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Money In Motion

Money In Motion

00:00 01 June in In the News

by Jeff Schlegel and featured in Financial Advisor
June, 2009:

The demise of Wall Street as we knew it has led to a new conventional wisdom that goes something like this—the wirehouse broker-dealers are dead, long live the independents! As part of this upheaval, waves of disaffected advisors affiliated with wirehouses are expected to bolt their companies for mid-sized or smaller firms, accelerating a long-term trend.

While reports on the death of the wirehouse brokerage firms are premature, news from the trenches indicates that advisors are switching firms—or at least inquiring about switching—in ever-larger numbers. “There’s certainly been an unprecedented number of bodies in motion right now,” says John Rooney, managing principal of Commonwealth Financial Network’s West Coast operations. “I’ve been in the business for 25 years and I’ve never seen this much activity.”

In March, 2,624 reps changed broker-dealer firms, up 34% from February, according to Discovery Database. More than 40% came from the wirehouses. Of these, 58% went to other wirehouse broker-dealers, 12% chose a regional firm, 10% went independent, and the rest scattered among other channels.

While many wirehouse networks find themselves playing musical chairs, or musical brokers, the statistics may understate the impact of their exodus from Wall Street. Some experienced brokers with huge books of business are giving up their securities licenses and becoming independent registered investment advisors. At the same time, more than a few rookies finding it difficult to survive are leaving the business entirely.

It’s a sign of the times that some firms have been established for the sole purpose of lifting some giant groups, each managing billions in assets, out of the wirehouses. Among them is HighTower Advisors, a Chicago-based registered investment advisor and independent broker-dealer founded last year backed by a group of financial heavyweights that includes ex-Charles Schwab CEO David Pottruck. One rumored investor, former Morgan Stanley CEO Philip Purcell, will neither “confirm nor admit” that he is an investor, as one HighTower executive quips. Read that as you want.

HighTower’s big broker recruiting efforts have landed a number of elite wirehouse reps from UBS, Merrill Lynch, Morgan Stanley and Goldman Sachs. Among them is Richard Saperstein, who recently brought over $10 billion in client assets from JPMorgan Securities. “In less than seven months we’ve gathered 15 managing directors from major firms,” says HighTower CEO Elliot Weissbluth. “We’ve proven we can successfully attract top advisors, and we think we’ll see more.”

As an incentive, HighTower has issued 25% of the company’s equity into a partnership that’s divvied up among financial advisors who join the firm. But the firm also sets each group up in an office, ensuring they have to pay little attention to transition details beyond moving clients to HighTower. “Not only do advisors become meaningful equity partners,” Weissbluth says, “but they’re treated like and they operate like real owners.”

In the case of Commonwealth, the company says that home-office visits by prospective advisors jumped 50% during this year’s first quarter, and that new advisor revenue leaped 70% during the quarter from the same period the year before. The firm expects that the advisors who have committed to join it will produce a 120% increase in new advisor revenue in the second quarter.

New Commonwealth advisors have come from traditional wirehouses, but also from insurance-company-owned firms and larger independents. “It’s not that we’re doing anything different,” Rooney says. “We’re the same company we’ve always been. It helps that we’re not having the issues that other big companies are having.”

Because of the bad market and because some high-profile firms have been in the news for the wrong reasons, advisors—and their clients—have begun to question the benefit of maintaining relationships with their current broker-dealers, Rooney explains. “For many financial advisors, their pain threshold has been exceeded and there’s been a quantum shift where the gulf between us and them [their former firm] is so large that they’re willing to go through the two to three months of transition to a place they think will be better for them for years to come,” Rooney says.

Smaller Pay Packages

Given the dearth of new blood coming into the industry, competition for experienced—and successful—advisors is keen. Wirehouse and regional broker-dealers, and even some independents, increasingly are targeting producers with $500,000 or more in production. At the same time, firms are purging lower-end producers, raising production minimums and scaling back their compensation packages.

“You used to be able to get a deferred compensation package and bonuses with at least $400,000 in gross dealer concession, but now it’s going above that,” says Dennis Gallant, principal at GDC Research, an industry consulting firm in Sherborn, Mass. “The combination of high overhead and the cost of chasing top producers has come home to roost at wirehouses, because when everyone started losing money they realized they couldn’t afford to keep their low-end producers.”

And the wave of mergers and acquisitions last year among giant financial institutions (think Merrill Lynch and Bank of America, Wachovia and Wells Fargo, etc.) created an unsettled landscape for affected advisors. “You’ve got Smith Barney and Morgan Stanley coming together, so you know there will be some attrition there,” Gallant says.

The upshot is that a lot of reps are on the move, even if it’s involuntary. For those making a change, most broker-dealer firms are willing to cover an advisor’s transition expenses. The industry benchmark is 2% to 3% of a rep’s trailing-12-months production, says Jonathan Henschen, president of Henschen & Associates, a broker-dealer recruiter in Marine on St. Croix, Minn. He says another dozen or so firms offer up-front transition loans in the neighborhood of a four- or five-year forgivable note for 10% to 20% of trailing-12-months production. But those amounts are shrinking. Some firms that offered, say, a 10% note to a $200,000 producer, have raised that to $250,000, Henschen says. Or a $500,000 producer who could expect an offer with a 15% note now might have to settle for a 10% note. Or rather than offer up-front money, some firms would rather give new advisors a 100% payout for six to 12 months. But not all advisors are focused solely on the pay packages and transition assistance. “I get reps trying to make what they can off of their trailing-12-months production,” Henschen says. “Sometimes it’s a matter of desperation on their end. But in most times they want substance with their new firms, and that’s especially true with independent reps. And if that happens to involve transition money, that’s icing on the cake.”

The Big Two

Recruiters and consultants say the largest independents, such as LPL Financial and Raymond James Financial Services, have an advantage in recruiting wirehouse brokers because their brand recognition, scale and infrastructure creates a comfort zone for wirehouse reps making the leap to the independent side. They also have effective recruiting programs.

In the second fiscal quarter ended March 31, Raymond James said it recruited a handful of advisors from the likes of Goldman Sachs, Citigroup Global, Merrill Lynch and Wachovia Securities. All told, the total production of all advisors recruited by the company during the quarter was 72% more than the same quarter last year.

LPL, the nation’s largest independent brokerage firm, saw new recruiting leads double last year to roughly 12,000. Of that, 72% turned into meetings. And recruiting jumped another 28% during this year’s first quarter.

In August last year, LPL launched a hybrid platform serving both registered reps and registered investment advisors. “We’re seeing advisors moving to LPL as registered reps with the intention of moving in the hybrid direction in the future,” says Bill Morrissey, executive vice president of new business development for independent advisor services.

And in the fourth quarter, LPL rolled out an in-branch recruiting program aimed at offices that want to bring on five or more new advisors during the upcoming 12 months. The program provides access to a database with roughly 500,000 licensed security producers, along with marketing materials and assistance from the company’s 30 national recruiters.

Beyond The Big Two

According to industry sources, the average payout for independent broker-dealers is 85% to 90% versus 30% to 50% for the wirehouses. Larry Papike, president and owner of Cross-Search, a broker placement firm in Jamul, Calif., says some smaller independent broker-dealers—particularly those with $30 million to $50 million in revenue who are contending with declining assets and gross dealer concession—might not have the resources to compete with the big boys in the recruiting game.

“The bigger firms can afford to offer a 90% payout rate because they have money coming in from a lot of different sources,” he says.
Nonetheless, Papike says some well-capitalized smaller firms, such as Geneos Wealth Management, are positioned to do well. In April 2008, Geneos bagged a group of 16 seasoned advisors with gross revenue of $6 million from Royal Alliance. “They saw the writing on the wall regarding large conglomerate broker-dealers,” says Ryan Diachok, vice president of marketing and business development at Geneos, a $70 million firm in Centennial, Colo. “They didn’t like the direction of their company, the corporate culture and lack of flexibility in dealing with headquarters.”

All told, Geneos added 44 advisors last year, and another 20 during this year’s first quarter. Prospective advisors need at least $150,000 in annual gross dealer concession (the firm’s average is $315,000) for individual reps and $350,000 for branch offices, and the firm seeks advisors with clean records and practices that jibe with Geneos’ existing business, currently a mix of about 55% fees and 45% commission. While the company does some proactive recruiting, it relies mainly on referrals from existing advisors and various industry contacts.

Geneos was founded in 2002 by Ryan’s uncle, Russ Diachok, and Russ’ father, George. They sold their prior broker-dealer, Multi-Financial Securities, to ING, and after a nice payday they stuck around for several years and oversaw the unit’s growth from 350 to 850 reps. The Diachoks left ING and started Geneos with the goal of remaining small and giving advisors more independence and a stake in the company.

The company is slightly more than halfway to its goal of 500 reps, but they don’t have a set time frame for achieving that. “That’s by design,” says Russ Diachok, Geneos’ president and CEO. “We want to keep it that way so we know who the advisors are and vice versa. We learned from past experience that you start to lose that after you exceed 500.”

Geneos offers stock ownership to new advisors, as well as options to existing reps based on production. It touts its proprietary, Web-based open-technology platform called Nexus, which it provides to other broker-dealers through its Gentech subsidiary.

And it believes one of its biggest calling cards is its independent culture. “We’re on the extreme independence side of the spectrum,” says Ryan Diachok. “We don’t have any proprietary products, and advisors have the flexibility to run their business as they see fit.”

VSR Financial Services is another small broker-dealer that believes its size and independent culture appeals to entrepreneurial advisors wanting to call their own shots. Based in Overland Park, Kan., VSR did $92 million in revenue last year, and it’s working on a three-year plan to grow revenue to about $140 million by 2011—both organically and through recruiting. VSR’s goal is to expand its 260-strong rep force by about 10% annually, or 25 to 27 reps per year. “We don’t want to do it too quickly because it will impact our services,” says Chris Radford, VSR’s president.

VSR is a passive recruiter that relies almost entirely on referrals. “The reps we see are those who drill down to the products and services and look beyond just the initial money and names on the door to see what’s there and how their small practice would work in our environment,” Radford says. “It’s a big decision because you want your next move to be your last move, and they’re taking the process very seriously.”

Closing the Deal

A lot of disgruntled wirehouse reps are kicking tires and contemplating a move to the other side, but not everyone has the nerve to close the deal. “A rep may tell a recruiter they want to go independent, but there are many wirehouse reps who will never make that jump because they’re comfortable with what the national brand name provides them,” says John Brett, senior vice president of MetLife’s broker-dealer group. “While it sounds very easy to do, it’s a significant commitment to go out and build a firm.”

Brett oversees a broker-dealer network with 13,000 reps that work either through two independent broker-dealers—Walnut Street Securities (predominately single-person shops) and Tower Square Securities (mainly larger office groups)—or through two entities structured like national wirehouses, MetLife Securities and New England Securities.

The company recruits advisors from across the board, and during the process it gauges which of its units would be the best fit for potential new recruits. Brett says reps seriously considering going independent should budget for a roughly six-month transition period. The first two months is the time to review various alternatives and to look within themselves. “It’s a process of self-evaluation about whether or not they’re ready,” he says.

The next two months is the time to interview with various firms to find the best fit for the advisor and for his or her clients. The final two months are spent getting situated with the new firm.

“The reps who I think have had the most success went through that process, established what they want to do with their clients, and made decisions based on what provided the best solutions for their clients’ needs rather than just getting a check up front,” Brett says.

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