The only way to eliminate conflicts of interest that cost investors millions of dollars annually is through clean shares and level product commissions, a leading consumer advocate is expected to tell Securities and Exchange Commission Chairman Jay Clayton this week.
The Consumer Federation of America (CFA) will submit to the regulator these and other comments advocating the creation of “clean” products stripped of sales costs and the elimination of variable product compensation in favor of “level” compensation. The framework also advocates precise disclosure, investor consent, conflict mitigation and heightened supervision.
This framework would better protect investors and the marketplace than the SEC’s nearly 1,000-page best-interest rule, expected out this fall, CFA Director of Investor Protection Barbara Roper told Financial Advisor.
“Our purpose in developing this framework was to demonstrate that it is possible to develop an approach to reining in conflicts of interest that works in both the brokerage and advisory business models. In particular, it is possible to attack the toxic web of conflicts that pervade the broker-dealer business model without in any way threatening investors’ access to transaction-based advice,” said Roper, who is also a member of the SEC’s Investor Advisory Committee.
“If the SEC were to adopt this approach as part of its requirement to mitigate conflicts of interest under Reg BI and to avoid conflicts under the Advisers Act fiduciary standard, its standards might actually live up to their best-interest label,” Roper added.
The CFA’s approach breaks out solutions for three types of current industry conflicts: those inherent in firms’ business models, product-specific conficts and those artificially created to increase sales, such as sales contests.
Product-specific conflicts can be eliminated or greatly reduced through “clean shares” and other product-neutral approaches to broker compensation, the CFA said. Some firms, such as LPL, had already created clean shares, stripped clean of all sales and marketing fees, in response to the U.S. Department of Labor’s now-defunct fiduciary rule.
“By removing all distribution-related costs from the products, clean shares in particular have the potential to eliminate incentives for broker-dealer reps to recommend funds based on their own financial interests rather than the investor’s best interest. (Though some clean shares appear to be 'cleaner' than others.),” the CFA said.
“One option would be to apply a level commission to load-waived A shares, as LPL announced it planned to do with its mutual-fund-only platform, an approach that reduces conflict-related incentives at both the firm and individual rep level. Another option is for firms to continue to distribute products that offer variable compensation, but to offer level compensation at the individual rep level for all similar products. In such cases, the firm neutralizes the conflict at the rep level but retains the conflict at the firm level, as well as the differences in cost to the investor,” according to CFA’s framework.
CFA’s approach to levelizing compensation for similar investments would apply equally to recommendations of annuities and any other class of investments.