Regulators eyeing fee-based accounts

SRO competition cited as a factor

Feb 9, 2004 @ 12:01 am

By Bruce Kelly

Fee-based advisers, the self-styled white knights of the financial services industry, face increased scrutiny from securities regulators.

Such brokers and financial ad- visers have long argued that charging a client a fixed fee, often in the form of a percentage of the client's assets, prevents potential conflicts of interest.

But recently, regulators at the New York Stock Exchange and NASD have sent signals to broker-dealer members that fee-based accounts will be under the microscope.

A spokesman for the Big Board said that it is currently looking at the suitability of broker-dealers' placing customers into fee-based accounts. He declined to comment on specifics.

And in November, NASD in a notice told its broker-dealer members that they should "implement supervisory procedures to require a periodic review of fee-based accounts to determine whether they remain appropriate for their respective customers."

Brokerage executives said it was another sign that regulators are becoming increasingly competitive with one another. In the wake of the recent mutual fund trading scandals, regulators rushed to leave no parts of the industry unexamined.

"It's almost like stating the obvious: Fees may be inappropriate," said Chester Helck, president and chief operating officer of Raymond James Financial Inc. in St. Petersburg, Fla. "I think [regulators] are looking at absolutely everything that's going on in the financial services industry."

As with any investment, suitability is a key issue with fee platforms. An obvious example, he said, is an elderly retiree investing in municipal bonds on a fee platform rather than owning the individual security.

Avoiding conflicts

It would probably be cheaper for such a "buy-and-hold" investor to own the bonds directly, Mr. Helck said. "Why would you pay somebody a fee?"

Ways to avoid potential conflicts, he added, include a broker-dealer's making sure it has a number of fee programs for clients and that its pricing is flexible.

Raymond James, like many firms, has been staking a larger amount of its business to fee-based investment platforms. Stock analysts and investors also tend to favor such platforms, as they give firms the advantage of a steadier stream of revenue than commissions.

In its last fiscal year, Mr. Helck said, 36% of the firm's retail brokerage revenue came from recurring charges to clients for a variety of services. His personal goal is to increase that to 50%.

Most quality financial advisers have services for clients that charge both a fee and a commission, he noted.

Change of heart?

Some executives are peeved by the latest round of inquiry from regulators, particularly because in the past, securities regulators have given their blessing to fee programs.

Regulators have backed up the assertion that fee accounts may be in clients' best interests, with NASD in 1995 labeling fee-based programs a "best practice."

At the time, NASD's reasoning was that such fee programs more closely align the interests of the broker-dealer and client, reducing the potential for abusive sales practices such as churning, using high-pressure sales tactics and recommending unsuitable sales transactions.

NASD is looking for broker-dealers to supervise more closely the registered representatives who sell fee-based programs.

Member broker-dealers "should consider whether reasonable assumptions about market conditions upon which the member based its initial determination of appropriateness have changed, as well as any changes in customer objectives or financial circumstances," NASD said in its notice.

And NASD is advising broker-dealers to offer clients a cost comparison between fee and commission investments. "Members also may wish - but are not required - to create reports that compare the asset-based fees to those that would have been generated in the same account on a commission basis," NASD stated.

Some broker-dealer executives believe that increased scrutiny of fee-based accounts is inevitable. "There's going to be a real focus on fee-based," said one compliance executive, who asked not to be named.

"That's my gut feeling."

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