Rick Peterson & AssociatesRick Peterson & Associates

On Wall Street

March 2000

What’s the bid-and-asked for brokers these days? For this year’s special coverage of broker compensation, we invited some of the leading agents in the broker market to share their insights with On Wall Street readers. Joining the magazine’s editors at a recent roundtable discussion were veteran recruiters Charles Amerkanian of Hudson Management Co., Michael J. King of Michael King Associates and Mark Elzweig of Mark Elzweig Co., all of New York, and Rick Peterson of Rick Peterson & Associates, Houston. Also participating was Andrew Tasnady, a senior consultant specializing in financial services compensation at Sibson & Co., a management consulting firm based in New York. Their edited comments follow.

OWS: What compensation changes do you expect this year?

Elzweig: I see a continuation of two trends. First, because wirehouse overhead is going up — for real estate and new technology, for example — payouts may come down. At the same time, I see boosts in payouts for people who have fee business and a lot of assets, and I would expect to see more firms possibly making a distinction between fee-based brokers and transactional brokers, especially larger firms in terms of the payouts themselves.

Amerkanian: I disagree. I don’t think payouts will go down; they’ll change. Brokerage firms don’t have a big problem with how much money they pay out to their representatives in total. It’s more a matter of timing. I see more and more firms going towards deferred compensation as opposed to paying out the big money up front. There are two reasons for that. One, deferred comp diminishes the need to create immediate income. It also creates loyalty — which makes our job a little more difficult — because it makes leaving a firm more costly. Some of the firms that are losing brokers are raising commission payouts in order to attract brokers.

OWS: Any names?

Amerkanian: Well, Alex Brown, for one, just raised the base from 32 to 40 percent. The independent brokerages also are changing their payouts, and in some cases with very large brokers they’re including interest income. Payouts can range anywhere from 60 percent to 90 some-odd percent. That’s a very wide variance, but it represents a very interesting opportunity for brokers.

OWS: Do you think more brokers will consider the independent alternative?

Amerkanian: As they become aware of it, yes.

King: I think they will. But, of course, you’re on your own and you must take into account your expenses. If you’re getting 40 percent from one of the major wirehouses, you’ll probably wind up with 55 to 60 percent, after expenses, at an independent. Is that going to be worth it to you? Working by yourself or with just one other person can be very, very difficult. You don’t have a home office for information and advice, and there’s not the kind of broker-to-broker interaction that can generate ideas.

Amerkanian: It’s not a business for rookies. But it must be working for many seasoned brokers because the clearing operations of major firms are growing and anxious to gather that business in.

OWS: So, bottom line, will there be a net gain at independent firms this year?

King: I think so.

Tasnady: I would say a small net gain.

Amerkanian: I agree, because many large firms are going to make it easier for their own brokers to become independent. All the large players want to keep their good people and provide them with whatever relationship they want. If you want to be independent, the firms will help set you up. First Union, for example, says don’t leave, don’t go to another firm. Stay here, pay some of your own expenses, and we’ll give you 70 percent.

Peterson: If the market stays where it is, there probably will be a slight net gain for independents. But a couple of cautionary notes. First, we’re seeing fewer people from wirehouses go independent because deferred compensation has become such an issue. Second, if we have a market correction, we’ll see a flight to quality. I think you’re going to start to see a lot of investors get real nervous about who they do business with. And John Jones, Inc. loses an awful lot of prestige when it comes up against a Prudential, a PaineWebber, a Merrill or somebody with a name identification.

OWS: Any other thoughts on this year’s outlook?

Elzweig: I’d just like to add one point that fits with what Charles was saying about deferred compensation. When you lock in brokers with huge levels of deferred compensation, it’s much easier to shave the payout in very small ways. You can cut everybody by one percentage point across the board, for example, or raise your asset thresholds, and you can do it with relative impunity, knowing that if you chisel in a small way you’re probably not going to lose many people. So while deferred compensation is a good thing, I think it gives brokerage firms more freedom to chip away at the payout.

Tasnady: Even though payouts might be lowered, firm costs keep on going up. Average producers, because of the market and inflation, keep bumping up into higher levels of the grid. That’s why costs as a percentage of revenues continue to rise at a lot of the firms, and they’re forced to make cuts in the grid to maintain their profit levels. It will be interesting to see how well these deferred compensation programs work if there’s a market downturn, particularly in cases where firms use their own stock as the form for the deferred. That’s why we always recommend not always using company stock in these programs. Deferred comp is supposed to be the glue to keep the firm together, but if the stock falls, people are going to start to look at other companies.

King: Deferred comp plans certainly a big attraction now. When you look at Morgan Stanley stock or even Merrill stock, it’s very impressive. But what will happen in the downturn? You also have this other interesting trend going on: While online trading is growing, deals for brokers are the best that I’ve ever seen.

Amerkanian: That’s part of the reason costs are going up. The recapture on an aggressive deal by a brokerage firm demands that they create some kind of contractual relationship and deferred comp so that they don’t lose the guy as quickly as they can hire him. As Michael says, the deals are astronomical. When I was a broker, they didn’t exist. And then George Ball started paying front-end money.

King: Thirty percent is the highest we ever heard.

Amerkanian: And now they’re 100 percent. I even heard of a 110 percent deal in one case. Some people talk about higher numbers, but I haven’t seen that.

OWS: Tell us about the state of deals these days. What’s going on out there?

Amerkanian: They’re high.

King: Every major firm is extremely competitive. They’re extraordinarily high. You have to get 100 percent and maybe even 110, 120. I’ve heard 150 percent. You need to have three things to get a great deal: A very good production level, a very low return of assets — they want 1 percent, but probably will take 2 percent in some cases — and a high asset base. In other words, if you have $1 million in production, you have to have at least $100 million in assets under management.

Amerkanian: To get a 100 percent deal would probably require $100 million in assets on $1 million in gross revenues.

King: If you had $1 million in gross revenues and you had fees of, say, $25 million, you’re not going to get that 100 percent deal. That doesn’t exist. Brokers at small firms have no concept of this. Some of them are used to returns of assets of 5 to 10 percent. No major firm will touch them with a deal.

Amerkanian: The high transaction broker who has a low asset base thinks the numbers we’re talking about in terms of bridge compensation apply to him; they absolutely don’t. As a matter of fact, I’ve been involved in a deal where a major broker was given a target in order to get 100 percent that was greater than his asset base. And we’re talking about $275 million as the base. In order to get 100 percent of his assets he would have had to produce over $300 million in assets.

Peterson: I agree with a lot of what I’ve heard here in terms of deals. They are the strongest I’ve seen in 21 years. They’re not going to get smaller. Deals may go away periodically, but every time they’ve gone away they come back with a vengeance. When they were at 30 percent max, they came back at 40 percent max, then 50 percent max. Now 100 percent yields are routine. And you don’t have to be a $1 million producer to get a 100 percent deal. If they go away because of a bad market or for other reasons, they will return even stronger.

One reason is the deferred comp issue, which is getting stronger and stronger. Second, as brokers get into the advice business — and even though it takes a while for a guy to get into a position of actually controlling a lot of assets — that guy’s business is worth a lot of m o n e y. Firms are not afraid to pay out for it because capturing assets is the name of the game at the major firms. The final point is that we’re in an incredible job market. Getting qualified people into the brokerage industry is almost impossible, and the turnover rate is horrible, because there are alternatives to being a broker. Therefore, the priority on getting a trained person from the competition becomes far greater.

Elzweig: Even if you could hire a trainee, the odds of a trainee being successful are remarkably poor. It costs between $100,000 and $150,000 to train a broker over three years. And the odds of that person becoming successful, I would say, are maybe less than 15 percent. So hiring people is a very high risk game, even if you hire people with connections from their previous career.

Amerkanian: I’d say the actual cost of training is probably much higher. In 1975, when I was involved in Merrill Lynch’s training program, the costs were about $75,000 per trainee. And that was in 1975! So you can probably figure the costs are close to a quarter-million dollars today. So if I have to train 100 guys to get just 22 successful ones, I’d rather pay up for a guy who’s got the assets, as Rick said, because that’s the name of the game.

Peterson: Right. Get a proven commodity.

OWS: Do most assets transfer with the broker?

King: Most of the good brokers can bring over the assets.

Peterson: Most of the Merrill brokers — even if they don’t bring the assets with him — are good enough to get them back, anyway.

King: If we’re talking about broker deals, the one key issue we haven’t addressed fully is golden hand-cuffs. In other words, you may get 100 percent for coming over, but at the same time you’re leaving behind 40 or 50 percent of the money you’re accumulated. What happens to that? Currently, some of the firms I’m familiar with are saying that the money left behind is included in the 100 percent package. But some brokers want to be made whole for the money they’re leaving behind. Nobody seems to want to address that. Rick, do you know whether Pru is addressing that?

Peterson: Yes. They’re addressing the deferred comp that people are leaving behind, in addition to which they’re starting to build in their own deferred comp. To my knowledge, all the major firms are addressing that issue, with the possible exception of Paine Webber. Some of the firms are making brokers 100 percent whole, and in other cases they’re addressing it by giving them more money up front or something on the back end above and beyond to make up the difference.

Tasnady: These are the types of programs we design for the firms, and they’re working. If our clients decide to give sign-ons, we advise them to put some of that money into a deferred comp program. So instead of having it all be paid in a forgivable loan up front and having the person be able to get their hands on it, you would place a big chunk of it into the person’s new deferred comp program.

Amerkanian: Andy, I agree with you 110 percent. I’m talking to a multi million- dollar producer with a phenomenal asset base — close to $1 billion — and he tells me, “I don’t need the money. Don’t pay me an up-front taxable event. Give me some form of deferred comp that is reasonably similar to what the front-end packages are.” But the brokerage firms I’ve talked to are just stymied. They have no idea what to do. As a result, he hasn’t moved.

King: Charlie’s absolutely correct. The whole question of deferred comp and golden handcuffs will be this year’s big issue. The solution has to be built into the program and planned. The answer that we’re often given — that it’s part of the total deal — is not what brokers want to hear.

Peterson: Let’s look at who has the largest deferred comp program: Merrill. Besides the transactional brokers who are leaving because of the Internet, the guys really leaving are those in the 8- to 15-year range. They’re the ones who have told us that if they could get out of the golden handcuffs, they’d leave. You know something? They’re leaving in droves. Why? Because the golden handcuffs situation has been addressed to their complete and utter satisfaction by many firms.

OWS: How many brokers is Merrill losing?

Amerkanian: It’s hard to quantify.

Peterson: It’s hard to quantify because nobody’s going to give you accurate numbers. But I think all recruiters recognize it’s happening. And it’s the largest group percentage-wise that I’ve ever seen leave Merrill. They’re a different group from the past.

Amerkanian: More relevant than the number is the fact that those leaving are the larger producers, older in length of service, larger in asset bases, larger in production, more part of t h e establishment of Merrill Lynch than has ever been the case among those who left.

Peterson: The younger guys see these senior pros leaving and say, “Wow, I thought that guy would never leave.” And all of a sudden it makes leaving a possibility.

OWS: Is it all because of online trading?

King: That and the fact that more people now believe there’s life after Merrill. Brokers used to be terrified to leave because they were afraid customers would never come with them. Now people believe they can leave and make a living. Merrill’s payout is the lowest of the major wirehouses because they pay a lot for fee-based business and assets. So brokers are asking themselves whether they should stay and worry about the online business.

Peterson: There’s another factor, too: Merrill can be a very harsh environment. It’s a very stern, disciplinarian, competitive, driven firm. To some people, a new firm can look like a haven.

Amerkanian: Well, Merrill often is very difficult in terms of quotas or numbers. And their managers very often are poor in interpreting the firm’s demands to their brokers in a reasonable fashion. What comes across is a dictum rather than a request.

OWS: Are there any firms that prefer not to hire Merrill brokers?

King: No.

Elzweig: Everyone wants Merrill brokers because they’re well trained.

Peterson: They’re the best in the world. The only negative we ever hear about a Merrill broker is that he doesn’t bring all his business with him. That’s a given, but firms still pay as much for a Merrill broker as they would for somebody who’s bringing 100 percent of their business because they know he’s well trained. Whatever he leaves behind, he’ll get back with the same work ethic that got him the business in the first place.

Amerkanian: In my experience as a manager and headhunter I’ve found that a broker who switches firms will lose 20 to 25 percent of his gross revenues the first year. He’ll make it up in the second year and then some if he’s working on it.

Peterson: Right.

Tasnady: One of the things I was going to discuss is the shift in what’s actually going on from the client’s perspective and how that might be driving some of these trends at the brokerage firms. In some of the customer research we’ve seen, firms are finding a big shift in the average knowledge base of new clients. With Web access, CNN and a high percentage of the workforce having investments — either through a 401(k) or their own stock participation — there’s less of a mystique surrounding financial information.

They know about stock indexes, S&P index funds, et cetera. What they really want is more help in financial planning.

It’s less about helping pick a stock, and more about helping manage wealth and pay taxes. That’s driving a lot of these trends. And this means that it’s not Merrill Lynch’s brand recognition that holds sophisticated investors but a broker’s customized advice. If you’re a good person, a good broker and a good adviser, you can bring your clients with you from Merrill Lynch.

OWS: And if you’re a good stock picker?

King: There’s still room for very good stock pickers. Whether the major wirehouses will continue to want them remains to be seen.

Elzweig: Interestingly, a study done by Dalbar found that an increasing number of clients actually favor com missions over fees because they felt it was a fairer way to pay for service. Many transactional brokers run very high quality businesses, which is still OK at the wirehouses. It’s not preferred, but it’s OK. I think that if at some point the wirehouses try to make that business too difficult to do — through payout reductions, et cetera — they probably will lose a lot of very high caliber people to regional and local firms.

Amerkanian: The stock pickers tend to gravitate to the smaller firms.

OWS: Any firms paying to keep brokers?

Amerkanian: If a broker is going to leave and you knew about it, you might structure something to keep him there. But most often you don’t know about it until the day he’s leaving.

Peterson: When [payments] are made you’re not going to hear about it afterwards. It won’t be easily traceable. [PaineWebber’s] Mark Sutton said they will not pay to retain brokers. And I think that is the official policy of every single brokerage firm. But we all know money is offered on occasion to keep brokers.

King: There are ways they can do it. I don’t think you’re going to find them offering the same big up-front checks. Higher, extra payouts — all those things can be done.

Amerkanian: It would cause an insurrection if you made it public.

OWS: Aside from incentives, are firms doing anything coercive to make brokers stay?

Tasnady: One strategy firms might be using, although it might not be explicit, is to move assets into fee-based investments, particularly proprietary ones, so they take control over from the broker. That way, if a broker leaves, people are less likely to shift their assets from a customized investment vehicle.

Amerkanian: If I were a brokerage firm and did what you said, the brokers in my firm would know exactly what’s going on and be angry enough that when the opportunity arose that they would leave.

Tasnady: I’m not sure it’s an explicit strategy. They’re going to fees because the financials are better; account control is a side benefit.

Amerkanian: A lot of brokers are smart enough to understand that. They know that if they take business to an outside, independent money manager, the business becomes 100 percent portable. Conversely, many brokerage firms are training young people to keep everything in-house, at which point they become captive or the assets become captive and you forget about ever moving.

OWS: Other trends?

Tasnady: In all professional service firms we’re seeing what we call a war for talent. There just are not enough qualified people there to hire. Another trend involves a demand for work/life balance. Many people are joining Schwab, to use one example, because it has excellent and flexible work/life balance opportunities. Brokers, particularly female brokers, can work just the hours their kids are in school. When your kids are out of school — spring break, winter break and in the summers — you’re off. People are taking pay cuts in order to have a more balanced and fulfilling life. And in Charles Schwab’s case, these people, if they started a while ago, are getting stock options that are worth huge amounts of money.

Elzweig: Another trend involves new competition. For example, money management firms setting up sales forces. They basically follow the Sanford Bernstein model, where you call on accountants and attorneys, you get referrals and you bring in money to be managed by your firm. You also have other money managers that now have sales forces that just go directly to high-net- worth people. Hedge funds have their own sales forces, and accountants are directly placing money with outside managers.

Part of what’s fueling all of these broker deals is that firms are realizing that the only way they’re going to be able to deal with all these new competitors is by having a sales force that controls the client and controls the revenue. That forces them to pay whatever they have to pay to get those people.

Tasnady: We also work with large banks, and as they compete for assets they’re learning they must find creative ways to keep assets with the retail brokerage people in their branch networks.

Amerkanian: Going forward, I think you’re going to see more cocoon operations with groupings of brokers responsible to one another and then responsible to a head. Believe it or not, that’s something Ross Perot was working on 25 years ago. And the reason for it is simple: A manager in a 110-man branch can’t be on top of each broker. But if you break down oversight responsibility into small groups, you could have a senior broker responsible for his group of eight to 10 brokers. That’s a very plausible way to slow attrition, because it’s tougher to move an entire group.

OWS: Are firms tying up brokers for longer periods in exchange for up-front bonuses?

King: That’s a general trend. In the early ’80s deals were three years long. Now they’re four, five and, in some cases, six years long.

Elzweig: Morgan has done seven. King: Morgan has proposed seven. I’ve never seen it.

Peterson: Somebody told me the other day that if a deal goes longer than four years, the IRS is going to look at it as a taxable event in year one. In other words, a five-year deal may not even be technically legal by IRS standards. So I don’t expect deals to get any longer than they are now unless the IRS gives its seal of approval.

Amerkanian: Rick, clarify something for me. If I have a 10-year deal and I take $100,000 up front, that means I can’t pay taxes on $10,000 a year for 10 years?

Peterson: That’s correct.

Amerkanian: That will change the business a lot.

Peterson: Some firms have had to negotiate and settle with the IRS because the broker received the money up front at once and paid taxes over the term of the deal. Unless the IRS gets a little bit more flexible, we’re not going to see deals ratchet beyond five years.

Amerkanian: I always advocated smaller payouts and taking the rest as deferred income. But brokers want it now and pay the taxes on it. They’re very short term.

OWS: Who’s recruiting most heavily?

Peterson: Probably Dean Witter. They seem to be getting the most results. Everybody, with the possible exception of Smith Barney, is in there plugging away.

King: Morgan Stanley Dean Witter.

OWS: What mistakes do firms make in hiring?

Amerkanian: They make policy without consulting the very people involved in the process all the time. I’ve never heard one brokerage firm ask a recruiter for advice or insight. They make up their minds in a boardroom, go out and execute their decisions, have managers implement it, and then get screwed.

Peterson: I’ve never been asked my opinion, and I’ve been at it for 20 years.

Amerkanian: Yet they pay in-house recruiters who are totally ineffective and out of touch with the market.

Tasnady: They are trying to listen to their brokers. We do a lot of broker interviews and focus groups as part of the process of changing comp. And the good news is, a lot of times you can find out what’s really an issue. In the past, firms tried to fix costly things and then found out the brokers weren’t concerned by the problem.

Peterson: I’ve been invited to brokerage firm meetings and asked to give my assessment of what’s going on in the industry. In some cases, I’ll be asked how to change grids or what kinds of deals to offer. I leave thinking they acknowledged what I said. When I come back, nothing’s changed. Why invite me in the first place?

OWS: How important is the grid?

Peterson: In 20 years, I can count on one hand the times a broker has told me they chose Firm A over Firm B because of a higher grid. It never comes up.

Tasnady: That’s in our feedback, too. Usually they’re upset about the client flow, the level of support they get internally in terms of helping them execute their trades and get access to information, handling their client billing statements, et cetera. It’s usually beyond just the money.

King: Payout does come up if there’s a big, big difference. Within one or two points it doesn’t.

Tasnady: They’re all so close, it doesn’t make a difference.

Amerkanian: The biggest reason brokers leave is because branch managers screw up the relationship.

OWS: Any last points?

Elzweig: If you’re a valueadded broker who really has something to offer, none of these industry trends should worry you. The total amount of high-net- worth assets you can capture and manage is growing astronomically.

Peterson: Every broker has his or her own niche, whether fee-based or transactional. There’s a home for every broker, so long as his business is clean.

Tasnady: I would suggest that brokers focus on long-term planning for themselves. What are their goals five, 10, 15 years from now in terms of wealth accumulation, where they want to be with their clients, and the life style they want? Then work backwards and select the strategy that’s going to get them there.

Amerkanian: Unfortunately, a lot of brokers become brokers simply to make money. They don’t understand they’re running their own business. If they approached it with a business plan and a determination to execute that business plan, they’d all be very successful.