Broker-dealers eye level commissions to reduce risk under DOL fiduciary rule

Broker-dealer executives are strongly considering a strategy whereby investment products with similar characteristics would have the same commission schedule as a way to reduce risk under a new Labor Department rule that raises investment advice standards in retirement accounts.
While the Department of Labor’s fiduciary rule allows brokerage firms and their advisers to receive forms of variable compensation, such as 12b-1 fees and commissions, some executives want to make commission payouts as similar as possible among like products to avoid the appearance of a conflict of interest when an adviser makes an investment recommendation.
Such a practice would be a departure from the way broker-dealers currently conduct business, whereby similar investment products could offer a fairly wide range of different commission payouts.
“The [DOL] rule allows for differential compensation. The more differential, the more your exposure,” according to an executive from a broker-dealer with several thousand advisers, who asked not to be identified because his firm hasn’t authorized him to speak publicly about such strategy deliberations. “There will be a strong desire, I believe, to try to levelize [commissions] as much as possible.”
The executive said his firm is “definitely considering” such an approach.
Will Fuller, president of annuity solutions at Lincoln National Corp., as well as two of the firm’s broker-dealers, Lincoln Financial Distributors and Lincoln Financial Network, announced Lincoln’s intent to go this route.
“Our approach is that we’re going to have standardized commission by each distinct product category,” Mr. Fuller said during an investor call last month. “For instance, take lifetime income. I think you’ll find the industry largely going in this direction.”
Mr. Fuller, through a spokeswoman, declined to outline the firm’s strategy in further detail.
Products such as variable and fixed-indexed annuities that would require use of the Best Interest Contract Exemption (BICE) to be sold in qualified retirement accounts would be the ones for which such levelization makes sense, broker-dealer executives said.
As an example of how such a strategy would work, let’s consider the scenario of all variable annuities with a seven-year surrender charge offered on a specific brokerage platform. The unidentified brokerage executive said his firm looked at the total compensation paid by such annuities (upfront and trailing commissions) over the seven-year surrender period, finding a range of gross commissions from 5.5% to 8%.

(More: The most up-to-date information on the DOL fiduciary rule)

The question under the DOL’s fiduciary rule becomes: If the annuity products are essentially the same, with the same commission schedule, how does a firm justify recommending a product paying 8% versus 5.5%?
“The logical conclusion is you eliminate that exposure by just saying all seven-year surrender charge variable annuities have to pay the same commission,” the executive said.
ValMark Securities Inc., an independent broker-dealer with approximately 400 advisers, is “definitely looking at” implementing such a strategy, according to Judson Forner, vice president of investment marketing.
However, such a strategy comes with inherent difficulties in terms of implementation. For one, insurance companies set commission schedules for their packaged products, not broker-dealers.
“Leveling commission amongst 10-20 carriers is like herding cats,” Mr. Forner said. “Each manufacturer prices their commission based on their own business practices but within a generally accepted range. This removes the range and creates a standard. So it’s not outlandish but it’s not as easy as it sounds.”
Because of their scale and the amount of product their brokers sell, the largest brokerages (the wirehouses, for example) could likely negotiate customized commission schedules with insurers that fit what each respectively deems to be reasonable compensation for specific product types, executives said.
Indeed, Wells Fargo Advisors, UBS and Ameriprise Financial Inc. have begun discussions with insurance companies to inquire about tweaking commission charges, Mr. Forner said, citing conversations with employees of those firms with knowledge of such activity. Spokespeople for those firms weren’t able to provide comment by press time.
Small firms, however, will likely not share that luxury.
“We’ll be more at the mercy of we’re offered [by insurers],” said Bob McCommon, senior vice president and director of annuities at Wunderlich Securities, Inc., which has around 225 advisers.
In that scenario, broker-dealers would have to look for products comparable to what is needed and offer something as close as possible, Mr. Forner said.
Further, unique or “one off” annuity structures may not fit with what a broker-dealer ultimately deems to be its accepted compensation model for certain products, so they would have to figure out if such products could be offered at all, Mr. Forner said.
Ultimately, control of the commission schedule will need to move away from the product manufacturers and through the distributors to make for a more manageable process, the unidentified executive said.
“To me, it’s the only long term solution to this thing,” he said.
Firms could adopt advisory, or fee-based products, or push insurers to allow brokers to set the commission schedule on brokerage-based products, as they do on individual stock and bond transactions currently, he added.
Indeed, even though plans haven’t been finalized, Mr. McCommon said his firm is “ready to pivot” to fee-based annuities to bypass the level-commission issue.