Broker Dealer Models Thursday

Broker Dealer Models Broker Dealer Types:  General Securities  Introducing/Fully Disclosed  Clearing  Franchise/Independent Contractor  Micro-cap  Mutual Fund  Discount  On-line  Bank Affiliated General Securities Broker Dealer  Description      Also known as “full service” or “wire house” B/D Generally, “Wall Street” firms such as Merrill Lynch and Morgan Stanley Agents are generally domiciled in large branch offices where business is conducted by phone with “face to face” supervision by branch managers Agents are generally considered to be “employees” Formal employee training program General Securities Broker Dealer   Normally not allow or restrict outside business activities Provide all types of services • • •  Execution Clearing Safekeeping Typically offer “managed accounts” for customers General Securities Broker Dealer  Advantages:   Nationwide name recognition and advertising campaigns Complete control of transaction processing • No reliance on third party for clearing activity  Retain all commissions • Do not pay a clearing fee to a third party to perform “back office” functions  Additional revenue generated through margin debits (excess interest charged to customers over B/D borrowing rate) and stocks loaned (practice of lending stock for a fee to other B/Ds) General Securities Broker Dealer   Capture multiple revenue streams Able to create, underwrite and distribute products General Securities Broker Dealer  Disadvantages  Costly initial set-up and continual operating expenses • Requires additional “back office” personnel and procedures     Considerable regulatory compliance responsibilities imposed Greater potential monetary and compliance liability Experienced personnel required Increased net capital requirements General Securities Broker Dealer  Regulatory Issues    Proprietary products Supervision Electronic records retention Introducing/Fully Disclosed Broker Dealer  Description   The vast majority of broker dealers are this type Defined as a broker dealer maintaining a formal written agreement with another broker dealer whereby the introducing dealer does not carry customer accounts (hold customer funds or securities or confirm transactions) • The agreement specifies the terms under which execution and record keeping will be maintained Introducing/Fully Disclosed Broker Dealer    Although introducing firms will have “back offices” and record creation and retention requirements, they enter into these agreements to reduce operating expenses Required to promptly transmit money and securities The phrases “account carried by” or “account courtesy of” will be on firm’s documents 10 Limited Product Broker Dealer  Description   Generally serves as a “salesperson” offering various limited products (i.e., mutual funds, variable annuities, direct participation programs, etc.) Orders are transmitted to the mutual fund sponsor on either an “application” basis (customers’ monies and a subscription application are sent to the mutual fund sponsor) or on a “wire order” basis (mutual fund orders are transmitted by phone or wire to the sponsor without an application) 29 Limited Product Broker Dealer  Advantage       Specialized firm requiring little capital expenditure or operational expenses beyond commissions to its salespersons and general office expenses Agents only need to pass Series exam Limited products allow for a less sophisticated supervisory system and agent training Products are well designed and marketed by the issuers Sales support from third-party wholesalers Less start-up investment needed 30 Limited Product Broker Dealer  Disadvantage     Offers a limited product line to customers Investor funds are “locked up” for extended period of time Limited incentive for agents to provide ongoing review of customer accounts Supervision relies heavily on electronic reports, self-reporting and internal audits 31 Limited Product Broker Dealer  Regulatory Issues      Variable annuity suitability Switching or 1035 exchanges Supervision Mutual fund breakpoints Revenue sharing 32 Discount Broker Dealer  Description     Characterized by minimal customer contact with agents and few services offered Customers may pay extra for additional levels of service Agents generally receive “unsolicited” calls via “800” numbers rather than solicit customers Relies on advertising to draw customers 33 Discount Broker Dealer  Advantages      Low transaction costs Ease of execution Most investors conduct their own research and choose their own securities Limited number of employees Agent’s advice is limited and many trades are unsolicited 34 Discount Broker Dealer  Disadvantages   Provide minimal, if any, advice to customers Most investors using the services of discount brokers believe their market knowledge is sufficient to perform their own research and make trade decisions 35 Discount Broker Dealer  Regulatory Issues    Customers’ ability to navigate a market crisis without advice Customer service Advertising 36 Online Broker  Description      Trades are placed with the firm via personal computers Execution of trades occurs generally without any personal contact Online firms offer help desk services Custodian for small IA clients Highly dependent on technology 37 Online Broker Dealer  Advantages    Low transaction costs Ease of execution Investors perform their own research  Disadvantages     Hackers/Intruded accounts Requires enhanced anti-money laundering (AML) procedures Investors perform their own research Server/Systems Interruption 38 Online Broker Dealer  Regulatory Issues     Customers’ ability to navigate a market crisis without advice Customer service Advertising Hackers 39 Bank Affiliated Broker Dealer  Characteristics        3rd party dealer under contract with bank Broker dealer may operate using a DBA Customers tend to be conservative Face to face contact in the bank Bank employees may help steer business to the broker dealer Compliance resources at home office Agents may be “circuit riders” 40 Bank Affiliated Broker Dealer  Advantages      Captive audience Real time ability to know when clients have bank funds to invest (CDs maturing) Partner with bank – ability to piggyback on customers’ trust of the bank Bank employees are a referral network Synergy with bank marketing efforts 41 Bank Affiliated Broker Dealer  Disadvantages      Clients are generally less sophisticated Need to spend time educating clients Line between bank and broker dealer can be blurred Agents assigned to multiple office locations (circuit riders) Bank employees may be protective of bank customers and work against the agent 42 Bank Affiliated Broker Dealer  Regulatory Issues    • • Compliance with NASD Conduct Rule 2350 Suitability Supervision Networking Arrangements Incentive Program 43