New York, NY – According to a report recently published by Colorado-based consulting group, the Compliance Department, the number of U.S. broker-dealers that shut their doors during the first quarter of 2012 was less than the number that closed down in the first quarter of 2011. Despite this slowdown, the overall number of B-Ds in the US continues to decline as sliding commissions and increased legal and regulatory requirements puts enormous pressure on smaller firms.
B-Ds Continue to Close
During the first quarter of 2012, 93 broker-dealers are reported to have closed, compared to 137 firms during the same period in the prior year. However, only 44 new B-Ds opened during the first quarter of 2012, whereas 57 broker-dealers started up in the first quarter of 2011.
This slowdown in closings doesn’t dramatically alter the negative trend in the industry. FINRA reports that the number of registered broker-dealers has dropped by 11% over the past five years – from 5,005 broker-dealers in 2007 to 4,428 in March of this year.
Factors Driving B-D Weakness
A number of factors have contributed to this decline. Certainly, increased regulatory requirements have been one factor which has led smaller broker-dealers to shutter their operations. David Alsup, national director of business development with the Compliance Department explained, “You just can’t be a two-man shop and hire a $70,000-per-year compliance officer and stay in business.”
Rising legal costs have also squeezed a number of B-Ds. Almost 50 broker-dealers that sold failed private placements of firms like DBSI, Medical Capital Holdings, and Provident Royalties are reported to have closed down due to the high cost of litigation and potential arbitration judgments.
Another factor which has prompted a number of B-Ds to shut their doors has been weak commission revenue caused by falling equity commission rates and declining trading volume. In 2011, Greenwich Associates reported that the average “all-in” commission rate paid by U.S. institutional investors was 3.7 cents per share – down from 3.8 cents from 2010’s study. This was due to a drop in the average commission rate for normal, high-tough agency trades. Equity trading volume also remains weak. In fact, in April 2012, the average daily trading volume of US equities was at its lowest level since December 2007.
“I don’t see an end to the steady downtick” of broker-dealers’ closing, explained the Compliance Department’s Alsup. “And I don’t see an uptick for a while.”
Impact on Research Biz
While most of the 93 broker-dealers that shut their doors during the first quarter of 2012 were either agency brokers or small retail oriented B-Ds and did not publish research, some of the closed firms clearly did. As we have mentioned in the past, Royal Bank of Scotland shut down its equities research earlier this year. Firms like Ticonderoga Securities, WJB Capital and Kaufman Brothers also recently shut down, while in the UK Evolution Securities was bought by Investec, and Collins Stewart Hawkpoint was absorbed by Canaccord.
Ultimately, this trend means there are fewer firms producing brokerage research, and fewer job opportunities for sell-side analysts. However, we are unlikely to hear a great deal of grumbling from the buy-side about this shakeout. Part of this is because declining commission pools have made it difficult for buy-side firms to maintain what they pay their sell-side firms for the research they provide.
In fact, one broker liaison we spoke with recently explained that his firm was likely to eliminate half of the large brokers they used due to the duplication of execution and research services they provide. They just don’t generate enough in equity commissions to keep all of their sell-side broker-dealers fed.
Could this trend benefit independent research firms? It is possible. However, most buy-side firms explain that the tight market conditions over the past few years have taught them that they don’t need to pay their research providers as much as they thought. Consequently, we doubt that any savings buy-side firms generate from reducing the number of sell-side firms they use will go to boosting payments to independent research firms.