Having your own broker/dealer has its advantages. It can be very profitable. It can allow you to grow a business and hire registered representatives. It can open the door to doing your own investment banking and trading. Moreover, owning a broker/ dealer lends some cache to your name.
But more and more, broker/dealers are being named mud in the eyes of regulators. Registration hurdles, capital requirements and waves of audits make owning and operating a broker/dealer expensive, arduous and mired in red tape. Indeed, the number of broker/ dealers operating today is up just 7% from five years ago--over a period of time when the stock market has more than doubled.
Some of those seeking the benefits of a broker/dealer are becoming registered investment advisers or working as independent contractors through existing broker/dealers. The number of RIAs has increased 24% over the last five years, from 18,000 to 22,400 at year-end 1996, while the number of registered reps has gone up 23%, to 545,723 from 426,979 in 1992. Both tacks, in the search for independence, are less cumbersome than starting a broker/dealer.
"Starting a broker/dealer is significantly more involved than starting an investment advisory firm," says Warren Forest of Forest Brokerage Advisers, a broker/dealer compliance consultant in Winter Springs, Fla. "There are a lot of compliance issues" in forming and running a brokerage firm, he says.
Here are the processes of RIA and broker/dealer registration, according to Delia Stafford at Securities Consultants International in Boca Raton, Fla.:
For an RIA, you need a series 63 or 65 exam (depending on the state) and an annual registration fee of between $200 and $250 at both the state and federal level. Waiting time for adviser registration runs about 45 days.
Contrast that with setting up a broker/dealer. First, there is the set up of a legal entity--a corporation, limited liability corporation, partnership, etc. Next is filing the broker/dealer form, which lists the shareholders and directors, clearing firms and business activities the firm will undertake. Once that letter is received, an NASD pre-membership interview is set. At this point, all capital, exams (sometimes five or more securities licenses are required) and fees must be readied. This process takes about a month. From the pre-membership interview to the actual meeting with NASD district members, it takes another month. Then, an approval letter is sent out, and the firm can begin to hold itself out as a broker/ dealer. In all, the process takes between 90 and 120 days at best. In some instances, the process can take six months to a year, if certain letters are misfiled or if the filing is in a busy district like New York.
In terms of costs, there is a $250 filing fee per state (per rep); a $3,000 NASD membership fee; a fidelity bond (beginning at $500); the cost of a mandated annual audit, which could range from $2,500 to $10,000 or more; as well as the cost of mandated continuing education, which averages $50 to $60 per rep.
"It's a lot less costly and there is a lot less compliance with investment advisers," says Stafford. "We have people come in to register as a broker/dealer and walk away as an investment adviser."
The compliance, audit and monitoring process required of broker/dealers continues to grow. The NASD now requires record keeping to be "memorialized--they not only want to know that transactions are being reviewed, they also want to know how the firm is reviewing transactions--and they want it written in the procedures," Stafford says.
Abuse and manipulation of small-cap stocks have promulgated stepped up broker/dealer supervision and audits. Of the 5,599 broker/dealers in the nation, some 1,200 enforcement actions were taken against those firms or their representatives last year, up 12% from 1995 and an all-time high.
"One reason there are so many RIAs is that it's a very simple process to register," says Carolyn Taylor, a former money manager at Neuberger & Berman in New York City who set up her own shop, Weatherly Asset Management in Del Mar, Calif. She says she looked into setting herself up as a broker/dealer but didn't see the need for it.
"It is much more involved. It depends on what you are trying to create," Taylor says.
Taylor's fee-based business didn't need the broker/dealer structure. Currently, Taylor uses between six and eight outside broker/dealers for electronic trading, research and best execution. "I considered the broker/dealer structure, but my business wasn't focused on commissions," she says.
For an average producer or group of producers who may do a mix of fee- and commission-based business, setting up shop as a branch of an independent contractor firm probably makes more sense than setting up a broker/ dealer firm.
"If you are a $150,000 to $200,000 a year producer, we would tell you that the costs and the time aren't worth it," says Stafford. "Most people who set up their own broker/dealer are big producers who have strategies and a plan in mind of exactly where they are going."
