For Full-Service Firms, the Potential for Conflict of Interest Abounds

Merrill Lynch wants to move faster toward providing fee-based services for individual investors, de-emphasizing relationships based solely on trading.

Besides providing a more stable revenue source, Merrill Vice Chairman John L. “Launny” Steffens said, the shift to fee-based accounts also “aligns the interest of the consultant [broker] with that of the customer” by removing a broker’s incentive to “churn,” or generate commissions through excessive trading.

That may be true as far as it goes, but it overlooks another glaring conflict of interest: The full-service firm’s need to sell the products generated by its investment-banking arm.

“Being a high-paid broker has nothing to do with doing well for your client,” argues Lockwood Financial’s Len Reinhart, a former broker, repeating a long-standing criticism of the full-service industry. “The big firms are manufacturing firms, and they want to sell their own manufactured product.”

Merrill, for example, is the nation’s leading stock and bond underwriter and has a growing family of mutual funds.

Registered Representative, a trade magazine for brokers, reported this spring on the departure from Merrill’s Glendale office of a team of top-producing brokers who felt pushed to sell Merrill’s Mercury Asset Management line of mutual funds.

Merrill denied using sales incentives or pressure tactics to sell the funds. It has also taken pains recently to bolster the funds’ performance by recruiting top managers from rival fund families.

Brokers bristle at the implication that the industry’s main conflict of interest arises from their greed for commissions.

Most full-service brokers won’t talk to reporters on the record--their firms actively discourage them from doing so--but some vent their feelings through online message boards such as one operated by Registered Representative (https://www.rrmag.com).

“Without the good intentions of individuals in this industry, the public customer would find themselves invested in a proprietary limited partnership . . . inside of a wrap account with an inactivity charge on top of it,” fumed a broker using the pseudonym Comrade, mocking some of the high-fee, in-house products that brokerage managements would prefer to have customers in, if they had their way.

Some industry critics also contend that brokerage analysts’ research--which is supposed to be a big selling point with the firms’ clients--is fatally compromised by the firms’ desire to curry favor with corporate customers. It is not uncommon to hear of analysts being punished for downgrading the stock of a current or potential investment-banking client.

Tom Dominick, a former Blue Cross of California employee now retired in Black Mountain, N.C., said that his broker in California guided him toward a number of small-company stocks, many of which didn’t perform well.

“When I got my transaction statement, it would say, ‘We are a market maker in this stock,’ ” Dominick recalled. “They were companies I’d never even heard of, by and large.”

The potential conflict of interest occurred to Dominick, but performance concerned him more. “Some of my picks were better than his,” he said of his broker, adding: “Lately I find myself pretty much making my own decisions.”

On technical matters, however, Dominick seeks help. He attended a seminar by a local broker who works for the firm Edward Jones and wound up consulting him for help with estate planning, long-term health-care and IRA distribution issues.

With 5,200 representatives now, many in single-broker offices in small towns, St. Louis-based Edward Jones claims to avoid the conflicts that dog full-service firms.

“The niche we picked was the individual investor, period. We do nothing for the institutional investor,” Chief Executive John W. Bachmann said in an interview. “When our research turns up an investment idea, who gets it? The individual.”

Bachmann said that by trying to be all things to all people, the full-service firms risk the kind of troubles that nearly sank General Motors Corp. when it was blindsided by aggressive new competition from Japan in the 1970s and ‘80s.

Indeed, full-service brokerages are being squeezed both at the no-frills end of the business and at the high-level advisory end--just as Toyota chipped away at Chevrolet while BMW fed on Cadillac.

But Merrill doesn’t appear to be willing to give up any turf without a fight. And some analysts cheer that aggressiveness.

Analyst Dean Eberling of Putnam, Lovell, DeGuardiola & Thornton notes that Merrill’s plans to introduce laptop computers into its branches later this year may help it compete in smaller markets against the likes of brokerage Edward Jones.

The laptops will enable brokers to take their technical resources into the field rather than waiting for customers to come to Merrill’s centralized offices.