Life of a Brokerage Firm - Part 1

Life of a Brokerage Firm <Part One> Ron Grossman and Ryan Griffeth conducted as series of interviews discussing the various stages of a brokerage firm. Interviews are presented here in Q&A form. There are a number of participants in this article series from brokerage firms, new individual brokers and industry professionals contributing their unique opinion and expertise. <Industry Professional> James Bibbings, Turnkey Trading Partners What is the background of new IBs or brokers entering the business today? I began my career in this industry when I moved to Chicago to work for NFA in 2005. At that time the CME and CBOT were still separate and both had active (albeit slowing) floor businesses. IBs were being created by guys who could see the end of floor brokerage was near. They were coming “upstairs” to broker and to do so needed to set up CFTC/NFA member IBs. From what I recall in the early to mid-2000s there was a “boom” in IIB formation that didn’t really let up until the financial crisis in 2008. Since 2008 though the industry has been in a period of consolidation for a number of reasons. The economy was tough, the financial industry saw a number of brokerage firms fail, a myriad of regulations were put in place driving up costs and complexity, and frankly the old guard started to get tired. As of today all of the aforementioned factors combined with compressed commissions have led to a significant decrease in IB formation. There aren’t a lot of “new” APs coming into our industry within the IB space today. In my opinion most new IBs are formed by guys who have established books of business. What is the typical path IBs or new APs take to get into the business present day? There are several paths to getting into the industry today that we regularly see at Turnkey Trading Partners. The first is when a relative of a longtime broker or trader is brought up in the family business. Our industry is small and very tight knit. Commodity futures can be difficult to understand and most people are not taught how the industry works in school. A lot of people coming in are simply taking over an existing book of business. Similarly, an existing brokerage shop may choose to hire a seasoned sales person from another financial industry. They then will focus on training such a person about how to work within our industry. Another way that new APs come into the industry is through the pursuit of becoming a Commodity Trading Advisor (“CTA”). The CTA pathway is the cheapest, fastest, and easiest way to get started in the commodity interest marketplace. Most people who are new to the industry find the idea of managing money in “derivatives” sexy. They think there is an easy pathway to riches as a “hedge fund manager”. The unfortunate reality for these people is that they usually end up losing the seed money of their loved ones within their first year of trading. So how is that relevant to your question? Rather than give up and quit, a fair number of these people realize that they are actually better salesmen or market analysts than traders. As a CTA they get exposed to the industry and our markets. They learn from their mistakes while making new connections. Some of these connections are other traders who have better records and are making a lot of money. Others are brokers who perhaps tried to help raise the start-up CTA money while it was trading. One way or another these failed “hedge fund managers” often can leverage what they learned as a CTA and become successful as a broker. Once an IB or Broker decides to enter the business, what are the most important things they need to do? In this order with no exception… 1) Work with a knowledgeable consulting firm or attorney to set your foundation correctly from the word go. Starting an IB and considering what pathways to take in developing the business is incredibly difficult. The money you spend on help will be well worth it. In many ways the expense will pay you back in spades over a successful career. Compliance and/or accounting missteps can and will kill an IB operation. 2) I know a lot of brokers and traders like the movie Glengarry Glen Ross so this should resonate “Always Be Closing.” A lot of brokers get complacent and start with a handful of relationships. Anyone who has been in the industry long enough will tell you that those accounts can close overnight. Constantly work your lead channels and find ways to get new relationships growing. If you do not have a steady flow of business coming into your business you’re working on borrowed time. 3) Be smart enough to know what you don’t know. Knowledgeable brokers should focus on sales and the management of their company. A huge mistake that is often made is that brokers and IBs take on work they are not competent in. They often refuse to outsource non-revenue generating functions such as accounting and compliance at their own peril. Choosing not to spend on the right resources at the right time can be as much of a killer as not having new leads. If you can’t get out from underneath your day to day obligations you’ll never be able to expand the business you already have. What is the most important thing for a new IB or broker to have in writing? As a compliance and operations professional obviously the answer is everything should be in writing. While we all have great relationships in the space our industry can be ruthless. Anytime a deal is struck it should be memorialized with an agreement that clearly identifies the terms. A good attorney or consulting firm can literally make or break your career. I suppose if I had to identify the largest single area where things get nasty it would have to be when there is a dispute over who has the rights to customer accounts. Brokers, IBs, and FCMs can and do try to claim customers introduced by or through them are theirs. It’s always best to know who has the rights to your accounts when times are good rather than fighting over it when times are bad. What are the most important things an IB should look for from an FCM Contrary to popular belief all FCMs are not created equal. As the industry has consolidated the FCMs left standing all have competitive advantages they have been able to exploit to stay in business. Some firms have great technology, other firms compete on service, yet other firms have established brands and relationships. There are any number of reasons an IB might choose to work with a given FCM. The choice in who you might work with depends on the type of business being brokered and the overall goals/needs of the IB. IB’s should not be afraid of having more than one relationship for different types of business. It’s also wise to have redundancy and/or contingency plans in place if something with your FCM relationship begins to go South and you need to move your business. What alternative arrangements are available for one interested in the business but not wanting to form a new IB and how do you make that determination? There are three ways to get into the brokerage business today. The first is to start your own independent introducing broker (“IIB”). Pursuing this route provides the most autonomy and largest possibility for flexibility. IIBs on the other hand also carry with them the largest operational and regulatory burdens. An IIB is 100% responsible for its own obligations and will need a relatively seasoned operator to be successful. The second way to start an IB is to launch a Guaranteed Introducing Broker (“GIB”). A GIB has much of the same autonomy of an IIB but is required to work exclusively with one FCM. In exchange for this exclusivity an FCM provides a GIB with the capital backing necessary to operate, many of the operational policies and procedures to remain compliant, and often will handle a large number of day to day office functionalities on behalf of the firm. The third and final way to become a broker would be to join an existing FCM, GIB, or IIB. This can be done by simply working at their main office location or convincing them to add you as a branch office manager at a branch location in your hometown. A branch is required to do everything the way the firm they join says and there is little to no autonomy. Whether a broker choses to pursue an IIB, GIB, or just become a broker at an existing firm depends on each individual brokers personal goals and needs. <Industry Professional> Matthew Kluchenek & Michael Sefton, Baker & McKenzie Once an IB or Broker decides to enter the business, what are the most important things they need to do? Generally, we see three items as the most significant at the outset: Registration, Compliance and Contracts. If the IB is not already registered with the CFTC and a member of NFA, it will need to do so prior to conducting any business involving commodity interests. Generally, the registration requirements are greater for an independent IB versus a guaranteed IB, and an owner of independent IB should allow 2-3 months time to complete the registration process. For individual Brokers, it is critical that they are properly registered as associated persons prior to soliciting customers. Generally, associated persons are required to pass the Series 3 exam as part of the registration process so individual Brokers should take into account any time necessary to study for the exam as well as the registration process, itself. In addition, new IBs will need to implement a compliance program. In the era of Dodd-Frank, this function is critically important. Finally, new IBs need to ensure that they have agreements in place that can protect them—whether with APs, vendors or others. IBs should not overlook the importance of agreements that protect their business. There are of course other considerations, but these tend to be the most prominent at the outset. What are the barriers to entry? From a legal perspective, barriers to registration are typically prior serious or financial criminal matters or regulatory disciplinary matters. It is important to remember that not all criminal matters or regulatory disciplinary matters, will be grounds for a denial of registration. Depending on the nature of the matter and when it occurred, registration may still be possible. However, failure to disclose a matter that is required to be disclosed will virtually guarantee a denial of registration, no matter if the underlying crime or disciplinary matter was relatively innocuous or some type of youthful indiscretion. Along with a registration application, individual applicants are required to submit copies of their fingerprints, which NFA uses to run background checks. If a matter is required to be disclosed, but is not, it will usually show up in NFA’s background check, even if the matter was technically expunged. Therefore, applicants should ensure that all required matters are disclosed on their applications. If an applicant questions whether a matter should be disclosed, they should check with NFA and/or seek legal advice prior to submitting the application. When a contract is presented to an IB or Broker what should and should not be included? Generally, any agreement between an IB and an individual Broker should address the nature of the arrangement, conduct of the Broker, compensation, ownership of confidential and proprietary information, restrictive covenants such as non-compete or non-solicitation provisions, indemnification and how disputes will be resolved. These agreements should be in writing. When being asked to sign a personal guarantee, are you able to cap the amount that is being signed for? Yes, but this is an item that would be negotiated between the parties and the amount of a cap, if any, will be a function of the parties’ leverage. Nonetheless, it is not unreasonable for an IB (in relation to an FCM) or a Broker (in relation to an IB) to ask for a cap. What is the best (legal) structure for an IB to set up in? From a legal perspective, any entity which provides limited liability for its owners will suffice. Most IBs are structured as limited liability companies or S corporations. Generally, limited liability companies provide the most flexibility for structure and require the least amount of corporate formalities such as written resolutions or meetings. Anyone interested in forming an IB should also consult his or her personal accountant. Depending on the owner(s)’ personal situation or tax liability, accountants may recommend one type of legal entity over another. <New Broker> Kyle Bumsted, Broker What is your background? Where to start on this one.... For the most part, production agriculture. Including but not limited to: Family farm operation where I served as CFO, that produced corn & soybeans, growing feeder cattle /backgrounding them. Cow/calf (purebred & commercial herds). I was also involved with a custom harvesting company that harvested wheat, pulse crops, & other small grains throughout the plains states & Canada. How did you decide to get involved in futures trading and brokerage? I've always had an interest in the futures markets. With boots on the ground experience in production agriculture, the futures markets & production agriculture/agribusiness go hand in hand. Have you found any barriers to entry? Not really, there's opportunities everywhere, you just have to find them. Whether it's word of mouth, phone calls, or Internet research....they're out there (opportunities) Were there any other industries you considered? A few, but I've always been fascinated with the futures markets...so it was an obvious choice!! What type of business do you intend to conduct? Clean, and by the book! The only way!!! My focus on investors/speculators, would be helping them get maximum ROI, while farmers & hedgers would be to utilize strategy in their marketing plans. Do you have a mentor or someone to help guide you through the process of becoming a registered broker? ABSOLUTELY!! Carmen at B&D commodities has helped me by answering questions, exam preparation, & meeting other brokers/industry professionals. I just walked into their office one day & started asking questions. Three weeks later, Carmen had me in Chicago at the RJ O'Brien IB conference, meeting other brokers & industry professionals. She introduced me to sone great advisers like James Brooks (Bugzy), and Ryan Turner (both from RJO). Meeting with these guys got me some good sound advice and insight into the industry. I've met several people in the industry that have given me sound advice as well: Steve & Paul Georgy (Allendale group), Sue Martin, (Ag & Investment Services Inc.) Brian Hoops, (Midwest Market Solutions), Ted Siefried & Brian Grossman (Zaner Group). Have you considered forming your own firm? I've tossed the idea back & forth, but I'd like to get some good solid training/experience...a branch office for a firm would not be out of the question at some point! What do you anticipate will be your biggest challenge upon entering the business? Learning all of the different strategies that are used to hedge & speculate the futures markets. Everyone has a different philosophy and strategy they like to use. I'm sure the answer that most are expecting is the "building a book & customer base"...yes, I know that will take a lot of time & work to accomplish! Have you found adequate resources and information related to entering the industry and navigating the space? Yes, from The NIBA website to the FINRA website, there's tons of information out there!

Life of a Brokerage Firm - Part 1

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