Broker-Dealers, Fees, and Bad Internal Controls


At Index Fund Advisors we provide many reasons why investors should steer clear of actively managed mutual funds. Mainly, they have failed to deliver on their proposed value proposition: consistent excess risk-adjusted returns (i.e. “alpha”). The number that has delivered a consistent "alpha" is actually less than what we would expect by random chance alone. All the while these fund companies have essentially enriched themselves without providing any real value to investors.

But today we are going to highlight another expensive reason. Excess fees!

It is one thing to agree on a price for services provided to investors but what if you were being charged a price that was more than what you agreed to? Instead of 0.80% of AUM it ended up being 1%. How would you know? Are you tracking all of the fees that are being applied to your investments? Does this actually happen?

In short, yes! Very often, in fact!

The most recent culprits are broker-dealers associated with Cetera Financial Group. According to a recent article published in Financial Advisor IQ, “five broker-dealers within Cetera Financial Group have settled with FINRA to pay clients back $3.3 million in mutual fund fee waivers.”

What are mutual fund fee waivers and fund sales charges?

Most broker-dealers and advisors earn fees through the products they sell, which includes mutual funds. For certain clients like endowments, pension and retirement plans, or high net-worth individuals, these advisors can file a “fee waiver” to lower the overall fee that is being applied to their clients’ accounts. These clients see a reduction in their overall asset-based fees since they have a large amount of assets. The waiver is signed by both the client and the advisor and is filed with the broker-dealer so they can apply the revised fee to the clients account. They can also remove a sales charge like a front-end load or a deferred load.

The problem is that there is a breakdown in the process of the waiver being signed and the fee being applied. According to the Financial Advisors IQ article, “from July 2009 to last month [July 2017], the broker-dealers allegedly failed to supervise the application of the waivers on accounts of eligible clients, including retirement plans and at charitable institutions.”

Sounds like a problem specifically surrounding Cetera right? Not quite!

Other fund companies and broker dealers that have found themselves in similar hot water. Here are a few examples spanning over a decade including restitution amounts:

Seems to be more of the trend than the exception.

We believe buying into actively managed mutual funds has many pitfalls. Most of them are quite expensive over the lifetime of an investor. Whether it is subpar performance or excess fees, they are not a prudent investment choice. A much better alternative is a globally diversified portfolio of index funds with a risk exposure that properly matches your individual risk capacity.

For those investors who still own active funds, are you being overcharged? Might be time to take a closer look.