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The Strange Birth, Growth and Death of Fee Based Brokerage Accounts

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We’ve just begun the last week of fee-based brokerage-accounts.
This spring a federal court struck down the rule allowing the accounts, requiring brokerages to shut down the programs by October 1st. The accounts were a popular choice with some brokerage customers, particularly those who traded frequently. Where traditional brokerage accounts charge per-transaction fees, the flat fee accounts charged a flat fee—usually between 1% and 3% of assets—for an unlimited number of trades. For frequently traders, the accounts could create substantial savings.
Wall Street brokerages loved the accounts, and so did federal regulators. In fact, the accounts were first created under a rule proposed by the Securities and Exchange Commission in 1999. At the time the SEC was trying to find a way to discourage “churning”—the practice of brokers and financial advisers encouraging customers to make more frequent trades to generate fees. After brokerages started offering the accounts, churning complaints dropped 43%.
More on the growth and death of the flat fee accounts after the jump.

The rule allowed banks to charge an asset-based fee without incurring the level of fiduciary responsibility that applies to investment advisers under the Investment Advisers Act. Where that act requires independent advisers to fiduciary responsibility, putting the welfare of their clients above themselves, brokers offering the flat fee accounts merely had to ensure that their recommendations had to be suitable for the client.
Wall Street brokerages loved the accounts because they generated a more reliable revenue stream than accounts where clients paid a per-transaction fee, making the publicly traded shares of the brokerages more attractive in the eyes of analysts and investors. Brokers saw them as a way to "annuitize” their book—that is, turn every customer into a source of annual revenue. The brokerages encouraged brokers to sell the programs to customers through bonus structures which sometimes gave twice as much credit for the wrap-accounts as for other customer accounts.
But not everyone was happy with the flat fee accounts. From the start, groups such as the Financial Planning Association opposed the accounts and the SEC rule permitting them. Some of the big discount brokerages also opposed the accounts. Eliot Spitzer, trial lawyers and industry regulators accused the brokerages of pushing the accounts on clients without regard to suitability—and many paid hefty fines for pushing them to clients. Of course, many of the opponents had very obvious self-interested motives. Professional advisers didn’t like the competition from brokers, and discount brokerages didn’t like the challenge to the transaction-based fee structure.
But the accounts weren't killed by rent-seeking opponents. It was killed by legal formalism. The death knell was sounded when a federal court ruled that the SEC had overstepped its authority when it granted the exception, and the SEC announced it wouldn’t appeal the decision. Now firms are scrambling to move clients into different types of accounts before the court’s deadline. Unsurprisingly, it seems that many of them have not given-up the dreams of charging clients flat-fees every year, and are pushing clients into other types of fee-based accounts.
“[Brokerage firms] have been trying to entice clients instead to move to another type of account known in the industry as a fee-based nondiscretionary advisory account,” the Journal’s Jane Kim writes. “With these accounts -- which can hold individual stocks and bonds, mutual funds, exchange-traded funds, and cash investments -- investors can get more comprehensive advice from a registered investment adviser, but still call the final shots since the adviser must get the client's permission before making changes.”
We’re sure that somewhere an attorney general is reading those words and smiling. Sounds like another round of lawsuits might be on the way.
Moving Past 'Fee-Based' Accounts [Wall Street Journal]


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