Morgan Stanley's New Compensation Indicative of Larger Trend

How brokers are compensated has been a hot topic for investors this year, and one we've covered at the Fool extensively in both our series on financial advisors, our in-depth look at Edward Jones, and our repeated calls for an enhanced fiduciary standard.

And it's a topic that brokers and regulatory agencies are tackling, although whether these changes are positive for investors is questionable.

Growth, longevity, and planning (for brokers)
Last week, Morgan Stanley  (NYSE: MS  ) announced that it was changing its compensation package for its advisors in an effort to grow the business, cut costs, and minimize broker flight.

The plan, which calls for cutting revenue awards, institutes a new bonus award program  for brokers who drum up new business. Currently, advisors who generate at least $750,000 earn a .05% bonus. Under the new program, that will be cut to 4.5% on revenues ranging from $750,000 to more than $5 million.

Advisors who want to take that bonus in cash will have to wait eight years. Those who opt to take their bonus in stock can get it in four. As part of this new plan, Morgan Stanley has created a program that allows advisors with more than $400,00 in revenue to purchase up to 25% of their pre-tax earnings (or $150,000 -- whichever is lesser), and receive 20 bonus shares for every 100. The shares will vest immediately. The bonus shares will vest on April 15, 2016, and all shares will be distributed on that date.

Also new to the plan is a ranking among advisors, whose bonuses previously were not tied to their peers. In 2013, advisors among the top 40% in the same experience tier showing growth in new assets are eligible for additional bonuses.

The new plan is risky, as brokers may not be willing to take a short-term cut in bonuses in the hopes that company performance over time will lead to a larger payoff. In a competitive market, in which high-profile turnovers have become the norm, it's a gamble.

But Morgan Stanley's attempts to clearly lay out how and when its brokers will be compensated may help it avoid the problems currently facing Merrill Lynch, which is only now nearing an end to its class action settlement from ex-brokers. The brokers, who left when Merrill Lynch was bought by Bank of America  (NYSE: BAC  ) , sued over retention bonuses and deferred compensation they claim was denied them after the buyout.

New rules for an old game
How brokers are compensated, and whether or not that compensation leads to a conflict of interest, will be affected by two changes that could have far-reaching impacts on regulation.

Mary Schapiro's exit from the SEC this week leaves her calls for the reform of the fiduciary standard thus unheeded. Schapiro has been heavily criticized during her tenure at SEC for failing to prosecute financial crimes, despite its $550 million penalty against Goldman Sachs  (NYSE: GS  ) , the largest in SEC history.

But if a year of financial disasters has taught us anything, it's that the calls for transparency, on everything from broker compensation to where money goes when it vanishes, are increasing faster than you can say "broker compensation." Whether Schapiro's replacement Elisse Walter, who calls for a "harmonized fiduciary standard" will be a benefit to investors remains to be seen.

FINRA this week called for comments on a proposal that would require firm-switching brokers to disclose to their customers any recruitment bonuses or other incentives. As we saw in our research into Edward Jones' conflicts of interest, customers who change firms to follow a departing broker are often hit with fees from their existing brokerage firm. It's clearly a win/lose situation when brokers benefit and customers are penalized for a move, especially when attempting to maintain consistency in financial planning.

The Foolish bottom line
There may be a growing shift in how brokers are compensated, but knowing exactly how a broker makes money continues to be pivotal to investors. Because when customers hire a broker to manage their portfolio, they're essentially opening a small business with them. In an ideal world, all parties would succeed and thrive. One can't succeed if the other fails. At least, they shouldn't.

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