The DOL Fiduciary Rule and Its Impact on Mutual Funds

Broker Edward Jones made headlines last year with the announcement of the firm’s decision to stop offering mutual funds and ETFs in IRA’s and other retirement accounts that charge investors a commission. The firm said this move is needed in order to adhere to the compliance restrictions imposed by the new DOL Fiduciary Rule that saw it’s first implementation take place in June 2017.

According to The Wall Street Journal, Edward Jones was among the first of the major brokerage firms to lay out its plans for compliance with the new rules. LPL Financial announced shortly after that it would begin to standardize commission paid to brokers, eliminating the advantage of choosing one fund family or share class over another.

More announcements from other major players followed soon after even as uncertainty around the fiduciary rule continued. Here's how the rule impacts mutual funds and retirement savings. (For more, see: Making the New Fiduciary Rule Clear for Clients.)

One of the biggest tasks that all brokerage and advisory firms are going to face is the need to justify variable compensation under the new fiduciary rules. In the case of Edward Jones, the variable compensation can include front-loaded A shares, C shares with their level back-end loads, and differing prices for different fund share classes. One of the many requirements of the new rules is that brokers will have to justify the varying commissions of products they recommend versus other products that they could have recommended for a retirement saver.

Selling mutual funds with commissions or other forms of variable compensation will require advisors to provide clients with a Best Interest Contract Exemption (BICE) disclosure to sign. It is likely that many brokers and financial advisors will try to avoid this conversation and the questions the BICE form might raise with clients. This is most likely one of the motivating factors behind the decision that Edward Jones made.

According to The Wall Street Journal, in 2016 Edward Jones managed some four million retirement accounts. Undoubtedly, many are owned by smaller investors who make very few trades each year, and taking away the option of using mutual funds or ETFs drastically limits their options. These existing account holders can retain their current holdings via the grandfathering provision of the fiduciary rule. However, new purchases since the rule began to take effect on June 9, 2017 will fall under the new rules already being implemented by Edward Jones.

One alternative for clients is to move to a fee-based account that charges an AUM-based fee. For clients who trade infrequently, these accounts could drastically increase their investing cost. For brokers at firms like Edward Jones, these fee-based accounts can be a source of a nice payday for doing very little in the way of providing advice. Time will tell whether a majority of clients will opt for the fee-based account or choose to leave and invest elsewhere. (For more, see: How the New Fiduciary Rule Will Impact Investors.)

The Edward Jones announcement was a surprise to the mutual fund industry. Theirs and similar decisions being contemplated by other asset managers could force many fund firms to reevaluate their offerings. With the spotlight on fees and charges, the impact on high-cost, actively-managed funds could be significant. Will brokers and brokerage firms try to compete on expenses? Will they try to steer clients into fee-based accounts with low or no-load funds and make their money on the asset-based fees they charge their clients?

Mutual fund firms like the American Funds, Franklin Templeton and others who distribute their funds almost exclusively through financial advisors as intermediaries certainly took notice of the Edward Jones move, the leveling of broker compensation by LPL and other compliance changes that portfolio managers have been making. Last year, Charles Schwab brokers stopped selling mutual fund shares classes with sales loads. While this was a relatively small piece of Schwab’s business, it is one more example of the changes that have been accelerated by the new fiduciary rule.

Another article discussing this move in The Wall Street Journal indicated that there has been an exodus from funds with sales loads for a number of years now. “Investors pulled more than $500 billion from load share classes between 2010 and 2014, while plowing $1.34 trillion into no-load share classes, according to the Investment Company Institute, a mutual fund trade group," the article said. "Share classes with various types of loads represented about 20% of long-term mutual fund assets at the end of 2014, according to ICI, down from about 33% in 2005.” (For related reading, see: Fiduciary Rule Prompts New Tech Products.)

Beyond sales charges and commissions, the cost of mutual funds will continue to come under scrutiny as part of the broader industry shift towards transparency. This is already beginning to have an impact on mutual fund firms who rely on active management in their various offerings.

The DOL Fiduciary Rule is certainly a game-changer for financial advisors and brokerage firms, this was foreseen and is not surprising to anyone. But the wider impact is beginning to unfold and financial products like mutual funds that have been staples in the financial advisor toolkit are likely to see changes as well. (For more, see: The New Fiduciary Rule: Will Lawsuits Overturn It?)