Banking Crisis

US Brokerage Model Called Into Question After Wall St Panic

Matthew Smith New York 13 October 2008

US Brokerage Model Called Into Question After Wall St Panic

Fear has advisors at the large US brokerage firms switching places, desperation has investors cashing out at the bottom of the market, and hopelessness has the government grasping at straws. Matthew Smith reports from New York where wealth management is in the eye of the storm.

Fear has advisors at the large US brokerage firms switching places, desperation has investors cashing out at the bottom of the market, and hopelessness has the government grasping at straws. We report from New York where wealth management is in the eye of the storm.

The Dow has tanked more than 20 per cent in 10 days of trading but advisors at the large brokerage firms have more to worry about than their clients’ assets.

They are changing places now more than ever – even more than before the crisis when the so called “war for talent” during all of last year had the big firms  dangling hefty sign on bonuses to attract big producing advisors.

The rationale for the talent war back then (let’s call it pre-Armageddon) was for a different reason: before the crisis took hold, heads of these businesses were using any means necessary to add revenue-producing advisors from a talent pool that was disappearing into the ranks of Registered Investment Advisory firms.

The often-touted Cerulli Associates estimates of 20 per cent growth in the number of RIAs entering the fray in recent years versus the stagnant (but still larger) number of advisers employed under the brokerage model points to this on going trend.

While this trend is no doubt continuing, the flurry of trading places among advisers between the brokerage firms happening right now is for a different reason – it is borne out of a sudden need for advisors to bolster their own financial positions.

In the US, wire house advisors have compensation structures highly leveraged to their companies’ stock. With the rapid deterioration of financials in recent weeks, advisors have seen their own financial positions whittled away, and they are looking around to make up for the money they have lost on paper.

And the wire houses – despite their own precarious financial positions – are still offering large sign-on bonuses to attract advisors.

According to compensation consultant Andy Tasnady of Tasnady & Associates, brokerage advisors can still get as much as 200 per cent of annual sales up front if they sign on with some firms now.

Even though Morgan Stanley appeared to be on the brink of collapse just last week before its Japanese tie-up, Mr Tasnady says the firm is currently offering the highest sign on bonuses on The Street.

And it seems to be working – at least it’s allowed the firm to maintain advisor numbers. According to Morgan’s most recent quarterly report, at the end of August this year, the firm employed 8,500 financial advisors, an increase of around 150 on the same time last year.

For an advisor with $1 million in yearly sales and falling stock options, a $2 million payment on top of regular commission splits has lead to more short term chopping and changing between firms.

However the fates of US's big-name brokerage firms are likely to be decided on some other long-term considerations that are swirling in advisors’ heads at the moment.

Firstly, the trend in the US for advisors to start their own fee only advice practice in an RIA structure will continue – it’s not surprising that third party administrators Pershing, Schwab Institutional, Fidelity and Raymond James are seeing record numbers of “breakaway” advisors and advice teams plugging into their systems and seeking consulting services to start their own advice practices.

Possibly more immediately relevant to the impact of the financial crisis is the new leadership structure of wealth management businesses following the recent spate of consolidation.

Brokerage advisors have traditionally rejected bank ownership and leadership, says Robert Ellis, a wealth management specialist for New York consulting company Celent.

In a very short space of time a lot has happened: Bear Stearns was bought in a fire sale by JPMorgan Chase & Co; Lehman Brothers filed for bankruptcy protection and most of the US business went to Barclays; Merrill Lynch is in the process of being bought by Bank of America; Citi tried, and failed to buy Wachovia; and Morgan Stanley has tied up with Japanese Bank, Mitsubishi.

“Every major American brokerage firm is now currently either buying a bank, being bought by a bank, or in the process of integrating with a bank,” Mr Ellis points out.

All of the above mentioned transactions (apart from the Bear/JPMorgan deal) are still yet to be consummated, and requests made by WealthBriefing to discuss the strategic direction of the wealth management businesses of the respective firms were generally met with the same response: “It’s too early”.

The leadership jostle currently being played out between BoA and Merrills will be of utmost interest to the 17,000-odd advisors who are wondering if they will be governed by bank oversight or the Wall Street brokerage mentality they are accustomed to.

Says Mr Tasnady: “Brokerage advisors think if they are owned by a bank they will be treated like bank advisors, and they don’t want that.”

Merrill advisors were given a glimmer of hope when Merrill chief John Thain accepted the position as president of the combined company's global banking, securities, and wealth management business following the completion of the acquisition.

However there is still no insight into how the brokerage business will be run under Bank of America chief executive Kenneth Lewis and where Keith Banks, BoA’s current head of the Global Wealth and Investment Management, fits within the new structure.

Foreign-owned wealth management operations that have avoided the shotgun marriages of their American counterparts are beginning to look like a safe option for US brokers – a spokesman at Credit Suisse said the US private bank has almost doubled its close to 300 advisor force in the last year.

Even the brand damage that UBS suffered earlier in the year seems to be forgotten, with the firm appearing to have quelled the unrest of its more than 8,000 brokerage advisors.

However the events of the past couple of weeks have shown anything can happen and the wealth management industry here remains firmly on tenterhooks until the market has stabilised.

Once the dust settles Mr Ellis suggests a new paradigm will be born.

“The transaction model in the US is dead. Small firms will handle ultra wealthy clients, technology will allow the mass market to do it themselves,” he says.

It might be too early at this stage to call the death of the brokerage model, although the crisis has highlighted gaps in the transactional nature of the US advice market.

A study in September by Prince Associates surveyed 351 people with more than $1 million of investable assets with brokerage firms and found almost 90 per cent were planning to withdraw at least some of their money, and 70 per cent say they want to fire their brokers.    

Reports over the past week have shown American investors have panicked, withdrawing their assets right as the markets have dipped.

Adding to, or possibly a reflection of the panicked mood, the usually bullish Jim Cramer, the host of CNBC’s stock picking programme “Mad Money” appeared on an American morning show amid the share market collapse imploring people to take any money they might need during the next five years out of the market immediately.

News reports quoted TrimTabs data measuring $43.3 billion in withdrawals from stock funds and $8.8 billion from bond funds during one of the most volatile weeks in history ending 8 October.

“What you’re getting is total panic among investors, even institutional investors who should know better are taking their money out at the bottom of the market,” says George Feiger, chief executive of RIA firm Contango Capital Advisors.

“The short term activities of brokerage accounts don’t work in an atmosphere of panic.”

At least investors now know not to look to Wall Street for a calming voice during a crisis.

 

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