Facing tremendous economic pressure and regulatory hurdles, small and midsize broker-dealers will continue to close, leaving hundreds and perhaps thousands of registered representatives and investment advisers seeking new homes for their books of business next year, executives and consultants said.
Last Tuesday,
Pacific West Securities Inc., which has 290 affiliated registered reps, told its staff and brokers that it is closing early next year. It has struck a recruiting deal for the brokers to move to Multi-Financial Securities Corp.
Pacific West's closing, with all accounts to be moved from the firm by March 1, is the largest independent broker-dealer to shutter since QA3 Financial Corp., which had 400 affiliated reps, closed in February.
(Click here for a list of notable exits.)
And more closings are coming, executives and consultants said.
“I think that consolidation in the industry will accelerate in 2012,” said Valerie Brown, chief executive of Cetera Financial Group, which controls Multi-Financial Securities in its network of three broker-dealers. “The situation in the market, with an incredibly volatile S&P 500, scares clients.”
The market volatility and attendant client fear also put pressure on brokers who do transactions to build their businesses, Ms. Brown said.
Add to that historically low interest rates' wiping out any potential profits for broker-dealers on margin business, and small to midsize firms are under siege, she said.
“These firms are under a lot of financial pressure,” Ms. Brown said. “And the regulatory environment has gotten tougher, to say the least.”
Firms that produce less than $200 million in fees and commissions are particularly vulnerable right now, she said.
Pacific West this year is on pace to generate $54 million in fees and commissions.
“I don't see pressure on smaller broker-dealers of this size stopping soon,” said Brett Harrison, chief executive of Multi-Financial.
And the pace of announced closures could accelerate in the coming weeks as firms sitting on the fence decide whether to remain open next year. According to one consultant, broker-dealers must be closed by Feb. 28 in order to avoid paying annual membership fees to the Financial Industry Regulatory Authority Inc.
But to meet that deadline, firms have to file their “broker-dealer withdrawal” paperwork with Finra 60 days in advance, meaning a flurry of firms could shut down over the next couple of weeks, said David Alsup, national director of business development for The Compliance Department Inc., a consulting firm for broker-dealers.
CRITICAL WEEKS
“The next week or two could be critical for firms closing, based on what we saw last year and the year prior,” he said. “What we're concerned about is seeing another spike [in broker-dealers' closing] coming in January, February and March.”
The number of broker-dealers has been shrinking steadily over the past five years. Last month, Finra counted 4,486 broker-dealers, 10% fewer than five years earlier.
On average, 20 to 25 broker-dealers close each month, Mr. Alsup said.
But over the past two years, the first quarter has seen much greater numbers of firms closing than average, he said.
Last January and February saw, respectively, 46 and 50 firms shut down, and in March 2010, 62 firms closed, he said. Big firms such as The Advisor Group Inc., Cetera and LPL Financial LLC will continue to benefit from smaller firms' difficulties, one consultant said.
“There is reshuffling the decks going on, no doubt,” said Alois Pirker, research director at Aite Group LLC. “Overall, profitability in the brokerage space has been a big problem, for small, midsize and big firms.”
Broker-dealers face a number of hazards, Mr. Pirker said.
Those include the stock market's erratic performance, low trading volume, bad consumer sentiment and the need for firms to invest in compliance and technology for clients.
“Consolidation results from all that, and it will continue,” Mr. Pirker said.
“We are meeting with a number of small firms who are looking to partner with us for our cutting-edge technology, open-architecture platform, and our strong capital and commitment to the independent-adviser space,” Larry Roth, chief executive of Advisor Group, wrote in an e-mail.
LPL spokesman Michael Herley didn't return a phone call seeking comment.
BROKEN MODEL
Pacific West is shutting down due to thin margins and the high cost of doing business, its executives said.
“The margins we are up against are getting thinner and thinner,” said Tony Pizelo, Pacific West's chief executive. “I'm in agreement with Ric Edelman; the model is broken.”
In October, Mr. Edelman, co-chief executive of The Edelman Financial Group and one of the most noted financial advisers in the country, said that the independent-broker-dealer channel is “severely flawed” and that independent broker-dealers face steep economic challenges.
“This is a tough industry right now” for all but the big players, Mr. Pizelo said.
Dozens of thinly capitalized independent broker-dealers have gone out of business or been sold over the past few years due to the rising tide of litigation costs stemming from investor lawsuits. Most of those complaints stemmed from sales of three products: Medical Capital Holdings Inc. notes, Provident Royalties LLC preferred stock and real estate deals by DBSI Inc.
Pacific West didn't sell any of those products. Mr. Pizelo said.
Still, Pacific West has faced increasing legal costs due to customer arbitrations. Over the past two years, the firm has lost Finra arbitration awards totaling $969,000, according to the firm's profile on Finra BrokerCheck.
It will be business as usual at the firm for the next couple of months as the brokers move, Mr. Pizelo said, with an anticipated shutdown date of March 1.
Pacific West and Multi-Financial are collaborating on how best to move the brokers, he said.
“We anticipate a very enthusiastic response and expect well over 50% to move,” Mr. Pizelo said.
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