Wachovia Securities, which recently announced its merger with one of our clients, A.G. Edwards & Sons, agreed to pay a $3 million fine for allowing buy-and-hold customers to sit in wrap fee accounts. A wrap fee account is one where the client pays a flat fee for either no commissions or reduced commissions. Some brokers throw in extra services in exchange for the wrap fee.
Wrap fees have been around for a long time. In the "old days" (i.e. when I first started defending brokerage firms), a broker accused of churning would throw up his/her hands and say "That's it, I'm going to managed money" meaning a wrap fee account. The broker saw this as a way of not being accused of churning the client's account. Of course, a wrap fee is not a cure for all ills.
Wachovia, like other firms before it like Raymond James and UBS, was accused of letting its wrap fee clients just sit there racking up fees but getting nothing for the fee. Further, it appears that "A" share mutual funds, for which a client already paid a sales load (commission), were also being used in a wrap fee account, a definite no-no.
This tension between commission business and wrap fee business creates the issue of "which is cheaper." Sometimes a broker won't know how much activity the client is going to do, so a wrap fee would be inappropriate. Other instances may call for a wrap fee, such as a client investing significant new money, but the long term costs can be high if the strategy is to buy and hold.
Ultimately, the decision comes down to the basic premise of what is best for the customer. That is and has always been the mantra of securities business. Sometimes, for a myriad of reasons both honest and not-so-honest, the securities industry loses sight of the goal - the best interest of the client. In this case, the wrap fee was seen as placing the client and the broker on the same side of the table, with no transaction-based incentive. Most brokers that I know feel this way. Unfortunately, the decision to recommend a wrap as opposed to a transaction-based account is not a simple one. And the regulators don't provide any real guidance on the front end but are more than willing to extract a fine or two when the plan doesn't work out.
That's the view from the The Law Planet, Jupiter, Florida.