By: Gary Droz
The U.S. Department of Labor (“DOL”) has endeavored to address the problem of conflicts of interest in retirement advice with its new fiduciary rule, which focuses primarily on brokers because of their compensation practices that often include 12b-1 fees and commission on proprietary or platform products. Unless the final DOL fiduciary rule is amended or abandoned, any financial professional who works with retirement plans or provides retirement planning advice will be automatically elevated to the level of a fiduciary under ERISA. This means they will be required to meet the standards of this elevated status as well as meet an exemption in order to receive certain compensation, which creates conflicts of interest, and clearly disclose this information to clients.
Here at MainLine Private Wealth, we applaud the DOL for its efforts, but we believe there is a significant conflict of interest these exemptions and the DOL fiduciary rule will not address including the ways in which fund companies end up with their investment products on your broker’s platform. Right now, in order for funds to be included on your broker’s platform, many fund companies or money management firms are often required to pay the brokerage firm a hefty access fee. This means that an investment product that your broker offers as a recommendation may have bought and paid for that spot on the platform instead of earning it. The question becomes are the funds who pay to play really the best investment options available or just those with the most cash?
These practices became a headline this year when Morgan Stanley, one of the largest brokerage firms in the world, removed Vanguard’s mutual funds from its broker offerings. Why would such a dominant broker network remove one of the most popular fund families available and also refuse to pay brokers on assets invested in Vanguard investments? It’s simple. In a recent Wall Street Journal article, Bill McNabb, Vanguard Chairman and Chief Executive, explained that “[t]hey have a model where they want to be compensated for being on their platform in one form or another and that’s just something we won’t do. We think it raises inherent conflict.” The article goes on to say that “by excluding Vanguard funds from its compensation structure Morgan would effectively be giving advisers a disincentive to keep clients in the funds.” Morgan Stanley isn’t the only big bank to ax Vanguard. Another earlier article in the Wall Street Journal noted that Merrill Lynch“already doesn’t allow new clients to purchase new share of Vanguards mutual funds.”
Again, we point to some obvious and important questions. Why remove Vanguard? What separates them from the rest of the pack? And why would Vanguard refuse to pay? Among other things, by refusing to pay access fees, Vanguard is able to keep their fund expenses at the lowest possible level, yet those low fees may be exactly what makes them solid performers. In fact, Morningstar discusses this very topic – the link between fees and performance – concluding that the correlation between low fees and good performance is almost unassailable, stating that “[l]ow fee funds give investors the best chance of success over the long run.”
This creates a conflict for investors, as some of the lowest fee options, like Vanguard, are removed from certain platforms because they are unwilling to “pay to play.” Therefore, it seems likely that other big banks and brokerage firms may follow in the footsteps of Morgan Stanley and Merrill Lynch, which would keep Vanguard (and other great products) out of the investment line up and out of reach for many investors. And, while the DOL fiduciary rule conceptually is good for investors, even it won’t prevent fund companies from buying their way on to certain platforms.