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First Republic's $70B-plus RIA roll-up loses four top executives as its contract with Luminous team ticks down

Sources say another Great Hou-Sear Escape could be in the offing based on the team's clannish ways when it comes to technology

Monday, August 8, 2016 – 8:10 PM by Lisa Shidler
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Alan Zafran: Luminous nearly doubled assets in the past three-and-a half years under First Republic.

Brooke’s Note: There’s no sale like a fire sale — especially when Bank of America is the seller. Chuck Schwab bought his company back from the national bank, built Schwab up and padded his wealth by billions. James Herbert has pulled the same trick — buying back First Republic for pin money when Bank of America sought to raise capital to help pay back the $45 billion it owed the U.S. government in 2010. But while these deals made these rich men much, much richer, there was a catch. Each executive was fitted for golden handcuffs that may or may not ever be completely removed. Herbert is on his second or third try at retiring, depending on how you count. But the wrinkle is that he has overseen the buildup of arguably the largest and most successful RIA roll-up since his last attempt to pass the CEO and chairman baton. Now, will the wealth unit stay in overdrive as Herbert angles for a graceful exit to his career? Or should some of the executive departures be taken — along with the upcoming expiration of a key contract — be taken as an ominous sign? Don’t count out another bout of Herbert magic. He founded First Republic in 1985 with 10 employees — something the RIAs under him today no doubt can feel in the company culture and respect.

For the last eight years, James H. Herbert II has been quietly working to upend at least two bits of RIA conventional wisdom: that RIAs can’t be rolled up and that banks can’t buy RIAs without belching them back out a few years later.

The CEO and chairman of First Republic Bank has overseen grown of the bank’s wealth manager mightily enough by focusing on high-net-worth and ultrahigh-net-worth investors.

Herbert is not your typical bank chief executive; he personally co-invested alongside two private equity firms in the San Francisco-based firm in 2008 when Merrill Lynch spun it out after a single star-crossed year as a unit of the Wall Street wirehouse, See: The hornet’s nest that a $25.9-billion AUM RIA owner stepped on and how much it cost. He founded Fist Republic in 1985, took it public the first time in 1986 and oversaw its sale to Merrill Lynch for $1.7 billion, bought it back for $1 billion and it now has a market capitalization of nearly $11 billion.

Simultaneously with the core bank’s growth spurt, Herbert took the wealth management unit, First Republic Investment Management Inc., from $14 billion in assets under management to about $75.8 billion of AUM today, according to the company’s second-quarter earnings release. First Republic Investment Management’s ADV shows $47 billion in assets.

Talent leaves

The dual anchors of the RIA roll-up are the purchases of two of the biggest, most dynamic RIAs in the country — Luminous Capital LLC and Constellation Wealth, each of which currently manages $10 billion.

Jeff Spears: They're just always wondering if the grass is greener on the other side.
Jeff Spears: They’re just always wondering if the grass is greener on the other side.

Now, a talent exodus at First Republic Wealth Management combined with rumblings that a legendary RIA breakaway never fully integrated into the firm — and may be set to bolt when its contract expires — has First Republic Bank showing signs of stress. Observers say that for all the success of First Republic, it is reaching two critical junctures.

One is that its wealth management growth has relied heavily on a roll-up strategy. Angela Osbourne, chief operating officer; Doug Fritz, chief technology officer; Hugh Westermeyer, deputy CIO at First Republic; and Michele Watson, chief investment officer, have all left the firm in recent months. None of them replied to LinkedIn messages seeking comment. First Republic declined to comment on the staffers either. But according to LinkedIn, Fritz is listed on LinedIn as founder of F2 Strategy, a technology firm for wealth managers based in Mill Valley, Calif.

First Republic acknowledges the turnover — but as a symptom of healthy 'deliberate’ growth. “Since July 2010, assets under management at First Republic Private Wealth Management have grown 32% annually, while bank assets have increased 21% annually. With growth comes change, including personnel change. We continue to evolve our business with great deliberation and in accordance with our thoughtful business plan,” wrote Bob Thornton, president of First Republic Private Wealth Management, in an email to RIABiz. Thornton assumed his current role in 2014 and was previously president of First Republic Investment Management starting in 2006.

Rumblings of dissatisfaction

But the second, and larger, crisis, sources say, is the more generic one in which a CEO, chairman and co-founder looks to execute a succession plan. Herbert is 72 and his second-in-command, Katherine August deWilde, is 68. Herbert agreed in 2012 to retire as CEO in 2016, but stay on as chairman well in to 2019. In 2015, Herbert extended his CEO contract through 2017 with the proviso that he remain executive chairman until Dec. 31, 2021.

In 2012, First Republic acquired Luminous Capital, the team led by David Hou and his long-time partner, Mark Sear — the duo that famously pulled of a cloak-and-dagger escape from the halls of Merrill Lynch back in 2008. First Republic forked out $125 million in cash for Luminous. See: First Republic pays a staggering sum for Luminous Capital, sources say, and shifts the breakaway and M&A games in the bargain.

Now it appears that with a year and a half to go on its contract with First Republic — it expires at the end of December 2017 — Luminous and Luminous advisors have kept themselves separate from their parent firm — at least as separate as possible, according to a source familiar with First Republic who says that Luminous has drawn a bright line between itself and its parent by not using First Republic’s technology and keeping the bulk of its assets with Fidelity Custody and Clearing instead of with First Republic.

Though Luminous executives declined to say whether their firm will continue on as a unit of First Republic, one member of its executive team wrote a statement indicating that much has gone well for Luminous in its new bank unit incarnation.

“My partners and I have had a very successful and productive relationship with First Republic over the past three-and-a-half years, having nearly doubled our assets during that time,” said Alan Zafran, senior managing director at First Republic Investment Management in a statement. “First Republic has been terrific for our clients and for our team,” the statement said in response to RIABiz queries.

Jeff Spears: They’re just always wondering if the grass is greener on the other side.

Wealth management growth

The success of the Luminous team is consistent with an astounding winning streak at the larger firm as told by revenues, assets and share price. First Republic’s stock was trading at $73.54 during midday trading Monday, edging above its 52-week high of $73.22.

It appears Luminous has helped accelerate First Republic’s wealth management division. In its first-quarter earnings report, First Republic reported that its wealth management increased 31% from the year-ago quarter — a rise no doubt also stoked by the more recent acquisition of Constellation Wealth Advisors. See: First Republic buys an eight-year-old RIA for $115 million.

Revenues for First Republic grew 23% from the first quarter compared to the year-ago quarter and 17% in the second quarter compared to the year-ago quarter. The bank reported loan volume of $4.8 billion, a record first quarter, and were up to $6.5 billion in the second quarter — another record.

“Overall, First Republic’s franchise is doing very well. We continue to succeed by remaining completely focused on exceptional client service,” said Herbert during the company’s first quarter earnings call on April 14. “The execution of a very simple business model that offers stability and predictability, the maintaining of the highest possible credit standards, and the retaining of a strong capital position at all times.”

Acquisition quest

Certainly, First Republic, founded in 1985, has rebounded from an inauspicious stretch during the financial crisis. Merrill Lynch acquired it in January 2007 for $1.8 billion. On Sept. 15, 2008, Bank of America bought Merrill Lynch the same weekend that Lehman Brothers Holdings filed for Chapter 11 bankruptcy protection.

In 2009, Merrill sold First Republic to Colony Capital and General Atlantic and other investors, including Herbert and vice chairperson August-deWilde. The fire sale was not caused by First Republic’s entanglement with subprime lending but rather the big trouble of Bank of America. See: Bank of America throws a legal wrench at big wealth management start-up.

John Furey: The reality is every advisor and every client has a choice. It's just a matter if you make that choice. No one is captured in the state of California.
John Furey: The reality is every advisor and every client has a
choice. It’s just a matter if you make that choice. No one is captured in the state of

John Furey: The reality is every advisor and every client has a
choice. It’s just a matter if you make that choice. No one is captured in the state of

Since that time, First Republic has been quietly buying giant Wall Street advisory firms. When First Republic purchased Luminous in 2012 the firm paid $125 million in cash and the goal was for Luminous to act as an adrenaline for the firm’s wealth management arm. Industry observers have said that the deal likely involved a wide-range of earn-out provisions.

In 2015, First Republic also acquired Constellation Wealth Advisors LLC for approximately $115 million. Meanwhile, the firm also recruited top Credit Suisse advisor Dagny Maidman in 2015. She is a managing director at First Republic Private Wealth Management in San Francisco. See: First Republic buys an eight-year-old RIA for $115 million.

Unhappiness a constant

Even competitor Jeff Spears, founder of Sanctuary Wealth Services in San Francisco, is impressed with First Republic’s rapid roll-up success of wealth management.

“They’ve got Luminous, Constellation and Dagny Maidman. Any Wall Street firm would kill for all three of those,” Spears says. “I think First Republic is doing an excellent job recruiting.”

But Spears also says these Wall Street advisors are constantly looking for newer, better options.

“The personality type that succeeds on Wall Street — where these guys are huge successes — it’s common for them to be unhappy. They’re just always wondering if the grass is greener on the other side. When people would come in my office, I’d say, get out, the grass is brown elsewhere. We’ve also trained these Wall Street professionals that we’ll pay you all of this money and at the end of the terms, you can leave and someone to pay you again.” See: Hiring 'ringer’, Big Four wirehouses launch joint RIA custody unit to stem breakaway broker tide as its leader delivers a reluctant 'sorry’ for the 2008 financial debacle.

Your Advent, our Advent

One source close First Republic, who asked us not to use his name, says Luminous held on to its website for a long time and would issue new employees business cards that still listed Luminous Capital on them as recently as a year ago. Luminous also maintained its own LinkedIn page. Luminous no longer uses its brand on business cards and no longer has a distinct website.

But one unusual aspect the source points to is that the Luminous advisors didn’t want to move to the bank’s version of San Francisco-based Advent Software and have instead stuck with their own separate, earlier, version of Advent.

For performance reporting, the bank’s wealth unit is moving to Mountain View, Calif.-based Addepar Inc”:https://www.riabiz.com/d/addepar and executives are trying to convince Luminous to use Addepar as well. The bank also signed a deal with San Francisco-based FutureAdvisor, according to the sources. See: Why BlackRock’s purchase of FutureAdvisor for $152 million could be a deal of destiny.

First Republic executives declined to comment on its technology and what technology is used by its staff or wealth management division. But a separate source says that Luminous advisors are beginning to move assets to Addepar.

Luminous remains autonomous in other respects, the source says. The Luminous advisors still house their assets at Fidelity and haven’t moved them over to First Republic’s clearing firm Pershing. The Luminous advisors do use Pershing Advisor Solutions of Jersey City, N.J., for new accounts but still receive exemptions to start some new accounts with Fidelity. See: An RIA innovation co-op is born with Fidelity and Pershing among the founding members.

Different systems

Luminous advisors use RedBlack Software, based in Manchester, N.H., for rebalancing portfolios. Luminous uses a different version of Advent for performance history than First Republic. Luminous has never moved to First Republic’s CRM, either.

“First Republic doesn’t want to get in the way of them getting new clients, but if all of the firms First Republic acquires operate on separate and distinct systems then operationally you can’t manage it all,” the source says. See: How the Luminous deal is rocking the recruiting world — and may set the stage for more fireworks.

The Luminous advisors also use their own pod-structure with their own middle-office teams. “Their structure works very well and you could almost argue that First Republic should take a look at what Luminous is doing and say 'maybe this is a better mousetrap’ but you’ve got 15 other mini-Luminous firms who have had to change their structures,” the source says.

All packed

However, the source says that Luminous advisors using their own back-office system has raised some flags that they are doing so purposefully so they can leave quickly if they choose to do so.

Matt Sonnen: I would certainly hope I'm the first call they make if they're ready to do something. And they haven't made that call yet.
Matt Sonnen: I would certainly hope I’m the first call they make if they’re ready to do something.
And they haven’t made that call yet.

“They want to be able to export their system and go elsewhere. They can’t say it overtly but when you talk to team members casually they’ll say, 'we’re shopping for another place.’ If you talk to large acquirers they’ll say, 'I just had those guys in my office. The folks at Luminous are smarter than the folks at First Republic,” the source says.

According to the source, Luminous crafted its deal with First Republic to carefully ensure that the company can’t get in its way. For instance, there are metrics Luminous advisors need to reach to achieve full payout and if First Republic asks the advisors to change its systems or processes, they can point to the agreement.

Luminous also isn’t pushed into using bank products in any way, the source says.

No capture in California

The rumors are new to John Furey of Advisor Growth Strategies of Phoenix, but he points out that there is a time frame in which the Luminous advisors could leave. Certainly, if they left now then they may be giving up certain earn-outs or an ability to depart, he says.

“The reality is every advisor and every client has a choice. It’s just a matter if you make that choice. No one is captured in the state of California. They can leave and do nothing until the terms roll over. Or they wait until the contract ends and they can leave and start a new business. For some it’s just a decision making process,” Furey says, pointing out that all states have different rules. See: Broker protocol may be endangered by complexities as membership starts to explode.

Matt Sonnen, who helped engineer Luminous’s first move out of Merrill Lynch, who served as director of operations, chief operating officer and chief compliance officer at Luminous from 2008 until 2013, and is now founder and CEO of PFI Advisors in El Segundo, Calif., has heard nothing about a Luminous move — yet.

“I would certainly hope I’m the first call they make if they’re ready to do something. And they haven’t made that call yet.”

Sonnen was a chief architect of the Luminous departure in 2008. See: A breakaway artist confesses the 'mistakes’ he made in ushering PBIG’s Hou-Sear team.



August 9, 2016 — 3:50 PM

Bad itel for this reporter…all those executives were fired!!! They didn’t choose to leave.

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