Beware of Financial Advisers Changing Firms; Investors May Pay the Price
by James J. Eccleston, Esq.
any individuals change jobs. But financial advisers are doing so in growing numbers, and there is a concern that this may drive up costs for some of their clients. In fact, recently the New York Stock Exchange (NYSE) issued an Informed Investor publication entitled, "If Your Broker Changes Firms, What Do You Do?"
As background, more financial advisers jumped ship in 2005 than ever before. 9,071 registered personnel decided to move from one brokerage firm to another. Today, brokerage firms face increased competition from many sources, including discount online operations and banks that have developed their own financial services businesses. There also has been a substantial amount of consolidation among brokerage firms in the industry.
All of this pressure has created what the Wall Street Journal recently described as a "bidding war for top-performing brokers." In this bidding war, financial advisers who switch firms can expect to receive signing bonuses for doing so. That's not new. But what is new is the soaring amount of those signing bonuses. Firms such as Morgan Stanley and UBS are offering some financial advisers as much as 150% of the commissions and fees that they generated in the last year of employment at their former firms. Coupled with stock and other deferred compensation, the figure can jump to 200%. That percentage, according to the Wall Street Journal, is three times to four times as great as the awards paid in the late 1990s!
Obviously, firms are not writing what can be several million dollar checks to financial advisers out of the goodness of their hearts. In return for the signing bonuses (and deferred compensation), firms expect financial advisers to deliver on their implied promise that they can generate as much or more in commissions and fee-based account charges on their client assets that transfer to the firm. Moreover, signing bonuses typically take the form of a "forgivable loan", with a term of 5 to 9 years. The significance of that fact is that clients can expect financial advisers to face pressure to produce expected revenues for several years. If financial advisers fail to do so, firms may fire them for lack of production and proceed to collect the amount of the forgivable loan still outstanding.
Therein lies the potential for client abuse, as the NYSE recognizes in its publication: "You should especially be aware of any potential conflicts of interest, including those that may be related to the broker's compensation arrangements at the new firm" (emphasis added).
The NYSE publication sets forth several general questions for clients to ask their financial advisers, including:
Why is the broker changing firms?
How will the change affect your account?
Will certain products or services that you like be available at the next firm?
Can your existing investments be transferred to the new firm?
How are fees different at the new firm?
Will you have to pay any fees to the old or new firm to make the change?
Are there any tax consequences if you are asked to sell any of your existing products?
Are there elements of the broker's transition package that relate to commissions, fees or costs associated with your account?
Regarding conflicts of interest, the NYSE states plainly that if the financial adviser asks the client to move his or her account to the new firm, the client "should know whether your broker is being offered any inducement that might affect his or her recommendations as to the type or amount of products or services being offered to you." While believing that a bonus may be legitimate, the NYSE (a self-regulatory organization) concedes that "it could lead to situations in which the broker seeks to do more business in your account to justify the upfront payment, particularly if the bonus is based upon a percentage of newly generated commissions."
The NYSE publication stands out as giving helpful guidance on a securities industry practice about which few investors are aware. As the NYSE states, be sure you are making a "well-informed choice" in deciding whether or not to follow your financial adviser to his or her new firm.
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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
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