It's one of the most indelible screen images of recent years — after rolling through a pit of fire to gain access to Alcatraz, a weathered Sean Connery emerges and announces defiantly, “Welcome to the rock.”

The last few years haven't been that much different for Prudential Financial. After coping with sales-practice litigation, pruning unprofitable businesses, demutualization and a public offering, Prudential — also known as “The Rock” in its advertising — is emerging, hair singed, muscles aching, but a bit more sculpted.

In 2001, Prudential's brokerage arm had a terrible year in what was a dismal year for the entire industry. Following the demise of the historic bull market, Prudential's private client group, which includes the brokerage business, lost an estimated $235 million due to lower trading volumes, shrinking assets and declining sales. The company has done well in moving its brokers beyond transactions and into fee-based account management. But, analysts say, unless these efforts start generating better returns, Prudential could wind up selling its investment brokerage business.

The entire brokerage industry has had a couple of tough years, and 2002 has started out rocky. But Prudential faces an especially tough set of challenges. Pru, the nation's ninth-largest brokerage, is aggressively staking its claim in the crowded field referred to as the “mass affluent,” those with $100,000 to $250,000 to invest. To increase its reach in that market, Pru has been rebuilding its distribution process by creating a consultant-style account management strategy. It is also cutting back on expenses, shedding brokers, and attempting to generate the earnings to make up for the loss of investment banking, a high-margin business that Prudential exited in 2000.

Oh, yeah, it's doing all this now as a freshly minted public entity, where scrutiny is intense, having raised $3 billion in an IPO this past December.

Some say there's reason to believe that Prudential's effort isn't just a series of warmed-over platitudes. “Right now, it is safe to say that all the major brokerage firms are deeply entrenched in the commission brokerage mode, save for Merrill Lynch,” says Stephen Wicks, founder of the Society of Senior Consultants in Richmond, Va., and former head of investment management consulting for Prudential Securities. “But if a major firm is going to make a breakthrough in the advice business, it's going to be Prudential.”

The firm, like many others, has no real choice in the matter. With commissions shrinking, there's no place else to go.

Pru may have more at stake in its drive to become a total wealth consultancy. Some equity analysts believe that without a turnaround, the brokerage arm could be sold. “They've got to get leaner and meaner,” says Salomon Smith Barney's Colin Devine, who has a “buy” on the stock. “Pru Securities has been given 18 months to fish or cut bait. They've got to prove they're a viable operation.”

It's not hard to see why some other firms would want Pru. As of the second quarter 2001, Prudential ranked fifth as a sponsor of managed accounts, with $34.1 billion in assets, according to Cerulli Associates (its definition of managed account programs includes proprietary wrap, consultant wrap, rep as a portfolio manager, mutual fund wrap and fee-based programs). Pru has a presence in 11 million American households, with 3.6 million of those in the mass affluent market. Currently, Pru is above average in terms of the percentage of its brokerage revenue that's derived from wrap-fee consultative business. Some of that has to do with the aggressive recruiting Prudential engaged in beginning around 1999. Executive recruiters say that Pru was among the most generous in terms of the deals it was offering to recruit talent.

The costs of that talent ended up getting slammed in what's been a painful two years. Pru, which has trimmed the number of its financial planners to 6,500 from 6,900 in 1999, is continuing to cut back on its poorest performers.

Meanwhile, Prudential's approach when it comes to recruitment has been modified, though not all that much. Pru says it is now more focused on hiring and retaining people (by paying them well) than hiring and training people, only to lose them. Jamie Price, president of Prudential Securities, says the firm's deferred compensation plan rivals Smith Barney's in terms of aggressiveness.

Check's in the Mail

Like many other brokerages, Pru is paying more for fee-based business than it is for transactional business. Brokers, depending on their level of production, are receiving “grid” plus five percentage points for fee-based business, as opposed to transactional business. One East Coast-based rep says, “All the industry is cherishing fees — it is nice, because you get a big check every quarter.”

The ultimate goal is for production to be split, with about half coming from transaction business and half from fee-based business. But the latter is going to be encouraged. The average broker concentrating on fees has 6 percent more in assets and is five years younger than his/her transaction-based counterpart.

Of course, all brokerages are pushing fee-based, “wealth management” type programs. But analysts say Pru is further along than some other firms. Price says Pru is trying to get representatives to focus first on the process of bringing in money and, second, to tailor the specific product. To that end, Pru is retraining its financial advisors, encouraging them to think in terms of estate planning, trust planning and promoting use of asset allocation models. “Our earlier training was about running your business and how to streamline your book,” Price says. “But it wasn't knowledge-based about external factors, [such as] issues about taxes.”

More Sell Recommendations

What makes Pru different from its competitors is its bold choice last year to exit the investment banking business. It now participates in underwriting on a co-managed basis only. The idea was to increase its own research credibility by eliminating the conflict of interest that investment banking poses to analysts.

It's a risky choice. The model is unproven for a firm of Pru's size, and, financially, Pru could also miss out on the lucrative banking business when the economy rebounds. “Will they regret it a year from now? They might,” says Anton Shutz, portfolio manager at Dresdner. “But there are people who say they like dealing with Pru,” he says, because of the perception of a less compromised position. (Of all its equity research calls, Pru has “sells” on 7 percent.)

In addition, Prudential is hoping the research-driven focus and myriad of asset allocation models, along with its efforts in wealth management consulting, will boost its third-party distribution efforts.

“Prudential is the firm among the five wirehouses that has made the most inroads to bringing a range of their offerings and technology outside the Prudential system,” says Andrew Guillette, vice president at Cerulli Associates.

Top Sponsors of Managed Accounts*
as of Q2 2001 figures in billions of dollars
Salomon Smith Barney 187.1
Merrill Lynch 180.5
UBS PaineWebber 58.5
Morgan Stanley 51.2
Prudential 34.1
SEI Investments 26.7
*Managed accounts, as defined by Cerulli Associates, include: consultant wrap, proprietary consultant wrap, mutual fund wrap, fee-based brokerage and rep as portfolio manager.
Source: Cerulli Associates