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Jul 30, 2023

First Banks; Now Private Equity Firms

I began my career on Wall Street when most firms were partnerships, and they focused exclusively on clients and employees. The firms were far from perfect, but now I see in hindsight, they were more client and advisor centric. That era has passed.

Banks were the first acquirers of wealth management firms, and for three compelling reasons. First, these firms used very little of a bank’s balance sheet. Second, recurring fees from investment management was highly predictable income for a bank’s’ earnings. Third, and best of all, large cash balances maintained by high-net-worth clients provided net interest margins that were extremely profitable. The two questions I asked myself when banks began their frenzied buying spree of acquiring wealth managers were as follows: 1.) What’s in it for the clients? 2.) What’s in it for the financial advisors?

Bank executives were quick to tell advisors they’d have access to checking accounts and credit cards. That sales pitch rang hollow because advisors already had access to industry-best credit cards and checking accounts prior to the acquisitions. Even better, brokerage clients' deposits were automatically swept into high interest money market funds unlike bank clients who earned near-zero rates on their checking and savings accounts. Then, bank executives would tout their robust mortgage programs. But again, wirehouses were ahead of their time, and offered innovative mortgages (e.g., interest only) with less bureaucracy and shorter underwriting times. From my vantage point, clients and advisors were not better off at banks. Maybe that’s why many advisors, and their clients, began moving to independent firms.

Spanish philosopher, George Santayana, wrote in his book, The Life of Reason, “Those who cannot remember the past are condemned to repeat it.” Sadly, I fear this will come true for some independent firms who are being acquired by predatory private equity firms. The PE industry is crowded, and it’s flooded with cash, a dangerous combination. Some firms come to market with a buy-to-build strategy; others with a buy-to-invest. The ones that trouble me are the buy-to-sell PE firms!

Financial advisors and the independent firms that support their businesses have the responsibility to uphold the fiduciary rule. Many advisors left wirehouses because they were tired of conflicted advice, and their firm’s self interest. A word to the wise. Never underestimate the street smarts of financial advisors. After a PE firm buys a large stake in an independent firm, advisors ruminate on the key question: When this private equity firm sells the business in three years for five times what they paid for it, how will I, and my clients, be better off?

Paul Sullivan
Founder and Managing Partner
Wealth Management Independence (973) 525-7626

PS Excessive greed and a lack of transparency in the C-Suite of several legendary firms on Wall Street led to their demise in 2008. Let’s not forget the wisdom of George Santayana.