Broken Brokers.

September 4, 2012

Young people, going to work for the largest broker dealers, Morgan Stanley, Merrill Lynch, UBS and Wells Fargo Advisors, do so on the premise of learning the trade while making an honest income for an honest effort.
But, even the best laid plans oft go awry.
The problems with today's large broker dealers are intrinsic. They inevitably avail themselves as might the demonic clown in a horror movie. His big cheerful smile eventually revealing that, horrifically, the guy twisting the balloon poodles has fangs.
As in the movies, in the world of Wall Street's broker-dealers (that is, its large brokerage firms), not everything is as it seems. Especially when Wall Street and Main Street converge.
For example, most of those working for today's largest brokerage firms have the moniker of Financial Advisor on their cards. Only because the word "oxymoron" cost more per card.
Brokerage firms hand out titles with all the credibility accompanies most of my four-year old son's swim meet ribbons. I didn't know they gave you a ribbon for eleventh place. Or if you were the only competitor. Every third broker at Merrill, UBS and Morgan Stanley is a Vice President of Investments/Wealth Management. The two out of three who aren't? Well, they will be soon. Unless they get fired first. And while nearly every card reads "Financial Advisor," many brokers are anything but.
Josh Brown, the son of legendary coach Larry Brown, is an advisor with Fusion Analytics. He is also the creator of the well-read financial blog, "The Reformed Broker." Like most of my colleagues, Mr. Brown formerly worked for a Wall Street brokerage. His sentiments on his former employer align with ours. As they do with most who have worked for and escaped a large wire house.
Mr. Brown often writes of his epiphany. That moment where, after years of toiling on behalf of his clients and his firm, he realized that many of the recommendations made by Wall Street, and the transactions that Wall Street gets paid to facilitate, are not in the best interests of clients.
Having had this realization, brokers can continue to make the same bad recommendations and trades, or they can change the way they do business. For more on Mr. Brown's increasingly common epiphany, click on this video link.
Once upon a time, being a "stock broker" was a respectable career choice.
Guys in nice suits, generally employed by brokerage firms, turned up in wood-ladden offices every day to practice Wall Street's enigmatic witchcraft. Quite simply, recommending the purchase or sale of different investments. They did not have to recommend investments that that were in the best interest of clients. They still don't. They need only those that are "suitable." They were, and continue to be, paid to move money around, and rarely get paid to manage cash. And often these transaction recommendations, well, they don't happen much. For years, I worked with brokers who were charging clients 1 percent or more each year to own mutual funds or separately managed accounts (i.e. money managers). Those guys were the heroes of every young broker. Getting paid massive amounts of money to do little more than occasionally recite the market updates they'd read in The Wall Street Journal and hold seminars for new, prospective clients. Marketing machines? Yes. Wall Street wizards? Hardly.
During the 2008 debacle, most brokers spent more time talking their clients down from the roof than they did exerting the effort needed to keep them from climbing up to jump in the first place.
"I don't know where the market will be in three months, Mr. Jones. But, in three years, if you stay the course, you'll be absolutely fine!"
"Quit panicking, Mr. Jones. You can't sell now. My book of business has already dropped 15 percent. My fees have taken a hair cut. If you go to cash? That's an even bigger hit to my bottom line. So, let's sit tight. Hope things get better. Eventually, things return to normal, right? Two, three, five years? You'll be fine! Now, next Thursday I'm taking 20 of my best clients to play golf, followed by a tax deductible steak dinner. Have you RSVP'd?"
Financial advisors generally work for Registered Investment Advisors (RIAs) and have a fiduciary duty to act in the best interest of clients. They attain professional licenses, and work within frameworks, that hold them to a higher standard. They can less afford to be marketing machines. Become they have more responsibility for their client's bottom lines.
The nation's affluent investors have become increasingly aware of the shortcomings within the brokerage firms. Prior to 2008, the brokerage firms counted 56 percent of the nation's high net worth households ($5 million or more in investable assets) as clients. Since 2008, the brokerage firms have seen their share of wealthy investors fall to 45% at the end of 2011. That's some healthy deflation.
So, why have the nation's wealthiest left in droves? Perhaps wealthy investors sense the effort the brokerage firms have expended in boosting profitability. Sometimes at a cost to clients. According to a report by Cerulli Associates (click here for more on the report), the brokerage firms' "efforts to raise short-term profits may be causing them to forsake their long-term domination of the industry."
The beneficiaries of the mass monetary exodus from the brokerages? RIAs (like Hyde Park Wealth Management) and the private client groups at established banks.
Care to glimpse the real kick in the old change purse? The exodus extends beyond their clients.
Of the advisors who have recently interviewed at Hyde Park Wealth Management, many of them complain of the second-rate technology employed by their firms. These advisors don't work at Wu Tang Financial. They hail from Merrill Lynch, Morgan Stanley, Wells Fargo. All the big dogs. Their complaints still resonate with us. We've been there. Seen it. Live it. The propagation of the sales culture cloaked in the garb of advisors. Branch managers who actually spend time perusing the number of calls to prospects. The inability to get paid for holding cash, even when cash is an attractive asset class. If the firm can't make money off it, they certainly won't pay the brokers to do it. So causing the brokers to, well, not do it.
Reuters recently ran a story on the discontent of some of Morgan Stanley's top advisors. Seems they are unhappy with the firm's technology platform. Mistakes have been common place. Its not efficient. These rain makers are unhappy enough to consider leaving the firm.
The article mentions 40 to 48 brokers who manage, in aggregate, wait for it, wait for it, nearly $47 billion. $47 billion. With a B. The group of malcontents allegedly wrote a letter to Morgan Stanley's brass. They said that widespread technology problems have made it difficult for them to do their jobs. They've even hired attorneys to argue that they should be able to keep their lucrative retention bonuses received for sticking around after Morgan Stanley swallowed up Smith Barney, should they decide to exit the firm. Remember what clients got in 2008 for sticking around after the merger? Yea, 40 percent losses. But, Wall Street and Main Street were never happy bedfellows. For the Reuters story, click here.
When I entered the business, I received sage advice from a family friend. He ran his own firm. But, he started at Merrill Lynch. He told me that the brokerage firms were a great place to learn the business. Teach you to hunt in a business where you only eat what you can kill. But he went on to say that the brokerage firms are not the ideal place to practice over the long run. Too sales oriented. Too many conflicts of interest. Looking back, the guy may as well have been short, green, and named Yoda.
Those words rang in my ears when, about six years into my stint at Smith Barney (now Morgan Stanley), I heard my branch manager opine on his financial advisory philosophy.
He was explaining how he had recently dined with a broker he was recruiting to our firm. He asked the recruit to discuss his business. The young man responded that he considered himself a money manager. A steward of client capital.
Recounting the story, my branch manager laughed in that condescending, "Guy doesn't know his tail from a hole in the ground" way. Said he knew then and there that he would never hire the guy. Why? Because the financial services industry may be the money management business, but brokers should never forget that they were salesmen, responsible for selling money management products.
That was all I needed to hear. At that moment, I knew the brokerage firm was a pit stop. Not home. The brokerage firms had disavowed themselves of placing clients first. Look carefully, you can see why.
A rising tide lifts all boats. But, when the economy was crushed in 2008, all of the poor decisions made by the banks and brokerages came to light. The skeletons paraded from the closet. Not even the most well-conceived multi-million dollar marketing communications campaigns, bolstered by advertisement during The Masters, March Madness and The Super Bowl, could hide one simple truth: the largest firms could not manage their own balance sheets. And as the next earnings per share deadlines arrived, followed by the next, and then the next, it would be increasingly difficult to place clients first. Especially until this hole was well into the rearview mirror.
Check out Morgan Stanley's stock price, three and a half years after 2008. You'll quickly learn where that hole is.
Groucho Marx was never, to my knowledge, a stock broker. But, he aptly summed up Wall Street, saying, "Those are my principals, and if you don't like them, well, I have others."
Marx was a brilliant entertainer. He would have been a terrible priest, doctor or financial advisor. Might have made a fine broker, though.
Now Henry Blodget? He grasps the situation. He descended to hell and back. But, he found wisdom.
The once-disgraced, former Merrill Lynch analyst was banned from the securities business for lying in the firm's research. Lying to clients. His bosses. And getting paid bazillions of dollars to do so. Just like Stanley O'Neill was rewarded half a gazillion for bankrupting the once proud firm. Then he found a gold-encrusted escape pod.
Blodget? Well, he found religion. They all do at the wrong end of a judge's gavel. Blodget finally grasped the situation upon looking back over a once stellar, now in the cellar, type of career.
"All else being equal, no one looking for sound financial advice should ever work with a stock broker over a financial advisor."
Touche, Mr. Blodget. Perhaps the truth can set you free.

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