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Creating an Escape Plan

Certainly, going indie has a lot of appeal. And there are lots of stories of happy former wirehouse brokers who have flourished on their own. But it doesn't just happen. Take, for example, the wirehouse rep from the West Coast. The rep hadn't done his homework, didn't take the time to map out a good transition strategy and anticipate how hard his former employer would fight to keep his clients. The

Certainly, going indie has a lot of appeal. And there are lots of stories of happy former wirehouse brokers who have flourished on their own. But it doesn't just happen. Take, for example, the wirehouse rep from the West Coast. The rep hadn't done his homework, didn't take the time to map out a good transition strategy and anticipate how hard his former employer would fight to keep his clients. The result was a haircut: At the wirehouse, the rep had managed $120 million in client assets, but he was only able to bring over $50 million to his own practice. The newly independent rep has been scrambling to build it back ever since.

“That's not very good. I'd say you want to get at least 80 percent of what you had,” says an independent broker familiar with the tale. “But if you have a big book at a wirehouse, it's going to take a lot of effort to take care of that big book.”

Independence has long been a dream of many wirehouse reps. But for the great majority of wirehouse pros, it remains simply that. After all, it is a tough proposition to leave the security and prestige of the wirehouse, or even a bank brokerage, in exchange for a likely setback in production (at least initially) and a whole boatload of new issues to contend with, ranging from paying electric bills to hiring a compliance expert to lessening the chances of being audited by the SEC.

Still, according to recent surveys by Moss Adams, roughly 1 percent to 1.5 percent of advisors at wirehouses go independent in any given year. So if there are approximately 110,000 wirehouse and bank brokerage advisors, it works out to about 1,600 advisors each year, Moss Adams says. Some join the ranks of independent broker/dealers, others go completely independent and become registered investment advisors with the SEC (see related story on page S3).

Not everyone is convinced that independence is the perfect solution to wirehouse reps frustrations, however. Paul Lally, who focuses on wealth planning and portfolio management “lift-outs” at financial advisory firm DAK Associates, says that he has not seen any great exodus of advisors turning independent, and notes that while there have been several studies attesting to the growth of new independent advisors, there is still scant evidence that such practices can make a long term go of it. “I am curious what the survival rate is after three to five years,” he says.

Maybe, but there is little evidence to prove that going indie isn't working. “You hear a lot of people that have gone independent, but I've never heard of anyone who is currently independent that is thinking of going back to a full-service firm. I think that's telling, that it's a one-way street,” says Philip Palaveev of Moss Adams.

Further, reps who have been independent for several years say that they're getting more inquiring calls from their wirehouse counterparts than they used to, and that the ingrained perception of independents as a caste of low-volume nobodies is finally changing on Wall Street.

During his years at a wirehouse, “I was told that independents were people that couldn't make it in the business, that those were the losers,” says Rob Wright, co-founder of Schannep Investment Advisors in Tucson, Ariz. Wright worked at U.S. Bancorp Piper Jaffray until he went independent in 2001. “The wirehouses do an amazingly good job of brainwashing,” he says.

However, the old arguments no longer are as potent, given the layoffs and downturns afflicting a number of wirehouses over the past few years. Schannep had been courting one Morgan Stanley advisor to no avail — until Morgan laid off a number of FAs, including the target. Naturally, Schannep didn't have any more convincing to do, and the advisor joined up.

Yet even happy independent-contractor advisors warn that going independent is a proposition fraught with peril and is not to be taken lightly. If you are sitting at a wirehouse desk right now and are thinking about the greener pastures in the independent sector, there are several key things you need to ask yourself: Do you have the adequate capital (sometimes as much as six months' revenue from your current job)? Are you ready for a legal fight with your former employer over clients? Are you ready to go it alone, or do you need to team up?

The Safety of Crowds

Another question: Go alone or take a group? “Three to four years ago we were seeing primarily single producers leave — now we're seeing teams that have been formerly aligned with wirehouse firms, and which have much bigger blocks of clients,” says Scott Dell'Orfano, executive vice president at Fidelity Registered Investment Advisor Group. Fidelity is doing triple the volume of such conversions compared with last year, he says, and the volume of assets moving from wirehouse to independent is far larger. “We're talking to groups managing anywhere from $600 million to $1.2 billion to $1.3 billion. It's a far cry from a single proprietor with a $30 million to $40 million platform.”

Derek Bruton, a national sales manager with TD Ameritrade (formerly TD Waterhouse) who specializes in helping wirehouse advisors become independent, agrees there has been a change in favor of larger-number, larger-volume moves. “We're seeing more teams break away. In the past, if it was a team, it was usually a father/son or father/daughter team, but now it's expanding into more robust teams,” he says. “We're seeing teams of producers, support staff, a CFP, a CPA — they're trying to be a one-stop shop to clients.”

Could this type of mass move lead to an exodus among the top-earning groups at wirehouses? Probably not. Wirehouses are wising up to the threat and paying top-dollar to keep top producers. “Let's face it: These firms take care of their best producers.” In addition to fatter payouts, top reps get far more autonomy in terms of products than most FAs, Bruton says. “In a way they are creating the RIA model in a brokerage firm,” he says. But behind the carrot lies the stick. Wirehouses “also are putting up larger barriers to exit, and are trying to provide fewer opportunities to break away.”

Because these top-earning wirehouse teams will likely stay at their current jobs, analysts say the place to look for movement is among second-tier teams, which may decide that the higher percentage of payouts that comes with going independent is worth taking a chance.

Sometimes moving en masse helps with the more mundane tasks, such as divvying up the grunt work. Wright says that he is glad he left Piper Jaffray with several of his colleagues, each of whom had a different specialty and dealt with specific hassles in setting up the new shop. “Because you're responsible for basically everything — paying for the rent, buying stationery — that can be overwhelming if you're on your own. But we moved as a team, and I'm glad we did it that way. If not, you often spend a lot of your time doing things that you're not good at.”

What to Spend

Another thing advisors thinking of going independent sometimes neglect is just how costly the whole enterprise is going to be. Without enough in-depth budgeting, and without hiring enough support staff, an RIA, for example, could spend way too much time on the mundane tasks of setting up office, establishing a health care plan and paying vendors rather than the lucrative and essential business of serving clients.

“I've seen several brokers get so caught up in the infrastructure that they forget their most valuable asset — their clients,” Bruton says. They put off calling their clients. By then, your former employer has already introduced them to their new broker, who is going to give them everything in the world.”

Establishing a realistic budget early on in your plans to go independent is key. Dale Brown, executive director and CEO of the Financial Services Institute (FSI), said that on average, prospective independent-contractor reps should budget $10,000 for legal fees, and anywhere from $25,000 to $35,000 for office-related expenses.

One of the biggest mistakes advisors make when going independent is not budgeting enough to cover down time between leaving their former job and truly getting up to speed as an independent. “You need to make sure you have cash flow for at least six months, make sure that you have a significant cushion and don't be overly optimistic. Maybe you'll break even in the first year,” says Mark Snyder, an independent advisor affiliated with Royal Alliance in Medford, N.Y.

Finding a good lawyer is also becoming essential. Take the case of Lynn Allen, who went independent in 2003, but wound up spending the early part of her independence battling her former employer, which sued her, arguing she had signed a contract that included a noncompete clause. After three months, they reached a settlement, with a list of clients she could approach and the fee she had to pay to exit her contract. (Allen declined to disclose the amount.) To pay for the $8,000 in legal fees, Allen tapped a $35,000 start-up loan she got from her b/d, LPL; the b/d also helped finance $10,000 of the settlement.

Two years later, Allen is happy as an independent, running Atlantic Investment Management in Annapolis, Md., with $20 million under management, and says she considers such legal struggles to be the price of breaking free. “There's no question that the noncompetes are getting stronger and stronger,” she says. “You have to factor in some funds for a legal battle. That should be part of a person's business plan for the first six to 12 months.”

Beyond the legal battle, there is the routine marketing fight over clients. The Golub Group, a San Mateo, Calif.-based independent advisor with $240 million in assets under management, signed a noncompete agreement with former employer Hoefer & Arnett. When the team left to go independent, letters were sent out to Golub clients notifying them of the change. Golub's b/d then mounted an aggressive telephone campaign to keep the clients. (Golub nevertheless says it wound up keeping 96 percent of client assets.)

One big improvement for indies is their ability to match wirehouse offers. A growing degree of commoditization, for example, means that the product selection offered by a Merrill Lynch rep versus an RIA affiliated with, say, Lockwood or Schwab, is almost the same, barring some proprietary products. “Product choice is no longer an issue at all. Independents can fully match what is available at wirehouses,” says FSI's Brown.

Because of this more-even playing field, a wirehouse rep frustrated with being told to push certain products, or being denied access to more lucrative ones, can now realistically expect to find a greater degree of freedom and access in the independent world. “We've heard from some advisors [at wirehouses] that feel somewhat handcuffed in terms of product access, in terms of proprietary products, that they can't access more robust wealth management programs,” says Fidelity's Dell'Orfano. “More and more principals feel that they want to have a business with equity. It's driving them to make the transition because they want to have equity at the end of the day.”

The Dope on the Dosh

Registered investment advisors, who mostly charge fees but who very often retain b/d relationships, are the most profitable of the FA models. But independent-contractor reps are a close second. Wirehouse reps don't have the hassles of running a business, but enjoy lower profit margins. The study assumes that each advisor has no partners and grosses $500,000 in revenue.

Affiliation Model for $500,000 Revenue Practice
  RIA   Independent BD   Wirehouse  
Practice Profile Principals/Sr. Advisors 1   1   1  
Total Revenue from Clients $500,000   $500,000   $500,000  
B/D Share on Sr. Advisors     $50,000   $302,500  
B/D Share on Jr. Advisors     $0   $0  
B/D Share of Revenue1 $0 0.0% $50,000 10.0% $302,500 60.0%
Net Revenue to Advisor $500,000 100% $450,000 100% $197,500 100%
  Percentages below are based on % of Net Revenue to Advisor
Professional Compensation2 $0 0.0% $0 0.0% $0 0.0%
Owner's Draws or Base Comp3 $250,000 50.0% $250,000 55.6% $0 0%
Other Direct Expenses $4,750 1.0% $4,275 1.0% $0 0.0%
Total Direct Expense $254,750 51% $254,275 56.5% $0 0.0%
Gross Profit (8 less 13) $245,250 49.1% $195,725 43.5% $197,500 100%
TOTAL OVERHEAD EXPENSES $221,008 44.2% $178,709 39.7% $5,000 2.5%
Operating Income $24,242 4.8% $17,016 3.8% $192,500 97.5%
Principal Pre-Tax Income
$250,000 50.0% $250,000 50.0% $0 0.0%
Firm Profit $24,242 4.8% $17,016 3.4% $192,500 38.5%
Total $274,242 54.8% $267,016 53.4% $192,500 38.5%
1 Independent b/ds typically allow the firms to aggregate payout, meaning that the entire branch has the same combined payout of 90%. Therefore the independent b/d keeps 10 percent of the revenue.
2 In an independent firm, the professional compensation is typically a salary plus a bonus. The model assumes that the sole professional in the RIA model is paid a salary of $125,000 each — corresponding to the top quartile of professional compensation in the 2003 FPA Compensation Survey, produced by Moss Adams and sponsored by SEI Investments.
3 As business owners, principals of RIA firms and IBD affiliated firms typically assign themselves a fair market compensation for their “labor” in the practice. The salary in the RIA and IBD models is assumed to be $250,000 per principal. Since there is no business ownership in the wirehouse model, such an assumption is not necessary. Ultimately, we compare all three models on a total compensation to owners, regardless of method, so this assumption does not impact the overall appeal of the model.
Source: Moss Adams/Charles Schwab Institutional, April 2005
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