How does the escrow rule affect financial advisors?

Talkin go money

Broker Edward Jones made headlines last year when it announced the company's decision to stop offering mutual funds and ETFs on IRAs and other retirement accounts that charge investors a commission. The company said this step is necessary to meet the compliance requirements imposed by the new DOL Treuhand Rule, which was first implemented in June 2017.

According to the Wall Street Journal, Edward Jones was among the first of the major brokerage firms to set out their plans for compliance with the new rules. LPL Financial announced shortly after that it would begin standardizing the commissions paid to brokers, eliminating the benefit of choosing one family of funds or share class over another.

More announcements from other key players soon followed, even as uncertainty over the trustee rule persisted. This is how the rule affects mutual funds and retirement plans. (For more information, see: Share the new escrow rule with customers.)

Why not mutual funds?

One of the biggest responsibilities of all brokerage and consulting firms is the need to justify variable remuneration under the new fiduciary regulations. In the case of Edward Jones, the variable remuneration may include pre-charged A-shares, C-shares with their respective subordinated charges and different prices for different fund units. One of the many requirements of the new rules is that brokers could justify the different commissions on products they recommend versus other products they would have recommended for an annuity saver.

Selling mutual funds with commissions or other forms of variable compensation requires advisors to present a Best Interest Contract Exemption (BIS) for clients to sign. It is likely that many brokers and financial advisors will try to avoid this conversation and the questions that the BICE form could raise with clients. This is most likely one of the motivating factors behind Edward Jones's decision.

Implications for savers

According to the Wall Street Journal, Edward Jones had around four million retirement accounts in 2016. Undoubtedly many are owned by smaller investors who make very few trades per year and take away the ability to use mutual funds or ETFs drastically limit their options. These existing account holders can keep their current holdings via the grandfathering provision of the escrow rule. However, since the rule was introduced on June 9, 2017, new purchases will be subject to the new rules already implemented by Edward Jones.

An alternative for customers is to switch to a paid account that charges an AUM-based fee; for customers who trade infrequently, these accounts could dramatically increase their investment costs. For brokers at firms like Edward Jones, these paid accounts can be a source of a nice payday for little advice. Time will tell if a majority of customers will choose the paid account or choose to go and invest elsewhere. (For more information, see How the New Fiduciary Rule Affects Investors.)

Implications for mutual fund companies

Edward Jones' announcement took the mutual fund industry by surprise. Your decisions, and similar ones, considered by other asset managers, could force many fund companies to reevaluate their offerings. In terms of fees and charges, the impact on costly, actively managed funds could be significant. Will brokers and brokerage firms try to compete at cost? Will they try to steer clients into paid accounts with low or unencumbered funds and make their money on the asset-based fees they charge their clients?

Mutual fund firms like American Funds, Franklin Templeton, and others, who distribute their funds almost entirely through financial advisors as intermediaries, have certainly noticed Edward Jones' move, LPL leveling of brokerage fees, and other portfolio manager compliance changes. have made. Last year, Charles Schwab brokers stopped selling mutual fund share classes with sales loads. While this was a relatively small part of Schwab's business, it is another example of the changes accelerated by the new escrow rule.

Another article discussing this move in the Wall Street Journal suggested that there has been a churn in funds with selling burdens for a number of years. "Investors withdrew more than $ 500 billion from load classes between 2010 and 2014, plowing a dollar in the process. According to the Investment Company Institute, a mutual fund trading group, the article read:" Share classes with different types of loads represented around 20% of long-term investment assets at the end of 2014, according to ICI, of around 33% in 2005. "(For related reading, see trust rule: New Tech Products.)

In addition to sales fees and commissions, mutual fund costs are under further scrutiny. as part of the general industry move towards transparency. This is already having an impact on fund companies that rely on active management in their various offers.

The bottom line

The DOL escrow rule is certainly a turning point for financial advisors and brokerage firms that was predictable and surprising to anyone. But the wider impact is starting to unfold, and financial products like mutual funds, which play an important role in the financial advisor toolkit, are also likely to see changes. (For more information, see: The New Fiduciary Rule: Will Lawsuits Get It Back?)