It probably won’t matter how much sponsors of pricey, underperforming mutual funds or ETFs are willing to pay a broker-dealer for a spot on its platform after Regulation Best Interest goes into effect June 30.

The threat of regulatory enforcement and the impact of rising consumer demand for value is likely to far outweigh any profits that broker-dealers could enjoy by offering costly fund laggards going forward.

That’s according to Matt Radgowski, Morningstar’s head of advisor solutions, who said the new regulation not only works to filter out higher-cost funds from firms’ platforms, but also highlights less desirable fund outliers at the recommendation level of retail transactions.

“As we’ve engaged with firms’ workflows, we are able to show higher-cost options in comparison to other funds with lower costs and better performance,” added Radgowski, who said Morningstar has heard from an increased number of broker-dealers in the past 30 days.

Reg BI mandates that broker-dealers give investors new side-by-side investment comparison reports, which the firms must also make available to examiners with the Financial Industry Regulatory Authority and the Securities and Exchange Commission. That will make it impractical from both a compliance and business perspective for B-Ds to offer funds that underperform and overcharge.

“The requirement that broker-dealers either eliminate or disclose and mitigate conflicts of interest, [as well as the] growing consumer demands for value, will make it harder for high-price funds that don’t offer value to stay on shelves. These regulations will accelerate the push toward lower-cost options,” Radgowski said.

“The way broker-dealers and reps work is really going to have to change under the rule and center on how and why they make investment recommendations,” he said. “Each recommendation will need to be evaluated relative to reasonable alternatives and their performance, risk and explicit price.”

What will the investor see after June 30 when he or she gets a Reg BI-compliant recommendation report from a rep?

“This gets to the heart of the changes that are required,” Radgowski said. “What we’ve done is taken all the data, research and tools we’ve developed over the years and created a reasonable alternative screener. What that means is that as the rep decides ‘I would like to recommend fund A,’ we will go out and show three, five, seven, nine alternatives from a fee, risk and performance perspective that may be better or similar.

“That data is presented side by side in a report so rep and investor can see right in front of them the investments that we feel are reasonably available alternatives.”

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