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The Future of our Industry - Where do you fit?

Let’s take a closer look into our changing industry to, not only look at the trends, but to pinpoint exactly where you make the perfect fit.  To do so, we need to consider the following:

  • What is happening in the independent broker dealer space and where is it going?
  • Private Equity firms have taken over
  • Insurance owned broker-dealers
  • Small-sized broker-dealer
  • Boutique and Specialized broker-dealers
  • Privately held broker-dealers

After considering in detail all of the above, just what does the future hold and where will you fit in?  Let us break it down and sort things out below.

What is happening in the independent broker-dealer space and where is it going?

All of us have been focused on the COVID pandemic, the economy and the presidential election in 2020.  We have tried to make sense of it all and certainly want to take the right steps to protect our families as well as our businesses.  Through all the confusion, if not deception, the distraction seems to steer us away from major changes occurring within our own industry.  A wave of consolidation among independent broker-dealers has been overlooked and continues to build momentum. 

After almost 20 years in the financial services industry, I have observed trends that affect all of us in the industry and offer the relevance below as confirmation, as well as my opinion on where the future of our industry is heading.  Please understand what I pen below in this white paper is strictly my opinion of the future of the independent broker-dealer space, however, it is based on historical data.

Private Equity Firms Have Taken Over

If you look around at the independent broker-dealer space the vast majority of broker-dealers are owned by private equity.  I am not going to say that private equity ownership is bad for the firm, their advisors and clients, you just have to fully understand the purpose of a private equity firm.  The purpose of a private equity firm and its investors is to purchase a broker-dealer and make as much money as possible within a 3, 5, 7-year period.  Money can be made through distribution of products, (not as typical anymore) or by flipping the broker-dealer for a profit.  In order to flip a broker-dealer profitably, in most cases it involves cutting costs and increasing revenues. 

The cost cutting portion can be tricky, because how does a PE firm do this without negatively impacting advisors and their clients?  One way is by consolidating entities within their portfolio and streamlining their operations.  If the firm has purchased multiple broker-dealers, they see that it makes sense to consolidate those operations through merging technologies.  They eliminate duplicate roles (jobs) within the organization as a whole.  This is certainly unpopular. 

The increasing profit portion is mainly accomplished through recruiting, which involves writing larger transition checks.  Now, you may ask, “how does writing larger transition checks help down the road?”  The way transition loans are structured, they are time based.  Let us say you write a $1 million transition check based on a 5-year note.  Only $200,000 of that loan is shown as a liability on the books for that particular year.  From an accounting perspective, the look from perspective buyers of the firm is all positive.

When your broker-dealer is owned by private equity, the majority will have some negative impact from a cost, service, or platform aspect to you or your clients.  I am not saying that private equity is a bad thing, but as a financial advisor, you need to realize that a PE firms’ strategy is not to buy and hold.  The firm will have new ownership within a 5-7 year period and the uncertainty of changes that will take place when new ownership comes in should definitely be a factor.  I think it is worth noting that one particular broker-dealer, Kestra has done a great job when changing PE ownership.  They have kept leadership, culture, pricing, and payout relatively the same.  If you look at other PE owned firms and their changes, pricing and/or payouts have adjusted and service has deteriorated.  Again, I am not in any way saying that being with a PE owned firm is a bad thing.  Just know what you are getting into. 

Insurance Owned Broker-Dealers

When I first came into the industry in the early 2000’s you had several broker-dealers owned by large insurance companies.  Pacific Life, ING, AIG, Hartford and many other insurance companies were in the independent broker-dealer space, seeing an avenue for the distribution of their insurance products.  However, over the last 10-15 years, these insurance companies exited the independent broker-dealer space for two reasons.  First, either the distribution of their insurance products was unsuccessful, or second, the regulatory environment prevented them from distributing their insurance products as they had hoped.  There are a handful of insurance owned broker-dealers that continue to operate in the independent broker-dealer space and will likely continue for a period of time, but it will be interesting to see how much more that number dwindles given the above. 

Small Sized Broker-Dealers

Going back to when I first arrived in the industry, many advisors wanted the ability to partner with a broker-dealer to feel like they were a part of something bigger.  Advisors wanted to feel valued by their broker-dealer.  They wanted communication with and access to executive leadership and they wanted to feel a part of that synergy.  In my opinion, that stance has changed drastically, given the consolidating marketplace we have seen over the last 5-10 years. 

Advisors now want the same feeling of being a valued client of their broker-dealer, but also want the financial stability shown in the scale of a large broker-dealer presence.  If we look at the consolidation that has occurred, there have been 1000’s of broker-dealers that have withdrawn their FINRA registration as a broker-dealer.  Why?  One large regulatory complaint or other large issue will likely put them out of business.  In addition, with the continued rise in regulatory costs in the industry, there is an increased demand for technology.  Technology and the costs associated with it, plus the need to continue to recruit has made it difficult to remain relevant.  In my opinion, this is why we will see fewer and fewer small broker-dealers survive the next decade in the independent broker-dealer space. 

It is important to look at the structure of a small broker-dealer.  Some, like United Planners’ are structured as a limited partnership, which allows those advisors the advantage of having input in whether the broker-dealer is sold.  This is a huge positive for advisors.  It is also important, when looking at small broker-dealers, to understand their financial strength and whether they can withstand declining interest rates and/or a regulatory event should one occur.

Boutique and Specialized Broker-Dealers

Boutique and specialized broker-dealers were once highly sought after for advisors that had a craft or specialty.  Examples might include a CPA focused broker-dealer, a broker-dealer focusing on alternative investments or a faith-based broker-dealer.  These advisors felt that being with a broker-dealer having the same focus would make them much more successful, and in many cases that was correct.  However, with the changes in the landscape among the independent broker-dealer space, I personally do not see the need to be with a specialized broker-dealer, given the continued consolidation in the industry.  Most of these broker-dealers charged more from a payout or affiliation cost perspective, because of the niche they served.  In my opinion, the ability for those particular broker-dealers to grow is now much more limited, which will impact the long-term ability to remain relevant and profitable.  Many of the larger independent broker-dealers have developed sub-sectors that specialize in these areas.  They give you the ability to continue to serve the niche in which you have, but give you the financial stability of a larger broker-dealer.

Privately Held Broker-Dealers

While there is not much to discuss in the area of privately held broker-dealers, simply because there are very few left in the independent broker-dealer space, it is a topic that should be mentioned.  Since the consolidation of broker-dealers have occurred, there are very few privately held broker-dealers in the space.  I believe there are only a handful of privately held broker-dealers left and many of them are large enough to compete into the foreseeable future.  When looking at broker-dealers that are privately held, it is important to look at the ownership structure as well as the age of ownership.  If the broker-dealer is owned by a sole person, what is the succession plan should something happen to that owner?  Looking at their financials and levels of debt a privately held broker-dealer has is vital.  What is their compliance history?  Lastly, what is the growth strategy and investment plan of the broker-dealer?  Will these plans allow them to continue to make a privately held broker-dealer remain relevant in the space? 

With all that said, what does the future hold?

Understanding all of the above, are you left asking yourself, “what does the future hold for the independent broker-dealers remaining?”  I strongly believe that consolidation will continue over the next 5-10 years, especially with all that has happened in 2020.  With the rising debt among many broker-dealers coupled with their descending credit ratings, lack of growth and interest rates declines, many broker-dealers will be forced to resistantly close their doors.  In my opinion, there are only going to be few (when I say few, I mean 20-40) relevant broker-dealers left in the next 10-20-30 years. 

Firms such as LPL will continue to be the 300-pound gorilla of the industry and maintain their strong growth initiative through recruiting, providing additional services and improving technology investments.  I believe firms like Reverence that just purchased the Ladenburg Thalmann network of broker-dealers are going to go public and attempt to compete with firms like LPL.  On a side note, with that particular network of firms, if you look at history, I cannot see them flipping the broker-dealers to another private equity firm for a profit.   Why?  First is the price that they paid for the broker-dealer network and, second is they have begun offering stock options.  This means that they will likely go public.  While many may disagree, if they go public, I see them attempting to compete with the likes of an LPL by continuing to consolidate the broker-dealers within the network and transitioning to a self-clearing model.

I strongly believe that many of the smaller and specialized broker-dealers will continue to be swallowed up because they cannot keep up with the regulatory costs, technology enhancements and be competitive enough to recruit at a high-level. 

Where does that leave you as a financial advisor?

After reading this white paper you are likely thinking, “where does that leave me as a financial advisor that is worried about my practice and the livelihood of my clients?”  That is a great question!  Let’s address that now.

Having been in the industry for nearly 20-years and our firm, collectively having 50-years’ experience specific to the independent broker-dealer space, I strongly suggest that you always at minimum have a Plan B in place.  I also believe it is important to understand the financial stability of your broker-dealer and their vision for the long-term sustainability of the firm.  Having spent the majority of my career in the corporate world, I am going to say what many of you likely do not want to hear.  Getting a straight answer from the broker-dealer leadership is unlikely to happen.  While I don’t believe most of them have ill intent, they also cannot and are not going to tell you “yes, Mr. Advisor we are actively looking to be sold, or yes Mr. Advisor we are going to make dramatic changes that negatively impact your practice and/or your clients.” 

So where does that leave you?  I strongly suggest speaking to unbiased subject matter experts such as 3rd party recruiters or consultants.  Ask them the hard questions!  They are able to be transparent with you and give you their honest opinion, because they do not face the repercussions of being in corporate America.

I thank you for reading this white paper and truly hope that you have found the information beneficial to you, your practice, and your clients.  Should you want to have a one-on-one confidential consultation to discuss your practice and our opinion of the longevity of your firm in the independent broker-dealer space, we welcome a call or email from you at (346) 703-3070 or info@trustedvisions.com.