Wall Street's Frenzy Over Fees
Wall Street's fierce grab for the online customer catches most of the attention these days. But there's another, even bigger battle going on among the major brokerages: to woo investors into accounts that offer unlimited trading for one flat fee, based on the dollar value of the assets in the portfolio. Merrill Lynch, Morgan Stanley Dean Witter, Prudential Securities, and Salomon Smith Barney are heavily promoting these accounts, betting that newer and younger investors would rather pay a flat fee than punch the broker's ticket every time they trade.
Even as these venerable firms are fighting each other, they are also taking aim at maverick Charles Schwab & Co. The Wall Street firms are looking to offer the convenience of cheap online trading while still making available the traditional relationship with a broker. Schwab doesn't even employ brokers. It does have relationships with 5,600 independent financial advisory firms that use Schwab's trading, record-keeping, and custodial services. They account for $180 billion in assets at Schwab, about 30% of all of Schwab's customer assets. "The big Wall Street firms have turned their guns toward us," Charles Schwab, the firm's founder, chairman, and co-CEO told the recent Schwab adviser conference in San Francisco. "They're jealous of our partnership."
In effect, these independents are Schwab's brokers. They typically charge a fee based on assets and use Schwab's discounted commissions to lower costs. Now, Wall Street is driving commissions down to Schwab's level and offering fee-based accounts as well.
The battle even goes beyond the Street vs. Schwab. The retail brokerage industry is trying to change its business model from commissions to collecting fees based on the amount and nature of assets in an account. That's because commissions are highly variable--depending on the ups and downs of the stock market--while asset-based fees allow the firm to collect even when the market is in a funk.
This is hardly a new idea. "If you look back 25 years, you will find statements from brokerage executives about moving from transactions to fee-based income," says Steve Galbraith, a brokerage analyst at Sanford C. Bernstein & Co. "Inertia is a powerful force in this industry." Oddly enough, Schwab's success--its stock is more highly valued than Merrill's--is what is attracting the Wall Street firms. Moreover, the Internet is driving commissions so low that the big firms can afford to trade them in for a shot at fee-based income.
CHOICES. The Securities & Exchange Commission is encouraging the shift toward fee-based accounts. "Asset-based fee programs better align the interests of the customers and their brokers," says SEC Chairman Arthur Levitt Jr. Excluding those held by the big Wall Street firms, fee-based accounts have grown from $120 billion in 1992 to nearly $700 billion last year, according to Cerulli Associates, a financial-services consulting firm.
Brokerage executives say they are pleased with the acceptance so far of fee-based accounts, but they don't expect them to dominate the business anytime soon. "In five years, I expect our retail revenues will be evenly split between commission and fee-based account," says James D. Price, president of the private client group at Prudential Securities Inc. "I would have thought that would happen sooner, but many people, when offered a switch, prefer the traditional relationship." Indeed, older clients--and the big Wall Street firms have older, wealthier clients than Schwab and the e-brokers--may do well to stick with commissions if they have large portfolios that trade infrequently. "What this is really about is giving customers and financial consultants choices about how they want to do business," adds Pamela Parker, director of Salomon Smith Barney's AssetOne program.
Schwab, long the innovator in the brokerage game, is clearly uneasy playing defense. So it has gone on the offensive. Daniel O. Leemon, Schwab's top business strategist, kicked off the adviser conference with a sharp, critical review of the Wall Street firms' new fee-based offerings. Leemon scoffed at excerpts of Merrill Lynch & Co.'s television advertising promoting the line, "when you succeed, we succeed," describing the new relationship in which a customer pays Merrill on the growth of his assets, not for the chance of rolling the dice on a stock. Schwab advisers, he said, have always been on "the same side of the table as their clients."
PRICING PRESSURE. It's no surprise that Schwab went for the jugular. On the face of it, Merrill's Unlimited Advantage program has some mighty attractive features that could trump Schwab. The main one: virtually unlimited trading, online or through a broker, for a maximum annual fee of 1% of assets, or $1,500, whichever is greater. Merrill will take accounts as small as $1,500 though they certainly would not make economic sense for an investor who doesn't have at least a high five-figure account and a very active trading habit.
Unlimited Advantage also includes a clutch of services such as the Visa Signature card, a Cash Management Account, financial planning, and Merrill Lynch investment research. "The target is us," says Leemon. Merrill Lynch spokeswoman Susan Thomson seems to agree: "This puts extreme pricing pressure on the independent-adviser-plus-Schwab model." She says most investors will end up paying an average of 0.80%, because the 1% is for equities, while bonds and cash have lower fees. The other big firms that offer similar fee-based programs also lower the fees on fixed-income investments (table). Thomson says Merrill's program has taken in $16 billion in three months and the firm is opening up over 1,200 accounts per week.
At first blush, those fees look competitive with advisers affiliated with Schwab, whose fees range from 0.75% to 1.5% of assets with a minimum account size of about $100,000. And there are trading commissions as well. However, the service is not the same. Most Schwab advisers take charge of running the portfolios. The new brokerage accounts don't do that. The broker may recommend an investment, but the client has to okay it. Brokerage customers who want a manager to take charge have to use separately managed accounts that can cost anywhere from 1.5% to 3% of assets.
Schwab's attack on Merrill clearly surprised a lot of advisers, many of whom say that their business is prospering. "Schwab vs. Merrill Lynch? It's like war," says investment adviser John Rhoads of Rhoads Grunden Lucca Capital Management in Dallas. "We've been competing with Merrill, and we do it with better service." Investment adviser Bill Dunn of Private Wealth Management Group Inc. in Princeton, N.J., argues the big firms can't offer the personal attention that the smaller ones can. At a large firm, he says, clients needing help with trust, insurance, or real estate matters will be referred to specialists, while he can offer all that counseling. Says Dunn: "Investment advice is only one part of what we do."
Schwab officials admit they may have been a little alarmist in their appeal to the advisers, but the annual conference is its one big chance to make them aware of the changing business conditions--something they might not get from their individual vantage points. "Our partners are small businesses, and we have research and resources they don't have," says John Philip Coughlan, president of Schwab Institutional, the unit that serves the advisers.
Whether Merrill, Schwab, or some other firm prevails shouldn't really matter to investors. Customers who can use these new accounts to lower their costs are already winning.