Do LPL clients pay more for mutual funds?

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LPL Financial is warning advisory clients that they could be paying higher expenses on their mutual funds, even if there’s no transaction charge.

This and other disclosures follow similar ones by wealth managers in response to the SEC’s Regulation Best Interest, which bulked up regulatory requirements. Making sense of new details about fees can be a tricky business, with massive implications on yields over the long term.

Here’s what LPL documents say about how and when clients may be paying higher expenses.

Clients opening a corporate RIA account on the Strategic Asset Management platform “expressly [waive] LPL's duty of best execution” with respect to the price of their mutual fund share classes, according to the firm’s latest customer agreement, effective June 30.

Clients of hybrid RIAs who use the Strategic Wealth Management platform can avoid transaction fees if the fund is paying LPL certain compensation. However, those products “tend to have a higher expense ratio, which is borne by the client,” the customer agreement states.

For clients on either platform whose financial advisors pay the transaction fees themselves, the firm also makes it clear that its representatives have incentives to avoid the trading charges. What isn’t as clear is exactly how often LPL clients have to pay higher fees on their funds.

To experts, the conflicts of interest read as typical of large wealth managers, other than the language waiving best execution on mutual fund share class prices. The question of cost comes down to unknowns, according to Nicole Boyson, a finance professor at Northeastern University.

“What we don't know, since it's impossible to calculate is, who is better off in those circumstances?” says Boyson, who studies dual registrant conflicts of interest. The firm is “effectively telling you that you're paying more for the privilege of being an LPL client.”

In an interview from the firm’s virtual Focus conference, Chief Investment Officer Burt White declined to comment on the price of mutual funds sold through LPL’s advisory platforms. A spokeswoman for LPL didn’t respond to follow-up inquiries seeking further explanation.

After this article was published, LPL spokesman Jeff Mochal emailed a statement about the firm's mutual fund fees. He says the firm uses its scale to drive down costs on its advisory platforms and that LPL hasn't retained 12b-1 fees in advisory accounts for a number of years.

"We offer a choice of thousands of funds and have one of the most expansive [no transaction fee] platforms comprised of non-12b-1 paying share classes," Mochal said. "There are costs for providing investment services and we strive to be transparent about fees and conflicts of interest. Although we strive to obtain the cheapest share class available, our disclosures are written to inform end investors on all scenarios.”

What’s in the fine print?

With nearly 17,000 advisors and $375 billion in assets under management in its corporate and hybrid RIAs, the firm’s arrangements with fund families and other product manufacturers carry extra weight. Out of 19 conflicts of interest listed by LPL on its website, nine of them involve mutual funds paying the firm expenses such as marketing, recordkeeping and networking fees.

Transaction fees revolve around whether fund manufacturers pay LPL the recordkeeping payments of up to 0.30% of assets or $25 per client position, the disclosures show. Many of the hundreds of fund families making the recordkeeping payments also show up on the list of those participating in LPL’s no transaction fee mutual fund networks. The firm doesn’t say in the document whether the funds defraying ticket charges or paying up to 0.25% of assets to be in the networks must pay those fees on top of their recordkeeping expenses.

The third-party payments affect the cost to clients and advisors in complex ways.

For instance, the advisor rather than the client pays the transaction fees in some accounts. In the firm’s corporate RIA, LPL provides rebates for any 12b-1 fees but still alerts clients that another firm “may offer the same mutual fund at a lower overall cost,” according to the client agreement.

“Client understands that the share class offered for a particular mutual fund through [LPL’s] program in many cases will not be the least expensive share class that the mutual fund makes available,” it states. “In certain cases,” it continues, LPL picks the share class based on “compensation for the administrative and recordkeeping services” provided to the mutual fund.

For the firm’s hybrid RIAs, the mutual funds often come with higher expense ratios if there’s no transaction cost, the client agreement says. And the transaction cost depends on whether the fund pays LPL for recordkeeping, asset-based services or 12b-1 fees.

It will amount to zero “if the compensation retained by LPL exceeds a certain qualifying amount (which is set by LPL in its discretion),” according to the document.

Industry RIA practices

The best execution waiver in the corporate RIA especially stands out to Christine Lazaro, director of the Securities Arbitration Clinic at St. John’s University. It shows firms like LPL have “more wiggle room” on the advisory side under fiduciary laws than under brokerage accounts, she says, noting that BDs can’t waive FINRA’s best execution rule.

“While LPL is receiving compensation for its services, it's not clear if the client's benefitting from those services,” Lazaro says. “It's hard to understand how LPL offsetting its own costs is really putting the clients’ interest first.”

Representatives for the SEC declined to comment.

Among large BDs, the conflicts of interest with respect to mutual funds are “all pretty much equally egregious,” according to Chris Tobe, a portfolio manager who became a whistleblower on the cost of placement agents and hedge funds in Kentucky’s state pension systems. He sent an email with his own interpretation of the best execution waiver.

The “[c]lient does not understand this game of overpriced recordkeeping fees so they allow themselves to be misled by the LPL broker into buying a higher fee identical fund,” he said.

Regulators are certainly scrutinizing firms’ mutual fund recommendations. As part of the SEC’s self-reporting program on share class disclosure, LPL’s RIA and 78 other firms agreed to pay combined restitution of $125 million in 2019. While LPL’s case didn’t mention best execution duty, attorneys for large wealth managers are concerned it could increasingly become an issue.

In an article last year for the legal journal “The Investment Lawyer,” four Morgan, Lewis & Bockius lawyers criticized what they see as a shift in the agency’s enforcement of best execution rules.

“The SEC’s inclusion of a best execution violation in mutual fund share class selection cases is a novel approach that seems to diverge from established SEC guidance, which is limited to brokerage selection,” the attorneys wrote.

‘Investing isn’t free’

Boyson, the Northeastern professor, doesn’t think the best execution language “reflects poorly or well” on LPL but rather an effort to avoid further cases with disclosure, she says. Most firms are rebating the 12b-1 fees to clients after the deluge of cases, according to Boyson. Questions remain around the total costs of revenue sharing, administrative fees and service expenses.

LPL is “going down kicking and screaming,” she says. Boyson describes LPL’s approach as, “We want to hold on to that fee, so we're going to tell you about it but we're still going to keep it.”

The firm’s disclosures include a link to an SEC report for investors about the impact of fees over time. An investment portfolio of $100,000 with 1% fees and 4% annual growth will earn $30,000 less during a 20-year span than the same amount will yield with an expense ratio of 0.25%. Investors should keep fees for transactions, underlying expenses and intermediaries in mind, Lazaro says.

“Investing isn't free, so there isn't no-cost investing,” she says. “It's just where the cost is being borne and really understanding how the fees are being charged and where the fees are being charged.”

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Mutual funds Independent BDs RIAs Form ADV Fee disclosures Fee-based compensation LPL Financial SEC Compliance Regulation Best Interest Premium Access