Still Getting It Done

They may not be making it ‘the old fashioned way’ with commissions on stock transactions, but in spite of reports of representatives fleeing wirehouses to affiliate with independent broker/dealers, controversy over Rule 202, and questions about who may be best suited to work with the investing public, wirehouses seem to be thriving in their retail businesses by using innovative strategies and very sophisticated products to solve problems for the wealthy.

Revenues are up, year over year, for the retail brokerage businesses of Merrill Lynch and Wachovia, two wirehouses that had reported third-quarter earnings as of mid-October. Merrill cited “higher fee-based revenues and net interest profit” in its announcement, and Wachovia similarly attributed its revenue growth to “retail brokerage managed account fees, wider deposit spreads,” and the impact of two acquisitions.

The big four, Merrill Lynch, Morgan Stanley, Citigroup, and Wachovia, are all hiring high-end, very seasoned brokers. One thing that is “surprising and confusing” to Richard X. Bove, financial institutions analyst at New York-based Punk, Ziegel & Company, is that he’s hearing “that Morgan Stanley is now willing to pay 200% of trailing 12-month commissions as a sign-on bonus,” although he hears from others that the figure is overstated, “that it is really 140% to 160%, but that strikes me as being outrageously high also.

“Morgan Stanley is down about 5,000 brokers–mostly because they’ve made a decision to disassociate with them. It also appears that Morgan Stanley has been a fertile field for its competitors to pick up individuals.” Bove adds that the firm “has publicly stated that they are going after the competition wherever the competition has hurt them; presumably they’re going after Merrill Lynch because Merrill has had a great deal of success in hiring Morgan Stanley brokers.” Of course, it was Morgan Stanley that in August 2005 hired James P. Gorman away from Merrill Lynch where he had been president of Merrill’s global private client group, including some 14,000 brokers, to be president and COO of its individual investor group, and later brought in Merrill veterans Jerry Miller and Richard Skae as regional directors to report to Gorman. Wachovia has also had some degree of success hiring Morgan Stanley brokers, Bove says. What is “most important in the industry at the moment is attracting and stabilizing a workforce.”

With equity trades on TDAmeritrade priced at $9.95, and Bank of America offering 30 free equity trades a month to customers with $25,000 in their accounts, selling stocks on commission can’t earn most high-end brokers a living. According to Bove: “You’re going to put people into wrap accounts where you say ‘You can trade forever for nothing but we’re going to charge you 1% or 2% of the assets which we have in-house in your account.’”

“You can’t simply sell stock, you want to sell mutual funds, interest in hedge funds, structured financial products, bank deposits, mortgages, business loans, anything that you can sell because all of those products have much higher margins than simply selling stocks. The bond market, particularly the municipal bond market, gives you an opportunity to make some money because in the municipal bond market you have unique products all the time. Microsoft is not a unique product–it’s a product anyone can buy. It’s a commodity, and [customers] can buy it at low price. However, Tampa Florida Water District III–that’s a unique product and you can wrap a pretty big commission around that product,” Bove explains. “For the guy in Tampa” who doesn’t want to pay taxes on the income, he notes, “that’s something they desire.”

What stands out to Bove is a growing need to provide custom solutions for wealthy clients. “If you step away from the wirehouses and look at Lehman Brothers and Bear Stearns,” these firms have “moved out on the risk spectrum to products which are more structured finance in nature because the margins are much higher.” For example, take a client who has accumulated wealth in the form of a large, highly appreciated position in their employer’s stock. Lehman Brothers would, he says, short that stock against the client’s position, hand them the money–”for a fee, obviously”–and then the client can go and invest that wherever he wants. They’ve effectively sold the stock position, have the money–so they’ve diversified, and deferred their taxes on the capital gain. “It’s doing innovative things like that to solve specific problems for high-wealth individuals, which is allowing these firms to make pretty good profits.”