Morgan Stanley Tests Fee-Based Advisory Plan

August 10, 2007
By Evelyn Juan

Following the end of the ” Merrill Lynch rule,” Morgan Stanley (MS) is introducing some new DNA to its suite of fee-based advisory products.

Morgan Stanley Advisory is its new nondiscretionary advisory, or NDA, account. It has started testing and will be officially launched in August to the firm’s 8,000 brokers. The new product will provide a home for some of the $30 billion in fee-based brokerage accounts at the firm that need to find a new home.

A March court ruling ended SEC Rule 202, commonly known as the Merrill Lynch rule, which allowed brokers to provide investment advice through fee-based accounts without being treated as investment advisors. The Investment Advisors Act holds advisors to a higher standard of client protection than that required of brokers.

While some Wall Street firms opposed the loss of their fee-based brokerage accounts, they now are planning for the end of the accounts. Even Merrill Lynch & Co. (MER), one of the most vocal opponents, is apparently planning a replacement product.

Morgan Stanley emphasized that its NDA program has been in the works for a couple of years, well before the court ruling. Nonetheless, the ruling accelerated its introduction. NDA is expected to be a popular alternative to the fee-based brokerage account, which is being phased out and must be closed by Oct. 1.

As firms move toward fee-based business and away from the traditional mode of generating revenue through commissions earned on transactions, the nature of brokers’ relationships with clients has also evolved from simply being stock jockeys to providing comprehensive investment advice. The fee-based brokerage accounts were part of this transition, and acted as a kind of hybrid account, mixing attributes of brokerage and investment advice.

Now the $300 billion in such accounts on Wall Street must be moved either into full advisory accounts or into traditional brokerage accounts.

Rules And Restrictions

Morgan Stanley currently has an advisory account, but it is discretionary – meaning brokers have the ability to make investment decisions for their accounts without seeking clients’ approval. The new advisory account is nondiscretionary, which means brokers will have to seek client approval before making investment decisions for their clients.

The new program “was designed to fill in the gap in our advisory platform offerings,” said Lule Demmissie, program manager for MS Advisory. She said the new program has been in the pipeline for the past two years and is aimed at high net-worth clients who need to have more than one account at a time.

Brokers in MS Advisory accounts, like all advisory accounts, have fiduciary duty to their clients, meaning that they must place clients’ financial interests ahead of their own.

Even when clients’ accounts are switched to MS Advisory, some of their assets can still be allocated into the brokerage accounts to have access to products that advisory clients are restricted from using. Investments that cannot be accessed through NDA include proprietary products, such as stock or bonds issued by the firm, or funds that are managed by Morgan Stanley. “For regulatory reasons, these products may be more appropriate in brokerage accounts,” said Demmissie. The new MS Advisory account also will require clients to diversify their holdings. The account won’t allow concentration in a single stock, bond, asset class or sector.

For example, no single fund can comprise more than 50% of the portfolio, while a single bond shouldn’t exceed 25%. “This account was designed with basic investment guidelines to ensure diversification,” Demmissie said.

Merrill’s Upcoming New Program

Aside from Morgan Stanley, Merrill Lynch is planning to release a new program that would replace Merrill Lynch Unlimited Advantage, its fee-based brokerage platform, which holds around $100 billion in client assets.

Erik Henrickson, a Merrill spokesman, said it is premature to discuss the issue. But people familiar with the company’s plan said it announced internally in recent weeks it would replace the Unlimited Advantage program over the next six months.

Wall Street firms have been lobbying regulators to retain the estimated 1 million fee-based brokerage accounts. Just this week, a Merrill Lynch advertisement, signed by Robert J. McCann, head of Merrill’s retail brokerage business, lamented the end of the accounts.

Some members of Congress have supported the firms’ bid for relief by asking regulators to lift restrictions on principal trading that apply to fee-based advisory programs.

Legal experts, however, say firms should maintain or establish significant controls on fee-based advisory accounts. Controls on principal trading, for instance, have always been viewed as a bulwark against self-dealing. Lawrence Klayman, a securities lawyer who represented clients who have sued Wall Street firms over fee-based brokerage accounts, says, “It’s going to be an area of liability if they don’t set up enough controls.”

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