There's a stark choice facing many players in the rapidly consolidating independent B-D game for the foreseeable future: Grow like crazy or call it quits.
As the Dodd-Frank law continues to tighten regulatory oversight, technology tools proliferate and competitive pressures drive transaction prices down, smaller B-Ds are running for cover - or crying uncle. Several executives and experts interviewed for this, our 27th annual FP50 survey of the nation's largest independent B-Ds, think that we're headed for a world with about 10 larger firms and a smattering of statistically insignificant mom-and-pops. Think of local florists battling 1-800-Flowers, or independent bookstores scrambling in the Amazon-ian era.
In the future, "an advisor can probably find 50 or 75 people willing to hire him and, if he's content to make a very small amount of money and work very hard to serve those people, then he can make a living," says widely followed advisor Ric Edelman of Edelman Financial Services. But a small independent advisor won't be able to offer clients the technologies, products and prices of the big firms. "If he looks at it ethically, from a client perspective, he would have to admit that he is not serving clients as well as they could be served."
Edelman, whose fast-growing RIA is in Fairfax, Va., speaks from experience. He opted to "go home" earlier this year when he sold off his company's independent B-D arm, saying the business model was "severely flawed" for everyone but the giants.
"We recognized that the only way to make it sustainable would be to gross it up," says Edelman, who had just several dozen advisors on the B-D side. "You have to have hundreds and maybe thousands of advisors to do well. Between compliance and technology, and the payouts you have to make due to increased competition, the costs are crushing."
Such pressures help explain why our top three companies, LPL Financial, Ameriprise Financial Services and Raymond James Financial Services, just keep growing. LPL has been the No. 1 firm for 16 years. At No. 2, Ameriprise just started reporting numbers in 2010. Raymond James has been No. 2 or No. 3 for the past decade.
Twin Forces: Mergers and Growth
Consolidation, though, doesn't mean contraction. Despite shut downs, more than 97% of brokers who lost their jobs in the past five years found new shops after their companies were bought or when they landed new gigs at big houses with more capital, better technology and more resilience to shocks, such as large settlement charges.
This year we're profiling three different advisors who recently moved to new B-Ds by choice or by necessity, to illustrate the turbulence transforming the industry.
As fallout from the 2008 financial crisis settles, independents, once again, are posting strong growth as investors continue their return to the markets.
Industrywide gains aren't as big this year as last. In our FP50 list last year, companies reported the first substantial bounce back after taking large hits during the financial crisis. In 2009, for example, average revenue on the FP50 was a disheartening -4.5%, which signaled worse news to come. In 2010, revenue sank 14%. In 2011, the world brightened with a 13.2% jump, and the recovery continues this year at 11.9%. LPL grew its revenues this year by 14.4%, versus 23.4% last year. Ameriprise posted a comparable 14.8%, versus 22.5% last year. Raymond James racked up 15.2%, compared with 22.5% last year.
As always, there are outliers. ING Financial Partners posted the fastest growth in the Top 50 this year, at 60.8%, compared with just 8.6% last year. As a result, ING vaulted to No. 17 from No.Ã¢â‚¬â€°25. Wells Fargo Financial Advisors tumbled 17%, the largest drop in revenues on this year's list, versus a hefty 40.9% jump last year.
The Great Migrations
As the movement of advisors to larger firms fuels consolidation, advisor defections to independent B-Ds from the big brokerage houses continue to pump up growth in revenues. From 2009 to 2011, the wirehouse channel saw a net drop of 3,621 reps, compared with a net increase of 4,288 reps in the independent B-D channel, according to the Discovery Co., a data provider to the financial services industry.
"We've benefited tremendously from this great migration from the wirehouses," says LPL Chief Executive Mark Casady. Acquisitions also helped. LPL completed four of them in the past 18 months, the most since 2007. Consolidation of this sort is a common phenomenon.
"Every industry in the history of man goes through this," says Eric Schwartz, CEO of Cambridge Investment Research, No. 15. A practitioner of transcendental meditation who is known for his sage-like ruminations, Schwartz thinks indie B-Ds are 15 to 30 years behind the merging of wirehouses. By contrast, he says RIAs are about 15 years behind indie B-Ds in their own consolidation.
"When I was growing up, there were 30 or 40 Wall Street firms. Now we're down to four," Schwartz says. "It's a natural maturing process."
He notes that the Top 10 firms last year accounted for more than half of the revenues of the Top 50. From 58.16% in 2011, that number grew this year to 58.72%, or $10.9 billion out of $18.5 billion. The effect of scale is evident in the top three companies alone. As they have for years, both LPL and Ameriprise generated twice the revenues as No. 3 Raymond James.
"Our focus is on being the destination for premier advisors and not on being the biggest," says Scott Curtis, the president of Raymond James Financial Services, adding that investing in technology is another significant focus.
In physics, escape velocity refers to the speed required for any object - whether a spacecraft or a moon - to break free from the gravitational pull of a sun or another planet. Schwartz predicts that only firms with $250 million or more in current revenues will have enough escape velocity to survive the crush of consolidation.
"If you are doing 250 [million dollars] today and you can grow aggressively, then you have a chance of surviving," he says. "Still, only a modest percentage of the 250s will make it as stand-alones."
Even with $400 million in revenues last year, Cambridge itself can't rest easy. "LPL's operating margin is 11%," Schwartz points out, explaining the power of scale in reducing costs. "Even at our size, as a soon-to-be Top 10, our operating margin is still half of theirs today, so clearly we have to run hard to compete with a firm with those kinds of reserves."
That's saying something given that Cambridge pays substantially lower fixed costs than many competitors, thanks to its decision in 1992 to move from Silver Springs, Md., a suburb of Washington, D.C., to the small town of Fairfield, Iowa. The move cut the firm's operating expenses by 26%. Since it opened, Cambridge has grown at annual rates ranging from 25% to 40% yearly. If it grows only 15% in the next decade, Schwartz calculates that will be enough to jump to the Top 5 or 10 on the FP50.
"We've always been an innovator and a grower," he says. "We just need to keep on doing it."
Cambridge is unique in another way: Along with Commonwealth, it is one of just two firms in the top 20 that is still privately held and majority owned by the founders.
In keeping with Cambridge's roots, Schwartz eschews the popular techniques other large companies use to bulk up. He's determined that Cambridge should grow without acquisitions, a boost from a public offering or sale of a majority stake to a deep-pocketed investor.
Being Big, Acting Small
Organic growth could help preserve Cambridge's intimate culture, an advantage that much larger firms hope to emulate.
"I believe that what people are looking for is some of the feel that they used to have when firms were smaller," says Ameriprise's Chief Executive, Don Froude. "People who have been in the business for 30 years miss the way it used to feel. People have gone from "show me the money" to "show me the love.'"
That may sound strange coming from a behemoth like Ameriprise. But, to hear Froude talk, it sounds as if Ameriprise is striving to do two seemingly contradictory things at once: grow aggressively through acquisitions while providing its advisors with a touch of Cambridge-style attention.
It's a Fortune 500 company, "and yet we have a very collegial atmosphere," Froude says. "For example, we don't have minimum account sizes. You can handle the kinds of clients you want to focus on. For years, that was not the case." Ameriprise is structured more like a regional firm, as opposed to a national one, with a large number of field leaders throughout the country, Froude says.
"We have a very flat organization," he insists, adding that Ameriprise doesn't have any offices with 100 advisors in it. He prefers to keep office sizes closer to 25 advisors. "It puts us on a one-to-one basis with our advisors."
It's one of the reasons Froude thinks Ameriprise has been able to keep its advisor retention level at 95% in the past year. "Every firm has its own subtleties," he says. "I think this cultural aspect is very important."
Super Branches Emerge
To achieve the big-yet-small ideal, large independent B-Ds are establishing super branches, many of which are the same size as the small B-Ds closing their doors.
In fact, some smaller B-Ds are choosing to join larger firms, but retain their own offices and local cultures.
"We are looking at small B-Ds that would look to drop their B-D and become a super branch," said Securities America CEO Jim Nagengast. "We've developed some expertise in helping small B-Ds go through the 1017 shut-down process to become a super branch." (FINRA's rule 1017 governs the acquisitions of B-Ds.)
"It's spawning a B-D within a B-D," Schwartz says. One rep who joined Cambridge this year chose between the custom feel of a small B-D and one of Cambridge's super branches. "That's new," Schwartz says.
Now, he says, he has 15 of these large offices, each of which generates $10 million to $20 million in revenues annually. For the past four years, the revenues of these super branches have grown 400%, he says, powering much of the company's growth. Between 25 and 100 advisors work at each one, led by a supervisor who serves as a de-facto president of what is essentially his small company.
Years ago, these firms would have been their own B-Ds, he says. "Today, the regulatory burden is so extreme that we are seeing more of these super offices. It's got the smaller, friendlier elements of a smaller B-D, but with the financial power and all the extra bells and whistles that a larger firm like us has."
Another company cultivating "big-small" appeal is Cetera, the parent of four of the firms in the FP50. Combine the revenues of Cetera's four firms, all of which report their financials separately, and Cetera would be in the Top10, surpassing Commonwealth Financial Network and AXA Advisors.
Six networks, including Cetera, can be found on our Networks Table on page 90. None consolidates revenues across all the indie B-Ds, but if any did, Cetera would be sixth, after Advisor Group, which owns three firms on the FP50: Royal Alliance (No. 12), FSC Securities (No. 21) and SagePoint (No.24). MetLife would be No.4, with its four large indie B-Ds. And Prudential's network of National Planning Holdings, SII Investments, Invest Financial and Investment Centers of America would be No. 7. Lastly, Ladenburg Thalmann Financial Services would be No. 9 with its three B-Ds (including its recent acquisition, Securities America). Securian Financial Group would be in the Top 15 with its two.
Clearly, these phantom giants value differentiation over the bragging rights afforded by size.
"The culture that you join matters a lot," says Cetera's Chief Executive Valerie Brown. "We don't think all cultures fit all advisors out there."
When it comes to picking a new B-D, Edelman recommends that advisors go beyond the numbers and spend time with that B-D's upper management to understand the company culture. "It's like picking a college to attend," he says.
With that in mind, Cetera offers four campuses. PrimeVest advisors reside mainly in banks and credit unions, "a very specific culture," Brown says. Financial Network is "team-oriented," with more than 30 regions, each with its own support and training capabilities. Multi-Financial is a B-D RIA that attracts advisors from smaller offices, and who prefer to keep a direct connection to the home office. Genworth Financial Investment Services, which Cetera acquired earlier this year, comprises advisors with tax and accounting practices.
To maintain each culture, Cetera organizes four separate annual meetings, in lieu of a massive, company-wide confab that, Brown believes, would alienate advisors in each group. "There's really a sense of belonging that matters," she says.
Protection Against Storms
The power of belonging to a big partner can't be underestimated. As the recent downturn showed, many firms without deep pockets didn't make it. We profile advisor Kirby McDonald in Omaha, Neb., who describes how one B-D tanked because of large settlements resulting from the sale of private placements in Medical Capital Corp. and DBSI Inc. Federal regulators accused Medical Capital of cheating investors. DBSI, a complex web of affiliated firms, was run as a Ponzi scheme, according to a court-appointed trustee. The company filed for bankruptcy protection and is being liquidated. About 50 B-Ds, large and small, closed after selling investments that regulators said violated securities laws.
The seventh largest company on the FP50, Securities America, was lucky. It, too, sold investors shares in both Medical Capital, and Provident Royalties, which also was accused by the SEC of violating securities laws.
Securities America's settlements to investors totaled $150 million. Because the advisory firm was owned by deep-pocketed parent company Ameriprise at the time, Securities America was able to pay the bill and survive. The payout's size, though, prompted Ameriprise to sell the company to Ladenburg Thalmann.
Securities America's Nagengast, an 18-year company veteran, says the firm has used these experiences to strengthen its due diligence policies and procedures.
Larger firms unscathed by these scandals have used their clean records to attract both individuals and smaller B-Ds. "We have been very diligent about looking at product," says Cetera's Brown, who takes pains to emphasize that she can't predict which investments might sour in the future. "We did not have DBSI on our shelf. We did not have Med Cap."
Indeed, Cetera's record was one factor that helped persuade McDonald to move to the Cetera company, Multi-Financial.
Fees Trump Commissions
The slow-but-steady industry shift to fee revenue from commission revenue, especially among top companies, is another trend that could help B-Ds weather volatile markets.
Although commission income remains substantially higher for most firms this year, the rates of growth are greater on the fee side. In the Top 10 firms, the growth in fees outpaces growth from commissions by double digits. Raymond James, for example, grew its fee business 24.2% versus 7.6% for its commissions. And the eighth-largest firm, Northwestern Mutual, grew fee revenue by 33.9% versus 3.7% for its commission business.
The revenue from fees could dwarf that of commissions in as few as five years. "With that said, there are still a lot of products that it makes more sense to offer in a commission base, especially for the middle market," Brown says.
This year's FP50 shows that Commonwealth Financial Network of Waltham, Mass., had the highest percentage of fee revenue, at 58.9%. Cambridge is a close second, with 57.5%, followed by Geneos Wealth Management of Centennial, Colo., at 55%.
Ameriprise's Froude thinks the evolution to fees is only natural and that more advisors will begin charging by the hour. The holistic approach that advisors bring to the table will rise in importance, he says. Clients will pay much more for advisors with 30 years of experience versus five years.
"The fees are determined by the advisor's experience and the complexity of the situation and what someone's hourly rate is compared to others," Froude says. "You are dealing with peoples' lives here."
Advisors have conversations with clients that absolutely no one else in their lives will take the time or trouble to initiate with them, he says. "Advisors who do a good job provide an incredible amount of value to their clients' lives and their families [in ways] that might not even be felt for multiple generations," he says.
In Froude's view, this role should be compensated increasingly through fees as opposed to commissions, which will require a shift in perspective. "We get so fixated on the management of the asset," Froude says, "rather than the overall care of the client."
The Democracy of Planning
The proliferation of technological tools and the switch to fee-based planning is ushering in a new era in financial planning, one in which independent B-Ds will be better positioned than ever to serve their clients.
LPL's Casady began his career in 1982 serving ultra-high-net-worth clients with $100 million or more in investable assets at Northern Trust Bank. Back then, he used mainframe computers to deploy complex planning tools. The cost of that planning lay far beyond the reach of even the mass-affluent.
Now, advisors access the same capabilities on desktop computers for clients with increasingly modest assets to invest, he says. "Today, we are really witnessing the democratization of financial planning and advice giving," Casady says, adding that LPL is migrating its advisors' capabilities to the cloud. "I think that this democratization is critical to the success of America."
Casady and others at LPL worry that there still aren't enough companies providing sound objective advice.
"If we are not there, then no one will do it," he says. "We are in a golden age of making that happen." FP
Ann Marsh is a senior editor and the West Coast bureau chief of Financial Planning.
Nebraska Advisor Chooses His Next B-D in One Week Flat
For many years, Kirby McDonald felt he was in good hands with his independent B-D, QA3 Financial. Well-known entrepreneur Steve Wild had launched the firm. McDonald, through his company Illuminate Financial Group, was QA3's first draft in 1999. The two companies were a few miles from each other in Omaha, Neb.
Fast-forward to February 2011. McDonald and his partner were in talks with their landlord to double the size of their office space as part of a planned expansion. In the midst of negotiations, Wild emailed to say that QA3 was declaring bankruptcy and closing because of high settlements it owed to disgruntled investors after QA3 had sold them private placements later deemed fraudulent.
McDonald says he had been reasonably happy with his B-D. Switching to a new one posed a major challenge that McDonald would have preferred to handle over six months, maybe a year. "We didn't have that luxury," he says. Instead, "We gave ourselves a self-imposed [deadline of] one week."
McDonald and his partner, Scott Cavey, put the lease negotiation - and much of the business - on hold. They needed to find a new B-D, and fast. McDonald, Cavey and their colleague, Laura Giesselmann, drew up a list of questions and concerns that they sent to 25 prospective independent B-Ds and waited to hear back. They eliminated several prospective partners based on the responses and their own research.
They didn't want to partner with insurance companies that seemed to be doing B-D spin-offs. They eliminated other B-Ds because of concerns about their financial health. And they wanted one that was large enough to handle big and bad stuff.
QA3 was one of dozens of independent B-Ds with due diligence departments that had cleared private investments in Medical Capital Holdings and DBSI Inc. for their advisors. Federal regulators accused Medical Capital of defrauding investors. DBSI, which declared bankruptcy, was run as a Ponzi scheme, according to a court-appointed trustee.
In a week, McDonald and his colleagues chose a B-D far from Omaha. Multi-Financial Securities in Denver is owned by Cetera Financial Group in El Segundo, Calif.
"We were really looking for a B-D that understands the complexity of running a branch and are set up for that," McDonald says. "They are supporting our ability to grow our own company."
Multi-Financial's technology platform, including its integrated reporting and planning tools, proved to be a key lure. Another tool, Connect2Client, is helping Illuminate build and maintain steady marketing and communication channels to its clients.
Looking back, McDonald says that being compelled to choose a new B-D yielded helpful dividends.
"The people we were with before were wonderful people, but they didn't necessarily have many resources available to them," he says. "The tools [that Multi-Financial] is providing to us are substantially superior. It's the economies of scale."
More Diversity for LPL's Former Top Producer
Sometimes growing to scale means exiting the indie B-D space entirely. Top advisor and advisor coach Ron Carson took that route last year.
Carson, LPL Financial's No. 1 advisor by revenues and assets for 21 years, left the firm's corporate RIA last year to establish his own RIA at his long-standing firm, Carson Wealth Management Group, in Omaha, Neb.
Carson retains a custodian relationship with LPL on the 2% of his business that is brokerage based. His firm generated $12 million in revenues last year.
"I would not recommend that [most] people set up their own RIA," Carson says. "But because of the nature and size of our business, it made sense to set up our own compliance department. As you get to more sophisticated planning and requests, you really want to be more nimble."
Carson says his wealth management firm has grown roughly 26% a year since its start. By making this change, and deploying new proprietary technological tools, he hopes to grow somewhere between 40% and 100% in the next decade.
"It will involve us becoming a super RIA," he says.
When he left LPL, Carson was widely quoted as saying he was unhappy with LPL's technology platform. In an interview last month, Carson says he has attracted wealthier clients and needed to let high-net-worth investors keep their assets with many custodians, from Schwab to TD Ameritrade to LPL. Many high-net-worth investors insist on this precaution in the wake of the Bernie Madoff scandal.
Carson also runs the well-known advisor coaching firm Peak Advisor Alliance, which claims to have worked with 20% of the top 100 independent financial advisors in the country at some point in their careers. After forming his own RIA, Carson teamed up with five other RIA firms in April to form aRIA, the Alliance for RIAs, a group providing leadership on growth through mergers and acquisitions in the independent advisory space. Collectively, the members manage $18 billion in client assets.
"My coaching clients tell me they have a great relationship with LPL, Commonwealth, Cetera and Cambridge. They get tremendous support," Carson says. LPL has been "a great partner and helped me grow over the years," he adds.
But, he thinks greater independence will get him to the next level.
"I've got to be B-D agnostic," Carson says. "It makes me a better advisor because I have more tools."
BIG BANK PRESSURES PUSH ADVISOR TO INDEPENDENCE
David Lowe should have listened to his college buddies.
Two of them have been advisors with Ameriprise for 20 years and repeatedly urged Lowe to join them at their independent B-D. Instead, Lowe left UBS in 2006 to work with a better-known brand, Merrill Lynch.
"If you would have told me six years ago that Merrill Lynch would have been on the verge of going under, and that, at the last hour, in September of 2008, it would be absorbed by Bank of America, I wouldn't have believed it," says Lowe, who co-owns his own firm in Miamisburg, Ohio, near Dayton. "I wanted to have that big brokerage name behind me. Little did I know that name would come back and bite me on the heinie."
He knew he wasn't going to like working for a bank because he didn't like it the first time around. After college, Lowe started his career at PaineWebber, which UBS acquired in 2000. Soon, UBS required Lowe to sell products to his clients.
After Bank of America became Bank of America Merrill Lynch in 2008, it was back to the future for a dismayed Lowe. Among other indignities, he says the bank insisted he send his account holders with $100,000 or more to a call center, which contacted them directly to pitch products.
Lowe and his partner, Adam Pfaff, could barely wait to jump ship after their contract with Merrill ended last year. Their firm - Lowe Pfaff & Associates - began moving to Ameriprise in March. Two months later they had lost only two clients and had transferred more than 90% of their assets. While the final accounts trickle in, they have added another $3 million to $4 million in AUM to their $100 million total as clients give them new accounts to consolidate.
Lowe says he chose Ameriprise not just because of his friends' recommendations, but because the firm uses a platform similar to the one at Merrill. He also has access to 99% of the funds he used at Merrill, only now he buys Class A shares instead of institutional shares. Yes, there will be added expenses now that he is running his own business, such as rent and an assistant. But he is keeping roughly 90% of his revenues, versus 40% with Merrill. Even after the costs of doing business, he expects to take home 70% - a big increase he might have enjoyed years earlier if he had made the move when his friends first started bugging him about it.
"I really couldn't get away from Merrill soon enough," Lowe says. "I coulda, woulda, shoulda done it back in 2006."