Regulators Sound Alarm on Shift to Fee-Based Accounts
Regulators are concerned that firms and brokers may not be paying close enough attention to the appropriateness of switching customers into fee-based from traditional commission accounts, and may be relying on the defunct Department of Labor fiduciary rule and other regulatory initiatives to encourage such switches.“There may be very good reasons why the best match for the customer is the advisory account as opposed to a brokerage account,” Lourdes Gonzalez, a Securities and Exchange lawyer overseeing sales practices, said at Finra’s annual compliance conference this week. “But if the reason that the customer is in the advisory account versus the brokerage account is because of a regulatory impetus….that’s unfortunate.”
Many firms cracked down on transaction-based brokerage retirement accounts out of concern that it would be difficult to meet the DOL rule’s fiduciary rule obligations when brokers’ compensation is based on transaction-based commissions. But they also have embraced fee accounts as a smart business move because the accounts throw off revenue regardless of a customer’s investment and trading activity.
Customers filed a class-action lawsuit against Edward Jones & Co. last year claiming that the firm pressured its brokers to move its largely buy-and-hold investors into high-fee accounts (as much as 2% of assets). It used the DOL rule that a federal court struck down last June as a subterfuge for the activity, the lawsuit said. The case is pending in the Eastern District of California.
James Wrona, Finra’s associate general counsel, warned industry compliance officials at the conference on Thursday that regulators have in the past brought enforcement actions for putting customers inappropriately into more expensive accounts. A wave of such activity followed the 1995 issuance of the “Tully Report” on broker compensation, which described fee-based programs as a best-practice preventative against abusive sales practices.
“We found that people were more than willing to move customers into a wrap account and charge an asset-based fee because firms actually got more money that way,” Wrona said. “Now we’re back in the same situation.”
He did not address whether any “reverse churning” cases are underway, and a Finra spokeswoman declined to comment.
To be sure, advisors at many broker-dealers say their firms have doubled-down on monitoring the appropriateness of advisory accounts, requiring notes on the suitability of transfer recommendations on a case-by-case basis and periodic updates.
Brokerage officials and regulators at the conference said that the SEC’s proposed Regulation Best Interest appears an attempt to preserve the dual-account model, and could influence future customer-protection behavior.
“The SEC staff said the aim [of Regulation BI] was to preserve the broker-dealer advice model,” Finra Chief Legal Officer Robert Colby said at a conference panel on Friday. “That’s to say, they are trying to preserve the broker-dealer business as we know it.”
Chris Lewis, Edward Jones’ general counsel, also put in a good word for the brokerage account model. “It’s not a binary world that we live in,” he said on the panel where Wrona gave his warning. Many clients have both kinds of accounts….and we are very supportive of the approach that the SEC has taken.”
Wrona and Colby have both said that Finra could drop its “suitability” standard of care for brokers if Reg BI in its final version preserves the fiduciary-influenced care obligations proposed. Under the standard, firms and brokers would have to put their clients’ interests ahead of their own and also identify and eliminate or mitigate conflicts of interest when recommendations are made.
-Jed Horowitz contributed to this story.