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How the DOL Fiduciary Rule Proposal Affected Fund Flows

Our research sheds light on load-sharing payments and inflows

When the Labor Department proposed its fiduciary rule in 2015, its key objective was to reduce the effect of conflicts of interest on the advice investors rely on to save for retirement. When we examine the data, we see that the DOL fiduciary rule proposal was successful in mitigating lower returns resulting from conflicted advice in the two years after the rule was proposed. Now as the Labor Department rule has been struck down by the courts, the question is, will the SEC turn its Regulation Best Interest proposal into a workable regulation that maintains these positive trends for investors?

One avenue for conflicted advice comes through load-sharing arrangements because brokers can collect more money for recommending one fund over another.

To assess the harms to investors, the Labor Department relied on an academic paper by Susan Christofferson, Richard Evans, and David Musto, whom we will refer to as “CEM,” to justify the fiduciary rule. CEM found that funds that paid higher-than-expected loads to brokers tended to see higher inflows as a result. Further, they found this relationship is particularly acute for unaffiliated brokers compared with captive brokers. Captive brokers are affiliated with a particular fund sponsor and sell only that fund sponsor’s funds, while unaffiliated brokers are not saddled with such a restriction.

However, CEM relied on data from 1993 until 2009. It’s reasonable to wonder if the market has evolved since then. Morningstar’s policy research team set out to answer this question in a recent paper, combining public filings from the SEC with Morningstar’s own data on flows, performance, and mutual fund attributes.

Unusually high payments from fund sponsors to broker/dealers drove inflows ...

When we replicated the methodology used in the CEM paper and updated the models with data from 2010 until 2014, we found that higher-than-expected loads still drove inflows through the unaffiliated broker channel. On the other hand, when paid to captive brokers, higher-than-expected loads did not affect inflows in a statistically meaningful way.

… Until the DOL fiduciary rule was proposed

We wanted to dig deeper and see whether the DOL fiduciary rule proposal affected the relationship between loads and fund flows, so we broke down the analysis into pre-rule proposal and post-rule proposal periods. We found that after the rule proposal, this relationship broke down and there was virtually no association between load sharing and flows. Furthermore, the change in inflows brought about by the Fiduciary Rule itself was statistically significant—this is not just an issue where we could not detect further changes in flows.

We interpret this empirical evidence to suggest that regulation played a part in the decisions that brokers made about which funds to sell. While loads appeared to play a big role in directing fund flows from 1993 to 2014, they do not seem to affect fund flows in a statistically significant way from 2015 onward. In short, brokers may have been swayed to steer their clients to funds that shared more loads with them, but that does not seem to be the case anymore.

The continued impact of the DOL fiduciary rule proposal

The fiduciary rule was effective in mitigating the effects of conflicted advice. The evidence indicates that brokers altered their business models after the proposal, such that funds that paid higher-than-expected loads no longer saw higher inflows than funds that did not. The SEC has indicated that a finalized version of Regulation Best Interest is forthcoming, and we expect that the increased scrutiny on conflicted advice brought about by the fiduciary rule will continue. That said, we think if the SEC makes some adjustments to their proposal, it will have a better chance of maintaining this momentum.

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