Merrill, Morgan reps wait on fee conversion

Some brokers at Merrill Lynch & Co. Inc. and Morgan Stanley have been hesitating to use new advisory options that their firms have deployed as replacements for fee-based brokerage accounts.

Merrill had an industry-leading $105 billion in its Unlimited Advantage fee-based brokerage program at the end of the third quarter, and Morgan Stanley’s $26 billion in its Choice account made it the No. 2 player in the market. Both firms are based in New York.

As of Oct. 1, though, fee-based brokerage accounts were no longer exempt from provisions of the Investment Advisers Act of 1940 under the broker-dealer exemption rule.

The rule was thrown out by a federal appeals court in March, making fee-based brokerage accounts illegal.

Morgan Stanley clients who didn’t choose another option saw their fee-based Choice accounts convert to commission accounts. In August, the firm rolled out its Morgan Stanley Advisory platform as an alternative.

At Merrill, brokers identified clients for a temporary transition into the firm’s Personal Advisor, an advisory alternative, brokers said. Merrill reps have been told they have until Dec. 14 to complete the paperwork to make that transition permanent.

After that, accounts may have to revert to commissions, brokers said. They could still convert to Personal Advisor, but it will require more paperwork, said a Merrill rep in California, who requested anonymity.

Merrill spokesman Erik Hendrickson confirmed that the firm is requiring that client enrollments be completed by the end of the year.

In a statement, he said that the Unlimited Advantage program became subject to investment advisory rules Oct. 1. Mr. Hendrickson declined to discuss how that change was handled.

But not everyone is jumping on board with the new advisory ac-counts. At Morgan Stanley, reps have been running into snafus with the firm’s Morgan Stanley Advisory account platform.

It is “archaic,” said one Morgan rep in the Southeast, who asked not to be identified. “Their phones are ringing off hook [with complaints] in New York,” he said.

The platform uses a different order entry system, “and it doesn’t integrate with our existing systems,” this rep said. “They want to segregate it because it’s an advisory account. It seems like [something that was] put together at the last minute.”

“There’s no doubt there are glitches” with the account, said a Morgan broker in the Midwest, who asked not to be identified.

The Morgan Stanley program was rolled out on an accelerated schedule and suffered “some initial growing pains,” said James Wiggins, a Morgan Stanley spokesman.

“There were some mainframe issues affecting speed that have been addressed, and additional functionality is being added on a regular basis,” he added.

Merrill, meanwhile, has been sending reminders to reps about completing the transition, according to some brokers at the firm.

“It leads me to think they’re worried” about brokers’ not permanently converting their clients into fee-based arrangements, said a Merrill broker based in the Southwest, who asked not to be identified.

Brokers suspect that their firms want to preserve the steady revenues from fee-based brokerage accounts.

“It probably is more profitable to do fee-based business,” compared with commissions, said Jeffrey Strange, a senior analyst at Cerulli Associates Inc. in Boston.

But not all clients are suitable for the advisory alternatives to fee-based brokerage accounts, according to some brokers.

With advisory accounts, reps must generally follow an asset allocation plan, limit concentration and, at least at Merrill, limit the number of unsolicited trades.

Clients may override some of those limitations.

“The broker is ultimately responsible, regardless of what the client wants to do,” said the Midwest Morgan Stanley rep.

“Once you’re an adviser, even if it’s a non-discretionary account, you’re giving investment advice,” said Leonard Reinhart, president of Lockwood, a Malvern, Pa.-based unit of Pershing LLC of Jersey City, N.J., that provides fee-based platforms.

“How [does a firm] monitor that? What if [an adviser sees] a client do something they really shouldn’t do” in a non-discretionary advisory account, Mr. Reinhart asked. “Do you just let them do it? There are gray areas in those accounts.”

In addition, brokers may be hesitant to discuss with clients new accounts and new fee schedules.

Clients already thought they were paying for advice, Mr. Reinhart said, but it turns out they really weren’t. “It’s a goofy conversation to have,” he said.

Some clients have used fee-based brokerage accounts to hold concentrated positions and trade individual securities as part of a larger portfolio, brokers say. Those tactics are more difficult in an advisory account.

Firms’ insistence on stricter guidelines for advisory accounts “is probably spooking some of the advisers,” Mr. Reinhart said. “With a fee-based brokerage account, you could do anything you wanted.”

In September, the Securities and Exchange Commission granted the industry relief from strict rules limiting principal trades in advisory accounts. That action has allowed clients to buy more securities from firms’ inventories without pre-trade written approval.

Still, “most of us are eyeballing” Personal Advisor, said a Merrill producer in the Northeast, who asked not to be identified. “We’re not sure what to do,” said this rep, who used Unlimited Advantage for a handful of active clients.

Mr. Strange chalks up much of the confusion to growing pains.

“When you’re dealing with any type of new system, you need some time to get over bugs,” he said.

Merrill and Morgan Stanley each had just a few billion dollars in their non-discretionary advisory programs as of September, Mr. Strange said, right before the end of the Merrill Rule. That contrasts with Smith Barney’s Advisor program, which had $37 billion.

The Smith Barney advisory platform, which can be run as a non-discretionary account, was set up as a stand-alone program with its own product managers, Mr. Strange said.

“It wasn’t established as an alternative to something else,” he said.

Brokers say firms could also see some effect on revenue from loss of fee-based brokerage accounts.

“I think we’ll see a lot of [assets] going back into commission” ac-counts at a lower return per dollar of assets, said the Southwest Merrill rep.

“I think [Merrill] could take a significant hit to revenue,” the California-based broker at Merrill said.

Brokers say active investors who direct their own accounts don’t have a workable alternative at the full-service brokerage houses. Brokers expect that these clients will go to deep-discount firms.

“We’re set to lose about $10 million in assets” from these types of self-directed customers, the California broker said.

Based on transition results at firms other than wirehouses, Mr. Strange said, about 60% of fee-based brokerage accounts have gone to advisory alternatives, and about 40% to commission arrangements.

Brokers said that commission accounts overall generate less than fee-based brokerage accounts, which on average are priced just under 1% annually, according to Cerulli Associates.

However, the alternative advisory accounts, which Cerulli Associates said charge on average a bit more than 1%, could make up some of the expected lost revenue.

Dan Jamieson can be reached at [email protected].