Yield of Dreams

Dropouts: Mom and Pops Aren’t Making It

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So far this year, more “mom-and-pop” broker/dealers are dropping out of the business compared to this time last year, according to new data from the Compliance Department Inc. I got on the phone today with Director of Business Development David Alsup, who said the little guys are dropping out because their trade volumes are taking a dive, and they can’t meet the minimum requirements to stay in business.

According to Alsup’s research, 11 firms that have clearing arrangements went out of business in April of this year, much higher than normal. Alsup said he typically sees about three to four firms going out per month.

But Alsup believes it’s more significant to look at several months of data. If we look at the trend over the first four months of 2012, we find that 53 firms closed up shop, compared to only 25 firms that went out during the first four months of 2011. The firms that have dropped out in the last couple months have indeed been smaller firms, ranging anywhere from two to 75 advisors, Alsup said.

So why are so many more smaller firms dropping out this year? Alsup believes these smaller firms cannot afford to stay in business because of today’s need for scale. In this environment, broker/dealers need scale to keep up with compliance requirements, technology enhancements, and the competition. Meanwhile, those that have scale—the larger players—are getting larger, Alsup said, a trend discussed in greater detail in our February Independent Broker/Dealer Report Card. Alsup also believes more firms are dropping out this year because regulatory requirements are more burdensome.  

On top of all those pressures, FINRA firms will now likely face higher fees, so the regulatory can make up for lost revenue. In an April letter to member firms, FINRA chairman and CEO Rick Ketchum said, “The broader economic downturn continues to affect trading volumes and industry revenues, which in turn has led to a decrease in FINRA’s revenues and resulted in a significant loss for fiscal year 2011.” This will likely result in increased user-based fees, branch office and membership application fees, and trading activity fees, he said.  

The numbers here don’t lie, but I question whether broker/dealers are facing more hardships and pressures this year. After all, it was this time last year that firms started dropping like flies after being hit with large arbitrations and lawsuits related to troubled private placements, including Medical Capital and Provident Royalties. This is what Securities America, which was sold to Ladenburg Thalmann, fell victim to.

But maybe that was just the beginning. It could be that many of the firms that sold these troubled investments were able to hang on and pay out these settlements initially, only to find later down the line that they were only kidding themselves. These things take time.

Either way, it doesn’t look good for these mom-and-pop shops so far this year. It’ll be interesting to see how the six-month figures trend.

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Casting a gimlet-eye on asset management issues.

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