Broker recruitment bonuses on DOL's radar

Agency concerned about brokers who sell out client positions at old firm and generate commissions at new firm when they recreate investment portfolios

May 12, 2016 @ 1:35 pm

By Bruce Kelly

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Buried in the sprawling, 1,000-plus-page Department of Labor fiduciary rule released last month are two references to “recruitment compensation,” the lucrative bonuses brokers receive when leaving one firm to join another.

The references have securities industry attorneys, typically a nervous bunch on their best days, all aflutter. They get anxious when new rules take effect and they don't immediately have clarity about their meaning. The published rule doesn't give much detail and simply lists “recruitment compensation paid in connection with transfers of accounts to a registered representative's new broker-dealer firm,” in a list of 10 other potential types of payment under the rule's explanation of ''fee or other compensation, direct or indirect.''

This additional compensation can add up, and whether brokers are disclosing the amounts of recruitment packages appropriately to their clients has been an issue over the last several years for securities regulators.

Currently, independent broker-dealers will pay an adviser with a strong book of business that generates fees rather than commissions 20% to 40% of the adviser's “trailing twelve,” or preceding year's total revenue. Wirehouse advisers, who typically annually produce two to three times more in fees and commissions than those working for independent brokers, get even bigger recruitment bonuses, which are paid out in chunks over several years. All in, those bonuses could be as high as three times a broker's trailing twelve, paid out over nine years.

Timothy Hauser, a DOL deputy assistant secretary, provided a bit of clarity about “recruitment compensation” and the fiduciary rule on Wednesday afternoon at a DOL fiduciary seminar sponsored by the Securities Industry and Financial Markets Association. The meeting was in New York, while Mr. Hauser appeared via video conference from Washington.

It sounds like the DOL is trying to prevent brokers from selling out positions of old products for new positions after they move to their new firms and generate fresh commissions, an industry practice that has become increasingly frowned upon over the past 10 to 20 years. In the eyes of the DOL, such recruitment compensation would be a reward for an increase in transactions, generating fees and commissions for advisers' new broker-dealers.

“Take the circumstance that comes to mind in connection with recruitment bonuses,” Mr. Hauser said. “You can tell me if this never happens, in which case you don't have a problem.”

“There is a circumstance in which the notion behind the recruitment bonus is that you are going to bring so much business to my firm, I'm giving you the bonus in order to have you bring this business in connection with” the broker's move, Mr. Hauser said. “And you are essentially advising customers to change their investments. To make that happen they are investing in different products, they are investing in different account types.”

“You are moving them to new investments, and you are doing it because you feel that's what you need to do to get the recruiting bonus,” he said. “That's the kind of circumstance I think that brought” the recruitment bonus to the list, Mr. Hauser added.

“I'm not going to tell you that it never happens, but it's a rare event when transactions or sales happen with clients just to make the adviser's transition to a new firm better,” said Danny Sarch, an industry recruiter. “They don't want to open themselves up to a complaint.”

Several years ago, the wirehouses often had their own proprietary, in-house mutual funds and didn't allow those funds to be carried to a rival firm, Mr. Sarch noted. Therefore, when an adviser moved from wirehouse to wirehouse and clients owned proprietary funds, they were sold new investment products and fresh commissions would be charged.

The wirehouses have moved away from that practice, he said. “Firms don't really have their own proprietary funds any more. And the industry compromised a while ago and allowed brokers [with clients who] still held in-house funds to transfer them to another firm.”

Will recruitment compensation be a non-starter or a big issue under the DOL fiduciary rule? It depends on whether the industry has truly moved away from the dubious practice, as Mr. Sarch contends, or whether it's still happening frequently.

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