Keeping Up

Twenty-five years ago, Investment Advisor was founded. Fifteen years ago, IA ran its premiere directory of independent broker/dealers. Much has changed over that time, and that's particularly true in the independent B/D world. For example, in the first directory, published in June 1991, there were 21 broker/dealers listed with a total of 17,848 representatives. Gross revenue for those companies was $509 million. By the time of the 10th directory, in 2000, 60 B/Ds participated. They could boast 61,484 reps, and total revenue was $5.7 billion.

This year, the number of broker/dealers has risen to 74 in the directory that begins on page 93. While there's been only a slight increase in the total number of reps since 2000 (64,325), total gross revenue has soared to $7.5 billion from 2000′s $5.7 billion.

Fee-based revenue has nearly doubled in absolute dollar terms since 2000, to $1.4 billion, or 18.7% of 2004′s total revenue, from 14.7% in 2000.

By some measures, bigger is better for B/Ds, particularly when it comes to sharing the ballooning costs of compliance and technology. A ranking of the biggest independent broker/dealers by revenue and reps (page 92) shows LPL Financial Services on top of both lists; familiar names like Raymond James, H.D. Vest, and NFP Securities appear as well. Among the fastest growing B/Ds are Cambridge Investment Research and NFP, which lead the way in number of reps and gross revenue, respectively.

A few caveats about the size-and-growth-equals-success formula. While numbers may illuminate, they can also obscure. Take NEXT Financial, for instance. This Houston-based broker/dealer was the second-fastest-growing company over the past five years as measured by gross revenue, which more than tripled, from $10.8 million in 2000 to $38.7 million in 2004. But NEXT didn't find its way into our directory until 2001, at which point it could report its actual revenue for 2000. However, the "number of reps" in our directory is actual as of the survey date–April 1. So NEXT wasn't in the running for fastest growth in reps, though its rep force increase nearly matched its revenue's–from 161 reps in 2001 to 590 reps this year.

Then there are the broker/dealers that have merged into larger B/D families over the years, such as AIG, ING, and National Planning Corp. For the most part, the individual B/Ds in those "families" have reported their results separately; if they consolidated their rep forces and revenue numbers, the ratings might very well be different. For instance, combining the individual ING B/Ds (ING Financial Partners, FNIC, Multi-Financial, and PrimeVest) would produce a single entity with 7,215 producing reps as of April 1, 2005. That would top the single largest B/D by number of producing reps, LPL, which reported having 5,800 reps.

Moreover, there's at least one area where headcount growth can be a sign of weakness, not strength, points out Jonathan Henschen, who recruits reps for a number of broker/dealers through his firm, Henschen & Associates in Marine on St. Croix, Minnesota (see his tongue-in-cheek suggestions for "ruining a B/D" on the following page). He notes that broker/dealers used to proudly point to the ratio of reps to home office staff–a smaller ratio was a sign of better service. These days, however, it might signal instead that the B/D is employing outmoded technology, and that it needs more people to perform manually the work that new software and hardware can do more efficiently.

Home office staff growth might be prompted by another development, however. Peter Wheeler, president and COO of Commonwealth Financial Network, notes that Commonwealth's home office staff has increased–from about 220 in last year's directory to close to 300 this year–for one reason: compliance. Wheeler says, "I have to get more and more people to review the exception reports; now that it's all electronic, if you're spitting out reports, you'd better be looking at them."

Compliance is also having an effect on the kind of reps that are attractive to broker/dealers. Henschen says B/Ds want advisors who take a financial planning approach. "The motive is that they're much less likely of getting arbitration and customer complaints," he says, "because the investment decisions have a financial plan behind them." That's why more and more B/Ds look askance at advisors whose business is heavy on the stock transactions, and on putting qualified money into variable annuities.

The Current Environment

Like the advisory firms they hope to attract, it's not uncommon to find a hard-charging, charismatic person as founder at leading independent broker/dealers. Many still guide them by the force of their personalities, and the firms still bear their names–like Roland Brecek at Brecek & Young, or Art Grant of Cadaret, Grant. But it isn't always a good sign for a founder to be too heavily invested in the culture of a successful company. Mark Tibergien and others have pointed out that a wise founder of an individual planning firm, or any company, should build systems and processes as he goes along that institutionalize the founder's charisms–and not coincidentally attract and nurture the right people to run those systems. Those people will serve as the successors to the founders, and the institutionalized systems will help ensure the firm's continued success regardless of the presence or absence of the founder. That's what's happened at LPL, where charismatic founder Todd Robinson handed over the reins to president and CEO Mark Casady this past year while Robinson took a sabbatical for personal reasons; LPL not only failed to stumble in Robinson's absence, but continued its growth.

But all B/Ds are operating under some newfound constraints. For one thing, the compliance burden is stifling. "The regulatory agencies are crawling all over us," notes Wheeler, whose responsibilities at Commonwealth include oversight of compliance, "and as a result, we're crawling all over our representatives." While reps are traditionally at odds with their B/D's compliance department, or "business hindrance" departments, as Henschen says some reps dub their compliance departments, Wheeler says pushback from his reps has been minimal. "Fortunately, the reps read the paper and understand that what we're requiring is a necessity and not of our doing," he says.

Many Paths to Success

The executives and observers interviewed for this article, and the hard numbers found in our directory, confirm what you probably already suspected: There is no single path to success in the broker/dealer world. There's room for both a Berthel Fisher & Co., which reports that some 35% of its revenue this year will come from products like REITs and options, and a Cambridge Investment Research, which expects to derive some 55% of its 2005 revenue from fees. Broker/dealers vary when it comes to the use of technology, as well. Commonwealth, for instance, prides itself on supporting a whole range of advisor technology; a smaller B/D like American Portfolios (see sidebar on page 89) believes its technology offerings help set it apart.

So what makes a B/D successful under all business and regulatory conditions? Wheeler argues that, "It's fairly straightforward: a mix of competitive payouts and great service, even though the two are often at odds with one another." He argues that smart reps "hire a good office manager," and build a staff that can shoulder the compliance and paperwork burden so that the advisor can "stay out in front of the client." Wheeler suggests, however, that the compliance burden in particular is "really being felt by your good old single practitioner, who can't really afford to have staff just to deal with compliance issues."

Service, technology, and "escaping suffocating compliance" are the three biggest reasons reps move from one B/D to another, Henschen says.

So the current environment for broker/dealers is more difficult, despite the healthier markets and greater size of the independent B/D channel. "Our margins are shrinking," Commonwealth's Wheeler says bluntly. Independent B/Ds "had a profitable niche, but more competitors are coming into it, and at the same time, you've got the regulators adding to the expense of it, and, guess what, we're not as profitable as we were ten years ago, and that's life."

For a complete directory of independent brokers/dealers, please click here

Editor James J. Green can be reached at [email protected].