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Independent Broker Dealers:  A Sound Choice for the Financial Advisor

By:  Shawn K. Smith, MBA, Principal, Financial Advisor Placement Services

Small Broker Dealers Tarnished by Private Placements

There has been much noise around independent broker dealers (IBDs).  The Small Independent Broker Dealers (SIBDs), who have less than 500 advisors, have received much of the negative press.  Some SIBDs shut down in 2011 and 2012 resulting from the IBDs, who sold private placements, REITs, and TICs that had gone south.   Medical Capital, Provident Royalties, and DBSI, Inc. created sanctions and fines causing about 50 IBDs to go out of business are reported by the Investment News. This has caused financial advisors to become especially wary of all of the IBDs, especially the SIBDs, as the public has “thrown the baby out with the bathwater.”  We recently spoke to a team of advisors who decided to put their move to an independent broker dealer on hold, due to the recent “stability “concerns they had heard about smaller broker dealers.

The Truth behind the Numbers

The decrease in number of IBDs follows suit with the decrease in the number of Financial Advisors.  There were 79,802 independent financial advisors in 2011, down almost 14% from 92,727 in 2010[1].   If you count dually registered advisors then the decrease is only 11% from 2010 to 2011. This compares to all financial advisors decreased from 323,566 to 316,109, a 2% decrease.[2]  The independent financial advisors rate of decrease is much higher than those of all advisors.  The independent advisors who were lower producers left the business as a result of the 2008 meltdown, or retirement, while others may have gone RIA, or possibly into the bank channel.  The pace of the advisors leaving the wirehouses has also decreased since 2008 due to recruiting and retention bonuses.[3]

There are currently 4,380 brokerage firms.[4]  In the first quarter of 2012, 93 broker-dealers closed , compared to 137 firms during the same period in 2011. Only 44 new B-Ds opened during the first quarter of 2012, while 57 broker-dealers started up in the first quarter of 2011.[5] In other words, there was a net decrease of 80 broker dealers in first quarter of 2011 versus a net decrease of 49  broker dealers opened in the first quarter of 2012.  The pace seems to be slowing.   If the IBDs finish 2012 at the same rate of losing a net of 49 broker dealers per quarter in 2012, they will lose 196 broker dealers or 4.5% this year. This is about twice the rate of the number of advisors leaving the business.   It was reported by Investment News that about 50 broker dealers went out of business from the failed alternative investments ie. Provident, Medcap, and DBSI.   This would explain the uptick in failed broker dealers in 2011.

There were also mergers in 2011 involving larger broker dealers, who have over 1000 advisors, that contributed to this decrease.  The major ones were:  Ameriprise Financial sold off Securities America to Ladenburg Thalmann; Wells Fargo sold H.D. Vest Financial Services to Parthenon Capital Partners, Lovell Minnick Partners acquired First Allied from Advanced Equities; Pacific West Securities closed down and moved its reps over to Multi-Financial; and Allied Beacon Partners  absorbed Workman Securities’ reps. This year Cetera Financial acquired Genworth’s broker/dealer,  LPL Financial purchased Fortigent.  In the regional space, Raymond James bought Morgan Keegan[6].

Accounting for non-retail BDs

Out of the 4,380 broker dealers. About 3,100 broker dealers have 150 or fewer financial advisors (71%), 2,650 have fewer than 25 representatives(61%) (micro broker dealers) and 450 have between 25 to 150 representatives.  We have recently done research and found that about  40% of the micro broker dealers are not retail broker dealers but are set up to  transact many other types of business such as: investment management, mutual funds, institutional business, private placements, REITs, investment banking, foreign business, trading, and mergers and acquisitions.[7]    In 2010, out of the 20 broker dealers, reported to have gone out of business, 9, or 45% had no retail reps[8].  When referring to broker dealers closing down, these firms should be segregated from the data to show a more accurate picture of the retail broker dealer landscape and to help us better understand how the retail IBDs are doing.   This would greatly reduce the reported number of independent broker dealers, on the retail side, who have exited the business.

Profit Margin Compression

In the past few years, many IBDs have gone through profit margin compression from decreased revenues as well as increased costs.   We see several reasons for profit margin compression:   1. Increase in costs associated with compliance and accounting costs as a result of the Dodd-Frank regulations, 2. decreased trading volumes from the 2008 financial meltdown, 3. revenue lost from margin loan interest and money market fees.  3. increase in competitive pricing, ie. payout to the financial advisor, as a result in competition between Independent broker dealers.  4. Cost of implementing technology.

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