The Wall Street Journal has an article on Morgan Stanley’s rising profits and stock price.  Much of the profits come from servicing retail investor accounts.  It’s an increasingly profitable business line:

Morgan Stanley’s X-Factor, though, is increasingly its giant retail brokerage, which oversees $2.4 trillion for some 3.5 million households. That unit’s revenue rose 10%, while lower expenses lifted its profit margin—once in the high single digits—1 percentage point to 26%. Mr. Gorman set a new upper goal of 28%.

Many of these profits come from gathering assets and then charging a management fee.  This allows Morgan Stanley to profit even when clients do not actively trade their accounts.  The Journal described it this way:

Morgan Stanley’s retail brokerage gets a growing portion of its revenue from steady fees that are assessed as a percentage of client portfolios, rather than commissions on trades. As the stock market marches higher, Morgan Stanley is guaranteed profits on those accounts whether clients trade or not.

Wrap fees or registered investment advisory services may account for much of this revenue.  At the end of December, the SEC released an investor bulletin about wrap fees.  It defined a wrap account as “an investment account where you are charged a single, bundled, or “wrap” fee for investment advice, brokerage services, administrative expenses, and other fees and expenses.” 
 
The SEC has concerns about wrap fee programs.  It’s 2017 examination priorities letter announced that the SEC will monitor these programs closely.  
Wrap Fee Programs. We will expand our focus on registered investment advisers and broker-dealers associated with wrap fee programs, which charge investors a single bundled fee for advisory and brokerage services. We will likely review whether investment advisers are acting in a manner consistent with their fiduciary duty and whether they are meeting their contractual obligations to clients. Areas of interest may include wrap account suitability, effectiveness of disclosures, conflicts of interest, and brokerage practices, including best execution and trading away.
Some retail investment firms have faced SEC enforcement actions arising out of their wrap fees.
 
The news about these rising retail-investor-driven profits makes me wonder how aggressively FINRA and the SEC now look at reverse churning issues.  The SEC made reverse churning an issue in its 2016 examination priorities letter, but dropped the term from its 2017 letter. Reverse churning occurs when a financial adviser convinces a client that has little need for ongoing services to move an account to an ongoing fee structure.  For example, a buy-and-hold investor investing with the intent to keep an index fund for a decade may not benefit from an account that charges 1.5% annually.  Instead of trading too much to drive profits (churning), the firm makes excessive profits by doing nothing.  In a bull market, an investor may never alert to the gains drained away by fees.  It may also be tough to recover for excessive wrap fees in FINRA arbitration because many arbitrators expect investors to have suffered some net-out-of-pocket loss.
 
As the SEC considers whether current disclosures effectively inform investors about the fees they pay, it should look at whether the retail investors driving Morgan Stanley’s profits actually understand how much money they pay Morgan Stanley over time and whether they believe that the services they receive are worth the fees.  
 
 
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Photo of Benjamin P. Edwards Benjamin P. Edwards

Benjamin Edwards joined the faculty of the William S. Boyd School of Law in 2017. He researches and writes about business and securities law, corporate governance, arbitration, and consumer protection.

Prior to teaching, Professor Edwards practiced as a securities litigator in the New…

Benjamin Edwards joined the faculty of the William S. Boyd School of Law in 2017. He researches and writes about business and securities law, corporate governance, arbitration, and consumer protection.

Prior to teaching, Professor Edwards practiced as a securities litigator in the New York office of Skadden, Arps, Slate, Meagher & Flom LLP. At Skadden, he represented clients in complex civil litigation, including securities class actions arising out of the Madoff Ponzi scheme and litigation arising out of the 2008 financial crisis. Read More

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