The SEC's decision on May 14 not to request a rehearing of the U.S. Court of Appeals ruling in March that vacated the “Merrill Lynch rule” has the Securities Industry and Financial Markets Association (SIFMA) and its member firms upset and scrambling for solutions. The SEC requested a four-month stay of the court's ruling instead. Now, whether the court grants that request or not, firms have an operational and administrative nightmare ahead of them, not to mention the difficulties brokers will have explaining the new reality to clients.
“How do you tell a client that this account, this great idea we had for them and they've had for so long is no longer appropriate?” asks one Morgan Stanley broker. Then there are the necessary hard, cold operational changes: Firms now have to choose between turning these accounts into commission accounts — the “unpredictable” revenue stream Wall Street has been moving away from for years now — or transfer the accounts to the advisory side of the business, a lengthy “multi-step process,” says SIFMA's Travis Larson. In fact, SIFMA says “many firms have reported that four months will not be enough time to make the required transition.” According to reps, before assets can move a firm needs to internally decide what products and arrangements are appropriate for each client, then draw up the paperwork and disclosures, then contact the client and explain and discuss the various options.
SIFMA and firms like Merrill Lynch and Morgan Stanley are saying what they've said all along: that fee-based brokerage accounts provide clients with more choice concerning how they want to pay for the broker's services. In a release criticizing the SEC's request for a stay instead of a rehearing, SIFMA said it expects the SEC to “expeditiously develop alternative solutions” to preserve that freedom of choice for clients. On the other end, financial-planning trade groups like the FPA and NAPFA applaud the SEC's decision not to appeal in the name of investor protection. “Nobody's taking anything away here, nobody's taking away fee-based accounts,” says the FPA's attorney in the case, Merril Hirsh. “The issue here is that if you're providing investment advice for special compensation, you have to act as an investment advisor,” he says. Saying it's about ‘choice’ “is like saying it would be a good thing to let lawyer's operate with conflicts of interest because then people could choose to hire lawyers with conflicts,” says Hirsh.
Incidentally, in the SEC's request for a stay, it indicates that it will help firms make the proper adjustments but it also leaves open the door to further action on the issue, stating that it will “consider whether further rulemaking or interpretations are necessary regarding the application of the Advisers Act to these accounts and the issues resulting from the court's decision.”
One former Merrill Lynch branch manager says reps are in for a lot of hassle in the meantime if firms opt to transfer the accounts to advisory programs. Not only is the process of “repapering” accounts — moving them from brokerage to advisory or vice versa — a time-suck, it's fraught with peril, he says. “Imagine all the questions you'll get, about fees, performance and, ‘Oh by the way, I've been meaning to talk to you about X or Y.’” Thousands of conversations will have to be had and, inevitably, what some advisors are going to end up having to do is “re-sell” to that client, he says — prove they're worthy of being the client's advisor all over again.
That's precisely what one Merrill Lynch advisor says he'll have to do if he has to switch his biggest client account out of MLUA ( Merrill Lynch Unlimited Advantage, the firm's fee-based brokerage offering) and into either a commission or advisory account. He says the account has north of $10 million in it, primarily in municipal bonds. With a fee of 17 basis points, it's a superb deal for his client, he says. “If I have to switch him to commissions, the mark-up will be significantly more than 20 basis points, even at the deepest discount,” he says.
Morgan Stanley spokesman Jim Wiggins says his firm “fully expects the [court to grant a] 120-day grace period to decide what is best for clients.” And his firm is going to need it. Morgan is in the process of building a non-discretionary fee-based advisory account program, but right now it is the only wirehouse without one. And with $40 billion in its Choice fee-based brokerage program, there's a lot at stake. Wiggins says Morgan will be done building the new program within four months, but the firm isn't happy with the situation. According to the firm's calculations, Choice clients have saved $400 million a year, or $2.8 billion in commissions on trades, between 2000 and 2007. “These accounts were good for customers,” says Wiggins. “For this to be foisted off as consumer protection is a travesty.”
