From the October 2010 issue of Research Magazine • Subscribe!

The Paycheck Question

Uncertainty clouds the compensation landscape. But pessimism may be overblown.

Advisors will make slightly more money in 2010 than they did last year -- but then that's not saying a whole lot, is it? And, going forward, uncertainty -- and even pessimism -- have many industry observers scratching their heads over what's next for advisor compensation.

"I was a lot more optimistic earlier in the year than I am today," says Alan Johnson, who heads Johnson Associates, a compensation consulting practice in New York City. Due to the threat of a double dip recession and the changing regulatory landscape, Johnson believes advisor pay will be only 10 percent higher than in 2009, an abysmal year. He cut his forecast in half when the markets started to tumble again in August amid signs of a faltering economic recovery.

"I try not to get depressed. There are millions here and everywhere else in the world suffering a lot more. I don't think we should feel sorry for ourselves," Johnson adds. "I had just hoped it would be better."

At the moment, the topic of advisor compensation is notable more for what we don't know than for what we do. As an example, the rumor mill is usually buzzing by early fall with speculation about the new wirehouse payout grids. Not so this year.

Danny Sarch, president of Leitner Sarch Consultants in White Plains, N.Y. reports that wirehouses have put a lid on any payout grid changes until the Securities and Exchange Commission signals what it's thinking regarding any change in the obligation and standard of care for broker/dealers that provide personalized investment advice about securities to retail investors. The public comment period on the fiduciary standard ended August 31.

"For 2011, it's clear the wirehouses are waiting for what the final [Dodd-Frank Wall Street reform] legislation will look like. All firms are paralyzed until that happens," says Sarch. "They have to figure out what their costs are going to be based on regulatory change. It's really hard to predict now." One possible revenue source: broker compensation.

"The big question is how will they manage to those changes? It will cost money to make them. Will they take it out of broker compensation? Will advisor compensation be negatively impacted in any way? You hear both," notes Mindy Diamond, president of Diamond Consultants, a recruiting firm in Chester, N.J. "This is a move that's going to play out in the next 18 months but the final chapter won't be written for the next couple of years. The broker will begin to feel the impact, however, sooner rather than later."

Also in play: the SEC's plan to eliminate 12(b)-1 fees as they currently exist. Will product manufacturers create some other way to pay their advisors? The issue is generating a lot of interest in the retirement plan arena especially, according to Sean Cunniff, a research director at Needham, Mass.-based TowerGroup. "A lot of retirement plans in the small to mid-size space are sold by brokers and advisors whose compensation often comes from mutual funds or insurance products that are part of the plan," he observes. "That's how a lot of the 401(k) providers and in some cases 529 providers build their compensation schemes. If fees are capped, the product manufacturers will figure out some other way to pay their advisors."

Then there's the whole drama surrounding the economic recovery. Most advisors are not optimistic that the market will drive growth any time soon, according to Philip Palaveev, president of Fusion Advisor Network. "The level of optimism is very low," he says.

That uncertainty has helped create a tug of war for wirehouses. On the one hand, notes Palaveev, there's the shortage of advisors and a fierce recruiting war for stellar talent. On the other, firms are pessimistic about growth and are facing an uncertain regulatory and economic climate that could, potentially, change how they do business.

"Both forces are very strong and they're pulling in opposite directions," he adds. "If two forces are pulling in opposite directions that thing in the middle may break. And that thing in the middle is the advisor."

The Road Ahead

The slam, when it does come, will affect the marginal producer the most. Diamond says firms will be much less willing to tolerate sub-$500,000 producers as they begin to deal with the new regulatory standard. "It will be increasingly difficult and more unpalatable for those advisors," she says.

But quality advisors, from a functional day-to-day perspective, won't experience much of a change, according to Diamond.

"Most quality advisors, whether they work for a wirehouse or in the independent space, have been acting as a fiduciary for their clients anyway. Will the traditional brokerage model become more restrictive and compliance heavy? Probably. But if you are a wirehouse advisor and you have been acting pretty much as a fiduciary anyway, and you're clean and compliant, you're going to be okay," she adds. "If the firm comes down with a zillion new rules or regs to prove compliance because the firm needs to manage to the lowest common denominator, that's when brokers move. That's what we'll be watching."

The likely beneficiary: the independent sector.

Going forward, Johnson says firms will become a lot more careful about how they design their compensation programs. "There's going to be a lot of scrutiny about how people are paid and what they are paid for," he says. "The tolerance for misbehavior is getting less and less and less. And I don't think that's all bad. But as you design plans and buy-out packages, you're going to have to be much more thoughtful."

And, notably, Johnson doesn't believe the compensation grids will necessarily change.

As he puts it: "If the client is paying you $100 today you will still get that $100. But what you need to deliver for that $100 may change." The penalty for the broker who doesn't get the job done in compliance with the new regulations? "Don't even think about it. Everyone is going to have to be a lot more careful," Johnson adds. "This is an industry with an outlandish number of forms to sign. That was in the old days. Now, it's going to be twice as many. It's going to feel a little like a hospital."

None of this will be completely foreign to wirehouses, which have pushed fee-based programs for years. In fact, half their revenues are currently generated by managed accounts. Still, as Lou Harvey, founder of the Boston-based consulting firm Dalbar, points out: "Not too many of them would be willing to give up their other half."

The only possible outcome, Harvey says, is the separation of the advice-driven and product-driven channels.

"That is going to be the super duper challenge. But there's a reason for the firms to decouple it. They need to create a different culture where the inherent conflicts of interest are not simply disclosed but avoided. It becomes a competitive issue," he notes.

Harvey says the new regulatory climate will force traditional brokerages to innovate different compensation models.

"Most firms don't have an effective way of collecting fees from clients outside of a managed account. There's no convenient structure for an advisor to go to a client and say: 'I'm going to charge you $500 to manage your account.' That's one of things that drives reps to go independent," he observes. "It may take a significant loss of reps before they do it, but it seems inevitable."

Meanwhile, in the short term, Harvey says 2010 won't go down in the record books as a great year for advisor compensation. As he frames it: "The broker doesn't make a lot of money when the client moves from equities to cash or bonds."

Keeping Perspective

Still, while advisors tend to have a "skeptical state of mind" that the new environment will affect their compensation adversely, Palaveev says it's important to remember that they routinely rank in the top one percent of the U.S. population in income surveys.

"Yes, the army is hungry and they're short on patience. They pay bills. They have children. They have cars. They have parents. They take care of a lot of people, actually. They have created a lifestyle with high-income needs. They have a pretty large footprint," he adds. "But let's not forget that this is an extremely attractive profession."

Johnson, in fact, calls it a dream job.

"No one's going to be holding a charity ball for advisors. It's the dream of most Americans to have a reasonably lucrative job and a lot of independence. If you are at the middle or senior level in these firms, you basically call your own shots. There are not many jobs that pay in the six figures, or seven, where you have that level of independence without a professional degree," he says.

"You're not an orthodontist or big time lawyer, but you have their income. And there are tens of thousands of these people, not just a handful," Johnson adds. "It's also a very rewarding thing, right? You get to help people by managing their money. You see their gratitude. You see that their world is going better. It can be lucrative -- but it's also rewarding."

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