Morgan Stanley’s retail brokerage recorded pretax tax profits of $30 million for the third quarter, a healthy 36 percent gain over last year, despite a continued exodus of advisors and large legal and regulatory costs. But client assets fell versus the prior quarter, an ominous sign.

Total client assets at the retail brokerage unit, or Individual Investor Group (IIG), were up 7 percent, to $619 billion, versus a year ago, even as total advisor headcount at the firm sank 14 percent, to 9,311, versus last year. Most of the drop in advisor numbers is the result of layoffs announced in August—about 10 percent of the brokerage force (roughly 1,000 reps) was fired for low production.

But the retail unit is also losing productive FAs, something that began this spring with the shake-up that lead to former CEO Philip Purcell’s ouster. Apparently, many productive FAs are taking their books with them to Morgan rivals, said Morgan Stanley CFO David Sidwell on a conference call Wednesday. “Competitors have stepped up already aggressive recruiting of our brokers. This will be a challenge going forward,” he said. And that's took its toll on asset flows for the quarter: IIG had negative net new asset flows of $2.1 billion in the third quarter compared to the prior quarter. That’s something that hasn’t happened in several years, an analyst on the call noted.

Morgan’s margins stood at 13 percent in the third quarter, well below those of peers at Merrill Lynch, Smith Barney and UBS. But Sidwell was optimistic that the firm will ultimately match its rivals: “It will take time to get to 20 percent margins,” he said on the call, “but we can do it.” (Morgan’s inferior margins—and revenues per broker—have made it a target of intense shareholder criticism, and are at least partially responsible for the departure of Purcell earlier this year.)

Sidwell said new leadership would play a central role in getting those margins up. He underlined the recent hiring of key management, including James Gorman of Merrill Lynch as the new head of retail; Eileen Murray as head of technology and operations; and Gary Lynch as the new chief legal officer. Gorman and Murray will lead the way in reinvigorating IIG’s focus on high-net-worth clients and expanding its product offerings, says Sidwell, including more alternative investments and structured products.

Lynch, meanwhile, will try to put the firm’s legal woes behind it. Until then, litigation related to current employee wage and hour lawsuits, as well as regulatory and branch litigation matters “will continue to be a drag on profit margins” at the retail unit, says Sidwell.