The last 16 months have seen an unprecedented volatility in the market for financial advisers, just as there has been an unprecedented volatility in the financial markets in general. Recruiting packages reached previously unseen levels in the second half of 2008. Since then, the size of recruiting deals has fallen significantly at most major firms and is about to fall again. Mergers have reduced the number of firms competing for advisers, and the culture of many private wealth management firms has been impacted as they became affiliated with commercial banks.
The retention packages offered as a result of merger or sale transaction have deteriorated or, as in the case of Wells Fargo and Wachovia, disappeared. The environment has become most unfavorable at the major firms for the financial advisers producing lower levels of annual revenues, below $400,000 or $500,000, or in some cases even below $1 million, as demonstrated by restructured payout plans for those advisers, low or non-existent retention packages and transactions like the sale of UBS branches to Stifel Nicolaus.
In addition, we have seen concerns arise among those on recruiting or retention deals over various legislative proposals related to compensation that could affect advisers at firms that have taken government assistance, or all firms in certain regulated categories. .
Seeing an opportunity, a second tier of firms has more aggressively entered the recruiting competition for advisers, some with the advantage of less adverse publicity and perceived “reputational” risk, some with the advantage of a more conservative history and stronger capital position.
This has had several impacts on the market. There is a mini-bubble in movement of advisers trying to catch favorable recruiting packages before they disappear. A number of factors are causing more advisers to consider going independent, often by forming their own advisory firms. These factors include: less attractive recruiting deals; producers at the low end of the scale being forced out; cost cutting that has adversely impacted support for advisers; a future where reduced payout is likely; client concerns created by the adverse publicity at some firms and advisers’ desire to control their own future and practice with less conflicts of interest (many having been burned by selling affiliate product).
There are many alternatives strategies for advisers planning their future, each of which shall be explored in more detail in future installments of this series. In considering strategic alternatives, advisers need to first evaluate their business as it is and as they want it to be in the future, and determine what services and forms of compensation they expect to receive.
1. Do you need to be associated with a broker-dealer? This is a critical primary issue. Over the years many, if not most, brokerage firm financial advisers have migrated to a primarily fee-based business, which is under an investment adviser registration. If securities commissions, including variable annuity and other variable insurance commissions and 12b-1 fees on mutual funds, are not significant to your business, you may not need to be in the broker-dealer business, with all of its related regulatory burden. Some advisers think they need a broker-dealer license to take care of issues like selling restricted stock, even if it is a minor part of their revenues. That is a mistake, as an investment adviser you can still assist a client in such matters as long as you are not receiving commissions.
2. Are you ready to be an entrepreneur and to handle all the details of running a business, especially one in a regulated industry, or can you afford to hire competent people to do so?
3. How strong is your desire to control your own life and business style?
4. Do you do any direct management of money that might result in a very valuable intangible asset of a strong track record some day?
5. Do you now or going forward want to provide other client services like insurance or family office services?
Starting your own firm is more difficult if you need a broker-dealer. The time and cost to set up a broker-dealer as opposed to an investment adviser is hugely different. However, there are independent contractor broker-dealers that will allow you to associate with them and still own and run your own investment adviser (and insurance agency for non-securities insurance products), subject to some extent to the broker-dealer’s supervision and possibly some override payment on fees.
If a broker-dealer is not a necessary part of your practice, it is much less difficult to set up your own firm, and there are many advisory firms of varying sizes, from family office firms to those specializing in direct management and every variation in between, seeking advisers.
There are independent contractor firms, where you bear your own expenses and make your own arrangements for office space, support, etc., to a greater or lesser extent. Many are both broker-dealers and investment advisers if you need both, and often support a traditional insurance business in addition to variable insurance.
For those who need to be at a dual registrant broker-dealer/investment adviser and are more comfortable as employees on payout with responsibilities limited to making their practice productive, there are many tiers of firms to consider, with smaller or regional firms seeming to present a more positive environment for advisers doing $500,000 or less in revenues. For such advisers, the independent contractor broker-dealer firms may not be attractive as a place to go as a completely independent adviser, but within such firms there are persons managing, and even housing, groups of advisers that may present an opportunity for going independent within a supported environment.
Another middle range of alternatives exists with the firms referred to as “roll up” firms. These firms are purchasing independent investment advisers and advisers with practices, paying with a combination of equity and/or cash, generally on an earn-out basis, in hopes of value in assembling a sizable firm and in increasing everyone’s practice by providing various service and marketing support and relieving advisers of the distractions of all the details in administering their own independent business and creating the cost advantage of services in a larger firm.
It is critical that, while you plan and prepare for your future, you do not violate your duties as an employee, your contracts, federal and FINRA rules on the confidentiality of client information or other laws, rules and regulations. Among these many concerns are the requirements of FINRA Rule 3030 requiring reporting of outside business activity and FINRA Rule 3040 requiring pre-approval of any involvement in outside securities transactions, including securities in your own new firm; prohibitions on solicitation of clients or other employees while employed, or even after, that may apply by law or contract; and legal prohibitions on giving certain client information to any third party or taking it with you when you leave.
If you do not take heed of these warnings, you may find yourself in regulatory trouble or facing devastatingly costly litigation, or even court orders stopping you from doing business. There are ways to address many of these issues, especially if you are at a firm which is a signatory to the Recruiting Protocol, and this is an area where the old saying about an ounce of prevention and a pound of cure certainly applies.
Attorney Steven Insel represented hundreds of the top financial advisers in the United States in such matters for decades. Advisors with questions can reach him at [email protected].