The Securities and Exchange Commission’s Regulation Best Interest will “force changes” in revenue sharing arrangements as brokers work to mitigate conflicts to comply with the rule, a new Morningstar paper asserts.
Reg BI “will both challenge and alter the industry in its fund-distribution practices,” the Morningstar authors write in their just-released paper, Regulation Best Interest Meets Opaque Practices.
Modern conflicts, Morningstar writes, “mostly involve revenue sharing — the practice of a fund sharing money back with broker-dealers under a variety of opaque arrangements.”
Because brokers now have an obligation to mitigate and disclose the kinds of conflicts that revenue sharing can create, “we expect certain kinds of arrangements to get increasing scrutiny as the regulation goes into force,” the Morningstar authors write.
The paper assets that because not all revenue-sharing payments create conflicts, Morningstar built a taxonomy of revenue-sharing payments from the least to most likely to create conflicts of interest: educational expenses; platform fees; data fees; select lists; and payments based on sales, assets or accounts.
“Critically, the degree to which any revenue-sharing arrangement creates a conflict depends on the magnitude of the payments and the degree to which the payments are directly tied to sales,” the paper states.
The authors recommend that policymakers as well as market participants use Morningstar’s taxonomy when evaluating revenue-sharing arrangements for the level of conflict they create.