What’s Next (For IBD Recruiting)?What’s Next (For IBD Recruiting)?

Halah Touryalai

If you're an independent b/d rep, you may own your business, but not the lifeblood of that business: your clients. At least, that is the conclusion that can be drawn from an “initial decision” filed in June by a Houston-based administrative law judge. According to Judge James T. Kelly, reps affiliated with independent broker/dealers are just like employee reps at wirehouses, where the b/d bears the ultimate responsibility for the clients' well being. After all, the judge reasons, federal securities laws recognize no distinction between independent contractor brokerage firms and wirehouses. In fact, the term “independent contractor” doesn't even appear in the Securities Exchange Act of 1934, the regulatory code for broker/dealers. (That's partly because independent contractor reps are a relatively new phenomenon.)

But this new regulatory reality could turn independent brokerages' recruiting processes — with their attendant “transition teams” — upside down. Administrative law judges typically rule in disputes between a government agency and the affected party, and this decision rose from an SEC action against Next Financial in February, when the agency said the firm was violating client privacy rules with its recruiting practices. The judge basically supported the SEC's initial findings, and ruled that Next had indeed violated industry privacy policies — Regulation S-P — that require the explicit consent of a client before his information is offered to a third party (in this case, the Next transition team).

And so, Next's problem has become an industrywide problem. After all, the violations Next committed are common practice in the independent b/d business. Apparently, somewhere along the line, there was a big communication disconnect between regulators and the industry. “The SEC has long taken the position that regardless of independent contracts, for the purpose of securities laws, every rep is an employee and should be regulated that way,” says Brian Hamburger of Hamburger Law Firm, and founder and managing director of MarketCounsel, a regulatory and compliance consulting firm. “The SEC will not make a distinction between wirehouse and independent reps.”

This conflict of interpretation between the industry and the regulators first came to light during a routine audit of Houston-based Next. (For a profile of Next, see the July 2008 issue of Registered Rep. at registeredrep.com.) At that time, the firm was accepting client information from incoming reps and using it to fill new account and account transfer forms before the reps officially joined the firm — without explicit client consent. According to the judge, Next recruits were provided with sample Excel spreadsheets they could complete with information about current customers. These spreadsheets included over a dozen items to be filled in, including the customer's name, brokerage account numbers, social security numbers, account types, net worth, annual income, years of investment income, passport numbers, driver's license numbers and occupations. Sensitive stuff, naturally. The information was then emailed to Next's transition team so that it could create new account forms for the prospective new clients.

Back in February, the SEC told the firm that this process violated customer privacy rules under Regulation S-P. Administrative law Judge James T. Kelly backed the SEC up. In his June 18 decision, Kelly ordered Next to cease and desist from using these recruiting practices and to pay a $125,000 civil penalty. (The SEC was originally shooting for a penalty of $325,000, but the judge reduced it since there was no evidence of harm to customers, prior violations or “unjust enrichment.”)

THE AMENDMENT

The case has sparked an industrywide debate over the intent of Regulation S-P. What are clients really being protected from? Critics of the SEC's position on client privacy say keeping independent reps from taking client information with them makes it harder for those clients to follow an advisor to his new firm without disrupting their accounts. Not only that, but it vastly reduces the value of running an independent b/d business if the advisors aren't able to own the client relationship.

To give independent b/ds a little bit more wiggle room, and make transition from one firm to another easier on clients, the SEC proposed an amendment to Regulation S-P in March that would allow departing reps to take not just the client's name and contact information with them to a new firm, but also to provide the new firm with general descriptions of accounts and products held by those clients. But the general opinion from independent b/ds and their reps is that this is not enough. They want reps to have more control over client information to smooth the account transfers — it's in the interest of the client, they argue.

In its comment letter to the SEC, the Financial Services Institute (FSI), the independent b/d industry's lobbying group, said the proposed changes will “create significant burdens for independent broker/dealer firms.” Dave Bellaire, general counsel at the FSI, says the amendment as it stands impedes clients' ability to follow a trusted advisor from one firm to another. “We hope the SEC will consider our comments. The proposal leaves the control of client information in the hands of a b/d rather than requiring them to facilitate investor choice. We need clear guidance. There are too many questions without answers right now.”

The response from wirehouses is very different. Wachtell, Lipton, Rosen and Katz, a New York-based law firm, responded to the SEC's proposed amendment on behalf of Citigroup, Merrill Lynch, Wachovia Securities and Morgan Stanley — firms that employ over 60,000 reps. He says the wirehouse firms strongly support the SEC's proposal. That's no real surprise since they are self-selected members of a “client-information” pact whose rules resemble what the SEC has proposed. The protocol, as it's referred to, was developed in 2004, and 54 b/ds and RIAs have since signed on to it. Essentially, the protocol governs the transmission of limited customer information — client name, number, address, email and account title — when a broker leaves one signatory firm to go to another. Signatory firms agree not to fire off temporary restraining orders (TROs) against departing reps as long as these rules are met.

In the meantime, the SEC is reviewing nearly 100 comments from respondents on both sides of the issue. John Heine, an SEC spokesperson, says that when this process is complete, the staff will either propose a final version of Reg S-P, or hold off and ask for yet more comments from the public. “The timing of the final proposal is hard to estimate. It's based on how many comments they've received, how long they are and how complex the issue is,” Heine says. And while Judge Kelly's 55-page decision against Next Financial only addresses that one firm's practices, rather than the industry at large, Heine adds that the SEC may include his decision in the final proposal.

MAKING IT WORK … FOR NOW.

Final guidance on Regulation S-P and what it will inevitably mean for reps who switch firms is likely far off, but of course there are advisors who have switched (and are continuing to switch) firms during this debate. What exactly are they doing? Well, for the most part, independent b/ds are no longer accepting detailed client information from new incoming reps. Several independent firms say they will only accept basic client information until the advisor has joined — a setback for transition firms that previously hyped their quick and efficient sign-on process. “The Next case has definitely changed the transition process and the way b/ds interact with recruits. Now, account transfer forms (ACATs) can only include public information about the clients,” says Jodie Papike, a vice president of Cross-Search in Jamul, Calif., an independent recruiting firm that helps match advisors with b/ds.

One way independent firms are getting in compliance with the privacy rules as they stand is by adjusting their client privacy policies. Firms are letting clients know that their advisors are permitted to take information with them when they jump to another b/d — a policy from which investors can opt out.

Still, if Regulation S-P is complied with literally, then independent reps should have zero possession of non-public personal client information when switching firms. That's right. All those filing cabinets and hard drives full of “your” clients' information should probably be disposed of, or handed over to the old b/d if you leave for a new firm. Reps can then contact clients once they're at the new firm and get consent to access their information.

Papike says while the new transition process of collecting only public information for ACATs is not doing too much harm at this point, it may keep some reps from making a move. “It's one more hurdle to transition now. But for motivated advisors, the change won't affect them. For those advisors on the fence about switching, it could put off their plans because the new b/d can't assist with the transition as much as it used to,” she says.

ASSET ACES/ The investing public loves indies. Assets grew at an annual average rate of 14 percent from 1995 through 2007, according to Tiburon Strategic Advisors. Only RIA assets grew faster.

Robert W. Dineen, president & CEO

Lincoln Financial Network
2005 Market Street,
Philadelphia, Pa.
19103
www.joinlfn.com
866.536.6630

Number of back-office employees: 1,047

Number of advisors: 7,293

Total client assets under management: Lincoln Financial Advisors Corp., $7.477 billion; Lincoln Financial Securities Corp., $1.297 billion

Advisors' average length of service: 10 years (with LFN)

Total revenue full year 2007: $826 million

Revenue from commissions: Firm declined to answer.

Revenue from fees: Firm declined to answer.

Average AUM per advisor: $30.1 million*

Average payout per advisor: 65%-92%

Average annualized production per advisor: $120,000

Number of dually registered reps: 2,544

*(for those advisors who participate in managed money programs)

Registered Rep.: What do you think makes Lincoln Financial Network b/ds different from other b/ds?

Robert W. Dineen: I don't think anybody else in the industry offers as much flexibility and choice in how advisors affiliate with their b/ds as we do. [The four affiliation models are: fully independent registered reps with Lincoln Financial Securities Corp.; fee-based planning advisors with Lincoln Financial Advisors Corp.; and, for the life insurance specialists, there are General Agents and Agency-Building General Agents.] We also have close to 100 technical professionals who are on our payroll, ranging from attorneys to CPAs to CFAs, who are there to specifically help reps.

RR: What is the best technology investment your firm has made?

RB: We've made a lot of investments in technology. Our Income Positioning System is a new retirement planning software tool that is in pilot with more than 160 of our advisors right now, and will be rolled out broadly across all of LFN at the end of this year. It is probably the most comprehensive retirement income-planning tool in the industry. We also have a separate business unit at Lincoln, Retirement Income Securities Ventures (RISV) group. We built out this unit two years ago as a firm, and spent significant sums of money on it because the largest opportunity advisors have in the last 50 years is the transition by the baby boomers into retirement.

RR: Your recruiting goals through 2008 and beyond?

RB: I was fortunate to have Chris Flint come over, and he has built out our entire national recruiting program — and done a spectacular job. He has a very achievable goal: To have 10,000 quality advisors by 2010. — Christina Mucciolo

Scott Romine, president & CEO

National Planning Corporation
401 Wilshire Blvd., Suite 1100,
Santa Monica, Calif., 90401
www.natplan.com
800.881.7174

Number of back-office employees: 162

Number of advisors: 1,387

Total client assets under management: $6.7 billion

Advisors' average length of service: NPC does not track this number

Total revenue year to date: $237.4 million

Revenue from commissions: $181.4 million

Revenue from fees: $40.6 million

Average AUM per advisor: $6.1 million (advisory only)

Average payout per advisor: 90-95% (80-85% for individual securities)

Average annualized production per advisor: $177,261

Number of dually registered reps: 86 reps are registered with an outside RIA

Registered Rep.: How is National Planning Corp. (NPC) truly different from other independent broker/dealers?

Scott Romine: Technology has always been one of our core strengths: We were one of the pioneers of the paperless office. Electronic Order Entry, the web-based advisor workstation, and e-signatures are the hallmarks of NPC and the National Planning Holding Network. Most recently we rolled out a new function that allows advisors to enter mutual fund orders electronically. They no longer have to deal with mailing; the orders get settled the same day and advisors get paid faster.

RR: How would you describe the relationship between advisors and management at NPC?

SR: We reach out to our advisors on a regular basis to find out what's working for them and what's not. As president of NPC, I come from the sales side. I've been an advisor — it's what I know and what I relate to. It's important to me that our advisors are involved. We have a president's advisory council made up of advisors who have tremendous influence in the field and provide business acumen. We meet with them at least quarterly to get their feedback.

RR: Insurance owned b/ds sometimes get ripped on for being unprofitable distribution channels for the parent company. How do you respond to that?

SR: There are two things I get asked by reps in recruiting: What kind of pressure is there from the parent company to sell their products? Are you profitable? First, there is zero proprietary sales pressure. This is an independent firm; we do not operate in a captive environment. And yes, we are profitable. Jackson National Life Insurance Company holds me accountable for top-line sales growth, but also bottom line profitability. I would make different decisions if I didn't have to worry about the bottom-line profitability. — Halah Touryalai

Frank A. Tauches, Jr., President

American Portfolios Financial Services, Inc.
4250 Veterans Memorial Highway
Holbrook, N.Y. 11741
www.americanportfolios.com
631.439.4600

Number of back-office employees: 56

Number of advisors: 480

Total client assets under management: $11 billion

Advisors' average length of service: 18

Total revenue year to date: $36 million

Revenue from commissions: $26 million

Revenue from fees: $7.5 million

Average AUM per advisor: $23 million

Average payout per advisor: 85%

Average annualized production per advisor: $145,000

Number of dually registered reps: 225

Registered Rep.: What makes you different from other independent b/ds? What really makes you stand out? What do you tell recruits?

Frank Tauches: We truly are an independent broker/dealer. American Portfolios is owned by its registered representatives, managers, employees and individual investors. When a broker/dealer is owned by a bank or an insurance company, how can it be independent? Many firms claim to be “rep-oriented” or “rep-centric,” but I think our record of very low attrition speaks for itself. We have had a Rep/Manager Advisory Board in place for several years now that has provided significant input. Our founder and CEO Lon Dolber still serves his customers accounts — and still supervises financial advisors.

RR: I understand your firm believes strongly in outsourcing. Why, and how do you think that gives your b/d an edge?

FT: American Portfolios has spent a great deal of capital and effort developing its own technology. Our STARS system, for example, provides for our new account processing, transaction blottering, business processing and correspondence approval. We outsource what we feel should be outsourced — and only if it's compatible with our existing systems. We first outsourced data aggregation and remediation to Albridge and commission processing to Extiva. We have worked extensively with Albridge in enhancing the products they provide us.

RR: You are also a big believer in technology. Is there any new technology that will be essential to the b/d business?

FT: The technology that we are focusing on now is that which directly supports the financial advisors, the managers and our firm in its supervisory responsibilities. DST Vision, Annuity Intelligence and Lipper Horizon are good examples. All are outsourced, as is Actimize, which we are working with for our internal surveillance. — Nancy N. DiCostanzo