October 31, 2016
A Tale of Two Cities
In the wake of the Department of Labor’s Uniform Fiduciary Standard, many investment companies are
doing their best to adopt the spirit of the law scrambling to comply with the bare minimum. As teams of incredibly intelligent, highly trained legal professionals pour over the new requirements and compare it to what they actually do there will undoubtedly be numerous phone calls to colleagues at other firms across the country that sound like this:
Lawyer A: “What do you think this means?”
Lawyer B: “I don’t know, what do you think it means?”
Lawyer A:”Well, how do we comply given that this is basically the opposite of our business model?”
Lawyer B: “We’re going to do X.”
Lawyer A: “Huh, well, we’re planning on doing the opposite of X.”
Remember, this document tells them how to act in their clients’ best interest. It’s not written in Sanskrit, it’s not a recipe for Molten Lava Cake (surprisingly hard to make), it’s a document that tells them how to give financial advice that is in the best interest of their clients!
Anyway, this will result in weird outcomes. Obviously. One such weird outcome is intersecting at Merrill Lynch and Morgan Stanley.
Merrill Lynch has decided that after April 10th, when the rules take effect, they will no longer offer commission based retirement accounts. All new retirement accounts will be opened under a flat fee for service model, based on the percentage of assets under management. Let’s really unpack that.
One, when the rule starts. Not immediately, not as soon as possible, but when they have to. I guess you could make the argument that they need time to change internal procedures or something but they don’t, not really. They already offer fee based accounts. They just have to start to only offer fee based accounts. (Full disclosure, Gainplan only offers fee based accounts. This isn’t about which is better, fees or commissions, it’s about the difference between the letter and the spirit of the fiduciary standard). They could do that tomorrow.
Number two, they will no longer offer commission based retirement accounts. You can still get a commission based brokerage account! With the fiduciary standard there are more and stiffer penalties for brokers that charge excessive commissions in a retirement account. This is a silent acknowledgement from Merrill that their brokers charge excessive commissions and they don’t want to get in trouble. If they believed asset fees were the appropriate investment vehicle for clients they would only offer that.
Number three, this only impacts new accounts. If you are paying commissions in your retirement account already, you are good. This one I can actually get behind. With these types of accounts the client likely paid a larger commission when they originally invested in the market and are possibly receiving a lower commission now. Taking them out of this account could result in losing that discount. Wait, never mind, Merrill Lynch could just keep giving that discount! A major issue with this type of account is called churning, whereby a broker constantly changes securities to generate additional commissions. Why not move this accounts to a fee based model to prevent churning and just let the clients keep the discounts they may be receiving?
The spirit of the fiduciary rule is to eliminate conflicts of interest (like big commissions) from financial advice. The letter of the law focuses on conflicts in retirement accounts. If there is a rule that says you have to act in your clients’ best interest, and your firm makes a minor, arbitrary change, it means they have no intention of acting in your best interest. Ever.
Elsewhere, Morgan Stanley, who has committed themselves to being an early adopter of the fiduciary standard has stated that they will continue to offer commission based retirement accounts.
“Morgan Stanley, one of the country’s largest wealth-management firms, said Wednesday that it will allow its nearly 16,000 brokers to continue offering individual retirement accounts that charge investors per-transaction commissions rather than fees as a percentage of an investor’s assets. The approach could mean lower costs for clients that don’t do much trading and could help Morgan Stanley retain and poach advisers who rely on commission-based business.”
To illustrate let’s break these clients into three groups:
- 1) Commission based clients that don’t make a lot of trades
- 2) Commissioned based clients that do make a lot of trades
- 3) Fee based clients that pay based on how much money is invested
Revenue from group three is fairly consistent and there are no incentives to trade the accounts excessively. The extra commissions from group two subsidize the clients in group one and it’s sort of a wash. Unless you’re not acting as a fiduciary. Then group two makes you a ton of money.
If, in the face of increased regulation and fines, you eliminate group two, it gets harder to keep group one around so everyone just sort of gets piled into group three. This kind of stinks for group one, who was probably paying less than everyone else.
While Gainplan only offers fee based accounts, I am in support of Morgan Stanley here. What Gainplan does with investment management can’t be part of my consideration. We don’t trade like other firms. When we talk about this it starts with Gainplan vs. Everyone Else. I believe that we are the better choice. In this instance I am talking about Morgan Stanley vs Merrill Lynch. Merrill Lynch HAS to eliminate commissioned retirement accounts because they know they are charging excessive commissions and they don’t want to change their culture. Morgan Stanley is saying, “Hey we know group one would pay more if we moved them to group three and that’s not in the spirit of being a fiduciary. As a firm we just need to make sure the people in group two aren’t being mistreated. This means we will need to work hard and spend some extra money to make sure our brokers are acting in peoples’ best interest and disclosing conflicts of interest.”
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