No doubt it has been a brutal six-week journey for First Republic advisors. Advisors may think they should be rewarded for their loyalty in staying the course when other colleagues fled early. The path of least resistance has certainly been to stay put, however, in doing so, advisors face changes in compensation, more bureaucracy, less autonomy and control, and pressure to cross-sell big bank products and services. Worse, the new contracts should come with major strings attached with some advisors should be candidates to be paid and others not to be paid a retention ‘stay’ bonus.
There is never a free lunch in life and business. It is important to assess how the strings JP Morgan attaches might limit your work, options, clients, and ultimately your business valuation. Advisors need to accept the fact that JPMorgan has full control and authority in buying all of First Republic’s assets, liabilities, advisory practices, and all its clients attached.
As history repeats itself, acquiring firms find it hard to justify owing advisors anything, particularly in receivership or bankruptcy. The First Republic name and culture is unfortunately over, and JPMorgan believes, for valid reasons, it is a superior firm with greater resources, client capabilities, security, and technology. Some may take the position that advisors and their clients are lucky to have a home with such an offering and advisors should thank them for the rescue. To put the relative size in perspective, JP Morgan has $4 trillion in assets to FRB’s $229 billion just months ago. However, after massive attrition which may exceed 40% of the advisory force, the firm may only have about $125-150 billion remaining. This remaining 3% of JPMorgan’s total assets will likely be retained though hold little power.
There is extensive historical precedent to retention deals. Simply put, retention deals factor in a few main inputs 1) Length of time at the firm 2) Size of production 3) On a contract deal or off deal. To understand what a retention deal might look like, let’s look at two advisors at FRB and what is likely to transpire.
On Contract Deal
A considerable number of advisors have joined the firm over the last 1-5 years, signed 10–13-year contracts and FRB paid far more than its nearest competition with massive upfront and backends, matched deferred, with total comp packages upwards of 450% of production. Just barely over a week ago, the firm went into receivership, weeks back there was serious risk of any real buyer of FRB, or one that advisors/clients may appreciate. Not only did advisors lose the firm they worked for but also took on the risk of having to pay back massive notes which were owed to a defaulted company. With the $10B JPMorgan paid for the bank and client assets, they would of course assume the liability of honoring these massive contracts. As history repeats itself, JPMorgan will likely take the position that advisors and their clients are fortunate to be saved with such a formidable platform as JPMorgan who will certainly honor the old contracts of advisors but should not be further rewarded with an additional bonus.
Example Advisor #1. This real-life example is an advisor who joined the FRB only 3+ years ago from Merrill Lynch whose production was about $10 million who realized payments:
- Upfront $250%= $25 million
- Matched Deferred from ML= $3 million
- 18-month hurdle of 100% production = $10 million
- 3-year hurdle of 125% production 30%= $5 million
* Unrealized Payments
- 5-year hurdle of 150% of production 30%= $5 million
- 7-year hurdle of 175% of production 30%= $5 million
This advisor is incentivized to stay at the firm since after three years all hurdles were met, and the advisor stands to keep $43 million for staying. However, the advisor might now question the ability to hitting the future hurdles of 35-50% of T-12 on the new JPMorgan platform since the heavy referral source will be essentially shut off and the markets would also need to perform as they did over the previous years. If they leave, they must pay back the amortized remaining 10 years on their contract. If another advisor had been there for 5-7 years and hit all hurdles, then the economics make it even harder to leave. Therefore, since these advisors were already very handsomely paid, were bailed out, and now have an even more robust platform, there is no reason that JPMorgan should be obligated to pay even more in a retention deal.
Example Advisor #2. This real-life advisor has been at the firm for over 11 years, has production of $6M and is not locked on a contract deal. This advisor is a free agent and could be considered a flight risk. As per historical norms, this advisor should receive anywhere from 50-100% of trailing 12-month production depending on size and seniority. As example, when JP Morgan bought Bear Stearns in 2008 they offered 100% of production for the highest producing advisor, with 75% in cash and 25% in JPMorgan stock, with a contract of 7-years. Since most advisors at FRB are above average in size production of $5 million or more, they should be offered 100%+/- and those below will likely get 50%. However, since JPMorgan bought the business the clients expect new 10-year contracts which will now be required to be signed with stringent new restrictions and covenants.
New Contract Terms and Conditions
Not only must advisors evaluate if JPMorgan’s new platform, new systems, operations and culture match advisors and their clients’ best interests, (see our report JPM/FRB- Pros and Cons 5/2) but now they must evaluate the risks, terms, and provisions of a new contract. Here are terms to look out for:
- Reset contract for 10 years with provisions and covenants that protect JP Morgan, not the advisor.
- Non-solicitation clauses- With the purchase of all assets, including your clients’ future cashflow, JPMorgan will surely try to protect this investment with stringent non solicitation clauses should you ever decide to leave the firm.
- Hurdles – FRB had very aggressive hurdles with upwards of 200% of T-12. Don’t expect the old or new hurdles to be lower. Keep in mind that hurdles will be harder to make at JP Morgan than FRB due to less banking referrals, a wire-house culture, and a market that may not to be perform as it did in the previous 10-year run-up.
- Garden Leave provision- When advisors eventually depart to another competitor, garden leaves are becoming more common place in contracts and, in fact, are widely used at JPMorgan. The name is derived because the employee is kept away from the business but able to spend time pursuing hobbies, like gardening. Leaves extend upwards of 90 days, without the ability to contact clients—a huge impediment to those considering a future transition.
- Deferring even more compensation- FRB had no deferred but is now commonplace with major firms, holding advisor’s earnings for a longer period of time, and portions of that compensation may be offered in vested shares of JPMorgan stock.
Provided you decide to sign a new contractual agreement with JP Morgan, you are likely devaluing your business with the restrictions the firm will demand of you and what are now not necessarily your owned clients anymore. Should you ever want to leave, your practice may be less valuable for a future purchase, you’ll have less leverage, and the balance of power is now with the firm and not the advisor. It is important to consider what options there are if the fit at JPMorgan isn’t right and to ideally position any transition from a position of strength, not weakness.
The problem is that most advisors can never be too sure the firm won’t get itself into trouble, further regulations, and more and more bureaucracy. Also, the firm is also always at liberty to change terms, lower GRIDS, increase deferred, add restrictions, and require more. In recent years we’ve watched big firms do this routinely which is a reason why advisors have been leaving big firms in droves for boutique options such as FRB or go independent.
Ultimately, any decision should be made based on your specific goals and the best interests of your clients. Even though advisors were forced into this position, the path to least resistance may turn out to be just the opposite. I strongly recommend that you begin by clarifying your vision for the business in the near and long term and not take the easy road just because circumstance brought you here. It’s important to determine the best fit for you and your team in consideration of all the possible firms and platforms that are currently available. Even the option of potentially becoming fully independent in a new RIA structure is quite appealing to some, removing the future risks of big banks, regulations, and restrictions.
If you determine that JP Morgan is the best place for you and your team to grow your business and serve clients for the next 10-20 years, then for certain advisors to be also paid a “signing bonus” is a terrific option. Those who have huge notes outstanding have the satisfaction that their notes will be fully honored. Though weighing that against a firm of your choice, a platform that may better suit your clients, a legal contract that puts you in a position of strength, and an economic package of 400% and more, may be worth comparing and contrasting.