Brokerages face exodus as advisers get better deal in indie firms

August 13
7:50 AM 2014

The four biggest U.S. brokerage firms are facing an exodus of employees who are finding they can make more money and save on taxes by taking their clients and starting an independent firm before they retire.

Prices are rising for independent brokers because of demand from investors and other firms, while supply is low because advisers have made steady money through a five-year bull market and are waiting to sell. At the same time the major brokerages -- Bank of America's Merrill LynchMorgan Stanley, Wells Fargo and UBS -- are fighting to keep their money-making assets from walking out the door.

For Jim Pratt-Heaney and Bill Lomas, two long-time brokers who left Merrill Lynch in 2008 to found Connecticut registered investment advisory group LLBH Private Wealth Management, the financial benefits were key. Both told Reuters they had no doubt they would get more money selling their shares of their independent business than Merrill Lynch would have offered them.


"The idea that we didn't own equity in our business as an adviser with a major wirehouse was concerning to us," said Lomas, 56.

Almost 100,000 brokers - or about one-third of the industry - are expected to reach retirement age over the next ten years, according to research firm Cerulli Associates, and the thoughts of many are turning to how to pay for it.

Big firms usually compensate departing brokers for the book of business they leave behind. Typically, brokerages pay between 0.85 and 1.4 times the annual revenue generated by the adviser, according to Nate Lenz, director of acquisitions for Raymond James Financial Services. The amount is usually paid out over three or four years, as long as the broker's clients stay with the firm, and the money is considered salary and subject to federal, state and local income taxes.

At those rates, a broker bringing in $750,000 a year in fees and commissions could receive $1.05 million at best over four years, which if taxed at the highest federal rate of 39.6 percent would leave the broker with $634,200.

By contrast, surging demand at a time when few wealth management firms are for sale means that a business owner with a high portion of fee-based revenue can now sell for an average of two to 2.25 times annual revenue, Lenz said. So a broker with a $750,000 annual book could sell for at least $1.5 million, using the lower multiple.

For that seller, the proceeds - less his investment in the business - would be subject to capital gains taxes, not income taxes. Capital gains taxes top out at 20 percent, so the broker could walk away with at least $1.2 million.

That extra money is attractive to the 55 percent of financial advisers who have said they expect the majority of their retirement savings to come from the sale of their businesses, according to a recent survey conducted by asset manager CLS Investments.

For example, Gerald "Zeke" Strid, 72, along with his sons Erik and Paul, left Wells Fargo Advisers to take the family's Philadelphia-based business, Concentus Wealth Management, independent about six months ago.

After 45 years, Gerald said feels he owns his business because it is based on relationships he built with clients.

For now, he is going to hold on to equity and transition some clients to his sons, but when he does step away, he expects to do better financially than he would have retiring from Wells.

"You get a higher valuation at a lower tax level; that's pretty compelling to people who make their living as financial advisers," said Shirl Penney, chief executive officer of Dynasty Financial Partners, a wealth management firm in New York. "It's a seller's market right now."

Potential buyers include Raymond James Financial Services (RJF.N), which is rolling out a program to help its independent advisers to find others who are ready to sell and retire. In 2013, some 54 independent advisory firms were sold nationwide, up 20 percent from the 43 deals that were done in 2012, according to a report by Schwab Advisor Services.

Steven Dudash, a broker who left Merrill with a team of five in June to launch IHT Wealth Management, said he plans to buy businesses of retiring Chicago area advisers. In his first few weeks of business, he has already fielded calls from interested brokers at all the four biggest brokerages, among others.


Merrill Lynch and Morgan Stanley recently added incentives for retiring brokers.

Merrill changed its policies to let retiring brokers stay on as senior consultants for a period of time they determine. That gives them a salary based on their last 12 month's revenue while they deliver a smooth hand-off of their clients to a successor.

In May, Morgan Stanley (MS.N) started giving brokers pre-retirement bonuses of up to 50 percent of the adviser's trailing twelve months' revenue, delivered before the adviser retires, and separate from the account payout that brokers get, according to a source familiar with the deals. The payout comes once the adviser joins a four-year program and starts transitioning their clients on to another adviser.

"We're forcing people to want to switch firms to try to monetize the value of the book (advisers) created, and I don't think that's good for the adviser, I don't think that's good for the clients," said Joe Nadreau, head of innovation and strategy at Wells Fargo Advisers. He said Wells was considering changes to its retirement policies but was not certain of the details.

UBS did not respond to requests for comment.

Still, not every broker who goes independent is prepared to start running a business after a lifetime of being an employee, said Mark Tibergien, chief executive officer of BNY Mellon's brokerage Pershing Advisor Solutions, and a long time expert on the financial advice business.

"If you're not prepared to be a business owner, you are going to spend your tax benefits making up for the clients you lost," he said.

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