Wrap Fee Abuse

No matter how they earn their fees, some stockbrokers, and investment advisors will find ways to bill their clients. When a commission is earned on each transaction, there is a risk of churning—buying and selling securities just to generate commissions. Wrap fees offer different opportunities for abuse.

Wrap fees are an alternative to commissions on transactions. Generally, an infrequent trader is better off paying the occasional commission, but an active trader will save money by avoiding numerous individual transaction costs and paying an annual fee. The client puts a portfolio in the hands of the broker, who manages it for a flat annual fee, usually 1 percent to 3 percent of the portfolio value.

By increasing the value of your account, the broker or account manager increases the value of the flat rate annual fee. It sounds fine in theory, but in reality there are significant abuses of the wrap fee system.

First, when you compensate your brokerage firm with an annual fee based on asset value rather than commissions, your broker gets paid whether or not she does anything. It's like an annuity for the broker. Granted, the broker may want your account to increase in value because she gets paid more if assets under management grow. But the reality is that many brokers tend to ignore their wrap fee clients in order to focus on earning fees from their commission-based clients' accounts.

Second, for brokers who do actively manage the account, there is an incentive to recommend unsuitably risky investments or to use aggressive investment techniques to generate increased income. While these actions may generate income in the short term, they also can result in a significant loss of principal.

Third, another form of wrap fee abuse is investing client money into products that already have steep management fees such as load bearing mutual funds which already charge an annual management fee. Add all these fees together and it’s clear that the investor must climb out of a hole just to break even.

If you have lost money in a wrap fee account or if you believe your portfolio has been paying an excessive amount in management fees, please contact a securities arbitration lawyer at Hermann, Cahn & Schneider today. From our offices in Cleveland, Ohio, we represent investors throughout the country.