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Goldman Risks Alienating Brokers in Asset-Management Push

Brokers chafe under the changed compensation setup, sparking some to exit the venerable firm.

Goldman Sachs

(GS) - Get Free Report

is dutifully following conventional market wisdom in its quest to build its asset-management business, but its push may be alienating some of its highbrow brokers.

Since even before the firm's May IPO, Goldman brokers have been chafing under the pressure of selling mutual funds and other products carrying the

Goldman Sachs Asset Management

name. And in December, the situation worsened after the firm changed how it compensates the group, which has about 500 brokers catering to the super rich and top executives from the firm's investment banking clients.

Seemingly as a result of those changes, a number of the firm's brokers have left for competitors. Just two weeks ago, five joined

Merrill Lynch


in Los Angeles, San Francisco and Boston, and another veteran left to run private money. Six brokers leaving Goldman in such a short time is rare.

"This is just the beginning. There are a lot of guys interviewing," says the head of a competing high-net-worth brokerage.

Goldman declined to comment for this story.

Goldman simply may be doing an upscale imitation of Merrill Lynch and the former

Dean Witter

(now half of

Morgan Stanley Dean Witter


), firms that made pushing brokers to sell their mutual funds into an art form.

The reason is simple: The recurring fees garnered from such products provide stable, predictable ballast for firms whose fortunes can turn on volatile trading and investment banking cycles. Analysts and shareholders love fee business and have longed for Goldman to do more of it.

Goldman lumps asset-management revenue in with net interest, commission business and other securities services revenue, and they totaled about 21% of its 1999 revenue. Over at Merrill, just the fee business accounted for 22% of the firm's overall revenue last year, according to industry analyst Michael Flanagan of

Financial Services Analytics

. (His firm doesn't perform underwriting.)

Building asset management was a "big promise during the IPO," says Patricia Ouimet, the assistant portfolio manager on the

John Hancock

(FIDAX) - Get Free Report

Financial Industries fund, which sold its Goldman shares. "People wanted to know how they were going to grow that business." Ouimet says her fund wouldn't mind seeing a more diversified Goldman, at least at its current prices.

Goldman is making progress. Assets under management were up 17% to $258 billion in the fourth quarter.

"Asset growth has been good. It's still in a build mode, but Goldman is in the institutional business, so it's not likely to have a fund business like Merrill Lynch has," says Joan Solotar, a brokerage analyst at

Donaldson Lufkin & Jenrette


. Firm management, she says, has said it expects profitability at the unit within the next 12 to 18 months. (DLJ has performed underwriting for Goldman.)

"Because of overall profitability of the firm, it hasn't been scrutinized," Solotar says.

Except for the brokers, that is, who are exhibiting a good bit of scrutiny.

Before its IPO, Goldman wasn't concerned with such banalities. Its brokers catered to blue-blooded prospects but were kept off the gilded partnership track. After a while, they took their clients and their assets to a hedge fund and faded into comfy retirements.

Goldman's brokers, however, see themselves as money managers and resent the in-house funds push, two brokerage firm executives familiar with Goldman's brokerage operation say.

The problems began about six months ago, when Goldman merged private-client services with asset management to form its

Wealth Management

unit. It also launched a new salaried sales force that gets leads on any major prospects.

Then, in December, the firm cut brokers' payouts (the portion of the overall commission that goes to the broker) on underwriting business, giving brokers less incentive to do IPO business. It also rescinded a practice of letting brokers keep a portion of the spread on over-the-counter trades and slashed the payout to 20% from 30% on accounts with less than $3 million in assets, according to two people close to Goldman's retail group. All of this, experts say, is meant to get clients into the firm's funds.

"These guys have the best high-net-worth brokers in the business, and they want them to sell these funds to people who have relationships with the firm's bankers," says a competing Merrill branch manager. "What's going to happen when they're unhappy with the fund performance?"

Goldman's funds haven't been blowout performers, although its two largest outperformed the

S&P 500

in 1999. But its

(GSGRX) - Get Free Report

Growth and Income fund returned just 5.80%.

Merrill, Morgan and hedge funds have descended on Goldman's sales force, using hiring bonuses that can exceed 100% of the previous year's commissions and chunks of stock, according to two executives on the recruiting trail.

Some think Goldman's moves are calculated to rid itself of the private-client group and replace it with a sales force compensated with an annual salary and bonus, as opposed to commissions, and bring assets into the firm's funds. It also has been developing an online distribution product that remains in a stealth development stage.

One Goldman alum looks downtown with a tinge of nostalgia for what used to be. "They don't want brokers," he says. "They want maitres d'."