Texas Slams Firm Over Brokerage-to-Advisory Account Conversions
(Updated with name of a broker recently terminated by Brazos in ninth paragaph.)
The state of Texas has fined a small Dallas brokerage firm $20,000 and ordered it to reimburse a client almost $33,000 for failing to have procedures for supervising the conversion of brokerage accounts to investment advisory accounts.
The sanctions filed Monday against Brazos Securities, which has eight registered representatives, were the first related to account conversions that the Texas State Securities Board has imposed, a board spokesman said.
State and federal regulators are stepping up scrutiny industry-wide of the trend to move customers from traditional transaction-based commission accounts to advisory accounts, which generate asset-based fees regardless of whether customers buy and sell securities. Advisory accounts mitigate temptations that brokers might have to churn trades in order to generate commissions, but they also can be more expensive for buy-and-hold investors than transaction-based accounts.
“Conversions are happening at a very fast pace, and the issue of whether an investor understands the fee differences is certainly one that state regulators are focused on,” said Laura Posner, the former head of New Jersey’s Bureau of Securities who is now a partner at Cohen Milstein Sellers & Toll.
The Texas case involved a Brazos broker who had worked at the firm since 2001 and began converting his customers to discretionary investment advisory accounts in March 2014. He charged most of them a reduced fee of 0.5% of account assets because of his plan to continue receiving syndicate re-allowance payments on the preferred stock offerings and 12b-1 fees on the mutual fund sales that comprised much of his practice, the order said.
But Brazos and the broker failed to discount the fee for one client who was charged a tiered annual rate of 1-2% of assets from 2014 to 2017. The customer paid an average of just under $16,775 annually for the advisory account, almost double the $8,632 average annual commissions the firm collected in the previous four years, according to the order.
Brazos was sanctioned for failing to have written supervisory procedures to address account conversions and its overall investment advisory activities, and for failing to have a system for monitoring the suitability of advisory accounts and the reasonableness of its investment management fees.
Bob Elder, the spokesman for the Texas securities regulator, declined to name the Brazos broker or to discuss whether any individuals have been separately sanctioned or are under investigation.
A broker named Thomas S. Amacker, who the firm lists as one of two people who conducted quarterly account reviews with clients, worked at Brazos from 2001 until he was discharged three weeks ago over allegations from the state that “one customer was improperly moved to a fee-based account service platform,” according to his BrokerCheck report. Texas opened an investigation of Amacker on October 1, it said.
Billy Sims, the president and sole shareholder of Brazos, which was founded in October 1987, did not return several calls for comment and Amacker could not be reached on his home phone number. Only two of Brazos’ employees are registered as investment advisers, according to a Form ADV that the firm firm filed on Monday.
Brazos manages $3.04 million for nine individual investors in 12 accounts, and uses Hilltop Securities as its custodian and executing broker-dealer, according to an earlier filing.
The Securities and Exchange Commission this year is focusing on advisers who “changed the manner in which fees are charged from a commission on executed trades to a percentage of client assets under management,” according to the regulator’s 2018 examination priority guidance.
The SEC generally regulates registered investment advisers with $100 million or more of assets under management, delegating oversight of smaller RIAs to states.
The Financial Industry Regulatory Authority highlighted brokers who recommend switches from brokerage to advisory accounts “where that switch clearly disadvantages the customer” as a focus of its 2018 sales-practice suitability exams.
In April, customers of Edward D. Jones & Co. filed a putative class-action complaint against the firm alleging that it pressured its brokers to switch them to advisory accounts that charge as much as 2% even though the customers rarely traded and would have paid less in commission accounts.
Posner, the former New Jersey securities commissioner, said it is “incredibly difficult” for brokerage firms to clearly educate customers on the potential differences between what they would pay in a brokerage versus advisory account since they are not apple-to-apple comparisons.
The SEC has proposed requiring firms to give clients and prospects a Customer Relationship Summary Form to explain the different care standards and payment schedules distinguishing brokers and investment advisers, but consumer advocates have said the initial draft of the regulator’s disclosure document is too long and confusing for most retail investors to understand.