Not the Boss of Me

Last May, Paul Sikorski earned his degree from the School of Intestinal Fortitude when he and his two partners opened their own broker/dealer for business. The road to graduation was an arduous one, comprising a year of document gathering and filing by Sikorski and his partners, and a six-month wait as the NASD considered their application. It was a difficult experience, says Sikorski, who is now

Last May, Paul Sikorski earned his degree from the School of Intestinal Fortitude when he and his two partners opened their own broker/dealer for business. The road to graduation was an arduous one, comprising a year of document gathering and filing by Sikorski and his partners, and a six-month wait as the NASD considered their application.

“It was a difficult experience,” says Sikorski, who is now chief operations officer and chief compliance officer of the b/d, Skokie, Ill.-based Prestwick Securities. And it doesn't get much easier any time soon — thanks to the start-up's administrative and technology costs, Prestwick, like many fledgling b/ds, is not expected to turn a profit for a few years.

Still, Sikorski — who says they launched the company to sell “terribly boutique-y” oil and gas investment programs, among other things — expects the ultimate rewards to be worth the effort. “We'll have control over what we sell and access to much wealthier, knowledgeable clients willing to invest at an entirely different level,” he says. “We couldn't do that before.”

Does the idea of starting your own b/d sound thoroughly loony to you? Are you thinking, “Why would anyone willingly submit to such torture?” If so, you aren't alone.

“We see more of firms trying to get rid of their own b/d and join an existing one than of the other way around,” says Phillip Palaveev, a consultant with Moss Adams, a Seattle-based accounting firm specializing in financial advisors. In addition to the application process, which involves filing a complex assortment of materials to the NASD, yearly registration fees for a b/d can total more than $20,000. Further, there are monumental compliance, technology and accounting issues to resolve before the firm can get up and running.

Still, the sheer numbers of broker/dealers — 5,339 according to NASD, or approximately one for every 100 active rep in the United States — suggests there are significant advantages for a rep who opens his own shop. In some cases, like Sikorski's, there's the possibility of making significantly more money; he hopes to more than double his revenues over the next few years.

But, in a business with such thin margins, it helps if a broker can derive secondary benefits from a go-it-alone move, such as avoiding the red tape connected to big firm compliance departments and obtaining the freedom to offer a wider array of products.

“You can create whatever you want,” says Palaveev. “You just have to pay the price.”

Home of the Brave

What, exactly, motivates most reps to take the leap? Like Sikorski, many want to sell products their old b/d won't let them offer. It's a problem that's worsening as the regulatory environment grows more hyper-sensitive with each passing day. “Everyone's afraid of liability,” says Sikorski. Often the only way to make up your own product menu is to start your own restaurant, so to speak.

Sal Caruso is a case in point. Four years ago, the New York-based rep, a former bank branch manager, wanted to add mortgages to his roster of product offerings. But his request to partner with a mortgage banker was nixed by his b/d as an unacceptable outside business activity. The incident served as the catalyst for Caruso's launch of his own b/d, Legend Securities.

At other times, reps rebel against pressures to offer products they don't feel are top-quality. One rep says his former firm pushed him and his fellow brokers to hawk variable universal life insurance policies. Later the rep says he found the company had arranged for a “15 percent kickback to the firm” on all such sales. His dismay at this arrangement led him to form his own firm.

Then, there's the matter of the red tape generated by the compliance departments at the larger broker/dealers. Caruso, for example, says his b/d's due diligence process was glacial. “If I needed to run an ad or to send a letter to a customer, it would take a month to get it okayed,” he says.

It's understood, reps say, that compliance departments loom large in today's brokerage industry. But reps who sometimes feel the need to work quickly with their clients complain that some firms are simply indecisive and are inconsistent. And, therefore, are no help in a broker getting his job done.

“Some may say, don't ever sell B shares, while others may tell you to evaluate each case for its appropriateness,” says one rep.

The consolidation of the brokerage industry is another big catalyst of go-it-alone b/ds. Five years ago, after his broker/dealer was acquired by SunAmerica, James Lorence and three friends feared that the next b/d they moved to would suffer the same fate. First, they tried to see whether their new company would consider selling the b/d to its reps. When that request was denied, the four, all of whom worked in different cities, held a pow-wow in Pittsburgh and decided to start their own rather than submit to the winds of fate. “We didn't want a surprise again,” Lorence says. Lorence's b/d, called NEXT Financial Group, now has 450 reps.

Devil in the Details

It's a long, dangerous walk from deciding to launch a b/d to actually doing so. One of the perils: you might be unfairly harassed by your old firm. One rep, for example, says his old b/d dinged his U-4 when it discovered he was striking out on his own.

Then there's the aforementioned NASD application procedure. This requires a financial statement with 12 months of income and expense projections, a business plan, a supervisory manual, a plan for your reps' continuing education, a disaster recovery plan, procedures to ensure that all transactions are deemed suitable — the list goes on and on.

“The application is probably a foot high by the time you're through,” says Marianne Czernin, senior vice president and director of broker/dealer client services for National Regulatory Services in Lakeville, Conn., which helps reps go through the application process.

Fortunately, the process can't go on forever. According to NASD rules, it has to be completed in 180 days. In 2001, the most recent figures available, 80 percent of new applications to the NASD took up to 180 days to be approved. There can be a lot of back and forth during that six months, since the NASD has 30 days to respond with what's known as a deficiency letter, asking for more information. If an application doesn't go through after 180 days, it can be denied. Making the process worse: The application can be found on the NASD Web site, but “you won't see the level of detail they want,” says Czernin. Take the matter of your proposed method for soliciting new clients. “If you say you'll do phone calling, that's not enough,” says Czernin. “They'll want to know whether you're cold calling and, if so, what your cold calling policies are.”

When a b/d application is approved, the work has only just begun. For starters, most firms must hire people to handle the compliance and operations tasks they probably took for granted at their old b/d. NEXT Financial will have a support staff of almost 30 this year. The alternative — smaller firms, such as the seven-rep Ayre Investments of Agawam, Mass. — is not much more attractive. Tim Ayre, who started the firm five years ago, says the firm's three principals wind up doing just about everything themselves, from compliance to operations management. “If there's only two or three of you, there's so much to do,” says Czernin. “You lose selling time, as a result.”

The process can be expensive. A full service b/d, like NEXT Financial, can expect to spend $1 million in technology, registration, legal advice and salaries (mainly for support staff) in the first year or two. There also are incidentals, like state registration fees, which cost $350 per firm and $50 per agent. All told, it took Lorence four years in business to turn a profit.

Smaller firms face smaller costs, but the numbers are far from nominal: Ayre, with his seven reps, spent about $80,000 on computers, telephone systems and other costs for his launch.

Compliance Complaints

The biggest hassle for go-it-aloners is keeping up with regulations. Greg Smith, president of RISE Inc. in Louisville attests to this fact. “My time spent on administrative chores has increased ten-fold since I started,” says Smith, who started his own b/d in the mid-1980s. He recalls that he and his staff recently spent three hours checking the background of clients named as foreign nationals — fallout from the U.S. Patriot Act. “Nobody pays me for that,” Smith says.

Then, there are monthly updates from the NASD and SEC to keep abreast of, plus educating reps to recognize signs of money laundering and preparing for NASD audits every year or two. In addition, there are quarterly and annual filings with the NASD, as well as a daily log-in of trades. The regulatory climate has gotten so hostile that one new b/d founder instructs his reps not to use instant messaging, because, he says, “It's a red flag for the auditors.”

For all this, though, there is good news for smaller firms: b/ds with more limited services face considerably less-stringent regulations. One b/d founder, Matthew Bishop of Bull & Bear Brokerage in Jacksonville, Fla., is a case in point. Bull & Bear deals primarily in variable products and mutual funds, and all its general securities are handled through a registered investment advisory, which makes it subject to the SEC's trading rules, which Bishop characterizes as “less onerous.” “We figured if we minimize what we do, we minimize the regulation,” says Bishop.

Another operator of a limited-service b/d reports that he officially was told to expect NASD audits every two years, but “privately, I was told it will be more like every four years.”

You Need Help

One way to make the experience of launching a b/d easier is to hire an outside service to help with the application process. Sikorksi, for example, went through National Regulatory Services; Bishop hired National Compliance Services in Ft. Lauderdale, Fla. Cost: about $8,500.

Another skids-greaser is choosing a clearinghouse that can offer your business what it needs. It's true that small b/ds, with their limited operations budgets and smaller trading volumes, face an uphill battle in getting good service from clearinghouses, but there are some that cater specifically to the little guys. Pershing, for example, through its DBS service, has a staff to help b/ds with 25 or fewer reps with such tasks as handling new accounts, doing background checks and looking out for signs of unusual activity, as well as the usual order processing tasks. It also offers reps and clients access to Web-based account services.

If this all seems like a lot of work — well, it is. Still, for many reps, starting their own b/d is the only logical course. Lorence and his co-founders, for example, wanted to start a different kind of b/d — one that involved its reps in decision-making. His firm's reps are stockholders in the company and they participate in decisions affecting the firm strategic direction. Recently, after Lorence negotiated lower ticket charges from the firm's clearinghouse, he held a conference call with reps to find out what they wanted to do with the extra money — pass the savings on to reps or plow it back into the firm. The consensus decision to use the money to build up firm reserves validated Lorence's unique approach to the business, one he could only execute in an independent b/d environment. “We didn't want to have a top-down hierarchy,” he says.

For Lorence and other b/d founders like him, this is the only way to go.

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