Brokers’ Fee Hikes Hitting Small Traders
Spurred by higher costs and changes in their products, large full-service brokerage firms such as Merrill Lynch have raised commission fees as high as 25% in recent months, with some of the increases targeted at small investors.
Meanwhile, some firms are also changing the way they pay brokers, rewarding them for handling wealthier clients and, in effect, discouraging them from spending a lot of time with the less-affluent.
These developments, some analysts say, reflect a reduced dependence on traditional stock trading commissions as a source of income for brokerage firms. These changes also reflect a realization among brokerages that handling smaller investors costs more and results in less profit.
The changes could prompt some small investors to switch more of their trading to discount brokers, which in recent years have been taking an increasing share of the stock trading business from full-service firms.
‘Start Charging More’
The fee increases “are going to make that many more investors focus on whether they really need a full-service broker,” said James R. Quandt, president and chief executive of Security Pacific Brokers Inc., the discount brokerage unit of Security Pacific National Bank.
“It’s good business to start charging more when the product’s hot,” said James Cloonan, president of the 98,000-member American Assn. of Individual Investors, noting that the fee hikes come amid booming trading volume in stocks. “But it will drive more people to discount brokers.”
Some industry officials and analysts predict that these and other developments will help blur the distinctions between discount and full-service brokers. Already, many discounters are offering many of the same products as their full-service brethren, such as mutual funds, individual retirement accounts and cash management accounts.
“The service level distinctions are diminishing,” said Hugo Quackenbush, senior vice president for strategic planning and marketing at Charles Schwab & Co., the nation’s largest discount brokerage.
The latest changes will not change the basic process by which investors are billed for stock purchases. Investors who trade stocks will continue to be charged commissions, generally between 1% and 2% of the value of the transaction.
The commissions, usually billed to the customer’s account with the firm, go to the company, and brokers are paid a percentage, usually between 20% and 50%, depending on the volume and size of transactions they handle.
Nearly every major brokerage has either raised commissions or altered its compensation structure for brokers in recent months, said Perrin Long, brokerage analyst for Lipper Analytical Securities Corp. They include Dean Witter Reynolds, which increased commissions 3.5%, and Paine Webber, which said it upped fees on the average by “less than 5%.” But the move that so far has gotten the most attention was by Merrill Lynch, the nation’s largest brokerage firm.
Merrill Lynch’s plan, which took effect June 20, clearly was aimed at the smaller investor. The firm raised commissions by an average of 4.8% on trades of $10,000 or less, but fees on trades of $10,000 or more were not changed.
Merrill Lynch increased fees on the smallest trades as much as 25%. For example, on a $1,000 trade of 100 shares at $10 each, the commission was boosted to $50 from $40. By contrast, fees on an $8,000 trade of 100 shares at $80 were increased only about 1%, Merrill Lynch spokesman James Flynn said.
Fees Steadily Rising
To be sure, this is not the first time that brokerages have raised commissions for small investors. Indeed, fees for retail investors have been steadily rising since May 1, 1975, when the Securities and Exchange Commission allowed brokerages to set their own commissions.
Since then, rates charged to retail customers on average have risen to between 31 cents and 32 cents per share from 24 cents, according to analyst Long. Meanwhile, rates have declined sharply for pension funds, money managers, banks and other institutional clients that buy securities in bulk. Those rates now average between 6 cents and 8 cents per share, down from 22 cents before May 1, 1975, Long estimated.
The latest changes come as national full-service brokerage firms are earning less revenue and profit from stock commissions and an increasing amount from such activities as investment banking, institutional brokerage, corporate finance, underwriting and sales of tax shelters, insurance, individual retirement accounts, mutual funds and other products.
Meanwhile, costs of computerization and other equipment, higher taxes and higher administrative expenses have made stock trading more costly. That makes smaller trades less profitable.
These higher trading costs have been offset somewhat by the booming stock market volume of recent months. But much of the increase in stock investing by individuals has been through mutual funds rather than direct purchases. Mutual funds, by buying stock in bulk, are charged lower commission rates than individuals.
“The small investor whose dollar amount of trading is $10,000 or less (is) not very profitable to full-service firms,” analyst Long said.
“Big firms want the wealthier players and want to discourage the small player,” said Mary Sunderland, brokerage analyst for Value Line Inc.
Accordingly, brokerages are increasingly seeking to earn fee income from managing all of their clients’ financial assets rather than just clients’ stock portfolios. These assets include such things as tax shelters, individual retirement accounts, mutual funds, cash-management accounts and insurance.
Recent changes in compensation for brokers reflects this new emphasis on asset management.
Shearson Lehman Bros., for example, now pays its brokers a percentage of the total amount of client assets they manage as well as a percentage of their commissions. For example, a Shearson broker with two years of experience would get such a payment if he had at least $6 million in assets under management, Shearson spokeswoman Laurie Heffner said.
At Merrill Lynch, brokers with five to 10 years of experience will now get paid a percentage of assets they manage above $24 million.
Previously, both firms paid brokers only on the basis of the commissions they earned.
“We’re trying to develop more long-term relationships with clients,” Shearson’s Heffner said, adding that her firm pioneered this new compensation system when it introduced it on Jan. 1. The change, she said, will help discourage brokers from churning, which is the practice of trading client stocks unnecessarily to earn more commissions. Brokerages also are increasingly discouraging their brokers from handling smaller trades. In the past, brokers generally could make as much in commissions doing many small trades as doing a few big ones, even though the small ones together would cost more in processing and time.
But Merrill Lynch, for example, now no longer pays brokers for trades of less than $35. Other firms are widening the gap between what they pay their brokers earning the most in commissions from those earning the least.
At Shearson, for example, brokers bringing in less than $100,000 in commissions will get paid only 25% of those commissions, while brokers bringing in more than $250,000 in commissions will get paid at a rate of 45%. Previously, the difference was not as great, spokeswoman Heffner said.
Some analysts say these moves will mean that smaller investors will increasingly be routed to paraprofessionals or other personnel rather than full-fledged brokers. “There is no question that service will deteriorate for small investors,” analyst Long said.
“The full-service firms are resigned to losing some of the small investors to discounters,” said Mark Coler, a discount-brokerage consultant with Discount Brokerage Advisory Services Inc.
Long estimated that the market share of discount brokerages will continue to grow from their current 20% share of retail transactions, up from between 12% and 14% five years ago.
But while full-service firms recognize that some clients will switch more business to discounters because of the price increases, they contend that most will stay.
“If you have a problem with a discounter, who are you going to call?” asked Merrill Lynch spokesman Flynn, contending that discounters cannot provide the personal attention that full-service firms provide, particularly when mistakes or unprofitable trades are made. James F. Higgins, national sales director for Dean Witter, contended that his firm is not reducing emphasis on small investors at all. In the past three years, Dean Witter has opened 350 offices in the stores of its parent firm, Sears, Roebuck & Co., Higgins said. “Clearly that evidences our strategy of going after the little guy,” he said.
Some investors say the increases do not bother them simply because they do not trade stocks that often. “If I was a professional trader, it (the higher commissions) probably would make a difference,” said a 74-year-old retired Santa Monica financial executive who uses Dean Witter. Some investors, however, see a good side if brokers pay less attention to smaller clients. “Your broker won’t be bothering you as much. That’s a blessing in disguise,” Cloonan, the president of the American Assn. of Individual Investors, said somewhat facetiously. “The less you hear from your broker, the better off you are.”
