Big Banks, Commissions, and Values-Aligned Investing

Merrill Lynch announced to last week that is was considering reinstating commission-based retirement investment accounts. It and of itself, this is not surprising. The major Wall Street brokerage firms have fought tooth and nail to prevent the implementation of the Department of Labor (DOL) fiduciary rule, an Obama era regulation that would force all retirement investment advisors to put their clients’ interests ahead of their own.

But Merrill also wants to continue being a leader in the space of ESG and values-aligned investing, recently announcing five new ESG portfolios. The juxtaposition of these two events begs the questions whether commission-based retirement accounts and values-aligned investing can sit under the same roof.

By way of background on the fiduciary rule, in 2015 the Obama White House released a report on The Effects of Conflicted Investment Advice on Retirement Accounts. A subsequent press release referred to commission-based retirement account as “a system where Wall Street firms benefit from backdoor payments and hidden fees if they talk responsible Americans into buying bad retirement investments — with high costs and low returns — instead of recommending quality investments”.

According to the research paper, conflicted financial advice was costing middle class families an estimated $17 billion a year. For an individual investor, this translates into an additional 1% in annual costs — the difference between turning $10,000 into $38,000 versus $27,500 over a 35-year period.

To address this challenge, the Obama administration Department of Labor passed a regulation calling for all retirement investment advisors to act as fiduciaries and put their clients’ interests ahead of their own. This meant no more commission-based retirement accounts. Not surprisingly, the brokerage firms hit the ceiling. In response, they launched a well thought out campaign to reframe the regulation as an attack on their ability to serve small clients. They claimed that without commission-based retirement accounts, fewer Americans would have access to investment advice.

This rebranding campaign was launched in tandem with commissioned research to negate the Obama administration findings, orchestrated ‘grassroots’ campaigns, and intense lobbying of Congress. Then they went to the courts.

In early 2017, the fight against the fiduciary rule gained a new ally; President Trump called for the Department of Labor to ‘review’ the rule. The message rang loud and clear, and over the past three months, the federal government refused to defend the rule in court. As a result, the fiduciary rule was officially declared dead in court on June 15th of this year.

When it looked as though the regulation was going to take effect, Merrill was one of the first firms to embrace the new regulation and switch clients to fiduciary accounts or other self-directed offerings. It argued that these changes were in their clients’ best interests. Now it is thinking about bringing back the commission system.

Merrill has been a leader in the field of values-aligned investing, conducting innovative research and constructing portfolios that help clients invest in companies whose business practices are aligned with their values. But Merrill should also consider how their own business practices align with their clients’ values.

There may be an argument for Merrill to reinstate some form of brokerage accounts, but the burden of proof is on them to demonstrate that they are only using them in a manner that is void of past abuses and serves clients’ best interests. At Vodia Capital, we have always held the position that commissions create a potential for conflict of interest between the advisor and the client, and are thus not aligned with our values as an organization.

Conscious investors should take note of the business practices of the institutions they invest with. These can have a tremendous impact on our society. For examples, we only have to go as far back as the subprime mortgage crises that triggered the worst economic crisis since the great depression and the loss of nine million jobs and millions of homes. Values-aligned work practices would not have allowed Merrill bankers to knowingly package poor quality subprime mortgages into triple-A rated securities and sell them off to unassuming investors. Stronger governance practices would have prevented Merrill from hastening its own demise by creating securities so toxic even their own traders wouldn’t touch them, as reported by NBC News.

Merrill is still in the process of deciding whether to reintroduce commission-based retirement accounts. If and how they choose to use these types of accounts is an opportunity for them to continue playing a leadership role not only in values-aligned investing, but also in values-aligned business practices. To reap the full benefits of values-aligned investing, investors should consider not only what they invest in, but who they invest with.

I am a Principal at Vodia Capital where I help investors achieve their financial goals by aligning their investments with their values.

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