What will Morgan Stanley’s James Gorman do with ETrade’s custody business?

After Morgan Stanley said in February that it was buying ETrade Financial Corp. for $13 billion in stock, its CEO, James Gorman, unabashedly sang the praises of certain parts of the discount broker that would augment the bank’s wealth management business.

ETrade’s corporate stock plan conversion business, which has a higher success rate than Morgan Stanley’s, was an opportunity for growth and the online brokerage platform, which gives the Wall Street bank access to a hotbed of younger and more engaged online clients, was a chance to gobble up clients’ assets held at competitors, a long-standing goal of Gorman’s. 

But when it came to ETrade’s fledgling custody business for registered investment advisers, which is relatively tiny, with $18.2 billion in assets compared to ETrade’s total of $360 billion in assets at the end of 2019, the CEO’s enthusiasm was far from full-throated. 

On the one hand, Gorman acknowledged that independent registered investment advisers — direct competitors of the advisers who work at wirehouses such as Morgan Stanley — are here to stay after more than a decade of incredible growth. On the other hand, he failed to muster much enthusiasm for the business, which directly competes with wirehouses like Morgan Stanley for advisers and adheres to a strict fiduciary standard, unlike the brokerage business.

In a call with analysts in July to discuss second-quarter earnings, Gorman said ETrade’s RIA custody platform, which reported 219 RIA custody clients and relationships at the end of June to InvestmentNews, was “a decent business model,” “a tiny business” for ETrade and “interesting.”

“It just isn’t a [platform] that we’ve had,” he told analysts and investors. “Now we’ve got an opportunity with it through ETrade. That’s an opportunity for us to pursue, but it’s very early days.”

Indeed, “leveraging RIA capabilities” was listed ninth when it came to potential positives for the bank’s valuation after it completes the purchase of ETrade, according to a research note by Steven Chubak, senior analyst for diversified brokers and banks at Wolfe Research. Reducing expenses, better funding prospects and the previously mentioned corporate stock plan conversion business topped Chubak’s list as the three biggest potential additives for Morgan Stanley. 

“The full integration of ETrade’s custody business into Morgan Stanley?” said a senior wirehouse executive who isn’t authorized to speak on the record about a competitor and requested anonymity. “I don’t see how it could happen. Culturally, the question for Morgan Stanley is, do we want to have RIAs around here?

“The deal kind of creates a clock if you’re Morgan Stanley to decide what to do,” the executive said. “If you are an ETrade adviser and client, you ask, ‘Is Morgan Stanley going to invest in the business or not?’”

Advisers have been fleeing Wall Street, taking billions of dollars in client assets with them, for the past 10 to 15 years to become independent RIAs and custody those assets with the likes of Schwab Advisor Services, Fidelity Clearing & Custody and Pershing Advisors Solutions. 

Will Morgan Stanley jump into a business in which it would compete against its own wealth management franchise? 

With the deal scheduled to close by the end of the year, a Morgan Stanley spokesperson said the company had no immediate plans to make changes to its own wealth management business or the RIA custody platform at ETrade. That means that a clear path for a Morgan Stanley adviser to become an RIA is not about to open.

“ETrade’s custody business is a small, relatively new business that, post close, we would plan to have remain on their platform and be separate and distinct from the Morgan Stanley wealth management platform,” the spokesperson said. “It’s already a profitable business which we would plan to continue and hopefully grow over time.”

A spokesperson for ETrade declined to comment. 

Taking a page from the playbook of discount brokers like the Charles Schwab Corp. and Fidelity Investments, ETrade entered the RIA custody business in 2018 when it bought Trust Company of America for $275 million. The hope for that group, under the brand of ETrade Advisor Services, was to gain traction in the market from the new owner’s resources and technology.

What was supposed to be a boon for ETrade’s burgeoning group of advisers will instead be a benefit for Morgan Stanley’s, noted one industry executive. 

“An issue for the ETrade advisers is the retail client referrals that ETrade was to send their way will now likely go to Morgan Stanley reps,” said Sean Gultig, CEO of Equity Advisor Solutions, a small RIA custodian with 130 RIAs and advisers and $29 billion in client assets. “First, Trust Company of America sold to ETrade, and then there’s the double whammy of selling to Morgan Stanley. I don’t know where ETrade’s advisers fit in the picture.”

DIRECT COMPETITION

Morgan Stanley has been built, in large part, through mega deals like the one for ETrade. Back in 1997, Morgan Stanley merged with Dean Witter Discover & Co. In 2009, in the middle of the Great Recession, it bought Smith Barney from Citigroup, adding thousands of financial advisers. But such deals are complicated and often take years to merge adequately together. 

The problem for Morgan Stanley, as well as the other wirehouses, is that RIA platforms like ETrade Advisor Services are in direct competition for tens of thousands of financial advisers who are employees. Broker-dealers like Morgan Stanley also make huge profits from trading and sales commissions, types of businesses that RIA custodians do not play in.

Wirehouses like Morgan Stanley, Merrill Lynch and UBS focus on high-net-worth clients, while RIAs troll the less rich, dubbed the mass affluent by the wealth management industry. But wirehouses have been spawning their own competition. 

Advisers leave a big bank like Morgan Stanley to start their own RIAs for both business and philosophical reasons.

First, it’s more profitable for them to control the clients, and they also can build a practice that they later can sell. Second, by working as an independent adviser, they eliminate some of the conflicts in the financial advice industry that come with offering products and services such as bank loans, mortgages and asset management that are created and managed in-house. 

Only one of the four wirehouse networks, Wells Fargo Advisors, has opened the door for its advisers to become independent RIAs. If Morgan Stanley made a similar move, it would have huge implications for Morgan Stanley’s 16,000 advisers. 

It’s not clear whether Morgan Stanley executives have been discussing such a move internally.

According to a Fox Business report from May, just a few months after Morgan Stanley announced its acquisition of ETrade, it was exploring the idea of opening its own independent RIA business. When asked at the time whether this report was accurate by InvestmentNews, a Morgan Stanley spokesperson denied the story. 

GROWING PAINS

One question hanging over ETrade’s custody business is its growth, executives and advisers said. Is Morgan Stanley willing to spend money on marketing and attracting new advisers to the custody platform — money and resources that could be spent elsewhere? 

A small number of ETrade advisers have recently moved their clients to other custodians. According to InvestmentNews Research, ETrade had 219 custody clients at the end of June, a drop of 2.7% from a year earlier.

Meanwhile, other smaller custodians are looking to pick off ETrade’s advisers, executives and advisers said. With Schwab working to close its acquisition of TD Ameritrade Holding Corp., smaller advisers, those with less than $100 million in client assets, are feeling the squeeze of fewer custodians to potentially work with, those executives and advisers said. 

“It’s a huge opportunity,” said Gultig, the Equity Advisor Solutions CEO. “The ETrade and old Trust Company of America advisers are calling us. They are not happy with the changes and purchase by Morgan Stanley, especially so soon after the [Trust Company of America] deal.”