Ranks of broker-dealers continue to decline

By Dan Jamieson

Feb 27, 2006 @ 12:01 am (Updated 12:00 am) EST

IRVINE, Calif. - Small brokerage firms that serve individual investors are feeling the squeeze.

Regulatory pressures have many broker-dealer owners talking about throwing in the towel.

Growing compliance burdens are at least partly responsible for the continuing slide in the number of broker-dealer firms. Last year, 80 firms ceased doing business, about 2% of the total, according to data from NASD in Washington.

The slide in the number of broker-dealers contrasts with the growth in the number of registered investment advisers. As of April 5, RIA firms registered with the Securities and Exchange Commission had grown 4%, compared with the amount the prior year, according to National Regulatory Services Inc. in Lakeville, Conn.

As is the case with the data for broker-dealers, the RIA numbers include all types of firms, not just those that cater to individual investors.

There is a trend toward small brokerage firms' merging with larger operators, industry observers say.

The merger trend will continue as smaller firms look for ways to access more resources and shift the compliance burden onto larger partners, predicted David Rosedahl, a securities attorney at Briggs & Morgan PA in Minneapolis.

The burdens imposed by regulators and congressional mandates, such as the USA Patriot Act, are "without question giving people pause about what the future of the small-business person is in this industry," said Nick Cochran, vice president of American Investors Co. Inc. in San Ramon, Calif.

The Financial Services Institute Inc. in Atlanta, which advocates for independent-contractor broker-dealers, has taken up the issue.

"The real issue is [registered representatives] leaving the securities business for the investment-adviser world," said John Poff, chairman of the FSI and president and chief executive of Mutual Service Corp. in West Palm Beach, Fla.

Quality individual brokers "are having to make conscious decisions about staying in the business because of compliance," he said.

Last fall, Mr. Poff and other FSI representatives met with NASD executives to discuss the issue. NASD is concerned, because with the shift to RIAs, they "begin to lose their franchise" to protect investors, Mr. Poff said.

These days, clients "do everything in their power to set up as an RIA," said Lisa Roth, president of ComplianceMAX Financial Corp. in San Diego. "They only do a BD if they have to because of a great fear about the compliance burden."

Hidden decline?

NASD data show a steady 2% annual drop in the number of broker-dealer firms over the past four years.

But the data might not reveal fully what may have been a larger drop in the number of small retail firms. Many startups are niche distribution players formed to wholesale products such as hedge funds, real estate or energy deals, industry observers say.

NASD doesn't break out its data by type of firm.

"What the numbers don't tell you is [what types of firms are] peeling off while others are coming in, like [mergers and acquisitions] firms," Mr. Cochran said.

"We've really seen a decrease in small retail firms," said Mike Brown, president of BD Solutions Consulting in Atlanta.

The competitive landscape is tougher, and the regulatory burden is "monumental, compared to past years'," he said.

Mr. Cochran thinks the worst may be yet to come. It may take a number of years for frustrated owners to develop exit plans.

Those who own or work with smaller firms - many of whom compete by offering a personal touch - say operating a broker-dealer just isn't as much fun as it was when more time could be spent with clients.

That is why "you're not going to see any significant growth in firms in our business," Mr. Cochran said.

Does it matter?

Consolidation in the brokerage industry isn't new. At the market peak in 1987, the number of broker-dealers peaked at about 6,700 firms and has fallen almost 25% since.

Meanwhile, the number of registered reps has grown, and the number of branch offices has grown even more. At the same time, the banking and insurance industries have consolidated, as well, so does consolidation in the brokerage industry really matter?

"Yes, because the small guys really care about the rep," Ms. Roth said.

Small, local firms are "in the community with their clients" and tend to care more about compliance, she said.

Mr. Poff said that it is important that small investors have access to commission-based providers who are willing to deal with them. Fee-based RIAs generally can't afford to handle smaller accounts, he said.

Capital formation is affected by the loss of smaller dealers, Mr. Cochran said. Local entrepreneurs engaged in small oil and gas enterprises, or real estate projects, don't interest the big investment banking firms.

"These are not necessarily bankable deals, where they can go in and borrow from a bank," Mr. Cochran said. "These are relationship-driven deals" that need a few million dollars, an amount he said he can raise.

"The subchapter S corporation and the sole proprietorship are still the backbone of our economy," said Ronald Kovack, founder and chairman of Kovack Securities Inc. in Fort Lauderdale, Fla.

"I would like to see [the little guys] hang on," Ms. Roth said. As a compliance consulting firm, "our whole business plan is to find the right tools to keep these guys alive."

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