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 But for a growing number of stockbrokers in a corner of the
securities industry known as "independent" broker-dealers, such
products are a big part of their income and their firms' revenue.
Many brokers are fuming over a proposed U.S. Department of Labor
rule that would block them from selling any investment into a
retirement account in return for a commission. Instead, the DOL
would restrict a broker's compensation to a fee based on a financial
adviser's hours or a flat percentage of the value of a retirement
account.
The goal is to curb an adviser's temptation to sell products with
the highest commissions rather than those that serve the best
interests of customers saving for retirement.
The DOL would allow commissions for easily valued investments
including exchange-traded stocks and bonds, but only if brokers sign
contracts giving customers the right to bring class-action lawsuits
if their best interests are not met.
The prohibition on commissions is particularly acute for the
independents because they monopolize sale of nontraded products.
Fearing lawsuits and revenue restrictions that they say will put
some small broker-dealers out of business, they are lobbying
Congress in a last-minute campaign to pressure the Labor Department
to modify the rules.
It's not up to the government to tell investors where they can put
their money or how brokers should be paid, they argue, and no one
understands their clients' needs better than their advisers.
Brokers say the DOL rule will deprive the middle- and lower-income
investors served by most independent brokers of the opportunity to
invest in potentially high-yielding products that are given to
wealthy people who can afford hedge funds and other pricey
"alternative" investments.
"It's the first time the DOL is limiting what type of investments
can be in an IRA," said Lisa Bleier, a managing director at the
Securities Industry and Financial Markets Association, the
industry's main lobbying group. "There is no good explanation for
why they did it."
The independent brokerage community includes more than 900 firms and
about 290,000 brokers who act as their sales force but are not their
employees. Independent investment advisers and brokers, many
affiliated with insurance companies, are the fastest-growing sector
of the brokerage industry. The two biggest firms as measured by
their sales groups are LPL Financial Holdings and RCS Capital Corp.
Shares of LPL are off 15.2 percent over the last year as of Aug. 31,
RCS Capital is down 91 percent and Ameriprise Financial, which sells
primarily through independent brokers but also has an employee sales
force, is off 8.8 percent.
NONTRADED REITS
In addition to selling conventional stocks, bonds, mutual funds and
exchange-traded funds, independent brokers are the primary sellers
of nontraded REITs that invest in real estate and mortgage
securities, of nontraded business development companies that make
loans to small and midsized companies and of oil-and-gas
partnerships.
Brokers say that they would have to abandon giving retirement advice
to thousands of middle- and working-class investors who cannot meet
the minimum balance requirements for fee-based advisory accounts if
the DOL proposal is not changed.
Investors who manage to hit the minimum could still be hit hard
because the financial services industry will likely raise its fees
to compensate for lost retirement-account commission revenue, Fitch
Ratings wrote in July.
Merrill Lynch already does not pay advisers on any accounts with
less than $250,000. Its parent, Bank of America, services such
accounts through the bank's no-frills Merrill Edge unit.
The brokerage industry as a whole told the Labor Department in July
that the so-called best-interest fiduciary rule would cost U.S.
securities firms more than $5.8 billion, much of which could be
passed to investors.
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The Financial Services Institute, the trade group for independent
broker-dealers, calculated that its members would spend $3.8 billion
alone for such startup costs as new record-keeping and disclosure
systems to implement the rule, almost 20 times the estimate made by
the Labor Department.
The rule will force small firms out of business, giving "small and
medium-sized investors" less access to needed retirement advice, it
wrote in a comment letter.
Still, both opponents and supporters believe the rule, which is
backed by President Obama and Secretary of Labor Thomas Perez, will
withstand the lobbying onslaught.
"What's different here is that regulators usually back down in the
face of so much industry opposition," said Barbara Roper, the
director of investor protection at the Consumer Federation of
America, a lobbying group, who testified in favor of the proposed
rule. "There will be tweaks but the [Department of Labor] staff
really believes in this."
Investors are drawn to nontraded securities by the relatively high
income they offer. Dividend yields on private real estate investment
trusts in recent years have been just over 6 percent, compared with
about 5 percent on real estate investment trusts that are listed on
stock exchanges, according to data from Robert A. Stanger & Co., an
investment bank that advises sponsors of nontraded products.
But to get that sort of yield on a private REIT, investors pay
broker commissions of 7 percent, with the total bill rising to 11
percent or higher once offering expenses, property acquisition fees
and other operational costs are added.
Once bought, the products are hard to liquidate. The principal way
to cash in at a profit is to hope that a product sponsor lists the
stock on a major exchange. If that occurs, it does not happen until
six to nine years after the two-year fund-raising period, according
to Robert A. Stanger & Co.
Out of 125 nontraded REITs that have been approved by the Securities
and Exchange Commission since 2000, 47 have been listed and nine are
pending. Out of 19 business development companies (BDCs) effective
since 2009, when the product was first offered, two have been
listed.
Investors held about $84 billion of nontraded investments at the end
of 2014, with 41 percent of the REIT money and 48 percent of the BDC
investments in individual retirement accounts at brokerage firms,
according to research firm DST Systems. That makes the investments a
relatively small part of the retirement asset universe— Americans
had about $24.7 trillion of retirement assets at the end of 2014.
The Labor Department rule, which was discussed in four days of
hearings at the department in August, is expected to be reissued in
September for a brief comment period and go into effect in the
second half of 2016.
(Reporting by Jed Horowitz, Editing by Dan Wilchins and John
Pickering)
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