Independent Broker-Dealers: Independent B-Ds facing tough times

After a sterling 2007, leading independent-contractor broker-dealers are facing a horde of significant problems this year, with the subprime-mortgage crisis, skyrocketing gas and oil prices and the threat of a recession the most daunting. At the same time, independent-contractor brokerages appear to be contracting — a shock to some longtime observers who have witnessed the industry's incredible recent growth — according to the latest study of the industry by Cerulli Associates Inc. of Boston. As the number of independent-contractor registered representatives has declined over the past three years, the number of registered investment advisers and those investment professionals who are both registered reps and investment advisers has increased. From 2005 to 2007, the number of independent reps dropped 5%, reaching 88,802. Meanwhile, the number of RIAs and dually registered advisers increased 26% to 13,622 and 38% to 9,477, respectively. The potential tough times could arrive following the good to excellent growth in gross revenue that many firms saw last year. While firms this month were still tallying financials, some executives and consultants reported estimates of revenue growth in the neighborhood of 20% to 25%. "2008 will be a very challenging year," said Larry Papike, president of Cross-Search, a recruiting firm in Jamul, Calif. "The independent model is not going to sneak up on anyone anymore." One significant test facing firms is the explosion in the number of recruiters chasing reps and advisers, Mr. Papike said. He surveyed six independent broker-dealers, and their total number of recruiters has recently more than quadrupled to 58, from 14. "It's a very cluttered recruiting environment," Mr. Papike said.

FEE-ONLY THREAT

Some executives and recruiters said that the decline in the overall number of reps who are independent contractors is not a major concern. Many firms over the past three to five years have raised the minimum of production in fees and commissions for each rep, pushing many low producers out of the business. Others said that advisers are aging and leaving the business, and that there recently has been a slowdown in the number of reps who are wirehouses employees moving to independent firms. But the threat of large-producing reps' leaving the industry to become fee-only financial advisers is real. "A lot of guys are taking a hard look at their broker-dealer and asking, 'Am I better off going to an RIA?'" said John Rooney, managing principal in San Diego with Commonwealth Financial Network of Waltham, Mass. And in a clear twist, another executive added that he has seen increasing interest from RIA firms in becoming affiliated with a broker-dealer. "We're seeing fee-only, stand-alone RIAs call and potentially hook up with a broker-dealer," said Joseph B. "Joby" Gruber, chief executive of FSC Securities Corp. of Atlanta, who also oversees recruiting for the recently formed AIG Advisor Network and is president of that division. "If reps go fee-only, they're beginning to recognize they leave too much on the table." Executives were also quick to note that most independent broker-dealers are not directly involved in the subprime debacle, which caused Wall Street firms such as Citigroup Inc. to record write-downs of $18 billion this month and Merrill Lynch & Co. Inc. to write down $14.6 billion. And that's good news for competitors who serve independent contractors, some executives said.
"In those boardrooms, they're talking about how to get through the mess," said Manish Dave, senior director of business development of the U.S. adviser group for Ameriprise Financial Services Inc. of Minneapolis. "That's a key competitive advantage. Those reps work for massive financial superstores. Those firms are not wholly or as focused on advisers as Ameriprise." But the broad markets at the start of trading last Tuesday had been hammered by the almost relentless bad news, with the Dow Jones Industrial Average off 8.8% for the year and the Standard & Poor's 500 stock index down 9.8%. And that's bad news for reps and advisers who are also financial planners. "Clients are nervous; the house isn't what it used to be worth," said Eric Schwartz, chief executive of Cambridge Investment Research Inc. of Fairfield, Iowa. "The neighbor's foreclosed, so clients are less likely to invest," he said, adding, "It's not unlike 2001, 2002; the industry could hunker down." Executives and recruiters were split on the effect of such a stormy economic environment on recruiting. Some said that it could hasten reps' decisions to leave one firm to join another, or it could force them to stay put and avoid that conversation with clients. "Some choppiness in the market may help recruiting, because it may make reps more inclined to move as they look for better support," said William C. Van Law III, senior vice president and national director of business development for Raymond James Financial Services Inc. of St. Petersburg, Fla. Others disagree. "Tough markets are tough recruiting times," said Bill Dwyer, president of the independent-adviser division of LPL Financial of Boston, Charlotte, N.C., and San Diego. "A flat market is best." Regardless of the market turmoil, the industry is "in the front end of the bull market for investment advice," Mr. Dwyer said. Some executives echoed that sentiment. They noted that advisers are now better prepared to weather the storm of a bad market than they were five years ago after the meltdown of technology stocks and the shock of terrorist attacks in September 2001. At that time, one common complaint about reps and advisers was that some buried their heads in the sand and didn't reach out to clients. "A lot of advisers are better educated," said Timothy Murphy, president of Investors Capital Corp. of Lynnfield, Mass. "And many advisers moved from transactions and commissions to fee-based." Commissions can dry up or disappear in such a market, executives said, while fees could decline but not vanish. And those reps who have clients' money invested in advisory accounts may have a stronger tie with clients in tough times than reps who charge only commissions, one executive said. "The fiduciary standard of an advisory account creates a relationship," said Randall Ciccati, chief executive of PrimeVest Financial Services Inc. in St. Cloud, Minn., which is a member of the ING Advisors Network. That kind of rep "meets with clients far more often than" a rep whose clients have a brokerage account, he said. Bruce Kelly can be reached at bkelly@crain.com.