Panel Urges Alterations in How Brokers Are Paid : Securities: Report says incentives work against customers’ interests but that system is firmly entrenched.

A committee of financial luminaries said in a report issued Monday that the way most stockbrokers are paid puts them in conflict with their customers’ best interests. But they called the system “too deeply rooted” to do away with soon.

Instead, the five-member committee on compensation practices, appointed by Securities and Exchange Commission Chairman Arthur Levitt Jr., proposed less radical steps aimed at taking away brokers’ financial incentives for exposing customers to unnecessary risks.

Levitt appointed the committee last year in response to growing attention to the problem of brokers who repeatedly cheat investors, including a 1992 series on the subject in The Times and an SEC investigation that followed.

Most brokers are not paid based on how customers’ accounts perform, but on how many transactions, such as buying and selling stocks, they make. As a result, brokers end up getting paid more if they engage in unethical practices such as selling unsuitably risky securities that carry bigger commissions than do safer ones, and if they churn accounts, rapidly buying and selling securities just to build up commissions.

The report says that “the prevailing commission-based compensation system inevitably leads to conflicts of interest” with customers. It notes that in many instances, the best recommendation for a customer would be to do nothing and simply hold on to the stocks and bonds in an account. But it also says that “the current compensation system is too deeply rooted to accommodate radical alteration in the near term.”

It recommends more modest steps so that brokers’ pay may be partly based on the amount of customer assets the broker is managing. The committee recommends doing away with the practice by some brokerage firms of paying brokers higher commissions for selling the firm’s in-house line of “proprietary products,” such as a firms’ own family of mutual funds, even though such funds may have lackluster performance records.

It calls for tightly restricting sales contests that reward brokers for selling large quantities of a particular product such as shares of a new mutual fund. It recommends keeping new brokers on salary for longer periods before switching them to commissions so as to reduce the pressure on new brokers to prove themselves by selling large quantities of securities. The report also recommends eliminating the big bonuses some firms pay to lure successful brokers away from other firms.

It also calls for disclosing to customers the hidden fees and commissions brokers receive for selling certain products--something the report says virtually no Wall Street firm discloses now. The report does not go into specifics as to what these fees are. But investors’ attorneys said an example is the secret “sales credit” often paid to brokers for selling an over-the-counter stock the firm’s trading desk is eager to unload.

The committee was chaired by Daniel P. Tully, chairman and chief executive of Merrill Lynch, the nation’s largest brokerage firm. Other members included Warren Buffett, the well-known investor and chairman of Berkshire Hathaway Inc., and Samuel L. Hayes III, a professor at Harvard’s Graduate School of Business Administration. The sole representative of small investors on the committee was Thomas E. O’Hara, chairman of the National Assn. of Investors Corp., which sponsors investment clubs.

In a news conference at the SEC’s headquarters, Levitt said he was pleased with the report. He also made clear that compliance with the recommendations will be voluntary; Levitt said he does not believe the SEC should dictate how the industry pays employees. In an interview, however, he said he will “persuade, cajole and commend firms to begin to embrace these practices.”

Several firms in recent months, including PaineWebber Inc. and Prudential Securities, announced that they were doing away with extra fees paid to brokers for selling in-house products. These fees, as well as contests, were heavily implicated in one of the biggest investment debacles ever to hit Wall Street: Prudential Securities’ sales of more than $7.7 billion in limited-partnership units to small investors beginning in the early 1980s, most of which produced losses.

But it was not clear how compliant the rest of Wall Street will be. On Monday, Dean Witter Reynolds, the nation’s third-largest firm in terms of the number of brokers employed, was noncommittal. Dean Witter has long heavily encouraged its brokers to sell the firm’s line of mutual funds. In a written statement, the firm said, “We will be studying the recommendations on broker incentives and will be guided in our decision by what is in the best interests of our clients.”

Other large firms, including Smith Barney Inc. and Bear Stearns, contended that they already comply with some key recommendations in the report but that they had no immediate comment on whether they would adopt the rest.

Some regulators and investor advocates expressed disappointment with the report.

Philip A. Feigin, Colorado’s securities commissioner and president of the North American Securities Administrators Assn., criticized it for not specifically dealing with the financial considerations that have led firms to hire and keep on “rogue” brokers. He said the committee should have looked at “what is it in the industry that allows these people to remain in business.”

Laura Polacheck, senior analyst at the American Assn. of Retired Persons in Washington, criticized the report for not at least stating as a long-term goal the elimination of broker compensation systems based on transactions.