Broker funds

"in general there are lots of problems with them, especially if they invest in other people's funds.

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Broker funds get the watchdog treatment, broker funds.

I don't believe that if there is double charging it can be good value," he said. Autif questions the validity of comparing broker funds' performance with similar non-broker funds. It says that broker funds tend to perform better when markets are falling and the PIA's figures do not pick this up.

Broker funds get the watchdog treatment

Independent financial advisers face stringent new rules on certain products, writes james moore.

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Barely a week passes without city investment watchdogs cracking down on another alleged financial scam. The most recent example concerns so-called "broker funds", a special type of investment that has vacuumed up almost pounds 2bn from more than 130,000 savers.

Just over a week ago, the personal investment authority (PIA), the frontline financial regulator, announced a package of new rules aimed at tightening up the rules on broker funds. It is also setting up a monitoring unit to keep a close watch on them, and on the activities of those who sell them.

The PIA's intervention, several months behind schedule, follows a survey it carried out suggesting that investors who place their money in them get a poor deal.

Broker funds are set up by firms of independent financial advisors (ifas) and managed by life insurance companies or unit-trust managers.

The fund management company provides the IFA with its "own" fund, the broker fund which can even be in that IFA's name. It holds the assets but the IFA tells the company how the cash should be invested.

These schemes have caused controversy, first because the supposedly independent IFA firm is recommending that its clients invest in a product it has a direct interest in, and second because with both life company and IFA taking a cut, the schemes can be expensive.

The IFA will typically receive a slice of initial commission between 3 and 6 per cent for placing the money in a broker fund. The management company may then charge up to 1.5 per cent a year for looking after the money, while the IFA creams a further 1 to 1.5 per cent for its fund-management "expertise". In effect, a broker fund may need to achieve annual returns of at least 5 per cent just to stand still against inflation.

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The PIA has taken action as a result of a report it published 12 months ago which compared broker funds against similar funds run by life and unit-trust companies.

The report says: "the performance figures from 1 january, 1990 to 4 november, 1996 show that whilst life funds grew by an average 7.3 per cent per annum compound during this period, the equivalent life broker fund grew by 6.1 per cent per annum. Whilst the average pension fund grew by 9.2 per cent per annum over the period, the equivalent broker fund increased by 7 per cent per annum."

The PIA blames the poor performance on "the additional management fee withdrawn from the funds".

The PIA is now demanding that ifas acting as broker-fund managers incorporate a "conflict of interest statement", with letters to clients explaining why they have recommended a particular product.

These letters will also have to explain why the fund is suitable for an investor compared with similar non-broker funds, what the options are to switch out of the funds and what this will cost.

Significantly, the letters will have to contain a periodic statement of the fund's performance and if the fund is not performing as well as its benchmark or index it will have to explain fully and clearly why.

Broker-fund managers will have to take specialist exams to run them, and annual letters sent to investors to explain why a broker fund remains suitable for them should explain why a fund has under-performed its target benchmark, if this is so.

Ifas are only allowed to recommend broker funds if there is no generally available product that would better suit a client's needs. But the PIA has dropped proposals to ban them from recommending broker funds if there is already a generally available product that would meet a client's needs as well as a broker fund - the "better than best" test.

Paul hatch, director of the national association of broker fund and investment managers, says he is pleased that the rules, due to be out in september, have been published. "it is positive they have come forward with a response, which is long overdue. Now we know the PIA is not trying to kill broker funds off we can move forward."

Mr hatch maintains that broker funds can survive and are a useful product for investors.

His view is echoed by philip warland, director-general of the association of unit trusts and investment funds (autif).

Autif questions the validity of comparing broker funds' performance with similar non-broker funds. It says that broker funds tend to perform better when markets are falling and the PIA's figures do not pick this up.

Mr warland says: "it should be down to the consumer to decide what is good value for money. A lot of clients will pay a bit more because they trust the manager and are happy to deal with him."

But despite these arguments, and the new rules, broker funds sill have critics.

Hargreaves lansdown asset management, a very large IFA firm, runs an offshore broker fund, a niche product, with a team of four specialists. Peter hargreaves, the managing director, says that "99.9 per cent of the market doesn't have enough experience to manage them in my opinion".

"in general there are lots of problems with them, especially if they invest in other people's funds. I don't believe that if there is double charging it can be good value," he said.

Gareth marr, chief executive of IFA firm MMB, said bluntly: "as an IFA you should only put a client into an investment if you are willing to take them out again. I suspect many independent financial advisers who do broker funds are not so active in advising clients when to go out as they are when to go in."

How broker funds compare

1 year % 3 years % 5 years %

Pension fund: 7.84 41.18 62.5

Sector average percentage change over one, three and five years to march 1998 (offer to bid, income reinvested) source: micropal.

1 /0 broker funds get the watchdog treatment

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Private funds and managers – navigating broker-dealer requirements

Introduction

When looking to raise capital, broker-dealer compliance may not be at the forefront of a private fund manager’s mind. However, engaging individuals (including the fund manager’s employees) or firms to identify, introduce or negotiate with potential investors can trigger a host of adverse regulatory consequences—including rescission rights and civil penalties—where such “finders” were not properly registered as a broker-dealer or broker-dealer representative.

Issuer’s exemption and associated persons

Under section 3(a)(4) of the securities exchange act of 1934 (the “exchange act”), a broker is a person engaged in the business of effecting transactions in securities for the accounts of others. Under section 3(a)(5) of the exchange act, a dealer is a person engaged in the business of buying and selling securities for the person’s own account. This excludes a person that buys and sells securities for its own account and not as part of a regular business. Section 15(a) of the exchange act prohibits a person from acting as a broker or dealer without registering as a broker-dealer with the SEC under section 15(b) of the exchange act, absent an applicable exemption.

Under the “issuers’ exemption,” an issuer (including a private fund) that deals only in its own securities (such as limited partnership interests) is neither a broker nor a dealer as it does not effect transactions for the accounts of others and is not engaged in the business of buying and selling securities for its own account. However, where a private fund’s employees or agents regularly market the fund and solicit investors, they may be deemed to be acting as an unregistered broker-dealer, particularly where those individuals receive commissions for their efforts. The SEC generally takes the position that the payment of a commission or other transaction-based compensation may be sufficient to trigger broker-dealer registration requirements, even in the absence of other qualifiers (see paul anka SEC no-action letter (july 24, 1991)).

Rule 3a4-1 promulgated under the exchange act provides a non-exclusive safe harbor from broker-dealer registration for associated persons of an issuer. An “associated person,” in the context of a private fund, is a natural person who is a partner, officer, director or employee of (i) the private fund, (ii) where the private fund is a limited partnership, its corporate general partner, or (iii) a company or partnership that controls, is controlled by, or under common control with, the private fund.

For rule 3a4-1 to apply, the private fund’s associated person must not be (i) subject to any “bad actor” disqualifications under section 3(a)(39) of the exchange act, (ii) compensated through commissions, and (iii) an associated person of a registered broker-dealer. In addition to those general restrictions, associated persons may only place securities to a limited class of investors, such as banks, registered investment companies or state-regulated insurance companies. They must also perform substantial duties on behalf of the private fund other than the marketing of fund interests, must not have been associated with a broker-dealer for the prior 12 months, and not have participated in more than one offering for the private fund in a 12-month period. Finally, associated persons must restrict their activities to either preparing written materials to be approved by a senior management person of—or investment adviser to—the private fund, or responding to investor inquiries (provided that the responses are included in the fund’s PPM or other offering document).

Placement agents and finders

A private fund or investment adviser can establish an affiliated broker-dealer to act as placement agent in connection with the marketing and sale of fund interests. Doing so may prove beneficial to large sponsors desiring to pay commissions to its internal marketing personnel and avoid restrictions in several states on using private placement agents in marketing funds to state and local government pension plans. However, broker-dealer registration is a lengthy and complex process and involves significant ongoing compliance requirements. Consequently, emerging fund managers may find it more practical to engage an unaffiliated third-party broker-dealer to serve as a placement agent.

Private funds, particularly those advised by emerging fund managers with reduced budgets, often forego registered broker-dealers and instead engage unaffiliated “finders” to identify, introduce, and negotiate with potential limited partners. However, one or more of the following activities by a finder in connection with fund marketing is likely to constitute acting as a broker-dealer, requiring SEC registration of the finder under section 15(a) of the exchange act:

Engaging in the solicitation of prospective investors

Receiving commissions or other transaction-based compensation

Providing advice on the potential investment in the private fund

Engaging in negotiations on behalf of a fund concerning the potential investment, or

Having prior securities sales experience or a disciplinary history in connection with selling securities.

The cost to a fund or its manager of working with an unregistered broker-dealer can be high. The limited partner sourced by that unregistered broker-dealer would obtain a right of rescission of the fund’s partnership interests under section 29(b) of the exchange act and applicable state securities laws. Of greater concern, the fund may be unable to rely on registration exemptions in future offerings of securities, and the SEC, through its investigative authority under section 21(a) of the exchange act, may subject the fund or its manager to accounting and disgorgement of profits, civil penalties and other equitable relief. To avoid these and other consequences (such as the reputational harm arising from regulatory investigation), fund sponsors should conduct thorough due diligence of their placement agents, resist the temptation to engage unregistered finders, and work with fund formation counsel to understand the limits of their fundraising activities.

Differences between brokerage accounts and mutual funds

When comparing brokerage accounts to mutual funds, investors should learn the key similarities and differences before investing. Each investment vehicle has its advantages and disadvantages. Find out which one is best for you or if you may need both.

What is a brokerage account?

A brokerage account is an account that is used by investors to buy, sell and hold investment securities, such as stocks and bonds. Brokerage accounts can be opened through a conventional full-service brokerage firm or through an online discount broker. Ownership of brokerage accounts can be on an individual basis or they may be owned jointly.

What is a mutual fund?

A mutual fund is a pooled investment security that combines assets of multiple investors into one professionally managed portfolio. Mutual funds can invest in stocks, bonds, cash or a combination of these assets. In this regard, mutual funds are like baskets that may have dozens or hundreds of holdings.

Brokerage accounts vs. Mutual funds: the similarities

There are a few key similarities between brokerage accounts and mutual funds. Although the similarities are subtle, investors should understand them before investing.

Here are the key similarities of brokerage accounts and mutual funds:

Diversification and flexibility: brokerage accounts and mutual funds can provide broad diversification, which means multiple security types can be held within each investment vehicle. However, the degree of diversification is up to the investor. For example, brokerage accounts can hold multiple security types but the investor may or may not choose to diversify across multiple asset types or investment objectives. Similarly, mutual funds can be broadly diversified or narrowly concentrated. The investor may choose to invest in one mutual fund or multiple mutual funds.

Taxation: although the nuances of taxation can vary slightly between brokerage accounts and mutual funds, there are key similarities: interest income, ordinary dividends, and short-term capital gains are taxed as ordinary income and investors pay a lower capital gains tax rate on long-term capital gains and qualified dividends.

Professional management: if purchased through a full-service brokerage firm, brokerage accounts can be professionally managed, which means a broker or advisor can recommend, buy, and sell securities on behalf of the investor. Mutual funds are also professionally managed, although some are passively-managed funds, such as index funds.

Brokerage accounts vs. Mutual funds: the differences

These differences will be key factors in deciding which investment vehicle is best. Here are the key differences between brokerage accounts and mutual funds:

Structure: perhaps the biggest difference between brokerage accounts and mutual funds is their purpose and functionality, which combine as the structure. Brokerage accounts are not investments; they are accounts that hold investments. However, mutual funds are not accounts. Although they do hold securities, the investor will buy the mutual fund inside an account, which may be a brokerage account, an IRA, a 401(k), a variable annuity, or directly through a mutual fund company.

Opening costs and minimums: brokerage accounts can be opened with no initial costs or fees to the investor. However, mutual funds often have minimum initial investments, which can range from as little as $100 to as much as $3,000 or higher.

Ongoing fees: after opening the account or buying the mutual fund, the ongoing fees can be different. For example, the fees for a brokerage account primarily consist of trading costs, such as transaction fees or commissions. If you use a broker, commissions are generally higher than if you do it yourself through a discount broker. Mutual funds can have sales charges, called loads. There are also no-load funds that do not have sales charges. However, all mutual funds have ongoing expenses that are expressed in the fund’s expense ratio, which typically averages around 1.00%.

Bottom line on brokerage accounts vs. Mutual funds

Comparing brokerage accounts and mutual funds is an “apples-to-oranges” comparison; they are related but not at all the same thing. Brokerage accounts are holding vehicles for investments, whereas mutual funds are investments themselves.

In fact, mutual funds can be held in brokerage accounts.

If you want the flexibility of investing in multiple security types, you may want to open a brokerage account. But if you want to invest in mutual funds, it is often best to buy directly from a low-cost, no-load mutual fund company like vanguard or fidelity.

The balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Differences between brokerage accounts and mutual funds

What is a brokerage account?

What is a mutual fund?

Brokerage accounts vs. Mutual funds: the similarities

There are a few key similarities between brokerage accounts and mutual funds. Although the similarities are subtle, investors should understand them before investing.

Here are the key similarities of brokerage accounts and mutual funds:

Diversification and flexibility: brokerage accounts and mutual funds can provide broad diversification, which means multiple security types can be held within each investment vehicle. However, the degree of diversification is up to the investor. For example, brokerage accounts can hold multiple security types but the investor may or may not choose to diversify across multiple asset types or investment objectives. Similarly, mutual funds can be broadly diversified or narrowly concentrated. The investor may choose to invest in one mutual fund or multiple mutual funds.

Taxation: although the nuances of taxation can vary slightly between brokerage accounts and mutual funds, there are key similarities: interest income, ordinary dividends, and short-term capital gains are taxed as ordinary income and investors pay a lower capital gains tax rate on long-term capital gains and qualified dividends.

Professional management: if purchased through a full-service brokerage firm, brokerage accounts can be professionally managed, which means a broker or advisor can recommend, buy, and sell securities on behalf of the investor. Mutual funds are also professionally managed, although some are passively-managed funds, such as index funds.

Brokerage accounts vs. Mutual funds: the differences

These differences will be key factors in deciding which investment vehicle is best. Here are the key differences between brokerage accounts and mutual funds:

Structure: perhaps the biggest difference between brokerage accounts and mutual funds is their purpose and functionality, which combine as the structure. Brokerage accounts are not investments; they are accounts that hold investments. However, mutual funds are not accounts. Although they do hold securities, the investor will buy the mutual fund inside an account, which may be a brokerage account, an IRA, a 401(k), a variable annuity, or directly through a mutual fund company.

Opening costs and minimums: brokerage accounts can be opened with no initial costs or fees to the investor. However, mutual funds often have minimum initial investments, which can range from as little as $100 to as much as $3,000 or higher.

Ongoing fees: after opening the account or buying the mutual fund, the ongoing fees can be different. For example, the fees for a brokerage account primarily consist of trading costs, such as transaction fees or commissions. If you use a broker, commissions are generally higher than if you do it yourself through a discount broker. Mutual funds can have sales charges, called loads. There are also no-load funds that do not have sales charges. However, all mutual funds have ongoing expenses that are expressed in the fund’s expense ratio, which typically averages around 1.00%.

Bottom line on brokerage accounts vs. Mutual funds

In fact, mutual funds can be held in brokerage accounts.

Broker

What is a broker?

A broker is an individual or firm that acts as an intermediary between an investor and a securities exchange. Because securities exchanges only accept orders from individuals or firms who are members of that exchange, individual traders and investors need the services of exchange members. Brokers provide that service and are compensated in various ways, either through commissions, fees or through being paid by the exchange itself.

Broker basics

As well as executing client orders, brokers may provide investors with research, investment plans and market intelligence. They may also cross-sell other financial products and services their brokerage firm offers, such as access to a private client offering that provides tailored solutions to high net worth clients. In the past, only the wealthy could afford a broker and access the stock market. Online broking triggered an explosion of discount brokers, which allow investors to trade at a lower cost, but without personalized advice.

Key takeaways

A broker is an individual or firm that acts as an intermediary between an investor and a securities exchange.

A broker can also refer to the role of a firm when it acts as an agent for a customer and charges the customer a commission for its services.

Discount brokers execute trades on behalf of a client, but typically don’t provide investment advice.

Full-service brokers provide execution services as well as tailored investment advice and solutions.

Brokers register with FINRA, while investment advisers register through the SEC as rias.

Discount vs. Full-service brokers

Discount brokers can execute many types of trades on behalf of a client, for which they charge a reduced commission in the range of $5 to $15 per trade. Their low fee structure is based on volume and lower costs. They don’t offer investment advice and brokers usually receive a salary rather than commission. Most discount brokers offer an online trading platform which attracts a growing number of self-directed investors.

Full-service brokers offer a variety of services, including market research, investment advice, and retirement planning, on top of a full range of investment products. For that, investors can expect to pay higher commissions for their trades. Brokers receive compensation from the brokerage firm based on their trading volume as well as for the sale of investment products. An increasing number of brokers offer fee-based investment products, such as managed investment accounts.

Real estate brokers

In the real estate industry, a broker is a licensed real estate professional who typically represents the seller of a property. A broker's duties when working for a seller may include:

Determining the market values of properties.

Listing and advertising the property for sale.

Showing the property to prospective buyers.

Advising clients about offers, provisions, and related matters.

Submitting all offers to the seller for consideration.

It is not uncommon to have a real estate broker work for a buyer, in which case, the broker is responsible for:

Locating all properties in the buyer's desired area sorted by price range and criteria.

Preparing an initial offer and purchase agreement for a buyer who decides to make an offer for a property.

Negotiating with the seller on behalf of the buyer.

Managing inspections on the property and negotiating repairs.

Assisting the buyer through to closing and taking possession of the property.

Broker regulation

Brokers register with the financial industry regulatory authority (FINRA), the broker-dealers’ self-regulatory body. In serving their clients, brokers are held to a standard of conduct based on the “suitability rule,” which requires there be reasonable grounds for recommending a specific product or investment. The second part of the rule, commonly referred to as “know your customer,” or KYC, addresses the steps a broker must use to identify their client and their savings goals, which helps them establish the reasonable grounds of the recommendation. The broker must make a reasonable effort to obtain information on the customer's financial status, tax status, investment objectives and other information used in making a recommendation.

This standard of conduct differs significantly from the standard applied to financial advisors registered with the securities and exchange commission (SEC) as registered investment advisers (rias). Under the investment advisers act of 1940, rias are held to a strict fiduciary standard to always act in the best interest of the client, while providing full disclosure of their fees.

Real estate brokers in the united states are licensed by each state, not by the federal government. Each state has its own laws defining the types of relationships that can exist between clients and brokers, and the duties of brokers to clients and members of the public.

Real world example of brokers

There are many companies registered as brokers with FINRA, though some may use their broker designation for different purposes than others. Many proprietary trading firms are registered as brokers so that they and their traders can access exchanges directly, however they do not offer broker services to customers at large. This differs from the role full-service or discount brokers might provide.

Full service brokers tend to use their role as a brokerage as an ancillary service available to high-net worth clients along with many other services such as retirement planning or asset management. Examples of a full service broker might include offerings from a company such as morgan stanley or goldman sachs or even bank of america merrill lynch. Such companies may also use their broker services on behalf of themselves or corporate clients to make large block equity trades.

Other full service brokers may offer specialized services including trading execution and research. Firms such as cantor fitzgerald, piper jaffray, oppenheimer and others. There are many such firms though their ranks have been decreasing because of mergers or from the higher cost of compliance with regulations such as the dodd frank act.

Still other full service brokers offer personalized consultations and communications with clients to help manage wealth and plan for retirements. These firms include companies like raymond james, edward jones or LPL financial.

The larger brokerage firms tend to carry an inventory of shares available to their customers for sale. They do this to help reduce costs from exchange fees, but also because it allows them to offer rapid access to popularly held stocks. Other full service broker firms are actually agency brokers. This means that unlike many larger brokers they carry no inventory of shares, but act as agents for their clients to get the best trade executions.

Late in 2019 many discount brokers made a significant shift in their business model that included charging no commissions on some or all of their equity trades. Examples of some discount brokers include fidelity, charles schwab, E-trade, interactive brokers and robinhood.

Proprietary trading firms registered as brokers may not advertise their services as brokers, but use their broker status in a way that is integral to their business. While larger banks or firms may have proprietary trading desks within their company, a dedicated proprietary trading firm tends to be a comparatively smaller company. Examples of standalone proprietary trading companies include SMB captial, jane street trading, and first new york.

Private funds and managers – navigating broker-dealer requirements

Introduction

Issuer’s exemption and associated persons

Placement agents and finders

Engaging in the solicitation of prospective investors

Receiving commissions or other transaction-based compensation

Providing advice on the potential investment in the private fund

Engaging in negotiations on behalf of a fund concerning the potential investment, or

Having prior securities sales experience or a disciplinary history in connection with selling securities.

Why do you need a broker to purchase mutual funds?

Investment brokers can explain the complexities of mutual fund investing.

Mutual fund companies, known legally as open-end companies, are investment companies that take money from a large pool of investors, mingle those funds and use them to buy a portfolio of securities. Each investor owns a tiny piece of each security in the fund. Different mutual fund companies use different methods for selling shares to investors. Some funds sell their shares only through investment brokers.

Access

Some mutual fund companies offer shares for sale directly to the investing public. You can buy shares of these funds from the mutual fund itself. Other mutual funds offer shares through a sort of mutual fund supermarket at online brokerage firms. If you have an account with such a broker, you can purchase shares of these funds online. Still other funds restrict the sale of their shares to a dedicated sales force, which typically includes investment brokerage firms that have a relationship with the fund. If you want to buy shares of those particular funds, you'll have to buy them through a broker.

Education and advice

Mutual funds are complex financial products, and thousands of funds are available. Each fund has its own specific investment objectives, risk tolerance and management philosophy. Trying to find just the right fund or funds that match your investment needs can be a daunting task. Your investments broker can help educate you on different funds that will be appropriate for your situation, and can advise you on which ones to avoid.

Convenience

Sometimes it's easier to deal with one individual or firm that you're comfortable with rather than a wide variety of financial companies scattered across the united states. By purchasing mutual fund shares through your broker, you can have all of your investment resources, reports and statements in one convenient location.

Considerations

Investment brokers typically work on a commission or bonus structure. If you use a broker to buy your mutual fund shares, chances are you'll either pay a sales charge, known as a load, or a transaction fee. Some brokers might also handle no-load funds, and some mutual funds that you can buy directly still charge a front-end load. A mutual fund's fees and expenses, including any sales load, will be included in the fund's prospectus. The securities and exchange commission recommends reading and understanding the prospectus before you invest any money, whether you go through a broker or not.

Broker / distributor / agent for mutual funds

Broker or distributor in case of mutual funds is someone permitted to sell mutual funds – they are intermediaries in the purchase process. They are typically identified by the ARN stamp they affix on your mutual fund application. Your broker name also appears in any mutual fund statement you receive. At the very least, a broker would guide you through the application process, and also help you get timely statements.