Fee-Based Accounts Come Under Scrutiny

The long parade of securities scandals has convinced broker/dealers to apply some prophylactic measures to their fee-based accounts.

Registered reps at the major b/ds say their managements have been heavily scrutinizing whether certain accounts have enough trading activity to warrant their fee-based status. Though reps seem to understand managements' motivation — “It just appears to me that they're trying to head off any future inquiries,” says one Morgan Stanley rep — they are nonetheless perturbed.

For years now, b/ds have been pushing reps to shift commission-based clients to fee-based arrangements, and the advisors have largely complied. At some of the major wirehouses, fee-based clients account for 20 percent of client assets, and that percentage is growing each year.

Now, advisors feel they are being cited for not trading enough on their clients' behalf — criticism that is hard to swallow, given that one of the supposed benefits of fee-based accounts is eliminating gratuitous trading activity.

“The original client complaint was, ‘He's always telling me to buy or sell something’,” says the Morgan rep. “The thought with fee-based accounts was to get clients the right advice — buy, sell or hold. Supposedly, we're on the right side of the table now.”

The impetus for the b/ds' inward scrutiny seems to be an NASD notice to members released in November reminding b/ds that fee-based accounts may not be appropriate for all customers. The notice notes that absent a certain amount of trading, fee-based accounts may violate several NASD rules aimed at ensuring the cost of such accounts is justified.

The suitability of fee-based accounts has become more important as they have taken up a greater piece of client assets at the major b/ds. For instance, at Morgan Stanley, asset-based accounts now account for 23 percent of client assets; at Merrill Lynch, asset-based accounts are 18 percent of client assets. Typically, fee-based accounts incur an annual fee of 1 percent; a $1 million account, for instance, would cost a client $10,000 a year.

Reps' core fear about the scrutiny of low-volume fee-based accounts is simple: “Sometimes the right course of action for a client is to do nothing,” says one Wachovia rep. “What they're saying is that doing nothing is not an action — and that's incorrect.”

So far, reps at various firms say they have not been given specific guidelines or benchmarks they can use to pinpoint appropriate trading activity for fee accounts. The emergence of such guidelines would go a long way to confirming or dispelling reps' worst fears about the fee-based inquiries.

Given their growth, it is not much of a stretch to imagine a day when such accounts account for the majority of total client assets. Cerulli Associates notes that of all managed account programs it tracks, fee-based brokerage assets had the smallest decline in overall assets, falling by just 0.8 percent. Thus, the attention given this issue makes some sense.

Some reps suggested that annual reviews would be the best way to handle the suitability of fee-based accounts. Of course, that means more paperwork — something reps would just as soon avoid.

“We've got tons of memos about” the fee-based account suitability issue, says a Smith Barney rep. “I just disagree with it. It's not a conflict of interest. The firms, I guess, are afraid of more repercussions from the SEC and NASD.

PERCENTAGE OF CLIENT ASSETS IN FEE-BASED ACCOUNTS