A New Order for Brokers
Energy commodities trader Parks Wesson of Manhattan Beach opened an account at brokerage giant Merrill Lynch three years ago because he wanted to focus on his job and leave his personal investments to a professional.
But last year, disappointed with the mutual funds he and his broker picked out--and with fees that he considered excessive--Wesson moved most of his money to do-it-yourself online brokerage E-Trade.
“I didn’t see the service I was paying for,” Wesson, 38, says.
Investors such as him have the full-service brokerage industry running scared. The threat of mass defections, as financial help and self-service trading become widely and cheaply available over the Internet, is fueling a revolution in the brokerage business--shaking it up as perhaps no other threat ever has.
Indeed, Merrill Lynch said last month that it would offer cut-rate online trading to its 5 million U.S. customers, a move the firm had long vowed it would never make.
Merrill’s plan to offer online trades for a commission of just $29.95--a fraction of the $200 to $300 commission its brokers now take in for many transactions--is certain to slash the incomes of many of Merrill’s 14,800 brokers, and of the firm itself.
The decision also puts other full-service brokerages, including Salomon Smith Barney and PaineWebber, under pressure to follow suit. Prudential Securities has already unveiled a similar program, beating Merrill to the punch by a few weeks.
The central issue now is this: What is a broker’s help really worth? As trade execution increasingly becomes a low-priced commodity, main-line brokerages will be forced to put an explicit price tag on what they have long maintained is the feature that sets them apart: their brokers’ advice and guidance.
But how many full-service brokerage customers will decide their brokers aren’t worth that new or additional fee?
“What Merrill did was the beginning of the end of the traditional compensation structure [for brokers]. It was a huge, huge event,” said Len Reinhart, a Smith Barney broker for 18 years who is now a principal of Lockwood Financial in Malvern, Pa., a fast-growing investment advisor for independent brokers.
Robert E. Litan, director of economic studies at the Brookings Institution, believes that the technological and competitive change that is sweeping the securities industry eventually will eliminate the jobs of most brokers. He expects the same thing to happen in insurance and real estate, where the agent’s “gate keeping” function is also under assault.
Counting on Needs of Aging Population
Merrill Lynch and many other retail full-service firms, however, believe that their future is clear--as providers of an extensive menu of financial resources to an aging population that will have to go somewhere for help. Why not to them?
Cheap online trading, Merrill says, is just another competitive tool its brokers can use to keep customers happy.
It’s also worth noting that critics have called full-service brokerages dinosaurs for more than 20 years--a period during which the major firms all have ballooned in size. The Wall Street giants may not be especially agile, but sheer bulk makes them formidable competitors nonetheless.
In fact, the trends that Litan cites date to at least 1975, when the end of fixed commissions on stock trades gave birth to the discount brokerage industry.
But the rise of the Internet has accelerated the pace of change in the brokerage business, cutting trading commissions to the bone--and, perhaps most important, giving individual investors access to financial information that even five years ago was available only to market “professionals.”
Today, there are 6 million online investors, accounting for more than 30% of retail stock trades and nearly 16% of all trades.
Yet so far, the rise of the online trader hasn’t slammed the full-service brokerage business.
The number of registered brokers at all New York Stock Exchange member firms totaled 122,446 at the end of 1998, up from about 101,000 in 1995. The majority of them are full-service brokers.
Far from needing fewer brokers, Merrill says that under its new strategy it will need more. By 2005, Merrill plans to expand to as many as 20,000 brokers, Chairman David H. Komansky said last month in announcing the firm’s Internet and discount initiatives.
But what will all these new brokers do? If commissions are going to dive, it’s certain that most new brokers won’t be commission-chasing “stock jocks,” spending their workdays speed-dialing through their Rolodexes of customers, suggesting securities to buy and sell.
Rather, what Americans increasingly are willing to pay for is big-picture financial planning--including assistance with insurance, college savings, estate planning, taxes and borrowing.
However proud online traders may be of their stock-picking skills, few feel comfortable tackling the intricacies of tax law or retirement-savings regulations.
“You can screw up an IRA rollover 101 different ways, so just that service alone is a tremendous benefit,” said one industry expert.
In fact, the full-service brokerages for years have been trying to encourage their brokers to become more consultant-oriented than trading-oriented. The goal is to bring the bulk of a client’s assets and liabilities under the broker’s purview, thus ensuring a steady stream of annual management fees rather than depending on the ebb and flow of commissions from stock or bond transactions.
Merrill is taking a much bigger step in that direction this month, when it begins offering clients with at least $100,000 of assets in their accounts unlimited free trading with a broker’s advice, plus an array of other services--from mortgage origination to credit cards to discount online shopping--for a flat annual fee starting at $1,500.
Wealthier customers will pay annual fees on a sliding scale of from 1% down to 0.75% of assets for this so-called Total Access account.
For do-it-yourselfers, Merrill in December will match Schwab’s price of $29.95 for online trades without a broker’s advice.
Merrill needed to provide that “a la carte” option to protect its flank from the Charles Schwabs and E-Trades. But clearly it wants most customers to choose a fee-based account.
Obstacles in Path of Transition
Despite years of emphasis on asset-gathering, however, commission income from retail and institutional transactions still is by far the biggest component of Merrill’s revenues. The firm earned commissions of $5.8 billion last year, one third of its total $17.6 billion in net revenues. About $3.2 billion of the total commissions were from retail customers.
Asset-management fees, by contrast, were $4.2 billion, or 23% of revenues.
Although Merrill said its existing fee-based programs--known as Asset Power and Financial Advantage--have been growing at a rate of 30% to 35% for the last two years, much of that growth has come from market appreciation rather than new accounts. Fewer than 10% of Merrill’s customers are in fee-based accounts. The firm has a stated goal of raising that number to 30%.
The advantage in moving to fee-based accounts is clear for broker and firm, many say.
David Blisk thought he left a lot on the table when he quit Smith Barney three years ago to open Legacy Advisors, an independent financial-advisory firm in McLean, Va.
A high-end boutique, Legacy caters mainly to people with investable assets of more than $1 million. The firm is able to provide lots of individual attention, calling on outside accountants, tax experts and insurance specialists as needed. Blisk himself is an attorney.
Because it farms out investment management to outside vendors and otherwise keeps overhead low, Legacy is able to pay its representatives a 60% to 70% share of the asset-based fees they generate.
That compares with broker “payouts” of 30% to 40% of commissions at the brokerage giants.
Still, Merrill faces many obstacles in shifting its brokers from a transaction orientation to a financial-counseling orientation.
One is simply that many brokers may balk. As commission payments instantly decline with new cut-rate trading, many full-service brokers--whose annual pay exceeds $158,000 on average--will take a pay cut.
Merrill, acknowledging the effects of the new pricing strategy, has promised to supplement its brokers’ incomes for up to two years.
Some Merrill brokers may jump to other firms. But many may find it difficult to move, because other full-service firms will probably adopt strategies similar to Merrill’s. Moreover, it can be tough to walk away from a big firm because of “golden handcuffs”--the discounted stock options, deferred compensation and other goodies that brokers forfeit if they leave.
The bigger issues are whether many of Merrill’s brokers, and other full-service brokers, are cut out for the often more time-consuming role of financial planner--and whether they can do it well enough to attract and retain enough clients to make a living.
Donna DiIanni, a Merrill broker based in Bridgewater, N.J., said that the shift in emphasis would be difficult for some brokers but would be healthy in the long run.
“It takes a little time to embrace, but those who’ve embraced financial planning and fee-based business are definitely better off,” she said in an interview.
After all, it was pressure from the brokers themselves that spurred Merrill to adopt its new strategy. DiIanni and other brokers at her office have seen clients take money away from Merrill to open discount-brokerage accounts, sometimes in order to trade Internet stocks, she said.
“We don’t want to encourage the gambling frenzy, but we realize some people want options,” DiIanni said. “They may want to enter a trade at 2 a.m., and this lets them do that.”
Reinhart predicted that as brokers are forced to sell the quality of their overall advice, not just stock recommendations, there will be a greater reliance on individual credentialing, including customer references, and a need for professional degrees such as Certified Financial Planner.
Today, most investors don’t know their brokers’ educational backgrounds, to say nothing of their investment track records. Reinhart expects there will be pressure on firms and individual brokers to supply such records, which have long been kept secret.
He also foresees a return to the old tradition of brokers serving apprenticeships with seasoned colleagues.
“There’s only so much you can do with software,” Reinhart said, alluding to the tendency of some firms to build their asset-allocation and investment advice programs around computerized models.
In a perverse way, the brokerages might also root for a major stock market downturn because that would put a premium on the experience and sound advice that they claim is their forte.
Competition With Independent Planners
Competing to be financial advisors to a large portion of well-off Americans, Merrill and other full-service firms are going up against an army of independent financial planners, as well as new advice services from mutual fund firms and discount brokerages such as Schwab.
Some analysts, such as Dean P. Eberling of Putnam, Lovell, DeGuardiola & Thornton, think Merrill is equal to the task.
“Merrill Lynch is ready to battle with a considerable franchise and very deep pockets,” Eberling wrote in a recent report rating Merrill stock a “buy.” “When investors begin to weigh all the pros and cons, the real concerns should be: What do Merrill’s competitors do?” he added.
The undeniable advantage held by Merrill and its peers is a great depth of resources--from mortgages to credit cards to small-business services--that smaller rivals can’t match.
In some cases, that may also extend to brokers’ old bread and butter: trading.
Wesson, the Manhattan Beach resident who has switched much of his money from Merrill to E-Trade, said that when he had a good stock idea recently he used Merrill because he didn’t trust the online brokerage to get that particular trade executed properly.
In that instance, he said, the $300 commission looked like a bargain.
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Times staff writer Thomas S. Mulligan can be reached by e-mail at thomas.mulligan@latimes.com.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Shake-up on Wall Street?
The ranks of full-service brokers have swelled with stocks’ bull market, but the Internet now is presenting brokers with a major competitive threat: cut-rate trading commissions and a wealth of financial information available to small investors. To meet the challenge, industry titan Merrill Lynch is revamping its pricing--a move fraught with risk to Merrill brokers and the firm itself.
Brokers’ Ranks Have Grown . . .
Registered brokers at New York Stock Exchange-member firms, year-end totals. Most of these brokers work for full-service firms.
‘85: 82,124
‘98: 122,446
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. . . And Earnings are Lush
Annual trading commissions and fees generated by the average broker, and the average broker’s earnings from those commissions (1997 data, which are the latest available):
Average commissions and fees: $387,583
Average broker earnings: $158,201
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But Online Firms Are Gaining . . .
Online trades as a percentage of all equity trades, by quarter:
First quarter 1997: 7.1%
First quarter 1999: 15.9%
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. . . As Commissions Tumble
Average commission charged by top 10 online brokerages, first quarter of each year:
1996: $52.89
1999: $15.75
Sources: Securities Industry Assn.; CS First Boston
How Wall Street Views Its Own
Merrill Lynch’s stock price has swung wildly in the last year. It peaked last July, was hammered in the broad market decline of last fall, then rebounded -- only to face more pressure this spring on concerns about the firm’s profitability as it moves to offer low-commission trading. Monthly closes and latest on the New York Stock Exchange:
Friday: $79.69
Source: Bloomberg News
