Why Brokerage Houses May Be PE’s Dream Opportunity

Proposed regulatory changes, if approved, will expand a stock broker’s fiduciary duty to their clients, meaning greater legal risk and higher compliance costs for brokerage houses across the country. That reality, coupled with agitation among some investors for large financial institutions to simplify and shed assets, has made it a good time to be a private equity buyer.

It’s a tough time to be a broker-dealer, and private equity smells an opportunity.

Proposed regulatory changes, if approved, will expand a stock broker’s fiduciary duty to their clients, meaning greater legal risk and higher compliance costs for brokerage houses across the country. That reality, coupled with agitation among some investors for large financial institutions to simplify and shed assets, has made it a good time to be a private equity buyer.

The AIG deal

Last month, New York-based Lightyear Capital and PSP Investments, the Canadian pension fund manager, announced the purchase of AIG Advisor Group, the broker-dealer arm of AIG. In addition to the impact of regulatory changes, AIG has been under pressure from activist investor Carl Icahn to shed assets.

“We were looking for another opportunity to be in this part of the business, and we found it in AIG,” Don Marron, founder and chairman of Lightyear, said in a recent phone interview. “The business is taking advantage of the enormous trend of going from defined-benefit to defined- contribution [plans].”

Look for Lightyear to follow the model it followed with Cetera Financial Group, an entity born from Lightyear’s 2010 purchase of ING Group’s broker-dealer arm, ING Advisor Network. Through acquisition and operational improvement, Lightyear successfully exited the company in 2014. As part of the AIG announcement, Lightyear appointed Cetera’s former CEO, Valerie Brown, as executive chairman of Advisor Group.

A New Reality for BDs

The proposed regulatory changes would require broker-dealers to act in a client’s “best interest,” a tightening of the current standard which only requires that a broker-dealer recommend a “suitable” investment. The inherent conflicts, real and imagined, of the traditional commission-based model, therefore, mean greater disclosures and legal exposure for broker-dealers.

And the burdens are potentially greater for broker-dealers that are part of a larger organization that, like AIG, “makes” some of the financial products sold through its brokerage arm.

The ability to consolidate broker-dealers into a single independent entity, along with Lightyear’s familiarity with fee-based revenue structures, made the deal irresistible to Marron, who had unsuccessfully sought to buy the AIG group once before, in 2009.

“We concluded that, first of all, the scrutiny and potential changes from the Department of Labor will move you more toward third-party managers managing assets for a fee, which is our focus in any case,” says Marron.

Combined with the ongoing transition from defined-benefit to defined-contribution retirement plans and the aging of the U.S. population, the broker-dealer opportunity, it appears, is private equity’s to lose.