Career Arbitrage: How independent advisors are gaining the upper hand over big corporations in the hiring game

They left the largest and most prestigious of corporations. They used to be CEOs, COOs, presidents and senior VPs at the largest financial services organizations in the country. Instead, they have chosen to say goodbye to such pinnacles of the corporate career and to work for a small firm, with less than 50 employees and with the brand-name recognition of a cupcake shop —- a loved but very local secret.

One after the other, the top registered investment advisory firms in the industry have recruited key executives from their service partners — custodians, broker-dealers and investment managers — to lead their operations and top-level management functions. Despite being much smaller and less established, independent advisory firms can offer more exciting career opportunities than the nation’s marquee businesses. They can offer better compensation, a more closely knit culture and the holy grail of personal wealth — equity.

You don’t have to do much research to see the trend. Simply go to RIABiz and scroll through recent news stories. You’ll see stories like Mariner Wealth poaches a chief investment officer from a big local mutual fund company and a former Smith Barney executive comes back from retirement to join Dynasty and that’s just the second week of April.

Many superensembles (RIA firms with over $1 billion in AUM ) have onboard an executive recruited from a custodian, broker-dealer or investment management company. In fact, often that executive was recruited from one of the firm’s service partners. Executives from Schwab, Fidelity, LPL and Raymond James have provided a lot of the expertise among the largest independent advisory firms in the country. In addition, I have met former leaders in the technology industry, accounting firm partners — and even one armored-car cash transportation COO — who now work for independent advisory firms. See: How a billion-plus RIA in upstate New York bagged top managerial talent from just down the street.

Alternative rewards

In fact, the consistent departure of executives from large financial services companies who go to work for Independent advisory firms suggests that there is a form of career arbitrage going on — it is more rewarding to work for an advisory firm than for a broker-dealer, custodian or investment management firm than servicing that advisory firm. The career opportunities and demand for talent in the advisory industry will make it difficult for the organizations that partner with them to retain their best people. Non-solicitation provisions with respect to the broker-dealer’s or custodian’s employees are already in place in many of the contracts but they hardly make a difference when the employees themselves are keenly interested in such opportunities. See: Ryan Shanks and Ned Van Riper eHarmonize big-fee broker recruiting.

The compensation levels in the advisory industry are at record highs and exceed by a wide margin the compensation to executives in corporations servicing them. The 2011 Compensation and Staffing Study published by InvestmentNews and Moss Adams reports that the average pretax income per owner in an advisory firm was $445,382 in 2010. Compare that to the compensation of CEOs of large financial services organizations as reported by the ERI Salary Survey of Security, Financial and Investment Services. The survey reports that the CEOs have an average salary of $285,000 per year and receive bonuses for another $264,000. In other words, the highest-paid executives in the industry — the CEOs of the largest companies in the industry— only made 23.5% more income than the average advisor. The top independent advisory firms actually reported average income per owner close to $1 million — almost twice that of the average financial services CEO. Remember, these are the CEOs, meaning that almost any other executive in the industry is paid less than the average advisor. Now you can see why executives leave to become principals in advisory firms.

Family feel

It is not just the money that works in favor of the advisory firms; the family-like culture of independent firms has its own strong appeal. Most Americans prefer to work in a business they own, as shown by surveys such as the one done by the Gallup organization in 2009. That survey of 1,010 randomly selected individuals reported that 55% of respondents would rather be self-employed because of the “personal independence, interesting tasks and self-fulfillment.”

The culture of small firms can be very comfortable for employees and owners alike. It tends to appeal to our human nature at a very deep level. First, it creates a family-like environment that is very comfortable for most people. It easily and fluidly combines social and business interactions (and there is quite of bit of psychological research that links the number of positive social interactions we have to our happiness level.) Most importantly though, in my view, small firms give their owners and employees a sense of control through the very direct connection between actions and results. You do something — you can see the result right away. You don’t like something — you can act on the change right away. Again, much sociological and psychological research indicates that we seek to control our environment and the ability to do so makes us happy. The opposite of course is true — lack of control, which is often a characteristic of large corporations (even if you are the CEO), can leave one miserable.

Wealth creators

Finally, and perhaps paradoxically, smaller independent firms have a much higher potential to create wealth than any corporate employment. Advisors know that intuitively. Executives know it from their own personal experience. No matter how high the salaries and bonuses, the paychecks are always spent and rarely saved, while the equity events of small business create the true spikes in the personal wealth of their owners. I remember running a data-mining screen over a database of 18,000 households and looking for high-income individuals with low levels of personal savings or investments. The resulting list was full of corporate executives. Perhaps an added factor is the tax rate — after all, the salary and bonus income will be taxed in the 35% and more federal, and then state, tax level while the sale of a business will be subject most likely to the more favorable capital gains rate.

This hypothesis that small businesses can create wealth better than corporate employment can help explain the attraction of independent advisory firms as employers since many of the corporate executives who switch to independent firms negotiate equity packages for themselves. The research evidence to support that hypothesis is not 100% convincing, however. A U.S. Trust survey indicates that 56% of the affluent (defined as having liquid net worth of over $1 million) derived their net worth from a business. This is more than the 43% who derived it from a corporate job. However, The Wall Street Journal reports that the “$5 million-plus crowd is dominated by senior corporate executives (17%) and entrepreneurs/owners (12%).” The answer perhaps lies in the industry we are considering. In financial services, the five-year annualized return on shares in many of the large financial services companies is close to zero and sometimes negative, while the superensembles probably have doubled and even tripled in price, and their valuations continue to grow.

Perils of joining an independent firm

The high career potential of independent advisory firms allows them to cherry-pick talent from their service partners and puts pressure on custodians and broker-dealers to create equity compensation programs and other bonus structures to retain talent. At the same time, abandoning a company job to join an independent firm is not without its perils. Some of the most common problems that occur are:

• Executives find it very frustrating to operate in a company that has no history of structured decision-making.
• Executives find that they are highly paid but often do not have high-enough levels of power to truly make changes to the company.
• Professional relationships in a small company can be very social, but that can also badly backfire — people who do not get along have no place to hide from each other.
• The culture of advisory firms is intensely client-focused and heavily favors the professional functions. Most executives are hired to manage the operations functions, which are often devalued and even subjugated in an advisory firm, and that can feel very uncomfortable compared with custodians and broker-dealers, where service and operations tend to rule.

No two-way street

We have discussed all the reasons why executives may want to join an advisory firm but this also means that, conversely, advisors will have a horrible time becoming executives. This is important because that is essentially the transformation that most advisors are asked to make when they sell their firm to a bank, CPA firm or another entity. Time and again, both acquirer and target are frustrated when a former owner is asked to accept a salary which is much lower than their prior income and leave behind the sense of control and the satisfaction of building equity. It just doesn’t work — an advisor who is used to making $900,000 per year is going to have a hard time on a salary of $250,000 plus a bonus. What is more, an advisor used to managing the firm based on gut instinct and relationship will have a hard time doing so through executive committee meetings and stock options.

This has been a major problem for acquirers, and my advice is that perhaps the only viable strategy is to buy out the owners and replace them with career executives. The transformation of principals to executives may very well be impossible. This issue looms in the horizon for consolidators, too: In the second phase of their growth, consolidators have to transform the former owners into local executives, and even though they still have some equity and culture levers the change is an uphill battle. See: Why a pair of Zero Alpha RIAs are combining and out-and-out avoiding roll-ups and private-equity money.

Advisory firms may not even realize what great employers they are. Most firms are intensely focused on hiring advisors rather than managers, and their self-perception as employers is driven by their ability to attract professionals. However, superensembles are starting to capitalize on their advantage and accumulate executive talent. Executives who don’t work with clients and advisory firms most of all need more client-service personnel. That said, hiring executives may help firms to create the processes, training and procedures that will allow the firm to hire less experienced professionals and become self-sufficient. The career arbitrage opportunity is clearly there and will likely persist for some time. Markets do not tolerate arbitrage opportunities for long, though. Corporations will likely seek to increase their compensation to executives to close the gap. The question is — can they be as profitable as their independent advisor clients are?

Philip Palaveev is the president of Fusion Advisor Network a $50 million revenue franchise network of independent advisors that provides business management and collective-bargaining services to its members. As president, Palaveev is responsible for the strategy of the firm and leads its practice management development, focusing on helping the 200-plus advisors expand their businesses.

See: What exactly is Fusion Advisor Network and who did it draw to Las Vegas last week.