Indie B/Ds Face New Barriers to Profitability

It seems like a day doesn’t go by without hearing about another independent broker/dealer blowing up, merging, or getting bought out by a bigger fish. Consolidation is the name of the game these days in the IBD channel; I asked Jeffrey Spears, co-founder and CEO of Sanctuary Wealth Services, what’s driving this and whether firms are going to have to eventually cut their advisors’ 90-some percent payout in order to stay profitable in this environment.

Spears doesn’t see how IBDs manage to make it work with such high payout; they’ve got to have significant scale to make it work. Sanctuary just recently completed research on advisor compensation.

Spears is not new to the broker/dealer space; he calls himself a “reformed Wall Street guy.” He started out as a retail stockbroker at Smith Barney in 1987, and ended up as head of the private client group for Montgomery Securities. He knows a thing or two about how the b/d business has changed. Here’s what IBDs are now up against:

  1. The net interest margin is gone. When Spears ran Montgomery, net interest was 30 percent of profitability. Now, as a result of the low interest rate environment, net interest margins are close to zero, he said.
  2. Decimalization happened. In 2001, the SEC converted the stock system to decimalization, meaning stock trading quotes were presented in decimal form, rather than fractions. So before, an over-the-counter stock would trade at $31 ⅛ by $31 ¼, and that one-eighth difference in price would be kept by the broker/dealer. Decimalization lead to tighter spreads.
  3. Commission rates. Broker/dealers used to charge 10-15 cents a share, and that was acceptable to the client. You didn’t have the Internet, and you didn’t have it in your face that you could get something at no commission. “Now, you’d be lucky to get five cents. It’s brutal,” Spears said.

Just two years ago, you could look in the back of an industry publication and find six pages full of IBD lists, Spears said. Now, they fill up just a quarter of a page because many have closed up shop.

TAGS: Industry
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