NASD-MEMBER FIRMS PROFITS REBOUND IN 1Q’06 ......SIA Research Reports, Vol. VII, No. 6 (June 7,...

RESEARCH DEPARTMENT Frank A. Fernandez, Senior Vice

President, Chief Economist and Director of Research

Charles Bartlett, Vice President and Director, Statistics

Kyle L Brandon, Vice President and Director, Securities Research

Stephen L. Carlson, Vice President and Director, Surveys

Nancy Cosentino, Research Assistant

Isabelle Delalex, Vice President and Director, Industry Research

Lenore Dittmar, Exec. Asst. Claire McKenna,

Manager, Surveys Paul Rainy, Research Assistant SECURITIES INDUSTRY ASSOCIATION – [email protected], http://www.sia.com

120 Broadway, 35th Floor, New York, NY 10271-0080 – 212-608-1500, fax 212-968-0703 1425 K Street, NW, Washington, DC 20005-3500 – 202-216-2000, fax 202-216-2119 Prepared by SIA Research Department – Copyright © 2006 Securities Industry Association, ISSN 1532-6667

Volume VII, No. 6 June 7, 2006

NASD-MEMBER FIRMS PROFITS REBOUND IN 1Q’06 AFTER SLUMP IN 4Q’05

Frank A. Fernandez

SECURITIES INDUSTRY EMPLOYMENT AND COMPENSATION TRENDS

Isabelle Delalex Kyle L Brandon, ed.

SIA RESEARCH

2 SIA Research Reports, Vol. VII, No. 6 (June 7, 2006)

Table of Contents 3 .......... NASD-Member Firms Profits Rebound in 1Q’06 After Slump in 4Q’05, by

Frank A. Fernandez. NASD-reporting firms reported 4Q’05 pre-tax net income (profits) of $1.9 billion, a 13.9% drop from the previous quarter, bringing total profits for 2005 for this group of broker-dealers to $8.1 billion. For 2005 as a whole, profits increased 15.5% above the $7.0 billion recorded in 2004, but were still well below the record results of $10.6 billion in 2000. Adding these results to those for New York Stock Exchange-member firms reported earlier, for the industry as a whole, profits were $4.2 billion in 4Q’05, down 16.1% from the prior quarter. For the full-year 2005, securities industry profits were $17.6 billion, 15.2% below the $20.7 billion earned in 2004. Results for NASD-reporting firms in 1Q’06, also released last week, were impressive, showing a strong start to this year. Profits for these firms were $3.1 billion in 1Q’06, a jump of 62.0% over the immediately preceding quarter and 73.8% above the same year-earlier period, and the best quarterly result in more than five years.

16........ Securities Industry Employment and Compensation Trends, by Isabelle

Delalex, ed. Kyle L Brandon. This article summarizes some of the findings presented in the May issue of SIA’s Securities Industry Trends, which offers an analysis of the occupational distribution and demographic characteristics of headcount and compensation, as well as the drivers of these employment trends.

SIA Research Reports, Vol. VII, No. 6 (June 7, 2006) 3

NASD-MEMBER FIRMS PROFITS REBOUND IN 1Q’06 AFTER SLUMP IN 4Q’05

Summary

ASD-member firms1 reported 4Q’05 pre-tax net income (profits) of $1.9 billion, bringing total profits for 2005 for this group of broker-dealers to $8.1 billion. Profits, which were $2.2 billion in both 2Q’05 and 3Q’05, had rebounded after a disappointing start to last

year, before slumping in the final three months, declining 13.9% relative to the immediately preceding quarter (3Q’05) and 8.5% relative to the same year-earlier period (4Q’04). For 2005 as a whole, profits increased $1.1 billion, or 15.5% above the $7.0 billion recorded in 2004, but were still well below the record results of $10.6 billion in 2000.

Pre-Tax Profits: NASD-Reporting Firms*

5.3

9.110.6

5.6 5.2

7.38.1

7.0

9.4

0

2

4

6

8

10

12

14

16

1998 1999 2000 2001 2002 2003 2004 2005 2006(f)

$ billions

Quarterly

0

1

2

3

4

01 02 03 04 05 06(f)

Source: SIA/NASD DataBank (2006 forecast) *Other than NYSE-reporting firms. Adding these results to those for New York Stock Exchange (NYSE)-member firms reported earlier,2 we now have full-year results for the entire securities industry. For the industry as a whole, profits were down in 4Q’05 and for the year 2005. Profits were $4.2 billion in 4Q’05, 16.1% less than the $5.0 billion earned in the prior quarter and 37.8% down from the exceptionally strong $6.8 billion of pre-tax net income recorded in the same year-earlier period. For 2005 as whole, securities industry profits were $17.6 billion, $3.1 billion, or 15.2%, below the $20.7 billion earned in 2004, and $6.5 billion, or 26.9%, below 2003 results.

1 Other than those that are also NYSE-reporting member firms. Included 4,917 firms in 4Q’05 and 4,911 firms in 1Q’06. 2 See SIA Research Reports, Vol. VII, No. 4, April 25, 2006, pp. 7-11.

N


Source: SIA DataBank (2006 forecast); 1Q’06 for NASD is actual, while the NYSE results are estimates. Subtotals may not add to totals due to independent rounding. Results for 1Q’06 for NASD-reporting firms, also released last week, were impressive, showing a strong start to the new year. Profits for this group of firms were $3.1 billion in 1Q’06, a jump of 62.0% over results in the immediately preceding quarter, 73.8% above the same year-earlier period, and the best quarterly result in more than five years.

Slump In 4Q’05 Results for NASD-Reporting Firms NASD-member firms3 reported 4Q’05 pre-tax net income (profits) of $1.9 billion. Profits, which were $2.2 billion in both 2Q’05 and 3Q’05, had rebounded after a disappointing start to 2005, before slumping in the final three months of last year. For this group of firms, both quarterly gross revenues and expenses hit record levels in 4Q’05, as they did in both 2Q’05 and 3Q’05, in part reflecting the impact of steadily rising interest rates on both sides of the income statement. Total revenues were $25.0 billion, up 7.1% from 3Q’05 and 15.7% above 4Q’04. Meanwhile, total expenses reached $23.1 billion, 9.3% above 3Q’05 and 18.3% higher than in 4Q’04, as interest expense reached $4.4 billion, up 7.7% from the prior period and 70.3% higher than a year earlier. Net revenues, or total revenues net of interest expense, provide a better summary gauge of industry performance. Net revenues in 4Q’05 were $20.7 billion, increasing 7.0% over 3Q’05 and 8.4% over 4Q’04.

3 Includes all registered broker-dealers doing a public business in the U.S. other than those that are NYSE-reporting firms.

Included 4,917 firms in 4Q’05 and 4,911 firms in 1Q’06.


Securities Industry Quarterly Domestic Gross Revenues(NASD and NYSE Firms)

38.5 39.0 35.6 35.5 35.1 39.533.7 36.2 39.4 36.1 37.8

46.9

16.9 17.216.5 16.4 14.9

17.317.3

18.719.3

17.9 17.8

21.6

68.968.569.269.466.1

49.2 53.361.1

25.0

21.222.4

23.4

25.5 25.2 25.2 25.9

0

10

20

30

40

50

60

70

80

90

100

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

$ billions

NASD

NYSE

2002 2003 2004 2005 2006 (f)

55.5 56.252.1 51.9 50.0

56.851.0 54.9

58.753.9 55.5

68.6 70.475.7

84.591.2

93.7 94.894.494.9

Source: SIA DataBank (2006 forecast); 1Q’06 data for NASD is actual, while the NYSE results are estimates. Subtotals may not add to totals due to independent rounding.

Securities Industry Quarterly Domestic Net Revenues*(NASD and NYSE Firms)

27.2 26.322.6 24.1 25.4

28.924.9 27.2

30.125.8 24.2

29.0 27.1 25.6 28.0 28.0 29.6 28.5 28.0 29.5

14.8 14.9

14.214.8 13.6

15.9

16.117.5

16.415.8

19.118.1

21.620.719.3

18.8

18.0 20.920.020.0

0

5

10

15

20

25

30

35

40

45

50

55

60

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

*Net of interest expense

$ billions

NASD

NYSE

42.041.2

36.938.9 39.0

44.841.0

44.748.0

42.2 40.0

48.1

2002 2003 2004 2005 2006(f)

45.2 44.447.9

50.448.7 48.5

51.647.4

Source: SIA DataBank (2006 forecast); 1Q’06 data for NASD is actual, while the NYSE results are estimates. Subtotals may not add to totals due to independent rounding.


For most NASD-reporting firms, interest expense and interest-sensitive revenues are substantially smaller items on balance sheets than they are for most NYSE-reporting firms, reflecting significant differences in firm size, the composition of revenues and the importance of particular business lines. The former group principally relies on revenues from commission and fee income (22.8% of total revenues), mutual fund sales revenue (14.7% of total) and asset management fees (8.7% of total), while the latter relies more heavily on corporate financial advisory fees (underwriting, mergers and acquisitions, etc.), trading gains and other activities that generally require additional interest expense.

Composition of RevenuesNASD 2005

Other26%

Commis-sions23%

Other Securities Business

16%

Commodity and Research

0.22%

Asset Management

9%

Tradng Gains7%

Investment Account

1%

Underwriting3%

Mutual Fund Sales15%

Composition of RevenuesNYSE 2005

Mutual Fund Sales3%

Underwriting8%

Investment Account

1%

Tradng Gains8%

Asset Management

7%Commodity

and Research1%

Other Securities Business

50%

Commis-sions12%

Other10%

Composition of ExpensesNASD 2005

Interest18%

Compen-sation34%

Floor Cost19%

Other29%

Composition of ExpensesNYSE 2005

Interest55%

Compen-sation27%Floor Cost

7%

Other11%

Source: SIA DataBank


In 2005, interest expense as a share of total expenses was 18.0% for NASD-reporting firms, while it was 54.9% for NYSE-reporting firms. For both groups, interest expense more than doubled from 2004 to 2005, up 105.8% for the former and 137.0% for the latter, and “margin interest revenue” and “other revenue” were the fastest growing line items on last year’s income statements, reflecting rising interest rates and the rapid pace of financial innovation and the introduction of new product and service offerings. Margin interest revenue, although still relatively small, accounting for $2.0 billion or only 2.2% of total revenue, increased 146.9% last year. Other revenue,4 business lines not included elsewhere in firms reporting to their respective SROs,5 showed strong growth for both groups. Examining the performance of individual product and service lines for NASD-reporting firms reveals some of these trends. Commission and fee income in 4Q’05 was up 2.7% from the immediately preceding period, but 3.2% lower than the same year-earlier period, as the ongoing impact of long-term margin compression was not offset by the strong growth in transaction volume. Mutual fund sales revenue showed greater relative strength and was up 8.9% compared to 3Q’05 and 21.6% compared to 4Q’04, as fund flows increased and investors showed a preference for more risk and towards funds with higher fee structures. Asset management fees, reflecting the same trends, were up 13.7% and 16.1%, respectively, when compared to 3Q’05 and 4Q’04. Smaller business lines6 showed a more varied picture, with trading gains down 12.4% relative to 3Q’05, while underwriting revenue rose 22.0% and investment account gains increased 31.9%.

Profits for NASD Firms Rebound in Strong Start to 2006 In 1Q’06, total revenues were $25.5 billion, up only 1.9% relative to the immediately preceding quarter but still 20.6% above 1Q’05. Net revenues of $21.6 billion were up 4.6% relative to 4Q’05 and 19.6% compared to 1Q’05. Enhancing these results was a generalized decline in costs in the first quarter of this year. Total expenses in 1Q’06 fell 3.1% from levels seen in the final three months of last year, although still 15.7% above 1Q’05 levels. Compensation, the largest single expense item,7 was unchanged relative to 4Q’05 (up 13.0% compared to 1Q’05), and interest expense was down 11.0% from 4Q’05, as total liabilities were reduced at year end and, on average, were lower during 1Q’06 than in the immediately preceding quarter. This more than offset the steady rise in interest rates. All expenses other than compensation and interest, which as a group accounted for 48.1% of total expenses in 2005, were down relative to 4Q’05, with the lone exception of floor costs. Floor costs, which are commissions, fees and clearance paid to other broker-dealers, rose 3.7%. All other expense items, such as communications, occupancy and equipment, promotional costs, data processing, regulatory fees and expenses, and other costs, declined in 1Q’06 from 4Q’05 levels. Some of these smaller expense items even fell relative to year-earlier levels despite a general increase in activity/volumes of most business lines across the course of last year. Strong revenue growth in 1Q’06 was led by a rise in commission and fee income and solid gains from trading and investment accounts. Commission and fee income of $5.7 billion was up 7.8%

4 Includes the two line items on Financial and Operational Combined Uniform Single (FOCUS) report filings of “Other

revenue related to the Securities Business” and “Other Revenue (not elsewhere included),” which accounted for 16.1% and 24.6% of total revenues, respectively, and increased 76.8% and 28.2%, respectively, in 2005.

5 SROs are self-regulatory organizations, such as the NYSE and the NASD. 6 Trading gains accounted for 6.9% of total revenue in 2005, while underwriting revenue and gains on investment accounts

contributed 3.0% and 1.4%, respectively, to total revenues. 7 Compensation accounted for 33.9% of total expenses and 41.4% of total non-interest expenses in 2005.


from 4Q’05 and 10.7% above the same year-earlier level. Trading gains were $2.0 billion, up 35.1% from 4Q’05 and the best quarterly result in more than two years, while investment account gains added $0.6 billion, up 18.9%. Growth of mutual fund sales revenues and asset management fees slowed in 1Q’06 from last year’s rapid pace, rising 2.8% and 4.3%, respectively, from 4Q’05 levels, to stand 18.2% and 22.7% above results in the same year-earlier quarter. Other revenues slumped after the sharp jump in 4Q’05 but remained well above year-earlier levels. The outlook for the remainder of this year brightened as NASD firms’ profitability showed solid improvement in 1Q’06. In 1Q’06, average pre-tax profit margins increased to 12.1%, well above the 7.6% rate in 4Q’05 and the 8.9% average for all of 2005, and the best quarterly result in two years. ROE8 (pre-tax) rose to 26.0% in 1Q’06 from 16.3% in 4Q’05 and a 17.8% average for all of 2005. Showing similar improvement, ROA9 (pre-tax) rose to 1.4% in 1Q’06. Prospects remain good as revenue per employee was above $1.0 million in each of the last two quarters.10

8 ROE is return on equity. After-tax ROE was 21.5% in 1Q’06, 13.0% in 4Q’05 and 13.4% on average for all of 2005. 9 ROA is return on assets. 10 Average revenue per employee was $1,048,856 in 1Q’06.


Industry Profits Fall in 2005

Adding 4Q’05 results for NASD-reporting member firms to those for NYSE-reporting firms reported earlier,11 we now have full-year results for the entire securities industry.12 For the industry as a whole, profits were $17.6 billion in 2005, $3.1 billion, or 15.2%, below the $20.7 billion earned in 2004, and $6.5 billion, or 26.9%, below 2003 results.

Securities Industry Annual Domestic Gross Revenues

170.8 183.4

245.2

194.8

148.7 144.5 160.2

229.8

276.0

56.873.2

85.9

78.4

67.1 68.276.5

91.9

101.8

0

50

100

150

200

250

300

350

400

1998 1999 2000 2001 2002 2003 2004 2005 2006(f)

$ billions

NASDNYSE

227.6

377.8

321.8

212.7215.7

273.2

331.1

256.6

236.7

Source: SIA DataBank (2006 forecast) Subtotals may not add to totals due to independent rounding. Total revenues were $321.8 billion last year, 35.9% higher than in 2004, while total expenses reached $304.2 billion, increasing 40.8%, with parallel growth on both sides of the income statement, largely reflecting the steady rise in interest rates and masking underlying trends in these aggregate numbers. Interest expense reached $136.1 billion in 2005, an increase of 133.1% from the prior year, while the most interest-sensitive revenue line items on the securities industry income statement rose between 80% and 100%.13 Net revenues were $185.6 billion in 2005, up from $178.3 billion in 2004, an increase of only 4.1%. Net revenue growth has declined sequentially from 6.6% in 2003 to 5.2% in 2004 before reaching 4.1% last year.

11 See SIA Research Reports, Vol. VII, No. 4, April 25, 2006, pp. 7-11. 12 All broker-dealers doing a public business in the U.S. This represented 5,134 firms at end-2005, down from 5,219 firms at

end-2004. 13 In 2005, margin interest revenues increased to $13.3 billion, an increase of 90.7% from 2004, while “Other revenue

related to the securities business” rose to $126.5 billion from $67.6 billion, an increase of 87.1% last year.


Securities Industry Quarterly Domestic Expenses(NASD and NYSE Firms)

All Other Expenses

Compensation

Interest

0

10

20

30

40

50

60

70

80

90

2001 2002 2003 2004 2005 2006(f)

$ billions

Source: SIA DataBank (2006 forecast) This sequential annual decline in profits and net revenue growth reflects a number of other forces as well. For example, commission and fee income fell 2.1% to $46.1 billion in 2005, as rapid compression of rates more than offset double-digit growth in transaction volume. This in turn reflects, among other things, intense competition and falling costs from faster, more efficient and more integrated trade and clearing and settlement systems, leading to rapid commoditization of traditional financial product and service lines. Trading gains were $23.3 billion last year, largely unchanged (down 0.8%) from 2004, but still 24.2% below gains in 2003, as a sharp $4.7 billion fall in debt trading gains was offset by a rise of nearly equal magnitude in trading gains other than debt and listed equities and options, with the latter’s growth reflecting the rapid expansion of new, higher margin derivative products. Last year’s flat performance may also reflect the difficulties in expanding these profits in an environment generally characterized by excess liquidity, low returns and low volatility.


Securities Industry Annual Domestic Net Revenues*

87.8113.0

134.7113.2 100.2 106.3 109.1 108.8 116.0

44.2

58.9

69.2

61.258.8

63.1 69.2 76.982.5

0

50

100

150

200

250

1998 1999 2000 2001 2002 2003 2004 2005 2006(f)

*Net of interest expense

$ billions

NASD

NYSE

132.0

185.6178.3

198.5

169.5159.0

174.3

203.9

171.9

Source: SIA DataBank (2006 forecast) Subtotals may not add to totals due to independent rounding. Revenues from underwriting activities rose 4.5% to $20.0 billion, extending a solid recovery from the 2002 trough in this highly cyclical business, and recorded the second best annual issuance performance behind the 2000 record $21 billion, as continued strong profit growth at non-financial firms restrained the need for raising capital. Mutual fund sales revenue rose 10.7% to $20.7 billion, while asset management fees increased 11.6% to $23.3 billion. Cost containment and the impact of consolidation through mergers and acquisitions also played a role in last year’s results, but were not enough to offset slowing net revenue growth. Compensation expense reached $88.4 billion, an increase of 6.3%, as average headcount was largely unchanged, with the number of income-producing personnel showing a fractional rise, and non-income producing personnel an equally small decline. Average seniority and tenure of employees declined, which helped reduce the growth of compensation cost from an 8.4% rate in 2004. Floor costs rose 7.7% to $18.0 billion in 2005, an increase from the 7.3% growth seen in the preceding year. Expenses other than interest, compensation and floor costs, as a group, rose 6.9% to $61.6 billion following an 8.7% increase in 2004. Frank A. Fernandez Senior Vice President, Chief Economist and Director of Research


SECURITIES INDUSTRY EMPLOYMENT AND COMPENSATION TRENDS

Introduction

s of April 2006, only 52.7% of the U.S. securities industry’s jobs lost during the 31-month cyclical retrenchment (March 2001 – October 2003) have been recovered. The year 2004 was the first, since the 2001 downturn, to show modest gains of total headcount (1.3%). In

addition, based on the 2004 data of the Bureau of Labor Statistics (BLS), U.S. Department of Commerce, all industry occupational groups benefited from the employment upturn in that year. Headcount gains were limited to revenue-producing occupations or jobs contributing to the industry’s ongoing structural changes driven by the consolidation of the industry, redesign of trading exchanges, revamping of market infrastructure, automation of trade execution and new regulatory and compliance frameworks. Structural changes also altered the seniority composition of the securities industry’s workforce. Gains for senior executive positions excluded general operations managers, while extending to investment banking, asset management, sales, and trading positions. Mid-level positions increased, but firms continued shedding managerial posts that were not critical to their operations. Job cuts were also made across the entire spectrum of support positions.

In 2004, compensation trends reflected firms’ strategies to retain and reward that part of the workforce contributing to the highest margin business lines, as well as highly skilled producers expanding broker dealers’ offerings of innovative and complex financial products and services. Professionals supporting risk management systems, regulatory and compliance mandates, and network and infrastructure redesigns also commanded compensation increases. As a result, average compensation increased by 6.9% in 2004, even though pre-tax profits fell by 18.3% from prior-year levels.1 However, despite robust overall compensation gains, 22.6% of all securities industry employees did not get a raise from the previous year and 13.6% saw their salary increase below the inflation rate.2 Employment and compensation changes are, for the most part, driven by business imperatives or regulatory mandates. For example, with foreign and cross-border transactions growing more rapidly than domestic operations, U.S. employment and compensation growth is expected to be moderate, except for professionals generating exceptional profits or contribution to the industry’s ongoing structural changes. This article summarizes some of the findings presented in the May issue of SIA’s Securities Industry Trends,3 which offers an analysis of the occupational distribution and demographic characteristics of headcount and compensation, as well as the drivers of these employment trends.

1 SIA DataBank, which is compiled from data reported to the self-regulatory organizations, NASD and New York Stock

Exchange, by their member firms. 2 BLS, SIA. 3 See www.sia.com/research/html/securities_industrytrends.html for information about SIA’s Securities Industry Trends.

A


Overall Employment Growth U.S. securities industry employment numbers have consistently risen since the economic recovery which commenced in 2003. The industry added 7,800 jobs during the first four months of 2006, confirming that the job recovery is ongoing. As of April, 52.7% of the U.S. securities industry jobs lost during the 31-month cyclical retrenchment (2001-2003) have been recovered.

Annual U.S. Securities Industry Employment(end-December levels)

486532

560 569608

660711

766

837810

771 755779 791 798

0

100

200

300

400

500

600

700

800

900

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06*

Thousands

Source: BLS *April Preliminary This recovery has been accompanied by profound shifts in the overall demographic characteristics of the industry. Significant drops in employment were observed, first within the ranks of junior and support positions in 2001-2002, then within mid-level professional positions in 2003. Sales agents, financial examiners and advisors, computer programmers, brokerage clerks, and administrative staff have borne the heaviest cost of both a cyclical decline in industry revenues and the ongoing automation and disintermediation of the industry. Positions in the executive ranks have not been spared either. Hardest hit have been senior general and operational executive positions, which have consistently declined year-after-year since 2001 to reach a low of 24,470 individuals in 2004, 26.5% fewer than in 2003. The economic recovery has had a moderate impact, with a lag, on the securities industry headcount. Total industry headcount began to rise in late 2003 but, as of December 2003, was 755,300, a 2.0% decline from year-earlier levels. The year 2004 is the first since the 2001 downturn showing a modest rise of total headcount (1.3%).4 Not all industry occupational groups, however, benefited equally from this upturn.

4 As of this date, the BLS has not yet published detailed securities industry employment data broken down by occupational

segment for full-year 2005.


Occupational Distribution Changes Functional Segmentation5

Headcount increases were concentrated in revenue-producing occupations, as well as jobs contributing to the industry’s ongoing structural changes. Driven by the consolidation of the industry, redesign of exchange and market infrastructure, automation of trade execution, and new regulatory and compliance frameworks, hiring increased in the categories of technology engineers, network specialist positions and compliance professionals. Front-end sales, trading and financial managers also increased as a group, up by 20.1% in 2004. Headcount of mid-level professionals in the same occupational category increased 10.6%. System and information technology (IT) manager positions increased 11.6%, while mid-level technology personnel increased by 12.6%. By contrast, the headcount of junior-level positions decreased. Low-skilled workers’ contributions were scaled back and either automated, outsourced or offshored. In 2004, junior general and operational jobs decreased by 10.5%, office and administrative jobs decreased by 3.5%, while sales, trading and financial clerks positions continued to decline from the prior year, falling 11.6%.

Securities Industry Headcount / Occupational Breakdown

0

25

50

75

100

125

150

175

200

225

250

ManagementGeneral

Operations

Compliance,Audit, Examiners

and Lawyers

Paralegal,Accounting,

Auditing Support

IT & Systems Office and Admin.Support

Sales, Tradingand Financial

Mgmt.

Financial Analysts& Advisors

Securities SalesAgents

Sales, Tradingand Financial

Clerks

Number of Positions (thousands)

200120032004

General and Operational IT Office Admin. Sales, Trading and Financial Management

Source: BLS, SIA

5 See Appendix for a description of the functional segmentation used in the analysis summarized in this piece.


Securities Industry Functional Segmentation of Employment

0%

10%

20%

30%

40%

50%

60%

General and Operational IT & Systems Office and AdministrationSupport

Sales, Trading and FinancialMgmt.

200120032004

-9.6%

-4.7%

+7.5%

+12.5%

Source: BLS, SIA Segmentation by Seniority

Aggregating employment by seniority shows that only mid-level positions gained in headcount (+8.5%) in 2004.

Securities Industry Headcount by Seniority

-

50

100

150

200

250

300

350

400

450

Management Mid-level Junior / Support

Number of Positions(thousands)

200120032004

-3.4%

+ 8.5%

-6.1%

Source: BLS, SIA


Compensation Trends Significant layoffs decreased the industry’s headcount by 7.2% during the economic downturn from March 2001 to October 2003. Only top performers were retained. Reaching higher profitability goals with fewer human resources challenged firms to retain and motivate employees, which is why 98.8% of the securities industry’s employees who kept their jobs received compensation increases. The strategy paid off and the total industry average compensation expense decreased by 10.7%, while contributing to a pre-tax profit increase of about 60.9%, to $16.7 billion in 2003 from $10.4 billion in 2001. For 2004, the statistics paint a different picture of securities industry wages. Total industry headcount grew by 1.3% and average compensation increased by 6.9%, while pre-tax profits fell by 18.3% from prior-year levels.6 Of those totals, 22% did not receive a raise, and 13.6% saw their salary increase by less than 3%. A salary increase of less than the annual inflation rate means that this group actually earned less in 2004 than in 2003. Broker-dealers’ total annual compensation reached $88.4 billion in 2005, reflecting a 6.3% increase from prior-year levels. Salary Gains by Seniority Level

From 2001 to 2003 increase in average base salaries rose with seniority: compensation for support positions grew by 10.2%, for mid-level positions by 15.7% and for senior management positions by 17.7%. In 2004, salary either grew from the prior year at a slower pace or decreased: up 9.2% for mid-level professionals and 3.0% for senior management, and down 2.3% for junior positions.

Securities Industry Average Salary by Seniority 2003-2004

-

20

40

60

80

100

120

Management Mid-level Junior / Support

$ thousands

2003

2004

+ 3.0%

+ 9.2%

- 2.3%

Source: BLS, SIA

6 SIA DataBank.


Salary Changes by Occupational Groups

A closer look at the growth of the weighted average salaries by occupational groups outlines several trends driving these compensation changes. Compensation Declines for Some …

In 2004, the overall decrease in headcount helped reduce average compensation for mid-level professionals in general, operational and office administration, while average base compensation for senior positions declined as their ranks increased, driven mostly by the decreasing wages of advertising and corporate communications executives. Average wages for all compliance officers and financial examiners were pulled down by the sharp rise in the number of lower-paid junior positions that were created to enable firms to comply with increased regulatory and supervision obligations. The steepest declines in average compensation came in office administration. The decrease in headcount for all categories of the highest-paid administrative management positions, as well as the ongoing cuts of the lowest-skilled administrative positions, pulled down the overall average wages for this group by 13.6% in 2004. Wage increases for the management of this group were slightly above inflation, which was not the case for junior administrative positions. The number of clerical positions, including those supporting sales departments, continued to decline, fostered by automation and technological improvements. Only highly skilled executive support staff enjoyed modest wage gains in 2004. … and Increases for Others

The weighted average salaries of IT professionals increased by 3.6% from 2003 to 2004. Not surprisingly, the highest-skilled IT specialists received the highest salary increases. Increased demand for electronic communication networks (ECNs) administrators and specialists (e.g., direct-market access and execution systems professionals) contrasted with the decrease in the number of research and quantitative analysts. Their wage growth, or lack thereof, mirrored the changes in demand for these different types of jobs. Overall, wage increases from prior-year levels were moderate, within a range of 4% to 8%. The exceptions were for cutting-edge positions supporting risk management systems, regulatory and compliance mandates, and network and infrastructure redesigns, which commanded double-digit compensation increases. From early 2001 until late 2003 the compounded effects of the cyclical downturn, automation and disintermediation of trading, and commoditization of some financial product and service lines fostered job cuts. The most severely impacted were sales, trading and financial management professionals. However, securities firms refocused on retaining top performers and achieved leaner and more profitable operations in 2004. Compensation increases for all categories of revenue-producing professionals signaled the end of the industry’s drastic cost-cutting phase. In 2006, as agency trading profits continue to dwindle, firms are seeking higher return and offering more sophisticated multi-asset products and services to their clients. To lead this transformation, firms’ hiring and compensation practices are reflecting their demand for highly skilled sales, trading and financial professionals proficient in sophisticated financial products and transactions. This trend should carry forward in the near term.


Drivers of Changes The industry and the markets in which it operates are undergoing profound structural changes. Some of these changes are driven by business imperatives, others by regulatory mandates. The following is a review of some of the ongoing changes impacting employment and compensation. Firms’ Innovation and Specialization Fosters Employment Growth of Mid-level Professionals

After a wave of consolidation swept the industry in the first half of this decade, securities firms are now refocusing on their core competencies, while innovating or developing by offering alternative products and services. While expanding the breadth and scope of the most profitable business units to achieve scale and dominance in selected markets, an increasing number of firms are spinning-off or swapping business units for which they do not have a competitive advantage. In the process, firms are achieving a greater degree of specialization. Shifts of strategic focus towards greater specialization is anticipated to foster further employment growth of highly skilled individuals within mid-level professional ranks. The profitability of alternative investments and multi-asset products and services suggests there will be further employment growth for these groups. Traders, sales people, financial engineers, risk management professionals, compliance personnel and IT specialists required to expand these businesses will be in high demand. Broker-Dealer Branch Networks’ Fragile Profitability Limits Wages Growth

The industry’s consolidation since 2000 has enabled economies of scale and minimized overhead through elimination of overlapping branches following mergers and acquisitions. However, the average number of branches per firm for branch networks with more than a thousand registered representatives (RRs) increased 22.6% to 385 in 2004 from 314 in 2003. In 2004, on average, RRs produced $418,003, while they were paid $174,105. Average production and earnings, while recovering from the downturn, are still 13.9% and 12.9%, respectively, short of the record-high 2000 levels. In 2004, average RR production increased by 12.1%, reaching its highest level since 2000, while average RR total earnings increased 13.7% from 2003 levels. To maintain or improve their profitability in the current shrinking margin environment, broker-dealer branch networks are likely to limit their employees’ base compensation payouts. Rising Staffing Costs Related to Regulatory and Supervisory Mandates

The costs of compliance have increased by nearly 95% between 2002 and 2005. Notably, 93.9% of the total compliance costs are staffing-related.7 However, 2004 wage increases indicate that the compensation of compliance professionals and financial examiners have, on average, decreased. It is the high double-digit rise of headcount that is fueling the staffing cost increase. Compliance with recent and pending regulatory mandates (e.g., Sarbanes-Oxley, Reg NMS, etc.) is expected to continue driving rising compensation expenses. Anticipated changes in self-regulation, market surveillance, and the shaping of hybrid market models, among other challenges, will require that firms continue to adapt in a cost-effective manner. Some of these challenges will be met by outsourcing or by incurring capital costs by relying on technology (compliance and electronic trading platforms) solutions, while others with increased hiring, and hence staffing costs.

7 SIA Study, “The Costs of Compliance in the U.S. Securities industry,” February 22, 2006,

http://www.sia.com/surveys/pdf/CostofComplianceSurveyReport.pdf.


Increased Use of Information and Communication Technologies Will Continue to Slash Back-Office Jobs

The pace of technological innovation in the securities industry has been staggering. One factor is that information and communication technologies optimize the use of capital and lower its cost. Electronic trading platforms, systems and networks linking markets that are increasingly global, concentrated and specialized has led to greater automation, disintermediation of trade processing and compression of margins. Not surprisingly, the operational efficiency gained by these innovations, combined with the 2001-2003 cyclical downturn, has translated into layoffs of sales, trading, financial advisory and back-office personnel. In 2004, employment and compensation data suggest that firms had professed to the upward slope of this operational transformation “J-curve.” Acquired operational efficiencies have lowered costs of operations, improved risk management and increased liquidity while improving firms’ revenues. Meanwhile, trade information processors and vendors are increasing their front-end support as well as delivering multi-asset post-trade solutions. They are also centralizing and automating risk management operations, thus enabling securities firms to further reduce their back-office headcount.

Outlook Employment and compensation trends driven by profound technological, regulatory and market structure changes will continue reshaping the securities industry. Profits from U.S. securities firms’ foreign and cross-border operations are expected to increase faster than profits generated by domestic operations. As a result, with the exception of professionals generating exceptional profits or contributing to the industry’s structural overhaul, U.S. employment and compensation growth in the year to come will be commensurately constrained. Excerpt from SIA’s Securities Industry Trends, Vol. XXXII, No. 3 (May 31, 2006), by Isabelle Delalex Vice President and Director, Industry Research Edited by Kyle L Brandon Vice President and Director, Securities Research


APPENDIX: Analysis Framework

For purposes of analysis, industry employment data is classified according to four functional segments and three seniority levels.8 Functional Segmentation

General and Operational: includes top executive management positions; compliance officers; accountants; auditors; examiners; lawyers; and their support staff. IT and Systems: includes information technology managers; programmers; engineers; network specialists; and their support staff. Sales and Trading / Financial Management: includes “front-office” personnel and their management; financial and research analysts; sales agents; brokerage clerks; and their support staff. Office and Administration: includes human resource and administrative managers; customer service representatives; clerks; and secretarial, legal, paralegal and other support staff.

Seniority Level

Management: includes senior managerial positions throughout the industry. Mid-level: includes professional staff working in an operational, technological and financial capacity. Junior: includes personnel with a narrow scope of responsibilities and the staff supporting Mid-level and Management professionals.

8 BLS, Occupational Employment Statistics (OES) for 2001, May 2003 and November 2004 (www.bls.gov/oes/home.htm).

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