An independent broker/dealer advisor will tell you he has almost nothing in common with a wirehouse rep. And vice versa. And there is a lot of truth to that. Wirehouse reps are employees of large diversified financial services firms; independent b/d advisors are independent contractors and the firms they work for tend to be much smaller and more narrowly focused. One pays rent on his office space; the other might get a corner office overlooking the Hudson River on the firm's dollar, and have a travel and entertainment budget. One balances his own profit and loss statement; the other simply reads a weekly production report provided by his branch manager. But there's at least one thing both kinds of reps can grumble about: compensation. Wirehouse firms and independent broker/dealers alike hack into their advisors' take-home pay with fees here, haircuts there, and then there is the dreaded “penalty box.”
Of course, it's no secret that b/ds keep a portion of the revenue generated by their advisors for themselves — they're not in this business for charity, after all. And they do provide lots of services. Exactly what a b/d will claim for its own account and how much it chooses to pay the advisor for his trouble varies by firm and channel. In general, the wirehouses officially take an average of 60 percent of an advisors' revenue — some of which then goes for the corner office, the T&E budget, the workstation, the research, the charitable giving expert at the home office, etc. Independent b/ds claim a far less aggressive 10 to 20 percent of advisor's revenue, as independent advisors pay for some of those other things themselves. But b/ds in both channels have long asked their reps (let's be honest, there's no real asking involved) for little slices of their revenue here and there on top of that.
In some cases, where they take these little slices from, and for what, is not very transparent at all. “The extremely high payouts at an independent broker/dealer can be a gimmick,” says Philip Palaveev, president of Elmsford, NY-based Fusion Financial Network. “It's silly to say advisors can get a 100 percent payout when you're charging him $40 a ticket. And on the wirehouse side, there is a big distance between what you are generating for the firm and what you are actually paid on.” According to a SIFMA survey of registered rep compensation, in 2005 the average rep production was $414,164 and average total earnings stood at $173,851. (SIFMA declined to provide its most recent figures, from 2009.) And though no b/d would ever come out and admit that it nickels and dimes reps, or that it charges hidden fees, there is no doubt that when it comes to compensation plans, the devil is in the details.
Corner Office Comes With a Price
The wirehouse broker mentality has long been affectionately described as “eat what you kill.” Stockbrokers live and die according to how much product they sell to clients, and how aggressively they lure in new clients and gather assets. But in reality, the wirehouse firms enjoy a small feast before the broker is even invited to the table. Wirehouse firms are notorious for “double-dipping” — taking a slice of an advisor's gross revenue before that number even hits the so-called payout grid. It's a practice that has been around for at least 20 years at many of the brokerage firms, according to advisors, recruiters and industry consultants. These haircuts are applied to almost every product an advisor sells to a client — mutual fund wraps, alternatives, annuities and other commissionable products.
While the practice is disclosed in wirehouse compensation agreements, the actual cuts the firms take on each product type are not — these are typically disclosed in periodic emails or production reports instead, which makes it harder for advisors to keep track. The amounts vary, fluctuate over time and can get as high as 36 percent. When you add it all up, an advisor with a 40 percent “payout” may only really be getting 30 percent of the gross revenue he generates — and sometimes it's even less than that.
“Firms are essentially double-dipping into the advisor's pocket,” says Danny Sarch, founder of Leitner Sarch Consultants, a financial services executive recruiting firm in White Plains, NY. “It has always caused lots of resentment. Brokers will argue that the firm is already getting over half of what they generate, while the firm will argue it's the cost of doing business. In reality, firms are taking that haircut simply because they can.”
Here's one way it can play out. If a rep generates $1.5 million in managed account revenue for the firm, the firm takes a 36 percent cut, dropping the number down to about $955,000. The advisor's 40 percent payout is then applied to that $955,000 — leaving him with income of $382,000, or 25 percent of the original managed account revenue.
“It's one of those things that sneaks up on you,” says one Morgan Stanley Smith Barney rep. “When I look at it closely, I think, ‘Wow, this is what my clients are actually paying to work with me?’ But when you compare what they are paying with what I'm earning, I would guess the average rep is probably getting less than 30 percent of the true revenue number.”
In managed money accounts, a portion of that haircut on revenue generated is passed on to the money managers themselves, Sarch explains. “If the client is paying 1.5 percent on a managed money account, the manager might be getting 30 basis points of that. That leaves us with 1.2 percent. The firm takes its cut of maybe 20 or so basis points. And the broker will get a sales credit on the rest,” he says. The firm then applies the broker's payout to that remaining sales credit — sometimes referred to as production credit.
For some advisors it's bothersome enough that they opt to take their business elsewhere. For example, Paul Spitzer, who used to work at Wells Fargo Advisors, says he left in 2009 to start his own RIA in part because he couldn't justify letting his firm take so much off the top. “I left for two reasons. One, I couldn't put my clients' best interests in front of Wells Fargo's. Two, I calculated that I only touched about 20 cents of every client fee dollar.” Today, he runs his own business with Concert Wealth Management, a San Diego-based RIA. “There was a haircut on almost every product,” Spitzer says. “If the client was charged 5 percent on a mutual fund, the firm might take a 1.5 percent cut and now I'm left with 3.5 percent. Now I'm getting my 40 percent payout on that leftover 3.5 percent. That's what the industry calls broker reallowance,” he says. “Your payout at the wirehouse might be about 40 percent, but the question is 40 percent of what?”
Of course, plenty of other advisors don't even notice — or care all that much. As one advisor puts it, “None of us are sitting here questioning our branch manager about the haircuts. It's not like they would change anyway.” Another Merrill broker says he gets emails from management about changes to these pay cuts, but he doesn't even read them. “I think at the end of day, if you're bringing in new accounts and generating business, you don't give a sh*t about the nuances of the plan,” he says. “You know, potatoe, potato. I do know the formula of how much business I do and how much should be in my paycheck. If that figure is off then I call someone up and say, ‘I should have taken home this amount.’”
John Furey, principal and owner of Advisor Growth Strategies in Phoenix, says firms tend to vary the cuts they take according to product performance, taking a little more from the most lucrative products at any particular time. “A firm can decide that it will take a 2 percent haircut on annuities this year and a smaller cut on certain municipal bonds for whatever reason,” says Furey. “Maybe they expect to sell more annuities, for instance. Don't forget wirehouses are also product manufacturers, so new products come in regularly and tweaks are made often.”
And then there are products and services a rep can provide to a client that generate revenue for the firm but provide zero compensation for the advisor — things like interest on margin loans, annual custodian fees on advisory accounts, fees on IRA accounts and 12b-1 fees. “Those are big money makers for firms, and the broker doesn't see much of it. The worst part is if I was to discount any of those fees for a client, I'd be discounting my own compensation when I wasn't getting paid on that stuff to begin with,” a former Merrill broker says.
Independence Ain't Free
Independent b/d reps boast plenty about the perks of running their own businesses and being in charge. They don't have to deal with weekly production requirements, they can hang their own shingle on the door, they're free to create their own culture and have complete control over how to run their businesses. Oh, and of course, they're doing all that on about an 80 to 90 percent payout on average — sometimes even more.
Unlike at the wirehouses, all of the revenue an independent b/d advisor generates goes straight to the payout grid — except when you're dealing with managed accounts. On managed accounts, the independent b/d may take a cut of 5 to 25 basis points, says Jodie Papike, a vice president of Cross-Search in Jamul, Calif., an independent recruiting firm that helps match advisors with b/ds. That's for performance reporting and billing, she says.
But the indie b/d payout numbers are still gross rather than net. Furey says advisors who are paid at the 80 percent payout level can see their “net payout” drop to somewhere near 70 percent. That's because the b/d charges fees on platforms, technology and other services that help the advisor run his business — though it's often up to the advisor to choose which services he wants. It's typically a la carte. After fees and overhead, the advisor may end up netting more like 50 percent to 60 percent — or less.
“The difference is that there is much more transparency on the independent b/d side,” Furey says. “Advisors know exactly what they are paying for and can account for nearly every dollar they give up.” So while the difference between gross revenue and production is minimal in the independent b/d channel, reps still complain about getting nickeled and dimed by their indie b/ds.
How much a particular service or offering costs will depend on the size of the firm and the quality of the offering, says Papike, with larger firms generally charging more. For example, one large b/d with more than 7,000 reps, charges its advisors a monthly fee of $75 per head for the most basic technology platform. The firm's top-notch technology platform, which includes real-time quotes and access to research, costs $600 per head per month. That same firm charges $2,500 annually for E&O insurance, $120 for every registered e-mail account in the office, $400 in audit fees per branch, and a $125 monthly association fee. And those are just the basics. “There are FINRA and SEC fees and marketing charges. It all depends on how much of the b/d's extra services the advisor wants to make use of,” Papike says.
At another firm with about 1,400 reps and between $50 million and $250 million in revenue, technology fees cost $80 a month, but may be waived all together for advisors who meet certain asset thresholds, says Papike. E&O insurance costs about the same as it would at the bigger firm, $2,500, while email registration might cost $100 per email address. This particular firm charges an annual $150 per advisor for continuing education fees.
And then there are ticket charges, which apply to every trade a client makes. The price ranges from zero to $40, plus a $5 processing fee, on average. But these charges can add up. “Everyone wonders how these independent b/ds make money,” says one LPL advisor who moved over from Merrill Lynch. “I wouldn't be surprised if the whole industry is staying afloat on ticket charges.”
Some firms also charge advisors a fee to use the b/d's corporate RIA to custody advisory assets, typically between 5 and 10 basis points per advisory account. Troy Stoll, an LPL advisor who uses the firm's corporate RIA, says most of that is for compliance oversight. But it's tough for some advisors to swallow, especially if the b/d doesn't allow its advisors to set up their own RIAs. “If I'm an independent using my own RIA, those assets are much stickier,” Furey says. “But if I'm using the b/d's corporate RIA, then essentially my clients have signed an agreement with the b/d, not me. Plus, I have to pay the b/d for it? No way. I want, at least, the option to be my own RIA.”
But again, all of these fees are transparent, says Stoll. The firm sends him bimonthly “commission runs” that itemize all of its charges. One fee that took him by surprise when he first joined the firm was a monthly “rep contract fee” of $125. “Til this day I'm not really sure what it is but I can't fault [LPL] for it because it was disclosed in the contract I signed with them,” he says. After fees (before overhead) Stoll says his 91 percent drops about 5 percent to about 86 percent.
Occasionally, a new fee will sneak into the mix. Some firms have begun charging advisors ACAT fees not only when he loses a client account, but when he gains a new client account, according to posts on Registered Rep.'s forums.
“At the end of the day, a dollar is a dollar. You can't magically make it two dollars,” Palaveev says. A b/d that promises you 100 percent of payout or something close to it is not giving you the whole story. They are always going to be taking money out elsewhere. And usually it's offset by high charges on marketing, technology and ticket charges.”
“These are certainly things anyone thinking about going independent should know about,” says one independent advisor.