Retail brokers have come under Securities and Exchange Commission Chairman Mary Schapiro's microscope, thanks to a warning she issued late last month about the dangers of recruitment deals.
In a letter sent to the heads of brokerage firms, she warned executives to look out for sales practice problems caused by the “large upfront bonuses and enhanced commissions” that firms are giving to new recruits.
Although many industry ob-servers think that Ms. Schapiro's concerns are off the mark, her warning, together with the increased government oversight of industry pay practices in general, will force changes in recruitment deals, observers said.
For one thing, back-end bonus arrangements on recruitment packages could be altered so that they are based strictly on assets rather than production. The typical recruitment deal gives brokers a big chunk of cash upfront, then pays out more money on the back end, depending on assets brought over and, in some cases, on the production level of a representative.
RECRUITMENT DEALS
Observers also think brokers may be forced to disclose recruitment deals to their clients — something Arthur Levitt pushed for when he was SEC chairman a decade ago.
Those changes, if they occur, won't be all that controversial. But many observers were left scratching their heads over Ms. Schapiro's letter, wondering exactly what sales practice problems the SEC sees in recruitment packages. Ms. Schapiro specifically mentioned churning in her letter.
“Where's the evidence this is happening?” said Mark Elzweig, president of an eponymous recruiting firm.
“Most of these teams [getting the biggest deals] are fee-based,” he said, so there would be no way to churn accounts to generate more revenue.
The SEC chief also warned about “enhanced commissions” given to recruits. But so-called accelerated payouts, which give brokers a bigger slice of their commission dollars for a period of time, are a thing of the past, observers said.
Brokers are assumed to have an incentive to churn before they leave a firm, in order to boost trailing-12-month production. That's an issue Ms. Schapiro did not address.
For their part, some brokers see a bit of scapegoating in Ms. Schapiro's warning.
“They've got no interest in investigating Bernie Madoff, but God forbid a broker gets some money, and they've got to jump all over that,” said a broker at UBS Financial Services Inc. who asked not to be identified.
Not all industry observers think Ms. Schapiro is off base, since in many of today's recruitment deals, more of the back-end bonuses are based on production rather than assets.
Merrill Lynch & Co. Inc., for example, will pay top-quintile recruits an extra 60% of their production in the first year if they bring over 60% of their assets.
Firms want to protect themselves in an environment where revenue has dropped, said recruiter Bill Willis, founder of Willis Consulting Inc. And brokers want a chance to do better and make up lost ground as well, he said.
Ms. Schapiro's warning also applies to “smaller [regional] firms that have doubled in size” because they've recruited so many brokers recently, said Andy Tasnady, founder of Tasnady Associates LLC, a compensation consulting firm.
The SEC letter was sent to “several” firms, said agency spokesman John Nester, but was made public because it applies to all firms.
He declined to comment further.
While no broker will admit that money was their primary motivator in changing firms, there's little doubt that upfront cash plays a big part in generating movement.
“If someone was motivated to leave because they get a check, then that broker will do everything they can to hit [production] goal[s]” at their new firm, said Marc Dobin, a partner at LaBovick & LaBovick PA who represents brokers and firms.
Recruiters won't be surprised to see brokerage firms return to pure asset-based back-end bonuses. In addition, firms might want to stretch out the time frames over which brokers earn the tail ends of their deals in order to reduce pressure to produce quickly, Mr. Tasnady said.
SUPPLY AND DEMAND
Despite the scrutiny, recruitment cash won't go away, recruiters said, because demand for good advisers is too strong and the supply too restricted. And if brokers have to disclose the terms of their recruitment packages to clients, that may be a price worth paying.
The lack of disclosure “in itself creates an incentive for sales practice issues to arise,” said Patrick J. Burns, a compliance consultant and attorney who represents brokers moving from wirehouses.
Mr. Burns and other observers think the move to harmonize investment adviser and broker-dealer regulations could be the impetus for more disclosure. He likens a recruitment deal to a soft-dollar arrangement for an investment adviser, which has to be disclosed on the Form ADV.
But Mr. Dobin doubts that brokers will have to disclose their transition packages.
“A fiduciary is not required to disclose every ounce of compensation,” he said.
Even if more transparency is required, it might be enough to say, “I received a check to go to Firm B ... and I may get an additional incentive bonus at the end of 12 months,” Mr. Dobin said.
“I think disclosure is coming,” said recruiter Danny Sarch, founder of Leitner Sarch Consultants Ltd. “I advise brokers to do that, because their old firm will tell the client if they don't.”
E-mail Dan Jamieson at [email protected].
