Regulators are starting to take a closer look at the prevalent practice at many brokerages of switching customers from traditional, commission-based accounts to asset-, or fee-based accounts, according to a BusinessWeek article.
Fee-based accounts, or accounts that carry an annual fee based on a percentage of assets instead of trading commissions, were introduced to reduce complaints of churning--excessive trading done by brokers to generate commissions. Churning complaints have gone down by 43% over the past four years.
At the end of last year, brokerages, which have a lot to gain from the steadier stream of income from fee-based accounts, served investors who had almost $270 billion in fee-based brokerage accounts, up 61% from the end of 2002, according to Boston research firm Cerulli Associates.
Fee-based accounts save money for investors who make an average number of trades, or more. Morgan Stanley says, for instance, that its customers have saved $2 billion in commissions over the past five years with the accounts. But the problem arises when brokerages inappropriately switch customers from traditional to fee-based accounts.
On April 27, the NASD brought its first disciplinary action over fee-based accounts. It said Raymond James switched more than 2,900 customers who hadn't made a single trade the previous year. Lack of adequate monitoring allowed 17% of customers in the company's fee-based accounts to make no trades in 2003, up from 14% in 2002, the NASD said.
Raymond James, which did not admit or deny wrongdoing, agreed to pay almost $1 million to settle the allegations. It also agreed to discontinue offering fee-based brokerage accounts.
NASD has "a number" of further enforcement actions coming, said Robert R. Glauber, NASD chairman and chief executive. The New York Stock Exchange may also follow suit, says Donald van Weezel, vice-president of the NYSE's regulatory branch.
The Securities and Exchange Commission has also conducted a review looking into fee-based accounts. So far, the SEC's probe has resulted in confidential warnings about possible compliance failures to an unspecified number of firms.
Regulators have also found cases of "double dipping", in which brokers sell mutual funds that carry steep commission-like sales charges to customers with fee-based accounts. Some customers are fooled by marketing materials that lead them to believe that they'll get investment management or financial planning with these accounts, when, in fact, those services cost extra.
"It's absolutely important that an investor is well informed of the advantages and disadvantages of a fee-based account," said the NASD's Glauber.