For James Gorman, head of Merrill Lynch's U.S. and global private client group, the largest brokerage operation in the world, the question of what financial advisors need to do to survive in the coming years is simple.

The broker has to be a person who can handle every aspect of a client's financial life. The broker must evolve into a kind of chief financial officer for the client — managing everything from investments to insurance, from estate planning to mortgage banking.

Brokers will still sell stocks, mutual funds and managed accounts, but selling investments has become a commodity business. And it's clear that clients see this. For every client a brokerage brings in another is lost because products — and product pushers — are too undifferentiated. This churning, says Gorman, is a “huge, unneccesary cost.” The solution is to make the relationship ‘sticky’ — to retain gathered assets for decades.

“Clients want that of someone,” Gorman says. “The presumption is that the financial advisor won't do that for them…that they're not interested. And if they don't do it, someone will do it for them.”

Gorman, speaking from his 31st floor office at Merrill Lynch in Manhattan, adjacent to Ground Zero, is issuing a challenge: Become a full-on financial advisor or die. It won't be an easy transformation. Gorman says that despite the recent move towards more comprehensive financial planning, the “DNA of the industry has been sales, and service has been an afterthought.”

Clearly, something has to change. Industry profits have plunged by more than 60 percent to an estimated $8 billion in 2002 from $21 billion in 2000.

Of course, much of that is testament to a slow economy and a lack of investment banking activity. But retail clients have left the market or curtailed their trading — marginalizing thousands of reps.

From Jan. 1, 2001 through the third quarter of 2002, the number of financial advisors at the five New York-based wirehouses has declined by 11.5 percent, to approximately 53,600 from 60,500, according to firm documents. Wall Street, decked by the worst environment since the Great Depression and embarrassed by the research, IPO and other corporate scandals, knows that business as usual is over.

“You cannot differentiate yourself with product,” says Dennis Mooradian, recently named head of Wells Fargo's financial consultant advisory group. “The challenge is, as much as we can't differentiate ourselves with product, that is how we get paid, by selling product. Unless we marry that with great advice, profiling, needs analysis and tax planning, the product is only the excuse to get paid.”

Clients see the difference: According to a recent study by Sanford C. Bernstein, 84 percent of investors who pay an annual fee for service rated broker's advice as very reliable to somewhat reliable; only 69 percent of clients paying by commission said similar things.

“Just buying and selling stocks, well, that's a tough business,” Gorman says. Investment products are so undifferentiated that many firms, in fact, offer the same financial product through third-party relationships as they sell through their own brokers. Prudential Securities' managed account platform, MACS, is available to smaller brokers around the country for example.

And you can be sure any new product will have a clone to compete with before long. For example, the multi-disciplinary account, or MDA, the fund of funds for managed accounts that was “invented” by Citigroup Asset Management, has competitors from software companies you've never heard of. These competitors sell systems they claim allow broker/dealers, money managers or whomever to run multi-style accounts on a mass scale.

Firms have recognized that in order to keep and grow assets they must invest more money in the financial consultant who will need better technology to do the advisory work well. Financial advisors will have expend more labor per client. And that means that advisors will have to limit the total number of clients they handle.

“The days of just gathering clients are over,” says Matt Oechsli, an industry consultant and columnist for this magazine. “Most FAs have more clients than they can properly serve.”

Another trend: reduce the broker's responsibility for finding the most specific investments, instead shifting as many clients as possible to some form of managed money or other packaged product in order to mitigate risk.

Already there are pre-packaged life-style funds that can take the burden of choosing managers away from the broker. All you have to do is interview the clients to assess their risk parameters. Based on that, you choose among pre-packaged fund of funds with the underlying managers and allocation already chosen. Morningstar offers such a product, while SEI Investments, Frank Russell and Brinker International all offer pre-made funds for this purpose and customize them.

To enhance customer service firms are pushing to have brokers form teams in order to spread out responsibilities. Merrill Lynch currently has 45 percent of its advisors in teams, and Gorman says 80 percent is the ultimate goal. Legg Mason's private client head Robert Sabelhaus says that of the firm's approximately 1,300 brokers, all of the largest producers are part of teams. “We think it's the wave of the future,” says Sabelhaus.

Privately, some producers worry that the focus on teams is yet another way for firms to try to keep control of assets should one broker leave the firm; the call a client gets after someone leaves now won't be from a stranger but from another trusted advisor.

The ABCs (and CFPs)

To make the relationship work, though, it takes more resources. That's more training and better technology. It used to be that a few months of training were all that was given before firms gave greenhorns a long list and chained them to a desk next to a phone, but that's expensive and has a low success rate — the turnover rate for new brokers reached 36 percent in 2001, compared with 20 percent in 1998, according to the SIA. That's hard to swallow for a brokerage firm that spends upwards of $250,000 per trainee.

Therefore, firms are spending money to make new brokers qualified to handle questions of all types. Morgan Stanley now spends 52 percent of training costs on course work, compared with 26 percent just four years ago. Merrill's training program has been extended to five years and trainees have internal designations and a CFP after they're finished; other firms have monitoring programs, such as Prudential, which monitors new brokers for five years. The firm also has an extensive training program to help branch managers advise and supervise their charges.

“It can't just be that you've just passed the Series 7,” says Merrill's Gorman. “I've passed the Series 7, a lot of people have passed the Series 7.”

Increased technology costs come hand-in-hand with increased training costs, particularly for tools that help the advisor become more adept at overall financial planning.

New technological offerings include more detailed investment policy statements and advanced use of simulations to help clients assess risk. Wachovia is testing advanced client relationship management software for its forthcoming Envision system (see story page 22) that takes a goal-based approach to retirement planning. Morgan Stanley continues to increase advisor use of its “Lydia” system, a discretionary trading platform that requires additional training by high-end producers.

Higher Costs = Bigger Fish

In a sense, the investments the firms are making mirror the platitudes that have been voiced for individual investors for years and years: Invest for the long term. But this greater investment in the financial professionals has to have a long-term payoff.

Problem is, even today's investment doesn't pay. “We ran some numbers that showed at a wirehouse, where the average production was $400,000, the broker got $160,000 and it cost the firm $150,000,” says Andre Cappon, president of CBM Consulting. “That is a big nut and it keeps going up.”

To make the math work, brokers will have to focus on clients who are most likely to provide repeat business. That's why firms are continuing to aim for wealthier and wealthier clients and embrace strategies of segmentation, whereby the biggest accounts receive more dedicated service with more people than smaller accounts.

Merrill has embraced this concept entirely; Morgan Stanley and Smith Barney have similar strategies. Meanwhile, American Express is joining the party, too: It is taking a more segmented approach to its clients, offering one level of service to clients worth $100,000 to $1 million, and clients with $1 million to $7 million get other perks (such as a concierge-type service and enhanced American Express Card features) under its Platinum Financial designation.

Along with a heightened focus on high-end clients comes more attention to high-end producers. The minimum for survival at a wirehouse is now somewhere around $250,000 in production. For 2003 Salomon Smith Barney has already reduced the payout for lower-end producers, and even A.G. Edwards, highly regarded for not pressuring its producers, enforces a minimum production level now.

Brokerages have to keep pushing for a deep relationship with profitable clients as they battle with banks and other institutions to capture as much of a person's wallet as possible. The desire for control of client assets has always been part of the thinking of any brokerage worth its salt, but it has intensified. “Even if you own 100 percent of a slice of a person's business, that will not be enough,” says one executive who requested anonymity.

To wit: Merrill currently has a major sales contest to push its new Beyond Banking platform, a bank account that works in tandem with existing Merrill cash management accounts. American Express, meanwhile is trying to drum up business in its advisory services by proffering Platinum credit cards; the large national banks continue to expand their brokerage offerings, and brokers at many firms, such as Prudential Securities, Raymond James and Wells Fargo, are getting licenses to sell insurance.

Consolidation Awaits

At the same time, firms are headed is to each other's boardrooms in search of assets.

CIBC's recent sale of its U.S. brokerage unit, Oppenheimer, to New York-based Fahnestock was only a hint of what many expect will be a year filled with acquisitions, ranging from large (Prudential Securities and A.G. Edwards are among those considered potential targets) to smaller wealth management firms. “The economics of running an advisor distribution model is under pressure from all sides,” says Barry Murphy, executive vice president of the retail group at American Express, who adds that compliance costs alone are enough to sink many a small firm.

This means a further thinning of the ranks among brokers. Consultant and Registered Rep. columnist Russ Alan Prince says that with 600,000 Series 7 holders, the industry has too many brokers, saying further consolidation of about 20 percent is possible. That's for an industry already experiencing its largest reduction in employment since the 1970s.

“Schwab has cut 35 percent of its headcount; Merrill has cut 25 percent,” says Kelly Tang, analyst at Sanford C. Bernstein. “They're all getting very aggressive in terms of cutting headcount and expenses.”

Happy New Year? Regardless of how well the market may do in 2003, the brokerage industry still hasn't worked off the excesses of the bull market. Gorman, for one, thinks that those who are truly the strongest will survive this year: “If firms haven't confronted this already, it may be too late,” he says.