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Wirehouse Wolves

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They’ve added fee structures, financial planning, and a glitzy drive toward an all-under-one-roof service umbrella in the hope of attracting the asset-laden client. They’ve advertised heavily about how impartial their advice is, and how much they care about the client. They’re wirehouses; they’re after your clients; and they’re a steamrolling juggernaut impossible to stop.

Or are they?

Well, yes to the first two, anyway. The third is probably true, too, although in a way that you might not have expected.

Wirehouses, long known for their drive to sell, and sell, and sell proprietary products, have long been an easy target for the independent advisor. Their image certainly hasn’t been improved by the bear market and the recent scandals that showed how the investment banking and investment advisory sides of the big Wall Street firms were in cahoots. Still, it remains common among independent advisors to fear that Merrill Lynch or Smith Barney or any of the other wirehouses may gobble up their clientele.

Since clients do tend to migrate when they’re unhappy, and there have been some very unhappy people in the last three years, you might think that if ever there were a time for that fear to be tested, it would be now. There have, in fact, been some client losses to wirehouses, according to Ramy Shaalan, vice president of, the unit of Rydex Funds that has for years conducted best-practices surveys of hundreds of RIAs.

“More [independent] firms are losing clients to full-service brokers over the past few years,” says Shaalan. “Compared to 2000, that number has doubled; where before it was only 10%, now it’s 23%” of the firms in his surveys who report losing clients to full-service brokers. However, he goes on to say that the numbers of lost clients are “not quantifiable” in that the observer can’t tell among that 23% whether they are advisors who have lost only one client to a wirehouse, or all their clients, or some number in between.

While “not quantifiable” numbers may sound like an oxymoron, Matt McGinness, associate director at Cerulli Associates, the Boston-based financial industry research and consulting firm, concurs. “It’s hard to judge which way the momentum is going. Nobody gives you data on the average assets per advisor and how much they’ve grown, so it’s difficult to pin down the extent to which one channel is gaining ground on another.”

And, Shaalan adds, AdvisorBenchmarking statistics show RIA firms last year grew their client base by 22%. “That’s one,” he says, ticking off yet more reasons to question the numbers. “Two is that we know part of that 22% [growth] came from do-it-yourselfers and other advisors, and a big chunk came from wirehouses. While we can’t hammer down an exact figure, the anecdotal evidence in conjunction with some of these figures is that [independent advisors] are not losing that many clients.” Only one out of four respondents to the AdvisorBenchmarking survey, he says, report losing any clients, and on a net basis they’re attracting more from full-service brokers than they lose to those brokers.

Hardly sounds like an unstoppable juggernaut, now, does it? But–you knew there would be a but–that’s not the whole picture. Not by a long shot.

A Wolf in Advisor’s Clothing?

There’s no doubt, says Shaalan, that more wirehouses are adjusting their models to look more like RIAs. He cites as an example the Total Merrill program from Merrill Lynch. Total Merrill is a fee-based wealth management package that includes everything from mortgages and estate planning to business advisory planning and money management. Designed to be tempting to the individual investor, Total Merrill puts everything into a one-stop shop approach. And while in the past, he adds, most private banking divisions were “just going after the mega- and the ultra-affluent, those with $2 million to $50 million in investable assets, now they’re moving downstream and going after the general affluent market,” which Shaalan defines as those with $500,000 to $2 million in assets. This is, of course, the target market of a great many advisor firms: By dollar volume of investable assets for the entire independent industry, including registered reps and RIAs, says Philip Palaveev, a senior consultant at Moss Adams, LLP, in Seattle, 47% have clients with less than $500,000. Thirty percent have clients with $500,000 to $1 million, 19% have clients with $1 million to $4 million, and only 4% have clients with more than $4 million in assets.

While the similarity in models does pose a future threat and the targeting of the slightly less affluent client market poses yet another, one area that advisors may not have considered, says Shaalan, is the potential client who is co-opted by a wirehouse before she has a chance to settle in with an independent advisor. “Advisors in this situation are unlikely to realize that they lost a would-be client,” says Shaalan. “They won’t find out about it. The figures don’t tell the whole story. Anecdotal evidence suggests that advisors are downplaying the competitive threat from outsiders, not just other advisors; more and more advisors are, frankly, not fully cognizant of the magnitude of the competition that could arise in the next few years.”

Since the average RIA firm grew its client base 22% last year, Shaalan says, RIAs may not be that concerned. But they should be, he insists, because the competition is shaping up. Wirehouses may not yet have lured away many clients, but they’re “building up in a way that can offer an effective value proposition to the investor: a fee-based model, no commissions, and a holistic wealth management range of services.” Shaalan points out that wirehouses are also realizing that “investors need one client relationship manager, and only one. They’re building their structure that way so there’s one [relationship manager] who has access to a slew of specialists–from estate planning attorneys to accountants and tax specialists.”

Such a fee-based model and personalized, customized client relationships once helped to differentiate the independent advisor from the wirehouse broker and “financial planner,” Shaalan argues, but now that the wirehouses are embracing both of these approaches, the prime advantages that remain to independent advisors are their independence and their objectivity.

Shape Up or Lose Out

If you ask Mark Tibergien, a principal at Moss Adams who consults to many advisors and is the lead author of the annual FPA Compensation & Staffing Study, “wirehouses are a threat to advisors because of their marketing muscle and market presence, and any shift in their positioning as wealth advisors or financial planners does confuse the market.” Wirehouses are not the only ones pushing advisors, either, points out Tibergien, who also writes a monthly column for Investment Advisor (this month on page 49). “Banks, CPA firms, law firms, and property and casualty insurance agencies have all entered into the traditional independent market,” he says, and “all this noise can be very distracting.” Tibergien sees the main challenge to advisors not in forestalling the loss of clients to these alternate channels, but in being able to let clients know that advisors are out there to help them–”getting opportunities to tell their stories.”

Wirehouses, he says, have not come to the local level where most advisors draw most of their business. If advisors focus on that local level, “actively improving their visibility in the market,” they will reach more potential clients and need to worry less about competition in any form. He has some suggestions as to how advisors can fend off competition from wirehouses and others (see “Advisor, Know Thyself” sidebar on page 90).

“My experience in doing strategic planning for advisors,” says Tibergien, “is that they often are reluctant to admit they have competition. Their perception is that nobody does business like they do, therefore they have no competition. But if this were true, they would have all of the clients in their community. Competition has always been real; now it’s becoming more formidable, but it’s not a time for panic.”

A Back-Door Drain

Palaveev offers a different take on how the wirehouses are providing competition to the independent financial advisor. “For years,” says Palaveev, “wirehouses have been the primary source of independent advisors.” The independents were essentially created by people leaving wirehouses to set up their own practices, he points out. “If that flow were to stop, the independent industry has no mechanism to replenish itself.”

The independents, says Palaveev, have not generally been challenged to find new clients at the moment, even in the current tough market. In 2001 and 2002, he says, independents offering fee-based investment services have increased their average revenue about 5%, despite the markets’ poor performance during those years. On the other hand, advisors who focus on transaction relationships have suffered a decline. “To me,” says Palaveev, “that suggests a movement of clients from transaction- to fee-based relationships. That applies to both independents and wirehouses.”

Moss Adams hears about clients continuing to migrate from the Merrills of the world to independent advisors because of the conflict of interest scandals, Palaveev says. He points out, however, that those are biased reports, coming as they do from independent advisors.

Whether wirehouse competition grows in coming years is not the only threat on the horizon, he reiterates. The more immediate issue is the question of where new advisors will come from.

“Wirehouses,” says Palaveev, “have a well-established mechanism in place to bring in young people who want to be brokers or advisors. They can get experience; there is a process. They recruit the inexperienced.” Independents, on the other hand, do not. “Most B/Ds demand that [advisors] have at least $100,000 in total revenue. An advisor has to be experienced to go with LPL, Raymond James, and the like.” In fact, he points out, Raymond James has on its Web site the saying, “Independence isn’t for everyone.” They’re right, says Palaveev. But winnowing prospective independents by size of client base is only effective when dealing with already-experienced planners with a client list. What of the independent newcomers who have not yet had a chance to build a practice?

Skeptics may say that there are more training programs than ever for those who want to become financial planners. That’s true, but when asked about the various training programs at colleges and universities throughout the country, Palaveev asks in return, “If I were graduating from college today, with a degree in finance and taxation, where do I go? The probability is that I will end up with a wirehouse.” He points out that colleges provide the education and theoretical knowledge to be an advisor, but to be a viable advisor as an independent in the marketplace, one must have clients. “Nobody wants to be your first client,” he points out. “A new graduate will have no client base. Without a client base, they cannot start a firm of their own. They will lose money for the first three to four years of their business life. They can’t afford to do that.” Beginners aren’t very credible, he says, unless they’re associated with someone who brings credibility. Not only that, he adds, but wirehouses will train young and inexperienced people with programs designed to see them through their Series 7 and other certifications while they are not yet producing.

“We know from our study [2003 FPA Compensation & Staffing Study],” says Palaveev, “that the median experience of a financial planner is 12 years. We know that 75% of the industry has more than seven years of experience. People who function as planners are very experienced.” There has been much discussion in the past couple of years about the need for succession planning for older advisors who want to retire, a need that Schwab is looking to meet with its new initiative (see “Exit Strategy,” page 21). Other than selling to a very large firm, though, will there be enough options available for all those planners who want to sell their practices?

The Giant Behemoth

Advisors who have recently left wirehouses have some poignant insights into how the big companies are changing. Jon Yankee is now an associate planner with the fee-only practice of Rembert, D’Orazio, & Fox in Falls Church, Virginia, after serving two years at a Merrill Lynch office in Phoenix. Yankee says that 30 to 40 brokers were hired while he was in that office, but only two graduated from Merrill’s PDP program–its Professional Development Program, now replaced by POA, or Paths of Achievement. The programs were different in the structuring of compensation; Yankee says that the PDP program paid brokers a salary and bonuses based on hitting certain sales numbers. POA, on the other hand, offered a salary too, but instead of bonuses it was structured more like commissions; brokers got a payout on assets under management.

Yankee, who will take the CFP exam in March and join NAPFA, the fee-only National Association of Personal Financial Planners “as soon as I am eligible,” says, “If you understand that Merrill is a sales organization first, then it’s a pretty good place to be.” But, he adds, “I’m not a salesperson, and that’s not why I got into the business. There, you had to hit your numbers, and if you didn’t hit them on a month-to-month basis, they started turning the screws.” Probably four or five other newcomers were “in the same boat I was–getting close to put-up-or-shut-up time. The rest had left either voluntarily or because they weren’t hitting the numbers.”

Yankee notes that he was more interested in building relationships with clients than in performing transactions. “If it takes four or five meetings to earn trust with a client and develop a relationship, then I was willing to have those four or five meetings. But at Merrill,” he says sadly, “you gotta close ‘em quick–you have numbers to hit.” His biggest potential clients at Merrill, he says, were a retired couple with more than $30 million in assets. “I did a lot of work on the front end for them,” says Yankee, including presentations on estate planning and how to save on estate taxes. The relationship lasted over a year, he says, but the man, who he notes was “an ideal person for a client–78 years old, retired, 5 kids, 20-something grandkids, filthy rich–never moved a dime” to Merrill.

Yet the elderly man thought enough of Yankee to call him about a month after he left Merrill to ask “if I was okay financially; he wanted to make sure I was okay.”

It’s been nearly a year since Yankee moved to his new firm, and he reports, “I can’t tell you how many Merrill accounts I’ve moved over here.” He hopes to get that 78-year-old man as a client, too. “He may have liked me,” Yankee says, “but not been sure of my motives because of the Merrill tie.” He hastens to add that otherwise he has no bad things to say about Merrill, pointing out that the firm allowed him to spend months studying for the Series 7 and other exams and gave him great sales training. He also has kind words for his former boss at Merrills, who he says was “extremely professional and generous” when he left.

It’s Tougher to Leave

Even if the wirehouses are good at training young planning hopefuls, how good are they at keeping those they train, particularly given Yankee’s experience with his peers in Phoenix?

Pretty good, actually, says Palaveev. The wirehouses are getting better at retaining advisors, he points out, “because they’ve become more experienced at it.” Those who might leave because of limited offerings for their clients are finding that wirehouses now offer a wider range of products and services, enabling advisors to do more for their clients than proprietary products and frequent stock purchases or sales. Developing a financial plan for a client is now an important part of many of these new programs.

Moreover, “you can make a ton of money if you’re successful,” Yankee says. Merrill has “golden handcuffs” that involve stock purchase and deferred compensation programs that, says Yankee, can’t be touched until the staff are vested or retire. If you stay past a certain point, says Yankee, “then you can’t leave because you’ve got so much tied up in deferred compensation programs.” And there’s an added enticement, he says; if you can make it past the first few years, during which you have to hit your numbers, “there’s a lot of flexibility to focus on whatever you want to focus on, whether it’s financial planning, 401(k)s, or doctors; they don’t tell you how to run your business if you hit the numbers. You’ve got the opportunity to run your own business.” In the early stages, though, he says, there’s always that conflict: Did he have the extra three or four meetings with people to cement the relationship, or did he spend his time on the phone making cold calls?

Then there’s the issue of fees. Advisors who develop a practice at a wirehouse and become uncomfortable about a commission-structured practice now have far more options to have a fee-based practice. However, Yankee points out that at Merrill, “Some of the programs are fee-based, but they’re different from fee-only.” He didn’t realize how different, he says, until he got out, but advisors at Merrill are paid differently in the fee-based program. “You get paid more if people are in equities,” he says, and “you get paid less if they’re in bonds, and least of all if they’re in cash. If it’s appropriate for a client to be 85% in cash,” there’s a distinct disincentive at Merrill to keep him there. “Advisors are motivated through the pay structure to keep their clients in stocks.” While he was in training at Merrill, the pay structure for assets under management “didn’t affect my pay” and so he didn’t focus on it. Three years from now, however, he says it “surely would” affect his pay.

Where Does It All Lead?

Palaveev says that the factors of product and service equalization, fee-based programs, and golden handcuffs will combine to produce a shortage of experienced planners “very quickly. As we know, a lot of them will retire in the next 10 years.”

His hope is that more of the larger advisory firms start to recruit young advisors. “That’s a phenomenon restricted to the cream of the crop,” he says. Only the largest of the independents use paraplanners–51% of the largest firms with more than $1 million in revenue. A mere 10% of smaller firms use paraplanners, although that’s generally a position, says Palaveev, where an inexperienced person would go fresh out of college.

He sees the next generation of planners coming from the insurance industry. “That segment of the [financial services] industry is somewhere between wirehouses and fully independent Schwab RIAs,” he says. They have a system for bringing in inexperienced people and subsidizing them while they build a practice. “We generally divide the industry into four segments,” he says. The first segment maintains full control of its people; into this category fall wirehouses and trust companies, among others. The second segment maintains partial control; they’re franchise operations, says Palaveev, such as American Express, Axa, Northwestern Mutual, and Mass Mutual. The third he calls “regulated autonomy,” and these are the independent B/Ds such as Raymond James and Commonwealth. Advisors for these companies are generally contractors rather than employees. Then last is the full autonomy of RIAs who custody assets at Schwab, Fidelity, TD Waterhouse, or the other custodians who cater to independent advisors.

Along that spectrum, says Palaveev, if wirehouses are to the extreme left and the independent RIAs are on the extreme right, “we see the recruiting of inexperienced people to mostly happen on the left. Curiously, the career of the typical person in the industry is movement from left to right; they start at wirehouses and move to some form of independence, or at some point form their own firm.” If the wirehouses were to “slam the door,” he says, he’s not sure where more planners will come from.