For the past 10 years, executives at the largest independent broker-dealers have been predicting a tide of consolidation, with economics forcing smaller firms to shut down or sell out to bigger firms.
Small-firm owners, often freewheeling entrepreneurs, bristled at such talk. Big firms were too bureaucratic and unfriendly to reps and advisers, giving smaller shops a competitive advantage in the recruiting wars, they argued. “We're here to stay,” they would say.
That now appears to have been wishful thinking.
The cost of technology, legal claims, compliance and keeping up with new demands from regulators — not to mention high payouts to brokers — are putting pressure on already razor-thin profit margins at smaller firms, leading many to reassess their future.
“The second half of 2010 and into 2011 is the most activity I've ever seen,” said Larry Roth, chief executive of the Advisor Group, a unit of American International Group Inc., which has three large independent broker-dealers -- FSC Securities Corp., Royal Alliance Associates and SagePoint Financial -- in its network. “Small and midsize broker-dealers are shopping themselves for a new owner.”
The first significant signs of trouble cropped up last year when substantial firms with hundreds of reps such as GunnAllen Financial Inc. and Jesup & Lamont Securities Corp. shut down because they ran afoul of Securities and Exchange Commission rules regarding capital.
In February, QA3 Financial Corp., facing rising legal claims from the sale of third-party private placements that were allegedly fraudulent, told its 400 brokers it was shutting down. The owner of that firm, Steven Wild, had been one of the most successful entrepreneurs of the independent-contractor-broker-dealer industry, selling Securities America Inc. to American Express Financial Corp. in 1998.
In March, Theodore E. “Ted” Charles, chairman, founder and largest shareholder of Investors Capital Holdings Inc., said in an SEC filing that he was going to sell his stake in the firm. With 582 reps, the independent broker-dealer Investors Capital Corp. generated $83 million in revenue last year.
Even small niche firms are throwing in the towel. In March, The Charles Schwab Corp. said it would buy optionsXpress Holdings Inc., which owns brokersXpress, home to 315 reps who specialize in options trading. The firm does not disclose its gross revenue.
In all, there were 142 fewer broker-dealers at the end of 2010 than the previous year. The decline continued in 2011, with 21 fewer firms registered with the Financial Industry Regulatory Authority Inc. as of March than at the end of December, bringing the total number to 4,557 — 9% fewer than five years ago.
Executives at large broker-dealers expect the trend to continue.
“My sense is that as costs to do business rise, we'll continue to see firms sell or go out of business because it's more difficult to operate as a small or midsize independent firm,” said John Peluso, president of
Wells Fargo Advisors Financial Network. “Size, scale and scope really do matter.”
“In my opinion, if an individual or group owns a firm doing less than $200 million in gross revenue, it's very difficult to make a profit,” Mr. Roth said.
(Click here for a list of B-Ds ranked by revenue.) “Part of that is the cost of technology, compliance and supervision, the cost of a new regulatory environment. The owners have a quality business with quality reps, but they're not making any money, and prospects to make money are not getting better. The sellers aren't desperate, but it's smart to know it's not the best time to be a privately held independent broker-dealer. It doesn't mean we'll get a deal done, but we're having really good conversations.”
Executives with small to midsize broker-dealers disagree. “There's always consolidation. That will never end,” said Russell Diachok, CEO of Geneos Wealth Management Inc., which generated $74 million in gross revenue last year. “The big guys always want to get bigger and the best way to do that is an acquisition.”
“Every time there's a market downturn, there's a three-year lag for a shakeout,” Mr. Diachok said. “I can't say that our model is dead when I look at our firm and what we do.”
Still, the pace of consolidation will pick up, one big-firm executive said.
“Consolidation is exacerbated by regulatory change,” said Valerie Brown, chief executive of Cetera Financial Group, a network of three independent broker-dealers. She pointed specifically to a revamped suitability rule proposed by Finra, Rule 2111, that is supposed to be in place by October. New Labor Department rules for retirement plans also are seen as particularly time-consuming and expensive for firms.
“Those are just adding an extra-ordinary expense,” she said. “I expect consolidation pressure to accelerate.”
Large broker-dealers that have been sitting on the sidelines for years, reluctant to make deals, are out kicking tires.
“We haven't made an acquisition since 1992 because we never saw any broker-dealers that remotely interested us, but we've actually taken a look at a couple of decent-size firms in the past year,” said John Rooney, managing principal with Commonwealth Financial Network.
Also in play are registered reps and advisers at firms experiencing legal problems, Mr. Rooney and other executives said.
Securities America Inc., home to 1,800 advisers, is in the middle of settlement negotiations with attorneys for clients who lost about $400 million in the same allegedly fraudulent private placements that helped sink QA3.
Mr. Rooney said Commonwealth was talking to “dozens and dozens” of Securities America reps about potentially joining Commonwealth.
For the big advisers at Securities America, a legal settlement “may be too late” to keep them with the firm, he said.
Securities America is stable, said Janine Wertheim, a spokeswoman. “The message we are hearing from the majority of advisers is that they are experiencing significant growth, [are] focused on their business and have no desire to make a move and disrupt their momentum and business plan,” she said.
E-mail Bruce Kelly at bkelly@investmentnews.com.
