New Share Classes in a DOL Fiduciary World

As it stands now, according to Ellenbogen, "active" T shares that have money in them and are available for purchase are being offered by four fund complexes (with a total of 54 different funds): Calamos has 16; Transamerica offers 34 (called T1 and T2); Columbia has three; and American Beacon offers one fund.

Seven other companies have filed to launch T shares and have received SEC approval, Ellenbogen said, but are also "hedging their bets" regarding Labor's rule, and "you can't buy them" yet. "We expected they'd be launched by now," he said. Those companies are: Federated, Cohen & Steers, Hancock, Allianz, Wells Fargo, BNY Mellon and Dreyfus.

ICI's Blass noted in a comment letter to Labor in late March regarding potential delay of the rule that the launch of a new share class "is complex and costly," and that "direct costs incurred by funds related to a share-class launch generally include legal consultation, audit work, system modifications and establishment of product parameters (e.g., account minimums, shareholder eligibility, rights of accumulation calculations), various filing fees (e.g., NASDAQ, CUSIP), Blue Sky registration fees by state, print and typesetting costs for production of regulatory documents, and seed money."

While the cost to launch a share class "can vary widely depending on several factors, the data reported to the Institute show that on average the direct cost to launch a fund share class is $31,000," Blass wrote.

ICI, the fund industry's trade group, estimates that to comply with Labor's fiduciary rule, "funds may need to launch more than 3,500 T share classes. The cost of creating approximately 3,500 new share classes will total at least $111 million." Of this, Blass continued, ICI estimates that funds "may have already spent upwards of $17 million in costs that they will be unlikely to recover if the rule is revised or rescinded."

Cost Benefits of T Shares

Traditional A shares purchased through a broker include an immediate fee called a front-end load (expressed as a percentage of the purchase) as well as management fees and ongoing fees for distribution expenses, called 12b-1 fees, Morningstar explained in its research.

Some investors stand to save money with T shares because they offer a lower front-end sales loads than A shares. In general, from early filings, Morningstar said, "we believe most T shares will have a 2.5% maximum front-end load — that is, the most an investor could pay in up-front fees would be 2.5% of their investment. In contrast, A shares average a maximum front-end load of 4.85% among the more than 3,000 A shares with loads we track in the Morningstar database."

Investors with less money to invest in IRAs could also benefit from the shift to T shares from A shares because these are investors who would be more likely to pay the maximum load, Morningstar said. "In fact, just 5.7% of A shares have lower maximum loads than the 2.5% maximum front-end loads we expect to see with T shares."

As Blass told Labor in his comment letter, "intermediaries plan to use T shares for transitional purposes, until they can develop a better solution (such as 'clean' shares, on which brokers charge an 'external' commission). Because other solutions will require significant implementation time due to regulatory requirements, however, many fund companies have determined that they have little choice but to go through the expensive and time-consuming process of preparing the T shares."

Ellenbogen agreed that T shares are "transitional because most of the broker-dealers, big and small, are not really set up to divorce the commission payments from the payments to asset managers," whereas with the clean shares "everybody gets paid directly."

Going forward, regardless of the fiduciary rule's fate, Morningstar anticipates the continued trend of "unbundling of asset management" fees, Ellenbogen said, suggesting "services will be billed separately, and then financial advice will have its own fees and not be wrapped in a 12b-1 fee."

— Read Morningstar Pushes Change in DOL Fiduciary Rule Enforcement on ThinkAdvisor.