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.