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Behind the Numbers

Every year, when the independent broker-dealer rankings come out, first in Financial Advisor and Investment News, then in Financial Planning and Investment Advisor, the highlight is on which firms bring in the most revenues and have the most affiliated advisors. The emphasis is always on size, and sometimes the article mentions growth rates.

These rankings don't tell us anything about quality–the quality of service, of due diligence in selecting investments, of compliance that would protect advisors and customers rather than the rear ends of the company itself, the integrity of the firm's operating principles, the ability to process trades, orders and requests with a low error rate or, really, anything that a real-world advisor would want to know about a company he or she was thinking about affiliating with. When the discussion DOES come around to quality, we hear the senior executives at the broker-dealers telling us what a great job they do, and how important that is to their culture. There is no visible effort to check out those claims.

Yes, Investment Advisor magazine surveys registered reps, and asks them to vote on the "best" broker-dealers. But the BDs routinely ask their reps to cast votes in these surveys as a matter of loyalty, and most of the voters have no way of comparing the quality of their custodial experience with any of the other competing firms. At most, they might have worked with one or two competitors.

So what do we learn from these annual data-gathering exercises? As the Financial Planning and Investment Advisor surveys come out, we will get a picture of how quickly different firms are expanding their total numbers of reps and gaining revenues and market share. Sometimes, if the magazines are feeling especially courageous, they will publish revenues vs. total dollars paid out to reps, which tells you the actual payout percentages, as opposed to the vague estimates typically given out by the firms themselves.

I would also look at the average "production" per rep, which lets you compare, in a rough way, how much the advisors at different firms are making, on average, which might tell you something about how efficient they are able to be with their custodial/back-office partner. This may also tell you something about the BD's practice management consulting and technology services–but it might simply tell you that the BD is only recruiting larger advisory teams.

Certainly, you should look at the growth numbers, and pay particular attention to firms who are taking in less gross revenues this year than last year, and, at the other end, firms that are experiencing extraordinary–and perhaps dangerous–increases in their field forces.

I would also invite you to notice the firms whose numbers are suspiciously even–as in, $25,000,000 rather than $25,468,974. Some of the firms are just giving estimates off the top of their heads, while others are providing real accounting. It is surprisingly easy to tell the difference.

And finally, I would invite you to look at the mix of revenues that each firm is collecting. How much of each BD's business is coming from asset management fees, as opposed to commissions on the sale of annuities, or selling other packaged products (including the increasingly anachronistic load mutual funds)? This is interesting because, with the exception of two firms (Cambridge and Commonwealth), all the broker-dealers are generating much more sales commissions than asset-based revenues, which makes it easy to see why the Financial Services Institute has been such a stubborn opponent of a strict fiduciary standard. The BD world tells the press that it follows a "fee-based" model, but the balance of revenues still falls heavily on the sales side.

Beyond that, there are things you won't see. It would be interesting to see total revenues next to total expenses, and be able to calculate the margins of the broker-dealer business, individually and in aggregate. (Rumor has it that broker-dealers operate on 1% margins, but this may be an urban legend created to discourage reps from asking for higher payouts.) You won't see any of the BDs share their actual compliance costs year-to-year, even though every survey includes a lot of complaining that this is a crushing burden that is only getting worse. (What IS the compliance share of total operating expenses? Is it going up or down?)

Finally, you will never see how many reps were cut loose by a BD, and the precise production threshold that these washout advisors failed to meet. This takes the whole exercise back full-circle; if advisors don't make their numbers, regardless of the quality of their service to their clients, they're invited to look for a new home. On the other side, if they're generating huge production numbers, even if most of the revenue comes from selling questionable products, they're a hero, a top producer, the focus of recruiting efforts. Just like the BD rankings themselves, size matters–and, alas, sometimes it seems as if it's all that matters.