Independent researchers seen easing DOL fiduciary burden for brokers

Big brokerage firms on Wall Street are shining a light on how broker-dealers may manage their duties under the Labor Department’s new fiduciary rule before it takes effect next year.

UBS Group AG’s wealth management group for the Americas announced in 2015 that Mercer would give it access to 9,000 asset-manager research opinions, a move that helps UBS screen which funds it makes available to its high-net-worth clients. And in May, Bank of America Merrill Lynch expanded its relationship with Morningstar Inc., which will provide due diligence on about 1,000 mutual funds on its platform by the end of 2017.

While the wirehouses say the decisions weren’t prompted by the DOL rule, outside research firms do provide varying levels of support to broker-dealers that will need to demonstrate to regulators that they’re putting clients’ interests ahead of their own when making recommendations for their retirement accounts. Research firms’ services may play an increasingly important role in helping financial firms examine their revenue mix and fund selection.

“Brokers use them to keep tabs on their clients’ portfolios,” said Alma Angotti, a managing director in the global investigations and compliance group at Navigant Consulting Inc. “It can be evidence for them” in litigation with investors, she said.

(More: Fiduciary Focus: The DOL rule from all angles)

Morningstar is speaking more frequently with broker-dealers about its fund research, as well as the role it can play in deciding which ones to cut from firms’ lineups or in suggesting asset allocation strategies, according to Jeff Schwantz, head of adviser and wealth management solutions at the company.

He said having proper processes and procedures in place can help mitigate litigation risk tied to the fiduciary rule, which advisers must begin implementing by April. Full compliance is required by January 2018.

“Firms have to be more precise in determining, demonstrating and documenting why they’re doing what they’re doing,” Mr. Schwantz said. “Our client engagement has been brisk.”

While UBS Wealth Management Americas’ decision last year to hire Mercer wasn’t made in anticipation of the DOL’s rule, it works well in the new regulatory environment, according to Jeff Miller, head of advice and platforms for the UBS unit. He said he wouldn’t be surprised to see more brokerage firms follow suit as having an independent partner can put them in “a good position” to more tightly manage their fiduciary responsibilities.

UBS saw Mercer’s comprehensive research and performance data on mutual funds and separately managed accounts helping its clients and financial advisers “to stay ahead of the rapidly growing and more complex investment environment,” Mr. Miller said.

As part of its current review, Bank of America Merrill Lynch expects to reduce total assets in its 3,500 mutual funds by as much as 5% as it works with Morningstar to determine which ones should be dropped, according to Matthew Card, a spokesman for the bank.

He said that the expanded research coverage from Morningstar wasn’t specifically prompted by the DOL rule and that the brokerage firm’s own team of due diligence analysts will continue to cover mutual funds with the most assets and interest from its advisers.

Bank of America expects the ongoing examination of its lineup to narrow the total number of mutual funds on its wealth management platform by about a third. “We believe this effort will help maintain an industry-leading standard of care for our clients, reduce risk in portfolios and improve investment outcomes,” Mr. Card said.

The Labor Department’s new regulation puts pressure on broker-dealers to ensure that investors aren’t being overcharged for investments in retirement accounts and that the products they’re being sold are on the higher end of performance benchmarks, according to David Doyle, a Parsippany, N.J.-based partner with law firm Day Pitney.

“To the extent they give advice, they don’t have to be soothsayers or have a crystal ball about the way an investment will perform in the future,” Mr. Doyle said. But “if they gave advice, the process by which they arrived at that is really important.”

Wilshire Associates is among the third-party research firms stepping up conversations with broker-dealers that are exploring ways to ensure compliance demands tied to the DOL fiduciary rule are properly met.

Some firms are concerned that using the rule’s best-interest contact exemption for investment products that charge a commission creates a potential basis for litigation by individual retirement account holders, said Jason Schwarz, president of Wilshire Funds Management.

The best-interest contract exemption, sometimes referred to as BICE, allows brokers to sell commission-based products without triggering penalties. But there’s concern that advisers who enter the contract must be able to prove they’re acting in the best interests of their clients.

“Outsourced investment due diligence services can be used to establish a clear record of investment monitoring, helping to provide a record of compliance with applicable BICE requirements,” Mr. Schwarz said. He said he’s seeing increased interest from brokerage firms, including the wirehouses, for services related to the DOL’s rule.

Day Pitney’s Mr. Doyle agrees that there’s a lot of DOL-related concern among broker-dealers and says using more independent research is one way to deal with potential challenges from investors claiming they were wronged.

“If the broker-dealer later gets sued for providing imprudent or biased advice,” he said, “I think one of their defenses, or stories that they tell, is that they followed the reasonable and prudent expert standard of care.”