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House committee explores payouts at brokerage firms

Retention bonuses, recruitment packages given to financial advisers under scrutiny

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By Mark Bruno

February 8, 2009 6:01 am ET

In the shadow of the Obama administration's efforts to curb compensation for top executives at bailed-out financial institutions, lawmakers are examining payouts at the retail-brokerage operations of those firms.

The House Committee on Oversight and Government Reform is reviewing some of the industry's pay practices — such as awarding large retention bonuses and recruitment packages to advisers, said Ronald Stroman, staff director for the committee, which is headed by Rep. Edolphus Towns, D-N.Y.

At the heart of the issue is whether such payments would impede a financial institution from using bailout funds for their originally intended purposes: to stabilize their businesses and defrost the credit markets.

"It's one of the primary issues that the committee has targeted to look into," Mr. Stroman said.

A formal hearing has not yet been scheduled, but Mr. Towns' committee is looking at how brokerage firms determine retention and recruitment packages for representatives and whether they are appropriate in the context of the current financial crisis.

"It's a somewhat logical progression, and it's low-hanging fruit for lawmakers right now," said Alan Johnson, chief executive of Johnson Associates Inc., a New York-based compensation consulting firm that services the retail-brokerage industry. "It's politically attractive to align yourself with Main Street."

Scores of politicians have been zeroing in on Wall Street compensation practices in recent months, but it has come to a head in the last two weeks. After a report from New York State Comptroller Thomas DiNapoli on Jan. 28 revealed that Wall Street firms paid out $18.4 billion in cash bonuses for 2008, President Obama labeled the payouts the "height of irresponsibility" and "shameful."

Last week, the president moved to limit the pay of executives at bailed-out companies even further. The brokerage industry, however, has managed so far to escape the spotlight.

EMERGING DETAILS

But more information is now surfacing about multibillion-dollar retention packages, such as the $3.6 billion in payouts awarded to reps at Merrill Lynch & Co. Inc. last month to keep them from leaving after the New York-based firm was acquired by Bank of America Corp.

Charlotte, N.C.-based BofA has received $45 billion in federal funds over the last four months.

At the same time, details are also emerging about recruiting packages that wirehouses have been using recently to lure reps from rival firms — packages that in some cases, observers noted, have hit astronomical levels. "Some of these deals have been unprecedented, said Steve Insel, a lawyer at Jeffer Mangels Butler & Marmaro LLP in Los Angeles who specializes in transitioning investment advisers.

He noted that in recent months, he has worked with reps who were given, at times, recruiting payments with a value of up to 300% of their commissions over the previous year. And the majority of these payments were granted up-front, he added, with a significantly smaller piece based on advisers' ability to bring their assets under management with them to their new firm.

"It hit a peak near the end of last year that I've never seen in my 30 years in this industry," Mr. Insel said.

Industry sources have said that the brokerage businesses of Morgan Stanley and UBS Financial Services Inc., both based in New York, have been the most aggressive in issuing recruiting packages, but added that the values of these deals have come down somewhat in the last month.

A spokeswoman for UBS did not return a call for comment; Christy Pollak, a spokeswoman for Morgan Stanley, said the company does not comment on recruiting packages for competitive reasons.

While lawmakers may be inclined to look at such industry pay practices, retention and recruiting packages should not be lumped in with the broader focus on Wall Street compensation, contends Rick Peterson, founder of Rick Peterson & Associates, a Houston-based brokerage industry recruitment specialist.

For one, he said, they're generally structured as long-term deals, and, in the case of retention packages, they're also structured as loans that require reps to stay with the firm for years before earning the payment in full.

"And when a rep has built up a significant book of business, you have to do something to induce them to join your organization, or stay with you after a merger," Mr. Peterson said of recruiting payments in particular. "You're essentially purchasing a stream of revenue, and that's not the same thing as awarding someone a bonus."

By awarding large payouts, wirehouses are "making a business decision to shrink their margins a bit," said Danny Sarch, founder of Leitner Sarch Consultants Ltd., a recruiting firm based in White Plains, N.Y. "But in a very competitive environment, it's critical for these firms to do what it takes to get new assets in the door and maintain their existing assets."

It's perhaps likely that retention payments will end up getting the bulk of the attention from lawmakers, because these packages are paid out in massive, single sums, said Andy Tasnady, founder of Tasnady Associates LLC, a Port Washington, N.Y.-based compensation consultant.

In addition to BofA's $3.6 billion in retention payments, Morgan Stanley and Smith Barney, also of New York, are expected to offer reps $2 billion to $3 billion to stay with their firms when the two form a joint venture later this year.

'100% POLITICS'

New York-based Citigroup Inc., which owns Smith Barney, has received $45 billion in federal aid, while Morgan Stanley was given $10 billion by the government last year.

Whether lawmakers see the business rationale behind these industry pay practices remains to be seen. "This is about headlines and it's 100% politics," said Mr. Johnson. "Congress wouldn't know appropriate retail-brokerage practices if it bit them in the heinie."

E-mail Mark Bruno at mbruno@investmentnews.com.

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