THE LM & SONS

Consider the message brokerage firms are sending to the investing public these days: Total Merrill. Or What We Do to Help Our Clients Succeed (Morgan Stanley). Or Fully Invested in Our Clients (A.G. Edwards). Or This Is Who We Are. This Is How We Earn It (Smith Barney). The messages, in one way or another, are meant to declare: We are not stock jockeys born out of a sales culture we are financial

Consider the message brokerage firms are sending to the investing public these days: “Total Merrill.” Or “What We Do to Help Our Clients Succeed” (Morgan Stanley). Or “Fully Invested in Our Clients” (A.G. Edwards). Or “This Is Who We Are. This Is How We Earn It” (Smith Barney). The messages, in one way or another, are meant to declare: We are not stock jockeys born out of a sales culture — we are financial planners.

The bigger firms have been beating this drum for a while now, much to the amusement of independent broker/dealers and registered investment advisors. We are the true financial planners, RIAs have claimed, adding that wirehouses have inherent conflicts of interest that doom any financial planning initiatives they undertake. Objective advice? C'mon, they can't change who they are, independents say, only we have your best interests at heart. Independent RIAs can point to the conflict of interest research scandals two years ago and to the more recent revelations that some brokers were paid more to sell their own firm's mutual funds instead of third-party funds. And anyway, independent advisors say, most brokers are stuck in yesterday's model: old fashioned, transaction-oriented securities peddlers.

To some extent that's true; transactions still account for 40 percent of wirehouse compensation, according to Cerulli Associates of Boston. But it is becoming clearer that, past missteps aside, wirehouses are making progress on their wealth management strategy. In fact, if a reliance on fees implies success at adopting the new-style “wealth management” model, then wirehouses actually are leaders in this area. For example, wirehouses dominate the managed account business, controlling 70 percent of the market, says Cerulli. (Regionals have 13 percent; independents only 5 percent.) Cerulli estimates that wirehouses and regional firms now hold more than a third of all fee-based assets, a 50-plus percent increase in just four years. The fee-based realm was once an independent stalwart, according to Cerulli, with virtually all RIAs choosing that method of compensation.

Wirehouse reps are getting the picture. As of the first quarter of 2003, nearly half of wirehouse rep compensation was generated by fee-based pricing, says Cerulli. Regionals, meanwhile, derived 51 percent from fees.

“Wirehouses have been doing a very good job promoting their fee-based and their financial planning business for a while now, and I certainly don't see them retreating,” says Matt McGinness, associate director for Cerulli Associates.

In fact, the world is becoming more challenging to independents. According to a recent report, authored by McGinness, the growth of independents has already begun to slow and is expected to continue that way in the next few years, even contracting by the year 2006. A large part of that is directly related to the wirehouses adapting independent-like business models for their own registered reps.

“Today, fee-based pricing, broad third-party fund offerings, financial planning, higher payouts, quality support and even autonomy are considered competitive requirements by leading traditional firms,” writes McGinness in a section of his report entitled, The Empire Strikes Back.

HERE THEY COME

The standard independent line of defense against wirehouses' ventures into financial planning has been, essentially, “They're big corporations merely out for their own interests, and they can't provide the one-on-one services independent advisors can.” Wirehouses have thought of this too. More wirehouses are structuring their offices with the client in mind, giving their advisors more face time with the investor, working with teams to provide specific, specialized services.

“It is becoming much more difficult to explain to clients why an independent advisor is different than a wirehouse advisor,” McGinness says. “From many consumers' standpoint, there is no difference.”

The wirehouses are accelerating financial planning programs. Merrill Lynch, for example, requires its advisors to obtain internal planning designations within 12 months of employment and pays substantial bonuses to advisors who attain the CFP designation within a three-year span, according to a company spokesperson.

“They're definitely encouraging their reps to take as many courses as possible,” says Neal Nakagiri, president and CEO of Los Angeles-based Associated Financial Group, which employs 265 producing reps. “Clearly, if [wirehouse reps] start to rise to the level of experience and knowledge that our [indie] reps have, it could be a problem.”

Wirehouses are fighting back, trying to prevent the best advisors from leaving to go out on their own. To do so, they are borrowing a few tricks from the independent model. For example, they are providing some coveted reps with more autonomy and higher payouts — Merrill's highest payout is now 49.6 percent, which is creeping closer to independent levels. The net take-home on a high-net-worth separately managed account is now the same for both wirehouses and independents, according to Cerulli. As a result, big firms are able to retain the best, top-producing reps. In addition, McGinness claims that most of the reasons reps would leave wirehouses for independents in the past — higher payouts, fee-based systems, open architecture — are now being offered at the wirehouses, along with the vast amount of resources that a large wirehouse firm can provide. “There's a set of clients out there who will say, ‘I have the strength and backing of Merrill Lynch, or Morgan Stanley,’ or whatever,” says Christopher Flint, vice president of branch development for Omaha, Neb.-based Securities America. “They'll say, ‘Who are you, Securities America? I'm going with the big boys.’”

But, many independents, including Peter Schick, president of St. Louis-based Moneta Group, say that in the high-net-worth market, the independents have a distinct advantage, since they have small offices and more time to devote to individual, special-need clients. “Independents can offer specific, one-on-one service to wealth customers without getting caught up in wirehouse muck,” Schick says. “They're always more important to us than they would be to a wirehouse.” And RIAs around the country have built quite a reputation based on their client service. “Most rich people won't get their car washed without a referral,” Schick says.

That said, wirehouses might have great success in attracting the mid-market investors (under $1 million in assets). Many observers see this group as the most malleable to mainstream advertising. When a wirehouse advertises itself as a financial planning institution, something that will take care of all financial needs, it's difficult for an independent, with a fraction of the marketing budget, to counterattack. “I think there's no question that Total Merrill and the like is having an effect on the mid-market investor,” Schick says. “There's a serious danger to independents that don't have an emphasis on the affluent investor.”

That's not to mention that many independents also point out that, in an ironic twist, the better the market does, the less likely clients are going to move toward independent firms. “I find myself almost rooting against the market sometimes,” says one RIA based in the Midwest. Clients are less likely to make a change if matters are going well, and as the market continues its rebound, independents are feeling the heat. “We definitely have seen growth in independents the last three years, but I suspect that will decline,” Schick says. “It's just the truth: In good times, we're less likely to get new clients.”

WIREHOUSES ARE WIREHOUSES ARE WIREHOUSES

Still, independents don't seem too panicked. The main reason, and it may not be a good one anymore: RIAs just aren't buying that wirehouses are changing. You can dress up a wirehouse broker as a financial planner, but at his core, he's still beholden to the firm, not his client, independents say.

“We view our competition as other, bigger independent contractor firms,” Nakagiri says. “Publicly, [wirehouses] say they're trying, but you still see them pushing in-house funds. Most of those New York wirehouses are still distribution-driven, product-driven.”

For better or worse, that seems to be the prevailing mind-set among many independents; wirehouses are what they are, and their attempts to be like independents are merely marketing, not philosophical makeovers. “There is always going to be an inherent conflict of interest between the buy-side and sell-side,” Schick says. And wirehouses are, by definition, both buy- and sell-side houses. “Until brokerage firms can get to the point where they can exist solely on a fee-based business, I don't think they can get to where we are.”

But some observers think that's just independents sticking their collective head in the sand as the world changes around them. Certainly wirehouses aren't backing off, and with the success they've found so far, they're not likely to slow down. “They're in a position to just keep getting better at this,” McGinness says. “They have vast resources, and even though they might have struggled at first, they're never going to abandon it. It's a serious push.” And as they hone their processes and remain devoted, many feel it's only a matter of time until serious danger comes to independents.

“The real question is, how much autonomy will rank-and-file brokers have in five years?” McGinness says. “If they continue to go toward what independents are doing, regular brokers' advice will be able to be tailored to individuals, just like with independents, while still using wirehouse products. And the most skilled advisors will have complete control. If that can happen, it's going to be a very different world.”

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