Hidden Costs: Revenue Sharing
Recently, I was reviewing a retirement plan for a potential business client and started digging into the costs of the plan. The plan administrator didn't know how much they were paying for the SIMPLE IRA so I called the mutual fund company to ask general questions about a retirement plan with them. What I found was another example of a sweet deal between brokers and mutual funds.
One of the top 5 mutual fund companies by assets managed has a deal to pay brokers 1% annually for retirement plans with $1,000,000 or more. This is a subsidy to the business with the SIMPLE IRA because they don't have to pay commissions to the broker when buying the mutual fund. The client had no idea this is going on and maybe if they did they would question if the broker put them in the best fund company.
The next question to ask is where is that 1% subsidy coming from? It's coming from high commissions charged to investors with less than $1,000,000 and from higher than necessary mutual fund expenses. These types of "revenue sharing" agreements unjustly raises the costs for many investors, lowers client returns, and creates conflicts between the broker and the client.
I have seen and heard how broker incentives and mutual fund companies entice brokers to sell products that benefit them and not always the client. A broker sells annuities to earn an 8% commission. A broker sells an exotic product, has no idea how it works but does know he receives an extra 2% commission along with the normal annual fee of 1% and doesn't have to tell the client. A broker has a short list of nine mutual fund companies she is allowed to sell primarily because of revenue sharing agreements. A broker who meets sales quotas receives free trips to Africa or Hawaii.
Should this type of payment be considered a kickback? Here is the definition of kickback: a percentage of income given to a person in a position of power or influence as payment for having made the income possible: usually considered improper or unethical.
It irritates me that brokers get away with receiving money from dual sources and are not required to disclose that information directly to the client. Instead, they bury their compensation in the fine print of thick prospectuses with legal jargon.
It is important to reiterate previous blog posts I have written. Please don't confuse or interchange financial advisor with a broker. Financial Advisors are held to a higher standard, a fiduciary standard, and can only receive compensation from fees paid by their clients. On the other hand, brokers are product salespeople who earn commissions and revenue from the companies they sell products for. The problem is brokers have found a way, through lobbying politicians and regulators, to take fees and commissions from clients and mutual fund companies. They don't have to disclose important information to their clients, don't have to work in the clients best interest and have conflicts of interest. I believe there is only one way to provide objective, independent advice that is in the clients best interest and that's as a fee-only, fiduciary financial advisor.