The Race to Zero Commissions and Compliance

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In the last month, we have seen an old fashion pricing war between brokerage giants across the industry. Things kicked off in late September with Interactive Brokers and the introduction of IBKR Lite, followed by Schwab, TD Ameritrade, ETrade and most recently Fidelity moving to zero commissions on all U.S. stock and exchange-traded fund (“ETF”) trades.

The initial news sparked positive reactions from your average investor. Zero commissions for stocks and ETFs, what could possibly be wrong with that?

After the dust has started to settle, it got us thinking about the future of wrap fee programs and custodial partnership due diligence.

Below we discuss both elements to get you thinking as well:

Wrap Fee Programs

A program that investment advisors once utilized to offer their advisory services for a single combined fee, now has a new wrinkle. As you have heard from us many times, part of an investment advisor’s fiduciary duty is to recommend services that are in the best interest of the client. Given the industry shift to no transaction fees for stocks and ETFs, if you currently offer a wrap fee program to clients where you charge a higher advisory fee to take into account transaction costs, have you asked yourself if wrap fee programs really are in the client’s best interest?

It is our belief that regulators will be asking you this question the next time you are visited. Historically wrap fee programs have been scrutinized by regulators to ensure their appropriateness. Specifically, under the microscope were reverse churning and high cash balances. Zero commission on certain securities will certainly draw the attention of examiners as they determine if a wrap fee program is in a client’s best interest.

Action Item:

If you sponsor or recommend the use of a third party wrap fee program, we strongly urge you to conduct a review of the underlying investments utilized to build client portfolios. Items to consider include:

  • What is the composition of underlying investments in the wrap fee program (percentage allocated to stocks, bonds, ETFs, mutual funds, options, etc.)?
  • Do you primarily invest in individual exchange-traded securities such as stocks and ETFs?
  • Do you primarily invest in mutual funds and if so, are they generally transaction fees or no transaction fee funds?
As you complete your review you may determine that staying the course with your wrap fee program is appropriate. However, if you determine that after your review a change is necessary you should begin to map out how that change will need to be implemented. You may decide that a wrap fee program is no longer necessary for clients. Or you may decide that the fee you previously were charging is no longer appropriate. Whatever the change is, you are urged to put the plans in place to see through a timely and accurate change.

Custodial Partnership Due Diligence

Whether you have brokerage discretion or recommend custodians to clients, these new incentives should be evaluated when considering your existing institutional relationships with your custodians. Although there is no immediate action needed, it’s certainly something worth staying on top of, as changes continue to unravel forcing increased competition in the brokerage space. It’s unclear where all of this is headed as there is already some speculation about potential changes to custody fees to make up for lost revenue and the layering of additional restrictions on zero commission accounts. Needless to say, it seems as though zero commissions are just the beginning.

What does AdvisorAssist Recommend?

We encourage all investment advisors to leverage this opportunity to document these reviews and as you complete your due diligence efforts, remember to document! This documentation can be captured either within AdvisorCloud or your own books and records.

Related: Anti-Money Laundering Best Practices for Advisors