Is flight to independence the reason wirehouses are leaving protocol?
When we look back at this era of the financial planning profession, I think we’ll assign greater significance to a story that many advisors might have missed this year: the wirehouse industry’s sudden misgivings about its Broker Protocol.
The protocol, which now encompasses 1,750 financial services firms, was developed in 2004 for a very specific purpose, benefitting very few companies. Prior to the agreement, wirehouses recruited one another’s brokers and paid hefty upfront bonuses to lure them away — with, of course, their books of business. The brokerage world’s retention strategy was to have their attorneys file temporary restraining orders on anybody who left, preventing departing brokers from contacting their customers after they walked out the door.
Why was this a problem? No doubt, the cost of paying retention bonuses on one end, and the expenses involved in suing departing brokers on the other, was becoming worrisome. But perhaps a bigger incentive was the embarrassing situation where your attorneys are arguing two sides. In one courtroom, they try to make the case that a broker had every right to leave another firm to join yours, customers in tow. Meanwhile, in a courtroom down the hall, they are citing legal chapter and verse to prove that brokers leaving your firm have no right to take customers with them.”
The protocol called a truce to that escalating battle. It provided that departing brokers can take customers’ contact information when they leave, but nothing more. There are many complications to this simple picture, including sly efforts by brokerage firms to include draconian noncompete language into innocent-looking documents that brokers are required to sign to receive their annual bonuses. But for the most part, exiting brokers have been relying on this safe harbor for the past 14 years.
Most of the ex-brokers I talked to said they left for reasons other than money.
So long as brokers were leaving one wirehouse to join another, the protocol was working as intended. Who could have imagined that high-performing producers would ever consider seeking a home at one of these fly-by-night (their perception) independent BDs or go fee-only and join an independent RIA firm? The only reason for brokerage firms to renounce the agreement would be if they started losing talent to the world outside the cozy brokerage brotherhood.
There are no good statistics as to how many brokers have left the wirehouse world. All we know is that suddenly, without warning, at the end of last year, three of the bigger brokerage players — Morgan Stanley, Citibank and UBS — decided to exit the protocol. That suggests, to me, that the exodus from captive broker to independent RIA (dually-registered or fee-only) has finally become a visible bleeding wound that needs a fast tourniquet.
There is speculation that Wells Fargo and Merrill Lynch will soon follow their peers out of the protocol, for different reasons. Wells Fargo brokers must surely be fielding embarrassing questions from their customers about their morality and ethics, while Merrill brokers who signed those generous retention deals when the world was collapsing in 2009 are now fully vested and no longer have millions to lose if they jump ship.
Whether or not the protocol collapses is irrelevant as far as the larger trend is concerned. In the years before the industry accord, brokers left wirehouse firms and generally won their right to contact their clients. They will certainly be able to do so again if the protocol goes away. But the renunciation of the protocol by three significant firms, and uncertainty around two more, tells me that the balance of power between independent advisors and the larger sales houses has finally reached a tipping point. The long, slow annexation of market share by the fiduciary advisor world is accelerating. Brokers are noticing that the pasture is greener on the far side of the temporary restraining order.
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Why now? First of all, the marketplace has evolved to include a lot of soft landing places for the departing broker. Companies like Dynasty Financial Partners, HighTower Advisors, Focus Financial Partners and United Capital specifically cater to helping departing brokers preserve their book of business, with software tools and back-office support that are similar to what they enjoyed as a top producer in the brokerage environment. Meanwhile, every large independent broker-dealer and all the major custodians now have a team of specialists who will help brokers find office space, computer equipment and software, a new brand identity and (most importantly) painless ways to get the transfer paperwork handled. The recent transition to paperless document processing, with electronic signatures, has taken the sting out of what was once a significant hassle for customers who wanted to follow their broker to a different firm.
Beyond that, the independent RIA world has grown up. In years past, a brokerage team with $1 billion under management would be hard pressed to find a firm that could comfortably absorb its client obligations. Today, more than 600 RIA firms have more than $1 billion under management, many with multiple offices who could simply plug another one into their centralized operations flow.
So long as brokers went wire to wire, the protocol worked as intended. Who would have imagined then that successful producers would ever consider a “fly by night” independent BD.
Finally, the technology lead that brokerage firms once enjoyed has completely reversed itself. None of the significant innovations in CRM, portfolio management and tracking, financial planning, client portals and vaults, online advice platforms, collaborative investing platforms and cybersecurity are coming from legacy brokerage systems. An independent software company that is hoping to attract new business can amortize its creative development costs over more than 17,500 potential RIA customers, while the largest brokerage firms amortize their software outlays over 8,000 to 10,000 at most.
Over the last six months, I’ve interviewed dozens of ex-brokers about their experience transitioning to independence. One of the most consistent responses I’ve gotten would surely be incomprehensible to the titans who sit in Wall Street’s corner offices: most of the departing brokers did not leave for the money. In fact, virtually all of them said that they expected to make less money after going independent.
Why on earth would they leave, if not for the money? The reasons I heard over and over again were: the freedom to give clients advice in their best interests, a move away from product pushing and an opportunity to align their conscience and their values with the advice they were giving.
A surprising number never realized that there was an independent, fiduciary alternative. Others were told by their branch managers that anybody who leaves the brokerage world is going “rogue.” But increasingly, they realized that the grass is greener where there are fewer conflicts, and the grass in the brokerage world — where the branch manager is alternately bothering you about quotas and providing sly financial incentives to push recommended products — has grown distinctly brownish over the years.
This is just a guess, but I wouldn’t be surprised if, sometime soon, the brokerage firms abrogated the current protocol and created a new one that only they and their wirehouse fellows would be invited to sign. But protocol or not, I expect that someday in the future, historians of the profession will point to this moment in time when a trickle of brokers seeking independence quietly became a flood. The brokerage model will retain the greedy, the timid and the oblivious, while the best of today’s brokerage breed will be finding new homes where they can truly put their clients’ interests first.