Securities Litigation:  Fee-Based ("Wrap") Accounts Continue to Draw Scrutiny

Securities regulators have recently raised concerns about the propriety of fee-based, or "wrap" accounts, which are brokerage accounts in which customers pay fees calculated as a percentage of the assets in the account, as opposed to commissions charged on specific trades.  Over the past decade, fee-based accounts have grown increasingly popular, with assets in such accounts estimated to be nearing $300 billion in 2006.

The problem with fee-based accounts is that the fees charged are often significantly greater than would have been charged for commissions in a properly-managed account with an acceptable level of trading.  In a press release announcing the filing of a complaint against UBS over its fee-based program (known as "InsightOne"), Eliot Spitzer described the program as a "scheme by UBS to move inappropriate clients from regular [commission-based] brokerage accounts into InsightOne, despite the program's far higher costs for those investors, by falsely promoting InsightOne as providing personalized advice and other financial planning services."  The SEC and NASD have recently reviewed the propriety of fee-based programs, and the NASD has brought enforcement cases against brokerage firms for unsuitable fee-based programs.

The New York Attorney General's website contains links to the Complaint filed against UBS and numerous exhibits to the Complaint.  See www.oag.state.ny.us/press/2006/dec/dec12b_06.html.   Although UBS has asserted its innocence and has stated its intent to defend against the AG's charges vigorously, the Complaint relies on various exhibits to contend that customers "paid tens of millions of dollars more in InsightOne fees than they would have paid in traditional brokerage account transactions."  One example cited in the Complaint is $35,000 in InsightOne fees charged to a 91 year-old customer when there were only four trades made in the account over a two-year period - i.e., about $33,000 more than what the customer would have paid in commissions.

For more information about fee-based accounts and factors that should be considered by customers when such an account is proposed, see NASD Notice to Members 03-68.  NTM 03-68 provides that fee based accounts may be appropriate for customers, but only when they either engage in at least a moderate level of trading activity or when the prefer consistent and explicit (albeit higher) monthly charges.  On the other hand, NTM 03-68 points out that brokerage accounts holding mainly bonds or mutual funds, or accounts with low trading activity because of buy and hold strategies, may be better served in a commission-based program.  The Notice requires brokers and firms to disclose all relevant information to the customer, including the fee schedule, services provided and the fact that the program may cost more than paying for the services separately.