Edward Jones' success may lead to trouble

The brokerage giant Edward Jones last year saw an astounding $15.6 billion of net flows into its proprietary group of funds, sold exclusively through its brokerage network. The flows into the Bridge Builder funds bested household names such as BlackRock Inc., Fidelity Investments and American Funds, according to fund tracker Morningstar Inc. Since the funds launched in 2013, Edward Jones' clients have invested $22.6 billion. The Bridge Builder funds are part of the firm's investment adviser platform, Edward Jones Advisory Solutions. Throughout most of its history, the firm preached the evils of selling proprietary products and instead relied on a cadre of outside money managers, led by American Funds Distributors Inc. With regulators recently cracking heads over brokers' sales of proprietary products and insufficient disclosure of fees and relationships, could the overwhelming success of the Bridge Builder program be a problem for the partners at Edward Jones and its legion of more than 14,000 brokers? William Fiala, Edward Jones' general partner in charge of Bridge Builder, doesn't think so. “The way we designed Bridge Builder funds was without a manufacturing profit,” he said. “They are offered exclusively in fee-based accounts.”

REMOVING CONFLICTS

That goes a long way toward removing any conflicts of interest, Mr. Fiala said. “There are no incentives for advisers to allocate to Bridge Builder.” “This was a big decision for us, and once we sat down and explained the rationale and how [Bridge Builder funds would] drive client cost down, and explained that we were not taking a product manufacturing profit, the acceptance became very high,” he said. “There was an initial shock, but we peeled back several layers and showed it was client-friendly and not an opportunity to build a profit center around manufacturing product.” Edward Jones has close to $900 billion in client assets, with $140 billion in its advisory solutions program, including the nascent set of Bridge Builder funds. Mr. Fiala stressed that the Bridge Builder funds currently are waiving management fees and expect to do so in the future. The advisory solutions program charges a standard fee of 1.35% to 1.50% of a client's assets and an administrative fee of nine basis points. The managers who sub-advise the funds then charge a fee of 60 to 70 basis points, Mr. Fiala added. The adviser to Bridge Builder, Edward Jones subsidiary Olive Street Investment Advisers, is paid a percentage of assets under management.

NEW CLIENT MONEY

The increase in sales of Bridge Builder funds should lower overall costs in the advisory solutions program, Mr. Fiala added. And the growth in the future should not be so spectacular. The firm has no sales goal and expects fund flows to come from new client money rather than moving clients from existing mutual funds to Bridge Builder funds. There is no doubt that the Securities and Exchange Commission is focusing on mutual fund disclosure at the moment. What that means, if anything, for Edward Jones will only be revealed over time. In December, the SEC and two J.P. Morgan wealth management subsidiaries agreed to a $267 million fine, with the company admitting wrongdoing to settle charges that it failed to disclose conflicts of interest to clients. The SEC investigation found that the company's investment advisory business, J.P. Morgan Securities, and bank, JPMorgan Chase Bank N.A., preferred to invest clients in the firm's own proprietary investment products without properly disclosing the preference. And the SEC is not only focused on giants. In January, the commission cited Everhart Financial Group Inc., a registered investment adviser with $250 million in assets under management, and two senior executives for failing to make disclosures to clients about mutual fund fees. Since 2010, Everhart “has principally invested in the mutual funds offered by a single family” of funds, according to the SEC administrative order. “Despite significantly higher fees, some adviser representatives at [Everhart] nearly always invested non-retirement individual advisory ac-counts in shares with a 12b-1 fee, which was paid to [the firm's] principal owners, who also were” reps licensed with a broker-dealer, according to the order. “Receipt of 12b-1 fees not only created a conflict of interest that was not adequately disclosed to [Everhart's] clients but favoring 12b-1 funds was inconsistent with [the firm's] duty to seek best execution for its clients,” according to the order, which required the company to pay more than $300,000 in penalties and disgorgement. How does a broker-dealer avoid such conflicts when selling either propriety funds or an extremely narrow band of funds? “Disclose, disclose, disclose,” said Terry Lister, a senior consultant with Edgerton & Weaver. “One of the big disservices that the SEC did with the JP Morgan situation was that after the SEC said that the firm had a few disclosure issues, the commission didn't give a road map” showing the industry how to avoid similar problems, Mr. Lister said. The SEC may be focused on more than just selling different share classes, he said. “It may be the difference between Vanguard funds and selling in-house funds. Brokers could have to deal with that issue even though they are not taking fees.”