Fat commissions from direct-participation programs such as non-traded REITs and business development companies may spur sales by individual brokers, but broker-dealers also have big incentives for selling the products: lucrative revenue-sharing deals.
A review of disclosure documents by Financial Advisor magazine shows that B-Ds can earn many multiples more from their direct-participation program (DPP) revenue-sharing arrangements than they do from mutual funds.
Revenue-sharing fees are paid by all types of product sponsors directly to B-Ds, ostensibly for marketing support, due diligence and training. But the payments also help manufacturers get preferred access and visibility at brokerage firms.
For the low-margin independent broker-dealer industry, revenue sharing is an important income source. Since individual advisors don’t directly share in the payments, the arrangements are all the more attractive to independent B-Ds that pay out most of their commission and fee revenue to advisors.
Revenue sharing from DPPs is especially enticing. Several of the largest IBDs serve as examples.
Cetera Financial Group’s broker-dealers can get up to 150 basis points on sales of direct-participation programs—five times the maximum of what they get on mutual fund or variable annuity sales. DPP sponsors also pay Cetera firms up to 20 basis points on assets annually, double the 10 basis points mutual funds might pay.
LPL Financial may receive compensation of up 60 basis points per year of customer assets in DPPs, or 1.5 percent of sales. For mutual funds, the firm gets just a quarter of those amounts—15 basis points yearly or 35 basis points on sales.
Commonwealth Financial Network earns up to 2 percent on sales of DPPs, or 70 basis points annually on assets in the programs, versus 30 basis points from mutual fund sales or 15 basis points on fund assets.
Cambridge Investment Research’s revenue-sharing arrangements generate up to 150 basis points on sales of DPPs, or 25 basis points on assets, far less than the 10 basis points from mutual funds sales and four basis point on fund assets.
Finally, Ameriprise Financial Services discloses only that it gets up to 8.5 percent of the amount invested in direct-participation programs, including the portion paid out to its reps. On mutual funds, Ameriprise receives up to 25 basis points on sales as well as assets from revenue sharing.
Spokespersons for LPL and Commonwealth declined comment. Representatives from Ameriprise and Cambridge did not respond to requests for comment, while Cetera executives were not available.
These larger independent firms are by no means alone in receiving revenue directly from product sponsors. Nearly all broker-dealers have revenue-sharing deals with a variety of product manufacturers.
The total amount the IBD industry gets from DPP sponsors could be substantial. About $115 billion is invested in DPPs, according to Robert A. Stanger and Co. Inc., which tracks sales data. Most of these nontraded products are sold through the independent broker-dealer channel.
Revenue sharing has long been controversial due to the conflicts it creates and the limited disclosure of the arrangements.
In the wake to the mutual-fund timing scandals more than a decade ago, the SEC pursued several fund-related revenue-sharing cases against brokerage firms. The agency pushed for better disclosures and even talked about banning the practice.
Revenue sharing creates “conflicts between broker-dealers' financial interests and their agency duties to customers” by creating incentives to sell certain products, the SEC said in a 2004 disclosure proposal, which was ultimately mothballed. The plan would have applied to mutual funds, variable annuities and 529 plans.
As a result of the fund-related enforcement actions, most brokerage firms now disclose the maximum amounts they receive from sponsors of different types of products, but not the details of each deal or the totals a firm receives.
Critics have called for the SEC to take the next step and ban incentives like revenue sharing.
The SEC “should seriously consider whether … certain compensation practices [should be] either banned or severely limited,” the Consumer Federation of America, Fund Democracy, the AFL-CIO, Americans for Financial Reform, Consumer Action and Public Citizen said in a March letter to SEC chairman Mary Jo White.
Separately, the SEC is reportedly scrutinizing the use of distribution-related fees like 12b-1s and record-keeping fees.
“I think [revenue sharing is] the next black eye for the industry,” said Robert Matthews, chief executive at Fieldpoint Private Bank & Trust, who also supports ending what he derides as a “pay to play” practice.
Greenwich, Conn.-based Fieldpoint, a hybrid firm that caters to high-end wealth managers, does not accept revenue-sharing payments.
“If you claim to put clients first, then do it,” Matthews said. “It’s horrifying that these arrangements persist, given the scrutiny” the industry is under.
Meanwhile, sales of nontraded REITs and BDCs fell 21 percent in the first quarter of this year, to $4.5 billion, compared to a year ago, according to Stanger.
For all of last year, sales of non-traded REITs and business development companies fell 13 percent, to $21.3 billion.
The drop last year was the first sales decline for direct-participation programs since 2008.
Fewer liquidity events crimped activity, and the fallout from the accounting scandal at American Realty Capital Properties caused a number of broker-dealers to suspend sales of programs from sister companies Cole Real Estate Investments and American Realty Capital, both major players in the nontraded REIT space.
Additionally, a new Finra rule set to go into effect next April, which will require per-share estimated values for DPPs to be reported on customer statements, is impacting sales, said Keith Allaire, managing director at Stanger.
The new rule is driving development of new nontraded products with daily NAVs and share classes with level loads, which some observers feel could lower costs to investors and sales incentives to brokers.