When Industry Routine Offends Your Ethics

What does an advisor do when clients at his firm are routinely charged an undisclosed commission on top of fees and he suffers for not falling in line? Q: I work for a major wirehouse. Like most others in our industry, we offer fee-based accounts as an alternative to the traditional relationships that most of our clients have in the full-service brokerage industry. Within the of the fee-based account,

What does an advisor do when clients at his firm are routinely charged an undisclosed commission on top of fees — and he suffers for not falling in line?

Q:

I work for a major wirehouse. Like most others in our industry, we offer fee-based accounts as an alternative to the traditional “pay-as-you-go” relationships that most of our clients have in the full-service brokerage industry. Within the “structure” of the fee-based account, our firm allows (and practically encourages, via internal email notices) the purchase of initial public offerings within these fee-based accounts.

With most IPOs, the clients typically will not pay a commission to buy at the offering price (but will pay a markup). What the client does not know, and what I find objectionable, is that in many fee-based accounts the brokers are double dipping: getting paid not only the fee the client pays to have the account, but also a portion of the markup on every IPO they sell to the client, effectively charging the client well more than the standard fee-based relationship cost — without the client even knowing.

Unfortunately, I have a manager who not only expects us to sell IPOs to clients with fee-based relationships, he actually requires this if we expect to get accounts distributed to us when brokers leave the employment of our office.

I refuse to run my practice like this. As a result, I receive fewer accounts and do less business.

What can I do about this? My office is not the only one in the firm that encourages this practice and I am concerned about potential repercussions if I complain to someone above my office manager.

A:

I think truly that you have it wrong. Your ultimate concern is that your firm is “double dipping” on fees, but that, frankly, is the nature of the beast. Most likely, the over-the-counter equities you place in fee-based accounts also come with markups, as do the fixed-income products you buy for your clients.

Come to think of it, just about every product you offer and sell to your client has one form or another of a spread built in by your trading desk. Is this wrong? I think not, because your firm is in the business of making money — and as much of it as possible within the confines of the law. I think the only structural objection you have here might be inadequate disclosure to your client, but I bet in the end that is not the case.

However, if you truly believe, that your firm's approach is unfair to your clients, I see two options: move to another platform that does it your way (but I don't know of any not-for-profit broker/dealers) or, better, tell your manager that you want to give up your part of the fee so as to eliminate the double dipping.

As to the “pressure” you feel to offer IPOs that is fairly inconsistent with you working for “a major wirehouse.” Few retail investors should qualify to buy a meaningful number of shares in an IPO, and you should be able to explain why a particular offering is unsuitable for your clients. (Point out the first two pages of the S-1 to your manager.)

And if you really are being punished for this, use the firm's toll-free compliance hotline.
Anthony Paduano
Paduano & Weintraub
New York, N.Y.
212-785-9100

[email protected].

A:

You have struck upon an issue, which has been prevalent on the Street for some time: It's called greed.

As you know and recognize, the practice in your office is to encourage the purchase of IPOs within fee-based accounts where an additional commission is charged. Your doubts about this policy are well founded. Every broker, despite the pecuniary interests of the firm and himself, is required to only make recommendations that are suitable for clients.

Full disclosure of the cost should be made, especially in a case where you believe the customer may be unaware that an additional commission would be charged over and above the normal account fee. You should check to see whether this information was already disclosed in any of the paperwork supplied to the client when the client opens the account or in other notification thereafter of such matters. Clients appreciate knowing the cost beforehand and limited surprises afterwards.

The issue with management that troubles you is a difficult one since it seems to reward reps that toe the line despite a questionable practice. You can choose to bring this up to the regional level in a diplomatic manner.

If the incentive to sell IPOs to clients with fee-based relationships is making an additional commission without the client knowing it — though your query does not make that clear — an inquiry at the regional level as to whether or not this is consistent with firm policy might be well received by an unbiased supervisor.

On the other hand, only you can judge whether going above the branch would not be well received, especially if the culture of the firm is consonant with the branch's practice. In that case, you may want to weigh the current negative affect on your earnings against having a clear conscience at another firm where greed is not such an overwhelming motive.
Theodore G. Eppenstein
Eppenstein and Eppenstein
New York, N.Y.
212-679-6000

[email protected]

“Ethical Rep” is our monthly column through which more than 30 prominent securities attorneys, experts and law school professors answer questions you, our readers, send anonymously to us.

Encounter a situation at work that makes you uncomfortable? Hesitant to change firms because you're unclear how your clients could be affected? Send your questions to Registered Rep.'s Contributing Editor Ann Therese Palmer, and our group of experts will help you through the problem.

Mail: Registered Rep
249 West 17th Street, Third Floor
New York, N.Y. 10011-5300
E-mail:
[email protected]
Confidentiality guaranteed!

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish