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Critic calls 'laughable' FSI study that shows only 14% of advisors want DOL rule to stay

The lobby group that sued to stop the DOL rule surveyed 1,300 member stockbrokers -- of whom 71% voted for Donald Trump

Author Irwin Stein December 1, 2016 at 8:43 PM
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Chris Paulitz warned of “untold liability exposure and class action lawsuits"

RIA Compliance




Ron A. Rhoades

Ron A. Rhoades

December 1, 2016 — 9:37 PM
I've heard this argument that small clients can't be served by advisors under a fee-based system so often, yet it is just not true. First, there are many fee-only advisers, as well as robo-advisor platforms, that offer low-monthly-subscription-fee or low-AUM fees or flat fees or hourly fees for advisory services. In fact, after the DOL rule was finalized, a couple of dual registrant firms announced the LOWERING of their minimums, in connection with fee-based accounts, in order to serve small clients. Many, many advisors currently work under a fee-only platform, and many (if not most) of them serve small clients. And most of them are actually trained to provide both financial and investment advice (not just sell products). Consumers should just look for advisors by visiting the web sites of Garrett Planning Network (<a href="http://www.GarrettPlanningNetwork.com" rel="nofollow">www.GarrettPlanningNetwork.com</a>), XY Planning Network (<a href="http://www.XYPlanningNetwork.com" rel="nofollow">www.XYPlanningNetwork.com</a>) and many members of the National Association of Personal Financial Advisors (<a href="http://www.NAPFA.org" rel="nofollow">www.NAPFA.org</a>) and the Alliance of Comprehensive Planners (<a href="http://www.acplanners.org" rel="nofollow">www.acplanners.org</a>). [Disclosure: I have served as a consultant to Garrett Planning Network in terms of providing educational content to them, and I am a member of NAPFA.] Second, being sold a product on commission is not "cheaper" - as FSI and SIFMA often like to say. Most brokers go out of their way to ensure that their commissions are not cut via breakpoint discounts, by spreading client funds over several fund families. (I've seen this again, and again, and again). So, let's examine the typical fees paid by clients sold Class A mutual fund shares: 1) 5.75% sales load. What is the impact of this? Assuming a 10% level annual rate of return for a stock fund, the fund must secure a 1.20% greater annualized return for the fund to "break-even" with a no-load fund, over a 5-year time horizon. If the fund were held for 10 years, the greater return required is 0.59%. If the fund were held for 15 years, then the break-even is 0.43%. But, here's the catch - the average stock fund is held for 4 years, and the average bond fund is held for 3 years, according to the ICI. 2) Class A shares also typically possess a 12b-1 "marketing fee" (80% of these collected fees are passed on to brokerage firms, on average). This fee is typically 0.25% a year. 3) Funds sold through the broker-dealer channel typically have fairly high commission structures, due to excessive trading of securities within the fund, using full-service brokers as the chosen brokers for such trades, and payment of soft dollars. While the impact may only be a few basis points, or in excess of 50 basis points (or even much more), the fees add up! Add in bid-ask spreads, which in turn fuel back to the brokerage firms payment for order flow, and even more costs are extracted from investors. 4) The funds sold by broker-dealer firms usually have higher management fees. In turn, these higher management fees often are used, in part, for revenue sharing payments, such as "payment for shelf space." 5) The funds sold by broker-dealer firms are often tax-inefficient. Not enough brokers structure portfolios tax-efficiently, nor do they utilize tax-efficient stock mutual funds. This results in a substantial tax drag on investment returns that often could be avoided, or at least minimized. I would also opine that payment of commissions on mutual funds is counter to Modern Portfolio Theory, in particular a strategic or tactical asset allocation methodology and rebalancing. Unless the fund is a target date fund (or similar fund) (which may have even higher costs, or may not be tax-efficient if the client has accounts with different tax characteristics), then rebalancing of the portfolio should be undertaken. Of course, this leads to more commissions. IN ESSENCE, COMMISSION-BASED MUTUAL FUNDS ARE CONTRARY TO THE SOUND MANAGEMENT OF AN INVESTMENT PORTFOLIO. In essence, the "suitability standard" that governs broker-dealers and their registered representatives (in most instances) imposes no substantial duty of due care upon the firm or its advisers. Not required to possess expertise in investment portfolio design, nor in investment product selection. No fiduciary duty of loyalty. Hence, no duty to truly evaluate and select the BEST mutual funds or other investment securities for the client. In essence, part of a product distribution network, purposely designed to obscure the many, many fees and costs investors are incurring. Additionally, for the 1% (or higher, or much lower) annual AUM fee charged by some fee-only advisors (which FSI and SIFMA tout as "too expensive" for small investors), nearly always substantial additional financial planning services are provided, fiduciary responsibility is assumed, and an ongoing duty to monitor the portfolio exists. It's just not an apples-to-apples comparison, to begin with. In essence, small clients get FAR MORE SERVICE and BETTER ADVICE from fee-only, fiduciary advisers, than they do from the vast majority of stockbrokers (i.e., registered representatives of broker-dealer firms). Lastly, to avoid breakpoint discounts many advisors have turned to the use of variable annuities. Yet, many broker-sold annuities have total annual fees and costs of 3%, 4% or higher. While "guarantees" exist - such as the death benefit guarantee, and possible lifetime withdrawal guarantees - the costs of these guarantees, the restrictions imposed when they are chosen, and the relatively low annuitization rates (upon annuitization, which is necessary to secure various lifetime withdrawal benefit guarantees) - all combine to negate the attractiveness of these guarantees. In essence, such guarantees fail any reasonable cost-benefit analysis, from the perspective of the investor (or the fiduciary advisor of the investor). Economic incentives matter. Remove the incentives to recommend high-cost products that pay the firm or its representatives more, and the client - including the small client - receives much better investment recommendations, for often far less total fees and costs. And the all-so-important financial planning advice is also included, as part of the lower fees paid. One could argue that a client who desires municipal bonds would be better served in a commission-based environment. But that ignores the present reality that municipal bonds require ongoing monitoring of the issuer in most instances. Also, a true fiduciary firm would seek to aggregate bond purchases for its many clients, in order to secure substantially less principal mark-ups. All fiduciary advisors need to push back against FSI and SIFMA's false statements. All fiduciary advisors need to let their U.S. Senators and U.S. Congressmen know that FSI and SIFMA are not trying to stick up for small investors, but rather stick it to them.
Jeffrey McClure

Jeffrey McClure

December 1, 2016 — 11:40 PM
Ron is right; if a bit long-winded. The FSI is an "industry" organization. The Financial Planning Coalition supports the DOL rule, and that coalition includes the CFP Board and the Financial Planning Association, both of which have a substantial and probably majority membership of broker/dealer licensed representatives. Congress passed and the President signed into law the Pension Protection Act of 2006, mandating that IRAs be brought under ERISA rules. Unless that law is repealed we will eventually have a "DOL Rule" just as we have ERISA rules today covering employer-sponsored retirement plans. Treating an IRA beneficiary in that beneificiary's best interest is not a huge hurdle. Yes, it will mean that the high-commission, high-cost products will no longer be allowed, but isn't that what "financial advisers" have been claiming all along?
Brett Walker

Brett Walker

December 2, 2016 — 12:49 AM
In Australia a fiduciary obligation was legislated in 2013 that affects ALL financial advisers. At the same time various means of remuneration were deemed "conflicted". Importantly the conflict can be resolved by obtaining express client consent. This represents a common sense solution to some of the obvious problems. The DOL approach looks much more complex than that and I get the impression it will apply in fewer advisory situations. But all that said, it's not impossible to impose a fiduciary duty through the Courts - is it?
Jeffrey McClure

Jeffrey McClure

December 2, 2016 — 1:19 AM
Brett, because of the existing legal structure built on the Securities Act of 1933, existing law and precedent assumes a caveat emptor relationship between a purveyor of securities and a customer. Both the United Kindom and Austrailia have adopted a new basic legal structure regulating the relationship between those who sell or advise on the purchase of securities and members of the public. In the United States, an "investment adviser" is mandated by law to act as a fiduciary, while a "financial advisor" has a legal role as a caveat emptor sales person, and is only restricted from selling "unsuitable" investment products. I agree with you that the United Kingdom and Austrailia's laws are far more appropriate and have, in effect, created a profession where previously there was only a trade. I wish we had such laws in the United States as they are fair, simple, and provide a clear distinction as to the level of expertise and impartiality a given securities person must have.
Brett Walker

Brett Walker

December 2, 2016 — 1:24 AM
Jeffrey, thank you for that succinct explanation. Been scratching my head about this for a while.
Stephen Winks

Stephen Winks

December 2, 2016 — 4:34 PM
How can the FSI which supports RIAs be opposed to fiduciary duty? It either supports independent RIAs or it doesn't. The point of differentiation is it supports transactions not advisory services which is the antithesis of fiduciary duty entailing no ongoing responsibility for recommendations as required by statute. SCW

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