Earlier this year, the Obama administration rolled out a long-anticipated rule that holds more financial advisers who work with retirement savers to the same ethical standard that doctors, lawyers and accountants are supposed to adhere to. This so-called fiduciary standard requires people in positions of trust to always put clients’ best interest ahead of their own.
According to a report by the White House Council of Economic Advisers, Americans saving for retirement lose an estimated $17 billion a year -- in the form of lower returns -- because of the conflicts of interest that often exist for advisers who earn fees and commissions on the investment products they recommend.
Since the rollout of the fiduciary rule in April, a good deal of speculation has swirled about how brokerage firms would adapt. For years, brokers who give investment advice have been held only to what’s called the suitability standard, meaning their recommendations need to be suitable for a client based on factors such as the client’s age, income, net worth and investment goals.
Now, it’s becoming clearer as to how the ground is shifting for retirement savers, thanks to the Department of Labor’s fiduciary rule, which is being phased in through January 2018.
Merrill Lynch, a division of Bank of America (BAC), became the first major brokerage firm to announce that it plans to stop offering IRAs that charge commissions to clients who rely on its brokers for advice. The change becomes effective April 10, 2017.
According to a statement, Merrill decided that the best way for it to provide retirement-related investment advice that meets the fiduciary standard is through its existing, fee-based investment advisory program, called Merrill Lynch One. Under the program, clients pay a fixed yearly fee that’s a percentage of their assets under management.
The move by Merrill, which has more than 14,000 financial advisers, could signal a sea change for the brokerage industry by pressuring competitors to follow suit. Wells Fargo (WFC), Morgan Stanley (MS) and other BofA peers are likely to do so, according to a report by Keefe Bruyette & Woods, an investment bank and broker-dealer specializing in the financial services sector.
“Since Merrill is one of the first firms to explain how it will structure its business under the rule, it puts down a marker. Other firms are going to see this and be forced to compete or lose business,” said Micah Hauptman, a financial services counsel at the nonprofit Consumer Federation of America.
“One of the huge benefits of the fiduciary rule,” he added “is that it promotes competition [within the brokerage industry]. When you promote competition based on the cost and quality of products and services being offered, that ultimately benefits investors.”
The fiduciary standard does allow brokerage firms providing retirement advice to continue to charge commissions and accept other common forms of compensation, such as revenue-sharing payments from mutual fund companies, tied to investment products.
But they need to contractually commit to putting their clients’ best interest first, charge only “reasonable compensation” and avoid misleading statements about fees and conflicts of interest.
Under the so-called best-interest contract exemption of the fiduciary rule, they also need to refrain from providing their advisers with financial incentives to act contrary to clients’ best interest and are required to clearly disclose advisers’ compensation arrangements.
Experts say BofA decided that the record-keeping requirements and litigation risks associated with using the exemption were too onerous in terms of offering new commission-based IRAs.
“We would expect other big wirehouses to go this way. There is a lot of litigation risk that could come as a result of not doing so,” said Brian Kleinhanzl, an analyst at Keefe Bruyette & Woods.
Commissions, he added, aren’t likely to go away entirely. If that were the case, commission-only brokerage firms would have to close up shop, noted Kleinhanzl.
“Every firm is going to approach how they comply with the fiduciary rule differently, based on what they have been doing and what’s easiest for them to do going forward,” explained Hauptman of the Consumer Federation of America.
“There is more work involved in complying with the best-interest contract exemption. It forces firms to wring out the really perverse compensation schemes they have created that make them a lot of money,” he added.
Merrill Lynch is offering several options to retirement savers. Those who don’t want to use its fee-based investment advisory platform can opt for self-directed brokerage accounts or the company’s soon-to-launch an online discount brokerage program, called Merrill Edge.
Clients with existing advised, brokerage IRAs can keep their accounts and will receive only those investment recommendations from Merrill that are in their best interest, according to the company.
The firm will use the best-interest contract exemption only for certain rollover recommendations that add assets to its fee-based investment advisory program, which Merrill has been seeking to expand in recent years. Such fee-based advisory services represent a more predictable stream of revenue than commission payments, which can be lumpy.
Critics of the fiduciary rule have argued that some investors, namely those who don’t trade very often, will end up paying more under fee-based advisory programs. Merrill has committed to keeping fees neutral for clients who have low-turnover brokerage IRAs and decide to transition to its investment advisory program.
Hauptman said some in the brokerage industry who opposed the fiduciary rule argued that investors would face higher costs under fee-based advisory models. He called the claims “scare tactics,” adding that “the really notable thing is that Merrill is making these changes without raising costs on investors.”
“There are conflicts inherent in every compensation model,” he said. “The fee-based advice in many ways has fewer conflicts.”