At this time last year, Ladenburg Thalmann stood out as one of the most prominent independent broker-dealer networks and firms in a thriving sector. Fast-forward to summer 2020: Ladenburg’s new parent, private equity-backed Advisor Group, is consolidating Ladenburg’s five firms into two.
Now the combined giant IBD network, with some 11,500 advisors, looks set to usher the sector into an entirely new era — one defined by rapid expansion, nimbleness and an ongoing evolution of its business model.
The coronavirus pandemic has only sped up the dramatic shifts taking place at IBDs, which had already been rattled by substantial margin pressures and burgeoning competition from the full RIA channel.
With consolidation reshaping the industry and the coronavirus upending long-term strategies, the industry faces an existential question: What is an IBD?
The simple answer could once be summed up like this: Firms that register with FINRA as BDs and provide services to advisors who are 1099 independent contractors. But that categorization no longer reflects the breadth of IBDs as RIAs and the back office to the largest number of advisors in the industry. These firms are also now subject to major new SEC regulations and CFP Board guidelines.
Labels such as IBD, wirehouse and RIA will cease being definitive categories for this “disparate cottage industry,” as fee compression tears apart the sector’s traditional value chain, says Jamie Price, CEO of Advisor Group.
“All of those lines are getting blurred, and the pieces that really had no value are being priced that way,” he says. “We’re in a massive convergence of technology, regulation and wealth creation in this country, which is still going to continue. It’s a massive change, and a bunch of firms won’t make it.”
For example, some 1,400 advisors at three IBDs will have new affiliations at the end of the year, when ex-Ladenburg IBD Securities America will have absorbed Investacorp, Securities Service Network and KMS Financial Services. The company is betting it can adapt technology and services more quickly by merging them after the $1.3 billion deal it closed in February.
However the industry redefines itself, IBDs remain, for the present, an industry force. Advisor Group’s newly expanded network is one of nine IBDs with more than $1 billion in annual revenue (Cambridge Investment Research joined the other giants in 2019).
At $23.7 billion in combined annual revenue, the firms generate 75% of the sector’s $31.2 billion, according to Financial Planning’s 35th annual IBD Elite study. Their growth in the past decade would be the envy of any industry or sector, with combined annual revenue at the top 50 firms surging by 136% since 2007.
Total revenue across the 50 IBDs participating in this year’s survey surged by 9% in 2019 — down from 12% growth in 2018 but equal to 2017. Even factoring in the likely lower earnings across the board due to the coronavirus pandemic, the sector produces revenue comparable to the GDP of good-sized economies such as those of Estonia, Iceland or Nepal.
Still, the sector’s massive scale may obscure its vulnerabilities, including varying degrees of pressure from interest rates and equity values tied to their business models. Declines in EBITDA from the coronavirus could amount to tens of millions of dollars or more at some firms, according to ratings agencies.
The economic fallout from the coronavirus will only prompt more firms to sell to the largest players, according to Carolyn Armitage, managing director of investment bank and consultant Echelon Partners.
Going forward, small and midsize firms will be particularly vulnerable to compliance and technology expenses, which have already pushed down IBD margins to around 3% on average, Armitage says.
“The continual change of the regulatory environment and the impact of those rules are really difficult for the smaller broker-dealers to implement,” she adds. “Growth and scale are still the name of the game for independent broker-dealers being able to survive going forward.”
Rules such as the SEC’s Regulation Best Interest take a toll: The agency concluded its disclosure standards will cost BDs a combined $1.5 billion initially and $500 million a year in ongoing expenses. Regulatory compliance and building and upgrading tech platforms are costing BDs more each year, says Michael Rose, associate director of the wealth management practice at Cerulli Associates.
“Those two things are helping to drive the fixed cost of running a brokerage firm,” Rose says. “That’s been a challenge for firms, regardless of what’s happening with the COVID crisis.”
Major rule changes that became effective at the end of June help explain why: According to the IBD Elite study, at least 12,196 CFPs affiliated with firms are now abiding by a heightened fiduciary standard under the CFP Board’s new guidelines.
CFPs and other planners leading the RIA movement are reeling in advisory accounts. At the same time, IBDs are vying for advisors and clients against RIA platform providers and consolidators that have emerged as power players during the past decade.
RIAs added more than 12 million non-high-net-worth retail advisory clients between 2012 and 2017, according to SEC figures cited in Reg BI. Some BDs achieved record profits by converting brokerage accounts into fee-based services, and all found more stable revenue in their RIA accounts.
“We’re wealth management firms; that’s what we’re doing for a living,” says Cetera Financial Group CEO Adam Antoniades. “In actuality, we’re some of the biggest RIAs in the world.”
The apparent paradox revolves around the fact that the expansion of their RIAs hasn’t sustained the same amount of BDs. The number tumbled by a third between 2005 and 2018 to less than 4,000, while the count of RIAs soared by 44% to more than 13,000, the SEC notes.
The channels evolved this way from the combined impacts of regulation, consolidation, tech innovation from robo advisors and online traders, and the rise of low-cost index funds and no-fee ETFs, among other factors, according to the regulator.
It’s likely “a reflection of the market for investment advice, and potentially of the choices available to retail investors regarding how to receive or pay for such advice, the nature of the advice and the attendant conflicts of interest,” the SEC wrote in Reg BI.
The changes stemming from the package of three rules — which also include a new “customer relationship summary” document and shifts in RIA guidelines — still hinge on the results of the 2020 election and court challenges. New administrations make new rules, and the lawsuits may consign Reg BI to the same fate as the Department of Labor’s fiduciary rule in 2018.
For the time being, IBDs are navigating Reg BI and the competition. To stem threats, IBDs are adapting some RIA methods: Kestra Financial launched its own RIA M&A channel last year. Because of the shifts in business, new regulations affect the firm less, CEO James Poer says.
“We are so heavily focused on investment advisory already, and so much of our revenues and earnings are tied to a fiduciary perspective already,” Poer said in a conference panel earlier this year. “We’re a wealth management business, we’re not a broker-dealer.”
Similarly, Cambridge CEO Amy Webber sees prospects for using the robo disruption once thought to be an existential threat to the firm’s advantage. Cambridge plans to roll out digital tools for smaller and self-directed accounts with the potential to expand to full-service clients.
“Firms like ours are here to partner and allow financial professionals to leverage the pieces that they need, the expertise they need,” Webber says. “It’s a complex world where they don’t want to go it alone, but they don’t need the old model as much as they used to, by any means.”
LPL Financial, the No. 1 IBD for nearly two decades, is also flexing its scale and ability to offer multiple options to advisors. After opening a suite of wirehouse breakaway services in April, the firm planned to launch its employee advisor channel in the second quarter.
But the coronavirus is altering supply chains, corporate real estate, AI and the client experience, among other areas, CEO Dan Arnold said on the firm’s first-quarter earnings call. “In a climate like this … we believe it creates an incredible opportunity to learn and apply that learning going forward to drive real structural differences,” Arnold said.
‘Not for sale’
Even as they shift into new forms in challenging times, it’s difficult to pin IBDs down by a single definition. Their ranks span publicly traded firms including LPL, Ameriprise and Raymond James; PE-backed IBDs such as Advisor Group, Cetera, Kestra and Atria Wealth Solutions; insurer-owned firms including Northwestern Mutual, MassMutual’s IBD, Equitable Advisors and Lincoln Financial Network; and privately held firms, notably Cambridge and Commonwealth Financial Network.
One private midsize firm, United Planners Financial Services, displays a message at the top of its website stating that the firm is “adamantly not for sale.”
Another midsize IBD with private ownership, Independent Financial Group, generated $76 million in revenue in 2012 as the No. 52 firm in the space. In 2019, it produced $193.5 million as the No. 26 firm.
Niche-focused firms catering to specific groups such as the bank and credit union-based advisors, or CPAs and other tax professionals, remain fixtures as well.
Perhaps there is one way to corral the disparate elements: Focus on advisors, who are driving the long-term industry changes.
Firms with the agility, infrastructure and capital to keep up with planners and their clients will make it through the current crisis and be able to answer an even more-important question: What do advisors want IBDs to be?
An aging advisor population has provided space for the firms to evolve incrementally while sustaining less contraction than expected about five to 10 years ago, according to Echelon’s Armitage. The next generation won’t give the same leeway, she says.
“Staying with something that you know and love like a nice worn leather slipper is great; you don’t want it repaired. … That inertia has really been helpful for the broker-dealers over the past few years,” Armitage says. “It’s a tightrope for them, for sure.”