence by the BD.

Many firms have been brought down by these products in a hailstorm of litigation when they failed to implement adequate due diligence as well as policies and procedures in the sale of said products.

QA3, DeWaay, Pacific West, Financial West, Sandlapper, Investors Capital, Capital Financial Services and GunnAllen are just a handful of firms that were largely brought down by inadequate due diligence and sales procedures on alternative investments and REITs.

Yet firms that do product due diligence competently are able to attract advisors with accredited and qualified investors that hunger for limited-availability products, and earn very attractive profits at the same time. Profitability is part of the picture, but there’s more. 

Larger Firms’ Issues

One inescapable problem for large firms is that advisors grow impatient when they feel insignificant, and even worse, have compliance protocols that are based upon the lowest common denominator.

We were recently reminded of this lowest common denominator when as part of BD due diligence in joining a large firm, the firm required an advisor to get three letters from board members of a fraternal organization for which he was treasurer.

Reasons to be suspicious of the advisor were nonexistent: The treasurer position paid no compensation, he had been involved with the fraternal organization for many years without incident, and the advisor earned substantial income.

There was no reason to think he’d need to embezzle to survive, and he had a spotless compliance history. Going to fellow board members and asking them to write a letter saying “The treasurer is a standup, ethical guy” made the advisor very uncomfortable, so he refused to do it.

He felt this was compliance overreach, so the BD would need to make changes in these over-the-top requirements for him to join the firm.

The 80/20 Rule

Large firms are black-and-white in how they operate because the large number of advisors makes them incapable of operating otherwise. Smaller firms with high-quality advisors have lower incidence of compliance issues because they know their advisors much better than larger firm.

Larger-firm management applies the 80/20 rule when it comes to pursuing relationships with their advisors, focusing on the top 20% at best. Meanwhile smaller firms know, and focus on nearly all of their advisors.

One indicator as to how well a BD knows its advisors is a firm’s ability to uncover Ponzi schemes. The only firms we’ve witnessed catch advisors in Ponzi schemes early in the cycle were small and midsize BDs because they know their advisors and are better able to closely track them on a compliance basis.

At large firms, Ponzi schemes typically aren’t exposed until they have imploded due to the lack of new investors to keep the scheme going.

The ‘Entrepreneurial Advisor’

Entrepreneurial advisors who think outside the box, wanting varying solutions for their clients, can feel restricted or trapped at larger firms. Smaller firms can customize to individual advisors’ needs rather than asking advisors to fit into a cookie-cutter platform.

Relationship-driven advisors prefer smaller firms where they have the ear of upper management. The advisors’ input has substantial weight on firm policy, and their time at conferences can feel like a family reunion (family they enjoy, that is!).

When advisors call in to the home office, they have go-to people they know by name, not a phone tree. Profitable smaller firms typically have low staff turnover, so staff competency is high, resulting in correct answers to questions and quick response times.

One frustration more common at larger firms is high turnover, resulting in less competent staff who don’t always have correct answers, resulting in advisors getting different answers from different people, which can be unnerving and erode trust.

People often forget that firms such as LPL started as small, humble broker-dealers. They, like other firms, struggled their way to enlargement.

Today, even though the industry has changed in many ways, small BDs that deliver expertise and specialization and bring value that the larger firms can’t provide will continue to thrive and grow.


Jon Henschen is founder of Henschen & Associates, a recruiting firm that matches advisors needs to best fit broker-dealers and RIAs