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Will the SEC Curtail Recruiting Bonuses?

Will the SEC Curtail Recruiting Bonuses?

Initial signs suggest few changes to broker pay in 2011, but that could all change on Jan. 21.

The payout grid is sacrosanct: Monkey too much with financial advisor compensation, and there will be a vocal uprising. But with brokerage revenues getting squeezed and regulators sniffing around compensation issues and potential conflicts of interest, it's possible that 2011 could bring some changes to broker comp plans.

In a November report, Standard & Poor's analysts predicted that Dodd-Frank provisions alone will shave between 18 and 21 percent from 2010 pretax earnings at the largest U.S. financial institutions. Bernstein Research analyst Brad Hintz is betting that firms will respond to revenue declines by cutting compensation and other perks for bankers.

But what of the retail financial advisor cohort — an unsalaried group who eat what they kill (well, around 40 percent of it anyway). New rules on broker pay could be forthcoming this year. Under Dodd-Frank, the SEC is required to submit a study to Congress on Jan. 21 that, among other things, will “examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.''

Runaway recruiting bonuses are one likely target — moving for money is not always in the clients' interest. At a SIFMA conference in November, Mary Schapiro mentioned the SEC planned to conduct rulemaking around compensation that it feels creates conflicts of interest, including broker recruiting bonuses. Some industry consultants suggest that if the SEC extends a fiduciary standard to Series 7 holders when they provide advice, other incentive pay could come under fire as well — bonus pay for sales of certain kinds of products, for example. For now, there is little concrete news on this but plenty of speculation.

Pay Plans

So far, broker pay hasn't come under the knife. A survey of the 2011 pay plans from the four Wall Street wirehouses indicates they are mostly making the usual tweaks to their compensation programs, giving brokers a little more incentive to build teams and conduct succession planning, expand client assets and raise production, and shift further into fees and lending products. For now, it looks like high performers at most firms will walk away with a little more padding on their paychecks while lower-end producers will get the short end of the stick.

“There is nothing dramatic in any of the compensation plans,” says recruiter Rick Peterson of Rick Peterson & Associates. Here's the rub: Firms just aren't willing to cut comp or costs on the retail brokerage end of the business unless they absolutely must, say analysts, recruiters and compensation consultants. They are too afraid of alienating their advisors. “I think you're going to have little cuts around the edges, but not much more than the usual scuttlebutt,” says Hintz. “The message retail brokers will get is, ‘we're trying to spend smartly.’”

Of course, broker comp is notoriously complex. “It's always a possibility that they could hide something in the comp plan, because they're hard to understand,” says Michael King, a New York-based recruiter with Michael King Associates. “But word would get out.” He adds, “What the brokerage firms want to do is keep their brokers in place. Anything they can do to keep them in place, they will do.”

And that's because competition among the wirehouses to retain and recruit brokers is still intense. Each of the wirehouse firms should end 2010 with a net negative in terms of headcount, as financial advisors depart Wall Street names to start or join independent firms and RIAs, says Hintz. He projects headcount on the independent side of the business to increase by at least 10 percent in 2011 and another 10 percent in 2012, much of it coming from the wirehouse firms.

The pressure to keep brokers happy is so acute at Morgan Stanley Smith Barney, for example, says Hintz, that they have been pushing back the deadline to reach their stated profit margin target of 20 percent, up from the current 8 percent. “It's not because they are not capable of taking expenses out,” he says. “(CEO James) Gorman is one of the more capable managers today. Firms are just much more cautious about coming down with a hammer on brokers.” Morgan Stanley counters that the delay is more about market conditions than about keeping brokers in their seats. “Turnover with the top two quintiles is at historic lows,” says Jim Wiggins, a Morgan Stanley spokesman.

The Plans

For the most part, firms have left their basic grids alone for 2011. Merrill Lynch, whose final plan had yet to be released at press time, will begin assigning advisors who meet at least three or four attributes in a list of eight with “elite” status, which will come with bonus pay rewards, says one recruiter close to management. These attributes include having a certain percent of assets annuitized, high average client size, and meeting growth targets. The elite team member doing $1.3 million in production or above will then get an effective grid of 55 percent, the recruiter says. On the other hand, if you have 10 years in the business and under $250,000 in production, managers will have the mandate to fire you rather than just sentence you to the penalty box. One top Merrill broker says he thinks this will apply to about 10 percent of all brokers at the firm. (A Merrill spokesperson disputed that it is making these changes to its 2011 comp plan.)

Merrill also wants to make it easier for high-performing financial advisors who work in teams to share the payout rate of the team's top producer—in the future, that is. Written into Merrill's comp plan for 2011 is a stipulation that in 2012 all junior advisors on a team will get paid at the highest team rate and also get the club benefits of the most elite advisor on the team. The idea is to encourage succession planning, so that senior advisors nearing retirement are not penalized for transferring assets to younger, less experienced advisors, explains the Merrill recruiter. (Again, Merrill says it has not released its 2011 plans and is not making such changes. But we believe our sources are strong.)

At Morgan Stanley Smith Barney, most of the compensation plan is unchanged—but the firm is trimming back some of its bonuses while boosting others. Net acquired asset and client acquisition incentive bonuses have been discontinued for 2011, says Wiggins. The firm is also going to make it more difficult for team members to get the same payout as the top team member. It used to be that all top-two quintile advisors on “registered” teams who got at least 50 percent of their revenues from the team would get that highest payout. But in 2011, it will only apply to top-two quintile advisors on “elite” teams—those with total revenue of $2.5 million and average revenue per FA of $750,000 or above. The firm is also adding an enhanced incentive for FAs who retire or otherwise leave the firm to transition their assets to a team. They will now get a maximum 200 percent payout on the revenues generated by those assets. For those FAs who plan to stay, the maximum grid rate (which applies to a $5 million producer), with the maximum revenue bonus and maximum length of service bonus (for those with 25-plus years at the firm), is a 58.5 percent payout.

UBS, meanwhile, will now give bonus comp to any advisor who does $1 million or more of recurring revenue business, whereas it used to only offer bonus comp to advisors when recurring revenue equaled 75 percent of total production. The firm also added to the list of things that qualify as recurring revenue—the old award included wraps, securities-based lending, trails (on mutual funds, insurance, annuities, alternative investment and UITs). The new award includes financial planning fees, life insurance commissions and mortgages.

UBS calculates that the new award will apply to about 90 percent of UBS advisors, said Jason Chandler, the primary architect of the plan, up from about a third of UBS advisors. “It's a sizable investment for the firm,” says Chandler, as the total cost of the program to UBS will rise about 25 percent (He couldn't put it in dollar terms.) The maximum award is still 2 percent of revenue generated in those categories, for an advisor doing $1.25 million in recurring revenue. The firm has also tweaked its plan so that net new money bonuses will no longer be awarded on inflows from interest and dividends, but it will be awarded on 100 percent of inflows from restricted stock and 401(k) assets.

Over at Wells Fargo, management has increased deferred awards by 1 percent to 2 percent across all production levels. And in 2011, advisors will be rewarded for achieving growth hurdles in terms of net new money from existing and new clients and creating and maintaining “Envision” plans—a proprietary financial planning program and software—on their key households. Advisors will also get extra pay for providing banking products for their clients, and growing their advisory-based business, the firm says. The maximum total payout will be awarded to financial advisors producing $1.2 million or more a year and at least $10,000 a month, and comes to 50 percent cash plus 10 percent deferred annually, plus $15,000 in expense money.

Speaking off the record, brokers and recruiters say firms may act on their own to restructure recruiting bonuses so that they are awarded solely on assets, as opposed to sales, and to require brokers to disclose their receipt of such bonuses on a website or in writing to a client. “I think a lot of people would welcome that because it would cool off all the switching,” says one industry insider—“people” being wirehouse management in this case. In the past several years, bonuses have soared to over 300 percent of trailing 12-month production, awarded over as many as nine to 14 years, as firms compete to attract talent.

In this new era of compliance, firms could also begin rewarding those with the cleanest records, says Alan Johnson, securities industry compensation consultant with Johnson & Associates. They'll get more and better leads on clients in the office, he predicts.

Firms say they haven't made any such moves yet, but come February, the world may look a little different.

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