What Advisors Can Teach the SEC

In fact, the SEC should began to examine how the industry has moved ahead of the curve to re-shape recruitment packages to tie performance and asset retention to their bonuses over a period close to a decade.

Yes, you read that correctly. If only investment banker and trader compensation even remotely resembled advisor deals. Most packages require brokers to stay with a firm for seven to nine years and to meet performance goals that are not just commission-oriented but asset-based. If brokers leave before their contracts end, they don’t get the full value of the deal.

The bonuses are no sure-thing in other ways. Changing firms usually costs advisors: It’s a huge paperwork hassle and some accounts don’t come along. In my experience, most advisors typically bring 75 percent to 80 percent of desired assets to a new firm. Since the new contract is usually based on what is known as trailing 12-months’ production, the new firm usually gives the advisor three years to build back to the prior trailing-12 level. Sometimes the deal pays a bonus for bringing over a certain percentage of assets.

Schapiro worries about churning. Firms worry about that as well, which is why the back-end bonus is often asset-based. Transactions don’t even play a role. Many contracts make the back-end based partially on commissions and partially on asset retention and growth. Occasionally I see a back-end that is linked to asset growth only.

Churning is a much smaller problem for elite brokers for another reason: most are fee-based leaders – they manage about 30 to 40 percent of client money on a fee basis. Trading turnover on their commission business is low on average, at most 1.5. Further, after the market crack-up, a number of clients are switching from fees to commissions: quarterly bills for a shrinking portfolio are hard to swallow.

And consider this: In the 1980s and 1990s, the brokerage industry cleaned up its practices extensively: sales contests bit the dust; proprietary product-pushing were killed, and compliance departments expanded.

Compliance departments for retail investors have strengthened technology and personnel to police the brokerage force. They are constantly scrutinizing asset/commission ratios, suitability and documentation. In my recruiting practice, I now find firms are very selective in taking even top producers if they don’t like the asset base or compliance history. Not just anyone can get upfront money.

In his report on the SEC bungling of the Madoff investigation, Inspector General David Kotz says “inexperience” tripped up the numerous opportunities to nab Madoff.

In my view it was in fact a lack of in-depth understanding of the industry itself. Why was a small money manager like Bernie Madoff allowed to custody client assets? In my view, the SEC letter is disheartening because it shows how little the agency has come in grasping the inner workings of Wall Street.

And here’s one last thought on that epistle to the CEOs of Wall Street: It’s ironic that Schapiro is in a dither about upfront money and the dangers of churning. Senator Chuck Schumer (D-NY) is about to propose a winner-take-all deal for the SEC: The watchdog can keep all the fees it snares from Wall Street bad guys for its own coffers.

Now, that’s what I call teeth. After all, isn’t that the perfect fodder for regulatory churning? You could call it the bad-guy commission.

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Mark Elzweig is president of New York-based Mark Elzweig Company, an executive search consultancy that relies on cutting-edge technology to aid clients. He has worked with financial advisors and investment managers for more than two decades.