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Brokerage Edward Jones appears to be throwing the baby out with the bathwater. The St. Louis-based financial firm is banning sales of all mutual funds and exchange-traded funds (ETFs) to a portion of its 4 million retirement customers.
Starting next April, investors with commission-based individual retirement accounts will be allowed to purchase only stocks, bonds, CDs and variable annuities. Edward Jones says the move away from funds and ETFs is to ensure the firm complies with a new Department of Labor rule—which goes into effect on April 10, 2017—that imposes a higher standard on the recommendations made by financial advisers and brokerages.
Proponents hope the rule will help retirement savers by discouraging firms from pushing high-cost investments that may not be as favorable for purchasers as for the firms and individuals that sell them. But in this case, Edward Jones is limiting access to products that have been central to many individuals' retirement savings. And the universe of funds and ETFs includes many offerings, including broad-based index-tracking portfolios, that offer easy diversification at very low cost.
The DOL rule requires advisers and firms to act as fiduciaries, or in other words, to put investors' needs above their own. The new rule allows the sale of commission-based products as long as firms follow several steps, including acknowledging their fiduciary responsibility, providing prudent and impartial advice, disclosing any conflicts of interest, and receiving no more than reasonable payment for their services.
Issues around potential conflicts and compensation are the sticking point for Edward Jones when it comes to certain products, including mutual funds, the company says. “Right now, because there is such pricing variability within and between mutual funds, it is difficult to align mutual funds with the requirements,” the firm said in a statement last week.
As the firm notes, commission charges vary not only among mutual funds but among what can be numerous "share classes" of a single fund. Indeed, a single fund can have a share class that builds in absolutely no compensation for sellers and another share class with an 8.5% upfront commission or "load."
It seems Edward Jones is concerned that the rule requires it to offer the cheapest mutual funds or ETFs available, says Marcia Wagner, an attorney specializing in ERISA and employee benefits. But she says,"that's incorrect. The rule's exemption clearly requires clients' best interest and reasonable compensation, both of which are entirely possible with the many available mutual funds and ETFs."
Instead of refusing to sell the products outright, Wagner says the firm should determine what funds and what fund families are appropriate. "There's good and bad in every products and they should be able to differentiate the wheat from the chaff," she says.
ETFs typically have no built-in commissions, and brokerages set their own transaction charges. Edward Jones declined to say why ETFs are problematic under the new rule.
Paul Ellenbogen, head of Global Regulatory Solutions for Morningstar, suspects the issue with ETFs may be more about profitability than compliance. “My understanding of the problem that broker dealers like Edward Jones had with ETFs is that they provide no way for a commission based adviser to get paid,” he says. “In that sense, I am not seeing where the conflict would come.”
By contrast, variable annuities (VAs) have been criticized as a product that is often oversold by brokers seeking commissions. Massachusetts senator Elizabeth Warren's 2015 investigation found that many companies offer a vast range of perks—from free trips to the Bahamas to diamond-encrusted ‘NFL Super Bowl Style' rings—to advisers to boost sales of annuity products. The Labor Department's rule allows firms to continue to sell VAs, as long as they follow the steps outlined to keep in line with clients' best interests.
To open a transaction-based IRAs at Edward Jones today, investors need to have $100,000 in retirement assets at the firm, or $10,000 if investing only in VAs. Existing customers will be able to continue buying mutual funds and ETFs in these accounts until April.
Customers wishing to purchase funds and ETFs after April in their IRA will have to transition to an advisory account, where the firm charges a flat management fee in addition to the costs of the underlying funds or products.
The financial-services industry has long argued that the new rules would limit choice and make it harder to serve clients—particularly those without millions of dollars to invest—in a cost-effective way.
Currently, there are three lawsuits filed in an attempt to derail the Labor Department’s rule. The most prominent, filed by the Chamber of Commerce and several industry trade groups, is scheduled for a hearing in mid-November in which the industry proponents will ask a judge for an injunction to block all implementation of the rule.
Meanwhile, investors should be mindful that firms like Edward Jones are moving forward to comply with the upcoming changes. And that could mean your options will become more limited.