November 8, 2016 / 6:30 PM / 3 years ago

Higher costs or lower revenue? Wealth firms split on fiduciary compliance

NEW YORK (Reuters) - Faced with implementing the U.S. Labor Department’s rule governing retirement accounts, Wall Street wealth managers must decide whether to forego revenue or spend more to comply, and the biggest players in the market are coming down on opposite sides.

In the works since 2011, the so-called fiduciary rule aims to eliminate conflicts of interest in the financial advice Americans receive on their retirement accounts by requiring firms to change how brokers get paid.

At issue is whether to maintain “transactional” accounts that charge clients a commission for every trade, rather than a flat fee based on assets. The new rule, which takes effect next April, makes it more difficult and expensive to put retirement assets into transactional accounts.

The goal was to eliminate the possibility that wealth managers could pad their commissions by making trades clients do not need.

Firms are therefore choosing whether to get rid of those accounts entirely, or spend the time and money required to prove the transactions are in the best interests of their clients. Two major players have already chosen their paths.

Bank of America Corp’s Merrill Lynch has begun cutting off parts of its business that butt up against the rule.

The bank’s third-quarter wealth management revenue fell 1.6 percent from last year partly because of a drop in commissions from brokerage accounts, Chief Financial Officer Paul Donofrio said last month.

Chief rival Morgan Stanley is making changes that will allow advisers to work within the rule’s confines by creating new contracts, re-training advisors and updating supervisory software.

It is adjusting operations in line with the best interest contract exemption, known in the industry as “the BIC exemption.”

The bank has not yet said how much compliance will cost, though it expects a “significant investment,” spokesman James Wiggins said.

“Merrill is taking the short-term hit now for the long-term pay off later,” said Paul Ellenbogen, Morningstar’s head of global regulatory solutions. “Morgan Stanley is buying time.”

Raymond James, Edward Jones and Ameriprise Financial Inc are aligned with Morgan Stanley’s strategy, while Commonwealth Financial shares BofA-Merrill’s.

Wealth businesses of Wells Fargo & Co and UBS Group AG have not yet announced changes specific to the fiduciary rule.

Combined with Morgan Stanley and Merrill, those top four firms, along with several private banks, manage three-quarters of all high net worth assets in the United States, according to analytics firm Cerulli Associates.


Broadly speaking, the fiduciary rule is expected to hurt profits in the short term, regardless of the strategy firms choose.

In interviews, seven analysts and industry consultants said there are good arguments for keeping or eliminating transactional accounts, and much depends on how a business is set up.

For instance, 10 percent of the $2 trillion in client assets BofA-Merrill manages are affected by the fiduciary rule, Donofrio said. Morgan Stanley has more to lose.Roughly 59 percent of its $2.1 trillion in client assets are in transactional accounts, although that includes accounts not affected by the fiduciary rule.

“The BIC route is more costly,” said Arjun Saxena, who works with wealth and asset management clients as a principal in PwC’s consulting business.

“It means incremental costs. But (these firms) are doing it because of what the revenue implications of not doing it would be.”

Even before the Labor Department handed down the fiduciary rule this year, transactional accounts had begun to fall out of favor.

The structure can encourage advisers to trade more to earn bigger commissions, whether or not the trades are necessary.

In extreme cases, some brokers have been known to “churn” accounts to juice profits.

Fee-based accounts, on the other hand, produce more income for a firm as clients’ assets grow, better aligning their interests.

The average adviser managed 40 percent of client assets in fee-based accounts last year, up from 26 percent in 2011, according to Toronto-based analytics firm PriceMetrix.

The fiduciary rule stands to accelerate that trend.


The fiduciary rule’s primary requirement is that financial advisors put clients’ best interests first.

If a brokerage maintains transactional accounts, it must explain the fee structure, and get clients to sign a contract confirming it is acting in their best interest, thus the “BIC exemption.”

Although transactional accounts have developed a bad rap, proponents argue that there are some investors who benefit from them.

A client with less money invested may pay less in a transaction-based account than a fee-based one. If that client were charged for advice, he or she would pay more than what one transaction fee would cost.

Still, it may be tough to explain changes to clients and to understand them as an adviser, said Danny Sarch, an industry recruiter.

He cited language in the rule that advises firms to charge a “reasonable” fee for clients at firms that use the BIC exemption.

“What the heck is reasonable?” Sarch said. “Reasonable is in the (mind) of the beholder.” Morgan Stanley has said it is keeping transactional accounts to give clients more options, and characterized the decision as an endorsement of its advisers’ professionalism.

Meanwhile, BofA-Merrill Lynch recently unveiled a new advertising campaign seizing on the awkwardness of discussing best-interest exemptions with clients, using the tagline: “We’re committed to your best interest. Not the status quo.”

Reporting By Elizabeth Dilts; Editing by David Gregorio

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