AUGUST 11, 2017  |  ARTICLE  |  BY FUNDKEEPER TEAM  |

With an eye toward the DOL Fiduciary Rule enforcement date of January 1, 2018, many broker dealers are trying to determine how they will handle the “level compensation” requirement, which directs that advisors receive the same level of compensation across similar investment products regardless of the brand. Broker dealers must figure out which products to offer, the commission rates and how commissions will be processed and paid. Even if the DOL Fiduciary Rule is not enacted on January 1, many broker dealers—mindful of the increased scrutiny over commissions paid for recommending one product over another—are planning to make changes to their fund lineups.

As a result, the “clean” mutual fund shares concept has been gaining traction. “Clean shares” are distinguished from other mutual fund share classes as the fund charges fees only for the management and operation of the mutual fund. All other commonly baked-in fees are stripped out, including commissions and 12b-1 fees. With clean shares, the broker dealer determines and assesses the commission.

LPL has another approach, they recently announced the launch of a mutual-fund only platform that offers load-waived shares from 20 mutual fund companies and standardized mutual fund compensation to the advisor through a “uniform, upfront onboarding commission.[i]  For this article we refer to both approaches as “level compensation shares”.

With “level compensation shares”, financial advisors are free to focus solely on investor suitability without worrying about recommending a fund with higher commissions. The “level compensation share” approach also lets the broker dealer set its own commission rates for funds, achieving consistency across all brands on the platform. There is industry dialog regarding products and commission rates, but how to process “level compensation shares” has not been widely discussed.

The Reality: Most Broker Dealers Can’t Process Clean Shares or Commissions

By setting their own compensation rates, the commission work is shifted to the broker dealer. This poses challenges for broker dealers that are not self-clearing and have historically processed mutual-fund investor accounts directly with mutual fund companies. These broker dealers rely on the ability to “hand off” money to the fund company when they want to do a trade. But that’s not workable with “level compensation shares”. With these shares, the broker dealer or a third party needs to take in the trade payment, calculate and process commissions and remit the net to the fund company. Recognizing this, mutual fund companies who plan to offer clean shares, including American Funds, have stated in their prospectus that they will not allow clean shares to be purchased directly from the fund.

Supporting these accounts on a conventional brokerage platform is an option some broker dealers could explore, but for relatively simple, mutual-fund only investor accounts, this approach subjects the investor to additional complexity and potentially expensive brokerage fees. Given the DOL Fiduciary Rule’s objective of providing greater fee transparency, investors who are suddenly exposed to brokerage fee may not feel their best interests are being served.

Technology and New Alternatives

Meeting the dual needs of processing “level compensation shares” and assessing commissions internally will require many broker dealers to consider alternatives to their current business practices. Both calculating commissions on “level compensation shares” and supporting new share classes may be incompatible with current back office processes used by many broker dealers for mutual fund only investor accounts.

New options now exist. Envision Financial Systems’ FundKeeper platform, for example, allows “level compensation” shares to be processed through broker dealers’ existing systems. With FundKeeper, broker dealers can offer “level compensation shares” and have processing continue as though the fund were handling commission processing. FundKeeper houses the various share classes with broker dealer-directed commission rates, receives trade payment, and calculates and processes commissions. With new alternatives such as FundKeeper, supporting multiple classes is not an economic or operational burden.

While the success and ultimate uptake of “level compensation shares” is dependent on multiple factors, including mutual fund companies’ willingness to roll them out, the broker dealer community can rest assured knowing a solution exists for processing them.

[i] LPL Website, “LPL Financial Announces Details and Fund Companies For Its Industry-First Mutual Fund Only Platform” July 13, 2017