By Jed Horowitz
At least three wealth management firms that market themselves as objective financial advisers are getting payments for investing their clients' money in certain mutual funds, a practice that even some of these firms say could create conflicts of interest.
The firms, known as registered investment advisers, are typically paid by clients with fees tied to the growth or contraction of client assets, and not to specific products. But Fidelity Investments and Charles Schwab Corp. (SCHW) are paying these financial advisers as much as 0.25 percent of the assets that their clients put into no-transaction-fee mutual funds.
Such funds are popular with ordinary investors because they don't have to pay commissions to buy or sell them, although some advisers say they have higher expenses than funds with commissions. Brokers such as Fidelity and Schwab make hundreds of millions of dollars in fees selling funds that they and others manage.
The three wealth management firms receiving product-related fees are Luminous Capital, a division of First Republic Bank Inc. (FRC); Sontag Advisory LLC, a unit of National Financial Partners Corp. (NFP); and PHH Investments Ltd., which specializes in managing retirement income for pilots, a Reuters review of regulatory filings shows.
Millions in Potential Revenue
A fourth firm, Dion Money Management LLC, had also been taking payments from Fidelity, according to a 2012 regulatory filing disclosing its business practices. Last month, however, the Williamstown, Mass.-based firm made a new filing that no longer mentions such payments.
The payments can potentially add millions of dollars of annual revenue for the wealth management firms, but also create incentives for advisers to direct clients to those funds for their own benefit.
Greg Berardi, a First Republic spokesman, said Luminous invests less than 4 percent of client assets in Fidelity's no-transaction-fee funds. Luminous, founded in 2008 by former Merrill Lynch brokers, is among the 20 largest independent financial advisory firms, with $5.5 billion in client assets, according to its regulatory filings.
"Clients trust us to make investment decisions that are always in their best interests, and that is the way we have always conducted business," Berardi said. The founders of Luminous, who sold their firm in December to First Republic for $125 million, declined to comment.
Calls to Addison, Texas-based PHH, which markets itself as Retirement Advisors of America, and executives at New York-based Sontag Advisory, weren't returned. A spokeswoman at Sontag's parent, National Financial Partners, declined to comment. Dion executives and a spokesman at its parent company, Focus Financial Partners, didn't return calls seeking comment.
Under securities laws, investment advisers registered with the U.S. Securities and Exchange Commission or state regulators are "fiduciaries" to their clients, which calls for undivided loyalty to the client and full and clear disclosure of any conflicts of interest.
In interviews, other advisers, compliance consultants and former regulators said these firms may not be properly disclosing these payments. For example, Luminous and PHH disclose these payments as fees they get for providing back-office, administrative, custodial support and clerical services to Fidelity, which the experts said doesn't appear to make sense. That's because these are the very services that Fidelity and Schwab provide to independent wealth managers, they said.
Improper disclosures or the lack of disclosure could trigger sanctions by regulators, including a possible return of the money received from Schwab and Fidelity. The conflict of interest could also dent the image of fee-based independent advisers, the fastest-growing sector of the wealth management industry, who pride themselves on giving unbiased advice to affluent investors.
A source familiar with the SEC's thinking said the regulator's investment management division is working on a "pipeline" of examinations and investigations regarding payments to registered investment advisers by brokers and mutual funds, and the level of disclosure.
Schwab "on rare occasion" pays advisers for sales of its OneSource no-transaction-fee funds if they provide some services to end clients, said Susan Forman, a spokeswoman for the firm. "It is the responsibility of the adviser to disclose this arrangement," she wrote in an email.
Forman and Fidelity spokeswoman Nicole Abbott, who also confirmed that the mutual fund giant selectively pays independent advisers, declined to comment on specific firms, the criteria for choosing who is eligible for the payments or the total number of firms they are paying.
Schwab earned $680 million from the average $216.6 billion of client funds on its OneSource no-transaction-fee platforms in 2012. Fidelity is privately held and does not disclose its sales numbers.
In their business practice disclosure documents, each of the advisory firms says that despite the payments, they remain true fiduciaries and put their clients interests before their own. They also stressed they were transparent about acknowledging the possibility of a conflict of interest.
For example, in the filing dated March 26, San Francisco-based First Republic said: "This relationship creates a potential conflict of interest as First Republic Investment Management Inc. would benefit more by recommending [no-transaction fee] funds for clients. In fulfilling its duties to its clients, First Republic Investment Management Inc. endeavors at all times to put the interests of its clients first."
In its disclosures, PHH says that it is the firm's policy to place the interest of its clients first, so the decision to invest in a particular fund or to have clients establish accounts with Fidelity isn't dependent on the fee arrangement.
Clients of Sontag, which discloses payments from both Schwab and Fidelity, can direct the firm in writing to turn down payments, its disclosure says.