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By Jed Horowitz
NEW YORK, Sept 1 (Reuters) - For most people saving for retirement, buying a non-tradeable real estate investment trust that charges fees and commissions of 11 percent or more doesn’t sound like a good deal.
But for a growing number of stockbrokers in a corner of the securities industry known as “independent” broker-dealers, such products are a big part of their income and their firms’ revenue.
Many brokers are fuming over a proposed U.S. Department of Labor rule that would block them from selling any investment into a retirement account in return for a commission. Instead, the DOL would restrict a broker’s compensation to a fee based on a financial adviser’s hours or a flat percentage of the value of a retirement account.
The goal is to curb an adviser’s temptation to sell products with the highest commissions rather than those that serve the best interests of customers saving for retirement.
The DOL would allow commissions for easily valued investments including exchange-traded stocks and bonds, but only if brokers sign contracts giving customers the right to bring class-action lawsuits if their best interests are not met.
The prohibition on commissions is particularly acute for the independents because they monopolize sale of nontraded products. Fearing lawsuits and revenue restrictions that they say will put some small broker-dealers out of business, they are lobbying Congress in a last-minute campaign to pressure the Labor Department to modify the rules.
It’s not up to the government to tell investors where they can put their money or how brokers should be paid, they argue, and no one understands their clients’ needs better than their advisers.
Brokers say the DOL rule will deprive the middle- and lower-income investors served by most independent brokers of the opportunity to invest in potentially high-yielding products that are given to wealthy people who can afford hedge funds and other pricey “alternative” investments.
“It’s the first time the DOL is limiting what type of investments can be in an IRA,” said Lisa Bleier, a managing director at the Securities Industry and Financial Markets Association, the industry’s main lobbying group. “There is no good explanation for why they did it.”
The independent brokerage community includes more than 900 firms and about 290,000 brokers who act as their sales force but are not their employees. Independent investment advisers and brokers, many affiliated with insurance companies, are the fastest-growing sector of the brokerage industry. The two biggest firms as measured by their sales groups are LPL Financial Holdings and RCS Capital Corp.
Shares of LPL are off 15.2 percent over the last year as of Aug. 31, RCS Capital is down 91 percent and Ameriprise Financial , which sells primarily through independent brokers but also has an employee sales force, is off 8.8 percent.
In addition to selling conventional stocks, bonds, mutual funds and exchange-traded funds, independent brokers are the primary sellers of nontraded REITs that invest in real estate and mortgage securities, of nontraded business development companies that make loans to small and midsized companies and of oil-and-gas partnerships.
Brokers say that they would have to abandon giving retirement advice to thousands of middle- and working-class investors who cannot meet the minimum balance requirements for fee-based advisory accounts if the DOL proposal is not changed.
Investors who manage to hit the minimum could still be hit hard because the financial services industry will likely raise its fees to compensate for lost retirement-account commission revenue, Fitch Ratings wrote in July.
Merrill Lynch already does not pay advisers on any accounts with less than $250,000. Its parent, Bank of America, services such accounts through the bank’s no-frills Merrill Edge unit.
The brokerage industry as a whole told the Labor Department in July that the so-called best-interest fiduciary rule would cost U.S. securities firms more than $5.8 billion, much of which could be passed to investors.
The Financial Services Institute, the trade group for independent broker-dealers, calculated that its members would spend $3.8 billion alone for such startup costs as new record-keeping and disclosure systems to implement the rule, almost 20 times the estimate made by the Labor Department.
The rule will force small firms out of business, giving “small and medium-sized investors” less access to needed retirement advice, it wrote in a comment letter.
Still, both opponents and supporters believe the rule, which is backed by President Obama and Secretary of Labor Thomas Perez, will withstand the lobbying onslaught.
“What’s different here is that regulators usually back down in the face of so much industry opposition,” said Barbara Roper, the director of investor protection at the Consumer Federation of America, a lobbying group, who testified in favor of the proposed rule. “There will be tweaks but the [Department of Labor] staff really believes in this.”
Investors are drawn to nontraded securities by the relatively high income they offer. Dividend yields on private real estate investment trusts in recent years have been just over 6 percent, compared with about 5 percent on real estate investment trusts that are listed on stock exchanges, according to data from Robert A. Stanger & Co., an investment bank that advises sponsors of nontraded products.
But to get that sort of yield on a private REIT, investors pay broker commissions of 7 percent, with the total bill rising to 11 percent or higher once offering expenses, property acquisition fees and other operational costs are added.
Once bought, the products are hard to liquidate. The principal way to cash in at a profit is to hope that a product sponsor lists the stock on a major exchange. If that occurs, it does not happen until six to nine years after the two-year fund-raising period, according to Robert A. Stanger & Co.
Out of 125 nontraded REITs that have been approved by the Securities and Exchange Commission since 2000, 47 have been listed and nine are pending. Out of 19 business development companies (BDCs) effective since 2009, when the product was first offered, two have been listed.
Investors held about $84 billion of nontraded investments at the end of 2014, with 41 percent of the REIT money and 48 percent of the BDC investments in individual retirement accounts at brokerage firms, according to research firm DST Systems. That makes the investments a relatively small part of the retirement asset universe- Americans had about $24.7 trillion of retirement assets at the end of 2014.
The Labor Department rule, which was discussed in four days of hearings at the department in August, is expected to be reissued in September for a brief comment period and go into effect in the second half of 2016. (Reporting by Jed Horowitz, Editing by Dan Wilchins and John Pickering)