Independent Brokerage firms have been growing at a high rate in the brokerage industry. Heavy recruiting backed by profitable business models and high payouts have attracted entrepreneurs on both the broker dealer and registered rep sides of the business. Working for an Independent is enticing. The name says it all: It´s the brokerage business mixed with the American Dream.

But where is this industry going? With major banks and insurance companies mixing it up with upstarts and aggressive privately held firms the future seems competitive yet promising. Very often a good way to predict the future is to have a better understanding of the past. When looking at the origin of the Independent Brokerage industry one uncovers a fragile yet resilient group of investment professionals.

The Past

From the late 1950s through to the late 1960s an interesting investment product was selling quite well. It was called, among other names, A Contractual Mutual Fund. This product allowed investors to commit a certain amount of money over several years, contributing $50 or more per month. The brokers who sold these Contractual Mutual Funds would receive high payouts sometimes as much as 100 percent on their sales commissions. The broker dealers could afford to do this because they would get money back on reciprocal trade deals from the funds they were selling. Therefore the rep would keep the commission and the broker dealer would get large volumes of fund trades running through their firm. It was not uncommon for the reps to be selling these products on a part-time basis. School teachers and cab drivers might spend their free time selling these investment products to friends and family. At the time, the only license one needed was a Series 1. Later on some of those Series 1s would be grandfathered into Series 7s. In the late ‘60s the SEC enforced laws that changed the way mutual funds could reciprocate with firms that distributed their products. These new laws ended the selling of Contractual Mutual Funds for Independents. Most of the firms went out of business and a lot of the reps migrated into selling Life Insurance.

Tax shelters

The late ´60s and early ´70s were very tough market years, but in 1972 a change in the tax code opened up a new type of investment product which was embraced by the fledgling Independent firms. Tax shelters allowed a phenomenal benefit to people with high incomes. A doctor, for instance, who at the time might be making $150,000 a year and, paying as much as 70 percent in income tax would be a prime candidate for this type of investment. The investment could be a cattle ranch, a movie theatre, or a gold mine; it didn’t really matter. The important thing was the leveraged tax savings. You could invest $10,000 and get as much as $40,000 in tax write-offs. Because of the high income tax rates at the time, it equated to a deal few people could refuse. And few did. Mainline firms also sold tax shelters, but Independents like Integrated Resources, which later emerged from the ashes as Royal Alliance flourished with this new product. Recruiting brokers for tax shelter sales proved relatively easy and the number of Independents grew.

Easy come retroactive go

Like a storm that destroys much in its path, every 10 to 15 years a major legislative change cuts the industry off at the knees. The Tax Reform Act of 1986 ended the tax shelter status of those investment products that rebuilt the population of Independent Brokers from the malaise of the early 70’s. The change in law was damaging enough, but it was enforced retroactively, which bankrupted many firms and sent a lot of investors to court. Fortunately, for investors and Independents alike, another investment product was booming just before the axe fell on tax shelters. Mutual funds were hot and Independents were good at selling them. The Wire Houses had many of their own funds to push so the Independents were actively courted with all sorts of payout mechanisms by funds looking for distribution.

For the firms that survived the storm it was off to the races again, and this time large institutions were starting to take notice. As the ‘80s slipped into the ‘90s, and crash turned into recession, many Independent firms continued to recruit based on the same fundamental reasons that continued to tempt future Independents: Liberty. Be your own boss. Sell whatever you think is best for your clients. No more office politics or wasted meetings. Just get out there and sell. The payouts were still high and technology was making the whole process much easier and more efficient.

Bull markets never hurt anyone

We all remember the ‘90s fondly. Yesteryear always seems so innocent until proven guilty. The bears came in and people complained. Complaints lead to lawsuits and lawsuits are now leading to change. The SEC and Elliot Spitzer have been busily auditing Wall Street and its vast networks of committees, correspondence and camaraderie. So far, Independents have seemed to be spared from the major scrutiny of the law, but they are extremely interconnected within the industry and scandals involving some of their best selling products (i.e. mutual funds) can lead to some legislative changes and/or fines potentially crippling to some and completely decimate others. Major firms like Wachovia, Raymond James and AIG can pay the legal fees and fines necessary to keep their Independent subsidiaries functioning. Some of the smaller firms may have more trouble if the law swings one way or the other, but rest assured where the law taketh away the law giveth with some new tax advantage or monopolistic niche. And Independents will be able to move faster than their cousins at the majors and regionals.

Who are the Independents?

“I must have liberty Withal, as large a charter as the wind, To blow on whom I please.” — William Shakespeare

Depending on who you count as an Independent there are anywhere from 100,000 to 135,000 Independent Reps in the U.S. according to Choose Information Exchange, Inc., which has kept data on stockbrokers for over 15 years. They make up anywhere from 15 to 20 percent of the approximately 680,000 NASD Registered Representatives in the United States. They have an average income of $119,282, have been in the business for an average of 12 years, and are on average 46.5 years old. Because they are on average older, and thus have been in the business longer, Independents tend to earn more than the average stock broker.

Independents typically have particular traits which guide them to the Independent side of the brokerage industry. They are entrepreneurial types who may not like the stricter guidance and management of their non-independent brethren. Independents may not mind picking their own office furniture or hiring (and firing) their own secretaries. They sell only their own investment advice to clients, without quotas or favoritism besides their own. They need to be a little tougher because there are very often no safety nets. While times can be lean and lonely, the Independent firms offer varying degrees of support for their registered reps which can sometimes go almost as far as a traditional firm in trying to ensure that the broker continues to produce.

Join us!

Independent firms are one of the fastest growing segments of the brokerage industry. They recruit from within the ranks of Wire Houses, Regionals, Insurance, Discounts, Banks and other Independents. They offer levels of freedom and commission payout that cannot be matched by the traditional brokerage firm models. The intensity of the recruitment effort by Independent firms shows the simplicity of their business models. The more producers that are on their rosters, the more they make. That model does not quite translate to the Non-Independent firms as easily. Non-Independents very often rely heavily on streams of income that have little to do with the quantity of brokers that work for them. Furthermore the NASD, SEC and Clearing Firms do try to manage the growth. They readily enforce proper ratios of compliance officers to brokers and try to curb disproportionately large influxes of new brokers into a firm.

The Future

As the number of Independent Reps surpasses the number of Wire House Reps, there may be some fundamental changes in the brokerage industry. We are already witnessing large traditional brokerage firms like Raymond James and Wachovia Securities offering first-class independent options to brokers under their brand names.

Will Independents start to become a force in the very lucrative investment banking side of the brokerage business? The old established networks of moneyed individuals and institutions are very selective about with whom they deal. Generations of wealth have stayed in the same banking channels for years, however, one must consider the effects of major technological changes like the Internet that can cause uprooting in all sorts of industries. Of course, there is always the chance of a well meaning legislative adjustment spurred on by shaky markets and prosecutorial media events than can make or break Independents for years to come.

We would like to give special thanks to Jay Lewis one of the founders of Nathan & Lewis for his insight into the history of Independent firms. Mr. Lewis is now a consultant for the financial industry.