Advocates: The 2014 Broker-Dealers of the Year

August 25, 2014 at 08:00 PM

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Throughout the history of the independent broker-dealer industry, the promise and the perils of being an IBD, and an IBD representative, have been consistent. The growing trend toward independent advice, the joys of owning your own business, the flexibility that comes with being an independent contractor and the benefits to the BD, the rep and the client of not having to flog proprietary products are well-known. Tight margins, industry consolidation, increasing costs (in both monetary outlays and human capital) to stay compliant and provide the best competitive technology are well-documented. Then there's the people issue: The business of independent BDs is recruiting and retaining advisors who are notoriously, well, independent. Moreover, if they're top producers, reps can also be quite demanding in what they want and expect from the firm where they hang their shingle. The aging of the advisor work force, the need to attract younger people to the profession, the dangers inherent in non-traditional investing vehicles and the inconsistent progress of advisor succession planning have risen to near-crisis levels.

Yet the veteran leaders of this year's Broker-Dealers of the Year, given that honor by their own reps, remain optimistic about their firms' futures and are clear-eyed advocates for the independent BD model. Each has different ownership structures, average GDC levels, revenue sources and geographic bases, yet they face the same issues year-in and year-out, and day to day.

So for the editorial roundtable with the 24th annual Broker-Dealers of the Year, we took a different approach. In a gathering in early August, Editor-in-Chief Jamie Green and Executive Managing Editor Danielle Andrus presented our winners with four scenarios that they could face in the near future to see how they'd respond. It turned out each had already faced three of the scenarios, so they spoke from experience. They were unconcerned about the fourth scenario—in which we envisioned a near future where the SEC mandated a uniform fiduciary standard for all brokers—but the reasons for their shared sang froid on the issue turned out to be instructive.

In the pages that follow, we'll share how David Stringer of Prospera Financial, Douglas Wright, CCO of The Investment Center (pinch-hitting for BD President Ralph DeVito), Kevin Bachmann of Questar Capital and Eric Schwartz of Cambridge responded to the scenarios. But first, a word about the process that culminated in that in-person gathering on a damp Tuesday in a Chicago O'Hare hotel board room.

As in the previous 23 years, we asked our readers who are independent BD reps to rate their own BDs in 14 different areas (such as product selection and home office support), and to provide an overall ranking. Nearly 3,000 reps voted at ThinkAdvisor.com in June. After our editorial staff validated those votes, those broker-dealers who received the highest rankings from their reps were named Broker-Dealers of the Year in four different divisions, based on their number of producing reps.

We also asked the reps to tell us which products and services they wished their broker-dealer offered (but didn't) and to tell us with which broker-dealers they'd consider affiliating (if they were to leave their current BD). The findings of the survey are presented in this article; additional content, including individual video interviews with the winners and expanded versions of the leaders' words of wisdom and warning can be found on ThinkAdvisor.com throughout the month of September.

Scenario 1: Do Independent Broker-Dealers Need to Grow?

You've become aware that another independent broker-dealer can be acquired by your firm. This other broker-dealer has a similar culture to yours, and you have always respected the leadership. This firm has also been struggling to keep its top producers. What are you going to consider before you decide whether to make a bid?

David Stringer, Prospera Financial (left): We actually went through this last year. It was not a 1099 firm; it was a W2 firm, a local firm.

The first thing we had to do was make sure it was a good fit, that they aligned with our culture. Our vision is to be the gold standard of boutique firms, and we wanted to make sure that they met that qualification.

The second thing we were looking at is, "Could we add value to them?" In our case, we thought we could. We had a little bit of work to do on the economics to shift them from a W2 environment to a 1099 environment, but the approach was, first, "Let's make sure the people are a good fit with our culture and our firm." Then we would follow with the economics. It's been a great addition to our firm.

Jamie Green, Investment Advisor: How do you define "culture?" Is it written down?

Stringer: It is. We just went through the Ritz-Carlton training process so we've defined our gold standard as we see it and our credo that we're financial professionals serving financial professionals. We're not going to be the big scale players in this age of consolidation. We're trying to stand in our spot and be an advocate for small firms.

Kevin Bachmann, Questar Capital: We would do many of the things that David was looking at. The culture: Is it the right fit? What's the rep profile? Do they fit with who we are and what markets we're in? What products do they sell? Then technology, how painful is it going to be to integrate?

Do you run it separately or do you integrate it? We'd look at clearing platforms, CRM systems, making sure that they align with our systems if we're going to integrate. What previous products were sold? What kind of due diligence was done? We want to make sure that we're not buying something that could cause us issues down the road.

Green: So it's both on a personal basis of the reps, but also how the two firms would merge. If you shared the same clearing firm, would that be a plus in terms of your interest?

Bachmann: It's a huge plus, but a lot of the firms that are being acquired, they're being left to run independently. That's an option, but I don't know if you're going to get the scale and the value—the synergies. You have to look at how the firm handles OBA [outside business activities] and what kind of services they allow. Does it align with who you are and where you're going, or are you just buying it to get head count?

Eric Schwartz, Cambridge Investment Research: This is a very secondary consideration in real life for us; we historically have grown entirely organically. It's a lot easier for us to control the quality of the advisor, the cultural fit and all the other pieces if the reps are voting to join us one at a time, or as a group of five or 10.

If you are [in acquisition mode], you've got to have the due diligence checklists. You're going to look at hard items like "Did they sell Medical Capital?"

If you're buying a larger firm, you're going to pay a high price because Nicholas Schorsch [of AR Capital], of course, and more recently LPL and now Securities America [Ladenburg Thalmann] and one or two others are in that market.

When you're buying a broker-dealer and people are paying 40% to 70% of GDC, I have a hard time justifying putting too much energy into that when you could bring in an individual rep, making sure he wants to be there.

Doug Wright, The Investment Center: [We're] very similar to the other three. What we do a little bit differently is to actually bring the senior management out and bring in all the reps. We'll have a roundtable so we all get to know each other. We'll also go through an analysis rep by rep, making sure that, like Kevin said, we're not buying something that we don't know about.

Like Eric, we also find it more valuable to recruit one or more small OSJs; the value prop is probably the best there. That's been Ralph's [DeVito, president of The Investment Center] philosophy for the last five, 10 years, but on occasion we come across deals that you have to look at.

Green: Am I right in assuming that all of you want to grow your firms in terms of revenue, in profitability, and does that require that you grow in the number of reps that you have?

Bachmann: It's a two-pronged approach. What we're trying to do is attract higher-producing advisors to our firm. Our goal would be to recruit anywhere from $20 to $25 million of new GDC to the firm. The flip side of that is to also grow our existing rep base and help them bring up their additional revenue streams primarily by teaching them new outlets to grow their practices.

Stringer: You do not have to be a scale player to win in this business. It's more about quality for us than it is quantity. I do believe that you need to grow at some level or you are dying, but that doesn't necessarily mean head count. You've got to evolve on a regular basis with this industry, so it's about increasing your technology to leverage your partnerships.

Green: Eric Schwartz, you said you grow through organic growth. Do you need to keep growing?

Schwartz: In any business, if you're not growing, you're dying, as David was saying, but [it's especially true] when an industry hits the inflection point we're in, where you have far more capacity among the players on the street than you have new advisors coming into the industry.

That wasn't true 30 years ago. Every independent broker-dealer would just sit there and grow because there was a huge influx coming into our market. Every industry goes through this. The auto industry started with 100 car makers 100 years ago and now there are three in the United States.

We're having the same thing happening. Fifteen years ago, the top five independent firms controlled 25% of the market. Last year it was 51%. If I look forward 15 years, the top five to seven firms will be 80% to 90% of the industry.

Wright: As far as growth, you have to grow. Ralph DeVito's made a commitment to grow the firm organically and externally. You have to continue to get your GDC higher and higher. We've been doing it internally by raising the revenue within the firm, but [considering] the aging rep force, we do [need] replacements.

Green: In talking about succession planning, we usually think about individual advisors, but now it's succession planning for broker-dealers as well?

Wright: It's both.

Green: Is part of [the reason recruits ask] you about the corporate succession plan because they've been in other situations where the culture has changed?

Wright: They see what's out there. They see broker-dealers either being bought or failing, especially this last round where we lost, I think, 20, 30 independents through purchasing the wrong products.

Scenario 2: Keeping Your Top Producers

One of your top-producing reps has come to you asking that an alternative investment be added to your approved list. You've considered this investment two years before, and you know your biggest competitors have it on their approved lists. However, in your due diligence two years ago, you decided it was too risky. What do you say to this top producer, who is adamant about using this investment?

Schwartz (left): In recruiting, everybody is out after the same people more or less. They want high-quality, sizable producers.

We've created a little issue where the top producers are so much in demand that it makes them that much more demanding.

First off, it's a question of, "Why do they want the product?" Sometimes they want the product because a wholesaler came in and told them a good story, and they didn't really research it, but it sounded good.

Probably 80% of the time we are able to show them, "Here's our due diligence. Here's why we didn't approve it. Here are three other products that are like it that we think have a better track record, or more financial strength or a better management team."

Presuming you're doing thorough due diligence and you have your story together, not just that you didn't approve it because the brochure was the wrong color, then hopefully your advisors value you enough and know that you've avoided Medical Capital and various other problems, that they say, "That's a good point. Okay, I'll pick one of those other ones."

I'd say that in this day and age, people having seen the ugliness that can happen when products go awry, 90% of the time the advisor will [do that.]

To the other 10%, we have to agree to disagree, but we're not going to approve it. I'll say there's an occasional exception to that because there are some products that are really complex and suitable to only certain types of people.

If we have an advisor who's dealing with 10 clients whose net worths are over $100 million, and they want a complex product that we don't think we should put out to our general advisors, we may say, "We will allow you to place it for those four clients that you have in mind who have $100 million net worth and are looking for a private equity program with a 10-year tie-up period."

Wright: I'm on the product vetting committee where we go through and analyze these products. One thing that we pride ourselves on in our compliance department is that we'll never say, "No," and not give you a reason. We'll come back to them with similar analysis and tell them why we're not approving it, and say, "Here's an alternative. This is how you get to the point that you want to get to with your clients."

Stringer: Part of our vetting process on the front end is to share our philosophy around compliance. It really is to protect our advisors and our clients.

We're a small boutique firm, but the product providers that we choose are the big scale players, so it's our job to make sure we do not allow a fraudulent product on the platform.

If somebody were to come to us, we'd share our due diligence with them, and we'd try to get a deep understanding of why it's important for them to have this product. If it is one of those special circumstances, it's really around suitability.

I would say 90-plus-percent of it is not going to happen, but if it were to be that rare occasion where someone was just adamant, we would say, "Maybe our firm is no longer a good fit for where you're taking your practice."

Bachmann: We're going to look at it again. If two years ago we didn't look at it and a top rep asked us to look at it again, absolutely. That's the relationship side of it.

If it hasn't changed, we are going to be very transparent with them about why we're not comfortable with it. You have to give them alternatives. There are plenty of products out there that are not that different.

There's still going to be cowboys who are going to put product on the shelf that won't pass our due diligence. We're just going to be straight up with them.

Danielle Andrus, Investment Advisor: When you re-evaluate an investment or make an exception for a certain client, does that ever cause tension between a top producing rep and other reps?

Schwartz: Most of the time it's an isolated case, and it's not like we make a public announcement about it. To me, I think the nature of running a broker-dealer these days is that you have to assume that anything you do could—

Stringer: —be in The Wall Street Journal, right?

Schwartz: That too. I was just saying it could be—

Green: It could be on Twitter.

Schwartz: Yeah. It could be in the hands of all of your reps.

Wright: Everybody talks.

Schwartz: If we're going to give somebody that's doing $2 million of business a higher payout than somebody else that's getting $2 million of business, we have to have a reason.

When we look at anything that we do at a broker-dealer, we're always saying, "Let us assume that every single one of our reps is going to know about it, and perhaps the Wall Street Journal as well. Are we making this [decision] at the highest level or are we making an exception just to get it out the way?

Wright: The due diligence process doesn't change if you have to vet a product for one rep or 100 reps. It's still the same risk to the firm. If you're going to do it, it should be something that you could approve for the whole firm in general.

Green: Are all top producers the same? Do they become top producers because they're just really good salespeople?

Bachmann: They're all different. They're in different markets, they're in different niches, they have different systems. They sell different products. They're wired differently. You have to be able to really be flexible.

We have to fit our broker-dealer into their practice, rather than having them fit into our broker-dealer.

Wright: They're all different, and they all have different needs. You look at our top 10, every single one's different.

Schwartz: If you looked at our top producers, if anything they are less interested in the innovative product than the smaller producer. They've been around a little longer; they know that innovation is good, but maybe the barber should shave on somebody else's face first.

They're also very successful, and they know what's tried and true. They're not needing to come up with a hot product to get new clients.

None of us are big fans of regulation, [but] to some degree, the pressure they put on us has forced us to be better people.

Scenario 3: SEC Imposes Fiduciary Standard on Reps

Following the lead of the DOL, the SEC rules that all financial advisors must adhere to the fiduciary standard mandated by the Advisers Act. The RIA custodians have made a concerted push to attract your top producers to the RIA model, offering financial incentives and marketing support. How do you respond?

Wright (pictured left, Ralph DeVito): I know [SEC Commissioner] Gallagher said some pretty interesting things about that. He said you may see some movement right before the election on it. I'm talking this fall's election, not the presidential. You see this back and forth [over fiduciary]: It's off the table, it's on the table, it's next year, the DOL may be coming out next year with it. It's all over the place.

Green: It seems like there's a fair amount of partisan bickering among the SEC commissioners.

Schwartz: It may have to do with how much bickering is going on in Congress.

Green: Eric, you already said that you asked a similar question [on whether reps feel they have a fiduciary standard] at your national conference. Just about everybody there said they already feel [they have a fiduciary standard].

Schwartz: Yes. I don't think most advisors in my world, and again, my advisors are a little more fee-oriented, a little more mature, perhaps, in their careers than maybe the average [advisor, but] it seems like most advisors, they don't go, "Oh, okay, I've got this fee client, so I'm going to be meeting a fiduciary standard with him. Over there, I've get this commission guy, I'm just going to give him a suitability thing."

The suitability rule is enforced by FINRA to be the fiduciary rule right now. When they sue you, they don't say, "Well, this wasn't suitable." They say, "It wasn't the best investment." They say, "You should have done this." In many ways, we're in a fiduciary world already. Ninety-eight percent of our advisors think they're acting in a fiduciary manner for all their clients right now.

I think the main concern of broker-dealers and of FSI is how they're going to define fiduciary and how that's going to translate to another blizzard of paperwork where people are filling out all kinds of things to show they acted in a fiduciary way.

No one's going to say, "Well, I really don't think we should take into consideration doing what's best for clients." It's a given that everybody wants to do what's best for clients. But how do you create a law and then put together paperwork that supports that, and what does it do to business procedures?

Stringer: Yes, how do you codify it? We're past all that, we've figured all that out. Now what?

Green: Now what? Or is it a question of "So what?"

Stringer: I would say that's it's probably "So what?" because I think about the services that we provide to our advisors. They look to us for some of these value-added services that are more than just processing a trade. We have a virtual sales assistant program that we offer that's outsourced services like that. Whether you're a broker-dealer or you're an IA, [advisors] are looking to outsource some of these capabilities to a firm like us. We do a lot of back office support for them.

I just spoke with Amy about HR essentials because we have an HR person who we're trying to find out how we can support our advisors using and leveraging our—

Schwartz: That's Amy Webber [president of Cambridge]. We have an HR program for our reps.

Stringer: We've got some money management programs that we're doing for our advisors, where we're taking the signals and providing some tactical money management capabilities for [our reps]. We do that whether they're an IA or with the broker-dealer. I think what they're looking for is, "Hey, can you help me run, grow and protect my practice?"

Some of these guys were going the IA [route] because they were trying to do a regulatory arbitrage. I think that the playing field will, over time, level out. Some of those guys are not going to want to deal with some of the compliance activities.

They're in this business because they want to support and help their clients achieve their financial goals. They don't want to do some of the compliance work that we do, no matter what fence they're on.

Bachmann: I totally agree: "So what?" from our perspective. Everybody treats their clients the same, as Eric said. They don't put on different hats. They do what's in the best interest of the client, whether that's a commission or that's a fee [client].

As David said, the RIA-only [advisors] were going RIA-only to get away from regulation. I think that's a bigger issue right now. I think they should focus on, "What are you going to do with these small RIAs that are out there who basically gave up their securities licenses to do that with very little regulation?" I think that's a bigger issue.

Green: In terms of the public being protected?

Bachmann: Correct. Whether fiduciary versus non fiduciary or suitability standard. I mean, really, [the issue for the SEC is to] get your arms around the independent RIA space.

Scenario 4: The Aging of the Advisor Work Force

In your year-end business review, your CMO delivered a report that showed the average age of your reps is 58 and that women account for only 7% of your reps. Moreover, your biggest producers' average age is 61, and there's only one woman on your chairman's council. You know you have to grow younger and more 'feminine,' and that poaching other BDs' top reps is only a stopgap. What do you do?

Bachmann (left): Our parent company [Questar Capital is owned by Allianz] is very actively involved in women. "Women, Power and Money" is a white paper that went out a couple of years ago. We dovetailed into that and really focused the last couple of years on building out female advisors. Growing up with six women in the house, I've got an affinity to helping that.

Half of my direct reports right now are female. I think of our new recruits, 16% this year are women. We've set up a couple other networking events specifically designed for women.

Stringer: Part of our value prop is culture, intimacy, relationship, high levels of service and core values. That seems to cross generation and gender. We've found that we have a younger advisor population and we have a fair amount of female advisors.

We've found that No. 1, the independent space is a great place for female advisors to find their work-life balance. That's a big part of what we sell in our value proposition, that work-life balance is great for females, but it's also great for males, too.

Wright: Right now, we're about 12% female advisors. That trend has been growing, and not only that, we have a number of reps who specialize in female investors, and I think that's a growing part of the population.

Green: Most people would say Wall Street is not a place that welcomes women.

Wright: That's where you have to change, and that's what we've done by providing our reps the education and a platform to get out there. They go out and talk to the women's groups. We have a number of female advisors in our office who get together and have their own little group together, and that seems to work out.

Schwartz: At Cambridge, the average age of advisors is about 51. It was actually a little higher, about 53, a couple of years ago. What we have found is that as they start doing succession planning, they quickly figure out they don't have the right people in place, so then they realize, "Oh, I better go out and hire some people."

On the female side, 16.3% of what we call active advisors are female. The number is 26% of our total advisors. Interestingly enough, I don't have the exact number, but we know it's a significant percentage of the 16% that are now active, used to be inactive; they used to be assistants.

To me, it's an enigma why it's not 50% already. You look at the number of CPAs, attorneys and doctors [who are women]—it's all around 50%. In some cases it's over 50%. Why would financial planners be different? It's a little more seen as a sales thing perhaps, so maybe women aren't as comfortable?

Bachmann: I see more spouses get into the business as well; there's a lot more husband-wife teams.

We have an initiative going where we will help sons and daughters come into the business. We're not a formal training program or anything, but we're open to having that type of arrangement where that's their succession plan.

Wright: We've seen the same thing, where we've had more husband-wife teams join us. Recently we've had a lot of daughters, which is interesting too.

Do we purposely recruit women? No. I think we recruit just advisors. We tend to have more seasoned advisors come to us, but we do see a little bit of the trend of Eric's model, where the assistants are starting to get licensed.

Bachmann: A lot of times they have the best relationships with the client. They're dealing with the client on a day-to-day basis and handling a lot of their issues.

Wright: They know the clients hands down. What they need there is just the sales training to make them successful.

Green: You mentioned doctors, the number of women there. That's one of those professions where it's often a father to a son or a daughter. I wonder if that's part of the answer; if kids see what the life is like and if it's appealing.

Stringer: I get the feeling the helping people part has not been well marketed.

Schwartz: I think you're right that the image of this industry, to some degree, is still stuck in that industry we talked about of 30, 40 years ago. Most movies about stock brokers are not about the financial planner who goes out and rakes leaves for the 90-year-old client because she was ill.

Stringer: Who gets the news? It's the bad apples. It's not the guy who's raking the leaves for the 90-year-old. There is probably a PR issue around our industry. When you talk about doctors, everybody pretty much knows that they help people. I don't know if that's the first thing that pops into people's minds about financial advisors.

Wright: I think our approval rating is under Congress.

Stringer: It's right there with politicians.

Wright: Do you think that millennials have more of an immediate need for income than just starting out in the financial business can provide them? Maybe that's one of the reasons we're not seeing them much.

Green: I don't know that there's a simple answer to that. We've written about studies that show that millennial types certainly get satisfaction from different things, and feel the rewards of working in a different way than perhaps older people.

One thing I've heard said is boomers, if they want to show you how good a job they've done, they tell you how many hours they worked, and younger people will say more about what they accomplished, and I think there's some truth in that.

Andrus: I've seen some studies about how younger people do think about the different ways their work impacts society. They want to understand how what they're doing [affects] other people.

Schwartz: What an opportunity for somebody who comes in and works for five or seven years and all of a sudden is buying a practice that's worth millions of dollars. There are not a lot of jobs you go into that give you that opportunity.

Stringer: What needs to be part of that conversation is the number of families and people you've had a positive impact on. It's not just the economics of the deal, it's that you are helping generations. You're helping people with long-term care needs. You're putting kids through college. You're helping with retirement needs. You're giving peace of mind to these families that you serve and that's the message.

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