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Ups and Downs

Brokers at most major firms will see little change in how they're paid this year. Brokers at Merrill Lynch and PaineWebber, though, have new compensation plans that deliver a strong message: Adapt to fee-based business or die.Merrill reps in 1999 will receive bonuses mainly for how well they pour assets of high-net-worth households into a defined set of products and services. According to compensation

Brokers at most major firms will see little change in how they're paid this year. Brokers at Merrill Lynch and PaineWebber, though, have new compensation plans that deliver a strong message: Adapt to fee-based business or die.

Merrill reps in 1999 will receive bonuses mainly for how well they pour assets of high-net-worth households into a defined set of products and services. According to compensation plan documents, the firm wants "to provide a greater degree of alignment" between broker pay and the firm's strategy to meet client needs with a broad product array driven by a financial plan.

"There's no such thing as a straight transaction," says a recruiter about the new plan. "Everything is tied together and production is almost irrelevant."

Well, not quite. Production still counts at Merrill. But with small-ticket payouts slashed and production hurdles raised, brokers will need some of the new bonus money to make up lost ground.

For one thing, the production quota has been raised by $100,000. Brokers receive a 25% payout until they reach the following length of service/production goals: six years/$260,000; seven years/$270,000; eight years/ $280,000; nine years/$290,000; and 10-plus years/ $300,000. Once the goal is reached, the grid rate is paid retroactively.

Being rewarded for business with smaller investors is also tougher under the plan. A new small-household payout grid pays brokers nothing on trades with households that have less than $20,000 in combined assets/liabilities at the firm. Trades with households in the $20,000 to $50,000 range will be paid out at 20%. Brokers are eligible for the regular grid payout with households having more than $50,000 in assets/liabilities.

Merrill reps can get regular grid payout on small accounts if assets are placed in "annuitized" products. These include all mutual funds and insurance; and Merrill fee accounts, credit products and retirement plans.

"In the past, a trainee could build business by bringing in $10,000 accounts," says the recruiter. "Now a trainee has to bring in $50,000, but no one is going to open that large of an account with a trainee."

Trainees also have a harder time graduating under stiffer quotas in the new plan. They now have to sell 30 financial plans to graduate instead of 25, and reach $175,000 gross instead of $150,000.

The new bonus arrangement makes up for the payout cut--at least according to the firm, which bills the new plan as "cost neutral." Reps can earn an annual bonus of up to 6% of production for net new growth in three categories of "Priority Household" accounts. These accounts feature a minimum of $250,000 in combined assets and credit products. Brokers earn one point for each net new Priority Household, an additional two points as a Priority Household grows to $1 million in assets/liabilities and/or invests in a defined set of products. They get two more points as the household grows to $2.5 million in assets/liabilities and adds more products (see "Merrill's Household Incentive Program," below).

If accounts are lost in any of the categories, new accounts won't count toward the bonus until the losses are offset. Market fluctuations can affect a household's status, so bonuses could be much easier to achieve in bull markets, and vice versa.

Points are applied to a bonus grid, based on length of service. To earn the maximum 6% bonus, a broker in the business less than five years needs 40 points a year. The 10-plus-year broker must accumulate 80 points. Bonuses are paid out 60% cash and 40% deferred.

Merrill brokers can now get into recognition clubs on the total revenue they bring into the firm instead of gross production alone. Total revenue includes revenue from commissions, asset-based fees, account fees, and net interest from margin and lending products. A broker producing $500,000 who might not make the $600,000 level for entry into Chairman's Club would qualify if total revenue hit $1 million.

But as before, no one gets into a recognition club without first earning 16 financial planning points. Planning points are based on the number of plans done, the size of the account and planning designations earned. "An FC could earn the 16 points and sell as few as six plans," says a Merrill branch manager.

PaineWebber Develops IncentivesPaineWebber's compensation changes offer a carrot-and-stick feature to promote asset gathering. An across-the-board 1% payout cut can be earned back for the year--plus another 1%--if brokers jump new asset hurdles.

The cash bonus rewards brokers for net new assets they bring in. The assets must be new to the firm and cannot include dividends, interest or market appreciation.

Brokers who start the year with at least $150 million in assets follow a grid to determine their bonus. To earn the minimum 25 basis-point bonus on 1999 gross, reps must reach $6 million in net new assets. It takes $15 million net new assets to earn back the 1% payout cut and $27 million to max out at 2%. The bonus is capped at $40,000.

Brokers who start the year with less than $150 million in assets face a complicated bonus formula based on a percentage of their 1998 assets, and a minimum net new asset hurdle based on length of service. A broker in the business more than five years, for example, with $60 million in 1998 assets who brings in $6 million in net new assets in 1999 (10% growth) gets a 1% bonus. But a broker with the same length of service with $40 million in 1998 assets who also grows assets by 10% in 1999 only gets a 0.5% bonus because he failed to meet a $5 million net new asset minimum for a 1% bonus.

PaineWebber reps like the firm's emphasis on rewarding assets, but not the way the reward is structured. "Asset targets are nice to have," says one rep in the Midwest, "but for bigger producers they're giving us a lot to gather in one year and still maintain current business. I think the firm will find it's unrealistic."

A rep on the West Coast finds the new bonus structure discouraging: "The way the firm is doing it is so convoluted. It's confusing to have more than one way of getting paid on assets. It's not motivational."

Brokers have less control over asset bonuses than over their payout, the West Coast broker says. "I [lost] a $7 million account this year when the client died. That creates the idea of why even try to work for asset bonuses?"

Like Merrill Lynch, PaineWebber also has new incentives to place client assets in fee-based products. Gone is the bonus on assets under control. Now, brokers only get a bonus on assets in PaineWebber fee-based products and services, such as central asset accounts, wrap accounts, trust accounts and IRAs.

Brokers also have a better chance of moving up the recognition club ladder if they increase assets. The firm credits 125% of a broker's 1999 production in calculating club eligibility if asset hurdles are met. A broker producing $500,000 can get recognized as a $625,000 producer for club purposes if 1999 assets reach at least $50 million. Asset hurdles increase to $75 million for brokers with $750,000 in production, and again to $100 million as brokers hit $1 million in production.

Yet brokers won't be told what club their production qualifies them for until late in the fall. "That's tough because the amount of my expense allowance depends on what club I'm in," the West Coast broker says. "I can't plan unless I know."

Meanwhile, brokers at Prudential Securities also are feeling the fee-business push with minor payout changes. They no longer get a regular payout on trades they've discounted more than 15%. Instead, payout is based on the size of the ticket after the discount. Only trades with commissions of $500 or more will get a full payout regardless of the discount. The firm also has upped the minimum ticket size required for a grid payout to $80 from $60.

Salomon Smith Barney made certain fee-based accounts more attractive in 1999. Brokers now will get a monthly cash payout on money market funds and insured deposit accounts instead of a three-year deferred payout. They also will earn a five basis point bonus on loans of $5 million or more arranged through the firm's portfolio credit line product.

Expect more firms to follow Merrill's lead in redesigning broker pay plans around strategic asset gathering, says Alan Johnson of Johnson Associates, a compensation consultant based in New York. "Wirehouses are less flexible than they were about how their brokers do business," he says. "It's a clear trend firms want bigger accounts and brokers to manage a series of accounts instead of one-time transactions."

Johnson sees a rough road ahead for brokers. "Our impression is that firms want their compensation plans to do too much," he says. "No one idea in them is bad, but altogether it becomes a problem." He says the effect of the compensation changes is this: Firms are slowly taking clients away from the broker and keeping them for themselves. "Brokers are concerned their payout will gradually be cut as a result," Johnson says, "and they should be concerned."

Merrill defines its target market by the following types of accounts. Market fluctuations will change the status of a household.

Priority Household * $250,000 combined balance of assets/liabilities

Premier Priority HouseholdMeets two out of the following three criteria:

* $1 million assets/liabilities

* central asset account

* financial plan

And three out of the following four criteria:

* $100,000 or more in asset management services (mutual funds, fee accounts)

* $100,000 or more in liability management services (mortgages, home equity loans, margin accounts)

* $100,000 or more in transition management services (insurance products, retirement plans)

* $100,000 or more in noninvestment retention products (Merrill Lynch OnLine, Global Gold card)

Premier-Plus Priority HouseholdMust have $2.5 million in total assets/liabilities and the following characteristics:

One out of two:

* central asset account

* financial plan

And three out of four:

* $250,000 or more in asset management services

* $250,000 or more in liability management services

* $250,000 or more in transition management services

* $250,000 or more in noninvestment retention products

Wirehouses revved up their recruiting in 1998. Salomon Smith Barney and PaineWebber appointed national recruiting directors to focus solely on experienced brokers. Merrill Lynch added recruiting to branch managers' list of "critical objectives" for the year, a first. "Merrill decided to go into recruiting more in 1999 because they know their trainees aren't going to cut it under the new compensation plan," says a recruiter.

When the market break in the third quarter left many brokers with sharply devalued stock plans, more were willing to negotiate a move. Here's what the typical broker can expect upfront by production level: $300,000/30%; $400,000/40%; $500,000/45%; and $1 million/50%.

But recruiting incentives are increasingly customized. "Five years ago, most recruiting pay was cash upfront," says Michael Herman, a consultant with Sibson & Co., a New York-based compensation consulting firm. "Customer retention is now the long-term trend, so the four- or five-year forgivable loan packages are hitting record highs."

Rick Peterson, a Houston recruiter, says firms are "trying everything" in their recruiting bonuses: stock, cash plus stock, straight cash and salaries. More brokers are crafting their own incentive packages, then looking for a firm that will accept them, he says. "Brokers are becoming like free agents."

Wheat First Union made waves in 1998 with a recruiting package that offered $750,000 producers 100% cash bonuses paid out over five years. "Firms are trying to come up with deferred comp incentives on a case-by-case basis," says Mark Elzweig, a New York-based recruiter. "The new frontier is Wheat First's approach."

Lower-end producers have more negotiating power than million-dollar producers do, especially if they're young and growing. "Firms are less hung up on ma intaining set [upfront bonus] percentages for younger brokers," says Danny Sarch, president of Sarch Leitner Consultants, a recruiter in White Plains, N.Y. Wirehouses appear to be strategically overpaying for talented up-and-comers, recruiters say. "They view it like buying an undervalued stock," Elzweig says.

Prime targets are brokers in the business less than five years, producing $200,000 to $300,000 with production increasing year to year and a 2% or less commissions-to-assets ratio. Present a firm with a good business plan, especially a niche approach, and negotiating power increases.

"A $300,000 producer may be offered 50%, but wants 70%, and is able to get the 70% because he will grow, the firm reasons," Sarch says. "But a $1 million producer who wants more than the firm offers has a hard time getting it because the firm reasons he may not grow."

Accelerated payouts are the one incentive out of fashion for now, recruiters say. Accelerated payouts have been the focus of criticism by the SEC and even the AARP. Both complained firms haven't adhered to the recommendations of the Committee on Compensation Practices (known as the Tully Report), released in 1995.

The SEC wants firms to publicly disclose recruiting deals and has asked the NASD to put forth a rule proposal early this year.

Deferred compensation is hotter than ever. More than 70% of wirehouse brokers now receive it, according to the Securities Industry Association's 1997 production and earnings survey. The value of deferred compensation in broker pay packages is around 10%, rising half a percentage point annually, estimates Alan Johnson of Johnson Associates, a New York-based compensation consultant. That should accelerate to around 20% in the next 10 years, he says.

"Wirehouses are finding the lower-end client is being picked off by online brokers, so this puts pressure on the demand for high-net-worth customers," says Andy Tasnady, a senior consultant with Sibson & Co., a New York management consulting firm that helps wirehouses design deferred compensation packages.

That means firms are doing whatever they can to retain top talent. "The big push now is getting voluntary contributions from brokers," Tasnady says. New plans are adding more matching contributions, allowing brokers to contribute from their production, assets and profitability.

At PaineWebber, 1999 deferred comp changes now allow brokers under age 55 with less than 10 years of service to be part of a self-directed retirement plan. The firm also introduced a stock option plan that offers more broker control than a plan discontinued in 1997.

Brokers who choose the new PaineWebber Equity Plus plan must deduct at least $100 a month of after-tax pay to purchase company stock. They are then free to defer up to 10% of after-tax pay to buy as much as 1,000 shares a year. The firm provides a two-for-one option match for each share purchased. Brokers must wait three years to exercise their options, which expire after seven years.

Merrill Lynch's comprehensive overhaul of 1999 broker pay rewards the "total revenue" a rep brings in. Total revenue is the inflow of funds to the firm from commissions, asset-based fees, account fees and net margin interest from credit products. Those in recognition clubs are awarded 2% of their total revenue and can earn an additional 25 basis points of revenue over $1 million and another 25 basis points of revenue over $2.5 million.

"The stream of revenue from a client relationship provides a more appropriate measure of the long-term economic benefit of that relationship to the firm," says Merrill's payout plan.

Early in 1998 Prudential Securities and Salomon Smith Barney raised their asset gathering thresholds for deferred comp awards, keeping pace with higher broker earnings from the bull market boom. And Salomon Smith Barney is raising the bar again this year. It now takes $40 million in assets instead of $35 million for a 10-year veteran to qualify for the Wealth Builder bonus.

Look for firms to make stock plan changes after brokers weathered steep drops in the value of those plans in third quarter 1998. Brokers at PaineWebber and Salomon Smith Barney saw company stock fall more than 50% in just a few months. "There will be some firms looking at reloading their stock options in light of the brokerage stock price drop," Tasnady says. "There also will be more fixed-interest-rate wealth accumulation plans for brokers."

Firms increasingly are more likely to tinker with deferred comp than payout grids. "The reaction to moving the grid is stark," Tasnady says. "You can shave an extra point off the grid instead by increasing money you give to long-timers. These deferred comp changes accomplish the same thing with less broker reaction."

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