The following is an edited transcript of the round-table discussion.
The following is an edited transcript of the round-table discussion. It was moderated by InvestmentNews deputy editor Evan Cooper and InvestmentNews senior editor Dan Jamieson.
InvestmentNews: Wall Street has been cast as the villain in the economic crisis. How do retail brokers deal with that?
Mr. Sarch: It's important to separate the retail brokers from Wall Street. These guys have been trying to look out for their clients' money, and they've all had their own wealth destroyed by the same mistakes that have really crushed the country.
Mr. Moy: Right. Everybody in a support role, who's working in legal or compliance or is a secretary or anything like that, is getting lumped in as well.
Mr. Gallant: The other thing is the retention packages. These guys are making a lot of money when their clients are losing money. The media loves to spin it. The media has been a real problem in the whole scandal.
I remember they were asking Suze Orman — this was when the [Emergency Economic Stabilization] bill didn't get signed initially — "Is this belt-tightening or bread lines?" She goes, "Oh, it's bread lines." They just love to create drama. They're not reporting the news, they're trying to make the news. It just emboldens this whole view of Wall Street greed and my broker's up to no good.
Ms. Diamond: As historic as this election was, after Sept. 15, the anxiety was less about the election and more about, "What's going to happen to our firm and the rest of Wall Street?" And I absolutely agree with Danny that you've got to separate retail brokerage, which has been the jewel of most of the firms through all of this, from everything else that's gone on around Wall Street.
Mr. Sarch: It's sad that the public views Wall Street as this two-word monolith. Mark, I'm sure, has gotten resumes from career assistants at Lehman Brothers [Holding Inc. in New York] or [The] Bear Stearns [Cos. Inc. in New York] who thought they had a nest egg of a few thousand shares of stock that at one point was worth a couple million dollars and essentially became worthless. These people don't have prospects the way brokers do. They don't have people bidding for them. They're out of work. So Wall Street is impacted as a victim. The loyalty is destroyed in terms of the loss of confidence that they have in the leaders of their companies, and that filters down to all the employees.
Ms. Diamond: I think if you queried brokers' clients, the clients would acknowledge that their broker didn't do anything wrong. They know that in their heads. But when the client looks at their statement and they're down 30% or whatever it is, the broker is the one on the front line who gets blamed. And absolutely, loyalty is gone. Merrill Lynch [& Co. Inc. in New York] in particular used to be a firm that bred loyalty. There were tons of 30-year and 40-year veterans who absolutely planned to stay and get the gold watch. If they choose to stay now, it's not because of loyalty. It'll be be-cause it's easier to stay, or the retention package was good enough, or it's just inertia.
Mr. Elzweig: Now we're all seeing people who have been with one firm for 25 and 30 years, people who I would have written off as lifers and not even bothered to prospect, moving. Advisers are realizing now that all the firms were guilty of reckless mismanagement. They basically have a loss of confidence in the leadership at all the different wirehouses. Brokers are realizing that the only thing they can ever really depend on is the strength of their own franchise.
Ms. Diamond: That's exactly correct. They're in infinitely better shape than the beleaguered Lehman, or salaried folks who are either soon to be laid off or already laid off. Their book is their book. It's their insurance policy, and as long as they've got their book, they've got equity in their business and the ability to replenish wealth.
Mr. Gallant: Despite all the issues, the demand for advice is still on the rise. The boomer wave is still seven years out. So advisers are still in a very good position. The environment has lent itself to advisers being more receptive to being independent, whether it's an independent broker-dealer or breakaway [registered investment adviser]. These advisers are saying, "I've got no one to rely on but my own abilities." I believe that's what the independent firms are going to play off. [Charles Schwab Corp. of San Francisco, Fidelity Investments of Boston, Pershing LLC of Jersey City, N.J., and LPL Financial of Boston] are seeing a big bump right now in recruiting efforts. They're starting to get those who were very resistant to going independent, but now they're receptive.
LEAPING TO INDEPENDENCE
InvestmentNews: Do you think that the traditional wirehouse brokerage crowd will really make that independent jump? We've always talked about this huge wave and it never quite gets past a steady trickle.
Mr. Sarch: If you look at the size of the sales forces at the five major firms, that is probably 50,000 people all in. So if 2,000 of those seek alternative solutions and maybe 1,000 of them actually make those types of moves at all different levels of production, I don't know if you would view that as a flood. But I think people who are seeking those people would say that this is unbelievable. This is wonderful.
Ms. Diamond: Going independent, in my experience, has always been the fantasy of nine brokers out of 10. If you asked, "What's Utopia?" they would describe some version of independence. Problem is, that when most brokers looked under the covers at the independent model, they either realized that they didn't have the courage or the desire to be a business owner, they have no desire to handle regulatory legal compliance, they have deferred [compensation] that they're going to walk away from, and unless they're remunerated for it, there's no way they're leaving. They are on a forgivable loan and they owe money back to their own firm. So they look at the money and realize that they can't do it. But I think you're going to see more and more, because the golden handcuffs at the major firms are a lot looser than they used to be, so people aren't worried about leaving as much behind, and that brand loyalty is gone. So, there's a lot more willingness to consider some component of independence now.
Mr. Elzweig: A lot of these independent firms, though, are being what I would call appreciated to death. In other words, now independence is something that everyone who moves looks at, but a lot of people don't do it, and one of the reasons they don't is [because] the wirehouses are easy places. They are turnkey in terms of having all the product services. Maybe the household name is tarnished, but it's still a household name. The other thing is, people have lost a lot of money in deferred compensation. Those people, if anything, are more money-oriented than ever when they make a move. So, most of those people, I think are going to stay with a familiar solution. The flood will get a little bigger, but I don't think it's going to be a dramatic trend.
Mr. Sarch: There's a price point that's crucial. If you have a $1 million producer at a wirehouse, when you add in his payout, add in his benefits and his assistants and travel, there's essentially 55% all in. If they go independent, after their expenses, they're at 65%, maybe. That's not life-changing for somebody who is already making that much money. But the $300,000 or $400,000 producer who is being cut and cut and cut, who's maybe making $120,000 at the wirehouses, sees it as a doubling to maybe $250,000. That's life-changing for that person. That's why those people have been more attracted to independents than the big producers. But the big producers now have seen their worth come down. They're looking for ways in which they can possibly do that.
Ms. Diamond: That's true, as long as the wirehouse deals remain astronomical. If they weigh the taxes and the hassle and the name brand being tarnished, I think more people are going to be willing to consider alternatives. We're beginning to see a wave of quasi-independent models that offer economics similar to the wirehouse. Not quite as much up-front, but recognizing the fact that advisers have wealth they need to replenish. They're looking for money, and they may not consider the traditional independent broker-dealer model, but they might consider some other alternatives.
InvestmentNews: What are some examples of that quasi-independent model?
Ms. Diamond: [Charlotte, N.C.-based Wachovia Corp.'s] profit formula, or what will be [San Francisco-based Wells Fargo & Co.'s] profit formula — it's an 11-year-old program — is probably the most popular example. Right now it's only available to advisers doing over $1 million. It's for a certain level. But it's a quasi-independent model where they're a W-2 employee. They get all the benefits of independence, but still have full branch support. So they don't handle regulatory legal compliance. They get 75% payout. They're paying their own expenses. Net is usually 50% to 60%, depending upon where they are, and they love that because they can self-brand. If they're portfolio managers, they can report historic performance results. All things they can't do in traditional platforms.
Mr. Gallant: The issue is what you mean by "independence." It is an extremely diverse marketplace. When you start dealing with the independents, they vary across the board. There are some that are very specialized. There are some that are extremely small. There are very large firms. It might be easier for an established wirehouse to actually provide something in between. For the independents, it's hard to move people back into less payout. You might start to see other firms experiment with giving advisers more choice on how they want to do it. You don't have to go off and be an RIA and jump off the cliff. There are gradations between that.
Mr. Elzweig: For people who are doing $2 million or more, who are basically fee-based brokers who have a lot of assets, you're starting to see new boutiques coming into the marketplace that are paying them combinations of upfront money and cash. There are a number of these wealth management boutiques that want these high-end wirehouse teams. It's not independence, but it's like that because it is an open-architecture model, where you're an owner. The firm is basically saying your equity will be worth more if you're part of their firm than if you're just hanging out a shingle yourself. They're going to start to suck away a lot of these very high-end teams and that's only going to accelerate the demand for very large producers.
I think that deals are probably going to start to go down, especially for people doing less than $750,000, and the reason I say that is basically twofold. You have wirehouses that are basically transforming themselves into deleveraged commercial banks. Therefore, the firms are going to be less profitable, they're going to have less money to spend, and when they do spend it, they're going to be more careful. You can look at the Merrill deal as a paradigm. If you're doing $750,000, they do want you to stay. Below that, they really don't care all that much. They're really interested in the $1 million-plus producers.
'SUPPLY AND DEMAND'
InvestmentNews: Mindy, you mentioned before that deals have dropped?
Ms. Diamond: I know [New York-based] Smith Barney [a unit of Citigroup Inc.] dropped their deals ... and I think Merrill is supposed to drop [its] recruiting deals. By how much I don't know, but certainly the expectation is that the deals are coming down. And so then, it's a question of whether others will follow.
Mr. Sarch: It comes down to supply and demand. There's still demand for big advisers, but there are fewer places for them. Smith Barney closed one of its Manhattan branches, so those advisers were distributed among the other offices. All these firms together in New York City are competing for the same people and there are fewer seats.
At the same time, you have in-creased supply, like Merrill advisers who had never considered moving. Morgan Stanley went into a weekend thinking they might go out of business. Wachovia went into a weekend thinking they might go out of business. Smith Barney remains in turmoil. There's not a single firm that has been immune from this stuff. So you have more people interviewing and looking for deals, at the same time there are fewer desks. Smith Barney shut a bunch of offices around the country. Merrill has done it quietly. Wachovia has done it very quietly. Legacy [St. Louis-based] A.G. Edwards [& Sons Inc.] offices are closing, and I'm sure they'll do a lot more of those.
Mr. Elzweig: I agree with you in the short term. The offers are going to go down, but I think the long-term picture is really good. I think the demand for advisers will go up. I checked the numbers, and after 1987 when the market crashed, the number of brokers plummeted. It took four years for the numbers to get back to where they were before, and I think we're going to start to see that now. People a couple years ahead of retirement are going to leave early. People who have weak franchises or people who were new are going to be blown out. At the same time, the average age of brokers across all channels is in the 50s. As the pool of retirement assets from baby boomers expands, you're going to have fewer advisers to service them. So I think we're all in a very good place.
Ms. Diamond: It's a production culture. I don't want to say it's less about quality, but the single biggest determinant of the haves versus the have-nots is production. The average production at wirehouses now is probably somewhere around $650,000 or $700,000. That's why we're seeing Merrill structure this deal where if you're below $750,000, it's not that interested in retaining you. Individual producers doing below that are having a hard time getting deals. Particularly in cities where the managers are having three breakfasts, five lunches and four dinners just to keep up with the demand to interview brokers.
Mr. Gallant: There are no new entrants. I know you said after '87 it took four years to come back, but after 9/11, it dropped off, and even before that the economics of bringing an adviser in and being more fee-based has just been daunting. I'm not sure how long it will take before firms start to ramp up new entrants to this business.
InvestmentNews: Do the newcomers at the independents come in as apprentices and work their way up?
Mr. Gallant: They come from different sources. If you go talk to the independents, it's always cyclical. In an up market, the wirehouses and more traditionals have done well because of stock and the ability to pay. Now we're not going to have any new recruits for two or three more years, and they weren't doing that much recruiting even when the market was up. So I think we're up for a large shortage.
Mr. Elzweig: Even if you add new recruits, it's not like the old days. Everything is by referral. And even when the firms try to hire second-career people, a lot of them don't have the requisite sales skills to really use their previous contacts. When you take a training class and look at who's still sitting at their desk three years later, I would say 15% is a high number.
Mr. Gallant: How do you build a planner from scratch? It's very difficult. It's very expensive, and now you're seeing all these advisers who we want to move into planning. Well, the economics are pretty tough. When you layer in what clients are looking for in an adviser — consolidation, trust, broader service, advice delivery — it just raises the bar even higher for new entrants to get into this business. How many actually do stay in the business? Or do they fade out because they're not going to be making money right away?
Mr. Elzweig: And how long does it take? Even if you're successful, does it take three or four years before you can make enough money to justify staying in? I've seen good people — people who were succeeding by the firm's measures — leave, because they just didn't want to wait for three, four years. It's hard.
Mr. Gallant: I hear everyone talk about how they're going to work on bringing in new people into the industry, but I think it's just easier to go after the seasoned producers right now.
Mr. Sarch: I think the training programs of the future will be about bringing in junior people to the senior teams. I don't see any way around it. To provide an exit strategy, the firms have to bring in junior people to whom the senior people will have to give more control and more assets, so they can essentially inherit the business. Here's somebody who's 52, you're 30. In 10 to 12 years, you will have this. It's going back to medieval times in terms of the apprentice inheriting the blacksmith shop.
Ms. Diamond: The way this Merrill retention package was structured, a lot of teams will split, because the deal was structured around a broker's individual production number. There wasn't really deference to a team. So what you've got is the have and have-not culture. You have the 52-year-old adviser who was doing $2 million, who got a 100% retention package, and he took on the junior guy doing $500,000 or $600,000, who got much less than he felt he was worth. So the senior guy is most likely going to stay, unless he was really unhappy beforehand. The junior guy wants to leave because he knows they're not investing in him. I think we're going to watch a lot of teams split up.
Mr. Sarch: Some of the senior people are actually giving money out of their own pocket. Merrill is allowing that to happen in order to keep those junior people happy. But it's a big problem. When we're recruiting them, the suspicion on the recruiting firm's side is how much of the relationships can really come. How much can you really bring with you? These things sometimes have gotten very, very nasty in terms of the fight for the clients.
The Merrill contract strikes me as Merrill's insidious way of keeping these teams from moving as a group. "Yes, we're going to obey the protocol, however, if you take any employees with you, then we're going to slap [a temporary restraining order] on you and enjoin you." I think it will remain to be seen how that's tested, once these things are signed and then executed.
Mr. Gallant: The teams are obviously good for economic-advice delivery and servicing broader needs, but then you have the Schwabs and the Fidelitys and the Pershings tailoring capabilities and saying, "Look, we can help bring that whole team right over." So a lot of the larger teams have gone, become RIAs.
Mr. Sarch: No question. I'm talking about what happens next. A big team wants to go, so what does Merrill do? Do they enforce the letter of the law in that contract and try to enjoin them from going because you solicited?
Mr. Gallant: The team issues are almost the same on the independent side. You always have that career path. There's a point where the principal wants to retire, and so he wants the junior partners to buy him out, but they're not well-financed, they're not ready to take the buyout, or they're likely to get acquired and the team member says, "What am I getting out of this?" So, they're having just as much trouble keeping advisers.
Mr. Moy: There have always been cases of people who have some type of retention requirements. The pressures now just seem to be greater. There are always people who sign retention deals with an eye toward not honoring them.
One thing that's a little bit different now is that firms have strategies for how they're going to keep the people they really care about. I think basically consideration does not have to be paid at the time in order for it to be an enforceable contract. You can have an enforceable contract by the exchange of mutual promises. It doesn't have to be executed. So a bigger issue is, even if I break something that on the letter of this document is a breach of a contractual obligation, what are you going to do about it? How are you going to establish that there are any damages? If I sign an offer letter and I don't actually go — which a lot of people ask me about — because I'm going to wait and see if I get countered by the firm I'm at, what's going to be the downside for me?
Are they going to argue that this is an enforceable contract? The answer is yes, they're going to argue this is an enforceable contract, but are they going to bother to go after you when basically they're going to be hard-pressed to show what the damages are, you haven't shown up there yet, and the agreement says that once you're there, you're going to be at-will anyway.
Then the big issue is what about all the restrictions that come with that. You're not going to compete. You're not going to solicit. You're not going to contact clients. You're going to give us 30 days notice. You're going to give us 90 days notice. Those are the things that get to be issues.
A lot of it's going to depend upon on where these people have an eye toward ultimately going. [Are they] going to another wirehouse? They're almost counting on being defended by the firm they're going to, both in terms of legal expense and if there's going to be a co-defendant. If the existing firm's going to sue them or bring an action for a temporary restraining order or something like that to try to tie them up, they understand that they're not just going to name the departing person or departing team. They're going to name the firm they're going to. And so they're going to be counting on that defense. But on the other hand, if they're just going to leave the industry, go independent or do something where they're going to have less of a support system, well, then maybe they'll think a little bit harder about it.
Ms. Diamond: What will life look like for these Merrill advisers? ... I'm going to hope that it all remains the same and life is as usual. If six months or a year from now, life is changed and I want to leave, I'll just pay back the unforgiven portion of what I've gotten and I'm free to go.
Is that going to be as easy as they think? And how does that relate to being able to move in pre-protocol times? [Bank of America Corp., based in Charlotte, N.C.] is not a part of the protocol [Editor's note: BofA said later in November that it would join. ] and there's a reason. Merrill has been having these meetings within their offices assuring brokers nothing will change and it has no intention of pulling the protocol, but Merrill management will no longer be in charge once BofA comes in.
Mr. Moy: My answer to that would be, you cannot count on not being sued because those non-solicitation of employee provisions have always been the ones that the firms have sought hardest to enforce, and a court or arbitrator takes the side of the firm more on those types of provisions than they would take on a non-solicitation of clients or a non-competition provision, because those directly impact an individual's ability to make a living. But do you really need to take your right-hand person to make a living? No. So I think that you can expect litigation.
Mr. Elzweig: How will that affect people going independent? A wirehouse has the firepower to settle, that's part of the cost of doing business. It would seem to me independents may be less interested in getting involved.
Mr. Moy: I think they are. That kind of support's not going to be there.
InvestmentNews: Let's assume that brokers are going to stay at the big firms, and the big firms are going to be fine. What's it going to be like at Merrill Lynch going forward or Wachovia going forward with the new owners, as well as [Zurich, Switzerland-based UBS AG] and the other big firms?
Mr. Sarch: Nobody knows, of course, but show me a mega-merger in any industry that people looked at five years later and said, "Boy, this was a great idea." Nobody's been able to come up with one. In the [Oct. 20] "60 Minutes" interview, Ken Lewis [chief executive of BofA] talked about Merrill Lynch like it was an afterthought. And he spoke with glee about cutting costs out of the organization, and he spoke with glee about how people were overpaid on Wall Street. So when the Merrill guys say it will all be the same and nothing will change, I think it's naive. Nobody knows what it's going to look like.
Mr. Gallant: Banks are a different culture. Bank acquisitions at brokerage firms have had mixed results at best. Most are still dealing with integration. There are still cultural clashes. It's very siloed. That mentality of looking at the cost and the salaries is just a huge difference between the bank brokerage.
Ms. Diamond: Banks tend to look to the lowest-cost provider. So a bank's mentality is entirely different than an investment firm's mentality. Morgan Stanley is the one firm that remains independent with that traditional investment culture. That's the one with probably the fewest question marks surrounding it. Citi Smith Barney would be the perfect example of nine or 10 years after [the] merger [of Citicorp Inc. and Travelers Corp.], they still haven't gotten it right. You've got tons of Smith Barney brokers that are very unhappy with the lack of one culture between bank and brokerage.
Mr. Gallant: BofA's much more of a mass-market type of bank than even Citi. So if Citi can't work it, when you're dealing with more of a retail bank, there's just more of that contrast.
Mr. Elzweig: It goes back to what I said earlier about the investment banks becoming commercial banks and deleveraging and being less profitable. The way I think all these changes are going to affect brokers is that the in-house support that they get now is going to be less. At a major wirehouse, you have product specialists, people who market managed accounts, people who market retirement products, internal people whose job it is to train you and then to be the point person for all the outside vendors. Those people in the last year have been dramatically slashed. So I think there's going to be dramatically less access to capable internal people who can help brokers with the business.
Mr. Sarch: The firms have al-ready stopped manufacturing product and then selling it. The Morgan Stanley-Dean Witter model of you produce it and then sell it has been discredited. None of the big firms are doing that anymore. So, what do you have that ties you to the big firm? You've got a brand that has been tarnished and you've got all these support things that are gone.
Ms. Diamond: Let's tack on to that the fact that in this Merrill/ BofA deal, those managers got nothing in terms of retention packages. Let's talk about the message that it sends those managers and how many of them will remain. And what tends to happen is that those advisers who don't like change want to believe management when they stand up and say, "Everything will remain the same." If you talk to the Piper Jaffray [& Co. of Minneapolis] and [Cleveland-based] McDonald [Investments] brokers who were bought by UBS, or [Baltimore-based] Legg Mason [Inc.] brokers at Smith Barney and what few [brokers of The] Advest [Group Inc. of Hartford, Conn.] remain at Merrill, they will tell you that despite promises from the get-go that nothing will change, little by little there were little changes, and in sum total by the end of a year or two, the firm was almost unrecognizable.
Mr. Moy: There's going to be massive culture shock, because New York Wall Street was always its own animal. They always thought that the New York folks were overpaid, and now everyone's going to be exposed to that.
Mr. Elzweig: Not only that, in the past, the heads of brokerage firms were always people who rose through the retail ranks. Those days are long gone and certainly never coming back. And just to Mindy's point, there was once a very funny advertising campaign launched by the New York Post about the three biggest lies and the first one was, "Don't worry, the merger won't affect your job."
Mr. Sarch: Well said. But I disagree. These firms, in order to keep cultures, are going to try to put more of their own people running the firms. That's one of the only ways they feel they can hold on to people.
Mr. Gallant: Will banks live up to the expectations in the brokerage world that we've been talking about for 20 years?
Ms. Diamond: I think that somewhere in the minds of these advisers, they're thinking that at some point perhaps they'll be able to capture some of the referral stream that may come from Bank of America or Wells Fargo, and we know sitting in this room that that's very unlikely to happen.
Mr. Elzweig: Not only that. If you're a good broker, you wouldn't want to capture the referral stream, because when a bank gives you a referral, they usually cut your payout in half. So if you're an entrepreneurial broker capable of going out there and making it happen yourself, you wouldn't want business that would be less loyal to you and where you'd be paid less.
Mr. Sarch: Absolutely. And Bank of America's history was that when an account was over $3 million, they gave it to a private bank. They took it away from the broker.
Mr. Gallant: That's still in place in most bank environments. And most of the leads they get aren't great leads.
Ms. Diamond: Right. But the reason that they give the $3 million-plus lead to the private banker is because it is the lowest-cost provider. The private banker is paid salary and bonus. But I think the Merrill advisers are having a hard time believing that. That they're in such incredible shock about all that has gone on, that unfortunately, a lot of them are going to have to live through it and feel the pain before they really get a sense that life at an independent investment house will be different than life at a commercial bank or wirehouse.
Mr. Sarch: A lot of it is they want to take care of their clients. Let's be fair, the last [three] months have been the most tumultuous that the market has ever seen. So they're saying, "I know there's other stuff. I've got a book. I can always go somewhere. I'm going to take the money. I can sit. I got to take care of my clients." I respect that these advisers are trying to really be the fiduciary and worry about their clients at the same time that they're worried about their careers, and that's why the stress level has been unbelievable.
InvestmentNews: The other side is that a lot of Wachovia brokers were pretty happy doing some mortgages and working with the bank.
Mr. Elzweig: In this tumultuous environment, a lot of brokers feel very reassured that if you're owned by Bank of America or Wells Fargo, you're probably not going to go out of business next week, and that actually is a positive for a lot of people.
InvestmentNews: Is this a time that regional firms provide an alternative incentive that's most like a wirehouse, but not too independent?
Mr. Sarch: Absolutely. Raymond James [Financial Inc. of St. Petersburg, Fla.] has had enormous success, along with RBC [Wealth Management Inc. of Minneapolis]. These firms never had these subprime issues. The problem is, they're not in all the markets. These firms, by definition, are regional and they're not an option for everybody, but a lot of them are expanding tremendously.
Ms. Diamond: It goes back to the idea that most brokers fantasize about the idea of going independent. But because money is an issue, many of them can't afford to go totally independent. So the regionals provide that best of both worlds — more autonomy and ostensibly higher payout than the [wirehouses]. And the platform is homogenous. Unless you've got some really non-plain-vanilla business, you can do your business, platformwise, anywhere you are. The only thing is that the regional firms don't pay deals as large as the wirehouses. But if it's an alternative to independents, many of them will take it in a heartbeat.
Mr. Sarch: A lot of them put it in writing that the broker owns their book. So that's a very powerful thing to somebody. It means that there's a death benefit if they die, it means they can sell it to somebody else, as if they were independent. Their retention rates have been so high, because they say to people, "You can leave and you can take your book with you," but because you can't get that somewhere else, they don't leave.
Mr. Sarch: At a lot of these firms, the model is never to have a 50-broker, 50-adviser office. Their model is to have a $5 [million] to $10 million office. A $20-million office in a wirehouse is modest, and you don't see that at these firms. They're just a much different scale.
Ms. Diamond: Most of the re-gional firms would put $3 million as a bare minimum for them to build infrastructure in place where they are not.
Mr. Sarch: It's a huge chicken-and-the-egg problem, because you want the advisers on board before you build out space, and the advisers want to see the space before they come on board.
Mr. Gallant: What's going to happen in the regional space? Do you think some will want to expand and capitalize on this?
Mr. Elzweig: I think a lot of people who explore going independent instead will join regional firms, and over time, they'll be very big winners, because even if they pay less upfront money, you still get some upfront money, and you're not required to change your whole business model. You don't have to track down your sales assistant, investigate health insurance, buy a copier.
Mr. Gallant: I always find that advisers often do the gross versus the net. The independents still pay that 93% payout, but what they don't tell you is the reality of paying your own freight and sweat equity.
Ms. Diamond: The regional firms, until very recently, went through a period where they really had a hard time recruiting because they were neither here nor there. But this debacle has been the very best thing that happened to the regional firms. They are thriving.
InvestmentNews: What's the outlook going to be if the market recovers? It sounds like you don't think the traditional brokers are going to be happy where they are now. Are there any big traditional firms where people are going to settle down and be happy?
Mr. Sarch: People ultimately have short memories. The stock starts going up, and their clients get happy. The question is what's going to happen behind the scenes to the organizations. As much as things might calm down in terms of the economy, the big changes are yet to come. We've got these massive mergers that haven't been consummated yet.
Mr. Elzweig: For whoever can make it through this, I think their future's really good and they will be happy, irrespective of what's going on with the firms, because of the simple numbers that you're going to have fewer brokers and more assets. I've talked to RIAs who have capacity issues. They're managing all the assets that they can possibly handle, and I think in the future, that's going to be an issue for some of the larger teams.
Ms. Diamond: They'll go back to being just happy enough. I think they realize that there is no perfect opportunity and there is no Utopia, and there are things that they love about being at a wirehouse and things that they may like a little more about independents. Ultimately, those who are cut out to be entrepreneurs will wind up with independents and those who are not and see the benefit of having a big-firm name behind them will stay where they are. They'll become happy enough. Will they be a 10? No. But if they're a seven, that's probably good enough.
Mr. Moy: It seems like everyone's expectations have been managed way, way down. There's definitely the layer of the ultradesirable. Everyone's wooing them. They're being offered retention deals. But beneath that, there's a layer of people who survived reductions in force, who are happy to have a seat, and not really anxious about looking to see what's out there and just want to wait for the storm to pass. They realize the rules are going to be different. They don't know exactly how, but they're just not expecting nearly as much as they used to.
Mr. Gallant: I'm wondering if the new adviser coming in is going to need more of a road map. Right now we're seeing this whole focus on RIAs. But is the next breed of adviser less likely to have the skill set to want to do all that stuff, and would having a full-service brokerage firm be a better place for them?
Mr. Sarch: You can be a registered investment adviser and not run the money yourself.
Mr. Gallant: Right. They can outsource the asset management. I'm not sure if they're that entrepreneurial.
InvestmentNews: Do you think there's any possibility the banks would say, "Who needs this business?" Or will they keep it for the name and say, "You're a Merrill Lynch broker, but you're on your own. You just pay us a fee in some way to use the name."
Mr. Sarch: They're worried about the name and what the name means. Somebody asked James Gorman [Morgan Stanley co-president] when he was at Merrill what his biggest fear was, and his answer, which I thought was very astute, was that the experience that a client gets will vary so much, depending upon the adviser that they're in front of, and I think that's still the worry.
Mr. Elzweig: One of the lessons of this whole financial crisis is the glory of the retail business. If you run your retail business in a prudent fashion with good people, it's a steadily profitable business that's not going to lose you billions of dollars every quarter. I think a lot of places are going to refocus on their core retail businesses as very attractive places to be.
Mr. Sarch: The regional firms never lost that focus.
Mr. Elzweig: Exactly. Which is why they're attractive. Wirehouses, in my view, are infinitely creative in terms of how to keep people. I would never underestimate them. If you think back just a few years ago, to when the independents started with open architecture, that was a big threat to the wirehouses. There was a movement of assets away from wirehouses to independent practitioners. Well, the wirehouses got the message really fast. They said, "Okay, we're not into proprietary product-pushing anymore. We're going to set up platforms where our best advisers can choose a best-of-breed menu."
So, I think that the people who run wirehouses, for all their missteps, are very smart and very creative people. A lot of them will come up with ingenious ways, above and beyond deferred compensation, to persuade people to stay there and not to leave.
Ms. Diamond: The Wachovia profit formula is a model that probably many of them at some point will copy in some form. RBC is launching a profit-formula-like model in recognition of the fact that no one model fits every adviser. Wachovia will tell you that their profit formula is their best retention tool. Those big advisers doing over $1 million love it, love it, love it. And it's a great recruiting tool as well. So I know that all the major firms have looked at it. They've scratched their heads trying to figure out how it's profitable, but I think at some point they'll figure it out.
Mr. Gallant: Now you have hybrids. You can be dually registered under the corporate RIA or your own RIA, and I think there's going to be choice with regard to affiliation. They're saying, "Look, I'm losing $2 [-million], $3 [-million], $4-million producers here. What do I do to retain them?" Maybe create an RIA-type environment. They're all going that way. They all have independent affiliations that they're toying with. The problem is that the marketplace is moving, there are all these different options, and advisers are having trouble figuring out how to make sense of heads or tails.
Mr. Elzweig: Just giving people choice keeps them in the fold. I've spoken to Wachovia managers and asked them how many people who are regular brokers decide within Wachovia to go to [Wachovia Securities Financial Network]. The answer is not that many. But just for Wachovia brokers to know that if they ever want to do that, they can do it without changing firms, that's a good reason to join the firm and it's a good reason to stay there.
Mr. Sarch: Raymond James does the same thing. Some of these things get corrupted, though, because the brokers always find a loophole. Wachovia has a big problem now with a lot of their profit formula guys. All these people figured out all this stuff, and the ones who were hurt were the shareholders and the managers of profitability, while the brokers were all making more money.
Ms. Diamond: We talked about how giving choice costs money. If we go back to BofA and the bank mentality of looking at the lowest-cost provider, then how is that going to work? And will firms that remain independent — the regional firms, Morgan Stanley, the true independent broker-dealers — will they actually be able to pull it off faster than these big commercial-bank-owned firms?
Mr. Gallant: Interestingly enough, a lot of the big banks were trying to buy RIAs. There was a time in the mid '90s, late '90s, where banks were calling RIAs left and right because they thought it was a very good fit for the trust and wealth management groups. So, they're not completely ignorant of the RIA marketplace. A lot of these deals never happened because of the cultural issues. But there are quite a few RIAs out there that were part of banks.
InvestmentNews: Is regulatory reform going to happen?
Mr. Sarch: If you ask the average adviser who's been doing this for a long time, they'll have a tough time thinking how they can be regulated at their level more. I guess they could be, but I think that would be very sad.
Mr. Gallant: If RIAs become big enough, then there's going to have to be greater scrutiny on them. There's no way to escape it. There's going to be more regulation across the board, which is hard to believe, and it's certainly going to be counterproductive to some degree, but that's the way it goes.
Ms. Diamond: Hypervigilant compliance is probably the No. 1 complaint of wirehouse brokers. It's not that the regional firms or the independent broker-dealers are less compliant, but they have fewer folks to manage. The bigger the firm, the more compliance procedures they have to put in place to corral everybody. They manage to the lowest common denominator. If a regional firm has 1,200 brokers and Merrill Lynch has 16,000 or 17,000 brokers, it stands to reason that there are more things that an adviser needs to do to prove that he's compliant at the major firms than he does if he's at an independent or regional firm.
Mr. Elzweig: Even though it's true that compliance has taken a lot of the fun out of the business, the number of lawsuits seems to be dramatically down. The number of people who have pending customer complaints is way less than it used to be. So that's the good part.
Mr. Moy: I don't think all the fallout has happened yet. In general, there's been pain so there's going to be some scapegoating, and it's bound to translate into more regulatory issues. I'm seeing a lot more of that hypervigilance or that hyper-scrutiny. I'm not sure really how it translates to any additional protection to the end-user or the investor. But it certainly creates more issues.
Mr. Sarch: It used to be that even five years ago, if someone had a nick or two on their record, they could move. Somebody came to me recently after being fired for [porn-ography] on the Internet. That by itself might have been forgiven if that were the only thing, but the guy had a couple of nicks on his record and he was done. Nobody wants to stick their neck out for anyone else, which is human nature, so the industry remains hypervigilant about those types of people.
Mr. Moy: But it's a supply and demand issue also. If you have a lot of people competing for seats, why bother with somebody like that when you can get somebody who's not going to have those issues?
Mr. Gallant: We haven't really started to focus on retirement income. But there's less margin for error as you're dealing with retirees and the decumulation side. You've got the government saying, "We've got to protect seniors and an aging society." At the same time, you've got home offices that are worried about what's being built with portfolios out there. So I have a feeling there's going to be a lot more scrutiny. Who's going to be left holding the bag 25 years from now when the portfolio runs out of money? It's going to be the brokerage firm, not the adviser. What's the optimal way of doing it? The advisory platforms have provided consistency and can be monitored. I think there will be more of that moving forward.
Mr. Elzweig: What they will probably do is use models based on a client profile of risk and goal.
Mr. Gallant: The unified managed account ... has yet to really develop, but I think [it] holds the promise of that. Advisers might have choice, but it's limited choice. They give them guardrails. You can supplement different investments here. Tweak it on the allocations, but we're not going to let you go too far outside.
Mr. Elzweig: With the UMAs, in order to attract the high-end advisers, you have to give them choice in each asset class. You can't give them an off-the-shelf product. There's no value.
Mr. Gallant: That's been the problem with getting those off the ground.
InvestmentNews: Will the wirehouses still dominate the fee-based business after the crash?
Mr. Elzweig: The problem with the wirehouses has been that 85% of the [separately managed account] managers are all the same. It's good because it makes it relatively easy for brokers to move from one place to another, but it's not good, because advisers want to have a unique manager to come to clients with. Also, the margins for SMAs keep going down. A stand-alone SMA manager used to get [0.45 or 0.5 percentage] points; now they're getting [0.36] or [0.38]. And if you're in a unified managed account, it's down to [0.25] points. So the wirehouses are all now seeking out institutional managers that are smaller, that tend not to have like sales forces, because they're trying to give their advisers more-unique managers to sell. And I think that'll be a good thing. I've spoken to a number of high-end advisers who used to do SMAs, stopped doing them, and went to mutual funds because they felt they had more choice and that the managers were better. They weren't limited to the same 20 or 30 companies. So I think that's a real issue for wirehouses.
Mr. Sarch: And some of those might be RIAs that were brokers. If somebody's running at $400 million or $500 million in assets, it's like a mutual fund, and they'll say, "Why not come into our program?" Some of the boutiques are actually finding a unique manager who will do that and give them exclusive rights into the sales force.
Mr. Elzweig: And usually, when you deal with boutique firms, non-wirehouse firms, their managed-money programs already look different. They don't have the same managers. They tend to have small institutional boutiques that they've sought out to get into their program, and they pay them more. There's one problem with the SMA business: Since five control 75% of the assets, it basically chopped the fee so low, a lot of people don't want to play the game. It's a challenge now for the wirehouses to find some new players.
LITIGATION
InvestmentNews: What else haven't we covered?
Mr. Moy: You were asking earlier about whether there's going to be more litigation, and I think unquestionably, the answer to that is yes. A large part of that is because the firms don't have the willingness or don't feel they have the capital to fund negotiations. They're willing to just put it off until tomorrow, as long as it avoids doing anything today. And they don't have the attention span to process a lot of situations now that they used to have before. Even as a lawyer, I think that's a negative, because it raises the transaction costs for everybody.
Mr. Sarch: I see the firms looking for any type of hole in the protocol. They instruct the brokers to ask clients questions like, "When did you discover that Joe was going to leave?" They're looking to see if they were pre-solicited. "When did you actually get the paperwork?" The paperwork arrived on a Thursday, they resigned on a Friday. Whoops. That person violated a protocol. And they can't wait to litigate those. So the hiring firms now are requiring advisers they're recruiting to sign something that says, "I obeyed the protocol." And there is no "wink-wink." You have to do this or else somebody will come after you and shut you down.
Mr. Moy: There is also strange stuff happening more frequently, like firms' saying, "I realize that was our deal, but I'm not going to honor the deal." Or, "Please take less," with not much explanation, and then wondering why they get sued over it or why the person walks.
Ms. Diamond: That goes back to the question of these Merrill brokers' blindly signing the agreement on the 14th. I think there's so much static around them with client upset and the state of the market and the fact that Merrill just got sold to BofA that their own career issues are put on the back burner in a lot of cases.
Mr. Moy: In the situation where you're signing something, you realize it provides for certain obligations, and you're just counting on being able to push the whole thing aside. That's a big bet. And you don't know down the line when the event actually happens, six months or nine months down the road, what's going to be motivating the party that's ultimately deciding whether to sue you. But you're giving them an opportunity to do that. People feel they don't have any choices. They don't want to signal that they're not a team player. I'm not saying it's an easy or happy situation, but I think it's unrealistic to expect not to be pursued on something like that.
InvestmentNews: What are your final thoughts on who will be the winners after all the turmoil?
Mr. Sarch: UBS right now is seen as a big winner because they're still getting very aggressive deals and their circle has turned where they had all the issues and they stayed out of the press. All the firms have had their moment in the sunshine and their moment of being tortured.
Ms. Diamond: Morgan Stanley has been net positive in terms of recruiting all the way through with an enormous pipeline, and that ability to say, "We are the only independent investment house remaining of the five major firms," plus their deals are very aggressive. I think they are absolutely winding up on top right now.
Mr. Elzweig: Especially in the last year and a half, Morgan Stanley has done extremely well in recruiting, but I think it's a little hard to say really who the winners are. I don't think we'll know until a future time because there's plenty of movement.
