As more investors buy shares of mutual fund companies through their broker-dealers, those broker-dealers are taking on processing tasks that would otherwise be done by the mutual fund companies or their service providers.
Problem? Two actually.
The results is a lot more administrative headaches for the fund companies and lost revenues for their service providers.
The latest example: Thomas McDonnell, chief executive of DST Systems, said in February on a conference call with analysts that a large broker-dealer was planning to take over some of the subaccounting work that DST performed for a mutual fund client.
"Current outlook for '11 of the movement to subaccounting includes the anticipation that a client that is managing a single state Section 529 plan will let one brokerage firm subaccount approximately 800,000 Section 529 plan accounts that are currently in our registered book," said McDonnell during the call about DST's fourth quarter 2010 earnings.
Also during that call, McDonnell said that during the fourth quarter of 2010, 3.3 million shareholder accounts that it handled were converted to subaccounting platforms. Of those 3.3 million accounts, 300,000 were migrated to DST's own subaccounting platform. Therefore, DST lost the revenue it could have made handling those three million registered accounts, all told.
McDonnell did not identify either the brokerage firm or the fund company but operations executives with knowledge of DST Systems say the latest brokerage firm moving accounts is Edward Jones, which will handle the subaccounting work. The mutual fund company using its own subaccountant, they say, is American Funds, until recently a DST client.
It could not be determined whether Edward Jones, which confirmed the news, will do the subaccounting work on its own or outsource that work.
What is unusual about the move is that broker-dealers have not pushed to handle subaccounting work for investors which buy mutual funds from broker dealers for their tax-advantaged college savings programs otherwise known as 529 plans. That is because unlike with other mutual fund accounts purchased through a broker-dealer, the broker-dealer servicing 529 plans must ask for the investor's permission to do the subaccounting work.
Chuck Freadhoff, a spokesman for American Funds, declined to confirm the news, saying that the firm's corporate policy prohibits it from discussing relationships with "third parties." That includes brokerage firms. American Funds operates a shareholder services unit.
DST Systems, citing its pending earnings report, declined to comment. As Money Management Executive went to press, DST was expected to announce its first quarter 2011 financial results.
Peter Heckmann, a senior research analyst for Avondale Partners in Leawood, Kansas, said that DST stands to lose about $3.2 million annually from American Funds because it will no longer do the recordkeeping for 800,000 shareholder accounts . That is based on his estimate that mutual fund companies typically pay DST an annual fee of about $4 per each account for licensing its processing platform.
"The most significant threat to the mutual fund shareholder recordkeeping business is the ongoing adoption of subaccounting platforms by financial intermediaries [broker/dealers]," Heckman said in a recent research report initiating coverage of DST. "Our research indicates this trend should continue, and our forecasts contemplate that an additional 20% to 25% of DST's 99 million registered mutual fund accounts are at risk of converting over the next three years."
The one bright spot: DST also owns a subaccounting platform called TASS, which can be licensed by broker-dealers to do the work on their own. Heckmann estimates that broker dealers using DST's subaccounting system pay DST about $2 per account.
Mutual fund companies pay broker-dealers for the subaccounting work, which can be further subcontracted to a large asset servicing firm, such as BNY Mellon Asset Services, a unit of BNY Mellon.
The unit is widely considered the largest to do so in the country, with over a dozen of the U.S. largest broker dealers either licensing its platform or relying on a complete outsourced package. The total number of shareholder accounts involved is over 80 million. The notable exception: Merrill Lynch, which operates its own subaccounting platform.
A dozen mutual fund companies contacted by Money Management Executive declined to comment on just how much they pay broker dealers to service each mutual fund customer on their books or how that compares to the amount they would pay a mutual fund company's service provider such as DST. Operations executives with knowledge of subaccounting estimate that broker-dealers are paid by mutual companies an average of $20 per year to service each mutual fund account.
Do mutual fund companies actually care who does the processing work? Freadhoff said that American Funds is "agnostic" to that, and he disputes any claims that American Funds is financially hurt if the broker-dealer rather than itself does the work. Regardless, American Funds, like other mutual fund complexes, must still carry plenty of overhead to run its shareholder services unit.
Mutual fund companies must also reconcile their records with those of the broker-dealer. The number of shares held in the name of the broker-dealer on the books of the mutual fund company or its transfer agent. Such a reconciliation is typically done by either the mutual fund company or its transfer agent and the broker-dealer electronically on a daily basis.
Far harder is keeping track of accounts of investors where recordkeeping must be done by the broker-dealer even though the accounts are still held by the mutual fund or its transfer agent. Such is often the case for 529 accounts; IRAs; and 401k accounts.
Any discrepancies on these so-called Network Level 3 accounts, which cannot be processed through Depository Trust & Clearing Corp., until recently were typically corrected by the broker-dealer and mutual fund companies or their transfer agents through faxes and phone calls, said Mike DeNofrio, director of subaccounting for BNY Mellon.
The bank's subaccounting unit has just released a new electronic service that allows its transfer agency group to find and correct those breaks on behalf of the broker-dealer in an automated fashion.
Work that could take about a day for operations executives can be done by BNY Mellon in a matter of minutes-and without errors.