Flight to In­de­pen­dence

As brokers leave wire­houses for greater free­dom, is the Bro­ker Pro­to­col near­ing ob­so­les­cence?

Financial Planning - - Contents - BY BOB VERES

As brokers leave wire­houses for greater free­dom, is the Bro­ker Pro­to­col near­ing ob­so­les­cence?

When we look back at this era of the fi­nan­cial plan­ning pro­fes­sion, I think we’ll as­sign greater sig­nif­i­cance to a story that many ad­vi­sors might have missed this year: the wire­house in­dus­try’s sud­den mis­giv­ings about its Bro­ker Pro­to­col.

The pro­to­col, which en­com­passes 1,750 fi­nan­cial ser­vices firms, was de­vel­oped in 2004 for a very spe­cific pur­pose, ben­e­fit­ing very few com­pa­nies. Be­fore the agree­ment, wire­houses re­cruited one another’s brokers and paid hefty upfront bonuses to lure them — and their books of busi­ness — away. The bro­ker­age world’s re­ten­tion strat­egy was to have their lawyers file tem­po­rary re­strain­ing or­ders on any­body who left, pre­vent­ing de­part­ing brokers from con­tact­ing their cus­tomers after they walked out the door.

Why was this a prob­lem? No doubt, the cost of pay­ing re­ten­tion bonuses on one end, and the ex­penses in­volved in su­ing de­part­ing brokers on the other, was be­com­ing wor­ri­some. But per­haps a big­ger in­cen­tive was the em­bar­rass­ing sit­u­a­tion where your at­tor­neys are ar­gu­ing two sides. In one court­room, they try to make the case that a bro­ker had every right to leave another firm to join yours, cus­tomers in tow. In another court­room, they’re cit­ing le­gal chap­ter and verse to prove that brokers leav­ing your firm have no right to take cus­tomers with them.

The pro­to­col called a truce to that es­ca­lat­ing bat­tle. It pro­vided that de­part­ing brokers can take cus­tomers’ con­tact in­for­ma­tion when they leave, but noth­ing more. There are many com­pli­ca­tions to this sim­ple pic­ture, in­clud­ing sly ef­forts by bro­ker­age firms to in­clude dra­co­nian non­com­pete lan­guage into in­no­cent-look­ing doc­u­ments that brokers must sign to re­ceive their an­nual bonuses. But for the most part, ex­it­ing brokers have been re­ly­ing on this safe har­bor for the past 14 years.

So long as brokers were leav­ing one wire­house to join another, the pro­to­col was work­ing as in­tended. Who could have imag­ined that high-per­form­ing pro­duc­ers would ever con­sider seek­ing a home at one of these fly-by-night (their per­cep­tion) in­de­pen­dent BDS or go fee-only and join an in­de­pen­dent RIA firm?

The only rea­son for bro­ker­age firms to re­nounce the agree­ment would be if they started los­ing tal­ent to the world out­side the cozy bro­ker­age broth­er­hood.

The ex­o­dus from cap­tive bro­ker to in­de­pen­dent RIA has be­come a vis­i­ble bleed­ing wound.

There are no good sta­tis­tics as to how many brokers have left the wire­house world. All we know is that sud­denly, with­out warn­ing, at the end of last year, three of the big­ger bro­ker­age play­ers — Mor­gan Stan­ley, Citibank and UBS — de­cided to exit the pro­to­col. That sug­gests to me that the ex­o­dus from cap­tive bro­ker to in­de­pen­dent RIA (du­ally reg­is­tered or fee-only) has fi­nally be­come a vis­i­ble bleed­ing wound that needs a fast tourni­quet.

There is spec­u­la­tion that Wells Fargo and Mer­rill Lynch will soon fol­low their peers out of the pro­to­col, for dif­fer­ent rea­sons. Wells Fargo brokers must surely be field­ing em­bar­rass­ing

ques­tions from their cus­tomers about their moral­ity and ethics, while Mer­rill brokers who signed those gen­er­ous re­ten­tion deals when the world was col­laps­ing in 2009 are now fully vested and no longer have mil­lions to lose if they jump ship.

Whether the pro­to­col col­lapses is ir­rel­e­vant to the larger trend. In the years be­fore the in­dus­try ac­cord, brokers left wire­house firms and gen­er­ally won their right to con­tact their clients.

They will cer­tainly be able to do so again if the pro­to­col goes away. But the re­nun­ci­a­tion of the pro­to­col by three sig­nif­i­cant firms, and un­cer­tainty around two more, tells me that the bal­ance of power be­tween in­de­pen­dent ad­vi­sors and the larger sales houses has reached a tip­ping point.

Greener Pas­tures

The long, slow an­nex­a­tion of mar­ket share by the fidu­ciary ad­vi­sor world is ac­cel­er­at­ing. Brokers are notic­ing that the pas­ture is greener on the far side of the tem­po­rary re­strain­ing or­der.

Why now? First of all, the mar­ket­place has evolved to in­clude a lot of soft land­ing places for the de­part­ing bro­ker. Com­pa­nies like Dy­nasty Fi­nan­cial Part­ners, Hightower Ad­vi­sors, Fo­cus Fi­nan­cial Part­ners and United Cap­i­tal cater specif­i­cally to help­ing de­part­ing brokers pre­serve their book of busi­ness, with soft­ware tools and back-of­fice sup­port that are sim­i­lar to what they en­joyed as a top pro­ducer in the bro­ker­age en­vi­ron­ment.

Mean­while, every large in­de­pen­dent bro­ker-dealer and all the ma­jor cus­to­di­ans now have a team of spe­cial­ists who will help brokers find of­fice space, com­puter equip­ment and soft­ware, a new brand iden­tity and pain­less ways to get the trans­fer pa­per­work han­dled. The re­cent tran­si­tion to pa­per­less doc­u­ment pro­cess­ing, with elec­tronic sig­na­tures, has taken the sting out of what was once a sig­nif­i­cant has­sle for cus­tomers who wanted to fol­low their bro­ker to a dif­fer­ent firm.

Most of the ex-brokers I talked to said they left for rea­sons other than money. In fact, vir­tu­ally all of them said that they ex­pected to make less money after go­ing in­de­pen­dent.

Be­yond that, the in­de­pen­dent RIA world has grown up. In years past, a bro­ker­age team with $1 bil­lion un­der man­age­ment would be hard pressed to find a firm that could com­fort­ably ab­sorb its client obli­ga­tions. To­day, more than 600 RIA firms have more than $1 bil­lion un­der man­age­ment, many with mul­ti­ple of­fices, who could sim­ply plug another one into their cen­tral­ized op­er­a­tions flow.

Fi­nally, the tech­nol­ogy lead that bro­ker­age firms once en­joyed has com­pletely re­versed it­self. None of the sig­nif­i­cant in­no­va­tions in CRM, port­fo­lio man­age­ment and track­ing, fi­nan­cial plan­ning, client por­tals and vaults, on­line ad­vice plat­forms, col­lab­o­ra­tive in­vest­ing plat­forms and cy­ber­se­cu­rity are com­ing from legacy bro­ker­age sys­tems. An in­de­pen­dent soft­ware com­pany that is hop­ing to at­tract new busi­ness can amor­tize its cre­ative de­vel­op­ment costs over more than 17,500 po­ten­tial RIA cus­tomers, while the largest bro­ker­age firms amor­tize their soft­ware out­lays over 8,000 to 10,000 at most.

Over the last six months, I’ve in­ter­viewed dozens of ex-brokers about their ex­pe­ri­ence tran­si­tion­ing to in­de­pen­dence. One of the most con­sis­tent re­sponses I’ve re­ceived would surely be in­com­pre­hen­si­ble to the ti­tans who sit in Wall Street’s cor­ner of­fices: most of the de­part­ing brokers did not leave for the money. In fact, vir­tu­ally all of them said that they ex­pected to make less money after go­ing in­de­pen­dent.

A Fidu­ciary Al­ter­na­tive

Why on earth would these brokers leave, if not for the money? The rea­sons I heard were: the free­dom to give clients ad­vice in their best in­ter­ests, a move away from prod­uct push­ing and an op­por­tu­nity to align their con­science and their val­ues with the ad­vice they were giv­ing. A sur­pris­ing num­ber never re­al­ized that there was an in­de­pen­dent, fidu­ciary al­ter­na­tive.

But, in­creas­ingly, they re­al­ized that the grass is greener where there are fewer con­flicts, and the grass in the bro­ker­age world — where the branch man­ager is al­ter­nately both­er­ing you about quo­tas and pro­vid­ing sly fi­nan­cial in­cen­tives to push rec­om­mended prod­ucts — has grown dis­tinctly brown­ish over the years.

This is just a guess, but I wouldn’t be sur­prised if, some­time soon, the bro­ker­age firms ab­ro­gated the cur­rent pro­to­col and cre­ated a new one that only they and their wire­house fel­lows would be in­vited to sign.

But pro­to­col or not, I ex­pect that some­day in the fu­ture, his­to­ri­ans of the pro­fes­sion will point to this mo­ment as the time when a trickle of brokers seek­ing in­de­pen­dence qui­etly be­came a flood. The bro­ker­age model will re­tain the greedy, the timid and the obliv­i­ous, while the best of to­day’s bro­ker­age breed will be find­ing new homes where they can truly put their clients’ in­ter­ests first.

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