The bad news for advisers considering a move (and the good news for shareholders) is that the recruiting “bubble” we’ve experienced for the last two years has finally burst. The “front end,” or non-contingent, portion of recruiting packages being offered by the major firms has been reduced by as much as a third or more.
The bad news for advisers that did not move, and for shareholders, is that the packages were at levels that can’t seem to have been justified. Many deals were at levels of 250 percent to 300 percent of trailing 12 month revenues, with the contingent portions requiring hurdles of less than, or no more than, historic assets or revenues.
Why is this bad for advisers that did not move and for shareholders?
Fixed overhead is being allocated over a reduced and falling revenue base at most firms. The allocation of costs for contingent liabilities (e.g. client arbitrations and regulatory settlements) seems to be climbing. And logic would dictate that all these huge recruiting packages and expenses will be paid for with falling profits and cost cutting, including reduced payouts.
Those advisers not on recruiting packages might be seen, in effect, to be subsidizing those on recruiting packages in the future.
And How Did This Happen?
Cycles seem inevitable, and the pendulum swinging too far in every cycle also seems inevitable. Mass psychology is hard to fight. The projections that justify these deals were based on optimism about advisers growing revenues and transitioning business, probably well past when such optimism was justified.
When people are paid bonuses for recruiting and increasing revenues, instead of long-term profitability, perverse incentives can be created. When a firm is stealing masses of your advisers, taking advantage of opportunistic moments of adverse publicity, there is a natural human desire to fight back.
When competitors keep increasing their offers, it’s hard to walk away from the game. It became almost a joke among people involved in the process, like the lawyers, who were trying to guess how long this cycle would last.
Who’s Most Attractive?
Of course, certain firms never got involved in the war of increasing recruiting packages, or at least not at the high levels that were reached.
And certain advisers are more attractive to certain firms, and that means they may still command premiums. This includes:
1. Larger producers, especially teams.
These are seen as more profitable and desirable, although once you reach rarified levels the packages can get so large that the financial risk may become a bit of an offset.
2. Fee-based businesses, those with high net worth families and individuals as clients (as opposed to funds or managers), plain vanilla low-risk business as opposed to esoteric products, and a clean U-4 all make advisers more attractive to firms.
3. Advisers in certain geographic areas or in certain demographics (the adviser or their clients) in which the recruiting firm is trying to build can make a difference.
4. Firms do actuarial evaluations of advisers they recruit from other firms. If you are coming from a firm where the recruiting firm has had good experience with the ability of recruits to move their client assets, you will be more attractive.
If you are at a firm that has signed the recruiting protocol (to be discussed in greater detail in a future piece), you will be more attractive to another protocol firm.
These attractive recruiting packages reduced the number of advisers who left to set up their own firms, although this trend continued to some extent. Now that recruiting packages are reduced and more advisers are angry at their own firms over bad product recommendations and constant waves of bad publicity, there could be an increase in advisers leaving to start their own firms or leaving to join smaller boutique private firms that do not compete with the same large cash incentives.
The cycle in that arena will probably inevitably come back around to where financial institutions will grossly over pay to purchase independent advisers and some advisers perceive the future value of equity.
Steven Insel is a broker-dealer and investment advisor attorney at the firm of Jeffer, Mangels, Butler and Marmaro LLP in Los Angeles, where he represents many international institutions and boutique firms. He has represented hundreds of the top-producing advisers in moving between firms and setting up their own firms.