Merrill Unveils Reg BI Policy Changes, Including “C” Share Sale Restrictions
Merrill Lynch on Thursday announced wide-ranging policies to help it comply with the new Regulation Best Interest effective in June, including halving the length of time in which advisors can collect commissions on high-paying “C” class shares of mutual funds.
The changes are effective as of the June 30 implementation of Reg BI, which the Securities and Exchange Commission said will not be delayed by the coronavirus crisis.
The regulation requires firms to adopt a series of disclosure, care and conflict-of-interest mitigation behaviors to ensure that brokers do not put their interests ahead of the interests of their customers when making recommendations in commission accounts.
All firms have to comply with Reg BI, which some states and fee-based financial planners are seeking to overturn or replace with stronger customer-protection rules. But Merrill’s announcement may evoke its industry-first role three years ago in banning commission-based retirement accounts in anticipation of the DOL’s fiduciary, a decision reversed when a court overturned the rule in 2018, said some brokers and competitors who spoke on condition of anonymity.
“The changes we’re making are focused on preserving client choice and access to brokerage, further mitigating or eliminating the potential for conflicts of interest in the brokerage space, enhancing client experiences and transparency, and continuing to demonstrate our commitment to putting their interests first,” Merrill said in a prepared statement.
Many of the new policies revolve around mutual fund sales compensation.
The period in which investors will be able to hold C shares that pay brokers annual commissions of about 1% of assets will shrink to five years from ten. (Morgan Stanley last year shrunk the time in which C shares can be held by clients to six years from 10 before they automatically convert to A shares.) Commissions fund companies pay on front-loaded “A” shares are generally 0.25%, and the load will not be charged to customers on converted funds.
Merrill Lynch designed compliance alerts for its managed advisory accounts two years ago that will be used to ensure that its more than 14,000 brokers do not game the new restriction by recommending purchases of new C shares as the old ones reach conversion dates, the company said.
Since some fund companies pay higher upfront commissions than others for similar investment styles, Merrill also is setting net advisor compensation caps for each fund based on its style category, the officials said.
As part of its product review in anticipation of Reg BI, Merrill will eliminate about 2% of some 1,800 funds it offers because of expenses or payments exceeding norms, the company said, though it noted that lower costs do not always translate to the most appropriate investment choice. The impacted funds range across all fund styles, the company said.
In another change, brokers will have to collect attestations from customers who buy market-linked investments that they are “accredited investors,” a regulatory definition requiring net worth of at least $1 million and income minimums. The investors must agree to e-delivery of prospectuses and other documents because many of the investments are time-sensitive new issues.
Regulators say market-linked products are often misunderstood by investors, but Merrill said most customers buying the investments already qualify for the accredited designation. It also had restricted sales of the instruments in retirement accounts when it was preparing for the now-defunct fiduciary rule.
Like other firms, Merrill is intensifying its push to have brokers copiously document conversations with customers and disclose potential conflicts of interests to satisfy examiners following up on Reg BI’s disclosure obligations. The firm is initiating training modules and educational efforts for all advisors, and will prompt them through workstation alerts when orders are entered to discuss alternative investments that may be more favorable to customers.
Reg BI also requires brokers to send a Customer Relationship Summary outlining their roles, scope of services, disciplinary history and billing practices to current retail brokerage customers within a month of the June 30 implementation date. Merrill is supplementing the four-page document with another more detailed one of about 15 pages to improve transparency, the company said.
Other firms have made changes piecemeal in their Reg BI preparations. UBS last year introduced a single-share class category for some fund sales in brokerage accounts. Wells Fargo Advisors is “finalizing plans” for Reg BI implementation, a spokeswoman said, but is well-positioned because of preparations it made for the DOL rule.
Reg BI does not apply to advisory accounts that charge clients asset-based fees rather than commissions. Merrill and many of its competitors prefer advisory accounts because they generate revenue regardless of whether customers make transactions and eliminate the temptation to churn accounts with needless trades.
Brokerage firm executives have said they expect the new restrictions to encourage brokers to try to convert more customer assets to fee-based accounts, a sentiment expressed before the S&P 500 plunged 20% in the first quarter as the coronavirus economy took hold.
More than 80% of Merrill clients have advisory accounts, the company said, though many also have brokerage accounts. In a first-quarter earnings filing on Wednesday, Bank of America said $1.16 trillion of client assets in its global wealth division were held in brokerage accounts as of March 31, and $1.09 trillion were in advisory accounts.
In addition to the litigation challenging the SEC for allegedly diluting congressional orders under Dodd-Frank to impose a uniform fiduciary standard on broker conduct, Merrill and its rivals are holding their breath over higher conduct bars that have been passed or proposed in Nevada, New Jersey, Massachusetts and some other states.
Officials at Merrill and Morgan Stanley have said they are closely monitoring the changes, which could require them to have different customer care standards in different branches. Morgan Stanley has in the past threatened to pull out of some states if the standard proves too restrictive, while Merrill said it may make additional changes to its standard where necessary.
Critics of the SEC’s new regulation have said that it largely reflects the brokerage industry’s success in convincing the regulator to pull back from imposing on sales-reliant brokers a fiduciary standard that registered investment advisers who provide only advice must provide.
“The SEC’s decision to proceed with Regulation Best Interest’s implementation despite the pandemic implicitly concedes that Regulation Best Interest does not require any significant departure from business-as-usual at brokerage firms,” Benjamin Edwards, a law professor at the University of Nevada, wrote in the introduction to a new study from the Institute for the Fiduciary Standard.”Brokers can continue to pitch marginally suitable, higher-commission products as they usually do, only with the added benefit of being able to pretend that they act in your best interest.”