Since the market collapse of 2008, scrutiny has intensified on the way large banks and securities firms treat their brokerage customers, particularly when it comes to steering them into the firms’ own products.
One possibility raised in the 2010 Dodd-Frank Act, adopted to rein in Wall Street’s risk-taking and bolster investor protections, was to require all brokers to act as fiduciaries, legally requiring them to put their clients’ interest above their own.
The Securities and Exchange Commission, which under the act must decide whether to impose such a standard, has since been wrestling with the issue in the face of opposition from some on Wall Street, who prefer current rules that require only that any investment be “suitable” for the client’s goals and risk appetite.
The issue came into focus in a recent countersuit filed by two former private bankers at Deutsche Bank, who said bank officials pushed them to put their clients’ money into the bank’s own investment vehicles — and against their clients’ interests.
The two, Benjamin A. Pace III and Lawrence B. Weissman, said in a New York State court filing in late May that the pressure increased after Deutsche combined its wealth management unit with an asset-management business in 2012.
Placed in an untenable position, the two said they chose to resign. Deutsche Bank denies those accusations, which were leveled in a legal battle with HPM Partners, co-founded by the New York real estate investor Howard P. Milstein, whose family owns the Emigrant Savings Bank, over alleged improper broker-poaching.
In this suit, Deutsche contended that HPM hired four of its employees in California in 2012 and this year has sought to hire an additional 14, including Mr. Pace and Mr. Weissman.
Legal wrangling over the poaching of brokers is commonplace on Wall Street, and the bank said in a statement, “Deutsche Asset & Wealth Management’s first priority is to fulfill fiduciary duties owed to clients and we reject the claims made in this complaint.” A lawyer for Mr. Pace and Mr. Weissman said they declined to elaborate on their filing.
Roger D. Gershman, a former broker who runs a service called WealthGuard in San Francisco that offers “watchdog” research on investment advisers for the wealthy, said pressure to favor house brands was “very common” at banks and securities firms, especially when it came to higher-fee “alternative investments” like hedge and private equity funds.
In 2005, New Hampshire securities regulators fined American Express Financial Advisors, later renamed Ameriprise Financial, $5 million for failing to disclose that its financial planners were paid extra to recommend American Express mutual funds. The Financial Industry Regulatory Authority, the securities industry’s self-regulator known as Finra, brought a similar case against Ameriprise in 2007.
A report last October by Finra noted that securities firms might also receive “revenue sharing” payments from other mutual fund providers in exchange for featuring their funds on a “preferred list.”
Over the last two decades, some Wall Street firms have moved away from business models in which brokers favor their own firms’ funds. In 1995, Dean Witter Reynolds became the last big firm to stop paying its brokers higher commissions for selling its own funds. But Mr. Gershman, who worked as a broker at Credit Suisse and UBS, said advisers still routinely felt pressure to bolster their commission revenue, giving them an incentive to steer clients into higher-fee products to “pump up their production.”
Two years ago, some former brokers at JPMorgan Chase said they had been pressed to favor funds sponsored by the bank even when cheaper or better-performing options were available. The bank denied the brokers’ accusations, saying its funds offered competitive returns and the brokers had no incentive to favor them.
In 2013, JPMorgan Chase reduced the average percentage of its own funds in the accounts in question, known as the Chase Strategic Portfolio, to about 31 percent from about 42 percent, according to the program’s current brochure, dated March 31.
Morgan Stanley, the nation’s largest retail force with 16,316 brokers, has less than 5 percent of its clients’ managed-account assets — reported in May by Cerulli Associates at $722 billion — in Morgan Stanley-sponsored funds. At the Merrill Lynch unit of Bank of America, its 13,845 brokers also have less than 5 percent of its $552 billion in managed client accounts in Merrill’s own funds.
The percentages are higher at some other big-name firms. Private bankers at Goldman Sachs, for example, typically put a majority of clients’ cash and fixed-income investments into Goldman funds, while steering a majority of their higher-risk assets such as actively managed stocks, hedge funds and private equity to external managers.
Deutsche Bank’s roughly 335 brokers in the United States invest about 34 percent of their client accounts in the bank’s own investment products, according to people close to the bank. The bank said it was committed to an “open architecture approach” offering clients “the best available solutions.”
Mr. Pace, a 20-year employee of Deutsche Bank and Bankers Trust, which Deutsche acquired in 1999, was its chief investment officer for private wealth management in the Americas for 10 years. Mr. Weissman, an alumnus of Citigroup and the money manager Neuberger Berman, was the unit’s head of portfolio consulting.
In their court filing, the two wealth advisers said they had acted as fiduciaries for their clients, but that Deutsche Bank tried last year to shift some of their group members into the bank’s brokerage unit, which could have eased their fiduciary-duty rules.
They cited four separate Deutsche-sponsored investment vehicles — European and Japanese stock funds, a fund to invest in private equity assets on the resale market and a hedge fund of funds — that they said the bank had pressed them to steer their clients toward.
The brokers said Deutsche had planned to invest $200 million of its own capital to “seed” the fund of funds, which would have invested in funds run by Omega Advisors, Chilton Investment, Lazard Asset Management and Atlantic Investment Management. They said Deutsche planned to recover this “bridge loan” by selling the fund to customers, and urged Mr. Pace to include it in a model portfolio. Mr. Pace said he refused.
In their lawsuit, the brokers said such investments were not suitable for many of their clients, who included retirees who did not want such “complicated alternative products” or others who already had other alternatives that they would have had to sell to invest in the Deutsche offerings, incurring additional transaction fees.
The bankers said the pressure to violate their fiduciary duties to clients caused their “constructive dismissal” when they resigned from the bank in mid-May, thus voiding Deutsche’s requirement that they give up to 90 days’ notice and refrain from soliciting Deutsche clients for an additional 120 days.
In an affidavit responding to the suit, Cynthia P. Nestle, chief operating officer of the Deutsche Bank Trust Company Americas, said proposals to shift the bankers into the brokerage unit “were part of internal discussions to improve DB’s business efficiency and potential, but were ultimately not implemented.”
Ms. Nestle called the accusations of pressure “a mischaracterization of the customary and appropriate everyday dynamics of an investment bank like DB.” She said the firm’s clients “expect to be offered DB’s proprietary products as potential investment options” because they are “a key factor” in their choice of the bank over its competitors. Asking Mr. Pace to include them in a portfolio model was part of an “innovation process” that would not have required his clients to invest, she added.
After four days of hearings, a Finra arbitration panel on July 23 cut in half the 120-day nonsolicit period, which now runs until mid-October for Mr. Pace and Mr. Weissman, but upheld their 90-day notice period, which ended in mid-August. The panel did not give its reasoning, nor did it specifically address the “constructive dismissal” issue. Deutsche Bank’s improper-poaching claim is still pending in state court.
The two joined the HPM firm last month. HPM announced their hiring along with the hiring of seven others from Deutsche Bank on Aug. 16.