THE GREAT EXPERIMENT

In March 2000, at roughly the peak of the stock market boom, the folks at American Express Financial Advisors felt expansive. The Minneapolis-based subsidiary of American Express announced it wanted to nearly double its advisor ranks to 20,000 within eight years, the better to serve the “emerging affluent” — a market that had ballooned thanks to newly minted, technology-fueled wealth. Soaring stock values had pumped up revenues and assets under management for AEFA. But the bull market also made jobs plentiful, and American Express was losing restless advisors faster than it liked.

In an effort to hang on to its best producers and lure a fresh crop, AEFA launched triple career tracks for its reps. Advisors could remain full-time American Express employees, with salary, benefits and expense reimbursement; they could become quasi-independent franchisees, with access to American Express research and product support but with responsibility for their own overhead; or they could work as fully independent contractors in the company's Securities America unit, without being allowed to use American Express' brand name or its resources.

The move was a first for the financial services industry. At the time, no other major institution offered the franchise option. Even now, only a handful of companies, including Raymond James Financial and Wachovia, lets reps choose between captive and noncaptive platforms. With a tradition of grooming brokers from scratch, American Express management hoped the franchise option would attract more seasoned planners who would bring sophisticated skills — and rich new clients — under the corporate umbrella. “AEFA is known for hiring and training novice advisors, people who are not generally licensed,” says Teresa Hanratty, senior vice-president of AEFA's U.S. advisor group. “We want more people who are experienced in the industry.”

Four years later, the strategy hasn't quite panned out. AEFA still has a reputation, among clients and reps alike, as a downmarket firm — a legacy of its roots as Everyman's mutual fund broker. The multitrack model has somewhat backfired, too. Many top-producing reps have picked the franchisee platform, opting for partial independence and a higher payout: Among the current 10,500 advisors in the U.S., 7,500 are franchisees. That means AEFA must support a platoon of relatively low-performing captive brokers whose high-octane colleagues are no longer subsidizing them.

“The company envisioned that many advisors would want to stay [as employees], with the higher level of support, figuring they'd have higher productivity,” says one veteran AEFA planner who opted for the franchise platform. “But few people chose that. They preferred to run their own business. The people who stayed were those who aspired to be American Express managers.” Or, as one former AEFA franchisee put it: “The only way you'd do that is if you didn't have any business.”

Indeed, AEFA isn't getting much out of its captive brokers. “The problem isn't unlike that of the big wirehouses,” says an executive at an independent brokerage firm. “They hire inexperienced people, train them and then plug them into the system to succeed or fail. After a year or so, they don't make minimum production goals — the attrition rate is somewhere around 40 percent to 50 percent. That's expensive.” A broker who now works for a top-tier Wall Street house and got his license while at AEFA says that American Express sets the bar pretty low for its trainees. “Some were ski salesmen,” he sniffs.

Launching the multitrack model hasn't helped AEFA's profitability. In 1999, the unit accounted for $935 million in net income, 37 percent of American Express' total. Last year, net income was $859 million, just 28 percent of the parent's total. Net asset outflows were $3.9 billion in 2003 and $5.1 billion in 2002, according to Boston-based researcher FRC; year to date, AEFA has lost more than $4 billion in assets. Pretax margins fell to 13.9 percent in 2003, from 15.4 percent in 2002, and the division's return on equity dropped to 10.4 percent, from 10.9 percent the previous year. “AEFA used to be a good earner for American Express,” says a New York-based financial service consultant who monitors brokerage firms. “Now it's not.”

Industry experts cite several reasons for AEFA's continuing struggle. One is that in trying to bring its decades-old business model up to date, American Express management has changed the rules too often. The triple-track advisor plan is just the latest in a long search for competitiveness in an industry that gets more cutthroat all the time. “Nobody has a clue as to what's going on,” says another independent research consultant. “[Management] tweaks the model every few years, and that makes everybody very nervous. The model is meant to be too much of everything to everyone, and no one knows which is the most cost-effective version.”

Another challenge is AEFA's history of promoting in-house products — regardless of their performance. “AmEx's traditional model has prioritized proprietary products and/or preferred partners' products,” says Bill McGovern, senior vice president for business development at Raymond James. “In today's regulatory climate, that's getting a lot of scrutiny and negative press. The public is getting more exposure to how the business works behind the scenes. That makes it more difficult for the average advisor.”

According to Morningstar rankings, American Express' mutual funds — staples of the AEFA menu — have generally turned in below-average performance for their investment classes over the past five years. (See table.) So planners are increasingly loath to recommend their employer's proprietary products to clients. And, while AEFA several years ago adopted open architecture for both its captive and independent advisors, many reps say they still get pressure from managers to sell in-house funds, insurance policies and annuities.

Like many other financial institutions, AEFA is under fire for such practices. In March, clients in New York filed a class action charging that American Express and AEFA failed to disclose that advisors were motivated to sell in-house mutual funds. Specifically, the complaint alleges that AEFA, through its financial advisors, “purported to provide objective investment and financial planning advice based on each client's particular circumstances in life but, in fact, had an undisclosed interest in pushing AEC Funds and certain other preferred funds, which were among the poorest performing mutual funds on the market.” Numerous individual lawsuits against AEFA planners are pending elsewhere around the country. American Express — again, like some other firms — is also under scrutiny by the NASD and other regulators for undisclosed revenue-sharing arrangements with mutual fund wholesalers including Putnam, Strong and Van Kampen.

The company says it is addressing the legal and regulatory challenges both internally and externally. “We're as proactive as possible in terms of cooperating with the SEC, the NASD and the New York attorney general,” says Hanratty. “As a consequence, we're in continuous review of all our processes — training, pricing, everything.”

Proprietary mutual funds still accounted for 61 percent of AEFA's fund sales in 2003, compared with roughly one-third at Merrill Lynch, but planners at the firm say they are rapidly losing ground to third-party products, which may perform better for clients but provide lower profits margins for American Express. “Our own Minneapolis wholesalers are competing for business as much as anybody,” declares one AEFA licensed paraplanner in Naples, Fla. “The company was disappointed that [our] proprietary percentage went down, down, down,” adds another advisor, who says he is “a lot more competitive” since open architecture took hold.

The firm is working to burnish its in-house funds' performance. AEFA has put well-regarded managers from Fidelity, Wellington Management, Gabelli Asset Management and Pilgrim Baxter Value Investors at the helm of several of its foundering American Express portfolios. (Mario Gabelli himself lead-manages the American Express Partners Select Value Fund.) “That's viewed as a quick fix — something brokers can sell right now,” says Kerry O'Boyle, a Morningstar mutual fund analyst. “There's pressure to sell these funds, and it's hard to do it in good conscience when their track records are so awful.”

Longer term, AEFA is investing in better research to improve its mutual fund results. It recently opened satellite offices in San Diego and Boston where portfolio managers can handpick their own analysts rather than relying on the pool back in Minneapolis.

Broader geographic diversity may help blunt criticism that the Minnesota company is out of touch with the financial community. “American Express is at the bottom end of its peer group, but they're making a better effort than other broker-type shops to improve,” says O'Boyle. “I give them kudos for effort.”

Regardless of what they sell, AEFA's planners get a relatively generous payout. “AmEx has more money than Steinbrenner,” says Nicholas Ferber, managing partner at Miami-based recruiter Sanford Barrows Group, referring to the New York Yankees' high-spending majority owner. “It's much easier to steal brokers than to train them, and they're buying good brokers.” AEFA's employee advisors gross around 50 percent; franchisees are compensated according to a performance scorecard, with payouts ranging from 79 percent to 91 percent; and the fully independent advisors at Securities America earn up to 100 percent payouts.

AmEx, the Innovator

Ironically, AEFA's old platform served it well for decades. Its predecessor firm, Investors Diversified Services, was originally founded in 1894 as Investors Syndicate, marketing investment trusts (the precursors of mutual funds) to the masses. By the mid-1970s, IDS was not only the Goliath of America's mutual fund industry, with $5 billion in assets under management, but also a pioneer in financial planning. It was one of the first firms to introduce fee-based compensation for brokers and to offer comprehensive packages for clients, including mutual funds insurance, annuities and real estate investments — all proprietary.

When American Express bought and renamed IDS in 1984, James Robinson III, then chairman and CEO, saw the unit as a hedge against his company's credit card business, which was under aggressive attack from MasterCard and Visa. He envisioned robust cross-selling, as AEFA marketers targeted AmEx cardholders for soup-to-nuts financial services. And his timing was impeccable: Millions of new investors sought financial planning advice during the long-running bull market. AEFA's assets under management grew steadily, hitting $263 billion in 1999. Last year, they reached $365 billion, in part through the acquisition of London-based Threadneedle Asset Management from Zurich Financial Services, which brought in $85 billion.

AEFA executives say the unit is still very much in expansion mode. “American Express is fully committed to growing the financial planning and advice business domestically and ultimately internationally,” says senior vice-president Hanratty. “And we are committed to building focused recruiting at AEFA — licensed reps in both securities and insurance who have a desire to move to a big-name firm and an advice-based approach.”

Indeed, AEFA has added planners in the last couple of years. But its global total of advisors has actually fallen since the firm began offering its three broker platforms, from 12,663 in 2000 to 12,121 in 2003. Still, some industry watchers think that multiple career options and high payouts have helped AEFA bring more productive reps on board.

“They've completely turned things around,” declares Ferber, the financial service recruiter. “We used to laugh them off. Now they have a good enough package to entice good people. At some point, other recruiters and the industry will figure out they aren't who they were a few years ago.”

Critics continue to complain that AEFA should be concentrating harder on overhauling its comprehensive planning model, what one disgruntled investor calls a standardized “Happy Meal” of mediocre mutual funds, annuities and insurance policies. But Hanratty insists that approach is a plus. “There's no one near us in terms of number of the relationships planners have with their client base,” she says. “We're a distribution organization, so we have a broad range of competitors — in money management, insurance and so forth — but no other single competitor has the same mix.”

Yet in an environment where even middle-market investors are taking a hard look at whom their advisors are really working for, the culture of cross-selling can be a minus, too. Until American Express' advisors can legitimately boast about their proprietary offerings, the best of them are likely to keep putting more distance between themselves and the brand.

Not Number One

American Express mutual funds, on average, have been laggards over one-, three- and five-year periods.