On a Friday afternoon shortly after 4:00 p.m. on May 9, 2008, four of the five future partners of Luminous Capital, a firm that would begin operations in less than 60 minutes, walked into their branch manager's Los Angeles Merrill Lynch office and told him they were resigning to start their own firm.

A fifth partner led 14 Merrill employees, who had worked with the team, off to another office in the same building and offered them all jobs. The employees, who had no knowledge of the creation of Luminous, were asked to fax in their resignations from Merrill within the hour so they could help transition clients over to the new firm starting at 5:01 p.m. Call it short notice.

After listening to the reasons for conceiving Luminous, 13 of the 14 employees agreed to fax in their resignations, while the 14th asked if he could mull it over during the weekend. On Monday, he signed on and reported for work with the other 13.

"We offered them equity participation grants to help them realize how important they were to us," says Kim Ip, who became chief operating officer and research director.

Knowing they would have to spend the next several months convincing clients to move their accounts, the partners got a dress rehearsal that afternoon in persuading employees to join the firm. Over that May weekend, clients received an e-mail brochure entitled, "Why," explaining the reasons that the group was launching its own firm.

What seemed so simple actually was years in the making. Ip recalls that when she joined the team in 2005 from Merrill's investment banking unit, her future partners had already been in discussions about forming an independent RIA firm.

The principals at Luminous had managed $8 billion in client assets at the giant wirehouse, though much of it was situated in stock options and restricted stock plans they planned to leave behind. But the formation of Luminous that Friday afternoon entailed nearly one year's worth of meetings on weekends and weekday nights, the retention of Brian Hamburger, founder and managing director of MarketCounsel, and numerous decisions about how to structure the firm.

Over the 18-month period between January 2009 and June 2010, it is estimated that about 7,300 brokers departed Morgan Stanley Smith Barney, Bank of America, Wells Fargo Advisors and UBS Wealth Management Americas. Some departures no doubt were involuntary and the exodus has slowed somewhat.

Hamburger estimates that MarketCounsel is retained by more than 20% of the large corner office teams that have exited Wall Street's wirehouses in recent years, and his consulting firm has an RIA incubator program that forms advisory firms. He says MarketCounsel is still starting up about one firm a week. "I like to tell clients that their firm will be up and running between the time they leave their old office and before they reach their new office, as long as their new office is a 15-minute drive from the old one," Hamburger jokes.

It was upon Hamburger's instructions that the principals of Luminous were forbidden from sharing any of their plans with either existing clients or future employees. "I have to give Brian credit for legal advice that would ensure that we weren't sued or given a temporary restraining order," Ip notes.

Starting in the summer of 2007, the principals first hashed out what kind of firm they wanted to create. Initially, they considered launching their own broker-dealer to run alongside the RIA. But since many had worked in firms with proprietary products and platforms, they argued back and forth about whether they could operate a brokerage and still offer objective, "agnostic" advice.
"Selling a bond portfolio out of a broker-dealer's inventory" ultimately didn't sound very "agnostic," notes Mark Sear, a Luminous partner. So they decided to relinquish the 30% of their business that came through commissions and take the RIA-only route.

The launch of a business with 19 people that hits the ground running at 5:01 p.m. on a Friday afternoon entails lots of advance planning. Finding the appropriate office infrastructure, creating a financial model, devising a marketing plan and selecting a custodian and a technology platform meant that each partner had to take on major assignments while still busy serving clients on behalf of Merrill. Hamburger and his staff at MarketCounsel have transitioned hundreds of wirehouse teams to independence, but ultimately, the new firm has to know what it wants to achieve if the business plan is to work. Ip was in charge of coordinating the move, holding all the partners accountable and ensuring that the business hung together.

Sear recalls lots of "macro-level issues with micro-level details. It turned out we outsourced almost everything we could, including payroll, health care and computer systems."

The actual divorce from Merrill turned out to be surprisingly amicable. "We had reached the conclusion that there were better alternatives for us and our clients," Sear says. "It was not a surprise to Merrill Lynch either. We had had a number of meetings with them. They made a good faith effort to improve [their services] and they put us on some committees. But it was like turning an oil tanker."

Part of the reason for the friendly separation may be that Luminous only took $1.7 billion of the $8 billion they managed out of Merrill. Less than three years later, the firm now has $4 billion in assets, six partners and 21 other employees.

Persuading clients to move to Luminous turned out to be easier than they anticipated. Then again, given that virtually all their clients were self-made, entrepreneurial types from the small business and venture capital worlds, maybe they should not have been surprised.

"Two-thirds were very excited. We had good relationships with them and they had started businesses themselves," Sear says. "Others, though, felt a sense of security with a big investment bank like Merrill and wanted to compare the balance sheet of Fidelity [Luminous' primary custodian] to that of Merrill. We were able to convince clients that we would have a bigger toolbox at a lower price."

As events played out over the summer of 2008, the security associated with giant financial institutions started to evaporate. Indeed, Ip admits she was surprised their old firm did not come up with a more compelling value proposition to convince clients to remain at Merrill. But at that point, the other brokers in the office probably were working overtime just to keep their own clients from jumping, either out of the firm or out of the market completely.

Luminous principals had a catbird's perspective on the financial crisis. They and their clients were invested in one hedge fund managed by John Paulson, who made his reputation and fortune making huge short bets on financial institutions. But their request to be able to invest in Paulson's Credit Opportunities Fund, which was up about ninefold in 2008, was declined by Merrill because it used too much leverage. But in the end, it was Merrill, not Paulson, that ran into problems with excessive leverage. Knowing what Paulson's thinking was about the state of the U.S. banking system, the team, still at Merrill, entered 2008 with 40% of their client portfolios in cash.

"The problems at Merrill put further urgency in our decision," Ip says. "And we were concerned about the general state of the financial services industry. Choosing Fidelity, a private company that wasn't in investment banking, was important."

Over the long, hot summer of 2008 as Luminous brought over their old clients, Fidelity typically had between three and five of their own people working in the office trying to make the client transition experience as seamless as possible. Schwab was selected as the second custodian because, as Sear says, competition means better pricing.

Given its size and scale, the experience of Luminous probably isn't representative of the thousands of advisors who have exited wirehouses over the last three years. Custodians like Fidelity, Schwab, TD Ameritrade and Pershing provide transition assistance, as do broker-dealers, but only an operation the size of Luminous warrants the full-time help of at least three people for several months.

Forming a business also requires financial sacrifice. The partners at Luminous had to pay their staff of 14 over the summer of 2008 while they had yet to receive any fees, so they took no salaries themselves.

But for Luminous, the RIA-only route made sense. The firm's average client has about $20 million in assets.

Ip argues that many of the asset managers she tries to find for client portfolios have little interest in spending their time marketing to a brokerage platform with 15,000 brokers. "The larger an investment manager becomes, the more closely their performance starts tracking the benchmark," she says. "Often, a brokerage firm doesn't make the lowest fee available to an advisor's clients. Here, we can negotiate a fee directly with the investment manager."

Luminous also makes alternative investments in an outside-the-box style more befitting a multifamily office. For example, the firm is approaching clients about investing in a fund that purchases U.S. farmland, reasoning that increased wealth in emerging markets is going to translate into much higher protein consumption on a global basis.

Ip has spent the last two years working extensively with agronomists who have conducted regression analyses to optimize seed varieties and has raised about $80 million to purchase two farms. She expects the firm will buy four more. "We want to be diversified geographically and by crop as well," she says. 

Independence isn't for everyone at a wirehouse, and Hamburger and his director of business development, Frank Pizzichillo, have learned over the years to spot the warning signs. Hamburger recalls working with a team whose leader failed to sit in on any of the calls about planning the firm because he thought setting up a business involved lots of little housekeeping details that were trivial.
"For folks like that, the wirehouse model works," he says. "How can we help design a firm if we don't know what you want it to look like? We've had ten projects canceled over the last year after it became apparent independence wasn't a viable option."

Other options Hamburger may recommend include affiliating with an independent broker-dealer or joining an existing RIA firm. Starting an RIA firm takes an average of 60 days and costs between $7,000 and $10,000, while forming a broker-dealer can take five or six months and cost $50,000 to $75,000. "Once they hear that, 99% of [MarketCounsel] clients don't want to set up their own broker-dealer," Pizzichillo says. "Ten years ago, you would see broker-dealers with just handful of people. Now it's too expensive."

Early in the engagement, Pizzichillo tries to gain a sense of what is the motivation or impetus behind a team's departure as he and Hamburger work to help clients create a business plan. "It can't be, 'I hate my branch manager.' We try to weed those folks out early," Hamburger explains. "You have to have a lot of drive to succeed."

Pizzichillo, who typically gets referrals from custodians, independent broker-dealers or mutual fund wholesalers, often looks for red flags in the language employed by a broker thinking of breaking away. "Are they comfortable with fee-based terms or are they talking about books of business and payouts?" he explains. "If five minutes into the call they are talking about how do I keep my trails [commissions,] then independence may be right for them several years down the road."

It's unusual for a new client to have a detailed formal business plan or have considered independence for more than three years to the extent Luminous did. "Typically, they may have an outline with some primary goals and they will have some questions," Hamburger says. "Starting a business has a lot of moving parts, so we are a bit like an air traffic controller."

Maintaining confidentiality is critical since information leaks can result in disasters. "The number one reason these projects run off the rails is pre-termination disclosure," Hamburger says. "Say someone is playing cards with his buddies and tells them about starting a business and then it gets mentioned in an e-mail." Needless to say, wirehouses routinely engage in e-mail surveillance.

For several reasons, Hamburger tells advisors to be deliberately vague if they mention their plans to clients at all. "You still want to fulfill your business obligations to your current employer," he says. "You can't be soliciting or selling away. You don't want to violate FINRA or your employment contract. You can tell clients we are evaluating several different business models and trying to figure the one that best suits your interest."

For his part, Pizzichillo acknowledges that forming a new business is not something anyone should underestimate. Many advisors who have been pampered in a wirehouse fail to realize all the so-called "moving parts" involved.

Unpleasant surprises can crop up. "When you are dealing with folks who aren't that well-organized, they can get overwhelmed and don't realize how many choices and decisions they will have to make," Pizzichillo says. "There are a lot of long nights and shouting matches about how things are going to run."

Moreover, the corner office teams at big firms are compensated comfortably, and while the long-term economic rewards of owning a business may be superior, the risks also are greater. "You have to really want it and have the fire to start your business," Pizzichillo explains.

But the psychic rewards of going independent may often outweigh the financial upside. "People have told me post-transition that they knew their clients appreciated them but they underestimated how much clients needed and supported them," Pizzichillo says.
For Ip, the biggest surprise comes from "just how much fun we are having."   

Wirehouse Exodus Normalizes
When Wall Street's wirehouses were teetering on the edge of insolvency in late 2008, the stream of breakaway brokers heading for the exits had reached a feverish pace. For custodians and independent brokerages, it represented the opportunity of a lifetime.
Raymond James Financial, which targets much of its recruiting at wirehouse brokers, offers custodial services to RIAs as well as four other advisory platforms, including independent contractor, employee, regional brokerage and bank models. In 2009, it experienced a net increase of 750 new advisors.

"In the last year, we've seen much more of a balanced momentum," says Chet Helck, president and chief operating officer at the firm.

Two years ago when Wall Street was clinging to survival with money from the Troubled Asset Relief Program, Raymond James' employee model was the most popular because of the security it offered. But that model is limited by where Raymond James has office space; it's not economic to open an office for one or two people.

"In the last year, the independent contractor model gained steam," Helck says. "People are making decisions in a much more considered way."

This is confirmed by MarketCounsel's Pizzichillo. In late 2008 and early 2009, many wirehouse brokers were given very short notice to sign bonus retention packages at a time when whatever shares they owned in their firms were approaching penny-stock valuations.

"The same people are coming back and talking to us," Pizzichillo says. "Now there is no impending event that they have to make a decision by Friday. They say, 'I didn't want to do it as a fire drill.'"