Morgan Stanley's decision to cut Vanguard funds likely due to DOL fiduciary rule

Because of the fiduciary rule, broker-dealers are looking to have level compensation across their platforms

May 8, 2017 @ 1:40 pm

By Bruce Kelly

+ Zoom
(Bloomberg)

Morgan Stanley's decision to eliminate new sales of Vanguard Group mutual funds appears to reduce a potential conflict under the Department of Labor's fiduciary rule.

Vanguard does not pay brokerage firms like Morgan Stanley for distribution, a practice that is commonly called paying for shelf space in the brokerage industry. Asset managers can pony up tens or hundreds of thousands of dollars to brokerage firms so their wholesalers can get in front of advisers. And that could have led to Morgan Stanley's decision to cut Vanguard funds, according to industry observers.

"It's possible Morgan Stanley did it because Vanguard is not paying for shelf space, but the company has to treat everyone the same now" because of the DOL's rule, said one Morgan Stanley adviser, who declined to be named and said he did not have any direct insight into the firm's thinking.

"Morgan Stanley is probably trying to get level compensation across the platform, and my guess is that Vanguard isn't going to pay anything to get on the platform," said Marcia Wagner, principal at The Wagner Law Group, who added that she had no direct knowledge of Morgan Stanley's reasoning.

Large brokerage firms like Morgan Stanley are in the process of "winnowing down the number of mutual funds, and that's directly related to the fiduciary rule," she said. Broker-dealers "have to prove funds satisfy that they are in the best interests of the client. And an infinite number of funds makes that an almost impossible task."

"It becomes a compliance nightmare," she said. "Payment for shelf space is going to be modified. This is what the industry is struggling with. How is distribution paid for and how is it paid for in a way to work with the fiduciary rule? This is just the tip of the iceberg."

When asked whether Vanguard's decision not to pay for distribution had an impact on Morgan Stanley's decision to stop selling Vanguard funds, firm spokeswoman Christine Jockle wrote in an email: "Having consistent economic arrangements with our asset management partners was one of the criteria used in evaluating funds along with performance and the scale of the funds in our system."

Industry website AdvisorHub last Wednesday first reported Morgan Stanley's decision to cut Vanguard funds from its wealth management platform.

Morgan Stanley in April announced a series of pricing, policy and product changes designed to further raise the standard of care for the firm's clients, Ms. Jockle said. The firm is going ahead with the changes regardless of the status of the DOL rule, which was supposed to take effect in April but has been delayed until June.

Morgan Stanley has reduced the number of mutual funds on its platform by 25% and currently offers more than 2,300 funds, she said. The funds the firm is closing to new sales, including Vanguard, represent less than 5% of the total mutual fund assets clients own, she added.

Vanguard ETFs remain available to Morgan Stanley clients. The firm halted new sales of Vanguard funds as of Monday. Clients who own Vanguard funds can add to their positions through the first quarter of next year.

Meanwhile, wirehouse competitors UBS Financial Services Inc. and Wells Fargo Advisors have no current plans to cut Vanguard mutual funds, according to industry sources.

However, Merrill Lynch over the past year — in a move similar to Morgan Stanley's — has culled the number of mutual funds from its wealth management platform, reducing the number of funds from 3,500 to 2,000.

Merrill does not allow new clients to buy Vanguard mutual funds, but if clients have existing positions in Vanguard funds, they can hold those funds and purchase more shares if the fund is covered by an analyst, according to a source.

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