Q. Is cost the only factor in deciding whether a fee-based account is appropriate for a customer in lieu of a commission-based account?
A. Cost is an important factor, but not the only one. For this reason, NtM 03-68 points out that factors other than cost may properly be considered to determine whether a fee-based account is appropriate. Firms must consider the overall needs and objectives of the customer when determining the benefits of a fee-based account for that customer, including the anticipated level of trading activity in the account and non-price factors such as the importance that a customer places on aligning his or her interests with the broker. Additionally, firms must take into account the nature of the services provided, the benefits of other available fee structures, and the customer's fee structure preferences.
Q. Is there a specific time frame of trading activity or inactivity that firms should consider when assessing the appropriateness of a fee-based account for a customer?
A. Servicing a customer account is usually a long-term proposition, so there is no set period of time of trading activity or inactivity that should be used as the basis to determine the appropriateness of a fee-based versus a commission-based account. Generally, fee-based accounts are particularly appropriate for investors who engage in at least a moderate level of trading activity. But, the activity during different time periods in a particular account may vary greatly due to market conditions, interest rate moves, size and diversity of the portfolio, or a customer's personal needs. As a result, firms should periodically review fee-based accounts to determine whether they remain appropriate for each customer, revisiting the assumptions and objectives that previously led to that conclusion. NASD staff believes that, at a minimum, an annual review of such accounts provides a reasonable interval to allow members to assess the trading characteristics of a customer's account.
Q. Does NtM 03-68 cover customer accounts that fall within the provisions of the Investment Advisers Act of 1940 (Advisers Act)?
A. The requirements of NtM 03-68 do not apply to accounts that a member services in its capacity as a registered Investment Adviser. However, as noted in the NtM, NASD staff does expect members to ensure that advisory products and services are appropriate in nature for a customer and that charges for such services are reasonable.
Q. Do fee-based "traditional" brokerage accounts differ from "wrap" accounts?
A. Generally, yes. Wrap accounts typically include services such as asset allocation and portfolio management for a fixed fee. Most wrap accounts with these features are subject to the Advisers Act and are not the focus of NtM 03-68.
Q. Has NASD detected any particular problems or issues with respect to fee-based accounts?
A. Certain potential problems have been identified through our examination program. For example, it is not always clear that customers receive adequate disclosure about the distinctions and features of fee-based versus commission-based accounts, including the differences in fee structures and that fees will probably be higher in a fee-based account if the level of activity is modest. Training and education at some firms are minimal, particularly in giving brokers guidance on how to evaluate whether a customer is appropriate for a fee-based account. Moreover, firms do not always have systems in place to reasonably ensure that mutual funds and other similar products that may be purchased outside a fee-based account are not shortly thereafter switched into a fee-based account and a customer assessed both a load and a fee. Similarly, documentation that supports the appropriateness of a fee-based account for a customer may be non-existent or weak. Also, in some instances firms have not assigned a broker to customers with fee-based accounts. Finally, some firms may lack systems or procedures to ensure that a fee-based account is appropriate for a customer both at the point where the pricing feature is added and periodically thereafter.
Q. Is NASD of the view that fee-based accounts outside of an advisory relationship are inappropriate?
A. No. NASD cites the 1995 "Tully Report" in NtM 03-68 that described fee-based programs as a best practice because they tend to reduce the likelihood of abusive sales practices. But the Tully Report also acknowledged that customer accounts with low trading activity might be better suited for a commission-based arrangement. NASD staff's view is that firms must take those steps necessary to assess whether a fee-based account is appropriate for a particular customer and to periodically update this assessment.
Q. What steps should a firm take to best ensure that a fee-based account structure is appropriate for a particular customer?
A. Firms must have reasonable grounds to conclude that a fee-based account is appropriate. Firms should train brokers with respect to the features of fee based- accounts and the need to assess whether a fee-based account is appropriate for a customer. This will help the broker understand his or her role in gathering relevant information from customers, such as investment objectives, financial status, and trading history, among other things. Similarly, adequate training on fee-based accounts will better ensure that brokers make full and clear disclosures to customers.
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