Raymond James Company and Robert W. Baird Company have agreed to settlements (penalties) with the Securities and Exchange Commission (SEC) for compliance failures within the brokerages’ “wrap fee” programs. While there have been many other such fines on other companies, this is simply a recent case, and worthy of scrutiny as a learning experience. We are not singling out these companies.
First, what is a “wrap fee?” In a wrap fee account, the stockbroker charges the client a flat fee annually, based on the size of the account. Because brokers are commission-based, this allows the brokerage industry to essentially hide behind the word “fee.” In truth, the brokers are in need of trading in the account in order to generate income for the firm in excess of what the brokers are earning. Since brokers are not fiduciaries, they are not mandated to act in a manner whereby their customers’ interests are always placed ahead of brokers’ own. This means that they can sell products and/or third-party broker arrangements to generate even more commission income (note: this means income to the company; expense to the customer, in addition to the wrap fee). In this SEC case, James and Baird acted in a manner that was not compliant with industry regulations.
According to the SEC, these companies failed to establish policies and procedures necessary to determine the amount of commissions their clients were being charged. This is a classic illustration of the difference between fee-only and fee-based financial advisors. The fee-based accounts were designed and named for a single purpose – to disguise the commissioned-based business model they had always employed. It only mattered after the Registered Investment Advisor (RIA) fee-only business model came into being, quickly became wildly popular, and began to eat into the straight commission business of the big brokerages. We have repeatedly warned people that the fee-based and fee-only differences are crucial.
According to the SEC, these firms “were unable to provide the magnitude of these costs to clients and did not consider these commissions when determining whether the sub-advisers or the wrap fee programs were suitable for clients, leaving certain clients unaware they were paying additional costs beyond the single wrap fee they paid for bundled investment services.” They said it, folks, I didn’t. And to me, it could not be more plain and simple – the purpose is to disguise commissions as fees.
Raymond James paid a $600,000 penalty to settle the charges, and Baird paid a $250,000 penalty. When was the last time you coughed up $600,000, or even $250,000, for an alleged act? Neither confirming nor denying guilt is a pretty stark admission in my world. Again, I’m not picking on these firms. You may know that the SEC is the government regulatory body charged with protecting investors from unethical practices, among other responsibilities. One of the current hot topics of the SEC is the implementation of what we call the “fiduciary standard” industry-wide. I mentioned the term fiduciary early in this piece, because it is germane to the way wrap fees work. Brokers have managed to avoid being held to the fiduciary standard until recently, when the SEC announced that next year things are changing. All advisors and brokers will be subject to the fiduciary standard, and the brokerages are scared. No wonder. So far, millions of dollars in penalties have been assessed to a wide variety of financial services firms.
Just to be fair, this shows that the two brokerages mentioned in this article are not being singled out for castigation. They all do it is the truth of the matter, and it is coming to a crashing halt. The whining and moaning you hear is from brokers having to re-think the way they do business in order to place their clients’ interests first. We, however, are smiling, as to us the fiduciary standard is simply business as usual.
Van Wie Financial is a fee-only RIA, and both of us are CFPs. You can reach us at 904-685-1505 or through our website, vanwiefinancial.com for a no-cost, no-obligation initial consultation in our office in Jacksonville Beach, FL. Give us a call – you may be very glad that you did.
One more thing; how about next we get to work on the insurance industry regulators to implement a fiduciary standard for life insurance and annuities? Would you like to hear some REAL whining? Time will reveal how the insurance industry will react to these consumer-oriented changes. You can skip the wait time right now by simply using the fee-only advisory platform. Van Wie Financial is fee-only. Always.