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Wirehouse Waste vs. Independent Broker-Dealer Efficiency

by Jonathan Henschen, CFS and featured in AdvisorBiz.com
January, 2011:

I received my introduction to the old school corporate structure through my father. After a long career as a partner with the accounting firm Price Waterhouse, dad finished his work life at Bethlehem Steel as one of their 11 vice presidents. The timeframe was 1978-1984, the declining years of Bethlehem Steel. Despite already decaying profits, the executive elite still lavished upon themselves as if the good times were still rolling. Here are a few examples:

Corporate Excess at its Finest

In some respects, Bethlehem Steel’s Boys Club style of management was similar to the television show “Mad Men” with a hierarchy of ego driven males smoking oversized cigars. For example, All of Bethlehem Steel’s upper management were members of the Saucon Valley Country Club, which featured two 18-hole golf courses, one of them being reserved exclusively for the use of Bethlehem Steel management and their guests. Bethlehem execs would throw extravagant catered parties that often included invitations etched on silver platters and express delivered to their guests. And the bill? All picked up by Bethlehem Steel.
During the Christmas season, the executives’ wives would travel together to New York City to shop for high-end clothing at Barneys, Bergdorf and the like. While in Manhattan, they stayed at the Bethlehem Steel apartments on Park Avenue. Even my mother, who was a sucker for opulence, was at times taken back by the extravagance.
And when it came time for the annual physical checkup, you might think that seeing a local physician would suffice. Not so. Bethlehem executives would be flown on private corporate jets (yes, the company had a fleet of jets), to the exclusive Greenbrier Resort in West Virginia where they would typically stay for a three-day weekend of luxury,oh, and a physical.

Upper Management Bloat Alive and Well Today

Compare Bethlehem Steel’s Boys Club style of management to the wirehouses of today and there are striking similarities. Consider Merrill Lynch, whose top tier execs nearly all have a military background (especially the Marine Corp). Besides the bloated upper management ranks who take home salaries in the multi-millions, there is also a thick layer of middle management that “earns” salaries in the mere one to two million range. One visit to the Merrill Lynch headquarters in Princeton, New Jersey, and you can see the spending habits similar to those of the old steel giant.
You might argue that Merrill is profitable, so who cares how it spends the money? I’m a big fan of capitalism and if firms are making money, I agree, it’s their business how they spend it. But who can forget Merrill Lynch CEO John Thain, who in the midst of the Troubled Asset Relief Program (TARP) bailout that saved Merrill Lynch from oblivion, spent $1.22 million for renovations to his office? These renovations included an $87,784 area rug, $35,000 commode on legs and a $68,179 19th century credenza. Another extravagance that year was John Thain’s personal driver earning $230,000 for one year of work. Thain also paid out large year-end bonuses to management for a job well done, loading up on toxic CDOs that would have been their demise without TARP money.
Thank you tax payers for the generous bonus! Just like Bethlehem Steel, in the midst of slipping down the great abyss, Merrill and firms like it still party like its 1999!

Abandon Command-and-Control and Share the Wealth

In sharp contrast to Bethlehem Steel and the boys club style of management is Nucor Steel. Nucor runs the firm lean. With no corporate jets, even the president flies commercial. The home office has fewer than 100 people, with the corporate structure having minimal staffing between upper management and the laborers. Nucor operates under a similar corporate structure to what you see with firms such as Southwest Airlines, JetBlue and eBay. This type of structure requires managers to abandon the command-and-control model that has dominated American business for the better part of a century. Instead, they trust their people, and do a much better job of sharing corporate wealth.
In the Independent Broker Dealer channel, this sharing of wealth equates to more for the financial advisor–no corporate jets, lean management and few frills with executive salaries usually in the low to mid 100s hundreds of thousands. Any sort of extravagances you see are usually limited to reward trips for the larger producers at the firm.

Indy Model Supports Reps and Clients

The Independent Broker Dealer channel is all about the rep making more and providing more choices for clients without bias. Publically traded wirehouses are working for share holders as they try to please them with 10-15% returns. Add the overstuffed management and high overhead to a need for high profits and at the bottom of that food chain you get the Financial Advisor who gets squeezed on pay.
Most Independent Broker Dealers are privately owned so you can say they work for the rep. At the end of the year, if they come out 4-5% ahead after expenses, they’re content. Independent firms have the added advantage of being quick and nimble. When they want to improve technology, they use third-party vendors and can make vast improvements in a matter of months. The wirehouse model will have their own large IT department develop a new technology platform that can take five to seven years to complete and implement.

The Independent Broker Dealer Value Proposition

Everything boils down to value proposition for the registered rep and their clients. Here’s a sampling of the value propositions the Independent Broker Dealer channel has to offer over wirehouses:

• Having a business you can sell
• Ability to net much more
• Greater ease of marketing yourself
• Broader product choices
• Access to Private Equity and Alternative Investments (accredited investors love these but you never see them at the wirehouses)
• Flexibility to hold Advisory assets at Schwab, TD Ameritrade or Fidelity Institutional
• Get full commissions on package products (example: Variable Annuity paying 6% upfront commission + 25 bsp. trail at Independent Broker Dealer versus wirehouse that only pays 3% at and you may or may not get the trail)
• Lower management fees on third-party managers at the Independent firms while wirehouses tack on their own profit center by increasing the managers fee
• Less bureaucracy!

Despite the advantages of going independent, some registered reps stay in the wirehouse model. Here are some of the reasons why:

• They struggle with the entrepreneur concept, i.e. operating their own office intimidates them.
• They’re stuck because of a sign-on bonus that must be paid back.
• They’re in a holding pattern due to deferred compensation plan that needs to vest.
• They’re waiting for the stock price in their deferred comp plan to recover after the 2008 crash.
• Show me the upfront money–imagine moving without a big upfront check.
• They do institutional business with clients requiring unusually large net capital requirements of the rep’s firm.
• They do large amounts of IPO business.
• They’re afraid to not have a well known name behind them (although the last few years have shown that the same comforting name can be a major detriment as the firm shows up repeatedly in embarrassing press articles).
• They are complacent, don’t want the hassle, and enjoy the status quo.
• They believe the propaganda wirehouses say about Independent firms such as “they’re full of rejects or most of them are in financial hot water.”

The coming years will bring further erosion at the wirehouses and growth for the Independent Broker Dealers. You can’t fight the math of efficiency. If reps get more value for themselves and their clients, that’s where the money will flow. FINRA has wirehouse hiring bonus programs in their crosshairs, which if hindered or restricted, could greatly accelerate the migration to the Independent channel. The current bonuses that go as high as 300% to 350% of a broker’s TTR are structured much differently than bonuses even a few years ago. The upfront cash is much lower and the deals are much longer and more complex. They now measure both assets under management and commissions. Brokers have to not only hit their current numbers but exceed them by a large percentage.

A wirehouse rep I place a few months ago with an Independent Broker Dealer says it all in an e-mail he sent me:

“It’s been a few months of non-stop work, but I couldn’t be happier with my choice of Broker Dealer thanks to you. I think the best way to sum up would be to quote the many Indy reps I spoke with when they told me that I would consistently be asking myself this question,’Why didn’t I do this sooner?'”