Money Matters: Industry Watchdogs fine brokerage houses for Not following rules

It has been a while since the NASD (National Association of Security Dealers and watchdog over its members) has levied fines making headline news. As an active broker and agent of a member firm, it is not appealing when I write about fines being levied. This action by the NASD should remind us to continue to be knowledgeable investors, as this could reduce the size and perhaps number of violations significantly. reported on Jan. 5, 2007 the NASD fined four brokerage firms a total of "$850,000 for failing to waive front-end sales charges for customers buying Class A shares by not having adequate supervisory systems and procedures in place." Here is a little background as to how this may occur.

When investors are unhappy with the management of their accounts, often they seek a new advisor. Generally, the new advisor is from a different firm rather than another advisor from the same firm. Often the thought process behind this move is all advisors at the same firm probably manage in the same fashion. While I cannot say this is true or untrue, it appears to be a perception believed by many investors. Unfortunately, changing brokers as well as changing firms may
open the door to improper action by the NEW advisor.

As an example, Investor Bob has not been pleased with the performance of his accounts and chooses to change advisors. If his accounts were truly underperforming the markets, a valid assumption could be his allocation did not take advantage of market conditions. The solution could be as simple as reallocating the funds within the same fund families. This action could potentially improve the performance, since the holdings may now be in areas of the markets/economy doing well. The difficulty with this action is there is no commission generated, and thus the new advisor has taken on a new client, spent time and effort in solving a problem, but is not compensated. Therefore, many brokers will not take this step.

Another possible solution is to move the assets from the underperforming fund company to a different fund company. This generally results in a commission being paid. Investor Bob gets a new allocation inside the new fund company, but in doing so he pays a new commission. Provided this action is disclosed to Investor Bob and he elected to pay the new commission, this is not a violation of any rules. The disclosure should also reveal to Investor Bob that he could remain in the old fund family and reallocate his investments with potentially the same result, but this is not required.

During the short period following the dismal market performance from 2000 to 2002, several fund companies offered to waive front load commissions for investors moving money to them if they had already paid commissions on that money. The fund companies offering to waive the Class A commissions were trying to make it easier for investors to move out of poor-performing fund groups into their funds by eliminating the cost of the move. This also would add to the assets being managed by the new fund company, but that result did not harm the investor who moved their account. This waiver however was not made known to the investors by the advisors of the four brokerage firms, thus causing the investors to pay millions more in commissions than required.

Had the advisors of the four brokerage firms reallocated assets within the existing fund companies, no violations would have occurred. Since a change in fund companies was recommended, had the advisors shared the commission waiver or been more knowledgeable of the fund companies they were representing, violations would have been avoided. It is the NASD’s position that the advisor and brokerage firms be fully aware of all pricing structures of the fund companies they offer.

In addition to Edward Jones, RBC Dain Rauscher, and Royal Alliance Associates paying a $250,000 fine and Morgan Stanley paying a $100,000 (per the NASD they took remedial steps to correct the matter), they are being required to refund millions in commission plus interest. Edward Jones is refunding $25 million; RBC Dain Rauscher $6.8 million; Royal Alliance $1.6 million; and Morgan Stanley $10.4 million, plus interest in each case.

By asking the advisor to explain ways to reduce or avoid commissions and how they are being compensated, can be a step in the right direction to avoid paying more than you have to for the management of your investments. By using an advisor holding the CFP license, you also have one more agency watching that your advisor is ethical and acting on your behalf.

Would you like a response to a financial question? Send your question to Doug Horn, 115 W. Broadway, Maryville TN 37801. Be sure to mark your envelope Money Matters.

Doug Horn, CFP, is an area financial planner with more than 21 years financial experience and founder of Quality Financial Concepts, located in downtown Maryville on Broadway.

Doug Horn, CFP, Registered Investment Advisor in Tennessee and Texas and Registered Principal, Branch Office of and Securities offered through CUE Financial, Member NASD, IPC.

© 2007 All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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