The game has changed for brokers who get large, upfront payments as they sign with or stay with big wirehouse brokerage firms, according to a new study, “The Illusory Recruitment Check: What’s Next For Wealth Advisors” from Sanctuary Wealth Services.
Jeff Spears believes that “the wealth advisory business model at wirehouses and big banks is broken,” he says in the preface to his new white paper. That said, he wants to know the answer to this question: “Why aren’t more really capable brokers going independent?” Spears, the co-founder and CEO of San Francisco-based Sanctuary, sat down with AdvisorOne.com/Wealth Editor-in-Chief Kate McBride, in New York, on Thursday.
Sanctuary provides investment, infrastructure and consulting services to brokers who want to become independent registered investment advisors (RIAs), and established firms who want to outsource those services.
In this first of a two-part series on broker compensation, Spears outlines the premise, and in part two, how this is working out for brokers and firms.
The reason he hears most often about brokers staying put at wires is that the “money is not there.” It’s true that RIAs don’t offer the giant, upfront payments that some broker-dealers (BDs) are dangling in front of reps who are deemed large “producers.” But Spears argues that the way that this recruiting is done has changed, and that while these payments seem huge, most brokers aren’t, when all is said and done, receiving a 300% or 350% payment, because revenue and asset hurdles are not being achieved.
There’s also the idea that the independent RIIA doesn’t have the big branding and ad campaigns or the cross-selling potential that a Bank of America Merrill Lynch or Morgan Stanley has. So how will these big brokers attract more clients if they go independent?
To Spears, independence means not only leaving the large broker environment of a bank-wirehouse, but also changing to the registered investment advisor way of advising clients.
What’s Keeping Brokers at the Wirehouses?
The recruiting payments for the past “20 years” according to the study, “have totaled 100% to 150% of a broker’s Trailing 12-month revenue (TTR).”
This has been in the form of a “loan”, Spears says, that effectively vested over five years. So if you were a broker producing $1 million in revenue, you’d get a check for $1 million, bank it, and pay “no taxes” on that million “initially, because it’s a loan,” he adds. Over the next five years, you were expected to produce $200,000 more per year as the payment vested, so $1.2 million in production each year. But, if you didn’t produce that much, that 1/5th of the $1 million recruiting payment would be forgiven—you’d pay the tax on that $200,000 in addition to your regular production. The same situation holds for the next year—and the next, for five years total.
The payments don’t show up as expense for the wirehouse either, Spears adds, because it’s a loan. They amortize over the five years as either “compensation expense” or loan “forgiveness,” he adds.
But this sounds a little one-sided, right? “High-number recruiting checks are uneconomic for the firm,” says Spears. But in reality, bringing in the assets and clients this way was cheaper, and quicker. The firms could make money, says Spears, on the “assets in the firm’s money market funds, margin interest, and by hypothecating the stocks out to hedge funds.”
But then the downturn hit.
Part 2: Next week: Firms wise up and change the rules. See "Broker Compensation Not as Advertised at Wirehouses: Sanctuary's Spears."