Shrink. The Big. Registered. By Diana Britton ELECTRONICALLY REPRINTED FROM FEBRUARY Photo: istockphoto.com/posteriori

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1 Registered Top 50 IBD Women Advisors p. 27 / IBD Report Card p. 40 / Selling Out p. 65 R February 2012 ELECTRONICALLY REPRINTED FROM FEBRUARY 2012 Got Social Media Spins? Got Social Media Spins? Help is on the way in Help is on the way in A Penton Media Publication $10 US $15 CANADA $20 INTERNATIONAL The Big Shrink In our second Independent Broker/Dealer Report Card, we examine the grades advisors gave their firms, and offer a look at one major trend that will shape the indie landscape in the next few years: consolidation. By Diana Britton Photo: istockphoto.com/posteriori

2 Despite a tough market environment and a squeeze on profit margins, plenty of IBDs large and small are doing an excellent job of keeping their financial advisors happy, Registered Rep. s 2012 Independent Broker/Dealer Report Card shows. Just look at the grades the firms at the top took home. (See page 3, The Grades are In. ) But analysts and executives predict the landscape is going to change dramatically in the next three years as the buying and selling of firms accelerates was a busy year for deal-making and offered a taste of what is to come. A number of major independent broker/ dealers got hitched, which meant a lot of upheaval for financial advisors. FAs need to examine their career aspirations and prepare for a potentially turbulent future, analysts say. First, a look at the coming shakeout. Dealmaking has been ongoing in the brokerage industry, but it really got rolling last year. To name a few of the major transactions, Ameriprise Financial sold off Securities America to Ladenburg Thalmann; Wells Fargo made a deal to sell H.D. Vest Financial Services to Parthenon Capital Partners, a private equity firm; Lovell Minnick Partners acquired First Allied from Advanced Equities; Pacific West Securities closed down and moved its reps over to Multi-Financial; and Allied Beacon Partners made a recruiting deal to absorb Workman Securities reps. So far, 2012 has started off with a bang, with Cetera Financial s acquisition of Genworth s broker/dealer, LPL Financial s purchase of Fortigent, and Raymond James buying Morgan Keegan, a regional firm. In fact, if you look at the list of 20 firms that responded to Registered Rep. s survey, 40 percent of these firms or their parent companies were bought, acquired another firm, or experienced a change of ownership last year. Industry analysts, M&A consultants and broker/dealer executives say M&A activity in the IBD space will pick up even more this year and continue for the next three to five years, at which point the number of acquisition targets will have dwindled. In the end, the larger players will get larger, the mid-sized firms will thin out, and a handful of smaller firms will continue to grow organically, they predict, leaving the industry in a barbell shape. David Alsup, director of business development for The Compliance Department Inc., foresees the b/d universe shrinking from 4,555 firms today to 4,000 by 2015, with the majority of the buying and selling happening among IBDs. Some of that will come from firms exiting the business altogether at a net rate of about 16 per month though Alsup says this rate will slow toward the end of the five-year period. Already, the number of firms in the business has declined to 88 percent of 2005 levels while the number of reps in the business has only dropped by 3.11 percent. He says this is just further proof that the large firms are swallowing some of these disappearing firms, while some of the orphan advisors may be heading to the smaller firms. Srini Venkateswaran, partner in Booz & Company s wealth and asset management practice, also says the consolidation trend will continue for the next three to five years, with, on average, a transaction every working day for the next year, including divestitures, acquisitions, demise of a firm, or some form of ownership change. And Chip Roame, managing partner with Tiburon Strategic Advisors, agrees that consolidation will accelerate in 2012 and continue for the next three to five years. He predicts we ll see over 50 deals of all sizes in the IBD space in 2012, and he expects 10 of the top 30 firms to sell. Buyers and Sellers Firms that are known to be on the acquisition trail include LPL Financial, Raymond James, AIG Advisor Group, Ladenburg Thalmann, and some insurance firms, such as Metlife. Analysts also say there are several private equity firms looking to put capital to work in the IBD space, including Lovell Minnick, Parthenon and Lightyear Capital, which owns Cetera.

3 The only barrier to more deals is the absence of targets, says Philip Palaveev, president of Fusion Advisor Network. Firms with a lot of fee business are in demand, says Aite Group s Alois Pirker. Another potential source of acquisition targets could be insurance-owned independent broker/dealers, says Palaveev. Many of the insurance companies that bought the b/ds six to 10 years ago now want to wash their hands of them because it s more difficult to distribute proprietary product and the profit margins just haven t lived up to what they expected going into the deals, says Roame. Some divestitures have already happened. Pacific Life sold its b/ds to LPL; ING sold its b/ds to Lightyear; and most recently, Genworth sold off its b/d. Scott Smith, senior analyst with Cerulli Associates, says the consolidation will be more like a slow trickle than a sea change. I think it ll start building because you re not going to see 50 of these entrepreneurs who own IBDs do it overnight. Margin Pressure So why are independent b/ds jumping into bed together? First of all, IBD margins are incredibly slim and getting slimmer, The Grades Are In Advisors from 20 independent broker/dealers ranked their firms for our survey. Here s how it turned out. Overall Rating* Sigma Financial Corp. Commonwealth Financial Network VSR Financial Services Raymond James Financial Services Inc. Cambridge Investment Research Inc. Investors Capital Corp. Securities America Inc. SagePoint Financial Inc. Multi-Financial Securities Corp. Woodbury Financial Services Inc SII Investments Ameriprise Financial Service Inc. INVEST Financial LPL Financial Corp. First Allied Securities Inc. FSC Securities Corp. Transamerica Financial Advisors Inc. Wells Fargo Advisors Financial Network Royal Alliance Associates Inc MML Investors Services LLC *Firms are scored on a scale of 1-10, 10 being the highest. VSR Financial Services: You Don t Have to Be LPL General: Location: Overland Park, Kan. CEO: J. Michael Stanfield Top recruiting executive: James Blosser Website URL: IBD only or Hybrid: Hybrid Custodians: First Clearing, Pershing Survey: Number of respondents: 112 Overall rating: 9.5 Quick back-office support can make a big difference in the life of a financial advisor. VSR Financial Services seems to have the routine down. Advisor Evelio Valdez was working on the computer at his office in Tampa, Fla. recently when an error message flashed on the monitor. A few minutes later, his telephone rang it was tech support at the home office in Overland Park, Kan. Was his computer program OK? the caller wanted to know. That s impressive, Valdez says. Impressive is how many brokers seem to feel about VSR (the acronym stands for Value Service Reliability ), judging from responses to Registered Rep. s Independent Broker/Dealer Report Card survey. The firm placed third out of 20 brokerages for overall experience, and exceeded the average rating in nearly every category measured. Founded in 1985 and privately owned, VSR has just 278 advisors with average AUM of $12.5 million. The ranks Financials: Total AUM: $10 billion Net revenue Q1-Q3: $76.2 million Net income Q1-Q3: $1.48 million Excess net capital: $2 million Staffing and Productivity: Number of client-facing FAs: 278 Number of client-facing FAs five years ago: 250 Average annualized production per advisor: $330,000 Average AUM per advisor: $12.5 million haven t grown much in the past five years, and the company is OK with that, says Co-President and Corporate Counsel Jon Stanfield, son of CEO and co-founder J. Michael Stanfield; a smaller stable of advisors is easier to serve, although he says his firm could handle 350 someday. The IBD sees itself as a niche player, Stanfield says. You don t have to be LPL. You have to provide a good alternative to them, he says. VSR will know who you are when you call, and you ll never have to tell us your rep number because we ll know your rep number when you pick up the phone. VSR has managed to increase revenues by 15 percent annually over the last 10 years, Stanfield says. The firm does business in 50 states. Advisors have a minimum production level of $150,000 a year, and VSR prefers to bring on people with at least five years of experience. Jerry Gleeson

4 squeezed as they are by shrinking revenues and rising costs. Jim Nagengast, CEO of Securities America, says revenues are struggling under the weight of competitive pricing and low interest rates. Low interest rates put pressure on cash spreads, a large part of IBD industry revenues, he adds. Low rates also make CDs, money market funds and short-term Treasuries unattractive for retail investors, other sources of revenue for many IBDs, says Darlene DeRemer, partner in New York investment bank Grail Partners. Anemic mutual fund trading volumes and slow proprietary trading are also to blame for revenue weakness, she says. And then there s cost. According to Palaveev, IBD expenses typically take about a 10 to 15 percent bite out of revenues. With competitive payouts to brokers at about 90 percent or more of revenues, there s a pretty narrow wedge for profit. On top of that, you have rising technology and compliance expenses. It s extremely challenging to be a small broker-dealer today, says Larry Roth, president and CEO of Advisor Group. To succeed for the long-term, you must be financially strong and well-capitalized. You have to be able to make large investments in technology, compliance, and other services, all while offering a flexible platform to advisors. The changing regulatory environment is expected to put further pressure on b/ds because of the higher compliance costs associated with a raft of new rules, including Dodd-Frank reform, cost-basis requirements, FINRA Rule 2111 governing suitability, new 401(k) fee disclosure rules, and new fiduciary standard regulations. Many smaller firms simply won t be able to afford the additional spending for compliance supervision and staff, says Jonathan Henschen, president of recruiting firm Henschen & Associates in St. Croix, Minn. The demand for high-end technology is also driving consolidation, says Venkateswaran. You have to think that the bigger firms have deeper pockets and can take on bigger capital expenditures in technology, and that s a big deal these days, Venkateswaran says. Venkateswaran says deals are being done at a fairly good price for buyers because of all of the challenges facing small firms. If you have some kind of distinct asset or capability, such as Genworth with its tax and accounting professionals, you can command a premium, he says. DeRemer says the valuation really depends on a firm s product mix and the buyer s ability to retain reps. Career Moves In this new world order, advisors are going to have to rethink their career strategies, say analysts. Larger firms may have greater resources and better technology, but an advisor is more likely to get lost in the crowd. At a smaller firm, there s a better chance of being heard but greater risk that the firm could run aground or get picked up Fee Shift On average, advisors expect asset-based fees to account for 55.4 percent of their business in three years, up from 44.1 percent now. Percentage of income now 0.6% 1.1% 1.7% 3.8% 44.1% 48.7% Expected percentage of income in 3 yrs. 0.9% 1.6% 3% 2.7% 36.4% 55.4% Commissions Asset-based fees Fees for financial plans Hourly fees Annual or retainer fees Salary by an acquirer. Either way, reps will have to think about what resources they really need to run their practice successfully and choose accordingly. While there are many small firms that are struggling to stay afloat, there is room for small firms that are nimble, focused, or have some niche market, says Pirker. Some producers simply aren t happy at a larger firm, he says. Henschen says he works with many small firms that are doing just fine. They ve got their overhead in check; they re tight on compliance; and they have better relationships with their reps because of the family-like culture of the firm. Movin on Up Across all categories, the indies scored slightly higher than they did in last year s survey, although this year s survey included more firms. Firms product offerings, management and sales and service support took top grades again, while compensation and benefits and technology got the lowest scores again. Average for All Companies* Product offerings B/d's management Sales and service support Compliance support 8.8 Professional development opportunities 8.5 Compensation and benefits Technology *Ratings are on a scale of 1-10, 10 being the best. Each firm is equally weighted.

5 Reps may also want to be careful about relying too heavily on their b/ds since ownership could change, and often. This is where reps will have to use their management skills and be careful of what they keep in-house and what they outsource to the b/d. I think advisors sometimes have a tendency to think of broker/dealers almost like these mountains in the landscape; they re always going to be there, Palaveev says. They re not mountains. They erode; they build up; they change. Show Me the Money While assets managed and revenues (production) generated by financial advisors at independent broker/dealers tend to skew lower than at wirehouses, the indies managed to get their numbers up from a year ago despite volatile markets. Annual Gross Production Under $100, % $100,000 to $249, % $250,000 to $499, % $500,000 to $999, % $1,000,000 to $1,999,999 $2,000,000 or more 6.3% 2.2% Mean: $427,076 Under $25 million $25 million to $49.9 million $50 million to $99.9 million $100 million to $149.9 million 0% 5% 10% 15% 20% 25% 30% 7.3% AUM 0% 5% 10% 15% 20% 25% 30% 35% How does that compare to a year ago? 25.4% Broker Report Card: Rankings and Results $150 million or more 6.9% Mean: $52 million Increased by 50% or more Increased by 25% to 49% Increased by 10% to 24% Increased by 1% to 9% 3.6% 5.3% 5.8% Remained the same 3.5% Decreased by 1% to 9% 4.4% Decreased by 10% to 24% 2.5% 3.9% Decreased by 25% to 49% 0.9% 1.7% 1% Decreased by 50% or more 0.8% 12.9% 0% 5% 10% 15% 20% 25% 30% 35% Where numbers do not add up to 100 percent, the gaps represent respondents who left their answers blank. 14% 21% 23.1% 21.3% 23.3% Registered Rep. s survey saw high satisfaction rates at both ends of the spectrum small and large. The top-ranked firm, for example, was Sigma Financial, which had 650 FAs as of June 2011; VSR Financial Services, number three on the list, has 278 reps. But some larger firms took top spots as well, including Commonwealth Financial Network, Raymond James Financial Services, and Cambridge Investment Research. The 300-pound gorilla, LPL Financial, Production 33.5% 29.5% 34.5% AUM which boasts 12,799 reps, however, ranked 14 on the list with an overall score of. The second annual survey was fielded in December 2011 and early January 2012, and yielded 4,271 responses. This time around, we partnered with Cerulli Associates to conduct the research. In our coverage of the survey, we only used data from firms that had 50 or more advisor respondents. The b/ds we chose to profile are among the top performing firms, and we feel they have a good story to tell. We chose not to profile Sigma, Commonwealth, and Cambridge, which ranked first, second and fourth, because we already profiled them in the first annual survey last year. Ann Arbor, Mich.-based Sigma Financial took the top spot again this year, with an overall rating of 9.8 out of 10. Commonwealth, which tied with Sigma last year for first place, came in just a hair behind Sigma with an overall rating of 9.7. VSR Financial Services ranked third with an overall satisfaction rating of 9.5. Raymond James Financial Services moved up a couple spots this year to fourth place, while Cambridge dropped from fourth to fifth on the list. The firm that registered the biggest jump was SagePoint Financial, whose rating climbed to 9.1 from 8.2 in last year s survey. Sigma scored particularly high on sales and service support, receiving a 10 out of 10 for its helpful home-office support staff. Reps also like Sigma s timely payout of commissions and fees

6 and the ability to choose a mix of commission and fee business, which both received 10s. Commonwealth scored highest on its management, with a 9.8 rating, followed by sales and service support at 9.7. In general, advisors seemed to be pretty happy at their current firms, with 86.7 percent saying it was very likely they would still be affiliated with their firm in two years. About 6 percent said they were somewhat unlikely or very unlikely to still be with the firm in two years. Overall across all firms, advisors seemed least satisfied in the technology department, which took the lowest average category rating of 8.3. Cerulli s Smith says the top complaint he hears from reps is that technology is not integrated enough. A larger firm, he says, will likely have more integrated systems, so advisors are rekeying data less often. In our survey, 47.1 percent of respondents said technology was the most important factor in causing them to look for a new b/d. IBD advisors are not entirely thrilled with pay, however. Compensation and benefits received an overall rating of 8.5, with the sub-category health and retirement benefits getting a low score of 6.5. Reps are more content with their firms product offerings and management, which each took a score of 9. Our survey shows IBD advisors are continuing the move to fee-based business. On average, respondents said 44 percent of their income comes from asset-based fees, with 49 percent coming from commissions. On average, respondents said they expect asset-based fees to make up 55 percent of their business three years from now. Commissions are going to be less of a focus in three years, with respondents expecting it to account for 36 percent of their business by that time. l For access to the complete survey data, go to RegisteredRep. com/research/broker-report-cards/ in February. Copyright 2012 by Penton Media, Inc. For more information on use of this content, contact Wright s Media at