Will Investors Pay for Schwab's Advice?

It's heading into territory in which rivals are well-entrenched

Independent financial adviser Thomas Gryzmala has kept all of his clients' stock-trading accounts at Charles Schwab & Co. (SCH ) since 1992, using it as a custodian for millions of dollars in assets. But lately, the Alexandria (Va.) adviser has parked clients' money at TD Waterhouse.

Why the change? Gryzmala is mad. Now that the online trading craze has faded, Schwab is increasingly selling investment advice from advisers on its own payroll. That treads on almost 6,000 independents such as Gryzmala who bring Schwab a third of its total client assets of $833 billion. "I can't feed the competition," says Gryzmala, who won't keep new clients' money at Schwab.

The ire of independent advisers is just one of the hurdles that San Francisco-based Schwab faces in transforming itself from America's premier discount broker into a full-service house. After the markets turned south in 2000, retail trading slowed. In the third quarter of 2001, Schwab's average daily trades were down 26%, to 187,800, from the same period in 2000. That convinced Schwab that its slick Web site and discount trades wouldn't hack it any longer. Its response: advising on trades, not just executing--an old idea in the business but a new one at Schwab. Brokers who once sent clients to independent brokers for advice now dispense it. High-end customers get the kid-glove treatment at U.S. Trust, the tony advisory firm Schwab acquired in 2000. "If [Schwab] doesn't offer advice, it risks losing the customer relationship altogether," says Matthew McGinnis, an analyst at Cerulli Associates Inc., a consultant to financial-services companies.

Advice can be lucrative. Schwab's Portfolio Consultation, an analysis of a client's holdings and a couple of hours' worth of advice, costs $400. Schwab will also manage a client's money for a yearly fee based on assets. But competition is fierce. Most of Schwab's rivals are attempting to offset lost trading fees by selling advice. Adding to the pressure is Schwab's poor financial performance. Bear Stearns & Co. analyst Amy S. Butte estimates that 2001 net income was $391.4 million, down 50.6% from $792 million a year earlier, on revenues of $4.35 billion, a decrease of 24.7%. The stock has dropped 40% since the start of 2001. On Jan. 7, Butte downgraded the stock from "buy" to "attractive," citing low trading volumes. Schwab's results are due in mid-January.

Schwab declined to make executives available for interviews. But in a mid-October conference call with analysts, co-CEO David S. Pottruck defended the strategy. "We're talking about advice that's objective and not driven by commission," he said. "That's what sets Schwab apart from every competitor." Pottruck downplayed the conflict with independent advisers: "All of this can coexist very well."

But obstacles abound. Schwab has historically paid less than full-service brokerages and therefore is likely to have trouble luring top advisers. Former managers say Schwab advisers earn $100,000 tops--a fraction of what senior brokers at full-service firms earn. Former Schwab managers, who declined to be identified, say that means some Schwab advisers are twentysomethings with little personal investing experience. "And here they are advising people on their retirement," says one. Another estimates that as of mid-2001, "only 20% of Schwab's adviser force [could] really deliver quality advice for the affluent client." A Schwab spokesperson counters that all advisers are qualified but with varying experience: "You don't need to have 100% of the staff all operating at the exact same level." Schwab, which cut 23% of its workforce of 26,000 in 2001, plans to raise advisers' salaries by 15%, analysts say.

At heart, Schwab has a marketing problem. For years, it sold itself as the place for do-it-yourself investors on a tear. Now, it wants to be the kindly financial adviser with all the time in the world--your grandad's broker. It will be tough for customers--and Schwab--to make that leap.

By Louise Lee in San Mateo, Calif.

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