New Tiburon Research Report - Separately Managed Accounts & Other Fee-Account Programs

	Please click the image above to view the table of contents for Tiburon's best selling Separately Managed Accounts & Other Fee-Account Programs research report.

Tiburon Strategic Advisors, a market research & strategy consulting firm serving a wide variety of financial institutions and investment managers, releases key highlights from its best selling research report addressing separately managed accounts & other fee-account programs. This research release describes some of the report's highlights regarding separately managed accounts & other fee-account programs market background.

The purpose of this report is to detail the heretofore rapid emergence of the packaged fee-accounts market, and predict both the future size of this market and its upcoming key developments. This report provides readers with a comprehensive understanding of not only the most widely studied product – specifically, separately managed account programs (SMAs) – but also the seven other types of packaged fee-accounts programs, from both proprietary sponsors and turnkey asset management programs (TAMPs). This is the fifth draft of Tiburon’s research on this topic; at this point, it is fairly well developed.

Market Background:

Fee-accounts, largely ignored until the Tully Committee of 1995, began to gain huge momentum in the late 1990s with individual investors. The super affluent and institutional markets have always had fee-accounts, but these accounts only penetrated the more traditional high net worth market over the past decade. More specifically, as recently as the 1970s, bank trust departments (high net-worth individuals) and insurance companies (pension plans) dominated fee-based money management. Full-service brokerage firms dominated the relatively small commission brokerage business.

The beginning of the transition to fee-account programs started in the early 1970s. Dean Witter retail broker Jim Lockwood was consulting to defined benefit plans, receiving back directed commissions.

The Tully committee in 1995 was the first body to shine a light on the inherent logic of fee-accounts. It stated, “If the retail brokerage industry were being created today from the ground up, a majority of the committee would not design a compensation system based on completed transactions. The most important role of a registered representative is to provide investment counsel, not to generate transaction revenues. The prevailing commission-based compensation system inevitably leads to conflicts of interest. Individual firms will survive and prosper in today’s competitive business environment only to the extent that they empower their brokers to compete on the basis of the tangible value they add.”

The Merrill Lynch Rule was established in 1999, upon the introduction of its Unlimited Advantage fee-based brokerage accounts to allow brokerage that previously relied solely on commissions to accept fee business without registering as investment advisers. The Merrill Lynch Rule seems to mock the need for fiduciary responsibility. The official name of the Merrill Lynch rule was the Certain Broker/Dealer Deemed Not to be Investment Advisors Rule.

The SEC warned brokerage firms that its view of fee-based brokerage accounts had changed in 2003. The SEC originally viewed them as a best practice, but more recently began investigating these accounts. The SEC sent SEC 0368 notice to members, who said that firms needed to look at fee-based brokerage accounts and flag those with limited trading; mutual funds were also declared as not logical holdings within the accounts. In addition, it was determined that buy-and-hold investors who do little with their brokerage accounts are better off paying a commission for each trade. It was decided that the definition of an active trader must also be sorted out.

The Financial Planning Association challenged the Merrill Lynch rule for the first time in 2004 through a lawsuit. It challenged the SEC’s capacity to create the rule and keep it temporarily in place for so long. The FPA filed a law suit after surveying members as to their opinions on how to proceed. It argued that the rule would allow brokers to dole out investment advice without having to adhere to important fiduciary standards mandated by the Advisers Act. It also argued that brokers provide a “lower standard of consumer protection” than the legal fiduciary guidelines set forth for investment advisers. Consumer groups joined in the battle with the FPA, and overall substantially delayed confirmation of the rule.

Under the 2005-modified and confirmed Merrill Lynch rule, the SEC created a safe harbor allowing brokers to offer fee-based accounts without registering as investment advisors under the more restrictive investment advisers act of 1940 as long as two requirements are met. One, if fee-based brokers do not have discretion, they do not necessarily have to register as investment advisors. Second, if fee-based brokers do not dispense financial planning advice, they do not have to register as investment advisors either. However, if they hold themselves out as a financial planner, represent themselves as offering holistic help, or deliver a financial plan, they must be an advisor. The SEC needs to further define the term financial planning to enforce this rule. Nonetheless, firms that heavily utilize financial planning software (e.g., Northwestern Mutual and their private labeled NaviPlan software) were caught by that clause. Some firms got cute on the topic. For instance, Merrill Lynch merely renamed its Financial Foundation Plans to be Financial Foundation Reports.

Brokers now have to make some bold statements to their clients, alerting them to the issues surrounding fee-based brokerage accounts:

• Your account is a brokerage account and not an advisory account
  
• Our interest may not always be the same as yours
  
• Ask us questions to make sure you understand your rights & our obligation to you
  
  

The Financial Planning Association was clearly disappointed with the SEC’s 2005 decision to confirm the Merrill Lynch Rule, and seemed intent to press on with its legal actions. It was expected to file another suit against the SEC to try and overturn the rule and hold brokers to an equal regulatory standard as financial planners. It said that at a minimum, a consumer warning label is warranted given the confusion in the marketplace over who is a broker and who is a financial investment advisor. The FPA praised the SEC for enhancing the disclosure requirements for brokerage customers, including a requirement that their interest may not always be the same as those of their customers, and praised the SEC’s decision to launch a 90 day study to identify the issues of investor protection raised by the rule proposal. Nevertheless, some like former FPA President Roy Diliberto believed that the association should push ahead with the lawsuit.

Former New York Attorney General & New York Governor-Elect Eliot Spitzer went on record with his disdain of brokers and advisers being held to a different standard in 2005. That year, he wrapped up the issue well, exclaiming “what used to be a conflict of interest became viewed as a synergy,” in reference to the perception that full-service brokers have taken full business advantage of their lack of fiduciary responsibilities to clients in the past, despite strong potential conflicts of interest arising from the fact.

Two major firms were caught up in the scandal surrounding fee-based brokerage accounts & abuses of the Merrill Lynch rule – Raymond James & Morgan Stanley. Raymond James was the first to be disciplined.

The Broker/Dealer Exemption, dubbed the Merrill Lynch Rule, was abolished in 2007 causing reps offering fee-accounts to convert them to another compensation arrangement or register as an investment advisor. Fee-based brokerage accounts were no longer exempt from provision of the Investment Adviser Act of 1940 under the broker/dealer exemption rule. The ruling ultimately made fee-based brokerage account illegal.

The Securities & Exchange Commission granted temporary permission for principal trades in non-discretionary advisory accounts, in order to give investors better access to hard-to-find securities in 2007. Principal trading allowed clients to purchase more securities from the firm’s inventories without pretrade written approval. This exemption asset to expire in 2009.

The Securities & Exchange Committee announced it would not fight the decision of vacating the Merrill Lynch Rule in 2007. The Court of Appeals granted a 120-day stay to give firms more time to adapt to the change.

Ultimately, the debate comes down to the fiduciary responsibility of the financial advisor regardless of the client account type. Len Reinhart, president of Lockwood, stated, “Once you’re an adviser, even if it’s a non-discretionary account, you’re giving investment advice.”

To better understand the developments in Separately Managed Accounts & Other Fee-Account Programs , executives can purchase the full Tiburon research report where the key learnings highlighted above are covered in greater detail. Please contact Sarah Sage at SSage@TiburonAdvisors.Com or 415-789-2540.