The severe market downturn is wreaking havoc on an independent-broker-dealer industry, putting all sources of income under siege and flattening already thin profit margins.
Commission income is down, as clients shun markets that have battered their investments — driving down brokerage firms' asset management fees.
Revenue from arrangements with product companies, especially those involving bread-and-butter money market funds, also has fallen, as yields drop below the cost of operating the funds.
While few independent brokerage firms are in immediate peril, observers believe the landscape could change dramatically.
"There's a shift going on," said Eric Schwartz, chief executive of Cambridge Investment Research Inc. of Fairfield, Iowa. "We could see a wholesale shake-up in the top 10 firms and who will be viewed as a leader" by the industry, he said.
"If the market stays ugly for the next six months, we could see the pain cut the top and bottom of the chain," Mr. Schwartz said.
"On [mergers and acquisitions], we see the number of sellers growing dramatically, and the number of buyers consolidating," said Bill Dwyer, managing director and president of independent adviser services with LPL Financial of Boston.
Firms looking at potential acquisitions include Securities America Inc. and Berthel Fisher and Company Financial Services Inc., executives with those firms said.
"Like 2001 to 2003, it's an opportunity to grow," said Thomas Berthel, president and chief executive of the latter company, which is based in Marion, Iowa. A rash of deals could occur involving firms that desperately need capital, he said.
After the last market slump at the start of the decade, independent firms typically embraced asset management platforms and products so that their reps could charge clients a fee rather than a commission for a transaction. During the past five years, many firms have seen those assets — and the corresponding fees — increase significantly.
Other broker-dealers, such as LPL Financial, have slashed costs or made widespread job cuts to cope with the downturn. LPL, which at the end of December had 2,750 employees, announced at that time an across-the-board 10% layoff, the first time in its history that the firm has made such wholesale cuts.
In addition to cutbacks, the industry is staring at a potentially frightening development: One of the major clearing firms, National Financial Services LLC, recently passed along a cut in trailing fees to broker-dealers on a handful of money market funds that invested primarily in Treasury bills.
Boston's
Fidelity Investments, the parent of National Financial, made that move because interest rates are at historic lows, and cutting trails to broker-dealer clients prevents the affected money market funds from slipping into negative returns, said brokerage executives with knowledge of those moves. Fidelity spokeman Steve Austin noted that a number of other fund companies have recently cut trails.
That leads some to wonder whether trailing fees on other money market funds, or other investment products such as stock and bond mutual funds, may be cut. Fees from money market funds and other cash products may make up from 10% to 30% of a broker-dealer's net profit, executives said.
Many officials with independent broker-dealers, designated as such because their registered representatives aren't employees but rather affiliated independent contractors, said that the future looks bright. In fact, they have been crowing since September that the breakdown of Wall Street vindicates the way they do business.
They say that their firms don't have the exposure to risk and leverage that led to the downfall last year of giant investment banks.
Independent broker-dealers such as LPL, Commonwealth Financial Network and Raymond James Financial Services Inc. said that they are seeing record levels of interest from brokers and advisers, including those who want to escape Wall Street firms.
Some wonder when that movement will become widespread.
"Independent broker-dealers are talking about wirehouse reps' moving. It's not happening — yet," said Brian Kovack, president and chief operating officer of Kovack Securities Inc. of Fort Lauderdale, Fla. "Maybe in six months," that shift will begin to occur in earnest, he said.
Leading independent broker-dealers, however, are far from immune from the perils of Wall Street.
At the start of the month, Raymond James told clients stuck with $1 billion of illiquid auction rate securities they would have to wait perhaps until June before the firm could make them whole. One executive downplayed any negative impact those investments had on the firm's affiliated reps. "It's not if clients get their money back; it's when," said William C. Van Law III, senior vice president and national director of business development.
The auction rate problem for reps and advisers is "nothing of significance," he said.
The reps and advisers affiliated with firms in the ING Advisors Network of El Segundo, Calif., also have been worried about a pay cut
ING Direct, the online bank, was recently considering a cut in trails on certain savings accounts to ING advisers who recommended clients to the banking platform.
REGULATORY REACH
Since the stock market peaked in October 2007, executives with independent firms and their reps have watched assets and fees dwindle, with many facing a drop in revenue of 20% to 40%.
After almost five consecutive years of solid growth, the market is causing independent firms to show signs of wear and tear, executives said.
And then there's the other side of the securities business: regulation.
Executives with independent broker-dealers are confident that events will lead securities regulators to bring registered investment advisers under the same compliance umbrella as registered representatives.
They point to last month's revelation that for years, Bernard Madoff was allegedly running a $50 billion Ponzi scheme under the nose of the Securities and Exchange Commission as proof that investment advisers are too lightly regulated. They believe that advisers — who claim that their fiduciary standard is more stringent than the brokers' suitability standard — often choose the RIA channel because regulation is less onerous.
But don't expect registered investment advisers to come under the same compliance regime as broker-dealers anytime soon, said one veteran industry attorney.
"Regulators are not concerned about RIAs," said the attorney, who asked not to be identified. "They are concerned about unregistered RIAs — in other words, hedge funds."
E-mail Bruce Kelly at [email protected].
