From the December 2004 issue of Investment Advisor • Subscribe!

December 1, 2004

Referral Madness

Comparing custodian referral efforts

Here's a sobering statistic. Accord- ing to the consulting firm Moss Adams, the most successful fee-based advisors--the top 10%--generate approximately one-third of their new clients from referral networks--custodial firms, referrals from CPAs, law firms, and other financial professionals. Another third of these firms' referrals come from existing clients.

How are these top firms able to achieve such a great referral flow? First you have to consider that the majority, if not all, of these firms have been entrenched in the advisory business for years--and their reputations precede them. They're also likely stellar marketers (which, it's safe to say, the majority of advisors aren't). Based on various studies of advisory practices performed by Moss Adams, Philip Palaveev, a senior consultant at the Seattle-based consulting firm, says it takes 10 years for an independent advisor or firm to develop a reputation in any given geographic area. It takes that many years, he says, for "advisors to reach the point that their message is out there in the marketplace and clients are aware of their existence."

During this developmental stage, if you will, of drawing in more business, one of the best places an advisor can turn to for help is their custodian. "The referral programs created by the custodians are an excellent way to perhaps accelerate the acquisition of new clients," Palaveev says. Indeed, concedes one advisor who wishes to remain anonymous, despite the fact that some advisors balk at the cost of the Schwab Advisor Network referral program, many advisors "would be nowhere" without it. The program "made many advisors' practices because it got them in front of enough people to build a client base," this advisor says.

In its annual study of advisory firms that it performs for the Financial Planning Association, Moss Adams found that advisors generally close between 33% and 50% of their qualified leads, Palaveev says. But "the biggest problem advisors have is in generating leads," he says, so "a referral program from their custodian provides just what they need."

We took a look at the referral programs offered by Schwab, Fidelity, and TD Waterhouse to see how they're faring and how they differ from one another.

Changes at Waterhouse

Waterhouse is in the process of revamping its referral program, AdvisorDirect, and is tight-lipped about how the new program will look. When asked why it's overhauling AdvisorDirect, Jennifer Olegario, a Waterhouse spokesperson, said, "We continuously strive to improve the efficiency of our operations. We are revamping AdvisorDirect to enhance the service experience for our advisors and for investors."

Advisors can likely count on paying to join Waterhouse's new program, which wouldn't be such a bad thing. The word on the street is that the 175 advisors participating in Waterhouse's current program haven't been satisfied with the quality of leads they've been getting from branch personnel (a problem that's not exclusive to Waterhouse). Advisors say that a monetary reward may give custodians' branch personnel the incentive they need to send more quality clients their way.

Schwab currently charges for its program, while Fidelity doesn't. Gary Gallagher, senior VP of product management in the registered investment advisor unit at Fidelity Investments, says Fidelity "has no plans" to charge advisors to be part of its referral program, Advisor-Access. Fidelity believes the referral program "is an extension of our capabilities to serve the investors at Fidelity," he says.

The word "quality" can be defined in many ways, says Palaveev. Advisors tend to rate clients on how many assets they have and how much revenue the advisor can generate from the client. But branch personnel also need to assess "what the client really needs" from an advisor--a wealth manager or financial planner, for instance--and if there is "a psychological compatibility between the advisor and the client," he says. Unfortunately, the majority of branch personnel participating in the existing referral programs focus mostly on the "asset level" of clients, Palaveev contends, and "offer cold handoffs," without considering advisor/client compatibility.

To avoid "cold handoffs," branch reps must "have a strong definition of who should be referred, and when," Palaveev says. The custodian has to set clear boundaries on which clients to keep and which to refer, then institute a "simple, but effective, diagnostic process that helps the branch rep understand in what kind of situations a particular advisor is good and not so good."

It's the advisor's responsibility, too, to step up to the plate and develop a relationship with reps. The advisors who are most satisfied with referral programs are those who are "most effective in marketing to their referral source," Palaveev says. Tom Meyer, CEO of Meyer Capital Group in Marlton, New Jersey--who has participated in Schwab's referral program for years--agrees. "The bottom line is that advisors have to work it just like anyone else," he says. "You have to market yourself to do well in the [referral] network."

Schwab Advisor Network

At Schwab, branch reps can now refer retail clients to independent advisors, U.S. Trust, or Schwab Private Client. The latter is aimed at investors who want advice but "still want to take responsibility for taking action," says Edie Heilman, senior VP at Charles Schwab Institutional and head of Advisor Network. U.S. Trust, meanwhile, has account minimums that many retail clients can't meet. "More referrals go to Private Client than the Advisor Network, but conversions [of referrals to closed business] are roughly comparable," she says.

The average account referred at Schwab is "just over $700,000," Heilman says. The average referral to Schwab Private Client is "closer to $1 million." In the past 2 1&Mac218;2 years, Schwab has seen a net inflow of $11.7 billion into its referral program. That includes $6 billion in all of 2003, and $4.6 billion in the third quarter of 2004. Schwab reps are compensated equally on closed business, no matter which of the three channels the assets end up in. But Schwab plans to change its compensation methods as well as its rules for how reps refer business. "One of the fundamental shifts in the new compensation plan is to give brokers a community--300 clients, average account size $250,000 or above," Heilman says. "The goal is to identify clients, and what their needs are, and to foster relationships." In the future, the referral system will be "much more relationship-based. We want to get to know who the [retail] clients are and generate more business for the advisors."

The close rate on referrals is 42%, compared to 25% in the former Schwab referral program, AdvisorSource. Planner Meyer says he gets "much more qualified leads" now than he did from AdvisorSource. "It's almost like a recommendation rather than a referral." Since revamping AdvisorSource a year and a half ago, Meyer says his "business has basically doubled." (Advisor Network is likely providing better referrals because advisors paid a flat fee to participate in AdvisorSource and there was no revenue sharing; there is now). Advisors must have at least $50 million in assets under management to participate in the Advisor Network; 325 of the 5,000 advisors who custody with Schwab are members.

Neither Fidelity nor Waterhouse provide close rates on referrals. But Heilman says that the 42% figure understates the actual close rate at Schwab. She says reps had been logging as referrals calls they made to clients suggesting a switch to an independent advisor. Reps did this to ensure that if the client ever took the lead and signed up, the rep would get the override. Heilman now wants to reform the process so that reps are compensated only for actual referrals and not on marketing calls that may lead to referrals.

Fidelity's Advisor Access

Gallagher of Fidelity says he's heard no complaints from advisors about "the quality of referrals" they get. "The average account size when [referral] business closes is $1.2 million," he says.

In fact, he says, advisors give branch personnel high marks in how they screen clients. Assets referred through Advisor-Access over the last four years total $2.2 billion. Of the 2,400 advisors that custody assets at Fidelity, only 150 participate in the program--a number that Gallagher says is "manageable." He says Fidelity plans to "build out" its network of 99 branches spread throughout the country, so Fidelity could easily accommodate more participants. Fidelity prefers that Advisor-Access members be advisors who can "provide discretionary investment management, including individual security management as well as a competence in dealing with high-net-worth clients," Gallagher says.

Planner Meyer, a member of Schwab's Advisor Network, says he's now dealing with a high amount of rep turnover and branch closings in his area of Marlton, New Jersey. This makes it even more imperative for him to get out in front of the new reps. "It's very competitive," he says. "It's up to advisors now to reach out to the new reps to let them get acquainted with us. We can't just sit there."

Some advisors complain that branch reps only refer business to those advisors with whom they have a cozy relationship. Heilman of Schwab says Schwab deters reps from playing favorites by having "advisors with different minimums." For instance, an "advisor with a minimum of $2 million is not going to see the same [client] flows as one with a $250,000 minimum," she says. "There are also differences in styles. My team exists with the sole purpose of facilitating relationships between the advisors and branch reps. We expect reps to go into advisors' offices with value propositions and case studies. We put a lot of resources into the training side...to minimize biases."

Schwab levies a $10,000 annual fee on advisors to participate in Advisor Network, and charges the advisor 15% of their management fees on business Schwab sends to them. Schwab charges 75 basis points on assets that advisors move to another custodian within five years. When asked if advisors have ever objected to either fee, Heilman said, "We never even had to negotiate."

Referrals are the lifeblood of any advisors' business, so it's crucial for advisors to step out there and develop their marketing skills and make new connections. You've got nothing to lose, and everything to gain.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

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