The World Turned Upside Down

Adviser Steven Dimitriou knows that his broker/dealer, Wachovia Securities Financial Network—the independent broker/dealer arm of Wachovia Corp.—is set to change hands as part of Wells Fargo & Co.’s deal to acquire Wachovia Corp., but he senses no panic from his plan sponsor clients. “Our clients did not care, because our clients are working with us,” says Dimitriou, Managing Partner of Boston-based Mayflower Advisors, LLC. Compared with an adviser employed at Wachovia, he speculates, “it is definitely a lot easier for us to be independent.”

Dimitriou, who does not use any Wachovia investment products with plans, has no current intention to switch broker/dealers. “So far, everything is business is usual,” he says. However, he will watch for shifts in key areas. On the individual-client side, he will look for trade processing to continue smoothly, and on the institutional-client side, he wants to keep using an open-architecture system. “That is the main thing we are looking for,” he says.

The broker/dealer world has been rocked by the market downturn. “Their revenues are dropping, because it is all tied to commissions, which are tied to assets, which are dropping,” says Mike DiCenso, President of GBS Investment Consulting in Itasca, Illinois. “Those broker/dealers ultimately will have to change their business model, and the value proposition they offer to retirement plan advisers and consultants.”

When major players like Merrill Lynch & Co., Inc., and Wachovia will no longer survive on their own—the former now acquired by Bank of America Corp., the latter absorbed by Wells Fargo; and Smith Barney and Morgan Stanley combine to create a joint venture—advisers know the brokerage world is hurting. That likely will lead more advisers to think about changing broker/dealers or going independent, and it may well cause some to rethink the prudence of striking out on their own. “Whether they will make a decision in the near term remains to be seen; the market environment will dictate that,” says Lisa Kottler, Austin, Texas-based Vice President, Retirement Services, at NFP Insurance Services, Inc., and its affiliated broker/dealer NFP Securities, Inc. (both subsidiaries of National Financial Partners Corp.). “Like many plan sponsors who are hesitant to move their 401(k) plans at this time, advisers are taking a look at their options. The conditions dictate that advisers take a serious look at their business model.”

The outlook for advisers at broker/dealers

Of course, some advisers say they are happy where they are. Jim Radler has spent 16 years at Merrill Lynch and, while declining to discuss specifics related to the acquisition or its aftermath, he says that being there during this tumultuous time has not been problematic.

“We get recruited every single day from Merrill Lynch to go somewhere else,” says Radler, whose Chicago-based The J&R Group’s seven-person team works with more than 100 plan sponsors and has about $750 million in assets under management. “If I thought it was better somewhere else, I would go there. I just have not seen it.”

Another Merrill Lynch retirement plan adviser, who prefers to remain anonymous, says he has been recruited “very hard” by some of his competitors. “I feel I have to give it an opportunity to see how it hashes out,” he says. Being with Bank of America may give him access to corporate clients that he does not have now, for instance. “It is too early to see if things will change for the better,’ he says, “but the only reason I would leave is if Merrill Lynch gives me reason to believe that it will not be the dominant financial-advisory business. I am not going to chase dollars to go across the street, especially to a platform that I do not think will be as powerful.”

However, for some advisers working at household-name Wall Street companies, the thrill is gone—and ultimately they may be gone, too, either to another broker/dealer or perhaps to head out on their own as a registered investment advisers (RIAs). Says Danny Sarch, President of White Plains, New York-based Leitner Sarch Consultants, Ltd., which specializes in placing retail financial-services salespeople, many of whom also work with retirement plan clients, “The turmoil in the industry has destroyed the loyalty from the adviser to the company.” Yet, he does not foresee major changes in broker/dealers’ basic business models.

Advisers working at publicly held broker/dealers frequently received stock that they believed ultimately would make them financially secure, Sarch says. “Now, the stock is worth a fraction of what it was,” he says.

“[Moving to another brokerage] is a way to rebuild their net worth through a signing bonus,” says Robert Ellis, New York-based Senior Vice President of the wealth-management practice at Celent, a financial services strategic consultancy, “and some of them are going to say, “My client does not care if I am with Citi or Merrill or Morgan Stanley or UBS.””

The number of advisers that Raymond James Financial Services, Inc., talks to informally about a possible switch has probably tripled in the past year, says Bill Van Law, Senior Vice President and National Director of Business Development. “The vast majority come from wirehouses and other traditional firms,” he says. “We have talked to more people from Merrill in the past three months than probably in the past three years combined.” That happens most commonly because Raymond James reaches out, he says, but some Merrill advisers have initiated contact.

On the plus side, Sarch says, proven producers looking to remain broker/dealer employees can get hired even in a really bad market. “The beauty of this business is that, if an adviser is a revenue-generator, there are always going to be firms that want to hire that adviser,” he says. If a company has an empty desk, and a chance to pick up an adviser who has been generating $500,000 or $1 million a year in revenues, the decision is simple, he says.

Some broker/dealers aim to offer retention packages or tweak compensation to keep good advisers. Bank of America unveiled its retention package in October, Sarch says, and “the jury is still out” on its effectiveness. It came too late in 2008 for many advisers to leave by year’s end, he says, so the first quarter of this year “will be very telling.” At press time, Wachovia advisers still awaited details on the retention package they had been told was coming, he says, while Morgan Stanley, Smith Barney, and UBS have tinkered with their adviser compensation, but the latter three companies’ initiatives involved relatively modest amounts of money by Wall Street standards, he says. “It was better than not getting it,” he adds, “but not anything dramatic.”

The challenges go beyond the big-name Wall Street broker/dealers. Even in good times, the business can be fundamentally tough. “I have always said that this is a business with lower-than-grocery-store margins and greater-than-Fortune-500-company risk,” says Cliff Oberlin, CEO of NRP Financial Inc., the broker/dealer arm of San Juan Capistrano, California-based National Retirement Partners, Inc. “That is the broker/dealer world.”

Oberlin got an early start on the industry’s consolidation trend when, in 2007, he sold the full-service broker/dealer Oberlin Financial Corp., where he served as President and CEO, to National Retirement Partners. He says he made the move because it seemed like a good cultural and business-model fit, since both organizations put a lot of emphasis on operating efficiently, and on compliance.

About broker/dealer consolidation, Oberlin says “there is a lot more to come.” With the market down so much, he says, revenues have declined at broker/dealers. For those that made risky plays in markets like sub-prime mortgages, that sort of cash cow has dried up. At the same time, they face the strong likelihood of stepped-up regulation that will require heavy investment to comply.

Which broker/dealers will survive? “The firms that have got a value proposition that is recognized by the client or adviser as being valuable,” says Jim Crowley, Managing Director at Jersey City, New Jersey-based Pershing LLC, a financial-services technology outsourcer that produced the report “The Broker-Dealer of the Future” in May 2008. “Firms unable to distinguish themselves are going to have a difficult time in this market.”

Crowley cautions against advisers making a switch based on the near-term payoff. “There are still a fair number of firms chasing advisers with a check,” he says. “It is not about the check.” Good advisers, he adds, “are going to be interested in the best partner for the long-term interests of their franchise.”

Here are five things sources say broker/dealers need to do, and advisers considering a switch need to look for:

1. Aligning business strategies and cultures. Advisers need a broker/dealer that aligns its interests with those of advisers, sponsors, and participants. Broker/dealers that did not expand their business ventures aggressively to boost short-term profits may win favor with advisers looking to move. “An adviser can understand every aspect of the broker/dealer’s business, so they know they are not at “headline risk,’’ Crowley says of broker/dealers with a more-local model. The tumult at some Wall Street companies that took huge, complex risks has genuinely harmed advisers and their clients, he says. “No one has the stomach to do that again for a long, long time,’ he adds. “People want to make sure that everyone’s interests are aligned.”

The anonymous Merrill Lynch retirement plan adviser has not seen his relationship with the broker/dealer change so far, he says. He adds, “It seems like Bank of America/Merrill are going to look a lot more at numbers, as opposed to what keeps this division happy.” He worries that Bank of America may cut back on Merrill’s traditionally high investment in recruiting and training, for instance. The adviser cites the departure of Merrill brokerage chief Bob McCann as dispiriting news. “He was the real advocate of my division. I cannot think that his leaving is a vote of confidence,” he says. “It begs the question: What does he know that someone at my level does not know?”

2. Focusing on fiduciary and compliance issues. To survive and thrive in the future, broker/dealers will have to help advisers develop an unbiased, consultative approach to working with clients, DiCenso says. In part, he says, that means advisers need broker/dealers that give them the option to play a fiduciary role. “Sponsors are going to need to focus on mitigating fiduciary risk,” he says. “When the Baby Boomers find out that they do not have enough money to retire, they are going to look for somebody to sue.” That, of course, is exactly the concern of compliance departments concerned with finding themselves a co-fiduciary target of litigious participants. Broker/dealers need to have compliance-related resources available to advisers such as attorneys with in-depth knowledge of ERISA, U.S. Securities and Exchange Commission rules, as well as FINRA (Financial Industry Regulatory Authority) rules, he says.

3. Helping advisers attract new clients. Broker/dealers have to help advisers win new kinds of business. “We are helping an adviser build the right business model, and add an executive-benefits strategy and a distribution-phase strategy,” Kottler says. Given the aging of the Baby Boomers, she says, the latter is essential for future growth. Without distribution-phase assets, she says, “advisers are going to bleed assets and revenues from their retirement plan business.’

Broker/dealers want new kinds of business, too. Since its acquisition, NRP Financial has added about 250 new advisers, Oberlin says. “While our initial focus was primarily retirement plan advisers, we also are targeting advisers who specialize in wealth management, in an effort to capture a portion of the estimated $13 trillion in retirement-fund distributions expected over the next several years.” The company aims to do that by offering advisers access to streamlined rollover solutions and a wide array of wealth-management platforms, he says.

Bing Waldert, Associate Director at financial-services researcher Cerulli Associates in Boston, expects to see some broker/dealer cost-cutting amid the market turmoil, but he hopes it does not come from this area. “The most important resources are those dedicated to helping advisers grow their practices,” he says. Referring to things like practice management and training, he says that “focusing on organic growth of advisers’ practices has long been a weakness for broker/dealers.”

4. Making payout changes carefully. The slumping market alone plays a role in lower adviser compensation, of course, but some broker/dealers have adjusted their compensation formulas, too. Merrill Lynch and Smith Barney are among the broker/dealers that announced reduced payouts for lower producers in late 2008.

Severe, across-the-board moves seem unlikely. “There are some cuts of payouts occurring at broker/dealers, but they are not drastic,” Waldert says. “Large cuts could have a very negative impact on retention.” NRP Financial’s standard commission grid starts at 85%, Oberlin says, but each office is evaluated individually to determine the appropriate payout. “While we have not made changes to our payout structure to date, we will continue to evaluate as the market situation develops,” he says.

Expect the trend toward differentiating payouts to continue. “Payout schedules are being made steeper, with a lot more differentiation between low production and high production,” Ellis says. “Back in my day, payouts ranged from 40% on the bottom to 44%, plus a bonus that got you about 50%, if you were a top producer. The range is much wider now.”

As an observer of the adviser-compensation issue, Pershing’s Crowley expects to see payout models shift to become more differentiated, and to reward advisers doing the specific kinds of business that particular broker/dealers want. “The compensation model is going to line up with the broker/dealer’s interests,” he says. “Broker/dealers perhaps are going to adjust compensation models to businesses they are familiar with, and away from compensating advisers in areas that are not their expertise, or where there is a high amount of inefficiency for handling that business.”

5. Trimming the fat, not cutting the muscle. Advisers obviously cannot control market volatility, Radler says, so “the only thing we can control is the service to the plan sponsor and participant.” He turns to Merrill Lynch to provide aids such as Webinars on market volatility and educational material on fund stability.

Broker/dealers are under pressure to decrease expenses—in the right places. “You have to wonder why a Merrill pays out 44% and an LPL (or other independent) pays out 90% or so. Are the services and support offered that different?” Ellis says. “It either says that independent broker/dealers do not serve the advisers, or wirehouses are larded up with too much overhead. I think the second is true. The old wirehouses are going to need cost reduction. They have to learn what services add value to the client value proposition—to keep—and those that do not—to cut.”

It is not just Wall Street titans thinking about budgets. NRP Financial’s high growth rate in 2008 helped offset revenue declines due to market conditions, Oberlin says, but the company is scrutinizing its budget. “We are reviewing carefully our budget for 2009 to identify areas where we can economize without cutting staff or affecting adviser services,” he says.

The need for broker/dealers to control costs “really gets to the heart of the matter these days,” Crowley says. “Broker/dealers are going to be very reluctant to change the services they provide to advisers, because that is their lifeline. Most firms are looking at other places to cut costs, and they are looking at where they can get more operating efficiency rather than change the service model to advisers. For example, he predicts that broker/dealers will scrutinize more closely expenses for areas such as traveling to conferences, advertising, and hosting events to attract potential new advisers. “People really are going to be looking for returns on that investment,’ he says.

As they reevaluate the efficiency of their services, Crowley also expects broker/dealers to do more e-delivery of things like trade confirmations and statements. Some may outsource document management and retrieval, or technology related to compliance and commissions.

Broker/dealers need to make efficiency moves carefully, though. “The battle for financial-adviser talent has been heating up for a while,” Waldert says. “Firms need to be careful right now. Cutting services is not a way to attract high-quality advisers.”

Ultimately, retirement plan advisers have to ask questions, NFP’s Kottler says: “Does your broker/dealer have the right business model for you? Does the broker/dealer support you in your sales and marketing effort? Does it create repeatable processes, such as vendor benchmarking and investment analytics that help you be more efficient? Does it allow you to claim fiduciary status in writing? Many broker/dealers still do not address the needs of retirement plan advisers. In some cases, they are almost second-class citizens.”

The pros + cons of becoming an RIA

Celent’s Robert Ellis does not see a bright future for broker/dealers’ current business model. “I think the broker/dealer model is probably irrevocably damaged,” he says. “The fee-based advisory business is ascending, and the brokerage/transaction model is in decline. Basically, the impact is driving the financial adviser toward the independent model.”

Adviser Jamie Worrell, President of Providence, Rhode Island-based GPS Investment Advisors, has always been an independent adviser. It “absolutely” has helped in working with retirement plan clients, he says, since the broker/dealer and RIA firms he has affiliated with have not offered a proprietary retirement plan product. In addition, they have been flexible in meeting the needs of specialized retirement plan advisers and their clients, he says, for example by allowing their advisers to serve as fiduciaries.

However, is this the right time for an adviser to start a business? “It depends on that person’s appetite for entrepreneurship, and his existing book of business,” says Worrell, who started GPS in the brighter days of 2007. “When you first start your own firm, you have to go through a lot of stuff that does not involve revenue generation,” he says. Advisers have to work with lawyers about setting up the business and Web site developers about getting their Web site up and running, for instance. “That takes time away, in terms of prospecting, but you need to be able to pay the bills. You have to be pretty organized, and you need a [financial] cushion or a book of business.”

Many advisers are concluding that they can only get a permanent solution to the issues and concerns they have by going independent, Raymond James’ Bill Van Law believes. “The only issue there is timing,” he says. “Some advisers take the view that, “I really want to do this, but I have got to wait until things settle down.”” They also realize that, with tighter industry regulation looming, spiraling expenses to meet new compliance requirements seem likely if they start a firm. “They have to ask, “Am I really going to move today, or should I go through the process of evaluating my options and then move when things improve a bit?”” he says. “There is not a right answer.”

The longer-term trend is toward independent advisers, agrees Cerulli’s Bing Waldert. “However, when the market is down 40% or 50%, that is not a good time to start your own business,” he says. Focusing on fee-based business does not save RIAs from volatility, he says. “You are hurting in this market either way. If you have a fee-based business and you get a fee of 1% of assets, the assets are down 30% or 40%, or 50%.’ As the total plan assets drop, so do asset-based fees. He does not expect a lot of movement in the near future. “It is an open question what is going to happen 12 to 24 months down the line,” he says.

Adds Cerulli Senior Analyst Tom Modestino, “You do not want to move today, in light of what is happening. Ultimately, there is still that risk/reward issue that applies. I do not see a big jump, but I do think we will see some folks take a hard look.”

For some, a good compromise may be to affiliate with a broker/dealer that can function as a corporate RIA. “We see great flows of advisers who choose not necessarily to go the fully independent route, but partner with a broker/dealer with its own RIA,” Pershing’s Jim Crowley says. These advisers can have dual registration and function with clients as both a broker and a fee-based adviser, he says.

Advisers affiliating with Raymond James’s broker/dealer can function as RIAs themselves or operate under its RIA, Van Law says. Most use the Raymond James RIA, in part because of the cost and compliance issues, he says. “If 80% of their revenue is fees, that means 20% is regular [transaction-based] business. The reality is that most do not want to give up the other 20%,” he says. “This is the best of all possible worlds. You can do it all under one roof.”

All in all, GBS Investment Consulting’s Mike DiCenso foresees a slowdown in advisers going fully independent, at least for now. “Fewer and fewer will start their own firms and many of those who have gone to the independent model over the past year-and-a-half to two years probably wish they did not,” he says. “Now they are out there on their own, without the backing of a large organization, and clients are looking for that backing, especially from the fiduciary side.”

The company acquired about a half-dozen advisory firms in 2008, and DiCenso anticipates more acquisition opportunities this year, given how many advisers went independent before the market’s slide. With no upswing likely imminent, he predicts, more advisers will talk about selling their businesses. “At the companies we have talked to in the past few years, a lot of the advisers said, “I am going to wait, because I can grow the business on my own.” Now, the multiple paid on that business is going to be less than it was a year ago, and that is going to be the case throughout 2009,” he says.

There has been some skepticism about whether the strategy of firms such as NFP to acquire existing advisory practices works in the long term, as some acquired advisers may lose interest or depart. A spokesperson says, “NFP remains firmly committed to its business model.” In an earnings call held in November, NFP Chairman, President, and CEO Jessica Bibliowicz was quoted as saying, “Looking past the unprecedented market turmoil, the long-term demographic trends of the markets we serve remain strong….The current market shows that a strong, independent adviser is imperative.”—JW

Illustration by Chris Buzelli