New point-of-sale fee disclosure rules under the ERISA Section 408(b)(2), set to take place this summer, are making it more difficult for wirehouses to raise the fees they charge investors. Their solution? Raise the fees (or at least their “cut”) on the mutual fund companies with which they do business.
Wirehouses typically charge for the privilege of investing their clients’ money as part of a revenue sharing agreement with mutual fund companies; usually a percentage of every dollar invested by a wirehouse client in the fund. The arrangement, while perfectly legal, is akin to gaining “shelf space” in a supermarket grocery store.
As The Wall Street Journal notes, starting Jan. 1, UBS (UBS) “roughly doubled the rate it asks mutual funds to pay, seeking as much as $15 for every new $10,000 invested by a UBS client and up to $20 a year going forward. Morgan Stanley Smith Barney (MS) also recently raised its rates to $16 a year, from the $13 it previously charged for stock funds and the $10 it charged for bond funds.”
For advisors and clients who believe wirehouses have an inherent conflict of interest due to such arrangements, news of the fee increases will do little to assuage their suspicion. Whether or not the fee increases will eventually be passed along to investors is also an area of concern.
Wirehouses counter that that since the payments go to brokerages rather than to individual financial advisers—who receive separate payment streams—they don't affect advisers' judgment in picking funds, according to the paper.
"I don't think the fees will be passed along to the end investor, only because the wirehouses are commanding a higher price for more flows, which the fund companies want," Alois Pirker, research director at Aite Group, told AdvisorOne. "ETFs and other areas have been taking flows away from the mutual fund space; it hasn't been quite what it once was for mutual funds and now wirehouses are in a position to better negotiate."
With so much profitability and margin pressure recently, and large wirehouses only getting larger through consolidation, the economies of scale they've acheived affords them the "power" position in which the now find themselves, he added.
The Journal notes that some mutual fund companies, like Vanguard Group and Dodge & Cox, say they don't make these types of payments at all. But for wirehouses and hybrid firms like Edward Jones the fees have a heavy impact on their bottom line. Edward Jones says 2011 payments made up nearly a third of its $481.8 million profit.
“In general, legal experts say, brokerage firms can inoculate themselves against legal problems by disclosing revenue-sharing agreements, typically in the fine print on their websites," the Journal reported. "But as of Monday, the UBS website still included links leading to client disclosures citing the older, lower rates. The company says it updates some materials only periodically.”
Similar disclosures on Morgan Stanley's website changed to reflect newer, higher rates following the paper’s questions about them.