Clearing Firms Gain New Clout by Supplying Investment Services That

Behind the scenes at most bank brokerages, far removed from the investment kiosks out front, lie the back-room clearing operations that are the guts of any investment sales effort.

Not as glitzy as the point of sale, the clearing firms make sure that sales and trades of investments are executed and recorded. The work is labor intensive and driven by technology, and is often farmed-out to specialized firms.

But now, many of these firms are stepping out from behind the shadows. With a new mandate of helping banks boost the productivity of their investment sales representatives, clearing firms are expanding their support services to reps and even producing customized investment products for banks.

Firms like National Financial, Pershing, BHC Securities, and Stephens Inc. have become the dominant players in this fast-changing industry.

"It's very competitive in this market, and the margins are razor thin," said Lynne Goldman, a consultant with Cerulli Associates, Boston. "These folks have had to look at different ways of packaging their capabilities to add value to their relationships with banks."

While one out of every five banks performs its own clearing functions, most banks lack the scale and expertise to do the job themselves. Among the things that banks are looking for in a clearing firm:

*Lower costs for basic trades and transfers of securities.

*More in-depth investment research and enhanced systems to deliver the information to sales reps.

*The ability to execute annuities sales as easily as stock or bond trades.

*A wide range of product offerings, such as mutual fund wrap accounts and cash management accounts.

Edward Diamond, president of Dime Securities, has had some experience in picking clearing firms. The brokerage unit of Dime Savings Bank of New York switched over to National Financial when it brought its investment sales program in-house in 1991.

When choosing a firm, Mr. Diamond said he looked to make sure that it had a "strong capital base" and kept "a good inventory of bonds available for our brokers."

Bank brokerages can save on costs by drawing from a clearing firm's inventory of fixed-income securities instead of fronting the money themselves to buy the bonds on the open market.

Other features to look for are whether a firm offers to clear mutual fund transactions through FundServe, a speedier clearing system set up by major mutual fund companies. Mr. Diamond added that National Financial has also helped Dime develop a cash management account, and "that's the kind of product you need to be competitive in this market."

National Financial, a unit of Boston-based Fidelity Investments, has by far the largest slice of the bank brokerage market. The company boasts relationships with 80 companies, including banking companies such as Chase Manhattan Corp., State Street Boston Corp., and Barnett Banks Inc., to name a few. Close to 50% of the firm's business is derived from bank-affiliated brokerages.

Robert J. Middleton, National Financial's vice president in charge of marketing and correspondent services, said that banks have been asking for the ability to execute sales of annuities through the same systems that mutual funds and individual securities are sold.

Right now, unlike mutual fund companies, most insurance companies that underwrite annuities are not linked in a system that's easily accessible to clearing firms.

Mr. Middleton said his firm is working on a system that would link brokers with annuity sellers, but for now the best the company can do is include annuities on brokerage customers' statements - another function that is often handled by clearing firms.

Clearing and executing investment sales have fixed costs, usually around $26. But to stay competitive, many clearing firms have dropped the price to well below the industry average, in effect eating away at profit margins.

"We make money off of margin lending, securities lending, and mutual fund asset management fees now," Mr. Middleton said. "There's not a high margin on processing transactions, but there are some economies of scale; it helps to be big in this business."

Another big player in the clearing market is BHC Securities. The Philadelphia-based firm was launched in 1983 by a consortium of 20 banks, including Citicorp, that needed a firm to clear securities trades. BHC broke away 10 years later, and now does work for 40 companies, 60% of which are banks.

The fact that BHC is accustomed to working with banks gives the company a competitive advantage, said its president, William T. Spane.

"This is our whole business, providing these services," Mr. Spane said. "We're not out there competing for credit card business, or checking, or our own mutual funds."

But working with many banks can be difficult, especially at a time of consolidation in the banking industry. Often an acquired bank will have had its own brokerage accounts, which then have to be merged into the new clearing firm's system. PNC Bank Corp. and Midlantic Corp. - both BHC clients - will have to undergo a similar consolidation of their brokerage operations.

"It is hard to do, but as the organizations themselves get larger they will produce a lot more volume" of investment transactions, Mr. Spane said.

But switching clearing firms, whether by acquisition or by choice, doesn't always go smoothly.

There is usually little incentive to change firms once a bank's brokerage has been established, bankers and clearing firm executives said.

"It's a complete nightmare to change" firms, said James R. Eads, president of Signet Financial Services. The brokerage unit of Signet Banking Corp. went through two clearing firms in six years before settling on Stephens Inc., Little Rock, two years ago.

Despite the pain involved, Mr. Eads said he felt Signet had to find another clearing firm in order to receive better service. Officials at the $13 billion-asset banking company felt like "a small fish in a big pond, when we kept getting reassigned to more junior-level managers."

During a switch-over, investor records are transferred from one clearing firm's computer system to another and are often keyed in by hand. Mr. Eads said the most problems seem to crop up when tax reports are generated for customers and often contain errors.

"The chances of things going perfectly are very slim," Mr. Eads said. "In fact, Stephens sent more staff up to help man the (customer service) phones during the switch."

Alton C. Jones, managing director in charge of sales marketing at Pershing, a Jersey City-based clearing firm, said that converting to another clearing system is "not on anyone's top 10 list of favorite things to do."

But he added, "It's not nearly as complicated and as cumbersome as it was a few years ago."

Six years ago, Pershing, a unit of Donaldson, Lufkin & Jenrette, staffed up an entire department dedicated to helping banks switch over after having "a very bad experience with too many accounting errors."

Since then, Pershing, which clears for about 60 banks, including First Union Corp. and Chemical Banking Corp., has poured much of its resources into information systems to help keep track of accounting and sales.

"What banks want now are more on-line systems that allow them to collect data on customers and reps," Mr. Jones said.

Manager View, a new software package the company unveiled this year, allows bank officials to generate a breakdown of all sales and costs, and then see the revenue associated with each transaction. The report can be broken down for a particular broker, product, geographic region, or time period, he said.

"You can't underestimate how important it is to track fees and charges," said Anthony P. Psilos, president of Hibernia Investment Services, the brokerage unit of Hibernia Bancorp, New Orleans.

Increasingly, sophisticated computer systems "are how we are going to profile our customers and know where we stand," he said.

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