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Going Independent Without The Headaches

More and more advisors are considering a move to independence. In this environment, there are a few more roadblocks.

It was either the worst of timing, or it was the best: The jury is still out. Early in November, Shak Hill took a leap he'd been considering for the past five years. An advisor at Wachovia Securities for more than 10 years with about $49 million in assets, Hill had written a book aimed at providing financial advice to women and, according to Hill, his employer wasn't happy that he was using the book for prospecting purposes. So, in the middle of the worst financial crisis in decades, he left to form Lantern Wealth Management, his own fee-based practice in Centreville, Va., where he works from home.

About two weeks after setting up shop, Hill had heard from about half of his 150 clients — and he was upbeat about his decision. “I think this was exactly the right climate to go independent,” says Hill, who hopes to build a practice that he can one day sell. “The turmoil in the banking and brokerage industries has made it a very favorable time to do this.”

That may be true — but, for many advisors, it takes an iron stomach to move from the relative safety of an established wirehouse or bank to the potential unpredictability of independence. In fact, while many independent broker/dealers and RIA-custodians — such as Schwab, Fidelity, Pershing and TD Ameritrade — report that inquiries from interested advisors have risen by 150 percent and 200 percent to record levels, only some of these inquiries have materialized into actual moves, according to Scott Smith, a senior analyst at Cerulli Associates. And for good reason. “Advisors are a little leery to tell their clients, your portfolio is down 35 percent and, by the way, I'm going independent,” says Philip Palaveev, president of Fusion Advisor Network in Elmsford, N.Y., which offers consulting services to RIAs.

Still, there are plenty of advisors making the switch. Raymond James Financial Services, for example, reports that it has doubled its revenue from recruits for the current fiscal year versus last year, according to Bill Van Law, national director of business development. Many of these advisors are gambling that today's turmoil and a widespread loss of faith in once-mighty financial institutions give them a clear story to tell clients about why they are leaving — a story that clients will embrace. In fact, even as Paleveev senses hesitation among advisors, he says, “If I were a rep in a wirehouse, I would switch right now. The client would understand.” (Of course, it is in his interest that wirehouse advisors switch: He stands to gain potential clients.)

That said, to be successful, those advisors brave enough to make the move need to face facts: Some of the rules of the game have changed. And certain considerations that used to be merely significant are now a matter of do-or-die. The upshot: It's possible to become an independent in today's market — as long as you understand what's involved.

First, you need to examine your motives for switching. In the current climate, if you're just looking for a higher payout, for example, it might not be worth your while to take such a risky step. On the other hand, client satisfaction may be at stake. Take Ben Valore Caplan. He and his seven-person team left UBS Financial Services in late August to form Syntrinsic Investment Counsel, a fee-only firm in Denver. While that was a few weeks before the crisis really hit, it was right in the middle of much-publicized scandals about the company's alleged involvement in tax evasion case. And when Caplan, who focuses primarily on foundations, faith-based organizations and philanthropic families with an average account size of $25 million, started hearing that important clients were concerned and upset, he realized he had to make a change. “A few said, we're going to leave the company. We like you. We're not staying,” he says. “That's a pretty compelling push factor.” About 25 key clients agreed to follow him to his new firm almost immediately.

As important to your decision is the quality of your client relationships. While this has always been a key consideration, it's especially vital now. The rule of thumb is that anywhere from 60 percent to 90 percent of clients stick with an advisor when he or she moves to a new firm. Obviously, the stronger the bond between you and your clients, the higher the chance you have of keeping them. “The transition is driven by the depth of the relationship between advisor and client,” says Julie Littlechild, president of Advisor Impact, a firm providing practice management advice to financial advisors. The bottom line: Take extra care before you leave to evaluate your rapport with clients.

How to do that? According to John Nersesian, managing director of wealth management services for Nuveen Investments in Chicago, one essential ingredient in a strong rapport is the perception among your clients that you are empathetic. “The number one reason clients of $5 million and above leave is because they feel their advisor doesn't understand what makes them unique,” he says. He suggests the following exercise: Write down the names of your top five clients and the names of their spouses. Then add their key issues to the list — “The two or three concerns that keep them awake at night,” says Nersesian. If you can't answer that, you probably score low on the empathy scale and it might be more of a challenge to get those clients to stay with you.

Whether you score well on empathy or not, it might be a good idea to take steps to reinforce your client relationships well in advance of a move. For example, three to four months ahead of your departure date, start stepping up the number of client contacts. “There's a direct correlation between the frequency of contact and client satisfaction,” says Van Law.

Working in your favor is the broker protocol pact between a number of wirehouses, b/ds and RIA firms. The protocol stipulates that signatory firms will refrain from instigating legal action against advisors who take basic client data with them when they move to another signatory institution. As long as both the firm you are leaving and the firm you are joining subscribe to it, you are permitted to contact existing clients, inform them about your new place of business and invite them to join you. Of course, you can only take the most basic client contact information with you — not details about their accounts. And, in some cases, you may still experience some hassles. For example, Brian Hamburger, an attorney and founding member of Market Counsel in Englewood, N.J., points to am advisor who recently left a wirehouse. The firm tried to stop him from contacting clients he shared with team members who remained at the firm. But the court ruled in favor of the advisor — saying his ability to contact his clients was in their best interests.

On the other hand, if both firms aren't parties to the agreement, then you'll probably have a tougher time transitioning clients. That was Shak Hill's experience. Thanks to the terms of his agreement with Wachovia, he wasn't allowed to contact clients directly. Instead, he had to resort to sending out a mailing on the day he handed in his resignation telling his clients that he had set up his own practice — and hoping that his clients would contact him.

You also might need to calculate how long it will be before you begin matching your old income. The rule of thumb is that for the first three to six months, your revenues will decrease, even as you are taking on startup costs, which, for a single-principal RIA, generally come to about $30,000, according to Palaveev. Trouble is, these days, you're also dealing with a loss of income, thanks to the falling value of portfolios. So, you may have to figure it will take longer than usual to break even.

In addition, there's the matter of financing. While most advisors self-fund their moves to independence, some also take out bank lines of credit — something that's increasingly difficult in this environment. Even as early as August, Caplan, for one, says he had a tough time getting a line of credit. He spoke to at least four banks that refused to even discuss the matter and three others that turned him down before finally getting an okay from a fourth institution. (He doesn't want to say how much the line of credit was for.) On the other hand, some b/ds and custodians do help with financing. For example, Schwab Institutional provides a five-year term note with a one-year draw period, according to John Furey, director of strategic business development for Schwab Institutional. And Raymond James provides help with startup expenses, offering a combination of cash and loans.

If finding the cash for startup expenses is a problem, you might want to consider a few cost-saving options. One is working from home. “You can run on a shoestring if necessary,” says Smith. Hill, for one, turned the downstairs sitting room just inside his front door into a plush conference room. He also is running a bare-bones operation, letting his b/d handle compliance, for instance, and hiring administrative help only during extra busy times — for example, when he sends out Christmas presents to clients. Hill says he has about nine months of emergency cash saved, and expects to recoup his lost income in a year.

Another alternative is to join an existing independent practice. It's an obvious way to cut down on both startup costs and overhead. “I'm seeing more advisors considering plugging into an existing RIA practice,” says Furey. “That way, they don't have to run the business and work with clients.” According to Furey, he recently advised five firms in a single week about the best way to bring a wirehouse broker on board — that number is considerably higher than usual, he says.

Joining an existing practice is the route that Grace Toh has taken. She and her partner left an international private bank in November to join Spire Investment Partners, an independent b/d and RIA in Mclean, Va., instead of starting their own company. “You're up and running more quickly,” she says. Her new firm provides compliance, back office support, a telephone system and other services, according to Toh, giving her the opportunity to focus on client relationships and prospecting.

Taking a team with you also helps. George Dunn, who recently left Smith Barney for Convergent Wealth Advisors in Rockville, Md., for example, brought with him his nine-person team, which manages $4 billion in assets. He also was joined by another team with which he had previously worked closely.

In fact, you may find open arms at existing independent firms if you go looking. Anticipating that a wave of advisors will defect to already-established independent firms, many of these firms are stepping up their recruiting efforts. Richard Dragotta, president of Integra Investment Service in Lyndhurst, N.J., says he is planning a series of mailings over the next six months to selected advisors that describe his firm and his intentions of going independent. His recruiting budget for the next year will double. Says Dragotta, “It's going to be a different world.”

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