Insurance-owned firms and small broker-dealers most likely to throw in the towel.
The sale of AIG Advisor Group earlier this week might be the first of a wave of mergers in the independent broker-dealer industry as a result of looming regulation from the Labor Department.
American International Group Inc.'s CEO Peter Hancock cited the DOL's proposed fiduciary rule as part of the insurer's decision to sell its broker-dealer unit to private-equity firm Lightyear Capital and Canadian pension manager PSP Investments. The rule, which raises investment-advice standards for advisers servicing retirement accounts, is meant to protect investors from conflicts of interest.
Broker-dealers owned by insurance companies are at the “greatest risk” of running afoul of the rule, as they're often viewed as distribution outlets for the parent's proprietary products, Cerulli Associates said in a report this month.
The rule moved one step closer to finalization Thursday night when the DOL sent the measure to the Office of Management and Budget, which has 90 days to review it before it becomes public.
All broker-dealers are facing compliance costs that may prove too difficult for smaller businesses to absorb, setting the stage for industry consolidation. One large brokerage firm, Cambridge Investment Research Inc., has estimated it will spend $15 million to $17 million to upgrade its technology and make other operational changes to comply with the DOL rule.
“There will be more merger activity as it becomes apparent some firms are unable to bear the additional regulatory burden,” said Ron Edde, co-founder and CEO of Millennium Career Advisors, a recruitment firm based in San Diego. “You're going to see mergers between small to mid-sized firms” to gain scale, while large broker-dealers will be eyeing targets, he said.
“The cost involved with compliance is the No. 1 concern,” said Mr. Edde. “Some will make the decision that they can't do business” on their own.
Bing Waldert, the head of U.S. research at Cerulli, said broker-dealers with under 500 advisers will likely have the hardest time complying with the rule.
On the other hand, large firms such as LPL Financial Holdings Inc. and Raymond James Financial Inc. “may have the resources to weather this” and make acquisitions, according to Mr. Edde.
AIG, a giant insurance company under pressure from billionaire investor Carl Icahn to split up the company to unlock shareholder value, announced the agreement to sell AIG Advisor Group on Tuesday. Lightyear's founder and chairman, Donald Marron, said in an interview the same day that he'd look for additional acquisitions to help build the business while adding investment products and services for its network of financial advisers.
AIG Advisor Group, with $160 billion in client assets, consists of four broker-dealers: FSC Securities Corp., Royal Alliance Associates Inc., SagePoint Financial Inc. and Woodbury Financial Services Inc. It has more than 5,200 independent advisers.
Insurance-owned broker dealers tend to focus on the middle market: individuals with $100,000 to $500,000 to invest and a group that has a greater portion of its wealth in retirement accounts, according to Mr. Waldert. “That puts these firms directly in the cross hairs of the DOL regulation,” he said.
The proposal “makes sense,” said Ron Weiner, CEO of RDM Financial Group Inc., a registered investment adviser based in Westport, Conn. with about 65% of its clients in or near retirement.
“This is such an important part of a person's life,” said Mr. Weiner, whose RDM is part of HighTower Advisors' network. “If you just keep doing the right thing, the clients appreciate it, and they'll stay,” he said. “That's the smartest business practice.”
Still, brokers worry about the increased liability risk and costs associated with the change. Right now, brokers need only recommend investments that are suitable for their clients, not act in their client's best interests as registered investment advisers must.
“In some cases the economics are less attractive if you can't sell proprietary products,” according to Mr. Waldert. Then there's the risk of being fined should brokers fail to meet the best interest fiduciary standard, he said.
Insurance companies may be large, but unlike the wirehouses, they “have a history of underinvestment in their broker-dealers,” according to Mr. Waldert. Wealth management is “much more core to” the four major brokerages at Wall Street banks — Wells Fargo & Co., Bank of America Corp., Morgan Stanley and UBS Group AG — which have deep pockets to comply with the proposed regulation, he said.
Wirehouses also tend to work with wealthier clients and over the past 10 to 15 years have been moving away from commissions toward a fee-based model, mitigating risks tied to the DOL's proposal, said Mr. Waldert.
