IT TOOK SOME TIME, but the brokerage industry finally is coming to terms with the death in the family. In this case, the dear departed is a way of operating that is now gone for good. Like any mourner, the industry has collectively gone through the classic phases — denial and anger, then, finally, acceptance. Perhaps cooperation is a better description, although there the metaphor ends.

It's no mystery what did in the old order — a combination of market forces and regulatory changes. Nor is it a mystery why it happened: Retail investors got trashed in the bear market of the early 2000s and, in the autopsy, regulators uncovered a series of abuses, ranging from corrupt research to self-dealing in mutual fund marketing.

Still, the brokerage management has had some trouble letting go; there were some abuses, but the system was working fine, they say. Lately, however, there is a palpable sense of acceptance that the new regulatory climate is likely to be a permanent one.

As one industry lawyer put it, the scrutiny has created a “new version of what's normal,” in the industry, and most firms and advisors seem to be adjusting. In their own ways, the individuals we highlight in the 2005 edition of Registered Rep.'s Ten To Watch list are all key players in this new world order (the profiles start on page 48).

On the List

The most visible sign of the industry's resignation to the “new normal” is, in fact, the most notorious resignation Wall Street has seen in years — the forced exit of Morgan Stanley CEO Philip Purcell. The one-time Sears executive certainly had become a symbol of what would no longer work on Wall Street, in particular trying to sweeten the bottom line by inducing thousands of former Dean Witter reps to push dubious house-brand products. Even before regulators clamped down on the practice, which cost consumers untold millions in opportunity costs, the game was up. Competitors that had embraced open architecture, and let reps sell what was best for clients, gathered more assets and saw greater broker productivity.

Now, it's up to John Mack to bring Morgan Stanley squarely into the new era. Mack is perhaps the highest profile executive on this year's Ten To Watch list. In this return engagement at Morgan (a 25-plus-year Morgan Stanley veteran, he was president of the firm after the Dean Witter merger in 1997, but left in 2001), his first task is to settle the turf battles that have plagued the company.

Another factor in the “new normal” brokerage environment is the evolution of nontraditional competitors, such as online broker TD Ameritrade and discount broker Charles Schwab & Co. The former, created through the June merger of TD Waterhouse and Ameritrade, is an instant powerhouse in the online trading market. But more significantly, it is also likely to be a potent competitor in the retail advisory market, with over 4,000 advisors in 140 branches nationwide. Meanwhile, Chuck Schwab has circled the wagons at the firm that bears his name. Though online trading remains hopelessly below bull market volumes, the firm is gathering new client assets at a pace that should not escape the attention of advisors looking to land new clients.

Also present on the Ten To Watch list are a pair of regulators — Chris Cox, new chairman of the SEC, and Susan Merrill, head of enforcement at the NYSE. Both are intent on improving their organization's effectiveness.

Two other of our Ten To Watch figures are hoping to put some limits on how far the regulatory backlash extends. Unlike other mutual fund firms, American Funds is protesting that regulators are unfairly, and opportunistically, punishing it for abiding by what were generally accepted business practices. Its message: You can't change a rule and then retroactively punish financial firms. Meanwhile, Dale Brown at the recently created Financial Services Institute, a group that represents independent contractor broker/dealers and their reps, is battling to prevent “regulation by enforcement,” as the retroactive punishment is called, and to have a voice in the making of any new regulations.

Rounding out this year's list are three executives with very different challenges in the coming year. Chip Mason, CEO of Legg Mason, for the first time in 43 years faces a future without a brokerage unit, which his firm sold to Citigroup. Jim Cracchiolo will have newfound freedom but also marketing challenges in running the American Express brokerage spinoff known as Ameriprise (formerly American Express Financial Advisors). Lastly, Bob McCann has the enviable task of making powerhouse Merrill Lynch even more efficient.

This year's Ten To Watch list is a roster of people coming to terms with the new reality that hyper-regulation and hyper-competition has spawned. All are likely to prove that acceptance of this reality does not mean passivity.

The Fighter

American Funds

Est. 1931 / Advisor: Capital Research & Mgmt. / AUM: $650 billion, 2nd largest fund family in the U.S. / Location: Santa Ana, Calif.

Are the executives who run American Funds crazy? Instead of settling with the state of California and NASD (without admitting or denying guilt, of course, and putting the matter behind them), the executives who run American Funds — or, rather, its parent, The Capital Group Cos. — are taking a stand.

It is highly unusual; most broker/dealers and funds just pay their fines (without admitting or denying guilt) and move on. Not American Funds. The company's management apparently believes it has nothing to lose.

The company's argument boils down to this (according to observers): We didn't do anything illegal, just followed what were considered established business practices. If those practices don't make sense any more, fine, we'll change as directed. But we're not taking a hit from overly ambitious regulators. (American Funds and its parent company declined to comment.) American will fight a two-front battle: On the federal level, the NASD has charged American with improperly directing $100 million in commissions to brokerages that were the top sellers of its mutual funds. American will argue its practices adhered to established rules.

And in California, American is arguing the federal government is the sole regulator of national securities offerings, which means that California's attorney general has no regulation over American and that California's beef should be moved to the SEC.

What are American's chances? Lawyers believe it will have a better shot at prevailing in California, where precedents for Lockyer's case are weak. “There's always an issue of whether you should fight — fight to get a better settlement, or fight to win,” and American appears to be doing the latter, said David Nolte, at advisor Fulcrum Financial Inquiry. “But if you fight and lose, you followed the wrong strategy.”
Christopher O'Leary

The Lobbyist

Dale E. Brown

Age: 43 / Position: Executive Director & CEO, Financial Services Institute / Location: Atlanta / Education: Georgia St.

Independent contractor broker/dealers battle perceptions that they have supervisory problems. Some indie b/d executives grouse that regulators have a negative bias against the independent contractor model because independent reps are dispersed and not concentrated in branches, with supervisors literally peering over their shoulders. Further, the recent rash of regulatory activity is having a disproportionate effect on independent contractor b/ds because they are often smaller (under 1,000 reps) and don't have the economies of scale to cope with increased compliance burdens.

The Financial Services Institute (FSI) wants to change how regulators, lawmakers and the public perceive its members. Born out of the Financial Planning Association, FSI aims to be the voice of the independent contractor broker/dealer and the independent financial advisor. Just over a year-and-half old, FSI, under CEO Dale Brown, has about 100 member firms, representing more than $8 billion in annual revenue and 125,000 independent reps. FSI is now open to independent contractor registered reps and has signed up 1,500. And it has launched a PAC to bring its case to Capitol Hill.

The goal? It's a tall one: “Our purpose is to help shape a more positive regulatory environment for independent broker/dealers and independent advisors,” says Brown. Besides signing up more firms and individual reps, like any lobbyist (although Brown never uses that word), FSI wants to influence regulators and lawmakers, to educate them about their business. “Our business model is unique in the financial services industry,” Brown says. “Some of our members don't get the impression that the regulators sitting across the table from them understands fully their business.” But they are listening.

“They don't agree on everything, but we're getting a dialogue going.”
David A. Geracioti

The Top Cop

Chris Cox

Age: 52 / Position: Chairman, SEC / Location: Washington, D.C. / Education: USC, Harvard Business School, Harvard Law

After two-and-half years of fierce regulatory action, the SEC's new head is likely to be much friendlier to business and slow down the pace of Donaldson-era regulation.

A former corporate finance attorney and libertarian, Cox has spent much of his Congressional 16-year career as “a champion of the free enterprise system,” President Bush said during a White House ceremony. He co-sponsored the Private Securities Litigation Reform Act of 1995, which supporters said curbed frivolous class-action lawsuits and critics said protected naughty corporate bigwigs, helping to create disasters like Enron and WorldCom.

Cox's supporters want him to undo some of the more controversial 3-to-2 rulings Donaldson passed at the SEC, including requiring hedge fund registration and a majority of independent directors at mutual funds. However, that isn't likely. “It would be very odd if he made big changes,” says Jaret Seiberg, a financial analyst at Stanford Washington Research Group. You may, however, see more 5-to-0 decisions, as both Cox and the outnumbered Democrats seek compromise and consensus, says Seiberg.

The industry will probably see a slowdown in the number of SEC “sweeps” and the feverish level of enforcement, which included an unprecedented 1,700 actions and $7.7 billion in disgorgements and penalties over Donaldson's tenure. That may require reigning in newly appointed enforcement chief, Linda Chatman Thomsen, who is said to be as aggressive as her predecessor, Stephen Cutler. Some think Cox will find a balance.

“The agency will continue to be aggressive with egregious violators of the laws, but probably less intrusive into business practices before there's evidence of wrongdoing,” says Aegis Frumento, a New York securities attorney with Duane Morris.
John Churchill

The Entrepreneur

Jim Cracchiolo

Age: 47 / Position: Chairman, CEO of Ameriprise Financial / Location: Minneapolis / Education: NYU, NYU Graduate School of Business

Ameriprise Financial has just been cut loose from parent, American Express, unleashing a more nimble giant into the retail brokerage world. With almost $250 billion in client assets, net income of $700 million in 2004 and around 12,000 advisors, it will emerge from its scheduled Aug. 1 spinoff a Fortune 500 company that rivals Wall Street's biggest wirehouses in size of its advisor network. Cutting the cord, say analysts, will also allow it to access the capital market on its own terms, and free it from brand confusion generated by the American Express credit-card business.

Still, the captain of this ship, CEO Jim Cracchiolo, faces a number of challenges. Ameriprise advisors tend to be lower-producing and less sophisticated than those at rival wirehouses and independent broker/dealers; its mutual funds are still relative underperformers despite significant improvements; its new brand is an unknown; and a few recent run-ins with regulators may have sullied its image with those advisors and investors who do know it.

So what will Cracchiolo do with his newfound freedom? The executive says he plans to build on recent efforts to improve advisor productivity through training and recruiting, to invest heavily in the new brand and to put together a strong team in senior management.

“This is a big opportunity for them. This should speed things up if they are able to make some smart decisions,” says Tom Watson, an analyst with Forrester Research. If he does it right, Cracchiolo could turn Ameriprise into a force to be reckoned with.
Kristen French

The Comeback Kid

John Mack

Age: 60 / Position: Chairman of the Board and CEO, Morgan Stanley / Location: New York / Education: Duke University

How beleaguered were Morgan Stanley employees by the Philip Purcell brouhaha? When John Mack returned to Morgan Stanley's headquarters at 1221 Avenue of the Americas this past June, the rank-and-file stood and applauded. (That he once was known as “Mack the Knife” makes the ovation all the more poignant.) Indeed, Mack's comeback has the trappings of a Shakespearean drama: the 20-year veteran loses a power struggle to Purcell and eventually returns to vanquish his vanquisher.

Mack the Knife? Try the Comeback Kid. The board of directors made the choice unanimously and quickly — within days of Purcell's resignation. But now Mack must quickly sort out the mess that Purcell's tenure left behind. But what will Mack do? How will Mack restore Morgan Stanley to the top of the league tables in underwriting and also bring its retail brokerage up in stature?

“I think Mack is the best choice the board could have made,” says Guy Moszkowski, an analyst at Merrill Lynch. “This said, he doesn't have a lot of experience running a retail unit, and the cultural fit between Individual Investor Group [Morgan's retail brokerage] and the institutional side of Morgan Stanley is poor.”

First, analysts say he must recruit a fresh, well-regarded management team — or bring back refugee executives. And, to turn around the IIG, which trails its peers on revenue per rep and profitability, “He has to build a team approach and get those advisors in a position where they can sell multiple products,” says Punk Ziegel analyst Richard Bové. Will he sell the retail brokerage? “He called IIG his ‘hidden asset.’ He has no intention of selling,” Bové says. Well, at least not yet.
DAG

The Dealmaker

Raymond A. “Chip” Mason

Age: 68 / Position: Chairman, President and CEO of Legg Mason / Location: Baltimore / Education: College of William and Mary

Legg Mason CEO Chip Mason just made a very bold move. He got rid of the brokerage business that launched his career 43 years ago, when he founded retail brokerage house Legg Mason. As one head of a giant brokerage put it: “Chip has just shorted distribution and gone long asset management.” It's an interesting bet. He may be one step ahead of the rest.

Mason's $3.7 billion swap seems smart, given the regulatory climate, but he still has a lot to prove. He has done numerous acquisitions over the years, but these were smaller and mostly top-performing niche asset management shops, which even now operate mostly independent from Legg. Citi's asset management group is known for its subpar performance. The operation will require integration of a big chunk of Citigroup's business into Legg's Western Asset Management Group.

And it will more than double Legg Mason's assets under management to $830 billion. The integration itself carries risks: If Legg isn't able to turn Citi's funds around, it could have a big impact on the firm's overall performance rankings, spooking investors and driving away assets. Still, Mason built a comfortable safety net into the deal. Citigroup will be the primary distributor for Legg Mason funds over the next three years. That's a blessing, because Legg brokers are a very productive lot, and a double-digit chunk of their productivity is attributable to Legg Mason funds, according to the company. If Mason succeeds, his deal with Citigroup may serve as a blueprint for future asset and brokerage swaps in the industry.
KF

The Pace Setter

Robert McCann

Age: 47 / Position: President, Global Private Client Group, Merrill Lynch / Location: New York / Education: Bethany College, Texas Christian University

By most productivity metrics, Merrill Lynch financial advisors are the best in the industry: average assets, revenue and earnings per FA. In 2004, the Global Private Client Group posted a 23 percent jump in pretax earnings. Which presents a problem, albeit a high-class one, for Robert McCann, a 20-plus-year Merrill veteran who in June replaced James Gorman as the head of Merrill's Private Client Group day to day: Where do you go from here?

Growth and higher efficiency will come, says Sandler O'Neill analyst Jeff Harte, from winning more high-net-worth clients and more “wallet share” of current clients. “Merrill has a pretty complete offering,” Harte says, referring to the new Merrill+Visa card and its Loan Management Account, which were introduced last year. “The challenge now is to take these products and market them effectively.”

The Private Client Group has done well in diversifying its revenue: 19 percent of client assets now reside in asset-priced accounts (includes fee-based and interest-paying accounts). In mortgages, Merrill has been very effective, Harte says.

But interestingly: most of the 7 percent gain in client assets for 2004 were from market appreciation. That means that while things are good, McCann has to help come up with a strategy for growth. First, McCann says he intends to focus on adding 5 percent more advisors per year to its already 14,420-strong FA network; top on his list are million-dollar producers. Also, while going for the high end, Merrill will have to successfully adhere to its so-called client segmentation strategy: providing no-touch but high-tech services for clients with little in assets and the sophisticated high-touch private wealth offerings offered by, say, Goldman Sachs for rich clients.

“Merrill has been pretty successful with its client segmentation strategy,” Harte says. “But they are trying to move upscale in to what is becoming an increasingly competitive high-net-worth segment.”
DAG

The Enforcer

Susan Merrill

Age: 47 / Position: Executive Vice President, Chief of Enforcement, NYSE / Location: New York / Education: Univ. of Md., Brooklyn Law

As the chief enforcer and one of four appointees who now lead a revamped New York Stock Exchange Regulation unit, Susan Merrill has a tough job: restoring the credibility of the Exchange's self-regulatory status.

A former partner at Davis Polk & Wardwell, where she represented some of Wall Street's biggest individuals and firms, Merrill is no wolf guarding the hen house door. Last September, after only a few months on the job, she slapped Morgan Stanley with a $19 million fine — the largest by the NYSE — for failing to deliver prospectuses and other supervisory violations. In another display of its newfound stridency, NYSE (and other regulators) fined Deutsche Bank $7.5 million for not producing email records in a timely fashion. In short, the NYSE is not going to take it anymore.

“I think you'll find clear agreement across the industry that everything from the nature of the discussions to sanctions is much more threatening,” says one wirehouse regulatory counsel, likening her approach to “sabre rattling” to scare firms into line.

Perhaps, but a lot is at stake: The exchange's inability to detect fraud among specialist firms operating on its floor between 1999 and 2003 has blighted the self-regulatory model — New York Attorney General Eliot Spitzer called it a “complete failure” before Congress. The SEC is even considering scrapping the NASD and NYSE and creating one super regulator.

Chief Regulatory Officer Richard Ketchum says “re-architecture” isn't the answer, and the merger with Archipelago and subsequent spin off of NYSE Regulation into a nonprofit — just as Nasdaq did with NASD — will provide the solution. It will be partly Susan Merrill's responsibility to convince regulators and shareholders SROs work.
JC

The Consolidator

Joe Moglia

Age: 56 / Position: CEO Ameritrade, CEO TD Ameritrade / Location: Omaha / Education: Fordham University, 8rgr University of Delaware

Remember when online brokers were going to render flesh-and-blood, full-service advisors obsolete? Now it's online brokerages that are struggling: Trading volumes have plummeted and a price war has broken out. There is simply too much online trading capacity. Ameritrade is the first online broker to pull off what analysts say is the inevitable; and it did so in style, cementing a deal in late June to buy TD Waterhouse. Joe Moglia, CEO of Ameritrade, is the man behind the merger and will become the CEO of the new combined entity — TD Ameritrade.

Known as a turnaround artist and dealmaker, Moglia has completed seven successful acquisitions, approximately doubling the size of the company, since coming on board as CEO at Ameritrade four years ago. But the current acquisition, at around $3.6 billion, is his biggest yet. Moreover, it represents a major strategic shift for the company: in the direction of retail advice given by flesh-and-blood advisors at actual branches. The combined TD Ameritrade will have over 4,000 financial advisors in 140 branches nationwide.

Alas, there are challenges. Compared with rivals Fidelity and Schwab, TD Ameritrade will still be the low-end broker: The average TD Waterhouse advisor isn't known for his prowess among the well heeled. And Moglia may not be through buying companies. E*Trade, who made a failed bid for Ameritrade, would make the most sense, according to Raymond James analyst Michael Vinciquerra. “It has a large platform, the same type of [online] customer, there are huge cost saves between the firms,” he says. And with E*Trade, TD Ameritrade would have a bank in-house. Is Moglia in the midst of creating the next giant brokerage?
KF

The Renovator

Chuck Schwab

Age: 68 / Position: CEO, Charles Schwab / Location: San Francisco / Education: Stanford

Having returned to the driver's seat just one year ago, Charles Schwab has certainly gotten his eponymous firm back on its feet. By slashing costs, and adding more fee-based advice offerings, he's been able to offset plunging trading revenues at Schwab's online brokerage. In the second quarter, Schwab recorded its strongest profit since the second quarter of 2003, including when online trading was still hot.

But, despite his comments to the contrary, U.S. Trust, the company's private banking arm that is oft rumored to be for sale, doesn't seem to be humming. U.S. Trust margins have almost tripled to 17 percent, but industrywide margins are closer to 30 percent. Having cut expenses, consolidated operations and put the right pricing in place, U.S. Trust can now work on adding new clients, says Smith Barney analyst Prashant Bhatia. The unit hired a new CEO (the former CEO of Citigroup's Private Bank) to help.

The resuscitation of Schwab poses a formidable threat to broker/dealer rivals. The company is already the most powerful asset gatherer out there: Schwab brought in $55 billion in net new client assets during 2004, vs. $57 billion at Merrill Lynch, Morgan Stanley and Smith Barney combined. Bhatia predicts Schwab can raise even more in 2005 and beyond.

Persistent rumors have it that Schwab was on the block, but Chuck denied them, and, just like that, those rumors fell out of the newspapers. After all, firms that are looking for partners or to be bought typically “have hit a brick wall in terms of growth,” says Bhatia. “There's nothing here a buyer is going to do to help.”
KF

Where Are They Now?

An update on last year's Ten To Watch, a list that was heavy with reformers and regulatory types.

  1. Danny Ludeman, CEO Wachovia Securities.

    Last year's challenge: Making the most of the firm's clout.

    How he's doing: Earnings in the capital management group were up 13 percent in the second quarter of 2005, despite a year-over-year 1.6 percent drop in revenue. Total client assets reached $655 billion, up 6 percent (roughly in line with other big firms).

  2. Mercer Bullard, President, Fund Democracy.

    Last year's challenge: Fight for mutual fund disclosure reform.

    How he's doing: No major reforms, but he continues to fight, addressing Congress and convening a group of influential mutual fund regulators at his Mutual Fund Summit.

  3. Mark Cassady, President, LPL Financial Services.

    Last year's challenge: Continue 10 to 15 percent annual growth.

    How he's doing: Proceeding apace — and then some. Revenues rose 27.6 percent in 2004 to $1.1 billion.

  4. Eric Dinallo, Head of Regulatory Matters, Morgan Stanley.

    Last year's challenge: Nip regulatory problems in the bud.

    How he's doing: Has established productive regulatory dialogue on many levels—accurately predicted and interpreted new challenges in the regulatory environment, with recognized advances in the firm's regulatory relations and matters.

  5. Charles Haldeman, CEO Putnam Investments.

    Last year's challenge: Rehabilitate Putnam's image and stem asset runoff.

    How he's doing: Ongoing net outflows have shrunk mutual fund assets 28 percent, to $117 billion, in the 18 months ending June 30.

  6. Robert Pozen, Chairman, MFS Investment Management.

    Last year's challenge: Fix fund-trading troubles with regulators.

    How he's doing: Imposed restrictions on mutual fund trading to stem market timing and late trading. The company has gone so far as to hire a forensic accountant to identify such activity and to freeze the assets of the traders involved.

  7. Paul Roye, late of the SEC.

    Last year's challenge: Scare mutual fund companies straight.

    How he's doing: He scared them good — and then left the SEC. Among his initiatives: a ban on directed brokerage and a raft of disclosure requirements for fund fees, expenses, breakpoints and market-timing policies.

  8. Mary Schapiro, President NASD Regulation.

    Last year's challenge: Give the NASD a stronger voice.

    How she's doing: Her investigations into 529 and variable annuity sales practices, IPO-lock up violations and supervisory procedures have made it clear she is on a mission.

  9. Paul Schott Stevens, President, Investment Company Institute.

    Last year's challenge: Rebuild investor trust in mutual funds.

    How he's doing: Fears of massive scandal-related outflows didn't materialize. Stevens arrived in March 2004 and by year-end stock fund inflows were $177 billion, the largest gain since 2000.

  10. John Thain, CEO NYSE.

    Last year's challenge: Upgrade the NYSE's technology.

    How he's doing: Merger agreement with Archipelago, an electronic stock exchange, modernizes an archaic institution.