07/14/97 'FLAT FEE' ACCOUNTS: READ THE FINE PRINT

'FLAT FEE' ACCOUNTS: READ THE FINE PRINT
Brokers' no-commission offerings may have hidden charges
It has been a problem since the dawn of the retail brokerage business: Brokers have a strong incentive to get customers to trade when it might be in clients' interest to do nothing. Responding to criticism of this conflict of interest, many firms such as Merrill Lynch, Smith Barney, and PaineWebber have recently promoted ''relationship'' or ''fee-only'' accounts. Instead of charging per-trade brokerage commissions, customers pay flat annual fees for a set number of trades. That, say the firms, puts the broker on the same side of the table as the customer.
Well, not always. Although firms don't go to a lot of trouble to point it out, customers in fee accounts are charged extra fees for purchasing initial public offerings--putting the broker right back on the other side of the table.
DISAGREES. The leading example is the Merrill Lynch Financial Advantage (MLFA) service. The headline of its ad campaign says: ''Merrill Lynch offers an alternative to commissions.'' The ad continues: ''No commissions on transactions. For a wide variety of investments including stocks, bonds, and mutual funds.'' But read the fine print of the agreement that customers sign to register for the MLFA service. In addition to the flat fee of 1.5% to .75%, brokers will be paid a ''selling concession,'' or commission on ''new issues of equities and fixed-income securities.'' Says former Dean Witter branch manager and industry gadfly Leslie Silverstone: ''The ads do not disclose that there is an extra incentive for a Merrill Lynch broker to sell a customer a Merrill underwriting, when there is.''
Merrill Lynch & Co. initially defended its advertisements. But in response to queries from BUSINESS WEEK, James G. Bennett, the program manager for the account, said it would change its ads. ''Any future ads or materials will explicitly tell clients that new issues are not eligible for the service,'' he says.
Regarding charges for IPO purchases, Bennett says that these trades do not reduce the client's number of allotted trades. And in practice, he says, ''less than 3% of transactions in the financial advantage account have been new issues,'' he says.
But Smith Barney Inc.'s AssetOne account charges the customer only once for trading IPOs. Smith Barney pays its brokers a commission for selling new issues. But it excludes the IPO amount from the flat fee. So if a Smith Barney customer had $200,000 in a fee account and bought a $20,000 IPO, the flat 1.5% fee would be charged only on $180,000. Under the Merrill system, the fee would be imposed on the entire $200,000. ''We do it differently than Merrill,'' says Smith Barney Executive Vice-President Jay Mandelbaum. ''On IPOs, customers do not get billed an AssetOne fee on top of the selling concession.'' Smith Barney also doesn't reduce the client's allotted number of trades for buying an IPO.
MANY VIRTUES. Smith Barney handles two other issues differently. What happens when a client makes 13 trades when his allotment is 12? ''We charge a discounted commission but the financial consultant is not paid. There is no incentive for the broker to do extra trades,'' says Mandelbaum. Not so at Merrill. Says Bennett: ''The customer pays the regular commission.'' And if a Smith Barney client has more than 10% of his assets in cash, the flat fee is not charged on the cash over 10%. At Merrill, the MLFA fee applies to all eligible assets within the account. Bennett says if a customer has that amount of cash, it is usually temporary.
PaineWebberInc.'s Premier Asset Account and Prudential's Valued Investor Program handle IPOs the same way Merrill does, according to spokesmen for the firms. As for Dean Witter's Choice account, spokesman Tim Lee didn't respond to BUSINESS WEEK's fax requesting comment.
It's true that fee-only accounts have many virtues. They give customers access to a wide variety of brokerage services while reducing the role of commissions. ''It's a positive move for both the consumer and the industry,'' says Louis S. Harvey, president of Dalbar Inc., a financial-service research firm. Still, these offerings are all less than a year old, with Merrill Lynch the only one so far to advertise. Maybe more time and more competition will give fee-only investors a fairer break.
By Leah Nathans Spiro in New York