News is good, but ...

Regulators' pressure a problem for indies

Jan 19, 2004 @ 12:01 am

By Bruce Kelly

The opportunities for growth in the independent-broker-dealer industry have never been more apparent for firms and brokers with the know-how and wherewithal to seize them.

That said, a panel including top industry executives, among others, has agreed that it would welcome any easing of the recent intense pressure and scrutiny by securities regulators.

"It would be nice to wave a wand and have the regulators see the world through our eyes," said William D. McGovern, of Raymond James Financial Services Inc. If regulators could "understand some of the challenges they've created for us, they don't necessarily benefit clients," he said.

Still, there is clearly good news for independent broker-dealer firms and their registered representatives, said the six panelists, five of whom met in InvestmentNews' New York office Jan. 6.

Wirehouse brokers are increasingly familiar with, and more interested in, the entrepreneurial business of being affiliated with an independent broker-dealer, the panelists said. And in the wake of a rash of scandals, first in 2002 tainting Wall Street firms' research and then last year in the mutual fund business, some clients are moving assets and accounts to independent firms.

"Just from knowing my friends in the industry, many [wirehouse brokers] would be really willing to take the leap if the technology is there," said Kathy Boyle. Her firm, Chapin Hill Advisors Inc., is affiliated with Linsco/Private Ledger Corp. of Boston and San Diego.

Ms. Boyle was a career wirehouse broker before starting her independent practice in 2000.

"You have to remember that not every broker is willing to go independent," she said. "You really have to be an entrepreneur."

And some independent firms are seeing a strong flow of new business from wirehouse clients, the panelists said.

Citing recent account-transfer statistics, independent broker-dealers are taking in almost 1.7 new ac- counts for each one that leaves, said James T. Crowley, o

f Pershing LLC. "It's approaching a 2-to-1 ratio, accounts transferring in as opposed to accounts leaving, so it's a very positive ratio," he said.

And when it comes to the independent-broker-dealer industry's role in financial services, whether providing top service to retail investors or dealing with regulators, it is time to boost its profile, the panelists agreed.

"I think it's a failing of our industry that we have not done a good enough job ... of advocating our position with the regulators," said Mark Goldberg, of Royal Alliance Associates Inc., who joined the meeting via teleconferencing. "I don't think they understand our firms well enough."

Later, he added that the "collective reputation of what an independent adviser does is not quite yet in the public mind as it should be. The independent financial adviser needs to be recognized on a public level for the value and services they provide."

All independent firms are under incredible pressure by regulators, the panelists said. But smaller firms that don't devote money and time to fix potential problems may be overwhelmed.

For instance, tallying correct discounts for clients based on mutual fund "break points" is also a significant issue that the industry continues to deal with, the panelists said.

"We're six months behind on a number of projects we really wanted to have for our advisers because we had to take our technology resources and shift them over to dealing with break points and various other [issues] to build those systems," said Eric Schwartz, of Cambridge Investment Research Inc. "I certainly wouldn't want to be a $2 million or $10 million or $20 million broker-dealer today trying to deal with these problems."

Regardless of their distance from Wall Street, independent broker-dealers are caught up in the sea change facing the financial services industry. Last week, the Securities and Exchange Commission said that a survey of 15 large broker-dealers had found that

13 firms appeared to give better treatment to fund companies that paid them.

The SEC didn't name the firms but said it was investigating whether eight of the broker-dealers hadn't properly disclosed the payments, perhaps breaking federal securities law.

Mutual fund firms' making a variety of payments or sharing revenue with broker-dealers has long been a mainstay.

"I know there's a lot of discussion ... happening now to wipe out a lot of those fees - which can be significant dollars that go to the broker-dealer - that is not shared with the rep," said industry recruiter Larry Papike. "That is a massive negative that's going to happen with the independent-contractor firm."

Mr. Pavia: What are the biggest challenges facing the independent-broker-dealer firm and its representatives?

Mr. Papike: There are three major issues. One is regulation. The regulations imposed in the last couple of years by the NASD have put burdens on all broker-dealers.

The second issue is managing growth. The independent-contractor-marketplace growth over the last six, seven years has been staggering. You take a firm like Cambridge or Linsco/Private Ledger -- Linsco/Private Ledger will recruit upwards of $100 million this year, and I think that managing that growth is a key component of the broker-dealer's success.

And the third challenge is staying ahead of the technology curve. Many firms have done a great job on technology. Most major independent-contractor firms now can compete with any major wirehouse in technology, and that's one of the reasons why the independent-contractor firms have done so well in the last five, six years. But keeping up with that technology, because it's changing so fast, is a real challenge.

Mr. McGovern: I think those are the three big issues facing the independent-contractor industry.

The added cost of remaining in compliance with the changing regulations -- and I don't think we've seen the end of it yet -- certainly puts a strain on margins in the broker-dealer business


Growth is clearly one of the issues. We are finding ourselves being far more selective in the people we bring into our firm than we have been in the past, and we've been a firm that's been very conservative along the way, and we're finding ourselves getting even more selective.

One of the things we're likely going to see more of as we look ahead in the next few years is, some of that growth will probably come from consolidation. This regulatory environment has put a lot of financial pressure on a lot of firms, and I think it's going to squeeze some of the smaller firms. Many of those firms may have to find partners, so I think we're going to see continued consolidation in the independent-contractor industry.

Technology is also one of the big issues. I think many firms can compete and are doing a good job of enhancing technology. But one of the areas in which many of the firms in the independent-contractor industry are going to be challenged is trying to keep up with some of the compliance regulations rules that are being handed down. Technology is really the key to doing that. That's going to put an added burden on firms.

The mutual fund break-point issue is a huge issue. I don't know many of the firms that have good systems to really comply with all the rules right now, and we're all going to have to get smarter faster to keep up with that issue.

Mr. Pavia: Eric?

Mr. Schwartz: We're a small firm compared to some of the firms in the room. Eight years ago, we were doing two and a half million dollars of business, and this year we'll do about $80 million.

I think our challenge, and everybody's challenge, is to stay focused on what you can be great at and what your real vision is.

Last year, I think, we spent about $300,000 just dealing with new regulations that came up, and for us, that was about 10% of what would have been profits. Building the technology and making sure you're complying with all those rules prohibited us from buying various technologies that we actually thought would help clien

ts and help the reps.

Staying focused in spite of all those challenges is the key. The way we've tried to do it is by being somewhat of a niche player. We specialize in the fee program side of things. We would like to think we could be best at that niche of flexible-fee programs that we're working on.

As to consolidation, which was mentioned earlier, it's partly a factor of whether the big boys are willing to pay the kinds of dollars they paid a few years ago to buy broker-dealers. There are certainly a lot of broker-dealers more willing to listen right now than people who are paying the big dollars.

I'm not sure we'll see a lot of consolidation, because of lack of dollars to justify it from the seller's point of view.

Mr. Papike: I totally agree that the money is just not out there that it was five or six years ago.

Mr. Crowley: I would add one other comment, which I think is probably a challenge not just for this particular part of the industry but more broadly, and that's the investor trust and confidence issue. This is a challenge for all of our organizations to overcome.

Second, we have got to help firms drive expenses down because there's such a compression in all the opportunities that we had in this industry. I believe that it's our mission at Pershing, anyway, to help the industry and help our clients with re-engineering their back offices and middle-office processes so there is the financial result at the end of the day.

Mr. Pavia: Kathy, your thoughts?

Ms. Boyle: I'm an adviser, so from my perspective, it depends on what market you're going after. If you are going after the baby-boomer market, the Gen-Xer market, where they have to transfer the wealth, or the women's market, which is huge, they want one-stop shopping.

They want to be able to get everything in one place, so you have to give your advisers the ability to provide strategic alliances if you're a niche player. And having the technology is important because they want to be able to go online and see their statements. They wa

nt what the big boys deliver.

Now many people are fleeing towards the independent adviser, so you also have to be able to provide the security that your assets are safe, and that's where technology comes into play in terms of letting them know what the relationship is.

The easiest thing for me to tell people is, LPL is my Merrill Lynch; they're my back office. It's easier for me to associate with someone to provide turnkey everything, and it would cost me a fortune to provide those services on my own, so that gives people an immediate understanding.

Mr. Pavia: We're going to jump to Maui. Mark, your comments?

Mr. Goldberg: As we talk about the challenges, I think we have some great opportunities. I think we have a great opportunity in the independent market to make inroads with the captive market in a way that we've never been able to do before.

The attraction of going independent today for the traditional-regional-wirehouse producer is so significant that if we create the proper environment for them to come over, we're going to see an accelerated growth. There are some firms, not just AIG Advisor Group firms, that are getting more aggressive in trying to capture the attention of wirehouse brokers, regional brokers, and are doing more so successfully today than ever before.

I think, in terms of defining who we are, we have to stay focused, and keep our reps focused, on the activities of every day, which is managing their clients' money. That's where we face the challenge. Whether it's the scandals within the fund industry, whether it's regulatory or shelf space issues, at the end of the day, we need to stay focused, and keep our representatives focused, on doing a good job with their clients, because at the end of the day, that's what drives our business.

The amount of clients we're capturing from traditional firms, wirehouse firms, the regional firms, is at proportions we've never seen, and that has a lot to do with the industry and the environment.

Mr. Crowley: At Pershing, we track the ACATs,

the account transfer statistics of our introducing broker-dealers relative to their competitors, and the statistics show that they are recruiting 1.6 to 1.7 accounts in for each account that leaves. So it's almost a 2-to-1 accounts transferring in as opposed to accounts leaving. So it's a very positive ratio, and evidence of what Mark just alluded to.

Mr. Goldberg: We surveyed our top 100 advisers -- this is about nine months ago -- and 64% of their new clients are coming from traditional wirehouse firms, so almost two-thirds of their new clients are coming from that environment.

Mr. McGovern: I do think we have this opportunity Larry alluded to earlier, and it's a growth opportunity for the independent-contractor firms. We too see about two-thirds of the new financial advisers we're recruiting these days coming from the wirehouse world.

One of the things we're seeing and hearing more is that many of the advisers that have been affiliated with the wirehouse firms don't attach nearly the brand equity to those firms that I think they did in the past because many of those firms' names have shown up in the media as being tainted with some of the problems that have occurred.

Mr. Papike: The biggest problem with the independent-contractor marketplace was, we didn't have the technology; we couldn't service the clients that the wirehouses could. Now, after all of the big scandals and problems that you have seen lately, not only the clients want to come into the independent-contractor market, but brokers also. The inflow for these broker-dealers over the next four, five years, I think, is going to be staggering. That's why my comment about managing growth is going to be of paramount importance because it's happening now, and it will continue to happen. If my guess is true -- that Linsco/Private Ledger is going to recruit $100 million -- that's a staggering number.

Ms. Boyle: If I could jump in, just from knowing my friends in the industry, many of them would be willing to take the leap if the technology is ther

e. But you have to remember that not every broker is willing to go independent. They don't have the capability. You really have to be an entrepreneur.

Mr. Papike: It used to be that when you talked to a wirehouse broker about going to an independent, their brainwashing was: "That's the first step to going out of business; they have don't have the technology, they don't have the service, they don't have all these different things."

That's completely flip-flopped now, and there isn't a wirehouse broker out there now that hasn't heard of Raymond James, Linsco/Private Ledger, Royal Alliance. And it's not the first step of going out of business; it's, "Hey, this may be a better jump for my career and my clients."

Mr. Pavia: We talked about the broker-dealer challenges. What challenges do your clients face?

Ms. Boyle: I think we might be in a secular bear market, and so managing clients' expectations is a real difficult challenge. Everybody feels that the bear market is over, and we are on to the bull market, and now let's get back to those double-digit returns.

The client still uses 20/20 hindsight, puts those rearview glasses on constantly, and getting them to manage risk going forward is a problem. They think the bull market is up, and they want to know: "What's my net return?" They forget it goes up and down and up and down.

Mr. McGovern: We've seen a very high incidence of customer complaints across the industry, and that's put a taint on many of the major firms.

But I think every firm in the industry is probably experiencing a higher incidence of customer complaints and settlements. Clients' expectations were much higher than they should reasonably have been. Everybody was expecting a '98, '99 kind of market to continue, and when it didn't, everybody was trying to get some money back.

Frankly, that's one of the other issues that hasn't been brought up yet. It's putting a whole lot of pressure on the availability of [errors-and-omissions] insurance. And for those firm

s that can still get it, the cost of E&O insurance is much higher than it was a couple years ago. Fewer [insurance] firms are willing to write it, fewer firms willing to cover. I think that's going to be one of the additional financial challenges many of the independent-contractor firms will face. Can they obtain and maintain E&O coverage or do they have to go without? It's a big risk.

Ms. Boyle: What do they do, self-insure?

Mr. McGovern: Self-insuring is one of the options available, and even that has risks attached to it.

Mr. Papike: A lot of risks. A lot of firms are self-insuring. The brokers feel that they're safe, but if you get one big arbitration case against you, everyone is out of business. That's where I think the smaller firms are really going to have more difficulty than the larger firms -- being able to afford E&O coverage.

Those that are self-insuring, it's like they have guns to their heads, and the registered reps out in the field don't really realize that they're self-insuring and what that really means.

Mr. Pavia: Larry, what are the cost differences?

Mr. Papike: Typically, a couple of years ago ... the charge to the rep was somewhere around $100 to $120 a month, and now those numbers are going up to around $200 a month.

Mr. Schwartz: That's basically correct. Ours was running, about three years ago, $850 a year, and this year, it's like $2,300 or $2,200. I think it's probably peaked and may start coming back down. We never had a huge number of claims. I think we had five claims last year, and this year, we only had two, and we haven't had any in the last six months. Obviously, the market going back up again has calmed that down. If the market holds for the next few years, prices will go back down.

The people that are self-insuring are of course the very ones who should not be. Linsco or Mark's firm could self-insure. It's the ones that can't get the coverage, or are smaller firms, that are self-insured. They don't really have any insurance. They have a half-million dollars in

the bank, and they're hoping that they're going to be OK, and that's very dangerous.

Mr. Papike: That's to the detriment of the registered reps. The registered reps see the E&O carrier say it's going to go from $1,000 a year to $2,200. A broker-dealer comes out and says, "Look, here's what we're going to do: We're going to keep your E&O costs the same; we're going to self-insure." Everybody says, "Goodie, great; we're self-insured." What does that mean? Whatever money you have in the bank is all that you have -- that's self-insurance.

Mr. Schwartz: And there's another problem with that. We have run into a few reps that have been with the firm that they didn't know had dropped their E&O until two months after they dropped it. If they want to switch firms, there's a problem. If a rep joins our firm from Raymond James -- doesn't happen very often; they're a good firm -- they continue to have coverage for the activities they did while at Raymond James as part of our coverage.

But if somebody is self-insured, you can't do that, so these people coming over from firms that are self-insured cannot be covered when they switch firms.

Mr. McGovern: To clarify, Raymond James does have a self-insurance program we've had in place for a lot of years now. We do buy reinsurance for bigger claims though, and that's an essential piece of the puzzle for us. I don't think we could operate without that additional layer of reinsurance that we have acquired.

Part of the issue with advisers' changing firms is, nobody is willing to cover what's happened in the past. The E&O carriers are reluctant to kind of go out there and cover everything that you did prior to coming in here because we don't know what we're covering.

Mr. Pavia: Jim, let's get back to you now about the client challenges.

Mr. Crowley: One thing that hasn't been spoken about is the excess [Securities Investor Protection Corp.] coverage, which in our case will change over in February of this year because excess SIPC coverage went away as

we all used to know it. Many of the underwriters of that coverage decided that they weren't going to be in that business any longer, and so firms like Pershing and others had to go out and secure a new source of excess SIPC coverage for the investors. I think that plays to all these things about making the investor feel comfortable and feel as if they're dealing with a firm that has the financial capacity to keep their assets safe and secure.

Mr. Pavia: Eric?

Mr. Schwartz: I think I'll go back to the word I used on the first question, which is "focus." What really matters for the client is for them to stay focused on what their goals should be, on what I would call "long-term financial planning" -- long-term investment objectives, balanced and diversified portfolios that are going to weather the up market and the down market.

A number of our advisers said that the only problem that they were seeing with the mutual fund scandal ... was, they had to spend half their time each meeting explaining to their clients what that was, and that took away from the time they could spend focusing on what really mattered -- the clients' needs, expectations, goals and the emotional issues that they have about money and about their family.

Mr. McGovern: That's an interesting comment, Eric. One of the consequences of a prolonged bear market has been this return to a more sane approach to investing and financial planning that I think was somewhat lost or at least pushed into the closet or the background during the '99 run.

The bear market has certainly brought us back to earth and back to a more sane kind of world, where we could come back and look at asset allocation, and long-term investment and asset management. It's something I would say has been more characteristic of the independent-contractor firms than it has of the wirehouse firms.

Ms. Boyle: I agree. I spent 15 years in large firms, and I was always the only CFP, the only financial planner, and I don't care what they want to tell you; Merri

ll and the rest of them continue to tell you that they get financial plans done. They don't support us as planners.

No matter what they want to say, you know a $250 plan does not compete with what I produce for $6,000.

Mr. McGovern: At the risk of taking shots, I could cite a couple examples. There was a time when Merrill wouldn't allow someone to put CFP on their business card.

Ms. Boyle: Me. I was there until '92.

Mr. McGovern: I expect that we're going to see this shift.

Ms. Boyle: Now they're requiring everyone to receive it.

Mr. Schwartz: Following on that, what happened right before the bear market in the last run-up, we didn't see people shifting back the transactions so much. What they shifted to is assets under management. Why should I waste my time doing the financial plan if I could put those assets under management? Bring them in, take the $500,000, take your 1%, move on to the next person. That's where the money was.

But of all those people that they brought in and didn't do the financial plan for, they lost 30% of those clients. The ones they did the financial planning, for they still have.

They forget that step one may not be where you make your money, but you still need to do it. Fortunately, "financial planning" is the buzzword again like it was 10 or 20 years ago. That's one of the best things that's going on in the industry.

Mr. Papike: It's a buzzword for the wirehouses, just like fees were for them five years ago.

Mr. Pavia: Mark?

Mr. Goldberg: When I hear the word "client," I typically think of people like Kathy as opposed to Kathy's client. One of the challenges for us is to make individual practitioners better able to deal with their clients. One of the things we talked about here is the fact of being distracted by the regulatory environment and the increased demands from the regulators.

What we can ill afford to do is stop progressively improving our service centers, our customer service centers, or properly staffing our ACAT divisions, our bro

kerage environment, our trading desks because we came off a difficult cycle.

There was contraction in the market, and a lot of firms did cut back, but we need to put into place the tools that Kathy talked about earlier that allow her to service her clients in a proper way.

Think about some of the challenges that are coming up in order to do that. The increased regulation is going to require increased documentation, increased disclosure. We have to make some sense of that so that by the time it reaches the client, it is a positive and a productive interaction between the individual practitioner and the client.

We have an enormous challenge to keep moving forward on technology, so we're delivering services to the client in real time like the wirehouses do it, and we're getting closer and closer. Some of the firms are there; some of the firms are getting there.

Mr. McGovern: I agree with Mark. I think we've got to not only do a great job of servicing, but I think we've got a huge responsibility on our hands to not only service our clients but better educate clients. I think part of the task ahead of us is helping clients understand much more about how the market works, much more about the issues that they're seeing in the press, far more about asset allocation and financial planning than we've ever done in the past.

I think an educated client is a much better client for all of us. That applies to the end client, and it applies to the adviser as a client as well. There are a lot of advisers in our own firm that we're working very closely with to help them improve their practices and shift their business for the benefit of them, for us and for the benefit of their clients.

Mr. Pavia: The next question deals with fallout you see on the business from the mutual fund scandal. Bill, do the customers know what it is about, and if so, how has it affected your business?

Mr. McGovern: I don't think that we've seen any major fallout from the mutual fund scandals or trading issues. I think it certainly caused a l

ot of noise, it caused a lot of stir, it's caused a lot of questions, but I couldn't say we've lost any clients or advisers over it.

I think the biggest problem is helping to educate people about what's going on here. There's been very little in the press to try and explain to the public the complexity of the issue we're up against.

The fact is, the mutual fund companies have brilliantly put together break-point offerings to try and generate business way beyond the ability of the broker-dealer industry to monitor and collect the data to ensure that we're complying and providing those break points.

And the regulators seem to be pointing at the broker-dealer community now as the responsible party -- saying we should know where those break points should be applied because we should know what other accounts our clients' families may have and what other funds they may have been invested in or what their retirement plans may have at their companies. The complexity is huge, and I don't think anybody has done a very good job of explaining that to the public.

Mr. Goldberg: If I could jump in on the question of fallout: In some ways, I think it's done an incredible job of reaffirming the role of the adviser in the process. And in some ways, it's been a boon -- maybe not in actually generating revenues for anybody, but something like this happens, it starts hitting USA Today, not just The Wall Street Journal or InvestmentNews.

There are issues of somebody needing guidance. At the end of the day, it's that personal relationship between the adviser and the client -- that's where the trust is, that's where the advice is, that's where the emotional decisions about money are made.

One of the repercussions of the mutual fund scandal, or any of the scandals, is that it reaffirms the role of the adviser as this trusted individual that the client turns to in times of crisis or in times of uncertainty. I think that reaffirms what everybody in this room does.

Imagine being in this type of scandal in a no-load environmen

t or do-it-yourself environment, or in an Internet-based asset allocation environment, without somebody sitting across the table who you trust, who can tell you the right thing to do and who could help you through it.

Mr. McGovern: Mark's comment is an excellent one. When it comes down to it, it's the face-to-face relationship the client has with their trusted adviser. That's an individual person; it's not a company.

Mr. Papike: I support that fully. This scandal, this mutual fund scandal, is just one in the line of six or seven or 10 scandals that have taken place in the last 10 years, most of which have to do with big busi- ness rather than the independent- contractor marketplace. I think it bodes well for people like Kathy and other advisers that are out there who can sit down in front of their clients and say: "OK, here's exactly what happened, and here's what we're going to do about it. Here's how your portfolio looks." So it really bodes well.

Mr. Crowley: What I think is unique about the mutual fund issue is that it touches a large number of households in the United States -- and for that matter, more broadly. You know the personal experience when visiting mom over the weekend, and she has a letter from a fund company talking about timing and break points and other things, and her response is: "What does it mean to me?"

That's the challenge for the advisers out there today: to address this educational issue because this issue hits home for all of us and for all of the people in our families.

The evidence that we have at Pershing -- and this is really a compliment to all the people in the room, and in Hawaii -- that the evidence is that there is really no fallout. What we see at Pershing is an increase in the mutual fund assets, an increase in the number of transactions.

Mr. Pavia: Eric?

Mr. Schwartz: I would agree. I think that there's been a distraction, more than a fallout, in the short run, and we're distracted by a lot of different scandals. But in large part, those s

candals don't relate to independent broker-dealers as much as they relate to many other sectors of the market.

If you look out over a 10-year period, it will be a net positive to independent broker-dealers because more advisers will go independent, and advisers who take a truly objective point of view, a long-term financial planning point of view, they are the winners in the long run.

The only negative fallout is the long-term scenario that collectively these scandals will put a regulatory burden on the industry that we will feel over the next 10 or 15 years that's going to be very substantial. Some of that is positive; it forces all of us to step up higher and say we're not going to take those people.

Mr. Papike: One comment I would like to make about that is that we're talking positives, but there's a negative that goes along with this. With the independent-contractor broker-dealers' paying 85% to 90% payouts, it's very nice when you get money that comes directly to the bottom line, such as mutual fund partner fees.

I know there's discussion happening now to wipe out a lot of those fees that can be significant dollars that go to the bottom line to the broker-dealer that are not shared with the rep. That is a massive negative that's going to happen with the independent-contractor firms because they're not going to be getting those fees anymore, and I'm sure that all of you would agree -- Mark, you too -- that's a big number for you going straight to the bottom line.

Mr. McGovern: Larry, do you think that's imminent?

Mr. Papike: I don't know. I think what's happening now is, everything is being overregulated because of the problems that have taken place. Instead of going in and knocking down the ant, you take an elephant gun and shoot everybody in the room. I think that's what's taking place.

I think those fees to the independent broker-dealer are justified and needed by the firm. Those fees do a lot to support the firm and what it can do for the registered reps.

Wiping out those fees is going to

be detrimental to the firm, but I don't know if it's imminent or not.

Mr. Schwartz: I think that some of those kinds of fees are going to go away, and some of them are going to stay, and they're going to have to be disclosed. For example, if someone is getting directed, trading at 6 cents a share when someone could really trade at 1 cent a share, that is probably hurting the customer, and that maybe should go away.

Other things will still stay, but if you disclose more properly, that is good. At the end, that means the broker, the independent broker, will get a little bit less than they do, and that will have some impact on payouts and so on -- not huge changes, but all these things factor in.

I think certain technology is helping us deliver things cheaper. If nothing else had changed, the technology that has improved over the last eight years would allow us to either make more profits or give higher payouts. That's been offset by the increased regulation and other things. So there's a battle there, whether payouts are going up, down, or which way.

Mr. Pavia: Kathy, you're really on the front line with clients. Have you gained new clients as a result of the scandal?

Ms. Boyle: No, not really. Everybody that has been coming in right now has been coming from somewhere else -- a bigger firm, a bank, a trust company or brokerage house.

Generally, I find people who are looking for advice, so they come from places that kind of mucked it up before and are not usually on their own.

In terms of the fallout, I've used separate accounts since `89, so very few of our clients actually have load funds, almost everybody's wrap if they have funds. But the broker-dealers just sent out letters on the break points, so we're getting a flood of calls: "Could you look over my accounts?" It's quick e-mails back or phone calls from my staff to say, "It doesn't apply to you. Don't worry, we would have taken care of it."

The other place where I see there's more scrutiny -- you're a little bit more on

high alert in terms of if you do any kind of business with the NASD, with the regulators.

Mr. Pavia: Kathy, how has the pressure from the regulators affected your business, and what do you see going forward?

Ms. Boyle: I'm very glad that I'm affiliated with a broker-dealer, especially LPL. I have a great relationship with compliance. I do a lot of TV and radio, so I have an advertising compliance need, as well as regular compliance, and we have great relationships with them, and that to me is a big safeguard. If I had to replicate what they do with an attorney on an hourly basis ... and finding a good attorney who has depth of knowledge ...

If I do a seminar, if I do a speech, just to be able to get that pre-approved so I'm off the hook, because you never know who's in the audience ...

If I had to read the regs and figure out what I had to come up with, it would be a real challenge.

Mr. Pavia: Jim, do you want to comment about the regulators?

Mr. Crowley: Sure. Obviously, in 2003, we saw a big change in our business with the introduction of new books-and-records requirements, and we spent millions of dollars and eight months' worth of programmers' time making all the changes that were required.

That was just sort of the beginning of what we expect to have with the new regulations that will be put into place with the mutual fund changes. In particular, we already know that there are things that we have to do in the mutual funds disclosure area.

We probably have to make an annual disclosure regarding break points. We probably will change our front end or improve our front end to publish the schedules and publish the rules by each family what those break points are and who doesn't qualify.

We will make changes to the confirmation process, and so we have to disclose the sales charge upfront. We have to also advise the investor where they can go to for more generic-type information.

I would also say that we have to support the broker-dealers out there with the data they're going to be required to

have, to make certain that they're in compliance with the break points and other things, because at this point in time, it looks as if that's where the finger is getting pointed -- at the broker-dealer.

Mr. Pavia: Eric, I have a feeling you have something to say about this.

Mr. Schwartz: We are being more diligent about brokers we take. We're asking people with "yes" answers, for example, if they will to go into an existing branch office, which would have been unheard of maybe a few years ago because people want to stay in their own truly independent office.

We are finding ways of not saying no in spite of the fact that we know that regulators are asking: "Why did you take this person?"

We try to look at someone and say: "He's got a `yes' answer, but is he a good person? Is what he's doing with his clients really good? Are these things lessons he learned, or things that weren't really his fault, and they could have happened to everybody?" If that's the case, we want to take that person. We need to be a little more creative in how we do additional supervision -- maybe we visit his or her office a few more times a year. We try to come up with some ways that you could keep the good guys in the industry.

On the other hand, we turn away people that have no "yes" answers because we don't feel comfortable with them, and I think every firm is doing more of that. That may be a good thing, within some reason. What I hate to see happen is good people in the industry who do good things for their clients be shut out of good firms. What ends up happening is, they go to a third- or fourth-tier firm where they're regulated less and given less good counsel, and they'll probably get into more trouble.

Fortunately, because of all the consolidations that have taken place, there are some good compliance people who were put out of jobs. We've been really fortunate in bringing about five new compliance people and moving them to Iowa, which isn't the easiest place to get people to mov


It is a serious area that you have to roll with and make sure you're doing a good job of it. It's definitely expensive. One way or another, it affects payouts because it's less money that's available to do other things with, but you get used to it.

Actually, what the regulators are trying to do, I believe, is push [onto us] the burden of moving rogue brokers and other people that are not as ethical as they should be, out of the industry. They encourage us not to take them, and then they weed themselves out, but it's not an efficient system. There's always going to be a third- or fourth-tier firm that will take those people where they're getting in more trouble because they're not getting good advice until that firm goes out of business.

Mr. McGovern: The problem I think we face is, we don't know what the [next] regulation is going to be and when the next one is going to be.

That means we have to develop new technology systems. It means we have to hire additional compliance people, we've got to provide more disclosure, etc., etc.

At Raymond James, we have been spending a lot of time putting online something called Eyesight, which is a compliance technology system to monitor the suitability of virtually every trade that occurs in our firm. It alerts the branch manager to the trade, the fact that the trade matches the suitability requirements in the client's new-account form. It's a huge undertaking to develop systems like that. It's a very expensive process, and yet it's something that's incumbent upon us if we're going to continue to operate with the kind of integrity that we believe is called for.

I think the E&O issue is going to cost us a lot more money, and yet it's imperative that we all have it. Our firm is more concerned with the quality of the people that we're bringing in than the quantity of the people we're bringing in, and we're shifting our focus to be even more diligent and selective than we have in the past. It's not just the criteria we're applying to it; it's the process.

It now

requires an involvement of multiple people in the organization, multiple departments. Client sales, management, business development all are being involved in evaluating and approving people that are joining the firm.

And the corollary to that is, we're being far more critical of the people in our organization who are not measuring up. And we are putting a lot of pressure on people either to improve the way they're working and achieve certain levels of business or find another firm to be affiliated with, because we find it's not profitable to support the low producer anymore.

I think if we as an industry want to pass muster and the scrutiny of the public, and maintain or regain the investor trust and confidence, we've got to be a step ahead of the industry, and deal with some of the conflicts of interest in our own shops.

Mr. Pavia: Larry?

Mr. Papike: I want to comment on this pressure from regulators' affecting your business. Are broker-dealers turning away brokers and hiring more compliance staff? Yes, they are.

The problem that I see with this is, you're creating a class system in the independent-contractor marketplace. Eric has the money and the wherewithal to be able to do the compliance tests and tasks that he needs to do, as does Bill, as does Mark. The bigger firms have all of these resources.

So what happens is, a person has a couple of "yes" answers on his U4. Eric won't talk to him, so he has to go to a lesser firm that's going to have lesser compliance, so you have a class system, the haves and the have-nots in the independent-contractor marketplace. And if we are going to have a problem down the road, it's going to be because the have-nots don't have the wherewithal to be able to put the compliance policies and procedures in place in order to really do whatever they need to do with the brokers.

Mr. Schwartz: It's partly by choice; they are choosing to be the way they are.

Mr. Papike: The issue is, there are an awful lot of brokers who have a "yes" answer, or pendi

ng arbitration, that you won't talk to that do a great job for their clients, and they have to go to a third- or fourth-tier firm that doesn't have the policies and procedures.

Mr. Schwartz: We do take people with "yes" answers, and we try to determine, "Is this guy a good guy who, however, has this unfortunate situation?"

Mr. Papike: I think that's the exception rather than the rule. At most firms, you got a "yes" answer, you got a pending arb, it's: "See ya later."

Mr. McGovern: We are wrestling with this issue. It's been an ongoing issue for as long as I've been around the business, perhaps exacerbated by the three-year bear market and the increasing incidence of frivolous complaints by clients.

It's all too common, and we do spend a lot of time working with people who come to us with those kinds of situations to try and determine if we are dealing with somebody with good character who simply is in an unfortunate scenario.

It is unfortunate to see people, as Larry said, penalized sometimes because they have two or three answers, and they did nothing wrong, and yet there is a regulatory environment that says we have to answer to the regulators.

Mr. Pavia: Mark, want to jump in?

Mr. Goldberg: I think it's a reality that there will be adverse selection in which certain representatives will migrate to the Tier 3, Tier 4 firms for the reasons mentioned.

Getting back to the original question, I think it's going to cost the industry millions and tens of millions, if not hundreds of millions, of dollars. I think there's a great opportunity for each of us, firms large and small, to create a distinguishing characteristic.

If you look at the compliance situation, the regulatory situation, the better job we do at implementing systems at each of our firms, that communicate well with the ultimate client ... the better the experience with the client, the lower the cost, the more reps will want to affiliate with us because we do a better job in servicing and communica

ting -- and because we represent a firm that's strong in regulatory compliance, and ultimately has lower costs of doing business because its E&O premiums are lower.

It's a failing of our industry that we have not done a good enough job of advocating our own position with the regulators. I don't think they understand our firms well enough. I don't believe we've done a good enough job educating on the role of the adviser and the relationship with the client and the relationship with our firms, how we work.

Through that misunderstanding, at times policies are enforced, or policies are set out, that may not accomplish what they're trying to accomplish.

Mr. Pavia: Mark, is the independent-broker-dealer industry in line for a scandal of its own?

Mr. Goldberg: There are some who might say that there's a scandal out there, but I can't see it. There's a lot of integrity in our industry. I don't know what that scandal could be. There is the ability for a headline to come out on some representative in one of our firms' having done something questionable, but a scandal inherent in the way we operate, I just don't believe it.

The reality is that this industry as a whole is based on integrity and trust. I'm hard-pressed to think of anything that's fundamentally wrong with our industry.

Mr. Pavia: Larry is champing at the bit.

Mr. Papike: I disagree with Mark's assessment to some degree, though most of it I agree with. Let's keep in mind, we did have a scandal in the independent-contractor marketplace with limited partnerships. It was a huge scandal.

I mean, Mark's firm alone almost went out of business as a result of limited partnerships and all the rest of us that owned broker dealerships at the time. I think the smart people really learned from that, and learned it doesn't feel good when you have to go to a client and say, "You invested in this limited partnership, and you lost all your money, and by the way, you lost all your tax benefits that you have gained, too."

I do think that there could b

e a brewing scandal, which I tried to touch on a little bit earlier. You have this class system. There are firms out there, independent-contractor firms today, that two years ago had 100 brokers, and now they have 700 brokers. They're thinly capitalized, they may be self-insuring. They're letting their brokers do whatever the heck they want to do. So we're going to see in the next couple of years an independent or several independent-contractor firms going out of business, and clients and brokers having problems.

That is going to take place because the regulators are not looking at those firms and saying, "How can you take a firm that's a 200-person and go to 600 in one and a half years?"

Mr. McGovern: I think Larry's point is correct, but my sense is, there have probably always been that group of people willing to operate outside the parameters that we would all consider the defines of ethical, professional behavior. My guess is, they will continue to do so.

I'm not sure what the independent-contractor firms can do about that. Should we be out there pointing the fingers and blowing the whistle and bringing them to light in eye of the regulators? That's an interesting question.

Mr. Papike: Let me jump in here. I think it's incumbent upon us to make sure that the regulators do understand what's taking place because I am staggered by what I see as the number of brokers that have five, six, seven, 10 "yes" answers, and they get willingly approved by the NASD and their states. As Mark was talking about, we need to educate the regulators as to what is a rogue broker, what is a firm that's stepping out of the bounds and not doing the things they're supposed to do, because they don't have arms around it.

Mr. Goldberg: Larry, when you say "an industry scandal," what you're pointing to, I hope, is a firm scandal.

Is this an industry that in its premise is based on something that is about to be disclosed that will create a scandal? I don't believe so; I think it's a fabulous model


Mr. Papike: I couldn't agree with you more, Mark. I think the independent-contractor model is the model that's in vogue, and will be for several years. But you look at some of these firms, like when Eisner went out of business. There were a lot of folks in the Midwest at the wirehouses saying, "You're with a thinly capitalized firm. Don't go with the independent-contractor firm; go with a big boy." So that is an industry scandal because it affects all of us.

Mr. McGovern: I agree with Mark's assessment. This is not new stuff that we're going through today. We've all survived other things like this in the past, and we will survive this, and I think we'll all come out feeling relatively OK. It just happens to be the elephant in the room right now.

There will be some firms that will get into trouble, and yes, there will be fallout from that. Look at our own comments here about some of the scandals that have affected the brand equity of Merrill Lynch and has kind of spilled over to other wirehouse firms. A similar kind of experience could occur in our industry. One of the places where we could be vulnerable is that the regulators keep looking at that: "How well are we supervising independent contractors?" After all, we don't have somebody on our own staff out there looking over their shoulder every day like you have in a wirehouse environment, where you have a paid branch manager looking out for the company's best interest. And yet we see a far greater sense of ethics and professionalism, generally speaking, among the independent-contractor group than I've seen on the other side of the world.

Mr. Pavia: Eric, do you want to jump in?

Mr. Schwartz: All of us in the room, we're constantly worried about the NASD, making sure we keep our good records and so on. But the NASD does not have the ability, or chooses not to do things about, "rogue brokers" even though they're very concerned about them or firms that have a large preponderance of them. They talk about it a lot, but they

really have tried to push the burden to us.

Mr. McGovern: The biggest problem we probably face is, we don't know what we don't know, and we don't know where it's going to come from next, like the next terrorist attack.

Frankly, it could come out of the annuity business; the product has been oversold.

Ms. Boyle: Putting it mildly.

Mr. McGovern: Not the variable side but the fixed side. My guess is, people are going to come back, as markets go up 20% a year, bitching about their 2% fixed annuity. "Why did you lock me into that?" and "I'm missing out." There is going to be a number of areas where people are going to come back and bite us, and we don't know where that's going to come from.

Mr. Pavia: Kathy or Jim?

Ms. Boyle: On the whole, the independent network for the broker-dealer is so much more transparent that there's less ability for a scandal to happen.

Mr. Crowley: I would just say that I agree with everything that's been said here. One or two or three firms could give this industry a black eye. The regulators need our help. It's incumbent on the leadership of the industry to work with the regulators. They don't understand our business in every respect, and need our guidance and our leadership.

Mr. Pavia: Kathy, if you could change one thing in the industry, what would it be?

Ms. Boyle: Coming back to the fact that the regulators aren't in touch, if there was some better way of communication back and forth. Congress, after it passes a bill, has small committees that get feedback from the constituents to see how it's working, and then it amends the bill. I think we need something similar from the regulator standpoint.

Mr. Papike: One of the biggest travesties, and one of the biggest problems in our industry today, is the CRDC system itself. There's no other business that I know of where so many brokers' careers have been or are going to be ruined because of the CRDC. It's a system where you're guilty until proven innocent, and then you're still guilty because it stays

on your record. That wasn't a big deal five or six years ago, but today, anybody who has a computer can access your information, whether you did anything wrong or not.

I think the CRDC is a system that's killing our industry, and that needs to be changed.

Mr. Crowley: I don't think I have a single thing I would change. It's the greatest industry in the world, and we've got lots of opportunities, whether it's the financial institution or the investor or the client, and I'm excited about the future.

Mr. Pavia: Eric, you have the power now.

Mr. Schwartz: I've got two. I think, in general, the regulatory system needs to be improved, and regulators need to understand our business better. There needs to be a better integration of the regulation of fee business and commission business.

They're regulated sort of separately, but the same reps and broker-dealers are doing both.

The last four audits we had followed each other within three weeks of each other. It would be nice to have it integrated in a system where there are comprehensive rules that apply to fees and commissions all together. The RA and broker-dealer businesses 30 years ago were two completely separate businesses. Now they're almost integrated together, so much that the regulations need to be upgraded.

From our side, I think, over the next five, 10, 20, 25 years, what I would like to see most in this industry is that it becomes much more than it has already, an industry of truly trusted advisers, people whose business is not to sell stuff.

Mr. McGovern: It would be nice to wave a wand and have the regulators see the world through our eyes. I was struck by a comment I saw in a recent article about a 14-year NASD veteran who went and joined an independent-contractor firm, and was struck by the realization of what he had put into place at the NASD, and the impact on the firm that he had.

I would extend that to the regulators' changing some of the rules that apply to the CRDC system because I think it is a misapplication of justice where peop

le are guilty until proven innocent, and those things never do leave their record. There needs to be some distinction made between those incidents that do result in settlements or some acknowledgment of guilt versus those that don't. Those that don't ought to leave that record in a short order or short period of time.

Mr. Pavia: Mark, you have the final say.

Mr. Goldberg: I don't think that enough credit is given to the financial advisers, the advisers in our industry. I think, collectively, as an industry, it would be wonderful if the work of the advisers, the type of practices they run, the type of services they offer to their clients, were recognized on a public level for the value that they are. It's not just that they're handling people's money; they're helping people in a real way that is very meaningful.


From left to right:

William D. McGovern, senior vice president of business development with Raymond James Financial Services Inc. in St. Petersburg, Fla.

Larry Papike, president of Cross-Search in Jamul, Calif.

Kathy Boyle, president of New York's Chapin Hill Advisors Inc., which is affiliated with Linsco/Private Ledger Corp. of Boston and San Diego

James Crowley, managing director of global customers with Pershing LLC in Jersey City, N.J.

Eric Schwartz, president and chief executive of Cambridge Investment Research Inc. in Fairfield, Iowa

Not pictured:

Mark Goldberg, president and chief executive of Royal Alliance Associates Inc. in New York

Jim Pavia, round-table moderator, editor of InvestmentNews

The round-table transcript has been edited for space.


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