the broker-dealer of the future

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Ideas Without Limits SM The Broker-Dealer of the Future Our partners in developing this study: InvestmentNews CAST Management Consultants, Inc.

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Changes in Compensation Will Move Focus Away from Payouts ................................ 17 The Looming Investment Professional Shortage Threatens Success .................................. 15 Shrinking Margins Demand Greater Operational Efficiency ................................................... 25 Distributions Drive Demand for Tax-Efficient Solutions .................................................. 14

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Page 1: The Broker-Dealer of the Future

Ideas Without LimitsSM

The Broker-Dealer of the Future

Our partners in developing this study:

InvestmentNews CAST Management Consultants, Inc.

Page 2: The Broker-Dealer of the Future
Page 3: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS i

Table of ContentsExecutive Summary ..................................................................................................................................... 1

The Critical Role of a Broker-Dealer ...................................................................................................... 5

Broker-Dealer Training....................................................................................................................... 8

Practice Management Support ...................................................................................................... 9

Bridging the Investor’s Evolving Needs .................................................................................... 11

Distributions Drive Demand for Tax-Efficient Solutions .................................................. 14

The Looming Investment Professional Shortage Threatens Success .................................. 15

Investment Professional Recruiting and Retention ............................................................ 16

Changes in Compensation Will Move Focus Away from Payouts ................................ 17

Technology Is a Powerful Recruiting Tool ............................................................................... 18

Value-Added Services Are Underutilized ................................................................................. 19

The Advisory Business Cannot Be Ignored ...................................................................................... 21

Broker-Dealers Resist Individually Owned RIA Firms .......................................................... 22

Who Is Managing the Assets Anyway? .................................................................................... 24

Shrinking Margins Demand Greater Operational Efficiency ................................................... 25

Technology ............................................................................................................................................ 27

Operational Efficiency ...................................................................................................................... 28

Conclusion ..................................................................................................................................................... 29

Page 4: The Broker-Dealer of the Future

ii THE BROkER-DEALER OF THE FUTURE

Page 5: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 1

Executive Summary

Abraham Lincoln once said, “The best way to predict the future is to create it.” The future of the retail financial services industry is being created today and broker-dealers are the architects. Standing as the bridge between the investor, the investment professional, and the complexity of the investment markets, broker-dealers have the potential to lead the way. However, broker-dealers are in danger of getting lost in the labyrinth of competition, regulation, and operational challenges. The results of the Pershing LLC–sponsored research study unequivocally show that both growth and change are inevitable. Broker-dealers are projected to grow by 21% per year, doubling in size over the next five years. However, to turn the growth opportunity into long-term profitability, broker-dealers need to increase operating efficiency, retool their product and technology offerings, tackle the talent shortage, and find ways to deliver additional value to investment professionals.

To provide thoughtful leadership and guidance to broker-dealers across the industry, Pershing LLC, in

partnership with InvestmentNews, completed a qualitative and quantitative study of the broker-dealer

industry. The study combined an investment professional survey, a broker-dealer executive survey, and

interviews with the leaders of many of the most influential broker-dealer organizations and industry

influencers. The development of empirical data was performed by CAST Management Consultants, Inc.

The study reveals that four factors will drive the future: the investor-driven change in the investment process,

the shortage of experienced investment professionals, the new affiliation models driven by the trend toward

fee-based business, and the pressure on profitability already experienced by broker-dealer firms.

The Critical Role of a Broker-Dealer

A number of gaps exist between the evolving needs of the individual investor and the product line of a

typical broker-dealer. The shift in demographics will drive additional investor needs and dramatically alter

the product profile of the broker-dealer of the future. Investors are aging, and many will transition from

accumulating for retirement to receiving distributions from their retirement portfolios. Retirement

distribution demands will require more sophisticated solutions than the industry is currently prepared

to deliver. Furthermore, as tax efficiency becomes more visible to retired investors, broker-dealers will

need to educate investment professionals on lifetime income solutions to help investors better plan for,

and more effectively minimize, the risks of retirement.

Page 6: The Broker-Dealer of the Future

2 THE BROkER-DEALER OF THE FUTURE

In addition, gaps exist between the desired support prioritized by investment professionals and the current

and future offerings of broker-dealers. Broker-dealers will need to evolve their technology, product, and

practice management strategies to address these gaps.

Investment professionals face challenges of their own. Their needs are quickly evolving, with an increasing

focus on the economics of their practices and the technology provided by broker-dealers. Broker-dealers

that add value to the practices of their affiliated investment professionals will find a growing opportunity.

However, the market will be increasingly competitive as the supply of experienced and productive investment

professionals shrinks.

The Looming Investment Professional Shortage Threatens Success

It takes more than ten years to train a productive investment professional, and today’s demand exceeds

the available supply. The investment professionals of tomorrow should have been recruited five years ago.

Therefore, the time required to incubate an investment professional’s practice creates a significant challenge

for broker-dealers. The industry continues to face a shortage of high-quality, top-producing investment

professionals—only 12% of investment professionals produce in excess of $500,000 and 64% produce less

than $75,000.1 Simply increasing the recruiting budget will not lead to long-term success, yet broker-dealers

continue to prioritize recruiting over the development of existing investment professionals. To address the

talent shortage, broker-dealers will need to reprioritize resources, empower investment professionals to recruit

and develop talent on their own, and adopt strategies beyond traditional recruiting.

In the race for top talent, differentiation will be critical. The survey indicates that investment professionals

rank payout first when asked what they value about their relationships with their broker-dealers—signaling

that the other benefits of affiliation are not resonating as strongly as broker-dealers would hope. We found

that more than half of the firms surveyed do not focus on a specialized market. Creating a niche strategy

may present an opportunity for broker-dealers to differentiate themselves.

Alternative recruiting strategies must be adopted. Broker-dealers could consider supplementing their

recruiting efforts by targeting second-career individuals with relevant backgrounds in areas such as tax,

accounting, and legal. These individuals come with established networks and will add an element of

specialization to the broker-dealer.

Succession planning is also becoming an increasingly important consideration for broker-dealers. With the

average age of an investment professional approaching the mid-50s, succession planning will allow senior

investment professionals to monetize the value of their customer relationships, while providing the broker-

dealer with the opportunity to skillfully transition the customer relationships and retain the associated assets

within the organization.

With proven talent becoming scarce, it has never been more imperative for broker-dealers to get the most from

their existing investment professionals. While the product suite is important, many investment professionals

are looking for broker-dealers to provide more robust practice management support.

1 Race for Top Talent, Moss Adams LLP, 2007.

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IDEAS WITHOUT LIMITS 3

The transition from transaction-oriented to fee-based practices is a good example of the type of practice

management support desired by investment professionals, yet it ranks as one of the lowest in satisfaction

scores. There is no doubt that fee-based revenue is an area of growth for broker-dealers, but it presents

somewhat of a paradox. The fee business, driven by the registered investment advisor (RIA) market, is

also an area of increasing competition for the broker-dealer.

The Advisory Business Cannot Be Ignored

Today, advisory fees are the number one source of revenue for broker-dealers. The various fee programs,

from separately managed accounts and advisor-directed discretionary accounts to turnkey asset management

platforms, typically generate higher revenue than mutual funds or commission-based transactions. In five

years, the proportion of revenue represented by fees may exceed 50% of a broker-dealer’s total revenue.

However, with the growth in fee-based business comes a perceived competitive threat. It is a fact that some

of the most successful investment professionals in the country have left their broker-dealer licenses behind

and now practice as independent, fee-only advisors.

Convergence is upon us. The worlds of broker-dealers and RIAs are no longer separate and distinct.

Today, more than 5,000 dually registered advisors have a Financial Industry Regulatory AuthorityTM

(FINRATM) registration (as a registered representative) and a Securities and Exchange Commission (SEC)

registration (as an independent RIA).2 Dually registered firms (those affiliated with a broker-dealer and

also operating as an independent RIA) pose several critical issues for broker-dealers: will they be embraced

or merely tolerated, and are they merely in transition or looking to stay in the dually registered model as

a long-term strategy?

At the same time, broker-dealers have found their growth and highest profitability in the corporate RIA

platform. The platform has consumed significant time and energy with the goal of developing a robust yet

carefully controlled advisory offering. At the same time, broker-dealers have to decide what risk tolerance

they have for dually registered firms that wish to hold their advisory assets away and concurrently develop

compelling strategies to keep them on their platforms. The approach to the fee-based business may be a

decisive factor for the growth and viability of the broker-dealer of the future.

Shrinking Margins Demand Greater Operational Efficiency

The competing demands of servicing investment professionals, increasing capabilities, and growing through

recruiting have taken their toll on the income statements of broker-dealers. In an environment of increasing

payouts, scale and efficiency are paramount. From full-service to independent firms, all broker-dealers are

continuously evaluating processes and systems that promise to improve efficiency. In the search for scale, the

clearing relationship is the great equalizer—the scalable platform that allows the firm to “borrow” efficiency.

The rate of innovation in the industry is high, with new technology continuously being adopted. Efficiency

will hinge on smart investments in technology, process enhancements, operational restructuring, staffing

optimization, and outsourcing.

2 Cerulli Associates Quantitative Update, Intermediary Markets, 2007.

Page 8: The Broker-Dealer of the Future

4 THE BROkER-DEALER OF THE FUTURE

Preparing for the Future Today

The broker-dealer of the future will be an organization that listens and responds to the needs of its investment

professionals and helps them address a changing investor market. It will be an organization that values and

develops talent in the home office as well as in the field. The advisory business will fuel the growth, but

efficiency and productivity will translate the growth into profitability.

Most of all, the broker-dealer of the future will be in synch with its investment professionals. The survey

data points at distinct disconnects between these two groups’ opinions on several key topics. The goal of

this study is to deliver a framework for identifying and evaluating how these gaps can be closed and to equip

broker-dealers with the insight they need to plan for future success.

Page 9: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 5

The Critical Role of a Broker-DealerInvestor demographics are changing while the investment industry is becoming more complicated. Investment

professionals still look to their broker-dealers to help them navigate this challenging landscape; however, there

are significant gaps to fill between the services broker-dealers currently provide and the services investment

professionals seek in order to optimize their performance.

Investment professionals and broker-dealers have different expectations of each other. When a comparison

is made between what investment professionals and broker-dealers consider important, we find a significant

disconnect, as the next four graphs will show.

Figure 1: Investment Professionals’ Reasons for Staying with a Broker-Dealer

REASONMoreLess

IMPORTANCE IN 5 YEARSMoreLess

DEGREE OF INFLUENCE

18.5

12.6

11.9

10.7

9.8

8.3

5.7

4.8

2.9

2.5

2.4

1.6

COMPENSATIONTECHNOLOGY

EASE OF DOING BUSINESSCULTURE

INERTIAPRODUCT ACCESS

BRANDSUPPORT

TRAININGBENEFITS

SALESSPECIALIZED FOCUS

19.3%

3.0%3.1%4.3%

10.1%26.3%

6.7%12.8%

7.3%4.8%

14.7%

47.5%76.0%

69.1%51.7%

44.7%58.9%

42.3%57.3%

38.7%36.8%

24.6%6.5% 45.2%

Note: “Degree of Influence” is an average weighting based on a distribution of 100 points across all reasons.

Broker-dealers were asked how they differentiate themselves from other broker-dealers, and investment

professionals were asked why they stay with their current broker-dealers. Investment professionals want a

broker-dealer with maximum compensation and minimum hassle, whereas broker-dealers rank the influence

of their culture and their brand above compensation and the ease of doing business. This discrepancy is

almost dramatic in its disconnect—while one side is trying to establish a relationship, the other side turns

a cold shoulder and focuses on the facts of the transaction.

Page 10: The Broker-Dealer of the Future

6 THE BROkER-DEALER OF THE FUTURE

Figure 2: Broker-Dealers’ Perceived Differentiators

ATTRIBUTEMoreLess

IMPORTANCE IN 5 YEARS

15.4%

5.3%15.8%

5.6%10.0%

0%6.7%

0%12.5%11.1%

6.7%

42.1%21.1%

55.6%50.0%

65.0%53.3%58.1%

37.5%44.4%

53.3%23.1%

HighLow

DEGREE OF DIFFERENTIATION

20.2

14.8

12.4

12.3

8.9

8.5

8.1

4.2

4.0

3.3

3.3

CULTURE OF FIRMCOMPENSATION

BRAND/REPUTATION OF BDEASE OF DOING BUSINESS

TECHNOLOGYSUPPORT

PRODUCT ACCESSSPECIALIZED FOCUS

TRAININGSALES LEADS

BENEFITS

Note: “Degree of Differentiation” is an average weighting based on a distribution of 100 points across all attributes.

The reasons investment professionals gave for why they stay with their broker-dealers reveal a relationship

between a vendor and its customer rather than a relationship between strategic partners. Such categories

of evaluation, namely price, ease of doing business, and inertia, are more typical for commodity businesses.

What is more, those are categories of competition that tend to favor large and heavily scaled (but impersonal)

businesses. It is difficult to accept such a future, but the results call for action. It appears that the lack of

differentiation and value-added services may be driving skepticism in the investment professional’s mind.

It seems investment professionals are saying, “If we can’t find the value added, at least give us the money.”

In the areas of service that are critically important to investment professionals, we find gaps between the

expectations and the delivery. Figure 3 shows the quality of the service on the horizontal axis and the

importance of the service to investment professionals on the vertical axis. Thus, a service with a high level of

importance and high quality of delivery will be in the upper right corner, while a service with a low level of

importance and low level of quality will be in the lower left corner. The upper left corner represents the most

important services with the lowest level of service (problem area), and the lower right corner represents the

least important services with the highest level of service (cases of overinvesting in an unimportant service).

Generally, any service where the importance score exceeds the quality score (e.g., importance of 4 but quality

of 3) is an area of concern.

Page 11: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 7

Figure 3: Investment Professionals’ Ratings of Service Quality Versus Importance

General sales training

Specialty enablement(wills, trusts, tax planning)Investment professional

portal

Case supportPC help desk

Proprietary research

Continuingprofessional

education

Broker-dealer brand

CRM tools

Assetallocationsoftware

Low High

IMPO

RTAN

CE TO

INVE

STM

ENT

PRO

FESS

ION

ALS

QUALITY OF SERVICE

High

Low

Producttechnical training

RIA – TechnologyCustomer

acquisition/prospectingUnified product techologyOnboarding/transition

assistanceSales concept

training

SERVICE QUALITY BELOWIMPORTANCE LEVEL

SERVICE QUALITY ALIGNSWITH IMPORTANCE LEVEL

SERVICE QUALITY EXCEEDSIMPORTANCE LEVEL

1 52 3 41

5

2

3

4

It is important to note that none of the value-added services received a quality score of 4 or higher (very

good). Most clustered around 3 (good). There are many areas on which investment professionals placed

significant importance (high score on the vertical axis) and the quality was below 3. In order of importance,

it seems that broker-dealers can improve in:

> Specialty planning: tax, trust, and estate

> Registered investment advisor (RIA) technology

> Customer relationship management (CRM) tools

> Customer acquisition and prospecting support

> Unified product technology

Also interesting is that the broker-dealer’s brand and proprietary research are the only two areas that exceed

the expectation of investment professionals.

Some of the gaps identified by the survey stem from investors’ evolving needs and must be closed before

investment professionals can optimize their potential. To bridge these gaps and help drive investment

professional growth and productivity, we suggest broker-dealers focus on the following two areas: investment

professional training and practice management support.

General sales training

Specialty enablement(wills, trusts, tax planning)Investment professional

portal

Case supportPC help desk

Proprietary research

Continuingprofessional

education

Broker-dealer brand

CRM tools

Assetallocationsoftware

Low High

IMPO

RTAN

CE TO

INVE

STM

ENT

PRO

FESS

ION

ALS

QUALITY OF SERVICE

High

Low

Producttechnical training

RIA – TechnologyCustomer

acquisition/prospectingUnified product techologyOnboarding/transition

assistanceSales concept

training

SERVICE QUALITY BELOWIMPORTANCE LEVEL

SERVICE QUALITY ALIGNSWITH IMPORTANCE LEVEL

SERVICE QUALITY EXCEEDSIMPORTANCE LEVEL

1 52 3 41

5

2

3

4

Page 12: The Broker-Dealer of the Future

8 THE BROkER-DEALER OF THE FUTURE

Broker-Dealer Training

General sales training and investor-focused training received the lowest quality scores in the investment

professional evaluation. While their importance score was also low, we believe that training may be under-

appreciated by investment professionals because of the quality of the current solutions. It appears that

broker-dealers have an opportunity to take the lead in providing investment professionals with solutions

to address emerging investor needs. While investment professionals are very close to investors, at times

this position prevents them from seeing challenges that investors themselves have trouble identifying.

Many of today’s investment professionals will appreciate learning more about key investor needs that will

become increasingly relevant.

When asked to rate the training they receive in terms of importance and quality, we found that investment

professionals place high importance on increasing their knowledge in specialized areas of planning. These

areas are noted in the lower right quadrant of Figure 4 below. The graphic plots the value investment

professionals place on various training topics versus the broker-dealers’ assessment of how well they are

delivering on these topics.

Figure 4: Training Valued by Investment Professionals Versus Training Provided by Broker-Dealers

Low High

QUA

LITY

OF

BRO

KER-

DEA

LER

TRAI

NIN

G

IMPORTANCE TO INVESTMENT PROFESSIONALS

High

ProductTransition

to feebusiness

Trading Practicemanagement

Advancedfinancialplanning

EstateplanningTax

planning

Lifetimeincome

solutions

Prospecting

Executivecoaching CRM

Low1 52 3 4

1

5

2

3

4

Note: “Quality of Broker-Dealer Training” is an average weighting given by broker-dealers based on a “1–5” scale, with “5” representing the most robust training program.

> There is a need to improve overall training, as none of the broker-dealer’s offerings received a rating

of 3 or higher. More than 42% of broker-dealers do not even offer training in the areas shown on the

lower half of the chart.

Page 13: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 9

> Tax planning is the fifth most valuable type of training for investment professionals but is deemed

the least robust by broker-dealers. This is especially worrisome given the increasing investor need for

support in this area.

> Product training, the least important to investment professionals, was rated the most robust by broker-

dealers, suggesting current product training is adequate.

To address these gaps, broker-dealers are advised to enhance their training curriculum in the following areas:

> Advanced financial planning, considered by investment professionals as the single most valuable form

of training, received only a 2.5 quality rating. Although complexity makes it challenging to build

meaningful and consistent advanced financial planning training programs, this is an area that should

not be ignored.

> Estate planning, rated the second-most-important form of training by investment professionals, received

only a 1.9 quality score. With baby boomers retiring and the tax laws facing potential revisions after

2010, this will become an increasingly important issue in the coming years.

> Lifetime income solutions received a quality score of only 2.2 based on the completeness of currently

provided programs. This product class is new and rapidly evolving. Broker-dealers must properly

train investment professionals to provide investors with the appropriate guidance. Guaranteed income

solutions were rated as most likely to gain in importance over the next five years, underscoring the

significance of training as soon as possible.

> Tax planning received the lowest overall quality score, at 1.6. More than 60% of broker-dealers offer no

tax planning at all. Tax mitigation will become increasingly vital as 401(k) accounts and retirement funds

are rolled over into distribution vehicles. Also, the tax implications for the wealthy or complex investor

create many options for income distribution and capital preservation. Broker-dealers must improve their

in-house capabilities, or partner with outside tax planning experts, to satisfy the needs of their customers.

Practice management occupies a special place in the training curriculum because of its importance for

independent investment professionals—those who own their own businesses. For independent investment

professionals, being successful in developing new business is not enough; the practitioner must also manage

the business he or she has created to maximize profitability.

Practice Management Support

Building value in the practice, creating liquidity for the owners, and recruiting and retaining talented

employees are the highest priorities for investment professionals. With the success investment professionals

have experienced in the past five years and the growth they anticipate over the next five years, come the

challenges of managing a larger organization. Investment professionals often find they need help managing

their businesses because they were never trained in business management, yet it has become critical for their

success. Broker-dealers are naturally positioned to support these needs.

Page 14: The Broker-Dealer of the Future

10 THE BROkER-DEALER OF THE FUTURE

Figure 5: Practice-Related Benefits That Are Most Important to Investment Professionals

MEDICALINSURANCE

EQUITYSHARING

67%

PRACTICESUCCESSION

ACQUISITIONFUNDING

RETIREMENTACCOUNTS

WAIVEDACCOUNT

TRANSFER FEES

SIGN-ONBONUS

FORGIVABLESIGN-ON

LOAN

63%

57%53%

45%43%

41%

28% 27%

AMO

NG

TOP

THRE

E

PROFITSHARING

PRACTICE-RELATED BENEFITS

Note: Investment professionals were asked which practice-related benefit ranked among their top three.

Practice management presents another opportunity to bridge the gap between the expectations of investment

professionals and what broker-dealers currently support. For example, investment professionals cited assistance

in equity sharing (i.e., providing a means by which investment professionals can add new partners to their

practices), as the most important practice-related benefit. While two-thirds of investment professionals placed

equity sharing among the top three most important benefits, only 46% of broker-dealers currently offer it.

Further, among those broker-dealers that do not currently offer support in this area, 57% do not anticipate

offering it in the next five years.

Practice succession closely relates to equity sharing, and therefore it is no surprise that it was rated second in

importance by investment professionals. Still, slightly fewer than half of broker-dealers provide support in this

area. However, a strong majority (83%) plan to address this issue and offer practice succession support in the

coming years. The traditional notion of retirement from the business of providing financial advice may be

redefined for many investment professionals currently in the business. Successful broker-dealers may need to

consider providing alternative environments for aging investment professionals who wish to work at a modified

pace while transitioning their customer relationships to the next generation of investment professionals.

Employee benefits are also a high priority for investment professionals, as illustrated by the importance the

investment professionals place on items such as medical insurance and profit sharing. Medical insurance is the only

practice-related benefit that has been addressed by most broker-dealers, while the benefit most offered by broker-

dealers, waived account transfers fees, appears to be low on the investment professionals’ list of important benefits.

Broker-dealers, particularly within the independent ranks, should consider offering their investment

professionals guidelines and best practices for enhancing the productivity and effectiveness of their practices.

The support could consist of planning tools and training, best-of-breed practice management techniques

(e.g., operations, fiscal management, human resources, and sales practices), and access to technology tools

(e.g., web-based customer and account interfaces, image and workflow management, investor segmentation,

and data mining). These tools, technology, and management techniques, if adopted, will measurably improve

investment professional performance.

Page 15: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 11

Bridging the Investor’s Evolving Needs

Investors need guidance from their investment professionals to make the right decisions for their financial

lives. Investment professionals need training on new ways to deal with emerging investor challenges. The

broker-dealer is a logical center of education and thought leadership to help investment professionals become

proficient in solutions that address these changes in the market.

Figure 6: Average Distribution of Investment Professionals’ Customers by Type

Other1.2%

Small business6.3%

Corporate3.2%

Beginners2.5%

Young families6.8%

Maturingfamilies17.6%

Pre-retired30.3%

Retired32.1%

Investor demographics are changing, with close to one-third of the average investment professional’s

customer base approaching retirement and another one-third already retired. If we fast-forward the

demographic profile in Figure 6 five years, retirement income solutions will dominate the service needs.

The pre-retiree category, defined as customers between 55 and 65 years old, will be 60 to 70 years old,

which means at least half of them will be retired, bringing the total percentage of retirees even higher.

It is no surprise that pre-retirement accumulation and post-retirement distributions dominate the mix of

services provided by investment professionals (Figure 7). When asked about the top needs of their customers,

investment professionals indicated that accumulation is important for 57% of all customers and distribution

is important for 47%. In addition, investment professionals anticipate that retirement distribution services

will only increase in importance over the next five years. A strong majority of the investment professionals,

88%, foresee that trend. The wave of pending baby boomer retirements is also evident in the increasing

importance investment professionals assign to estate planning and long-term care.

Our interview results tell us that broker-dealers are thinking ahead to how investment professionals can

replenish their customer base with younger customers who are still in the accumulation stage. Without a process

to replenish the customer base, practices are in danger of facing declining revenues and increasing service

needs, leading to lower profitability and less opportunity for staff. Executives frequently tell us that the natural

tendency of investment professionals is to work with customers who are near their own age. Furthermore,

working with younger customers does not always yield immediate profits for an investment professional but

can be critical for the long-term health of the practice. Encouraging and accelerating the development of junior

investment professionals has been an important strategy for adding younger customers to practices.

Page 16: The Broker-Dealer of the Future

12 THE BROkER-DEALER OF THE FUTURE

Figure 7: Investment Professionals’ Perceptions of Important Customer Needs

HighLow

5.8%

MoreLess

7.6%0.0%2.4%3.0%

9.2%2.3%

17.1%13.5%

9.2%4.6%5.5%

60.9%87.6%

62.9%78.9%

41.0%73.8%

34.8%27.1%30.5%

56.1%34.6%

49.4%

CUSTOMER NEED IMPORTANCE IMPORTANCE IN 5 YEARS

57.3%46.9%

45.2%42.6%

38.5%28.5%

23.0%22.3%20.5%

16.0%11.5%10.1%

(Average % of Clients)

RETIREMENT PLANNINGPOST-RETIREMENT ASSET MGT & DIST

TAX MITIGATIONESTATE PLANNING/WEALTH TRANSFER

DEATH PROTECTION (LIFE INS)LONG-TERM CARE PROTECTION

COLLEGE TUITION FUNDINGDISABILITY PROTECTION

ASSET CUSTODYCHARITABLE GIVING

FAMILY GOVERNANCEBUSINESS SUCCESSION PLANNING

Note: “Importance” represents the average percentage of customers for which the need is important.

When discussing the needs of investors, we should not forget that many investment professionals focus

on different segments of the market and are likely to use different solutions. The average American is not a

high-net-worth individual who needs family governance help and business succession planning. The typical

(median) customer serviced by investment professionals in our survey has between $100,000 and $500,000

in assets (Figure 8). Thus, a typical customer is primarily focused on his or her retirement portfolio, most

likely held inside a tax-deferred account such as an IRA or a 401(k). The nature of the investment solutions,

therefore, is biased toward more automated and user-friendly programs.

Figure 8: Average Distribution of Investment Professionals’ Customers by Investable Assets

$10,000,000or more4.7%

$5,000,000-$9,999,999

3.8%$1,000,000-$4,999,999

12.8%

$500,000-$999,99921.9%

$100,000-$499,99933.6%

<$100,00023.3%

Page 17: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 13

Broker-dealers are fairly in tune with the product needs of investment professionals. For their most

important needs, broker-dealers believe their product offerings are relatively strong. However, with respect

to emerging needs, broker-dealers have plans to shore up their offerings. The gaps that appear between

investment professional needs and current broker-dealer support relate primarily to trust accounts, health

insurance, and discretionary portfolio management. Broker-dealers indicate that they will be enhancing the

quality of these offerings over the next five years.

Figure 9: Broker-Dealers’ Ability to Meet Investment Professionals’ Most Important Product Needs

BROkER-DEALERS’ QuALITy RATING

PRODuCTS IMPORTANT FOR PROFESSIONALS TODAy IN 5 yEARS

CuRR

ENT

1. IRAs 4.4 4.6

2. Mutual funds 4.6 4.5

3. 401(k)s 3.6 4.3

4. Life insurance 3.3 4.3

EMER

GIN

G

5. Discretionary portfolio management 3.1 4.2

6. Variable annuities 4.3 4.4

7. Trust accounts 2.5 4.0

8. Health insurance 2.6 3.1

Note: “Quality Rating” is based on “1–5” scale with “5” being of the highest quality.

> Trust accounts are currently only rated 2.5 by broker-dealers but are forecast to increase to 4.0. This

will be critical to meet the estate planning needs of investors.

> Discretionary portfolio management is rated only 3.1 today, but broker-dealers anticipate bringing this

to a score of 4.2.

> Alternative investment products (e.g., private equity, hedge funds, structured lending) were reported

to become more important in the next five years. However, many of these products were not seen as

becoming core products in the near future.

Page 18: The Broker-Dealer of the Future

14 THE BROkER-DEALER OF THE FUTURE

Figure 10: Product Importance as Rated by Investment Professionals

IRAS MUTUALFUNDS

401(K)S LIFEINSURANCE

DISCRETIONARYPORTFOLIO

MANAGEMENT

VARIABLE ANNUITIES

TRUSTACCOUNTS

HEALTHINSURANCE

DISABILITYINSURANCE

GUARANTEEDINCOME

MANAGEDACCOUNTS

DEPOSITACCOUNTS

IMPO

RTAN

CE

TODAY

IN 5 YEARS4.1

4.24.1

4.0

3.33.5

3.03.2

2.7

3.1

2.7

3.0

2.6

3.1

2.5

3.1

2.3

2.5

2.0

2.7

2.0

2.2

PRODUCT

1

5

2

3

4

0

Note: “Importance” is based on a “1–5” scale with “5” being of highest importance.

Distributions Drive Demand for Tax-Efficient Solutions

In our interviews, we found that broker-dealer executives understand the increasing need for more

distribution solutions, which would ideally include tax-efficient solutions that can be offered to a mass-

market investor. As tax efficiency becomes more visible to retired investors, broker-dealers have an

opportunity to help investment professionals deliver lifetime income solutions to help investors plan

for, and more effectively minimize, the risks of retirement.

Given the additional risk inherent in guaranteeing lifetime income, distribution costs will likely diminish

as product manufacturers look for ways to improve profitability, further squeezing broker-dealer margins.

However, opportunities will be available to proactive broker-dealers that are adept at helping investment

professionals understand how to package and sell lifetime income solutions leveraging emerging products.

New high-value, lower-cost products will emerge as the product landscape becomes more efficient.

Working with retired investors, especially mass-market and emerging affluent investors, will require efficient

processes at the investment professional and the broker-dealer levels. As a result, investment in technology

platforms that support advisory activities will distinguish many firms and bring them to the next level

of competitiveness and investor satisfaction. The compression of the overall fees attached to providing

investment advice will drive the creation of better cost-versus-return product usage and a higher level of

portfolio analytics and reporting. Advanced advisory platforms will allow broker-dealer-owned RIAs to

capture an increasing share of the overall value chain.

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IDEAS WITHOUT LIMITS 15

The Looming Investment Professional Shortage Threatens Success“The biggest issue for the brokerage community is the lack of qualified people. There’s a shortage of investment

professionals at all levels in the industry now,” says the CEO of an independent firm. “It’s caused by the aging

of the population, but also, everyone gave up on training about five years ago. You don’t have new people

coming in, so you have record prices being paid for experienced, mature investment professionals,” says the

CEO. The results of the study provide strong support for that statement. More than 35% of the participants

started in the business in the 1970s or earlier, implying that many are approaching retirement age, while

fewer than 10% of the participants started in the industry between 2002 and 2007.

Figure 11: Distribution of Investment Professionals by years Worked in Investment Industry

>3021-3016-2011-156-101-5PERC

ENTA

GE

OF

INVE

STM

ENT

PRO

FESS

ION

ALS

9.7%

26.7%

15.9%17.7%

20.4%

9.6%

NUMBER OF YEARS

The aging of investment professionals is not the only factor driving the shortage of talent. The lack of

training of new investment professionals makes it difficult to hire young talent profitably. In addition,

during the past ten years, we have seen many investment professionals convert to an RIA model, reducing

the available recruiting population even further. Ultimately, demand exceeds supply. There is no one source

of new investment professionals left in the industry except the training and development of new investment

professionals. For most firms, however, the priority still appears to be recruiting from other firms, which is

a short-term, if not shortsighted, approach.

Page 20: The Broker-Dealer of the Future

16 THE BROkER-DEALER OF THE FUTURE

Figure 12: Broker-Dealers’ Top PrioritiesAV

ERAG

E IM

PORT

ANCE

RECRUITING

1.8

2.2

2.7

3.6

40

COST CONTROLMEET INVESTMENTPROFESSIONALS’

TECHNOLOGYNEEDS

INCREASEINVESTMENT

PROFESSIONALPRODUCTIVITY

COMPLIANCEREQUIREMENTS

INVESTMENTPROFESSIONAL

RETENTION

2.2

4.0

1

5

2

3

4

0

TOP PRIORITIES

Note: “Importance” is based on a “1–5” scale with “5” being of highest importance.

If we consider the graph above, we can see that growing the number of investment professionals is still

overshadowing every other strategic priority.

As an industry, broker-dealers are aware that recruiting is a zero-sum game—the gains of one broker-

dealer are the losses of another. For the entire industry to address its acute talent shortage, training of new

investment professionals has to become more commonplace and has to be prioritized. This is particularly

true for the independent broker-dealers that traditionally do not recruit or train inexperienced investment

professionals. Training is a process that is risky (as investment professionals may leave after they are fully

trained) and requires tremendous scale or specialized training resources. As a result, recruiting continues

to be the highest priority of most firms.

Investment Professional Recruiting and Retention

Recruiting budgets are healthy. Most broker-dealers in the survey project a substantial increase in the base

of investment professionals in the next few years. More than 32% of the participants expect to have more

than 1,000 investment professionals in five years, versus fewer than 20% that have greater than 1,000 today.

Further, even among the smallest firms that have fewer than 50 investment professionals, 12% project

moving up to the next category (Figure 13).

Page 21: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 17

Figure 13: Distribution of Broker-Dealers by Number of Investment Professionals, Current and Expected

2,001+

1,001 – 2,000

501 – 1,000

201 – 500

101 – 200

51 – 100

<50

TODAY

10.3%

14.7%

IN 5 YEARS

PERC

ENTA

GE

OF

BRO

KER-

DEA

LERS

11.8%

11.8%

8.8%

29.4%

17.7%

13.2%

19.0%

7.4%

17.7%

11.8%

13.2%

13.2%

Average: 631 Average: 1,013

To address the talent shortage, we estimate that the 69 broker-dealers in the study will have to collectively

recruit as many as 22,000 investment professionals. If we consider that almost 10% of the existing

investment professionals will likely retire in the next five years, as we saw in Figure 11, the net number

of new hires will need to exceed 30,000—a formidable number.

At present, the competition for top talent is focused on compensation, technology, and ease of doing

business. For such dramatic recruiting results to materialize, broker-dealer differentiation will be critical

and alternative recruiting strategies must be adopted.

Changes in Compensation Will Move Focus Away from Payouts

While compensation is cited as the number one reason why investment professionals stay with their broker-

dealers, it is difficult to believe that it is truly the underlying driver of retention. After all, it is highly unlikely

that 69 broker-dealers all offer the same compensation package. Some are bound to have higher payouts than

others, which means that even within the category of compensation, other factors ultimately influence the

investment professional’s decision. Further, it is likely that compensation in the next five years will focus less

on the cash component, which appears to be maxed out. Rather, we are likely to see increased use of deferred

compensation and equity as a means of attracting and retaining investment professionals.

The understanding that compensation is not likely to increase in importance is shared by investment

professionals and broker-dealers. Note that while investment professionals give compensation an

overwhelming importance in their reasons to stay, only 47% believe that it will increase in importance.

Page 22: The Broker-Dealer of the Future

18 THE BROkER-DEALER OF THE FUTURE

Figure 14: Expected Change in the Importance of Compensation

BROKER-DEALERS INVESTMENTPROFESSIONALS

PERC

ENTA

GE

IND

ICAT

ING

5-Y

EAR

CHAN

GE

53%

42%

3%

47%

5% LESS IMPORTANT

SAME IMPORTANCE

MORE IMPORTANT

50%

Similarly, broker-dealers also understand that while investment professional compensation is their largest

expense, it is not likely to be reduced. Only 5.3% of broker-dealers assign any probability to decreasing

compensation costs.

Technology Is a Powerful Recruiting Tool

Technology takes the number two spot in terms of importance to the investment professional and creates

additional opportunities for broker-dealers to distinguish themselves. We already noted that RIA and

customer relationship management (CRM) software are both on the list of critically important services

that fall below the desired level of quality. There are many other differentiators on the technology list,

namely paperless statements, consolidated statements, and a web-based portal for customers.

Figure 15: Investment Professionals’ Perceptions of Important Broker-Dealer Attributes

BRAND DEVELOPMENTMULTIPLE TRADING PLATFORMS

CALL CENTERCORPORATE RIA

EXTERNAL AGGREGATED REPORTINGWEB-BASED PORTAL FOR CUSTOMERS

INDIVIDUALLY OWNED RIACONSOLIDATED STATEMENTS

PAPERLESS STATEMENTSPORTFOLIO MANAGEMENT TOOLS

OPEN TECHNOLOGY

ATTRIBUTE

13.0%

MoreLess

2.0%4.0%1.6%4.0%

8.0%4.0%3.0%

15.0%20.0%

10.0%

72.0%72.0%77.5%75.0%

57.0%62.0%67.0%

31.0%35.0%

42.0%42.0%

IMPORTANCE IN 5 YEARSHighLow

IMPORTANCE

15.0

12.4

11.6

10.7

9.3

8.7

7.2

6.3

6.0

5.3

5.2

Note: “Importance” is an average weighting based on a distribution of 100 points across all attributes.

Page 23: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 19

Value-Added Services Are underutilized

Beyond compensation, in the next five years, broker-dealers are looking to increase the priority of a number

of currently underutilized opportunities. Succession planning leads the list of services, with 84% of firms

looking to increase their level of succession planning support for investment professionals.

Figure 16: Broker-Dealer Provision of Practice-Related Benefits

PERCENTAGE OF BROKER-DEALERSTHAT CURRENTLY PROVIDE

80.0%64.3%

53.9%53.3%

50.0%46.2%

41.7%33.3%

21.4%

LikelyUnlikely

WILL PROVIDE IN 5 YEARS

33.3%60.0%

16.7%42.9%42.9%

57.2%57.2%

75.0%54.6%

66.7%40.0%

83.3%57.1%

42.9%28.6%

42.9%25.0%

36.4%

BENEFIT

WAIVED ACCOUNT TRANSFER FEESMEDICAL INSURANCE

PRACTICE SUCCESSION PROGRAMRETIREMENT ACCOUNT

SIGN-ON BONUSEQUITY SHARING

FORGIVABLE SIGN-ON LOANPROFIT SHARING

ACQUISITION FUNDING

Successful models of guiding investment professionals in the transitioning of their practices to the next

generation will not only aid in recruiting and retention efforts, but also will lead to superior economic results.

> Broker-dealers should design structures and processes to retain the customer relationships of retiring

investment professionals. One option is to pair older investment professionals with younger up-and-comers

and provide financing to help facilitate the ultimate transition. Furthermore, these team arrangements

will create an insurance policy against the unexpected death or disability of an investment professional.

> Broker-dealers should develop continuity plans for all practices, but particularly for investment

professionals over the age of 55. Each plan should include a designated successor.

> Broker-dealers should develop succession guidelines based on specific criteria. There is much interest in

the broker-dealers providing financing for succession, but many are concerned that they will be saddled

with too much financial risk and may end up overpaying for the practices.

In addition to practice management solutions, there are other areas where firms can stand out, including these:

> Broker-dealers should consider supplementing their recruiting by targeting second-career individuals

with relevant backgrounds in areas such as tax, accounting, and legal professionals. Broker-dealers should

provide them with technical training and up-front financing. These second-career individuals offer access

to high-net-worth customers and provide the specialized skills likely to flourish in a team environment.

> Broker-dealers that specialize in enhancing the effectiveness of their investment professionals’ practices

should recruit lower-producing investment professionals who have been displaced at the larger firms

because their production failed to meet the new, heightened revenue targets.

Page 24: The Broker-Dealer of the Future

20 THE BROkER-DEALER OF THE FUTURE

> Broker-dealers should explore offering the following types of transition assistance for those investment

professionals moving from other firms, including:

– Waiver of account transfer fees

– Single point-of-contact transition resource

– Automated account transfers

– Administrative assistance

– Investment professional orientation program

While broker-dealers are aggressively competing with each other for talent, a new threat poses greater

competition for some of the most experienced and talented investment professionals. The prominence of

the RIA segment of the industry has increased dramatically and threatens to upstage broker-dealers as the

primary channel for the delivery of advice to investors. However, broker-dealers are best positioned to take

advantage of the movement to fee-based advice. Broker-dealers can adopt corporate RIAs to retain these

investment professionals within the broker-dealer—allowing an investment professional to operate in

a commission-and-fee-based environment.

Page 25: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 21

The Advisory Business Cannot Be IgnoredThe investment advisory business represents the fastest growth opportunity for broker-dealers, with many

organizations reporting they expect to double their advisory assets in the next five years. At the same time,

the exact structure for servicing the advisory business and the regulatory setup chosen by the investment

professional and the broker-dealer diverge. While broker-dealers have a strong preference for using their

corporate RIAs, many investment professionals already own or would like to own their own RIAs. The

role of the investment professional in managing the account is also somewhat unclear. Some investment

professionals actively manage the assets, while most rely on outsourcing that expertise. The dynamic changes

in the industry are perhaps well exemplified by the presence of the fee-based brokerage accounts in our

survey. At the time of the survey data gathering, a substantial amount of assets were still in such accounts.

At present, this option is no longer available and the assets have been converted to other types of accounts.

Survey participants have high expectations for growth in their advisory revenue. Two-thirds of all broker-

dealers project growth in advisory assets under management (AUM). The percentage of firms with annual

advisory revenues of more than $20 million is also expected to double from 21% to 44% over five years.

Advisory AUM is also expected to double, from 31% of firms holding more than $1 billion to 61%.

Figure 17: Distribution of Broker-Dealers by Advisory Revenue, Current and Anticipated

TODAY

4.9%

13.1%

IN 5 YEARS

PERC

ENTA

GE

OF

BRO

KER-

DEA

LERS

31.1%

14.8%

23.0%

18.0%

14.8%

11.5%

9.8%

4.9%14.8%

18.0%

11.5%

1.6%8.2%

$100M+

$70M–$99.9M

$40M–$69.9M

$20M–$39.9M

$10M–$19.9M

$5M–$9.9M

$1M–$4.9M

<$1M

At present, the industry is divided in the way it delivers advice. Of all investment professionals surveyed,

17% own their own RIAs, while 45% affiliate with a corporate RIA. Finally, a surprising 38% of the

investment professionals have no RIA affiliation, meaning they are not licensed to deliver advice. Over

the next five years, fewer than 25% of the investment professionals expect to still have no advisory license.

Page 26: The Broker-Dealer of the Future

22 THE BROkER-DEALER OF THE FUTURE

Figure 18: Distribution of Broker-Dealers’ Investment Professionals by RIA use, Current and Expected

TODAY IN 5 YEARS

PERC

ENTA

GE

OF

REG

ISTE

RED

INVE

STM

ENT

PRO

FESS

ION

ALS

45.0%

37.8%

23.0%

23.0%

17.2%

INDIVIDUALLY OWNED RIA

AFFILIATED WITH BROKER-DEALER’SCORPORATE RIA

NO RIA

54.0%

Almost 25% of the investment professionals surveyed plan to have their own RIAs. This is an option only

available to investment professionals affiliated with an independent broker-dealer. The question is whether

that means that they will terminate their broker-dealer relationships or become dually registered firms.

Broker-dealers are not currently very receptive to allowing dual registration. In our survey, 50% of the

firms currently allow dual registration. However, when asked about the future, 75% of the firms believe it

is unlikely that they will continue to offer it in the future. Chances are they may not have a choice. Dual

registration will likely become an industry standard. As long as one sizeable firm offers it, other firms have

to either match that offering or risk losing investment professionals.

Broker-Dealers Resist Individually Owned RIA Firms

The issue dually registered advisors may have with corporate RIAs is perhaps more economic and emotional

than regulatory. It is clear that broker-dealers have a compliance responsibility for the individually owned RIA,

so investment professionals who choose to have a dual registration remain under broker-dealer supervision.

In other words, they do not decrease their compliance burden in any way. What they gain is control over the

contract with the customer. In a corporate RIA the contract is between the customer and the broker-dealer,

with the investment professional named as the person servicing the customer on behalf of the firm. In an

individually owned RIA, the contract is between the investment professional and the investor—the broker-

dealer is not involved. This creates a sense of control and portability for investment professionals, in that

they can more easily change the relationship and have more control. This clearly appeals to many investment

professionals as evidenced by the existing number of dually registered firms. Today, more than 5,000 dually

registered advisors have a FINRA registration (as a registered representative) as well as an SEC registration

(as an independent RIA), representing more than $700 billion in total assets. Average profitability at these

dually registered firms is very competitive with the pure RIA model.3

3 Cerulli Associates Quantitative Update, Intermediary Markets, 2007.

Page 27: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 23

Some facts to consider:

> The number of RIA firms grew by 28% between 2001 and 2004, while the number of FINRA-

registered broker-dealers decreased 2% over the same time period.

> The survey results show revenues increasing across the board in the next five years, but both investment

professionals and broker-dealer executives expect the strongest growth will be among advisory accounts.

> Within five years, 77% of surveyed firms plan to offer an RIA solution, compared with 62% today.

Figure 19: Comparison of RIA-Only and Dually Registered Firms

RIA-ONLy FIRMS DuALLy REGISTERED FIRMS

Pricing structure Fee-based Fee-based and/or commission-based

Account minimum $408,000 $75,000

Number of customers 314 420

Revenue per professional $660,000 $691,000

Revenue per customer $4,600 $5,000

Operating profit margin 28% 29%

The growth in the RIA industry has not gone unnoticed. The RIA market is seen as an opportunity, not

a threat, by 85% of surveyed broker-dealer executives. The impact on the industry seems clear: advisory

models present an opportunity for broker-dealers to drive recurring annual revenue, meet investor preference

for advice delivery, and build long-term customer relationships. In order to do this, broker-dealers need

to make major investments in advisory platform capabilities and in training investment professionals to

maximize their opportunities.

Figure 20: Broker-Dealers’ View of the Independent RIA Marketplace

Threat14.9%

Opportunity85.1%

Page 28: The Broker-Dealer of the Future

24 THE BROkER-DEALER OF THE FUTURE

It is not clear how this opportunity will be captured. The value proposition that a broker-dealer can offer

to an investment professional wishing to operate as an RIA is yet to be formulated. The traditional role

of providing scale and infrastructure has already been fulfilled by the custodians. To create a meaningful

affiliation, broker-dealers will have to identify new factors.

While the RIA issue is specific to the independent broker-dealers, it affects the entire industry, as many

investment professionals also leave banks and full-service firms to establish their own businesses.

Who Is Managing the Assets Anyway?

The role of the investment professional in the advisory business is also dramatically and rapidly changing.

Different affiliation channels seem to use varied approaches to managing assets. Investment professionals

affiliated with banks and credit unions are currently heavily skewed toward mutual funds, but they project

a more balanced portfolio in the future. Investment professionals affiliated with independent broker-dealers

see modest shifts in the portfolio mix. Primarily, this is a shift away from mutual funds and toward more fee-

based managed accounts. Modest portfolio allocation changes were anticipated for investment professionals

at full-service regional firms, primarily in a shift toward managed accounts. Investment professionals across

all affiliations project a reduced focus on mutual funds and an increase in fee-based managed accounts.

Figure 21: Advisory Program Assets, Current and Change Expected

CuRRENT PERCENTAGE

OF TOTAL

ChANGE IN 5 yEARS

TyPE INVESTMENT PROFESSIONALS BROkER-DEALERS

Mutual Fund Advisory 34.9% -6.1% -2.3%

Fee-Based Brokerage 20.8% +2.5% +1.6%

Separately Managed Accounts (SMAs)

14.7% +5.5% +3.7%

Investment Professional as Portfolio Manager

14.5% -1.9% -5.2%

Unified Managed Accounts (UMAs)

3.0% +2.9% +6.7%

Other 12.1% -1.8% -4.5%

To manage the shift from transactions to advice, broker-dealers must embrace the advisory model and

support their investment professionals in a fee-based environment. For those broker-dealers that choose

to utilize their corporate RIAs to address this trend, a focus on the implementation of packaged investment

solutions will simplify and streamline delivery. The packaged approach provides integrated financial

planning, product selection, and investor communications. This approach improves the economics for

customer acquisition and servicing, while allowing flexibility and customization.

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IDEAS WITHOUT LIMITS 25

Shrinking Margins Demand Greater Operational EfficiencyThe operating profit of broker-dealers is being squeezed by growing payouts and the increased costs of

compliance and service. The competition is also fierce, and requires even higher levels of scale in order to be

profitable. Many broker-dealers already operate on very thin margins. When surveyed, approximately one-

third of broker-dealer management personnel indicated they have a less-than-5% profit margin. Another

third indicated operating margins of 6%–10%. However, fewer than 20% of respondents indicated their

operating margins would be less than 5% in the next five years.

Figure 22: Distribution of Broker-Dealer Profit Margins, Current and Expected

25%+

21% – 25%

11% – 20%

6% – 10%

0% – 5%

<0%

TODAY

7.9%

25.4%

IN 5 YEARS

PERC

ENTA

GE

OF

BRO

KER-

DEA

LERS

3.2%

31.7%

30.6%

6.5%9.7%

35.5%

16.1%6.3%

25.4%

1.6%

Despite thinning margins, however, cost control was ranked the lowest among the list of broker-dealer

priorities, as noted previously in Figure 12. While it is not the highest of priorities, many broker-dealers are

very likely to make some attempts at cost control. Most likely among the measures are process improvements,

imaging and workflow, and automation. Staff reduction is the least likely measure, with lower investment

professional compensation a close second.

Figure 23: Broker-Dealer Likelihood of Cost-Reduction Activities

PERC

ENTA

GE

OF

BRO

KER-

DEA

LERS

100% CERTAINTY

SOMEWHAT LIKELY

NOT VERY LIKELY

NOT AT ALL LIKELY

VERY LIKELY

LOWERINVESTMENT

PROFESSIONALCOMPENSATION

5.3%

15.8%

47.3%

31.6%

STAFFREDUCTION

21.1%

42.1%

36.8%

AUTOMATIONOF MANUALACTIVITIES

36.8%

36.8%

26.4%

PROCESSIMPROVE-

MENTS

55.0%

30.0%

15.0%

IMAGINGAND

WORKFLOW

55.5%

27.8%

16.7%

RELOCATION

5.6%

16.7%

50.0%

27.7%

LOWERCOST

TECHNOLOGY

5.0%

45.0%

35.0%

15.0%

CONSOLIDATION

15.8%

10.5%

31.6%

36.8%

5.3%

Page 30: The Broker-Dealer of the Future

26 THE BROkER-DEALER OF THE FUTURE

One critical decision that broker-dealers need to make with respect to cost-reduction initiatives is which

activities benefit from an outsourced versus proprietary solution.

The cost of operating as a broker-dealer consists of two primary components that are difficult to separate,

but nonetheless should be separately analyzed. If we focus on the necessary functions of a broker-dealer to

operate in regulatory compliance with, and facilitate the business of, affiliated investment professionals, we

will find a cost structure significantly below the average operating cost reflected in the income statement of

most broker-dealers. The difference comes from the fact that today, a very significant portion of the broker-

dealer expenses relate to value-added functions that are offered to affiliated investment professionals as part

of the broker-dealer value proposition (Figure 24).

Figure 24: Broker-Dealer Service Activities

CORE SERVICES VALuE-ADDED SERVICES

> Accounting and record keeping> Commission processing> Compliance> Trading> General occupancy and administration

attributable to the above

> Analytical tools> Marketing assistance> Practice management> Research> System support> Trading and reporting technology> Training

It is fair to say that close to half of the expenses of the broker-dealer relate to value-added functions of

the organization. Without the value-added components, the broker-dealer will be unable to retain (not

to mention recruit) investment professionals.

Back-office processing had the greatest number of broker-dealers anticipating an increase in outsourcing,

followed closely by product training. Sales, marketing, and fulfillment represented the greatest source of

insourcing, along with research and sales training. The most outsourced activities today are trade clearing,

research, and account aggregation.

It is important to note, investment professionals ranked a paperless environment as their third-most-

important broker-dealer attribute. Although more than half of the broker-dealers surveyed do not currently

offer this, every broker-dealer surveyed believed this would be offered within five years.

Page 31: The Broker-Dealer of the Future

IDEAS WITHOUT LIMITS 27

Figure 25: Broker-Dealer Tendency to Outsource or “Insource,” Current and Expected

TODAy IN 5 yEARS

Account aggregation In/Out In/Out

Back-office processing Insource In/Out

Call center Insource Insource

Mail/image Insource Insource

PC help desk In/Out In/Out

Product due diligence Insource Insource

Product training Insource In/Out

Recruiting Insource Insource

Research Outsource Outsource

Sales training Insource Insource

Sales, marketing, and fulfillment In/Out Insource

Systems development Outsource In/Out

Systems support Insource Insource

Trade clearing Outsource Outsource

Web administration In/Out In/Out

Technology

Innovative technology, whether delivered internally or through outside providers, will be critical to success.

The strength of the technology platform will differentiate broker-dealers by creating more satisfied, productive

investment professionals and by increasing margins. Many of the technological solutions viewed today as value-

added services will become must-haves.

Successful broker-dealers will wisely invest in enterprise systems to lower costs, increase operating

effectiveness, enable investment professionals, and support the ease of doing business. Most will forge

strategic partnerships with outside providers, including scale players with enough market presence and

negotiating clout to be rewarded with proprietary customization at nonproprietary prices.

Page 32: The Broker-Dealer of the Future

28 THE BROkER-DEALER OF THE FUTURE

Operational Efficiency

In an environment where payouts reach as high as 98% for independent broker-dealers, operational

efficiency is no longer something for which broker-dealers should strive; it is a critical component of their

survival. To be able to afford the high payouts, broker-dealers need to have tremendous scale and efficiency.

The executives we interviewed focused on three primary sources of efficiency:

> Streamlining of operations: Efficiency at the broker-dealer is a function of streamlining processes, as a

typical broker-dealer organization processes thousands of transactions every day. Excessive exception

handling that requires manual processing results in high costs. The same is true for acquiring specialized

systems to process relatively small amounts of business.

> Achieving scale: Economies of scale play a significant role in the total cost structure of a broker-dealer

organization. The scalable portions of the income statement include technology, compliance, research,

due diligence, and general administration. Larger organizations with their own advisory departments

benefit from scale in their portfolio reporting and due diligence functions.

> Leveraging investment professional productivity: There is obviously a strong correlation between the

productivity of investment professionals and a broker-dealer’s profitability. Low-revenue investment

professionals tend to tax the operating systems of the broker-dealer through inexperience and demand

for support.

Every organization will find its own combination of factors. Ultimately, efficiency is not a goal in itself and

needs to be integrated with the strategy of the broker-dealer. Achieving the lowest level of overhead is not

necessarily the goal of every organization, as some may focus on delivering a higher level of boutique services.

One thing is clear: the combination of high payouts and a low level of efficiency is unfeasible.

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ConclusionThe evolution of the industry is directed by changes in investor behavior, regulation, and technology. The

changes we have discussed —changes in investment professional expectations, investor behavior, and advisory

business models—are not merely opportunities to fine-tune the strategy of broker-dealer organizations, but

rather require dramatic shifts in strategy.

There are many paths that can lead to success. Regardless of the path, certain factors will be critical for all

broker-dealers: improving investment professional productivity; supporting fee-based advisory models; and

improving margins through outsourcing, expense controls, and operating efficiency. Not one of these is

possible without astute investments in technology.

In order for broker-dealers to optimize investment professional performance, they must close the gaps

between their current value proposition and the needs of the investment professional. In addition, broker-

dealers need to help investment professionals learn about the forthcoming changes in their customers’ needs.

A conscious investment of financial and human capital will be required, but the investment will pay off by

way of attracting and retaining top talent and supporting streamlined investment professional practices that

are reflective of the needs of investors. Those firms that empower their investment professionals with robust

training programs, efficient technology, and practice management support will be among the leading firms

of the future.

Competition will only intensify. There are few signs of decreasing regulatory pressure or a decline in investment

professional compensation. Broker-dealers must sustain and revive their profitability by selectively outsourcing

noncore functions and capitalizing on the increasing demand for advice to drive fee-based revenues. Successful

broker-dealers will utilize technology to drive better investor outcomes, particularly with regard to the tax-

efficient distribution of assets and income solutions.

The broker-dealer of the future will be an organization that is well differentiated from the competition and

capable of attracting and retaining talented investment professionals. The conditions for success are there—

the investor demand for financial advice is higher than ever, and the changes in the industry allow smaller

firms to find successful ways of competing with large, well-established firms. Although it is easy to become

overwhelmed by the challenges, the goal of this report is to have laid the groundwork that combined with

the vision and passion of a leadership team, will allow broker-dealers to set their own course for the future.

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30 THE BROkER-DEALER OF THE FUTURE

Ideas Without LimitsThis study is part of Pershing’s thought-leadership program, Ideas Without LimitsSM. Ideas Without Limits

provides financial services firms and their investment professionals with strategic insights, ideas, and

best practices delivered through independent studies and white papers. It is a component of our unique

practice management program designed to help firms drive growth, optimize human capital, and maximize

operational efficiency—going beyond high-level guidance to offer actionable information, personalized

consulting, and ready-to-execute solutions.

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About UsPershing LLC (member FINRA, NYSE, SIPC) is a leading global provider of financial business solutions to more than 1,150 institutional and retail financial organizations and independent registered investment advisors who collectively represent over five million active investors. Financial organizations, investment professionals, and independent registered investment advisors depend on Pershing’s depth of experience and consultative approach to provide them with forward-thinking solutions that help them to grow their businesses. Located in 19 offices worldwide, Pershing is committed to delivering dependable operational support, robust trading services, flexible technology, an expansive array of investment solutions, practice management support, and service excellence. Pershing is a member of every major U.S. securities exchange and its international affiliates are members of the Deutsche Börse, the Irish Stock Exchange, and the London Stock Exchange. Pershing LLC is a subsidiary of The Bank of New York Mellon Corporation. Additional information is available at www.pershing.com.