Volcker rule would affect rich clients most

As work begins on the final version of the Volcker rule, wirehouse financial advisers say that their high-net-worth clients would feel the biggest impact from any new regulations that placed investment restrictions on financial institutions. “Ninety-nine percent of clients probably wouldn't be affected by the Volcker rule, but the 1% who would be are probably pretty high-end clients,” said one UBS AG adviser, who asked not to be identified. The proposed restrictions on banks that take federally insured deposits from conducting proprietary trading and investing in hedge funds and private-equity funds likely would have little direct impact on the bulk of wirehouse financial advisers and their clients.

SELLING POINT

But the cachet of providing access to alternative strategies, hot investment products and managers is a selling point for the wirehouses with many high-end investors. Losing the ability to offer such products to those clients could hurt the Wall Street brokerage firms at a time when their parent companies are looking for new sources of revenue. Last week's earnings reports from three of the four wirehouses, though not disastrous, showed continuing weakness — particularly on the investment-banking sides of their businesses. Morgan Stanley, for one, essentially would have broken even if not for a $3.4 billion accounting gain due to the falling value of its own debt and the $162 million share of profits from the Morgan Stanley Smith Barney LLC joint venture. The Volcker rule likely would be one more factor pinching revenue and margins — in this case with some of the more lucrative clients in the brokerage business. “The large investment banks get in bed with the big hedge funds and money managers,” said the UBS adviser. “If the firms can't commit capital there, I think it will hurt those relationships and limit access to speculative investments.” Even advisers who don't offer access to hedge funds, limited partnerships and the private-equity investments that their banking colleagues arrange worry that the Volcker rule could hurt their firms. “The average mom-and-pop adviser like me won't be affected, but it will affect some brokers in the firm,” said a Bank of America Merrill Lynch adviser, who asked to remain anonymous. “[The Volcker restrictions] are a clear negative.”

ELIMINATE CONFLICTS

Scott Smith, an associate director at Cerulli Associates Inc., said the proposed rules would remove a conflict of interest at the wirehouses that often has resulted in clients' getting burned. “They address the temptation to push product from the proprietary desks to clients. It's happened before, and the regulators don't want it to happen again,” he said. Mr. Smith said he doesn't believe the wirehouses will have any trouble finding more-exotic alternative investments to offer high-end clients who want them. “The richest of the rich will get their piece of the pie,” he said. “If the banks can't originate the deals, they'll still maintain access to them. The four wirehouses control 40% of the country's retail-investment assets. The originators of these kinds of products won't shut out that big a market.” As far as another Merrill adviser is concerned, he wishes they would. “I protect my clients from the product creations of Wall Street,” said the adviser, who asked not to be identified. “Every four to seven years, Wall Street blows up, and our clients blame us for it. Our steady income helps them make the big bets. They make a lot of money for a while and then they blow up.” His biggest concern about the Volcker rule is not the limitations it would put on Merrill's investment-banking operations but the indirect pressure he expects to feel if the restrictions cut into the company's revenue and profits. “If it's going to limit revenues, they're going to grind on us,” he said. “They'll cut our resources. Maybe they'll cut our health insurance further.” With the markets as unsettled as they are, and the regulatory environment being so uncertain, wirehouses likely will be watching their nickels and dimes for some time. UBS, for one, is already planning significant changes to its business model — in large part prompted by the $2.3 billion loss incurred by a London-based trader. It has indicated it will reduce its investment-banking activities and direct them to support the firm's global wealth management operations more closely.

TOO SOON TO TELL

Whether market conditions and new regulations such as the proposed Volker rule push the other wirehouses to exit businesses or significantly redirect resources remains to be seen. As Morgan Stanley CEO James Gorman said in an earnings conference last week, “It's far too early to determine the impact of the Volcker rule on our business model and the industry.” There's a good chance, however, that the Volcker rule could further challenge the already uneasy relationship between wirehouses and their financial advisers. Email Andrew Osterland at aosterland@investmentnews.com