Long story short: The Financial
Planning Association (FPA) files a lawsuit challenging
the SEC's rulemaking in 2004. Three years later,
the U.S. Court of Appeals found in favor of FPA,
saying the SEC exceeded its authority when it
granted brokers the exemption.
In mid-May, SEC
said it wouldn't appeal the federal court decision that effectively prohibits
fee-based brokerage accounts. But it did ask for a four-month transition period,
during which "the Commission will consider whether further rulemaking or
interpretations are necessary regarding the application of the Advisers Act to
these accounts and the issues resulting from the court's decision."
customers face decisions
Now brokerage firms face upheaval as a million
customers with an estimated $300 billion of assets must switch to some other type
of account, according a recent article in the Wall Street Journal. Most of the
alternatives promise to be more expensive than the fee-based accounts, which typically
charge 1 percent of assets per year.
- Traditional brokerage accounts in which brokers receive
commissions for stock transactions and product sales to clients.
accounts run by an RIA in which firms assume a fiduciary role.
fund wrap accounts that charge an asset-based fee on top of fund costs.
managed accounts run by professional money managers that cost between 1 percent
and 3 percent of assets a year.
On the surface it looks
like investors with money at brokerage firms will lose as a result of the court
decision. But maybe they never got their money's worth in the first place.
holds true regardless of whether they put their assets in the custody of a broker
or an investment adviser.
advisers levy fees
An article in the May issue of the FPA Journal
compares the three different ways in which financial advisers can get paid. Not
all advisers take the fee-based approach. Author John H. Robinson attempts to
expose the incentives at work in each compensation model, and he turns up some
"All three models contain incentives
that align adviser and client objectives," Robinson says. But all three also
"can create significant conflicts of interest."
commission model gets the most flack.
The drawbacks are that
brokers and advisers:
- Are rewarded regardless of whether
investments succeed or fail.
- Have incentive to steer customers
to high-commission products.
- May be motivated to generate
transactions for the purpose of increasing income.
the other hand, commission-based brokers and advisers:
in a competitive environment and don't want to lose customers.
incentive to forgo churning to engender trust and get more referrals.
want to continually have to stake out new customers.
Here's a surprising finding. Robinson
argues that if commission-based advisers put their
own interests ahead of their clients, you would
expect them to make a lot more money (measured
by return on assets) than their fee-based counterparts.
fact, the opposite is true -- and by a rather wide margin. Industry data regularly
report that the average return on assests (ROA) for brokers is below 0.75 percent,
while the average ROA for independent RIAs is approximately 1.3 percent and rising."
the investment advisers' white hats are showing signs of wear.