2010: The year of the battered B-D

Scores of broker-dealers were bruised and battered this year, with dozens of small and midsize B-Ds closing doors amid desperate — and mostly futile — searches for much-needed capital.
Through November, there were 101 fewer broker-dealers registered with the Financial Industry Regulatory Authority Inc. than in 2009. And since 2005, the total number of broker-dealers has decreased by 9% and now stands at 4,619.
There has been a steady decline in the net number of broker-dealers in the past few years, according to statistics on Finra’s website. Finra, however, does not detail how many new broker-dealers were registered each year, so it is not possible to determine with accuracy how many firms closed doors and how many opened them in a given year.
By the end of 2009, however, there were 175 fewer broker-dealers registered with Finra than a year earlier, according to Finra. And by the end of 2008, there were 110 fewer.
Owners and executives of small broker-dealers contend that a decline in the number of firms is damaging to the economy and small investor. Many of these broker-dealers act as engines for small, local investment banking deals, and small firms are also willing to work with retail investors with small amounts of money — $100,000, for example — which the national wirehouses shun.
The giant firms have no interest in either market, some executives said.
“I’ve been in the business for 45 years and nothing has ever come close to the carnage that’s occurred in our industry,” said Ron Kovack, chairman of Kovack Securities Inc.in Fort Lauderdale, Fla.
He pointed to two types of firms that have recently run aground and been forced to shut down. Some simply cut corners during tough times, leading to bad business practices. Others were shuttered due to minor rule violations that led to staggering legal costs arising from lawsuits and arbitration claims.
“From the number of calls I’m getting from other small-broker-dealer owners, people are getting out,” said Alan Davidson, chief executive of Zeus Securities Inc. and president of the Independent Broker-Dealer Association, an industry group with 250 broker-dealer members.
He said regulatory pressures and business conditions — including rising fees and assessments — are pushing broker-dealers to the brink. “The membership is under attack and small firms are taking the brunt,” he said.
Mr. Davidson added that according to his research, the number of firms that closed in the past few years totals 20% of the Finra membership.
When asked about this story, and if the declining number of forms was a concern to Finra, Nancy Condon, a spokeswoman for the regulator, had no comment.
In 2010, net-capital requirements tripped up a number of firms.
The Securities and Exchange Commission requires broker-dealers to maintain a certain amount of net capital at all times. The levels, however, vary widely from firm to firm, with many small firms required to have as little as $5,000. Once a firm fails to meet its required net-capital level, it’s practically a death knell.
Two high-profile firms were closed this year due to such violations.
In March, GunnAllen Financial Inc., which had been one of the fastest-growing independent broker-dealers of the last decade and at one time boasted 1,000 affiliated registered reps, was closed. Then in June, Jesup & Lamont Securities Corp., a Wall Street mainstay whose corporate lineage dates back to the 19th century, closed due to net-capital violations.
At the time of its closing, GunnAllen had about 500 reps, and Jesup & Lamont 300.
Expect more failures and closings in 2011, industry observers said. “It’s been a horrible market and firms are thinly capitalized,” said Larry Papike, president of Cross-Search, a recruiting firm specializing in independent reps and executives at such firms.
“And then there’s the limited-partnership debacle,” he said, referring to the cascade of lawsuits and arbitration complaints that numerous independent broker-dealers face in the wake of SEC fraud charges against Medical Capital Holdings Inc. and Provident Royalties LLC.
Dozens of independent broker-dealers sold those private-placement offerings and now face potential class actions, arbitration complaints from investors and even lawsuits from receivers in bankruptcy proceedings looking to claw back commissions from broker-dealers.
Some broker-dealers that closed this year sold the allegedly fraudulent private placements.
That group includes Okoboji Financial Services Inc. The firm which was based in the Iowa town of the same name, was a leading seller of Provident Royalties private placements and closed in May. Cullum & Burks Securities Inc., which was also heavily involved in the sale of Medical Capital private placements, also shut its doors in 2010.