Landscape is changing for broker-dealers

Since 2000, the financial industry has seen drastic changes in regulation as a result of two recessions, a credit crisis and a massive Ponzi scheme. The newly imposed rules and regulations have had a severe impact not only on the major Wall Street firms that service billions of dollars but on the independent broker-dealers and financial planning firms that cater to much smaller accounts.

In the past 50 years, the industry has gone through massive changes in how we do business and what services we provide.

In the "70s the stabilization of Regulation T rates and the practice of negotiated commissions radically changed the way that investment transactions were conducted, as did technology in the 1990s. These changes eventually made the industry stronger and more efficient, but those who refused to take notice were left behind.

The changes that now are under way again will severely alter the way that broker-dealers conduct their business.

For years, broker-dealers have sold securities, relying on transaction costs and commissions to make a living. Those days are coming to an end quickly.

Broker-dealers need to ask themselves: “Why would a client do a trade with a commission cost of $50 when they could go online and do it themselves for under $10?” The price disparity is too great, and broker-dealers can't lower their prices to those levels and cover overhead costs.

TO SURVIVE, SMALLER FIRMS MUST CHANGE

The old way of doing business is no longer profitable for small independent broker-dealers, which is why many midsize firms have been bought out by investment banks or have been dissolved altogether. Small firms can survive and even thrive in today's marketplace, just not on sales alone.

Small firms need to focus now more than ever on how to help clients position their money in the right place at the right time. Technology can lower transaction costs to minimal levels, but it can't make an investment more profitable.

Remember, there are no economies of scale for knowledge.

The other change coming to fruition involves the cost of regulation. Ever since the Madoff scandal and passage of the Dodd-Frank financial reform legislation, the financial services industry has seen a massive spike in oversight.

Examiners are cracking down on all firms in a feeble attempt to save face after being disgraced by their failure to catch Bernard Madoff and others who defrauded investors.

These errors on the part of the Financial Industry Regulatory Authority Inc. and the Securities and Exchange Commission have resulted in an array of layered new rules and regulations. These regulations, very few of which have any practical application, have increased costs to hardworking, honest broker-dealers and don't protect customers at all.

EXAMS INEFFECTIVE

The most important thing to realize is that examiners don't understand your business, not even a little bit. An examiner will sit down in your office with a checklist of the regulations that you need to follow, and cross-reference accordingly, leaving the door wide open for fraud and theft.

Mr. Madoff, for instance, had a fairly clean record with the SEC, but the final result of his venality was tragic for nearly all his clients.

There will be opportunities for broker-dealers and their clients to make a lot of money in the next decade. Although the market has been relatively flat for the past 10 years, markets historically rebound with gusto following such a cycle.

It happened in the 1930s, it happened in the 1970s, and it is going to happen again.

However, broker-dealers need to begin assessing business risk as well as investment risk. If small broker-dealers want to survive and become big players in the next few years, they need to remember two things: Sell your knowledge, not a product, and be prepared to defend your business from excessive regulations and oversight.

Ben Treece, a 2009 graduate of the University of Miami, is a money manager with Treece Investment Advisory Corp. and a stockbroker for Treece Financial Services Corp.