At Morgan Stanley, the message is loud and clear: shoot for the best-quality, high-producing advisors.

James Gorman, head of the firm’s global wealth management group, says that when it comes to professional standards — and litigation — in the securities business, “We are defined by the bottom half.” And, he further notes in a speech at the Oct. 5 Securities Industry Association’s marketing conference in New York, “You’ve got to be brutal in defining the bottom half of your organization.”

At Morgan Stanley, this approach is starting to translate into improving financial results — including a return to double-digit margins and growing sales per advisor (see lower chart). But it’s entailed the firing of some 1,500 advisors — 1,000 low-producing reps in August 2005 and 500 trainees in May 2006. Meanwhile, nearly 1,400 have departed voluntarily since November 2004.

The headcount of advisors stands at some 8,070 (see top chart). That’s down 26 percent from the roughly 11,000 with the firm in late 2004 and puts the size of Morgan Stanley’s global wealth management group at close to half that of rival Merrill Lynch, which has 15,520 advisors.

Going forward, Gorman’s plans center on continuing increases in sales per advisor, as well as the hiring and retaining of “rising stars” and related measures. “James Gorman has stated that he expects the FA force will stabilize around 8,000, give or take a few hundred in either direction,” the company says. “We will continue to recruit, while also placing an emphasis on retention.”

Though Gorman came on board in February 2006, Morgan Stanley began shifting course about a year ago, analysts point out. Increasing income and margins for the wealth-management segment and rising average production and assets per advisor are now showing up in the firm’s financial results.

“These results are certainly encouraging,” says Andy Tasnady of Tasnady & Associates, a compensation consultancy. “When unprofitable people are pushed out, it can be very helpful to short-term profitability.”

How do Morgan Stanley’s results stack up versus rivals? In wealth management, Merrill and Smith Barney’s margins — at 23 percent and 18 percent respectively — are way ahead of Morgan Stanley’s, at 12 percent. Income in this segment topped $700 million at Merrill in the most recent quarter and was nearly $240 million at Smith Barney vs. $158 million for Morgan Stanley.

In terms of average revenue per advisor, Morgan Stanley stands at $675,000. While that is up substantially over an average of $551,000 three quarters ago, it still is far below the $780,000 in production of the average Merrill rep.

“On the Street, it’s been know for years that the Dean Witter brokerage force was the least productive out there,” notes Danny Sarch, head of Leitner Sarch Consultants. “They’ve gone a long way at changing morale. But there’s still a long way to go.”

In terms of its operations, Morgan Stanley continues to run Dean Witter — which it bought nine years ago — as a separate broker-dealer. The two broker-dealers are set to merge in the first half 2007, the company says.

Most of the former Dean Witter reps are part of a 7,000-plus global wealth management team. Several hundred Morgan Stanley reps work on the company’s institutional-technology platform in the private wealth management division, though they also report to Gorman.

“The merger next year of the two broker-dealers will be a step toward further integrating the businesses but will not initially change the two different technology platforms,” a company spokesman explains.

The fact that the two groups aren’t expected to be fully integrated technologically and otherwise — some 10 years after the corporate merger — has some industry experts scratching their heads: Why so long, they ask? And why aren’t more business-building tools being shared across the organization to boost results? For its part, Morgan Stanley says, it plans to further develop and introduce some middle-market business initiatives next year to its retail brokers.

Still, as Sarch acknowledges, Morgan Stanley has gone “from being a horrible name to being a curious name” in the brokerage community over the past year. “They’re doing what they can to change perception and get people more excited about Morgan Stanley.”

For recruiters, the latest excitement concerns the rising star program (see box). “These are the up-and-coming advisors,” says Carrie Degenhardt-Burke of Degenhardt-Burke consulting. “They are joining Morgan Stanley from other firms, are already registered and know the game. Their business should skyrocket with more resources for things like growing their institutional business, travel and entertainment expenses, seminars, etc.”

According to Howard Diamond of Diamond Consultants, some of Morgan Stanley’s rivals wouldn’t dare offer such high upfront payouts for those with such limited time in the industry. “This shows they are hungry and are looking to grow their advisor force. I mean $75,000 cash can be life changing to a recruit. It’s a real commitment to that person that you are going to let them grow their business with you.”

And it’s not just smaller producers who may be attracted by the rising-star offers. “We are talking to those with $450,000 in production and up, too,” adds Diamond. “This is a good story. We told it when it wasn’t so good. It’s more fun to tell it now.”

At the same time, there are more seasoned advisors and managers entering Morgan Stanley’s ranks.

For instance, Stephen Hird, a $1.1 million producer with $177 million in AUM, recently left Piper Jaffray after its merger with UBS to join Morgan Stanley in Madison, Wis. And in late September, Morgan Stanley tapped former Merrill Lynch branch manager Daniel Long to head up its office in Smithtown, N.Y.

Morgan Stanley has two ex-Merrill managers running its four regional divisions — Rick Skae leads the Northeast and Jerry Miller directs the Midwest. And several of the firm’s 21 district managers are from Merrill.

One, however, has chosen to return to Merrill after switching over to Morgan Stanley in April: Donald Plaus, who led Morgan Stanley’s efforts in the Carolinas and Virginia for the past few months, is expected to start serving as a regional director of Merrill’s Coastal South Region later this year.

And Morgan Stanley advisors continue to jump ship. Recently Wachovia Securities picked up three high-net-worth female advisors from Morgan Stanley in Puerto Rico. The three reps reportedly had a combined asset base of about $350 million — an average of $117 million each; this is well above the average asset base of Morgan Stanley advisors today, which stands at $81 million.

Despite the high level of recruiting (and at times legal) tension between Morgan Stanley and Gorman’s former firm, Merrill Lynch and related recruiting concerns, Morgan Stanley has decided to sign the inter-brokerage pact on transferring reps later this year. The agreement permits advisors to switch firms with contact information for their clients without the risk of being sued.

“It’s a work in progress,” says Sarch. “But we can’t say yet that their reputation is stellar. Let’s see if they can really right the ship.

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Less is More

The number of advisors with Morgan Stanley has declined by nearly 3,000 reps in the past two years to some 8,000 as the firm moves to sharpen assets and production per advisor and cut back its training program.

4Q0410,962

1Q0510,471(-492)

2Q0510,438 (-33)

3Q059,311 (-1,127)

4Q059,526 (+215)

1Q069,000 (-526)

2Q068,179 (-821)

3Q068,069 (-110)

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Morgan Stanley’s Wealth Management Results

3Q06*2Q061Q064Q05

WM Rev$1.37 bn$1.4 bn $1.3 bn$1.3 bn

WM Income$158 mn$157 mn $23mn$84 mn

Margin12%11%2%7%

FAs**8,0698,1799,0009,526

AUM$652 bn$639 bn $633 bn$617 bn

Fee AUM$193 bn$190 bn $182 bn$173 bn

AUM/FA$81 mn$78 mn$70.3 mn$65 mn

GDC/FA$675,000$653,000 $554,000$551,000

*Fiscal 3Q ends Aug. 31, while the fiscal year ends Nov. 30. **Includes planned reduction of 1, 500 in 2Q06 and 3Q05 plus attrition

Source: Company reports

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Morgan Stanley’s Rising Stars

Who’s eligible?

o Those with less than 2 years in the business, trailing 12 month sales (T12) of at least $75,000 and $8 mn in assets

o 2-3 years, T12 of $115, 000 and $12 mn AUM

o 3-4 years, T12 of $175,000 and $18 mn in assets

o 4-5 years, T12 of $225,000 and $25 mn in assets

o 5-6 years, T12 of $400,000 and $40 mn in assets

o 6-7 years, T12 of $500,000 and $50 mn in assets

What’s the deal include?

o 100% cash

o 25% bonus paid on T12, if broker brings over 80% of assets after 14 months

o 25% bonus if T12 grows 25% after 24 months

o 25% bonus if T12 grows 50% from original T12 after 36 months

o 25% bonus if T12 is twice original level after 48 months

o $100,000 bonus if advisor hits $1 mn in T12 within 60 months and is considered a rising star

Source: Industry, company reports