While the Labor Department has said it plans to propose a new, streamlined exemption as part of its revised fiduciary rule built around “recent innovations” in the financial services area, namely “clean shares,” Morningstar warns that Labor “must get the details around promoting and defining these shares.”

The development of clean shares — first came T shares (or “transactional” shares) and then share class Z, or “clean” shares — are in direct response to Labor’s fiduciary rule, Aron Szapiro, director of policy research at Morningstar, said on a recent webcast, but Labor “needs to understand this is a new idea, and we are still coming to a consensus on what clean shares mean.”

These “clean” share classes, Szapiro said, “have a different structure” than typical mutual fund share classes, and the innovation “won’t stop there. Broker-dealers will fine-tune the solutions.”

Regulators, Szapiro continued, “are really interested in clean shares, [and are] trying to figure out what they are and what they intend to solve.”

As he pointed out during the webcast, unlike other share classes, clean share “payments are direct — from investor to the provider of advice, rather than indirectly through the expense structure of the fund.”

He added in a recent blog post that “regulators generally agree that clean shares will not have front-end loads or 12b-1 fees, which are those used to pay for a mutual fund’s distribution costs.”

At the start of 2017, interest in clean shares surged as broker-dealers and advisors considered “offering a new share class that would have commissions that the broker could charge directly to the customer,” Szapiro wrote. Then on Jan. 11, the Securities and Exchange Commission opined that mutual funds could offer clean shares under an arcane part of the 1940 Investment Company Act, known as Section 22(d).

“This was just the beginning of a discussion that the industry — asset managers, broker-dealers, financial advisors and others — are now having about how to define clean shares,” Szapiro wrote.

Morningstar told Labor in a recent comment letter on the fiduciary rule that “if regulators assume that clean shares with [sub-transfer agent] fees and other kinds of revenue sharing are the same as the cleanest shares without them, they will be endorsing products that can have embedded conflicts of interest.” 

Labor, Szapiro said on the webcast, is asking “lots of questions” about clean shares, as “they want to leverage clean shares for an exemption” in the fiduciary rule. While professional staffers at Labor are inquisitive about the products, clean shares also “seem to be gaining traction with political appointees” at Labor as well, he said.

In its comment letter, Morningstar also told Labor that clean shares and T shares “could absolutely play a role in reducing conflicts of interest. The key for the department is ensuring that clean shares are properly defined so that they do not permit any inducements from asset managers to advisors or distributors to offer one product over another.”

Morningstar noted that clean share classes “should create a level playing field for asset managers, so that advisors evaluate a fund on its investment quality, its role in an investor’s portfolio, and its fit to the goals of the investor.”

The Chicago-based fund research firm also recently created an infographic to clear up the competing definitions of what “clean” really means that details what it says are “simple guidelines” for the cleanest share classes.

All of the Morningstar participants in the webcast agreed that in the next five years, 90% to 100% of asset managers will be using clean shares.

— Check out SEC Continues Crackdown on Mutual Fund Share Classes on ThinkAdvisor.