Some independent b/ds have already benefitted from the damage done to the reputations of wirehouses in the credit crunch by gaining assets and advisors. But not all independent b/ds (IBDs) are riding high on the hog; many of the smaller fish in the business are stumbling in this market.

In fact, small IBDs (loosely defined by industry experts as firms with less than $150 million in client assets) are facing a number of damaging crosscurrents: On top of increases in costs—both compliance and overhead—they are now experiencing revenue losses and margin erosion coupled with scarce credit. Those without a capital-rich corporate parent, or a capital cushion of their own, may need to sell out, or risk going under. “Over the next 12 to 18 months, if we see this market continue, you are going to see an awful lot of firms trying to find a partner that can take them out of the mess they are in,” says Larry Papike, president and owner of Cross-Search, a Jamul, Calif.-based recruiting firm.

Margins were already slim at small IBDs. With average payouts to independent reps of 90 percent of revenue generated, some independent b/ds are left with a paltry 3 percent to 4 percent pre-tax profit margin, says Papike. And today, most brokerage’s assets are down somewhere between 40 percent and 60 percent, he says, further pinching profits—if not wiping them out.

Take Hanson McClain of Sacramento, California, a small, independent b/d run by Scott Hanson and his partner Pat McClain. After 14 years at Omaha, Nebraska IBD SecuritiesAmerica, Hanson and McClain left in January to start the new firm, and today they have 10 salaried CFPs and $900 million in assets under management. While Hanson McClain has much better margins at 35 percent than your traditional small IBD, the challenges they face are similar. Hanson says he and McClain set out on their own because they wanted greater control and independence. But today he’s having second thoughts. “If you asked me today if I would do it again, I would tell you ‘no.’ Really, you’re trading one set of compliance and regulatory procedures for another.”

Like many IBDs, Hanson says his firm not only faces the challenges of hiring and retaining staff, but a 20 percent to 40 percent decline in assets, as well as reduced revenue and an increased client workload. As a result, Hanson says they have had to cut costs and even make some staff reductions. “We had some money we were going to spend on growth initiatives and we said we can’t do that right now,” Hanson says.

Meanwhile, compliance is one thing on which small IBDs (who are required to register with the SEC and FINRA) cannot cut corners, and as the number of rules on regulators books has grown in recent years, compliance has gotten more expensive. It doesn’t help that down markets often mean increased arbitrations. “Skimping on compliance has a lot of implications for fairly small operations because if they have a couple of rogue reps the firm can be brought down,” says Cerulli analyst Bing Waldert.

Falling profits and rising costs have already pushed some small b/ds into the arms of bigger players this year—and in 2007. For example, in August, Securities America agreed to acquire Brecek & Young Advisors, an independent broker/dealer based in Folsom, Calif., with some 300 reps and $1.3 billion in assets under management. And Ladenberg Thalmann recently agreed to acquire two independent b/ds: In the fall of 2007, it struck a deal to buy Investacorp of Miami with 500 reps and $8.5 billion in assets under management; in the summer of 2008, it agreed to acquire Triad Advisors of Norcross, Georgia with its 380 advisors and $9 billion in assets under management. After fourth quarter losses are tallied, there may be more of these pairings to come.

For now, there is just a lot of talk. “I’ve seen a lot of people talking, and a lot of chatter, but very few deals getting done,” says Joel Marks, vice chairman and COO of Advanced Equities, parent of San Diego-based IBD First Allied Securities. Marks points out that many of the firms have yet to feel the squeeze of Q4 results, 2008 audits and arbitration rulings, not to mention few of the bigger firms have the economic luxury to contemplate deals right now—for deals to get done you need buyers, not just sellers. While First Allied recently closed on a deal to buy the assets from Red Bank, N.J., First Montauk Financial Corp., Marks says the firm is not pursuing an acquisitions strategy. Still, he says, “At the Financial Services Institute’s b/d conference in January there will be a lot of talking going on.”

Whether that talk will develop into something more remains to be seen. But large IBDs might find themselves loathe to pass on potential discounts they could get in this market to acquire smaller troubled shops. In the meantime, it’s all hands on deck for small IBDs and their reps.