broker wars are breaking out again

broker wars

Although little noticed, they’re a recurring feature of the traditional “full service” brokerage business.  The Wall Street Journal reported last week that Merrill Lynch is now targeting a large number of high-producing Morgan Stanley registered reps to woo.

The fact itself that this is happening isn’t so interesting, since widespread poaching of salesmen occurs every few years.  But two other aspects are:

–the fact that this is happening now, since broker wars almost always happen when times are good, and

–that for the first time I know of, the terms of the deals offered can be seen in print.  For a MS broker who earns $1 million a year, the WSJ says ML is willing to pay a $1.5 million signing bonus.

why not grow a sales force instead?

The traditional brokerage business has enormous overheads–branch offices, administration, advertising, trading desks–to support.  So brokers constantly need revenue.  There’s no guarantee–look at the Yankees–that home-grown talent will ever reach stardom.  Recruiting already successful “free agents” is faster, and potentially produces a more certain stream of income.

the economics are favorable

Typically, a “full service” broker nets a bit less than half the gross revenue he produces for his firm.  A $1 million annual income implies a broker makes another $1 million+ that goes to his firm each year.  Assuming that he can continue to earn at the same rate for his new employer, the hiring firm will break even in 18 months.  (Typically, such recruits sign three-year contracts preventing them from moving again.)

In today’s world, the cost of financing the signing bonus is effectively zero, another plus.

retaining clients is the key variable

As soon as a broker leaves a firm, his accounts are redistributed to other registered reps–who immediately begin to contact these customers to try to persuade them not to follow the leaving broker to the new company.

Of course, the departing broker does the same thing.  Invariably, he sends a letter to his customers (probably in a form suggested by his new firm) explaining that he has made the move for their benefit and extolling the virtues of his new address.  Somehow, he always “forgets” to mention the gigantic signing bonus he is receiving.

One big key in this process is the extent to which clients own proprietary mutual funds managed by the “old” firm.

Such clients have paid a sales charge–sometimes as much as 5% of the principal originally invested-when they bought the shares.  Hopefully, they also have capital gains.  These clients tend to be more loyal to the firm than to their broker.

Even if they aren’t, they may also be reluctant to transfer the shares to a new firm where they won’t get as much information about the holdings.  They certainly won’t want to incur the capital gains tax and new sales charges that switching fund holdings would entail.

Knowing this, and planning for the possibility that a headhunter will call someday, savvy brokers will try to focus their clients’ investments on third-party mutual fund groups, which can be seamlessly transferred to another brokerage house.

investment implications

On a microeconomic level, this behavior is what happens in a mature industry.  There are few new customers, ones who have no brokerage relationships–traditional or discount.  So the easiest (only?) way to gain market share is to take it from someone else.

More important to me, if this ML recruitment attempt is successful, it will imply that the underlying tone of business is better than commonly thought.  Because it is making this push, ML must have already reached this conclusion.


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