Prior to the Department of Labor’s 2015 fiduciary rule proposal, funds paying higher loads to brokers tended to attract more assets. But a new report by Morningstar found a statistically significant shift away from load sharing, with a notable reversal in flows to those type of funds after the DOL fiduciary rule was proposed.
Before the proposal, a 100-basis-point increase in excess loads to unaffiliated brokers resulted in a 0.28 percent increase in monthly flows to that fund, Morningstar says. After the rule proposal came out in 2015, the researchers found no relationship between high loads and fund flows.
“There was already a shift in place that’s been going on for many years—diminished importance for load sharing arrangements where broker/dealers and all kinds of advisors are moving toward a best interest model,” said Aron Szapiro, Morningstar’s director of policy research. “But I think it shows that the regulation kicked the improvements into high gear.”
Although the rule never went into effect, firms and brokers prepared for it, Szapiro said, restructuring their business to make recommendations that are the best for clients.
“We know that all of these advisory firms, broker/dealers—they were developing policies and procedures to comply with the rule, and if they did, they were scrutinizing their business relationships, how they generated recommendations and where the conflicts of interest might be.”
Morningstar’s report builds off of a similar study by the DOL, which indicated that load sharing caused harm to investors. But that study only analyzed data through 2009. Morningstar set out to look at more recent data to see if the rule proposal had any effect on the sales of load funds.
“DOL comes along, pours fuel into rocket ship and gives it enough power to reach exit velocity and completely change business models,” Szapiro said. “And now the question is, will the SEC keep this rocket in orbit?”
He’s referring to the Securities and Exchange Commission’s Regulation Best Interest, a rule package that would set a broker advice standard, institute a mandatory disclosure document summarizing investment advisors’ and brokers’ relationships with clients, and offer an official interpretation of the standard of conduct for investment advisors.
The trend is already in place, thanks to the DOL; the SEC just has to sustain the momentum, he said. And the way the SEC rule is currently written, it’s broad enough that that momentum would depend on how it’s enforced and how seriously financial institutions take the rule, Szapiro said.
“By making a few adjustments, we would feel much more certain that it would sustain this momentum,” he said.
Morningstar submitted a comment letter to the SEC this summer, outlining its recommendations for making the standard better. For instance, its advocates for clear standards for what constitutes best interest for rollovers. It also calls for more data to be collected on revenue-sharing arrangements. While load sharing has been declining, the company believes revenue sharing has been increasing. This conflict is more likely to be levelized and, perhaps, easier to mitigate. But we need more data on it, Szapiro says.
“[The SEC is] not in the position where they have to create a sea change in business practices, because all the press for the DOL rule already did that,” he said.