Top five reasons the independent broker-dealer space continues to shrink

When I first entered the business 19 years ago, advisers expected a lot less of their broker-dealers. Firms could recruit and stay attractive simply by keeping service standards high, processing business efficiently and paying their advisers on time. Broker-dealers felt a lot less regulatory pressure and there were more profit centers available, making it easier to run a firm while staying profitable.
Fast forward to today, and the expectations of broker-dealers and the role they play for advisers have changed dramatically. Firms today must do much more in their relationship with advisers to keep them satisfied.
The mounting pressure on broker-dealers has forced a significant contraction in the space. In 2005 there were 5,111 broker-dealers, while today there are roughly 3,917. A decrease of approximately 23% over an 11-year period is certainly not something advisers are taking lightly.
I frequently hear from advisers that their No. 1 concern is their broker-dealer’s stability. They fear their broker-dealer doesn’t have the staying power to deal with the Department of Labor’s fiduciary rule. They worry that one bad arbitration will put their firm out of business or that they aren’t staying competitive enough to make it long term. These concerns, along with several others, are common in today’s environment. So what is happening to create this contraction?
Here are five major reasons that broker-dealers are selling, merging or going out of business:
1. Increased regulatory pressure: Long before the conversations surrounding the increased costs associated with the DOL rule, firms had been feeling a regulatory squeeze. The rising expenses associated with remaining compliant and staying on top of regulatory changes has put a tremendous strain on broker-dealers’ already thin profit margins. Couple this with the unknown consequences of the DOL rule and it’s clear why many firms have considered other options.
2. Competition: There is no doubt that advisers expect much more from their broker-dealers today. Advisers looking for a new firm are frequently searching for top-notch technology, marketing support, practice management tools and back-office resources that many, regardless of size, don’t have. Firms that aren’t competitive have been or will be forced to decide if they want to invest in the resources necessary to really compete for advisers in this new environment.
3. Thinner margins: Several of the benefits to having size and scale in the broker-dealer business have to do with the cost associated with services. Firms that lack scale have a harder time negotiating contracts with their clearing vendors and technology providers. Couple this squeeze with the increasing cost of running a broker-dealer and the decreasing number of profit centers available, such as the almost nonexistent interest on margin balances, and it’s difficult to produce profit margins that make sense for many.
4. Trouble recruiting: It takes an awful lot of time, energy, effort and money to have success recruiting in today’s environment. It’s an very competitive marketplace. For this reason, the past few years, we have seen an environment of extremely lopsided recruiting numbers. Broker-dealers that have remained competitive and have invested in valuable infrastructure have done well recruiting, whereas those that haven’t continued to remain relevant and put the energy into recruiting have really struggled to grow.
5. Offers they can’t refuse: The past couple of years were an abnormal period for acquisitions. Inflated price tags tempted broker-dealer owners with offers that they could not refuse. As these types of acquisitions have tapered off and we have gone into a buyer’s market, most of the transactions we are currently seeing are taking place out of necessity.
There is no denying that the unprecedented consolidation that has taken place in our industry over the past decade has changed the way advisers do due diligence on broker-dealers before they move. The good news in all of this change is that consolidation is not always a bad thing. Firms that have consistently invested back into their back offices and have prepared for past and current regulatory changes continue to see tremendous growth even during these tougher times.
Jodie Papike is the executive vice president of Cross-Search, a third-party, independent broker-dealer recruiting firm that connects advisers with broker-dealers.