November 2nd, 2016
New Labor Department rule is pushing brokers to decide whether to continue use of commissions
Commissions are at the center of a new brokerage battle.
Stockbrokers for years have been moving away from commissions—payments per trade—as a way to charge their customers. Instead, they have been pushing fee-based accounts, where they charge a percentage of assets regardless of the amounts of trading.
For investors who rarely traded, though, commissions remained the more cost-effective approach.
Now a new rule from the Labor Department concerning retirement accounts is pushing brokers to decide whether to continue, or nix, the use of commissions.
Known as the fiduciary rule, the policy is aimed at eliminating incentives that might cause brokers to give conflicted advice—an inherent problem with commission-based retirement accounts that can have varying sales costs depending on the types of investment products. But a move away from commission accounts could mean investors may now end up paying more in fee-based accounts.
So far, brokerages are breaking into two broad camps: those that plan to offer some level of commission-based options and those that would rather avoid the thorny issues of trying to make commission accounts comply with the new rule, which begins to take effect in April.
“There’s definitely going to be a percentage of people hurt by these conversions,” said Steven Dudash, head of Chicago-based IHT Wealth Management. “Old-school, traditional investors who have nothing but bonds because they want ultrasafe security [and] your buy-and-hold investors are going to get hurt if they go to more costly fee-based accounts.”
The new order is being illustrated by two Wall Street bellwethers that have taken opposing views on the best approach under the new rule, with Bank of America Corp.’s Merrill Lynch effectively eliminating commission-based individual retirement accounts and Morgan Stanley attempting to retain such accounts.
Moving an IRA to a fee-based structure from commissions could mean higher costs for some investors, especially those who trade stocks occasionally or have portfolios consisting mostly of bonds, experts say.
Fee-based IRA accounts are typically charged a fee of around 1% annually. So a theoretical $1 million fee-based account would cost about $10,000 a year, brokers say. That doesn’t include other fees, such as embedded costs in exchange-traded funds and mutual funds, although those expenses are typically small, says Matthew Papazian, a financial adviser with Denver-based Cardan Capital Partner.
The costs associated with a commission-based IRA can vary more broadly depending on the frequency of trading, the investment products purchased and the fees that come with them.
If that theoretical $1 million was in a commission-based IRA at a brokerage, and the client did about 10 stock trades over a year, the cost could be around $3,000 or less, according to brokers. Those fees would be pushed higher if the client bought other products, such as structured notes, which can carry upfront charges of 2%
But an investor who trades more frequently or buys higher-cost products would incur higher costs. If that same investor executed 30 significant trades of a specific stock in a year, their costs could be as much as $13,000.
For bondholders, the cost difference between a commission-based IRA and one that charges fees is even greater, says Mr. Dudash.
Moving clients to a fee-based structure is a simpler step toward complying with the rule, as well as part of a broader industry shift over the last decade, observers say. Brokers say those costs are justified because they have to provide a higher level of service by spending more time understanding a client’s full financial situation.
“Some brokerages are seeing [commissions] not being offered at all as a competitive advantage,” says Bharat Sawhney, a managing director focused on wealth and investment management at consulting firm Gartland & Mellina Group in New York. “There could be an asset play here where firms like Morgan Stanley choose to offer commissions as others pull away.”
However, brokerages will have to justify such conversions to avoid violating the rule. A broker who recommends a fee-based account to a commission-paying retirement saver who trades little or doesn’t need close monitoring would be an “abusive practice,” according to guidance released by the Labor Department on Thursday.
Retirement savers also have the option of moving their account away from full-service brokerages like Merrill and Morgan Stanley to self-directed IRAs or an automated robo adviser that relies on an algorithm to provide advice, both of which aren’t significantly affected by the Labor Department’s rule.
Those options, especially a self-directed account, would mean investors no longer have access to advice.
“Unfortunately some of the fallout on some investors will be choosing between no longer receiving advice or paying higher fees for it,” Mr. Dudash said.
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