For years, wirehouse executives privately complained about the high cost of recruiting experienced advisers. Yet the transition packages, commonly called "up-front money," only became more and more lucrative. Shrewd advisers would often play two ardent suitors against each other, squeezing concession after concession from firms desperate to gain assets under management from the top advisers who were willing to move.
Back-end incentives, when added on to the front-end inducements, drove the total packages up to 350%, with whispers that even 400% deals were possible for the most attractive candidates. For example, a compliance clean, planning-based, fee-based adviser generating $2 million in production could move to a big firm and receive $8 million. The asterisk attached to this hypothetical transaction is that the adviser would need to meet aggressive asset and production targets in the first few years of employment at the new firm in order to collect the full value of the package. The second asterisk is that the money was attached to a contract that lasted for about 10 years, sometimes even longer.
Advisers openly talked amongst themselves about the timing to "monetize their practices." Critics pointed out that a significant percentage of advisers did not perform well enough to collect the back ends. Cynics opined that firms could not make money after paying so much, even as they amortized the deals for longer and longer periods of time. Regulators argued that advisers and their suitors should disclose the payments and any conflicts in order to protect clients. Others merely derided the wirehouse recruiting as a "prisoner exchange" which benefitted nobody but the "greedy" adviser who happily accepted the millions thrown his or her way.
On Oct. 27, 2016, the DOL released an FAQ section which explicitly discussed back-end incentives to recruits: "Such disproportional amounts of compensation significantly increase conflicts of interest for advisers making recommendations to investors, particularly as the adviser approaches the target." All firms who are active in recruiting advisers with deals reacted immediately to make any necessary changes to be in compliance with the regulation. Back-end deals from the wirehouses disappeared overnight.
Not all firms have stopped giving these back-end incentives. Some are as aggressive as they ever were, while explicitly excluding the accounts under the DOL rule's jurisdiction from any back-end deal's computations. Yet, as of now, the wirehouses have scaled back their deals dramatically with total packages topping out only in the 250% range.
Recruiting deals did not originate in a vacuum; they arose as an incentive to attract a limited pool of top producers, a direct result of the laws of supply and demand. In the absence of differentiation amongst the biggest firms, the wirehouses defaulted to price, i.e. big bonuses, as a way to attract talent. The wirehouses are using the DOL regulation as a justification to test whether they can still attract talent at a lesser price. They cannot be accused of colluding if they are only responding to a regulation. But what will be the real net effects of the first recruiting bear market in years?
Of the employee-based advisers who are currently unhappy with their firms, I see three different groups:
1. The adviser who truly was looking to move because he or she needs the money now will swallow hard and take the lesser deal.
2. The adviser who does not need the money now but can only see himself or herself at a wirehouse will wait a few months for the DOL rule to be clarified and to see if the big firms will go back to paying the biggest deals. Why sell your business when the market has corrected if you suspect that the same supply and demand dynamics that drove deals in the first place will force firms to get more aggressive later in the year?
3. The adviser who wants out of the biggest firms because they are too big and rigid will still seek a smaller firm, or an independent solution. He or she will continue on a quest for a happier home, outside of the wirehouse environment.
By my own calculations, 2016 was the third year in a row where fewer than half of all wirehouse departures ended up at another wirehouse. The wirehouses have not yet recognized that group three is their fastest growing population and therefore have not addressed their issues. This group has never cared about the wirehouse uber-financial packages because they are unhappy with the policies and procedures that make a wirehouse a difficult and bureaucratic place to work. The shrinkage in the recruiting deals therefore does not affect the decision-making process of the largest group of advisers who are looking for new homes.
So while the first authentic pull back in recruiting packages in over 20 years is interesting for all, and disappointing for many, the net effect on where the best advisers go and which ones move, I predict, will be minimal.
The age of wirehouse hegemony ended with the financial crisis. Are any of them brave enough to actually change the policies and procedures that are driving their most talented advisers away? The ones that figure it out will not only slow their attrition, but will enable them to attract top talent for even less than they are paying now.
Danny Sarch is the founder and owner of Leitner Sarch Consultants, a wealth management recruiting firm based in White Plains, N.Y.