Fee-Based Accounts Draw Scrutiny; UBS' Insight One Account Already Subject To Regulatory Action

ecurities regulators have focused their attention on brokerage accounts for which customers pay fees calculated as a percentage of the assets in the account, as opposed to commissions per trade. While this fee-based arrangement appears innocuous on its face, regulators have concerns that it harms customers. Let's examine why.

Preliminarily, fee-based accounts are only about a decade old. Large brokerage firms designed them to respond to intense price competition by discount brokerage firms over the price of commissions to trade securities. In doing so, brokerage firms devised a way to reap a fee, normally far greater than commissions from trading securities, whether or not there is trading in the account. Today, fee-based accounts are popular. Assets in such accounts grew from $5.7 billion in 1996 to $272 billion in 2006.

The fee-based arrangement sounds great -- if you are a shareholder of a large brokerage firm -- but what's the value for the customer? In a press release announcing the filing of a complaint against UBS over its fee-based program (known as InsightOne), Eliot Spitzer (the former New York Attorney General) explained the value proposition as a "scheme by UBS to move inappropriate clients from regular [commission based] brokerage accounts into InsightOne, despite the program's far higher costs for those investors, by falsely promoting InsightOne as providing personalized advice and other financial planning services."

The Securities and Exchange Commission (SEC) has jumped on the bandwagon as well. Recently, an SEC official stated that the agency is "actively reviewing individual firms" to determine whether brokers are placing customers in fee-based accounts appropriately. This issue also has been the focus of the National Association of Securities Dealers (NASD), which has brought enforcement cases against brokerage firms for unsuitable fee-based programs.

To protect themselves, investors first must be familiar with a Notice to Members (brokerage firms) that the NASD issued in 2003. NTM 03-68 recites that fee-based accounts may be appropriate for customers, but only when they either engage in at least a moderate level of trading activity or when they prefer consistent and explicit (and normally much higher) monthly charges. On the other hand, NTM 03-68 states that brokerage accounts holding mainly bonds or mutual funds, or accounts with low trading activity because of buy and hold strategies, may be better served in a commission-based program. The NASD notice also requires brokers and firms to disclose all relevant information to the customer, including the fee schedule, services provided and the fact that the program may cost more than paying for the services separately. That said, the NASD considers customer consent to a fee-based program to be "irrelevant".

Second, customers should protect themselves by reviewing the allegations of the complaint against UBS (and the many exhibits to the complaint found on the attorney general's website). While UBS has proclaimed its innocence and vowed to "vigorously defend" the charges, the complaint has assembled an impressive arsenal to show that many customers "paid tens of millions of dollars more in InsightOne fees than they would have paid in traditional brokerage account transactions." Such examples include UBS' charging a 91 year-old $35,000 in InsightOne fees for just four trades over two years - about $33,000 more than what that customer would have paid in traditional brokerage commissions. Another example is a customer who kept most of her assets in cash because she used it for check writing, yet paid UBS more than $1,700 in fees over a 12-month period. Another abuse -- reported by a financial planner who now services a former UBS fee-based account customer - relates to a customer who paid both 1% in asset-based fees as well as commissions when his broker sold him a 5.75% front-end load (commission) mutual fund.

Third, customers need to understand that brokerage firms like UBS may market fee-based accounts as "more than just a pricing alternative to traditional brokerage accounts" with "value added" services. Yet, as in the UBS example, such promises may be false and misleading.

Fourth, customers should beware that some firms, such as UBS, may create a conflict of interest between the customer and the broker. In the UBS case, UBS allegedly gave brokers financial incentives to not only enroll but also to keep customers in InsightOne even when the program was ill-suited for those customers.

Finally, to protect themselves customers must recognize that brokers may encourage some securities trading merely to satisfy the brokerage firm's internal requirement that a certain number of trades be placed over a given period of time. This is a form of "churning" that UBS allegedly encouraged its brokers to undertake. In a 2004 email from one broker to his supervisor stated, "[N]ow we have to trade heavy or light to stay within guidelines to keep insight one alive …. How wrong is that? You are not looking at the best interest of the client …. CONFLICT is all over this."

Already we have witnessed the debacle associated with brokerage firm research analysts and their stock "recommendations". Inappropriate fee-based accounts may be the next several items of headline news about Wall Street shenanigans!

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.