Last week's DOL Q&A cast an immediate chill on wirehouses whose back-end-loaded incentives meant to jack up sales production have essentially been outlawed

November 4, 2016 — 4:02 PM UTC by Guest Columnist Howard Diamond

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Brooke's Note: I get a handful of inquiries every week from people wanting know what a guest column submission to RIABiz should look like. There is no formula. But this piece by Howard Diamond is as good a prototype as I could hold out. It takes an event inside the nerve center of a firm and allows us readers to use it as a window into a shift occurring in the broader industry. Typically, nothing moves fast in this business -- until it does. As thousands of us try to make sense of the DOL's FAQs, Diamond, who also happens to have a flair for writing, gets us past all that to an indisputable set of events that emanated from a wirehouse's reading of those FAQs, how it reacted and how it affected him and the clients of his recruiting firm. Diamond then tells RIABiz readers what he thinks it means for them. Possibly, big RIAs and IBDs are set to end the drought of talent that has retarded their growth.

This past week has been one of the most hectic we have experienced in the recruiting world in some time.

Actually, ever.

The precipitous release of guidance related to the Department of Labor's new rules relating to an advisor's fiduciary duty to a client when recommending retirement products prompted a tidal wave of emails, calls and texts with advisors asking, essentially, “What’s going on with my deal?”  See: Using DOL as cover, Bank of America cuts the Merrill Lynch bull as it adds a robo, stops paying brokers to stick around and kicks John Thiel upstairs

Their anxiety was well-founded. Consider "Patrick," a wirehouse advisor I had been working with. His world literally changed in an instant. With $350 million in AUM generating about $3.2 million in annual revenue, he had been offered the kind of deal that keeps so many wirehouse advisors only dreaming about the independent space rather than making the move to it. He was offered what was once considered a standard wirehouse deal for quality advisors like him, that is, 330% of production once upfront signing bonus and back-end earn out provisions were figured in.

With a deal like that, why wouldn’t he stay in the wirehouse world?

I was the one to confirm the bad news: His 330% wirehouse deal turned into 140% upfront and no back-end bonus. See: Coming RIA custody fees and a new recruiting war catch the attention of deal hounds in Manhattan.

To be fair, this wirehouse was only responding to the very clear language the DOL published Oct. 27 in the form of an innocent-enough sounding FAQ (frequently asked questions) blog post. While the DOL’s fiduciary rule isn’t set to be enacted until April 10, 2017, all indications are that the rule represents the end of the world as we know it -- starting now.

Shock to the system

Yet for all the short-term bad news that seems to be in store for advisors sitting on or anticipating outsized wirehouse deals, a winner will emerge -- and that’s the RIA business.

Because for Patrick, and many captive advisors like him, an uber-deal like the one he was offered was hard to pass up, even if his real desire was to go independent. He came to us feeling stifled by the ever-increasing bureaucracy of his firm, which he felt limited his ability to serve his clients and grow his business. And he was also concerned about the meaningful amount of commission-based business that he needed to accommodate. See: How I became an RIA by winning a golfer's trust in my caddie days and why I broke from his OSJ to avoid conflicts of interest

At the start of this year, Patrick had entertained some meetings with a few RIAs, attracted by the freedom and flexibility of the independent realm. Ultimately, however, he leaned toward moving to another wirehouse that he believed would give him a better – albeit imperfect – opportunity to grow his business, and upfront cash and back-end bonuses that could not be matched in the RIA world. See: Fidelity gleans why so many 'attractive' advisors cling to wirehouses and Cerulli's newest RIA data shows plenty find courage

Once Patrick and I talked through the situation and he calmed down, we revisited what initially motivated him to seek a new opportunity. Money aside, he was seeking the entrepreneurial freedom to more creatively grow his business, and a quality place in which he could maintain some commission sales without oppressive compliance. See: What swayed me to the hybrid cause after an early indoctrination as a 'pure RIA' disciple

That led us to discuss some quasi-independent models that offered an upfront cash component, higher payout and equity. 

Suddenly, the chasm between the RIA and wirehouse deals diminished -- especially once he factored in the quality-of-life uptick he would be gaining in a non-traditional sector.

Confounding logic, inescapable conclusion

Question 12 of the FAQ is devoted to the payment of recruitment bonuses by firms to advisors who join them. Typically, such deals have an upfront component (140% to 150% of trailing 12-months' revenue) and a series of back-end hurdles that are tied to various asset and revenue bogeys that the advisor must hit in order to achieve the all-in amount of more than 300% of their pre-hire trailing 12 months of revenue.

However, in the Oct. 27 FAQ, the DOL states that the “front-end” portions of the bonus “are permissible" but the “back-end” portions that are “expressly contingent on the advisor’s achievement of sales or asset targets” will not be permitted.

The DOL's rationale, essentially, is that the other 190% tempts the most honest of brokers to sell unsuitable, high-commission products and/or churn the account by selling products and using the proceeds to buy new products with no justifiable improvement in risk profile or investment performance. See: An X-ray of one affluent, educated and sophisticated investor's portfolio shows how it was chewed up by fees

There is certainly an argument to be made for this logic. Still, the DOL also does not want incentives tied to brokers bringing in more assets—reasoning I hardly understand or agree with.

What is almost inarguable is that this conservative interpretation of the rule, if broadly adopted, will mean a recruiting bonanza for the RIA space.

While every financial advisor covets freedom, flexibility and control – the very attributes that becoming an RIA offers – the biggest competition for independent business owners has been the enormous recruiting deals offered by the wirehouses. With the very structure of these deals now in jeopardy, and likely limited to an upfront amount, we predict that the slow trickle toward independence will accelerate to a flood. See: 9 ways for RIAs to minimize brain drain and secrets seepage in an era of employee mobility

More questions than answers

We all certainly anticipated that recruiting deals offered by the big firms would be impacted by the DOL's fiduciary rule. We all thought that the back-end, revenue-based bonuses paid to advisors could be seen as a conflict, but that the asset-triggered bonuses would be OK. Obviously, our prognostications were wrong. We were blindsided by the DOL's “clarification” of their position, which now seems to bar any and all back-end payments to advisors based on incentive to grow.  

We have been in contact with scores of advisors who were planning on a move -- or at least thinking about one. Moreover, we have advisors who have committed to move to new firms who are now on hold because their deals have been rescinded or rewritten. These advisors – and hundreds of others across the country – have had the carpet pulled out from under them. They are obviously frustrated, confused and looking for answers. 

Some of the major questions and issues the FAQ raises are:

  • It was anticipated that any changes would take place in April of next year when the underlying fiduciary rule goes into effect. Instead, the FAQ states that deals that were in place “before the date of this guidance [Oct. 27], could still be honored by the financial institution.” However, it also seems to indicate that, as of Oct. 27, revenue or asset based back-end portions of deals are no longer permitted.
  • How can the DOL mandate or proscribe activities that will not be subject to law until five months from now by putting out a series of frequently asked questions and answers? I would posit that this is not permissible and perhaps even unconstitutional. And certainly this raises further questions about the status of deals in the pipeline See: Why SIFMA & Co.'s trip to a friendly North Texas court to upend the DOL rule looks more like its Alamo
  • The DOL is only empowered to regulate IRA, ERISA and other retirement plans. The large firms are taking the position that the DOL is attempting to regulate all advisors—even ones that do no retirement work at all and who would otherwise not be subject to the new fiduciary rule. See: The DOL's final rule contains a litany of 11th hour concessions to brokers that show Wall Street lobbyists earned their keep
  • By taking this very conservative approach, these firms are ignoring the reality of the DOL’s actual authority.  Shouldn’t firms be able to write their current recruiting deals for advisors who do no retirement business? Couldn’t the firms roll out a bifurcated recruiting model that would carve out back-end bonuses for any retirement-related accounts? 

Interesting times

Firms such as HighTower Advisors LLC and Focus Financial Partners LLC that do not have traditional back-end components to their deals will immediately become much more attractive to advisors who realize that the delta between these types of firms and the large brokerage firms has either narrowed or completely disappeared.  See: After chats with Phyllis Borzi, a flagship HighTower team executes a 'deliberate' breakaway to form a $2.5-billion RIA

While many advisors have been willing to pass up on the features that independence offers in favor of the big upfront paycheck, the playing field has completely changed. Those same advisors are reconsidering what’s most important to them, with a push from the very firms they have come from by way of less monetary incentive. See: In search of a 'mind-set' shift, $2.2 billion Wichita team tunneled out of Morgan Stanley -- taking absolutely no chances with the guards

I just returned from Schwab’s IMPACT conference in San Diego, where I had the privilege of interacting with many high-quality RIA advisors and firms. Every independent firm is hungry to acquire, recruit or “tuck-in” new advisors and teams—and many noted that such advisors are difficult to attract and retain. If the FAQ had been issued the day before the conference ended instead of the day after, the conversation would have been much different. This announcement has made their waters far more bountiful. See: As Bernie Clark and Walt Bettinger go on offense, LPL and Wells Fargo names get named and a B2C robo dry-up gets foretold at Schwab IMPACT in San Diego

If the wirehouses and other similarly situated firms don’t become more creative with their approach to the DOL restrictions on recruiting bonuses, the independent advisory space will become the most dominant force in the FA world.

The next few weeks will prove to be very interesting.


Howard Diamond is managing director and chief operating officer of Diamond Consultants, a financial services search and consulting firm in Morristown, N.J.


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Stephen Winks said:

November 5, 2016 — 4:03 PM UTC

The most powerful incentive for our most successful advisors is not matching the highest bid, but the support rendered for their professional standing in advisory services. There is an indisputable correlation between how adept an advisors is in rendering advice in a highly competitive business environment and their compensation. The fact that most brokerage firms openly oppose the fiduciary standing of brokers (as evidenced by the SIFMA/FSI suit of the DOL) translates into less than enthusiastic support of fiduciary duty for ALL client accounts. Thus, RIAs do indeed have an edge, but not all RIAs have the size and scale to be exemplary in advisory services. Expert standing requires the advisor to go far beyond the conventional brokerage (algorithmic) approach to advice. How (1) trade execution is treated (minimized in the clients best interest), (2) adoption of prudent process (asset/liability study, investment policy, portfolio construction, performance monitor) which puts "financial services" back into the financial services business (has yet to be adopted by any US b/d) (3) the retooling of product menus to be consistent with portfolio construction requirements of fiduciary duty; all are requisit considerations that will determine professional standing and market share enjoyed by advisors . By default, there are no brokerage recruiters that can speak to these issues. Thus our largest and most capable RIAs who are in fact liable for their "tucked-in" advisors counsel, have a massive competitive edge. It would be great for the industry to compete on the basis of the depth and breadth of counsel supporting firms provide. A virtuous cycle of innovation would be fostered and the professional standing of being an advisor would be achieved. There are many Mega RIAs emerging each with a market value of more than $100 million which will redefine the industry and professional standing which will be the hallmark of excellence. Five years ago this way not the case. Keep your eyes on Savant, CapTrust, Edelman, etc. which have the critical mass and technical support to constitute large scale institutionalized support for fiduciary duty. None on these firms have formalized recruiting and by necessity are highly discerning in who they entrust their well earned reputations. These firms do not straddle the line between product sales and advisory services, they are driven by professional standing in advisory services. SCW, SCW

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