Fees from custodians fail smell test

The practice of registered investment advisers’ collecting fees from custodians for recommending certain mutual funds to clients throws the raging fiduciary debate into a whole new light.

As reported in InvestmentNews, more RIAs are quietly accepting such payments of up to 0.2% of assets held in certain no-transaction-fee mutual funds. Charles Schwab & Co. Inc. and Fidelity Investments, the nation’s No. 1 and No. 3 custodians for advisers, respectively, are among the biggest payers. TD Ameritrade Institutional, the No. 2 custodian for advisers, does not pay such fees.

RIAs who hold themselves out as fee-only, conflict-free advisers and yet accept such fees ought to be called out for the practice so clients can determine on their own whether the advice from these agents is indeed fee-only and conflict-free. Can these advisers really be fiduciaries? At the very least, the practice fails the fiduciary smell test.

“AN ELEMENT OF BIAS’

An adviser could, certainly, in good faith determine for himself that even though he accepts these “small” fees, they do not sway him to recommend a fund from a custodian that pays them over one that doesn’t. After all, these are no-transaction-fee funds, so their cost is low. Aren’t they in the best interests of clients? In some cases, depending on the entire fund lineup, perhaps. But why raise a conflict of interest in the first place? We would question the veracity of that adviser’s point of view and whether it can really hold true.

“We think this is one of the most egregious [conflicts of interest] we’ve seen in recent years, and it seems to be more widely practiced,” Tom Nally, head of TD Ameritrade Institutional, told InvestmentNews recently. “It’s a problem. It adds an element of bias that most clients probably don’t understand.”

To be sure, firms disclose the practice fully, and some, like HighTower Advisors and Mariner Wealth Advisors, acknowledge that the payments create conflicts of interest. Kudos to HighTower, Mariner and other firms that “fess up, but the reality is that if such an admission is buried in a Securities and Exchange Commission filing or a 30-page investment brochure, chances are slim that clients will see it.

And that’s probably how the firms would like it.

Sure, RIAs taking these fees must report them. But where? Part 2 of their Form ADV. The next question would be: How many clients a) know where to look for the disclosure and b) know how to make sense of it in order to make an informed decision?

Mr. Nally said the trend may be driven at least in part by the increase in wirehouse breakaways who are used to receiving service fees on mutual funds. He added that the fees sounded to him like a commission, which is something that raises certain expectations in the minds of clients. Namely, if their adviser charges commissions, clients know there will be some level of bias in the recommended investments. No commission, no bias.

Ah, the c-word. We can hear the hackles rise already. “It’s not a commission!” “Do you even know what a commission is?!” “Commission? That’s insane!”

But if something smells like and looks like a commission, you can call it whatever you want, but it’s equivalent to a payment for sales of a product. And clients understand the word commission a whole lot better than “shareholder services fee,” which is how these payments are classified.

If anyone wonders why the financial advice industry has not risen to the level of a noble cause (as it surely could, considering the number of people who are unlikely to meet their financial goals but might if they had some solid guidance), blame practices like this.

SUBPAR PLANNING

A survey from Northwestern Mutual earlier this year found that while 58% of Americans think their financial planning is subpar, 34% haven’t done anything about it. In addition, 43% haven’t spoken to anyone about retirement planning, while 21% don’t even think they’ll be able to reach their financial goals.

That spells a lot of opportunity for advisers. Unfortunately, too many of them are too worried about their own compensation to truly put clients first.