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A Big Name Cools on Schwab

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Editor’s Note: This is a corrected version of part I of the Gluck Report for June 2003. It replaces a version that was earlier posted in error.

One of Schwab Institutional’s largest RIA clients has put its relationship with the San Francisco brokerage firm on hold. It is withdrawing from Schwab’s retail referral program and is expected to transfer $200 million from Charles Schwab to its four other custodians, Merrill Lynch, Smith Barney, UBS, and Fidelity Investments.

According to an e-mail sent to employees of Fisher Investments, the Woodside, California-based manager of more than $11 billion in assets has stopped placing new assets at Schwab. An employee at the firm says Fisher Investments decided to withdraw from the Schwab Advisor Network, even though its referrals brought in $300 million of new business in 2002. The Fisher employee added that Schwab Institutional is the custodian of $3.6 billion of the assets Fisher manages.

Fisher Investments founder and CEO is Ken Fisher, who has written Forbes Magazine’s “Portfolio Strategy” column since 1984. According to the firm’s Form ADV, Fisher advised more than 10,500 clients last year; more than 75% of them were high-net-worth individuals. The employee said Fisher brought in $1.2 billion of new assets last year to Schwab. So, in deciding not to place new assets with the San Francisco brokerage firm, Schwab would be losing a significant stream of new assets. The employee said the decision to stop placing new money at Schwab will allow Fisher to review its relationship with the San Francisco discount brokerage.

The employee says that one reason Fisher Investments is cooling on Schwab is that the firm recently had been receiving fewer retail referrals through the Schwab Advisor Network. He maintains that Schwab branch em- ployees are favoring U.S. Trust Company, a money manager for wealthy individuals owned by Schwab.

The Fisher Investments employee also asks whether high-net-worth individuals who are Advisor Network prospects are being properly informed about Schwab’s ownership of U.S. Trust.

Schwab spokesman Lance Berg says, however, that “we clearly disclose to referred investors the affiliation between Schwab and U.S. Trust, and we have procedures to ensure that happens. The disclosure is made at the time of the referral.” Berg says that “No Schwab representative is personally rewarded in any way for steering a client” to U.S. Trust. According to Berg, Schwab Advisor Network’s “new assets in the first quarter of 2003 totaled $1.1 billion, compared with $203 million in the first quarter for referrals to U.S. Trust.”

Schwab Advisor Network, formerly called AdvisorSource, is a network of about 300 RIAs who clear through Schwab. They pay Schwab a percentage of revenues in exchange for referrals made by employees working in the firm’s branches. Fisher Investments, a separate account manager, is one of a few national advisory firms in Schwab’s national referral program. In the first quarter of 2003, Schwab said in a filing with the Securities & Exchange Commission that it made 4,400 referrals to RIAs and 300 to U.S. Trust.

Slipping Assets

The rift between Fisher and Schwab, if not patched up, would represent the latest in a string of setbacks that have plagued Schwab Institutional as the bear market has deepened.

Advisor assets at the brokerage slipped from $240 billion on March 30, 2002, to $220 billion as of March 30, 2003, while TD Waterhouse Institutional says its net assets held by advisors increased by $1.16 billion, from $16.8 billion to $18.4 billion. Schwab rival Fidelity Institutional, meanwhile, says net assets increased by $2.3 billion, from $61.3 billion to $63.6 billion. In addition, Schwab’s an-nouncement in late 2002 that would stop selling its portfolio management system to advisors who do not do business with Schwab Institutional, and its decision to require that advisors pay a percentage of their fees in exchange for receiving referrals from Schwab’s retail branches, have heightened longstanding worries among advisors about depending too much on Schwab.

On top of those concerns, Schwab Vice Chairman John Philip Coghlan, president of Schwab’s Individual Investor division, has resigned. According to Schwab, he will now seek a job elsewhere as CEO. The resignation came just four days before Chairman Charles Schwab was scheduled to relinquish his title as co-CEO and make David Pottruck the sole chief executive. For the nearly 6,000 independent advisors clearing through Schwab, Coghlan’s departure ends a longstanding relationship. Since Coghlan started with Schwab in 1986, the independent advisor business has blossomed under his stewardship from a cottage industry to a major segment in the delivery of financial services to high-net-worth individuals.

Understanding the Business

The success is largely due to Schwab’s entrance in the early 1990s and the support it provided. Deborah McWhinney, the top manager of Schwab’s Services for Investment Managers division, reported to Coghlan, and many advisors believe that Coghlan was one of the only managers left in top management at Schwab who understands the independent advisor business model. Coghlan, according to a recent SEC 10-Q filing, was paid $597,475 in salary in 2002 plus a $365,000 bonus. In a filing on April 24 with the SEC, he reported directly owning 878,708 shares of Schwab common stock plus another 222,615 shares through an employee stock ownership plan.

Schwab said Coghlan’s resignation provided an opportunity to rearrange management responsibilities. Coghlan’s retail job will be filled by William Atwell, while his job of overseeing Schwab Institutional goes to Lon Gorman, who runs Schwab’s Capital Markets business. McWhinney, who is president of Services for Investment Managers, will report to Gorman.