New, higher assessments by the Securities Investor Protection Corp. are causing ”sticker shock” at several broker-dealers, particularly independent-contractor firms.
Firms whose fiscal years end in December were required to pay their first assessment under the new fee schedule — 0.25% of net operating revenue, up from a flat $150 — by July 30. The assessment was based on second-quarter revenue; future assessments will come semiannually.
In this first go-round, SIPC is offering firms a 15-day grace period for payment, SIPC spokesman Scott Stapf said in a statement.
The new assessments represent a staggering increase in both percentage and dollar terms, although many brokerage firm executives probably anticipated a fee hike.
“In light to the Lehman [Brothers Holdings Inc.] and Madoff failures, I don't think anyone can say it was unexpected that [assessments would not] stay at $150,” said Stephen Harbeck, president and chief executive of SIPC.
At Wedbush Morgan Securities Inc. in Los Angeles, the SIPC bill will total roughly $400,000, said Edward Wedbush, chief executive at the firm, which generates about $250 million in gross revenue.
With business down, the timing of the higher fees is “really bad,” he said, echoing the sentiment of others in the industry.
Don Bizub, chief executive at Western International Securities Inc. of Pasadena, Calif., which has about 300 independent-contractor reps and $25 million in gross revenue, said his assessment will rise to about $44,000 a year.
“I was pretty amazed,” he said. “We hadn't budgeted for that.”
Jed Bandes, president of Mutual Trust Company of America Securities Inc. in Clearwater, Fla., which has about 30 brokers bringing in $2 million to $3 million in gross revenue, estimated that his fee will come to about $4,500 a year.
“I'm totally appalled,” said Mr. Bandes, who thinks that buying private insurance would be less expensive than SIPC coverage.
Industry observers said that larger firms will be paying millions of dollars in SIPC assessments. A spokesman for the Securities Industry and Financial Markets Association of New York and Washington, which represents broker-dealers, declined to comment on the higher assessments.
“A lot of smaller firms are really resentful,” said Howard Spindel, founder of Integrated Management Solutions in New York, who consults for broker-dealer firms. “They're paying for Bernie Madoff; it's sticker shock for some of them.”
Last month, SIPC said it had committed $231 million to pay 543 approved claims from clients of Bernard L. Madoff Investment Securities LLC in New York. The SIPC pays up to $500,000 per customer in cases of lost or missing securities, including up to $100,000 for cash balances.
The Washington-based SIPC is charged with keeping at least $1 billion in reserves to compensate customers of failed broker-dealers. The increase in assessments is necessary to ensure that the reserve fund “is sufficient ... thereby increasing public confidence in the securities markets,” Mr. Stapf wrote in an e-mail.
The Securities Investor Protection Act of 1970, which created SIPC, allows it to set assessment levels, depending on the size of the reserve fund. SIPC can adjust assessments based on risk, “but that would cost more to effectuate than the current system,” Mr. Harbeck said.
“There are so many factors that go into a risk-based method that it's not practical,” he said.
Because all firms are assessed under the same formula, SIPC is “subsidizing high-risk broker-dealers,” John Coffee, a professor at Columbia Law School in New York, told Congress in January.
“Future Bernie Madoffs are re-ceiving an undeserved discount on their insurance costs that increases their incentive to commit fraud,” he testified.
Mr. Coffee wasn't available for comment.
Observers said that independent-contractor firms could be hit particularly hard because of the way SIPC fees are calculated. Firms don't get to deduct the commissions they pay out to reps in calculating SIPC's net operating figure, against which the new SIPC assessment of 0.25% is charged.
Yet independent-contractor firms typically pay out 70% to 95% of their reps' gross revenue, leaving a relatively small amount for the firm itself.
The fact that SIPC assesses gross revenue is “a real shocker,” said Don Gloisten, chief executive of GBS Financial Corp., a Ventura, Calif., independent-contractor firm.
“If you're in environment where your expenses are 90% of gross income, then one-quarter of a percent translates into 2.5% of net income,” Mr. Spindel said.
Some firms might simply pass along the increased SIPC cost to their reps, said Jim Biddle, founder of The Securities Center Inc., a broker-dealer in Chula Vista, Calif., that grosses $1.4 million a year. He said that his SIPC assessment will be about $3,200 a year.
[More: SIPC raises assessment fees on brokerage firms]
Joseph Kuo, a spokesman for LPL Financial of Boston, said in a statement that his firm will be able to absorb the cost of the fee in-crease, which won't affect adviser payouts.
Under the law, broker-dealer revenue from the sale of mutual funds, variable annuities, insurance and institutional advisory services don't count as revenue for SIPC purposes.
“That goes back to 1970, when the mutual fund and insurance industries lobbied strenuously that they should not be part of the [SIPC] program and were ex-cluded,” Mr. Harbeck said.
On the other hand, advisory fee revenue from retail clients — which has increased in recent years — does count for SIPC purposes, said Dave Bellaire, general counsel for the Atlanta-based Financial Services Institute Inc., which represents independent-contractor firms.
E-mail Dan Jamieson at djamieson@investmentnews.com.
