Small Broker-Dealers' Secret Weapon

We were recently reminded of this lowest common denominator when as part of BD due diligence in joining a large firm, the firm required an advisor to get three letters from board members of a fraternal organization for which he was treasurer. Reasons to be suspicious of the advisor were nonexistent: The treasurer position paid no compensation, he had been involved with the fraternal organization for many years without incident, and the advisor earned substantial income.

There was no reason to think he’d need to embezzle to survive, and he had a spotless compliance history. Going to fellow board members and asking them to write a letter saying “The treasurer is a standup, ethical guy” made the advisor very uncomfortable, so he refused to do it. He felt this was compliance overreach, so the BD would need to make changes in these over-the-top requirements for him to join the firm.

Large firms are black-and-white in how they operate because the large number of advisors makes them incapable of operating otherwise. Smaller firms with high-quality advisors have lower incidence of compliance issues because they know their advisors much better than larger firms. Larger firm management applies the 80/20 rule when it comes to pursuing relationships with their advisors, focusing on the top 20% at best, while smaller firms know most all their advisors.

One indicator as to how well a BD knows its advisors is a firm’s ability to uncover Ponzi schemes. The only firms we’ve witnessed catch advisors in Ponzi schemes early in the cycle were small and midsize BDs because they know their advisors and are better able to closely track them on a compliance basis. At large firms, Ponzi schemes typically aren’t exposed until they have imploded due to the lack of new investors to keep the scheme going.

Entrepreneurial advisors who think outside the box, wanting varying solutions for their clients, can feel restricted or trapped at larger firms. Smaller firms can customize to individual advisors’ needs rather than advisors needing to fit into a cookie-cutter platform. Relationship-driven advisors prefer smaller firms where they have the ear of upper management. The advisor’s input has substantial weight on firm policy, and their time at conferences can feel like a family reunion (family they enjoy, that is!).

When advisors call in to the home office, they have go-to people they know by name, not a phone tree. Profitable smaller firms typically have low staff turnover, so staff competency is high, resulting in correct answers to questions and quick response times. One frustration more common at larger firms is higher turnover resulting in incompetent staff that don’t have correct answers, resulting in advisors getting different answers from different people, which can be unnerving and erode trust.  

People often forget that firms such as LPL started as small, humble broker-dealers. They struggled their way higher. And today, even though the industry has changed in many ways, small BDs that deliver expertise and specialization and bring value that the larger firms can’t provide will continue to thrive and grow.

Jon Henschen is president of Henschen & Associates, a firm that helps advisors find broker-dealer relationships.