Fees & charges for investment accounts are becoming more complicated in recent years as a result of versatility of products and services. If retail investors do not spend time to understand fees & charges thoroughly, they will pay a "premium" for relying on their service providers.
NASD recently fined Wachovia Securities LLC US$2 million for failing to adequately supervise its fee-based brokerage business between 2001 through 2004. In addition, NASD ordered Wachovia to identify and pay restitution to approximately 1,300 customers who were inappropriately allowed to continue maintaining fee-based accounts, or who were inappropriately charged account fees on Class A mutual fund share holdings for which they had already paid a sales load.
In fee-based brokerage accounts, customers are charged an annual fee that is either fixed or a percentage of the assets in the account, rather than a commission for each transaction, as in a traditional brokerage account.
Wachovia began offering a fee-based brokerage account, now called "Pilot Plus," to its customers in 1999. In 2001, Wachovia had just over 18,000 Pilot Plus customers who paid more than US$55 million in Pilot Plus fees. By the end of 2004, that number had grown to more than 41,000 customers who paid more than US$110 million in Pilot Plus fees.
During 2001 through 2004, while Wachovia informed its brokers that a Pilot Plus account was not appropriate for customers who made a limited number of trades, buy-and-hold customers, and customers with assets below US$50,000, it failed to put in place a system and procedures reasonably designed to determine whether Pilot Plus accounts were appropriate for its customers.
NASD's investigation revealed that 594 Wachovia customers, who conducted no trades in their Pilot Plus accounts for at least two consecutive years, paid the firm approximately US$1.9 million in fees. Also, 620 Pilot Plus customers held assets of less than US$25,000 for at least one full year and paid at least the minimum annual fee of US$1,000. This fee represented twice the firm's stated top rate of 2% allowed under the Pilot Plus agreement. During the time that these customers' eligible assets averaged below US$25,000 for at least one full year, they paid a total of about US$1m in Pilot Plus fees.
In addition, Wachovia failed to protect Pilot Plus customers from being assessed both an initial sales charge and an on-going asset-based fee on the purchases of Class A shares of mutual funds. Ordinarily, when a customer purchases Class A shares, the customer pays a front end sales charge or "load" at the time of purchase. Under Wachovia's procedures, customers who purchased Class A shares outside of a Pilot Plus account and paid a front end sales charge on the purchase were not allowed to transfer those shares into a Pilot Plus account for at least 13 months so as to avoid duplicative charges for the fund shares. But Wachovia failed to enforce these procedures. Consequently, Wachovia charged more than 110 customers both a load and Pilot Plus fees on the purchase of Class A shares.
Wachovia also failed to adequately supervise certain high revenue-producing brokers, who were members of the firm's "Red Carpet Club." The Red Carpet Club members were exempted from some of the firm's review and approval processes. Whereas most Pilot Plus accounts were opened only after review and approval by both a branch manager and a representative from the unit responsible for the oversight of all of the firm's fee-based programs, only branch manager approval was required for customers of Red Carpet Club members. This less vigorous review resulted in Red Carpet Club members opening Pilot Plus accounts for customers with total assets which were below the firm's stated US$50,000 minimum account balance. This resulted in Red Carpet Club members' customers constituting approximately 99% of those accounts in Pilot Plus that held less than US$25,000 in assets for at least one full year.
Additionally, two brokers, who were recruited from another firm and immediately became Red Carpet Club members, brought more than 340 of their customers to Wachovia and opened Pilot Plus accounts for them. In recommending Pilot Plus accounts to these customers, the two brokers incorrectly told them that Pilot Plus was an advisory account rather than a fee-based brokerage account. Wachovia failed to adequately supervise these brokers' communications with their customers. Moreover, once the firm discovered that these brokers had incorrectly described Pilot Plus as an advisory account, it failed to respond in a timely manner to correct the inaccurate representations made to these customers.
NASD also determined that Wachovia violated NASD rules governing communications with the public by providing its brokers with an optional letter they could send to customers which inaccurately stated at one point that Pilot Plus was "a fee-based, investment advisory service." In fact, Pilot Plus was not an advisory service or advisory account, which would be subject to a different regulatory regime, but was in fact a fee-based brokerage account.
The facts are complex but the lesson is simple: A firm's sales compliance standard was blinded by profit motive.
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