Alive and Well in the Small B-D World

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Small Broker-Dealer Market Shrinking”, “The Latest Casualty in the Small B-D Closing Streak”, “Small Broker-Dealers face Pressure to Merge”… Given these recent headlines, one would think that the B-D landscape resembles the foreboding ashen wasteland portrayed in Cormac McCarthy’s apocalyptic best-seller, The Road. As the CEO of a San Diego-based boutique B-D, I am here to tell you that we are alive and well, thankyouverymuch. And by “we” I don’t just mean Financial Advisers of America. In fact, there are scores of small to mid-size B-Ds that are not just surviving, but thriving.

That is not to say we are exempt from well-publicized challenges – costs are rising, the regulatory environment is growing more complex and burdensome. But these challenges are no different than the political gridlock in Washington or the complexity of the tax code – they are neither new nor unexpected. For savvy B-Ds with experienced leadership , managing these issues is built into the business plan from the outset. To borrow a quote from Darwin’s The Origin of Species, “It is not the strongest of the species that survives, not the most intelligent, but the one most responsive to change.” For those B-Ds that are programmed for adaptability, the changes that are taking place, not just in the B-D space but also in the wirehouse environment, create extraordinary opportunities for asset and revenue growth.

With respect to what is happening in the small to mid-size B-D space, the spate of firm failures and closings is more akin to a healthy culling of the herd than to an extinction event. Survival of the fittest, as it was. There is no doubt that many B-Ds should not have existed in the first place. Over the past decade, many individual reps and small adviser groups who were refugees from the wirehouse world have been drawn by the allure of total independence to set up their own B-Ds, only to realize that the time commitment, capital, and regulatory experience and knowledge doomed the micro B-D model to failure. Similarly, the industry news is peppered these days with stories of B-Ds of all sizes that have failed because the temptation of easy revenue from the sale of high commission, illiquid alternative investments was just too great to resist. It should come as no great surprise that lax or, in some cases, non-existent due diligence, has led to client lawsuits that have sunk these firms. For the well-managed B-D, these problems are largely avoidable with common sense, discipline, and ethics. One of our top adviser affiliates has a very simple saying on his office wall – “Don’t do dumb things with people’s money.” Words to live by, yes?

On the other end of the spectrum, it is hard to imagine that life at the wirehouses – either for the reps or the firms themselves – is all that rosy. One of our adviser affiliates who joined us last year noted that all three of his prior B-Ds prohibited him from speaking with the media out of fear that he would say something that might harm their brands, but, despite their spending millions of dollars on television advertising, sports sponsorships and stadium naming rights, the brand names of all of these firms have been relegated to the B-D graveyard while his brand name is still going strong. My impression is that life as a wirehouse rep is increasingly oppressive and that net payouts have been falling while pressure to produce is constantly being ratcheted up. Over the past several weeks, I have heard a number of comments from brokerage execs at the few remaining wirehouses proclaiming that there is no discernable exodus of reps to the independent B-Ds. Although the wirehouses’ threat of litigation is the Sword of Damocles that undoubtedly helps prevent some reps from jumping ship, it is our view and experience that the “firm-first” wirehouse service model will continue to go the way of the dinosaurs, while the more adviser- and client-centric independent firms will, in due time, inherit the Earth.

For the successful small to mid-size B-Ds, defections from the wirehouses and displacements caused by independent B-D closures, obviously creates opportunities, but they also present challenges. First, while the pool of prospective recruits is expanding, firms like ours must be careful in their hiring decisions. Many reps from the failed B-D ranks carry baggage that can wreak havoc on your balance sheet faster than you can say “arbitration settlement”. On the other side, many wirehouse reps have a limited understanding of the differences between the retail wirehouse brokerage environment, where they functioned as employees, and the more entrepreneurial independent firm environment. To put it bluntly, prima donnas – even high producing ones – can ruin the chemistry of a B-D. At FAA, we are always looking for successful, down-to-earth reps who understand that a good partnership is based upon trust and respect and must be beneficial to both parties. Of course our competitors – at least the smart ones – are seeking these folks too, and, though the applicant pool has swelled a bit recently, the best advisers will always be in short supply and high demand.

Another challenge that firms like ours face is how to manage growth over time. One of the truly wonderful things about our firm is that my husband (and co-founder of FAA), Ken, and I know all 200 of our affiliated advisers personally and we regard many of them as family. A primary benefit of the small to mid-size B-Ds will always be that they are absent of the layers of corporate bureaucracy and impersonal compliance culture that inevitably invade larger firms. Our reps know all of our home office staff, and communications are generally friendly and familial. Although I know that many of the largest independent B-Ds still try to cling to their small firm origins, speaking for FAA at least, I don’t think it would be possible to retain our culture if we had 1,000 FAs. For our benefit and the benefit of our affiliated adviser partners who have placed their trust in us, a better course is to grow slowly and selectively, and to remain vigilant and adaptable.

In closing, my point in sharing all of this is to advise the financial adviser community at large that reports of the death of the small to mid-size B-D world are greatly exaggerated. While we are very proud of FAA’s ability to grow and prosper in these times, we are by no means alone in this regard. The small to mid-size B-D market is alive and well, and, although my opinion is biased, I believe it offers the best balance of freedom and resources for successful independent minded advisers.

Jodi Johnston is the CEO of Financial Advisers of America, a FINRA member B-D and RIA based in Carlsbad, CA with offices in California, Hawaii and Arizona, and partners across the United States.

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