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Thursday, May 17, 2007

Better Late than Never: Wrap Accounts Finally Wrapped-Up

Thankfully, a federal court has put an end to the free wheeling ways Wall Street treats wrap accounts, also known as the “Merrill Lynch rule,” and this week the SEC announced it will not appeal the decision. Two years ago I published this article in the “Wall Street Lawyer” arguing that the transition from commission-based brokerage accounts to fee-based, or “wrap accounts,” opened up the door for more Wall Street shenanigans. The switch-over was actually well-intended and sought to curb churning for commissions on frequent trading. But churning was replaced with other unscrupulous activities.

For example, Wall Street brokers would convince their clients to double-up assets on margin when a hot stock tip came down the pipe, then charge the 1-3 percent fee based on the client’s gross assets. So someone with a $1 million account would borrow another $1 million to increase profit on a surging tech stock. The broker then charges a fee based on the $2 million, unfairly doubling the fee. Then there’s the “hit and run” brokers who open up wrap-accounts, convince client to buy some speculative stocks and disapear while their client’s assets deteriorate.

By over-turning the Merrill Lunch rule, the court decided that brokers who offer fee-based accounts must register as investment advisors with the NASD and accept “fiduciary” responsibility for their clients. This means brokers now have to put a client’s best interest first (the horror!) and on an on-going basis monitor client trading and make active recommendations reacting to market volatility and a client’s changing risk tolerance (such as a client’s financial circumstance).

What I find most interesting in all this is the shock and horror from Wall Street. Merrill Lynch sent a memo to its legion of brokers saying that it “strongly disagrees with any action that would end fee-based accounts.” The Securities Industry and Financial Markets Association (Sifma), Wall Street’s main lobbying group, calls the decision “an outrage.” Is it so outrageous to put a client’s interest ahead of your own? Wall Street’s outrage is actually somewhat comforting. Finally they are publicly admitting that a client’s best interest play second fiddle to their own.


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