Wrap accounts, the most rapidly growing form of asset management, were recently declared illegal March 30, 2007.  This decision is set to go in effect October 1, 2007.

    Wrap accounts allow unlimited trading, with an annual fee of 1 to 3 percent, but charge no brokerage commissions.  Reuters reported; “This court ruling affects an estimated 1 million brokerage accounts that hold a combined $300 billion in assets.”

    Substituting an annual fee for brokerage commissions creates an illusory shared interest between the broker and his customer. In a commission based relationship the customer often worries (quite rightly) whether transactions are being proposed for his benefit or the benefit of the broker. In theory, a fee based relationship puts broker and customer “on the same side of the table.”

    In fact, the broker has only converted an irregular income stream into a regular income stream. The brokers’ primary loyalty is still to his or her firm. The customer’s interest can still be sacrificed to the business interests of the firm.  Brokers do not have the same loyalty and obligation to the investor as investment advisors.  Penn, Schoen & Berland Associates released a study about brokers with the following results;

  • 58 percent of customers incorrectly believe brokers are required to act in the investor’s best interests in all aspects of the financial relationship;
  • 63 percent of customers incorrectly believe brokers are required to disclose all conflicts of interest prior to providing financial advice.

     Legally, brokers are not fiduciaries. They don’t have the obligation of a fiduciary, which is to put the customer’s interest first.   Instead, brokers have what the legal world terms as an “arm’s-length” relationship. This allows them to downplay conflicts of interest with simple statements, such as: “Our interests may not always be the same as yours.”

    Like hidden compensation schemes, undisclosed conflicts of interest are part of the financial service industry’s dirty laundry.  For example; proprietary funds, house owned bond issues, house owned securities, etc.  
    A new press release issued September 19th by the Securities and Exchange Commission (SEC) will most likely halt those brokers complying with the court ruling.  The SEC will allow fee-based accounts to remain in place for now.  Under the temporary fix, brokers may continue to offer the accounts – provided they inform account holders about potential conflicts of interest.

    The sad thing about this entire court case is the SEC’s position.  The SEC, a government organization specifically created to protect investors, granted fee-based brokers an exemption to disclosing conflicts of interest.  The SEC is in the odd position of fighting legal battles to protect this exemption.  At AssetBuilder, we believe this is wrong.  

Customer friendly financial relationships are built on full disclosure.   Here is our full disclosure:

  • We act in the investor’s best interest in all aspects of the financial relationship.  
  • The fee we charge our investment customers is our only source of compensation.  
  • We accept no fees or commissions from Dimensional funds, Charles Schwab, or any other third party.  
  • We also don’t have a sister company or division that receives any monetary benefit from our investment decisions.


September 20, 2007 – The Securities and Exchange Commission (SEC) issues temporary rules for wrap accounts.  The SEC’s stop-gap rule is silent on what investors and brokerage firms should do, but gives brokers limited relief.  The relief is based on more complete disclosure. http://www.sec.gov/news/press/2007/2007-193.htm

May 14, 2007 – The Securities and Exchange Commission (SEC) said it would not appeal the March 30 federal court decision.  The SEC asked for a stay of the court’s decision until October 1, 2007. http://www.sec.gov/news/press/2007/2007-95.htm

March 30, 2007 – the U.S. Court of Appeals for the D.C. Circuit found the Securities and Exchange Commission had exceeded its authority by promulgating Rule 202(a)(11)-1, which exempts broker-dealers offering fee-based brokerage accounts from registering as advisers.    http://pacer.cadc.uscourts.gov/docs/common/opinions/200703/04-1242a.pdf

On the Web

Kim, Jane J. “Moving Past ‘Fee-Based’ Accounts” Wall Street Journal, 22 Sep 2007:

Opeila, Nancy. “Paving the way: Court ruling and new standards a good start for consumers – but only the beginning” Journal Financial Planning, September 2007 Issue:

Burns, Judith. “SEC OKs Temporary Rules for Fee-Based Brokerage Accounts” Morningstar - Dow Jones Newswires, 19 Sep. 2007: 

Giannone, Joseph A. “Wall St. scrambles as court bans fee-based accounts” Reuters, 17 May 2007

“Morgan Stanley To Roll Out New Fee-Based Advisory Program” Financial Advisor – Dow Jones Newswires, 16 May 2007: 

Coleman, Murray. “Brokers to push special fee-based account status” Market Watch, 15 May 2007: 

Wutkowski, Karey. “US SEC won’t appeal fee-based accounts ruling” Reuters, 14 May 2007: