DOL rule slows down wirehouse recruiting and crimps bonuses

After months of secretive planning, seven teams of financial advisers had new business cards and client lists in hand, poised to dump their employers and join Morgan Stanley with more than $500 million of assets in tow. But the wealth managers woke on Oct. 28 to find the ground beneath them had shifted. Morgan Stanley had pulled the advisers' lucrative recruitment packages overnight after U.S. regulators clarified new rules to reduce conflicts of interest in the industry, according to people with knowledge of the situation. The teams were thrown into limbo. For years, top Wall Street financial advisers have cashed in on client relationships by jumping to rivals offering rich recruitment packages. But those multimillion-dollar deals abruptly crumbled in October when the Department of Labor briefed banks ahead of the April implementation of its so-called fiduciary rule. Major firms including Morgan Stanley and Bank of America Corp.'s Merrill Lynch soon restructured their enticements, typically offering at least 25% less than before, according to the people. And even though the rule's future is now in doubt, its impact on bonuses endures. "Right this second, I find almost nobody moving," said Michael King, a New York-based recruiter. "Unless there's a special situation they're trying to fix, like if they hate their manager, people are waiting to see if the bonuses come back." DOL IMPACT At the center of the disruption is the Department of Labor's interpretation of the fiduciary rule. Broadly speaking, the regulation says advisers handling retirement accounts must give advice in a client's best interest and shouldn't earn more than reasonable compensation. More specifically, the regulator said in October, hiring incentives risked running afoul of rules because they include sales targets that can pressure brokers to push expensive products on savers. In January, President Donald Trump signed an executive memorandum directing the regulator to review the rule. But after years of preparation, Morgan Stanley and Merrill Lynch have said they will still follow through with reforms they drafted to become compliant. They haven't specified what they'll do with compensation. Hardest hit are brokers who focus on commission-based accounts, where revenue is fueled by higher-cost investments such as variable annuities. While top financial advisers usually cater to a wealthy clientele who pay a flat fee, many still have at least some assets subject to the restrictions. None of the seven teams poised to join Morgan Stanley in October followed through, according to the people with knowledge of the situation, who asked not to be identified discussing confidential talks. But of several dozen others who agreed before the last week of October to take jobs, almost half eventually accepted the smaller packages, another person said. SETTING TARGETS Signing bonuses are calculated based on an adviser's trailing 12-month revenue, which includes fees and commissions. Before the Labor Department issued guidance in October, top performers could expect total incentive packages equal to about 330% of their revenue. That meant an adviser with $200 million in assets under management producing about $2 million in annual revenue could expect a deal worth $6.6 million. The payouts were split between upfront bonuses and back-end awards spread over about a decade. To collect the full package, the recruit had to hit certain production targets. But since October, the four major wirehouses of Morgan Stanley, Merrill Lynch, Wells Fargo & Co. and UBS Group AG have been offering packages worth 200%to 250%. That means the same adviser would reap at least $1.6 million less. The back-end awards have either been replaced by pay based on the deferred compensation that brokers forfeit when moving firms or changed to de-emphasize production targets to comply with the Labor Department directives. Regardless of what happens with the rule, wirehouses may not rush back to their old practices. For years recruitment deals have been derided as a zero-sum game that hurts industrywide profitability because big firms mostly just trade brokers among themselves. But brokers continued to offer the bonuses to defend and build wealth management businesses with steadier revenue and lower capital requirements than trading operations. The disruption in October may help ratchet down the bidding for top producers. "It's been an ongoing bull market for top talent, and this has been the first correction in at least 15 years," said Danny Sarch, president of recruitment firm Leitner Sarch Consultants. "We've had pauses, like during the financial crisis, but this is the first real step back. Now the question is, will they still be able to get people to move?"