HighTower takes on Morgan and Merrill

December 3, 2010, 9:10 PM UTC

A Chicago-based upstart brokerage is making waves on Wall Street by offering a conflict-free business model to wealth management clients, but the backlash has already begun.

Elliot Weissbluth founded HighTower to offer a new brokerage model.

Elliot Weissbluth has the broad grin and breezy charm of a born salesman. He is as good a listener as he is a talker, and when he opens his mouth the talk is very good. He’s the kind of man who could unload just about any product on an unwitting customer, from gold coins to auction rate securities.

But the 43-year-old travels the country selling something that investors actually need: a Chicago-based brokerage called HighTower that only makes money when its clients prosper.

Weissbluth carved a unique path into the financial services world via a legal career that included both institutional and high-net-worth advisory work. He had the good fortune to launch HighTower just before the financial world unraveled and the depth of Wall Street’s cynicism was revealed. At the largest banks, wealth management groups had been pushing products that other divisions were betting against. Investment advisors were paid to sell products, regardless of whether clients made or lost money. The turn of events made it easier to market HighTower’s business model: conflict-free advice from a network of financial advisors.

Weissbluth co-founded HighTower with Drew Kornreich, the firm’s president and architect of its capital structure. The pair attracted a star-studded group of early backers including former Morgan Stanley (MS) chief executive Phil Purcell, former Charles Schwab (SCHW) CEO David Pottruck, and trusted investment advisor Morris Offit, who counts New York City Mayor Michael Bloomberg as a client and a friend. The confluence of timing and support has propelled HighTower from start-up status in April 2008 to a firm with $16 billion in assets under management, and growing.

A new broker model

Here’s how HighTower works: First and foremost, the advisors get paid fees for giving financial advice, a compensation model that rewards them when their clients do well rather than when they sell ill-fitting products. HighTower clients get the benefit of different advisors competing for their business, which keeps prices competitive. The firm doesn’t have investment banking or proprietary trading arms, so investors need not wonder whether someone at their bank is shorting the very investments recommended by their advisors.

Second, HighTower advisors can choose their custodians and clearing firms, a move that keeps costs low by creating competition among service providers. They can go to several desks to get the best pricing on all investment products.

Third, advisors are partners in the firm. They pay their own expenses and split their profits with the house, so there is no incentive for them to spend money unless it serves to increase the bottom line.

This is in stark contrast to how the major banks operate. Doug Brown, a former vice chairman of investment banking at Morgan Stanley and the non-executive chairman at HighTower, describes the big bank model as a “trifecta of unhappiness” for the clients, the advisors, and the banks. Clients worry that they’re buying advice and products that serve the bank’s needs over their own. Advisors get conflicting messages with regard to whether they are trusted advisors or salespeople for products, as their compensation models are always changing; and firm expenses that have nothing to do with money management must be shouldered by all, even the advisors. Finally, the bank itself is schizophrenic about what its role should be.

Unsurprisingly, advisors are starting to move from banks. Wirehouses and bank broker dealers each lost a fifth of their brokerage forces between 2002 and 2009, according to a TowerGroup study released last May. The losses were even bigger at regional broker dealers. Meanwhile, independent broker dealers increased their number of advisors by 21%.

HighTower attracted Morgan Stanley veterans like Todd Lyon and Michael Bapis and Goldman Sachs (GS) alum Larry Gilbert. Richard Saperstein and Pamela Rosenau, who were named by Barron’s as among the country’s top 100 financial advisors, also moved to HighTower. HighTower has 34 advisors working in eight offices around the country, with plans to expand in Boston, Los Angeles, and Scottsdale.

Fighting the backlash

HighTower has forged a reputation of integrity in a short period of time, a key bit of currency in a world where finance is increasingly synonymous with fraud. But that reputation is under attack in the form of two legal actions against the firm and its advisors. In the first, clients of an advisor named Curtis Lyman sued him for putting their money into Banyon, a feeder fund for the Ponzi scheme run by disgraced Florida attorney Scott Rothstein. The suit alleges fraud and breach of fiduciary duty. Lyman made the investment prior to joining HighTower, and he lost a significant amount of his own money with Banyon as well. In this case, the judge has said that the claim was not strong enough to require a response from the defendants, giving the plaintiffs another chance to rewrite the complaint and try again. HighTower is happy with what the judge had to say, but the suit highlights the fear of fraud that has cast a pall over the advisory business.

The second suit poses a more serious threat because it takes direct aim at HighTower’s business model of recruiting brokers from other firms. Morgan Stanley Smith Barney sued five advisors who left the bank in February to join HighTower. The suit alleges that the advisors broke an industrywide code of conduct, called the protocol, by improperly taking clients and confidential client information to a competitor. The arbitration panel hearing the case concluded that any improper information obtained by the defendants must be returned to Morgan Stanley Smith Barney, insofar as any information was improperly taken.

But things are not black and white in this case. In November the arbitrators extended the temporary restraining order that Morgan Stanley Smith Barney had sought against HighTower by issuing a permanent injunction enjoining HighTower from using certain client information. But it also allowed the firm and its brokers to “continue to solicit any and all customers of Morgan Stanley Smith Barney.” Both sides claim this as a victory, with Morgan Stanley saying that “the Panel concluded that the Individual Respondents had in fact taken information prohibited by the Protocol for Broker Recruiting,” and Weissbluth saying that had the brokers done anything wrong they would not be allowed to conduct business as usual.

Weissbluth thinks of this as evidence that banks are indeed threatened by his firm, and says he is undaunted when it comes to building out the business. He has a lot of room to grow. Depending on whose numbers you use, wealth management is a $4 trillion to $5 trillion market. “Even if we are wildly successful and grow into the hundreds of billions, there is still a huge market for truly independent advice,” says Weissbluth. He would be willing to share proprietary information with the right startup, even knowing that it could someday pose a competitive threat, because he feels investors need more HighTowers.

Weissbluth compares financial services to another industry that was once extremely rich and laden with influential lobbyists: tobacco. “Regulation alone didn’t change big tobacco,” he says. “In the face of the industry’s claims that there was absolutely nothing harmful about their business, an ongoing open debate over the impact of smoking on health changed that industry. We need this ongoing conversation if the Wall Street model is to change, and I think it should.”