TD Ameritrade, one of the country's major custodial firms, is in turmoil, with a minority shareholder group pushing for a merger and its independent advisors rebelling against the firm's new affiliation contract.

Early last month, two hedge funds, Jana Partners and SAC Capital Advisors, which represent 8% of the company and which had been pushing for TD Ameritrade to go on the block, successfully forced the firm to remove two insiders from the board's three-member Mergers and Acquisitions committee. The board members represented shareholders Toronto–Dominion Bank (with a 40% stake) and the Ricketts family (21%), both of which are reluctant to sell or merge. Two board members, Wilbur Prezzano and Robert Slezak, were replaced by two outside directors.

While that alone isn't enough to put the firm seriously in play, it does, in the words of one analyst, "mean that the M&A committee may become a lot more aggressive about finding a deal."

Even before the board's composition changed, Mike Fisher, a research analyst with Deutsche Bank, wrote on June 5 that the company's stock, in his view, should be carrying an acquisition premium, and that SAC and Jana Partners' call for a merger with one of the company's competitors seemed to "encourage a merger." On July 11, the stock closed at $19.83, a few cents below the price when Fisher issued his report.

Patrick O'Shaughnessy, an analyst at Morningstar, isn't so sure. "A merger sounds good, but it's easier said than done," he says. "Schwab is not interested and E-Trade probably isn't either, unless the price is right." What's more, he's bearish on the stock. "As a standalone firm, it's hard to see where they get growth from," he says.

It's also unlikely that TD Ameritrade would be an acquirer. Spokeswoman Katrina Becker agrees that there is "excess capacity" in the industry, but she notes that the company has completed nine M&A deals since 2002, including "the largest three acquisitions in this industry." She says that while no one is ruling out a merger, "right now we're focusing on organic growth." She says the company is filing a Form 8K with the SEC, rejecting a request by Jana and SAC for a pile of documents relating to the company's strategic plans.

Salt in the Wound

Meanwhile, management recently faced another unsettling task—smoothing the feathers of independent advisors after the company issued an imperiously worded new affiliation contract. The contract, mailed on March 29 to all independent advisors, said they could no longer use the firm's name in any way "without prior written consent." More disturbing, advisors had to agree to be personally liable for financial damages in any dispute arising between the company and an investment client.

Called an Advisory Services Agreement, the contract—a first for many affiliates—said that as security for the payment of any transactions, including those resulting from advisors' instructions on behalf of clients, advisors had to grant the company "a continuing security interest in, lien on and right to set-off against, all management fees now or in the future payable to advisors by clients or by the company."

Rubbing salt in the wounds, the company made the new contract "self-executing" on April 30, when advisors would "become bound by the enclosed Existing Advisors' Agreement by your use of our brokerage and/or custody services for you and/or your clients."

Blame the Lawyers

Advisors' reactions to the contract were electric. "I looked at this and said, 'Hey! Let's blow the whistle on these guys!' " recalls Mike Hambrecht, a principal at Financial Service Group, in Racine, Wis. "Everything in that contract was tilted against the advisor, and the worst part was, it was drafted from the perspective that the advisors are just tag-along and not the primary service providers—which we are."

Morningstar analyst O'Shaughnessy observes that advisors are significant contributors to TD's revenues and earnings: "They've been trying to boost that business and investors want them to expand it, so this problem is concerning." S&P analyst Matthew Albrecht agrees: "With the acquisition of Fiserv and the introduction of managed portfolios and their ETF platform, clearly building a relationship with advisors is an important part of the company's strategy," he says. "So this contract dispute would seem to be a bad misstep on their part."

Some advisors in late April contacted Scott Gottlieb, an attorney at US Compliance Consultants in Greenwich, Conn. Gottlieb told them that the contract contained numerous problems. The liability clause could allow TD Ameritrade to go after a sole proprietor's personal assets. And a clause promising that advisors would always be "in compliance with all applicable laws" would, "in a world where virtually every SEC audit finds something to write up," mean that any advisor who entered the agreement would likely be in violation of the contract immediately.

"I think Ameritrade made a mistake," says Ben Tobias, a principal at Tobias Financial. "I think their compliance attorneys got their hands on it instead of their business people and just put in language that dealt with every imaginable angle."

TD Ameritrade quickly backed down, announcing in early May that it was rescinding the new contract and starting over.

"We screwed it up," concedes Matt Judge, the company's director of product management and business solutions. "Following [last year's] merger of TD Waterhouse and Ameritrade, we were hoping to come out with one new advisor agreement, but some clauses didn't reflect what we wanted to say. Advisors told us what they thought about it. We've heard them, and we're looking to redo it."

Judge is heading up a group of executives who plan to meet with a cohort of advisors headed by Saxon Birdsong, president and chief investment officer of Baltimore-Washington Financial Advisors, in Columbia, Md. The two groups hope to hammer out an agreement by summer's end. "We're going to go over this from stem to stern, and if we end up in disagreement over the contract, it will be newsworthy," Birdsong says. "Each advisor pays this company significant amounts of money. I think when TD Ameritrade has a client with a couple hundred million in assets, they'll listen."

Mike Joyce, president of Joyce Payne Partners in Richmond, Va., and a former chair of the National Association of Personal Financial Advisors (NAPFA), put it more bluntly: "There is no contractual agreement with clients, so advisors could just walk and take their clients with them."

Judge expects a new working draft in a few weeks. "Advisors are a critical piece of our business and one of the fastest-growing parts of our business," he says.

The blowup came at an awkward time. Fresh from handling the integration of TD Waterhouse, the company now has to manage the $325 million acquisition of Fiserv Support Services, the custody unit of Fiserv. Moreover, TD Ameritrade hit a pothole this year with an unexpected 18% drop in net second-quarter earnings. Becker attributed the slide to a falloff in overall market trading activity rates. But pressure from both shareholders and advisors can't be helping.