Merrill's Bronx Tale: 'Now Youse Can't Leave'

By Bruce W. Papps - Black Ridge Consultants, Inc.

June 2, 2017

On May 12th, Merrill Lynch rocked the recruitment world by announcing that, on June 1st, they were no longer engaging in sign on bonus deals to recruited advisors. A week later on May 23rd, Morgan Stanley followed suit as the next domino to fall by announcing that they too were changing their approach to recruitment deals. With the two largest houses of advisors in wealth management declaring that they were done with sign on bonuses, it appears the days of high six figure and seven figure deals may quickly be fading.

The deal market has been characterized as an ‘Arms Race’ over the last few years. Deal levels became unprecedented and, although great for advisors, were taking a severe toll on the firms underwriting them. When DOL regulations befell the financial sector, the costs involved in adhering to these new rules, combined with these runaway recruiting bonuses, began to damage the bottom line. We first saw the major wirehouses attempt to de-escalate this ‘Arms Race’ last year after DOL forced deals to eliminate any “backend bonuses” tied to retirement assets. Initially, these firms simply removed their “backend bonuses” and merely left remaining only the front end portion of the old deals. For a little while, using DOL as an excuse, the major wirehouse, in this way, got away with bringing down these deals and were able to keep costs under control. However, movement dried up as a result of a candidate population grown accustomed to almost 400% total sign on packages. This, combined with uncertainty and anxiety over DOL, brought advisor movement to a crawl.

As a result of this dearth of advisor movement, these firms began to juice up the front ends of these deals to levels previously not seen. In addition, they began to include the full replacement of all deferred comp for the moving advisor. Finally, once again, they replaced the back end bonuses, but now with retirement assets carved out so as to comply with DOL. Essentially, the 'Arms Race' was back on. It was at this point, that this mutually assured destruction scenario began to appear as costs spiraled out of control. UBS, due to lack of financial fortitude, remained on the sideline, having cut their recruitment budget by 40% the previous summer. They began to bleed advisors.

As a backdrop to all this, it is important to understand the following wirehouse strategy, particularly at Merrill; about one-third of all advisors will be retiring within the next decade. That is an absolutely astronomical proportion of advisors expecting to leave the industry. It is nothing short of a paradigm shift of epic proportion. The result of this sea change is that approximately $2.2 Trillion of wirehouse wealth will be transferred intra firm. That is to say that the major wirehouses are expecting that within each of their firms, a behemoth of assets will be passing from older advisors to younger ones. The major wirehouse firms envision a truly exploitable unique opportunity, as a result of this enormous demographic intra firm transition of wealth. They view it like this: “If we can design this sea of assets to migrate from these highly compensated older advisors, whom make up the largest expense we have as a major wirehouse, to advisors that cost us substantially less, then we can dramatically increase our bottom line.” Therefore, the focus becomes how can they can seed a rank and file of future advisors to whom they will not need to compensate the same way they compensate their current advisors. It appears Merrill Lynch has decided to halt recruitment of the conventional type of advisor – one that is attracted and then must later be replaced by big recruitment bonuses – in favor of a new young army of advisors that are paid by salary and retained by legally inhibiting their free movement. This can be most effectively done by Merrill withdrawing from Broker Protocol and aggressively restraining in court any advisor that departs. Thus, rendering said advisor radioactive with severely diminished value as a candidate in the deal market.

Broker Protocol offers no value to a firm that is not out there participating in offering large sign on bonuses in order to attract high producing advisors to that firm. The only reason a firm joins Broker Protocol is so that when they hire an advisor away from another firm, that hired advisor is not impeded by the array of legal tools available to a losing firm to entangle the departing advisor. Should the receiving firm not be a participant of Broker Protocol, this tool kit is lethal and includes Temporary Restraining Orders (TRO), which bar an advisor from contacting his clients for months. A firm can join Broker Protocol in a matter of days, so why not withdraw if one can quite easily rejoin; or particularly if a firm does not need it since they are not recruiting with deals.

Edward Jones is a prime example of a firm that does not participate in the recruiting wars, opting to instead train and groom their own advisors and not participate in Broker Protocol. As a result, they are notorious for exercising their legal teeth so as to both psychologically intimidate advisors from leaving, and firms from hiring, by engaging in legal steps that inflict substantial costs on those advisors that do dare to depart from Edward Jones ranks as well as tactical legal maneuvers to prevent client contact. The greatest damage is the four to six month TRO (Temporary Restraining Orders) that is often dispensed by a court until the matter is sorted out and that advisor is finally permitted to contact his clients. By then, however, it is too late as these clients have been absorbed by the ravages of the departing firms’ advisors. This risk significantly diminishes the deal market value of an advisor working at a non-protocol as hiring firms price this cost and risk into substantially diminished deal values. This is a clever way to hobble a captive rank and file of advisors at a firm having chosen to itself halt recruitment.

It is interesting to notice that recently Merrill Lynch has expressed publicly that they are seeking to mirror Edwards Jones' methodology for acquiring advisors Merrill Follows Ed Jones Merrill explained that they seek to follow Edwards Jones' style of acquiring brokers which is, as we now know, revealing Edward Jones is known for not providing recruitment bonuses but in training advisors from scratch. When Merrill announced that they were halting all deals, they also declared they would launch a new concept of putting new advisors on salary Merrill Salary Plan.

So, I ask any thinking man or woman to combine the fact that $2.2 Trillion of intra-firm assets will shortly move to new younger advisors, with the fact that Merrill just announced a plan to put new younger advisors on salary. While you ponder that, also include a recent precedent inducing court ruling favoring Morgan Stanley against two departing advisors whom Morgan successfully froze their ability to contact their clients with TRO’s (Temporary Restraining Orders) because they had signed FFAP’s (Former Financial Advisor Program) agreements Morgan Stanley TRO. It seems that the writing on the wall is revealing that the executives at these major wirehouses are still licking their wounds from the recruitment wars, bitter that the biggest expense detrimental to their bottom line is advisor compensation. They have awoken to the idea that if they put all the new young advisors on salary, and then have everyone sign a FFAP or perhaps a non-compete agreement or possibly a garden leave letter Merrill is perfectly positioned for this enormous intra-firm, demographic shift in assets over the next several years with a cheaper and much less transient type of advisor; permanently hobbled and captive.

To hinder broker movement, it seems a certainty that Merrill will withdraw from Broker Protocol. Remaining in Broker Protocol provides Merrill no benefit but in fact is a detriment as it prevents them from turning off the spigot on the other side to prevent brokers from leaving. Therefore, fully expect on the heels of Merrill's recent announcements of a cessation of recruitment deals to soon be announced a withdrawal from Broker Protocol. This would serve to severely diminish the market value of advisors in an already compressing deal market, rendering Merrill Lynch advisors radioactive in an already significantly weakening deal environment.

My short term read on current events is that Merrill Lynch is committed to exploiting the current demographic and structural changes occurring with respect to the $2.2 Trillion of intra wirehouse firm asset migration from older retiring advisor into the hands of a new young rank and file of advisors. Nobody does it better than Merrill, but the problem with this is that Merrill takes care of Merrill. They are not apt to let a once in a demographic lifetime opportunity to permanently reduce costs pass without being exploited. Merrill is now run by commercial bankers who think like commercial bankers. I fully expect that Merrill leave the recruitment big bonus business permanently and summarily withdraw from broker protocol making their existing advisors radioactive in the deal market. 

Morgan Stanley is an entirely different matter. Whereas Merrill is but one business line amongst many to mother BOA, Morgan Stanley understands on which side their bread is buttered and continues to respect their advisors. They dare not withdraw from broker protocol nor entirely halt all recruitment bonus deals as has Merrill. However, they will not be immune to a softening deal environment wherein UBS has reduced their recruitment efforts by 40% and Merrill has ceased recruitment deals altogether. So expect deals to, at least in the short term, become available only to 'franchise' players (meaning first quintile advisors) as well as to come down substantially in a less competitive market. In the short term Morgan Stanley may utilize Merrill's new posture as a means to 'shake the tree' but my view is that Morgan will soon be back in business with deals relatively soon but with a much more finicky approach about the advisors they entertain. UBS is standing pat.

As the famous Chinese proverb states, "May you live in interesting times." As always; awareness and ability to adapt will continue to be the defining qualities of any successful financial advisor going forward in a dynamic deal market environment.

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Bruce W. Papps, CFA is founder and managing partner of Black Ridge Consultants with more than two decades of industry experience as an investment advisor, in positions as Vice President at Merrill Lynch, Lehman Brothers, Oppenheimer and Bank of America. Bruce also successfully owned and operated Papps Capital Group, an independent advisory firm, for over ten years and which he later transformed into an RIA and sold. With decades of diverse advisory experience, Bruce launched Black Ridge Consultants as a boutique style recruitment firm specializing in servicing the unique needs of today’s investment advisor.

Currently, Bruce is a member of the CFA Institute, a charter member of the Penn Club of New York, The New York Society of Securities Analysts, and is Vice President of the Wharton Club.

Bruce possesses the pedigreed Chartered Financial Analyst (CFA) designation and holds a B.S. in Economics and Finance from The Wharton School, University of Pennsylvania.

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