When John Lynch left PaineWebber in January of 1998 to move to regional brokerage firm Wheat First, Butcher Singer, he was looking for a little more independence and more money.

Frustrated by the tight reins and standard 40% commission payouts offered by traditional brokerage firms like PaineWebber, Lynch had been hesitant to jump ship for a no-name independent brokerage. Even if it offered payouts of 90% or more, it would not have offered the product and back-office support that wirehouses provide.

At Wheat First, Lynch got what seemed to have been the best of all worlds. He became a hybrid broker of sorts, running his own business but receiving considerable support from the regional brokerage. Above all, he got to keep 80% of his commissions.

And Lynch, it turned out, quickly got more than he had bargained for. A month after joining the firm, First Union Corp. acquired it, and suddenly Lynch was working for a company with tremendous clout and a slew of products to sell. He came under the umbrella of the nation's sixth-largest bank, and became part of the sixth-largest brokerage firm. And First Union continued Wheat First's hybrid brokerage policy.

"It's a sweet deal," Lynch says. "They call it 'independence without the hassle.'"

Traditionally, there have been two basic types of brokers. The first is a wirehouse broker, who gets only 40% of commissions generated. To compensate for the meager share, the broker pays no rent, phone or utility bills, has no responsibility to pay employees, and the firm deals with all accounting and legal issues.

The second kind of broker is totally independent. Although the broker clears trades through an affiliated firm, he or she runs the business autonomously. The broker pays rent, phone and utility bills, hires and pays the staff, and deals with any problem that arises. In return, the broker keeps 90% of commissions generated.

Wheat First developed the hybrid broker. These hybrids pay their employees, their rent and utilities, but First Union pays employee benefits, handles all back-office and legal bills, pays all transaction fees and provides products to sell.

"First Union has all of the products and all of the services, plus they are giving you a very generous deal to join," says a head hunter who asked not to be identified. "That's why we've been able to place some top people there."

Under the bank's Profit Formula system, brokers manage their own business, hire and pay their own employees and collect 75 to 80 cents on the dollar. For the slightly lower payout compared to a traditional independent firm, the broker gets all the research, all the legal support, all the back-office services and the caché of the First Union name.

What brokers don't get are the headaches of hiring an accountant, providing employee benefits, doing payroll and having to explain to clients why they have never heard of the firm they are affiliated with. That's the stuff that keeps most top brokers from making the jump to independence.

"It was easy to move my book because I didn't have to tell my clients that I was going independent," Lynch says. "I just said I was going with First Union. All clients wanted to know was what was in it for them, so I could tell them about the Goldman Sachs research and all of the other products and services they were going to get."

That's exactly the message Daniel J. Ludeman, president and chief executive officer of First Union Securities Brokerage Group, is trying to send to other experienced brokers looking to move. As competition for experience brokers heats up among the wirehouses, big bonus checks are no longer enough to entice top producers. They want payout and autonomy.

While most of Ludeman's Wall Street competition is focusing resources on offering customer choice, First Union believes the battle for gathering assets under management is going to be waged at the broker level. And the competition to recruit and keep top brokers is reaching a fevered pitch in the industry trenches.

By just about every measure, that part of First Union's strategy is working, according to David Stumpf, an equity analyst with A.G. Edwards in St. Louis. "Relative to how First Union executes a lot of things, I think they have handled their retail brokerage business pretty well," he says.

"They have managed to retain key people, and the growth in that business has been pretty dramatic. They've built themselves into a solid, middle-market brokerage/investment banking entity."

In the third quarter of 2000, First Union reported a 49% increase in fee and other income from its Capital Management business, which includes the retail brokerage division. That includes last year's acquisition of Everen Securities, but even without Everen, income grew 16% year-over-year. Assets under management have grown to $173 billion from $166 billion at year-end 1999.

First Union gives brokers three different business models to choose from. Brokers looking for less independence can opt for a more traditional arrangement managed out of the firm's 370 stand-alone brokerage offices. Financial consultants more comfortable dealing with walk-in clients instead of having to cold-call for prospects can opt for First Union's in-bank brokerage operations, offering investment products through the parent company's 2,200 bank branches.

"We believe very strongly in open architecture," Ludeman says. "And we believe that choice though providing one of the most flexible models in the industry is one of our key strategic competitive advantages going forward."

And it's working, says Christopher Marinac, an analyst with Robinson Humphrey in Atlanta. "They have been able to attract and retain brokers in such large numbers mainly because they have been able to offer a much bigger platform of products and services," he says. "The better platform and better product reach make the Merrill Lynches and the Morgan Stanley Dean Witters much less attractive (to brokers)."

Through the 1980s and 1990s, the name of the game was transactions. Brokers earned their commissions selling product and making trades. With the onslaught of the Internet, though, that business has migrated to online discount brokers, offering trades for as little as $8.95--a price that traditional brokerage firms could never compete with. The focus now is on becoming full-service financial consultants, gathering all of a client's assets into one account and then charging a flat fee, usually about 1.5% of assets, to manage accounts.

With asset-gathering quickly eclipsing transactional business as the primary goal for the brokerage industry these days, firms are putting a premium on attracting established brokers who can bring those assets with them. Even Merrill Lynch, which has long depended on its legendary training system to fill in the slots in its sales force, is joining the feeding frenzy.

While trading ruled the industry, top sales people were rushing the exits at the wirehouses, looking for the caché of a boutique firm or the freedom and higher payouts of going independent. That traffic has made a 180-degree turn in the past few years, though, with brokers more interested in technological and product support than a parking place out front and their name on the door.

Today, brokers need the big names and the deep pockets behind them to help them build their businesses, and are looking for that wirehouse advantage. But the question becomes which wirehouse?

"Now that it's become a fee-based business, you really need to be at a place that's well capitalized, with good name recognition, and at a company that has the capital and the commitment needed to create these fee-based products," says Mark Elzwieg of Elzwieg & Associates in New York.

With the rapid consolidation and technological advancement going on in the industry today, brokers are more concerned than ever about being at a firm with staying power.

"With the world changing, brokers want to know, 'Am I at the right firm or with a dinosaur?'" says Alan Johnson, a New York-based consultant. "People are thinking about the products, the systems, the communications, the reputation that allows them to do the kind of business they want to do."

Offering brokers the freedom of choice is where First Union is building its competitive advantage, Ludeman says. "Giving financial advisors alternative ways to work with us and allowing them this choice is a key factor in our goal as being recognized as the firm of choice for the top advisors in the country."

Still, attracting brokers is only half the battle. The next step is providing the full range of products and services that will attract and retain the high-end client that has become the Holy Grail of the financial services industry, and on that score First Union has some ground to make up, Marinac says.

"The rest of the story is how well First Union can serve the upper-end wealthy," he says. "They aren't ignoring that sector, but it has not been a strong focus."

A big part of that challenge is building up its fee-based business, particularly in grabbing a share of the $276 billion market for separate managed accounts. That sector has been a key area of focus this year, says Ludeman.

Today, 28% of the brokerage unit's revenues come from fee-based accounts, with the rest coming from the traditional transaction-based business. First Union's goal is to have the entire operation's fixed costs covered by the fee-based side. Ludeman says the company is about a year away from that.

Also in the early stage is a brokerage trust product that was rolled out late last year. Leveraging First Union Bancorp's existing trust department, the brokerage division will offer clients the flexibility of thousands of different mutual fund and private money managers to chose from, combined with all of the features of a full-blown trust operation licensed to practice in all 50 states.

"If we were really going to service the entire relationship with the client, we knew we had to offer the entire package: investment products, loans, cap accounts, 401(k)s," Ludeman says. "We are blending the best of brokerage and banking."

To coordinate all these products with delivery through three different brokerage systems, First Union Securities is on target to spend more than $100 million on technology upgrades this year, with more coming in 2001.

"One of the ways we stay competitive is through having a very efficient system in place that is very client-focused," Ludeman says.

Like the rest of the industry, First Union is trying to figure out how to get a bigger piece of the wealthy investor's wallet. While he wouldn't break out specific numbers on average product use per client, Ludeman says a key measure of the program's success is increased broker productivity. Since merging Wheat First into the fold, broker productivity has increased 85%, he says--one of the biggest jumps in the industry.

And most of that productivity jump has come from the Profit Formula sector, where average broker production is $1.1 million in commissions a year, more than twice the industry average. "The model itself is driving growth," Ludeman says.

In fact, the only thing really holding back growth is First Union's notoriously bad reputation for service among its banking customers, says Stumpf. "That's something they are trying to overcome by fixing the bank, but it doesn't go away overnight," he says.

Among brokers, the Profit Formula has become a big draw for the company. It was that model that lured Kathy Heidtbrink and her partner John Arnold away from A.G. Edwards this past spring to open their own business under the First Union banner in Denver.

"What made this really appealing is that we have all the benefits of a major firm, but our environment is very boutique--almost old-fashioned," she says. "We would not have moved without this program."

Instead of the cubicles of brokerage bullpen stuck in a downtown high-rise, Arnold & Heidtbrink Financial Management Group of First Union Securities is a small, custom-designed office with views of the Rocky Mountains in the distance. More important than atmosphere, though, is the upgraded level of support the partners can attract now that they aren't dependent on A.G. Edwards to set salaries and benefits.

"We can pay north of average and get a staff that's north of average," she says. "They can be part of the growth and have a vested interest in what we are trying to accomplish."

The autonomy gives John Lynch the motivation and financial incentive to grow his business that a traditional brokerage firm never could have provided, he says. Since hooking up with First Union, he has opened offices in Dallas and Tyson's Corner, VA. Control over expenses also gives Lynch control over his profit margins. With a fixed payout, brokers get 40% whether they are doing $1 million or $10 million a year. "If you want to run a real lean enterprise, you can run out 60%," he says.

These are the types of brokers First Union is banking on in its goal to grow income at a clip of 15% to 20% a year. Growth will also come from continued acquisitions. Last summer, First Union's brokerage unit acquired the brokerage operations of First Albany Co., and in September it announced the acquisition of independent broker firm J.W. Genesis.

"Once you have a common infrastructure in place, it's easy to leverage off of it," Ludeman says.

First Union Securities has the elements in place to continue building market share, according to Marinac. "I think this is a very interesting time for them," he says. "If you look at the revenue pie, the first quarter was a bang-up quarter on the securities side. The question now is to what extent they are going to stay below that first quarter mark and for how long."

He adds, "That part I'm not sure of, but I think you will continue to see progress on the brokerage side."

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