On Advice

Cambridge's Eric Schwartz looks into the future of independent broker-dealer industry

Predicts next market downturn will usher in new era of big B-D mergers

Dec 29, 2016 @ 10:12 am

By Bruce Kelly

Eric Schwartz, founder, chairman and CEO of Cambridge Investment Research Inc., is one of the brightest guys in the securities business. One of the most unassuming, too.

He started a predecessor to Cambridge in the 1980s but struggled with it due to its focus on selling foundering oil and gas partnerships. In the 1990s, he launched Cambridge, which was an early proponent of broker-dealers generating revenues from fees rather than commissions. He eventually built the firm into one of the top-tier independent broker-dealers, with more than 3,000 registered reps that produce close to $725 million in revenue annually. A recruiting powerhouse, Cambridge has become a destination for many independent reps and advisers.

I usually check in with Mr. Schwartz at the end of the year to hear his take on industry trends and what could happen in the coming year. But before we get to that, first a little more proof of his sagacity.

When the former nontraded real estate investment trust czar Nicholas Schorsch made overtures about buying Cambridge from him in early 2014 for who knows how many hundreds of millions of dollars, Mr. Schwartz made it clear he would turn the REIT czar down if any offer were made.

Mr. Schorsch, through his broker-dealer holding company RCS Capital Corp, or RCAP, weeks later announced it was going to buy Cetera Financial Group from Lightyear Capital for $1.1 billion in cold hard cash.

Cambridge advisers should be grateful for Mr. Schwartz not dumping them in the lap of Mr. Schorsch. They were spared the many months of gnawing uncertainty that many Cetera Financial Group advisers, particularly those who bought now worthless shares of RCAP in a secondary stock offering, deeply felt.

RCAP eventually collapsed under hundreds of millions of bad debt used to fuel Mr. Schorsch's acquisition binge and slid into bankruptcy at the start of this year. It was a humiliating turn of events for Cetera advisers and executives.


Now to the forecast. Five years ago, Mr. Schwartz foresaw the extent of the consolidation that is a driving force in the independent broker-dealer industry, which is famous for its thin margins. At the end of 2011 he told me: “In 10 or 12 years, there will be only seven or eight broker-dealers doing 80% of the business, and insurance companies will own only one or two.”

He was spot on in his prediction. Just this year, giant insurers American International Group and MetLife Inc. sold off their adviser networks. They wanted no part of an industry that is facing higher compliance costs due to the Department of Labor's fiduciary rule and the general risk of securities brokers.

With a tumultuous 2016 coming to a close, I asked Mr. Schwartz to gaze into his crystal ball once again and tell InvestmentNews readers what was in store for the independent broker-dealer industry in the future. He has sharpened the forecast for the industry he gave me back at the end of 2011.

“The next real thing to drive consolidation, once the Department of Labor rule is settled halfway through next year will be the next downturn in the market,” he said. “If a firm is just hanging on by a thread with the DOL, the next big market drop will force consolidation.”

Up to now, large broker-dealers like Cambridge have been the drivers in consolidation, gobbling up smaller firms that have fallen behind in service and compliance. That's the way industries evolve, Mr. Schwartz is quick to note.

That will change over the next three to five years.

He see 13 large potential IBD survivors, from stand-alone firms LPL Financial and Commonwealth Financial Network to networks such as the Advisor Group and Ladenburg Thalmann Financial Services.

“There's a reasonable chance of those surviving 13 IBDs controlling 90% of the business,” he said. “But over the next three to five years, the industry will start seeing consolidation among those 13. To me that's the next phase.”

“Once all the small, desirable firms are gone, the next logical step is to buy your big competitor,” he said. “That's the way to get efficiencies. Somewhere in that time frame, the big boys will start dropping, and those 13 will get cut in half. And once one falls the 13 could drop to five or seven IBDs. I have to believe that's coming.”

And I have to believe that Mr. Schwartz has a shot at being 100% right in his forecast. The current high cost of business and the lack of smaller firms to buy, plus the impact of a sharp market downturn on the industry's thin margins, would push even the largest IBDs to look around the landscape, find a partner and merge.

Have a happy New Year and a fruitful 2017!

(More: Top minds in financial advice share their resolutions for 2017)


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