Morgan Stanley Sets Off a Fight Over the Cost of Your Retirement Account
November 1, 2016 by Michael Wursthorn
Morgan Stanley will let its customers keep paying for retirement advice with commissions, setting up a split in how the brokerage industry interprets new federal regulations governing $3 trillion in assets.
A Labor Department rule taking effect in April requires investment advisers to act in the best interests of their clients when it comes to retirement accounts. But that straightforward directive has complicated implications for how clients pay for services and how brokers are compensated.
Morgan Stanley, one of the country’s largest wealth-management firms, said Wednesday that it will allow its nearly 16,000 brokers to continue offering individual retirement accounts that charge investors per-transaction commissions rather than fees as a percentage of an investor’s assets. The approach could mean lower costs for clients that don’t do much trading and could help Morgan Stanley retain and poach advisers who rely on commission-based business.
The approach is directly opposed to that taken by rival Merrill Lynch. The Bank of America Corp. unit said earlier this month that it plans to ditch the industry’s traditional commission-based sales model for retirement accounts and will effectively offer only IRAs that charge a fee based on a percentage of assets starting next year.
The divergence will be a test of what works best for retirement savers and brokers, who could end up moving their business to firms that better suit their approach. Americans have $3 trillion in assets set aside in commission-based retirement accounts in the U.S., much of which will be affected by the decisions Morgan Stanley, Merrill and other brokerages make on compliance.
The Labor Department didn’t immediately comment on either firm’s decision. But agency officials in the past have said the so-called fiduciary rule was structured to permit commission-based retirement accounts and have said that such accounts are more appropriate for certain investors, such as those who trade little or have portfolios that consist mostly of bonds. The rule’s final draft was released in April and brokerages, asset managers and other financial-services firms have been waiting for additional guidance on compliance, from the Labor Department expected sometime this fall.
At the heart of the division between Morgan Stanley’s and Merrill Lynch’s approaches is the fiduciary rule’s so-called best-interest contract exemption, which allows brokers to receive variable or commission-based compensation in some circumstances. By going with fee-based accounts, brokers avoid questions of conflict because clients are charged a level fee based on a percentage of their assets, minimizing potential problems tied to specific investment products.
Brokers who want to charge a retirement saver a commission must enter into a best-interest contract with the client, which still requires the broker to act in the client’s best interest but puts the client on notice that the broker should receive no more than “reasonable” compensation.
Brokerage experts say risks associated with the best-interest contract include a higher hurdle for brokers to justify the varying compensation they can receive for investment products in commission-based accounts. Firms also fear lawsuits from investors who claim their interests weren’t served, including possible class-action litigation.
A single approach to retirement savings isn’t the best path toward putting retirement savers’ interests first, Morgan Stanley executives say. The firm, which has shifted in recent years to make wealth management the heart of its business, says clients should have the option of choosing the best way to pay for retirement advice that is in their best interest.
Fee-based IRAs are “not the right answer for every single client,” Shelley O’Connor, co-head of Morgan Stanley’s wealth-management unit, said in an interview. “Clients simply want choice in how they pay.”
Morgan Stanley, which will use the rule’s exemption to continue offering investors commission-based IRAs, says the exemption allows for different commission pricing based on “neutral factors,” such as the time and effort put into recommendations, and on the product’s complexity. Morgan Stanley also is drafting commission and pricing schedules to offer commission-based retirement savers greater disclosures as required by the exemption.
Morgan Stanley clients will be able to use commission-based IRAs to invest in many of the types of products they do now, including stocks, bonds and a range of mutual funds and exchange-traded funds, the firm said.
Morgan Stanley clients also can choose to move their IRA to a fee-based arrangement.
For its part, Bank of America executives said they believe the best-interest contract is unworkable for commission-based IRAs and that not using it is the best path toward compliance and acting as a fiduciary for its clients, as well as for its more than 14,000 brokers.
Merrill Lynch will use best-interest contracts only to advise on rollovers from commission-based accounts and 401(k) plans to a fee-based option. It won’t more broadly use best-interest contracts to offer commission-based IRAs because it “is going to create confusion, it’s got operational pain for clients [and] it’s going to be inefficient and cumbersome for advisers,” Bank of America Chief Financial Officer Paul Donofrio told analysts earlier this month.
Merrill Lynch will give commission-based investors an option: pay a fee for advice based on a percentage of their portfolio’s assets, move the account to one of online brokerage Merrill Edge’s product offerings or leave the commission-based account unchanged. However, the latter option denies investors the ability to make any significant changes or receive advice after that deadline.
Morgan Stanley’s and Merrill Lynch’s moves also will have big implications for their brokerage forces.
Merrill Lynch risks losing brokers who will be significantly affected by its decision, experts say, while Morgan Stanley could be perceived as opening itself up to a higher level of litigation. “You don’t want to pull the rug out from your adviser community. If a broker loses enough business, he or she will walk and go somewhere else,” said Denise Valentine,a brokerage analyst at Aite Group.
Many Morgan Stanley brokers still work with clients in commission-based accounts despite the industry’s broader push toward collecting fees in recent years. “Advisers want this, too,” Ms. O’Connor said. The firm added that its decision was done with clients in mind and not to please its brokers.
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com
