Reversal of Fortune: Compensation Trends 2002

The old saying is that brokers eat what they kill. And these days it seems that everybody is on a diet. Our annual broker compensation study shows about one-third of the respondents took a substantial hit in the wallet last year, as clients fled the markets and trading volumes fell. Many brokers — optimists that they are — confidently predict a comeback this year. But, there aren't many signs of that happening yet. “You know how bad it is?” asks a veteran broker who handles wealthy clients for Credit Suisse First Boston in New York. “It's like, why even go to work? Clients are scared. And on days when the market tanks, other brokers come into my office and complain. So, I just leave. I take two-hour lunches. Who cares? What am I going to do, sit there and bitch with everyone else about how bad the market is? No thanks.”

“In 1999, I once produced $1 million in a month,” he recalled recently over a lengthy lunch at the exclusive Union League Club. “One million dollars. In a month. Those days are gone.”

His partner, eating a Martha Washington She-Crab soup (a Union League specialty), nods his head appreciatively. He is facing a big tax “hickey,” as he calls it, for the upfront money he received when he joined CSFB a couple of years ago. He adds, “I've got to write a $17,000 check. That's gonna be fun. My production is down 30 percent.”

But he's one of the lucky ones. He never dipped into his $400,000 forgivable loan. “I have the money. For a lot of these guys around here, the frickin' money is gone.”

The brokerage business is hurting. New York Stock Exchange member firms' pretax profit of $10.4 billion was cut in half last year from 2000, according to the Securities Industry Association. Underwriting and M&A transactions have evaporated. But the brokerage business has always been cyclical, with booms and hiring binges followed by busts and layoffs. Brokers can be forgiven for forgetting that. According to the SIA, registered reps enjoyed increasing commissions and fees for six consecutive years ended 2000.

If 2000 introduced many new brokers to their first bear market, 2001 gave them their first prolonged taste of desperation. The investing public, spooked by the bear, seems to have gone into hiding. It's not surprising then that broker production is off. Just how much off, we wanted to know. Last month, Registered Rep. issued a survey via e-mail to take the pulse of various financial intermediaries, from professionals who call themselves brokers to branch managers and even CEOs.

We included wirehouses in our survey, as well as small independent broker/dealers. The idea was to get a sense of what brokers were producing and earning, but also where they worked, and what their businesses looked like. How were they generating their gross? What did they expect in 2002? We also wanted to set a baseline so that we can compare salaries and other factors in subsequent years.

Readers should regard this survey not so much as an exercise in trivial pursuit, but as a benchmark to compare their performance with their peers. In a tough climate such as this one, reps need to know exactly where they stand in their firms' eyes. The bottom line? Wirehouse firms spend roughly $200,000 to train each broker, according to the CBM Group, a consulting firm who helped us analyze our survey data. Reps who don't produce $200,000 should start sweating.

As Rick Peterson, owner of Rick Peterson & Associates, a Houston-based executive search firm, puts it: “It's career counseling time for the fifth quintilers.” The fifth quintile is the lowest-producing group of brokers, which is being hit hard by layoffs industrywide. Mark Tibergien, a principal with consultancy Moss Adams, says, “Firms are culling out the lower-producing reps, the bottomfeeders. They simply can't afford them. The firms are either coaching brokers up or coaching them out.” Up to now, much of the bloodletting on Wall Street — it's the worst since 1974 — has spared brokers. That is starting to change.

About 800 professionals responded (for a strong response rate of nearly 7 percent). The majority (nearly 72 percent) classified themselves as “stockbrokers” and “financial advisors,” and a small amount (around 5 percent) identified themselves as upper management. Taking our survey results and extrapolating them, we created a picture of the average rep. Our sample found that the typical broker is a male, aged 46, has a Series 7 (92 percent) and works at a wirehouse, national or super-regional brokerage (61 percent). More than 50 percent are college graduates and 25 percent of the respondents have graduate degrees. Only a small percentage (15 percent) have advanced professional qualifications, such as the CFP.

Our respondents are an experienced group with a sizable book. The typical broker has been licensed for nearly 13 years, and manages $67.2 million in assets (see table on page 27). Gross production averaged $342,000 last year, way down from 2000, in which reps averaged a gross of $485,478, according to the latest survey by the SIA. Branch managers, not surprisingly, average a far lower gross production ($277,855 in 2001), but enjoy a higher payout (47.1 percent on average) than the average nonmanaging rep.

To smooth out the cyclical nature of their revenues, Wall Street brass have been preaching the benefits of the fee-based model, in which investing decisions are left to an outside portfolio manager while the broker concentrates on raising assets and paying attention to customers. They have been tweaking their payout grids over the years to reflect that change. Thus, firms have been rewarding fee-based business and discouraging transactions.

There is some happy news in this year's data. The average payout was 42.9 percent, much higher than the 37.6 percent average in 2000, according to the SIA. In fact, firms have in general increased fee-based payouts by up to 5 percent and lowered them for transaction business by 1 percent or 2 percent, says Peterson. Consequently, the fee-based strategy is growing among the rank and file, but still has a way to go. Just 30 percent of the rep's business is fee-based, according to our study. Still, that's up from the SIA's 20 percent findings in 2000. Nevertheless, about a third of our respondent reps said that they are still mostly commission-based brokers.

Merrill Lynch now offers the highest payout on the Street, capping out at 49.5 percent, given certain performance goals, says an executive recruiter who requested that his name not be used. Merrill penalizes brokers for small accounts. Wachovia (formerly First Union), for example, punishes brokers who gross under $200,000 with a flat 25 percent rate. That trend will continue, recruiters predict, as the industry serves to expunge what Merrill Chairman David Komansky calls “overcapacity.”

Last year, total average compensation came in at $171,600 (including commissions, fees, deferred comp and bonus). That figure doesn't tell the whole story. The study shows that it pays to devote at least some portion of your business to the fee-based model. Reps, who say that 90 percent of their book is fee-based, earned on average $194,554. That compares with an average take of just $134,764 for brokers who do below 10 percent in fee business. Curiously, reps with 50 percent to 75 percent of their book fee-based earned the most, with total comp of $229,541. But that may just be an anomaly of the data rather than any particular strategy difference.

Either way, it's clear that the investment-advisor approach has a big edge over the transaction model in down markets. Assets in individually managed accounts totaled $769 billion at the end of 2001, and managed to grow by 15 percent in the fourth quarter, according to Cerulli Associates. Trading volume, considered an excellent barometer to brokerage health, in the first quarter of the year was down by 17 percent on the tech-heavy Nasdaq.

Brokers who have no experience beyond trading equities are at a particular disadvantage at times like these, says Tibergien of Moss Adams. But those who have fee-based business, not only enjoy the “annuity” of annual fees on assets under management, they also have a better chance of selling new services. “If you have a commission product, it's simply too hard to demonstrate value to clients in a down market,” he says. If you offer a suite of financial planning services, you can generate additional fees. “You can tell the client, ‘If you want help on retirement plans, estate plans and your special needs, it's going to cost you,’” Tibergien says.

Clearly, the pain of the downturn is not being felt equally. So, although the average drop among respondents to the Registered Rep. survey was a painless 3.6 percent, many younger brokers did far worse. Nearly 40 percent of the respondents reported declines in compensation from 0.1 percent to 30 percent last year. And among the youngest brokers — those in the business for less than five years — the money is, relatively speaking, of course, thin indeed. More than half (53 percent) who have been in the business less than five years say they make between $40,000 and $99,999.

Nearly a quarter said they earned less than $40,000. Those on the other end of the brokerage workforce — respondents describing themselves as CEOs, COOs and the like — enjoyed a 4.3 percent increase in comp in 2001. Branch managers were flat at 0.6 percent. “Undoubtedly, the ones who do the best have other investments to sell, especially fixed income products,” says Andre Cappon, president of CBM Group.

In other professions, it often pays to move around to increase pay. In this business, that does not seem to be the case — at least since all those big upfront deals became harder to land. Some 64 percent of respondents say that they have been at the same firm for five years. And, our data show, the brokers who move least have actually outearned their more itinerant peers by a substantial amount (see chart, page 35). This is, in part, a function of how difficult it is to leave a firm with one's book intact. “It can be expensive to leave a firm,” says Jonathan Arfa, a White Plains, N.Y., lawyer who represents brokers in employment negotiations. He notes that the upfront payments — the forgivable notes — brokers receive usually contain a provision forcing them to repay the loan if they leave before a set period of time, usually four years.

These incentives, often called sign-ons, are paid to new brokers to lure them from their old firms. At the height of the market, the best brokers were getting 100 percent of their trailing 12-month compensation as a sign-on bonus. In some rare instances, super brokers were able to get 110 percent. Today, the sign-ons are much less, closer to 50 percent to 70 percent. While big producers — those doing $700,000 and up — still have a chance at getting 100 percent payouts, there may be more performance caveats, more deferred income and other noncash components, such as stock appreciation rights and incentive stock options.

Another thing we found in our study: Brokers with more experience — those with five or more years and higher levels of assets under management — tend to have significantly lower gross production/assets under management ratios than do new brokers. Our study found that novice brokers had a GP/AUM ratio of closer to 1.4 percent, meaning they tended to generate more commissions per dollar under management. Brokerage management regards any ratio over one as a possible red flag for churning (unless the broker specializes in, say, options strategies, which by necessity require lots of trading). By comparison, seasoned producers (10 to 14 years experience) posted just 0.60 GP/AUM ratio. “I think the more experience you get, the more you realize that buy-and-holding is a better strategy than trading,” reckons CBM's Cappon.

Brokerage recruiters pay attention to that figure. “If you're doing more than 1 percent, Merrill Lynch won't even touch you,” says Nick Ferber, a recruiter with SolomonEdwardsGroup. “The lower the better.”

Interestingly, experienced brokers and inexperienced brokers have adopted fee-based products to roughly similar degrees. Our study reveals that wirehouse reps tended to have around 35 percent of their business fee-based, regardless of time served in the industry. This is not surprising for new reps, who have been trained to go fee-based since day one. But it is surprising for veteran brokers with 15 or more years in service, the ones who were brought up to sell individual securities. Still, fee-based products have been embraced at wirehouses far more than they have at regional or independent brokerages (who averaged just 20 percent fee-based revenue).

Which leads us to another fact about wirehouses: Payouts average around 40 percent, much lower than the 50-plus percent averaged by independent firms, those with 20 or fewer reps. Some independents are known to pay out even more, but the advisors get less support, less advertising help and the like. Further, advisors have to pay ticket charges, for their computers and support staff. The rule of thumb, says Cappon: “The payout differentials are a reflection of the firm's franchise. The stronger the franchise, the less the firm needs to pay out.”

Still, brokers at big wirehouses and big regionals do, in the end, produce more. They, therefore, earn more. In our study, wirehouse reps averaged a $181,470 net, versus $170,090 for regional firms (100 to 999 reps) and just $163,452 for independent firms (see chart above).

And though 2001 has hung over into 2002, brokers are still optimistic about the current year. On average, they predict that their business will improve by 17.5 percent in 2002. There is reason to hope, says one Merrill broker. Like many who ply his trade, he is an optimist, able to see the glass as half full. Sure, things are tough, he says. But, “There's all this cash sitting on the sidelines. There are millionaires still out there; there are still $500,000 401(k) rollovers. They're not going away.” This time next year, we'll know if this is cockeyed optimism, or myopia.

From the Registered Rep. 2002 Compensation Survey

• Age: 46

• Sex: 90% male

• Education: 61% are college graduates; almost 17% have graduate degrees. So far only 11% have advanced professional qualifications (such as CFP, ChFC/CLU or CFA). Branch managers seem to have less overall education than producers.

• Years in the business: 15

• Assets Under Management (AUM): median $38 million, mean $75 million

• Gross Production: Median $236,500, mean $277,900. These appear to be producing managers, and their production is clearly below that of the broker sample.

• Gross/AUM: 0.40% - 0.60%

• Payout: median 51.4%, mean 47.1%

• Compensation (including commissions, fees, deferred comp, bonus): Median $170,500, mean $186,300. Comp is higher than producers, which reflects management perks, such as overrides and salaries.

• Length of Service: 56% have been at the same firm for the last five years.