Fee-ling the Pinch: US Online Brokerage Fee Wars and the Fiduciary Duty Rule


March 10, 2017

Published March 10, 2017 10:11 PM

Table Of Contents

    Key points

    With all the legal and political battles going on in the US right now, it’s a little hard to keep track. There are, however, a pair of feuds that DIY investors and Canadian discount brokerages may want to keep on their radars, namely the commission price war between US online brokerages and the efforts to […]

    With all the legal and political battles going on in the US right now, it’s a little hard to keep track. There are, however, a pair of feuds that DIY investors and Canadian discount brokerages may want to keep on their radars, namely the commission price war between US online brokerages and the efforts to rescind the Department of Labor’s (DOL) Fiduciary Duty Rule.

    A tale of two fees

    For DIY investors, competition between online brokerages is generally a good thing whereas for the online brokerages themselves, it’s not so rosy.

    Compared to the Canadian discount brokerage marketplace, the world of US online brokerages is much more competitive. While the standard thesis that competition drives price cuts helps to explain why commission pricing is under pressure in the US online brokerage market, there’s also potentially another strategy related to the Trump view on financial deregulation that some bigger players in the DIY investing space might be hoping to use to their advantage.

    Over the past several years, while interest rates have been low and market volatility muted, major players in the online brokerage space have diversified away from relying heavily on trading commission revenues and instead increased the proportion of their revenue that relies on fee-based advisory services, including newer services such as robo-advisors.

    The result: certain players, such as Schwab, one the largest of the US online brokerages, now make most of their money from services and fees other than trading commissions. Other brokerages, such as their peers in the space TD Ameritrade or E*Trade Financial, are relatively more dependent on trading commissions.

    Thus, the bigger players like Schwab can sway their online brokerage peers into a price war and still emerge a winner because they have the assets and scale to price out their competition.

    Making the cut

    While the pricing wars on US trading commissions between online brokerages seemed to have subsided for the time being, the carnage on the charts is already clear. Schwab’s price chart looks remarkably untouched by recent price cut announcements, whereas TD Ameritrade has clearly been knocked down a few pegs.

    Chart of TD Ameritrade from 3/10/17
    Chart from Schwab 3/10/17

    Fidelity, one of the three biggest Assets Under Management (AUM) companies (the others being Vanguard and Schwab) led the battle to rock-bottom pricing several months ago by dropping commissions on some of its Blackrock ETFs, among other assets. Fidelity and Blackrock share an ETF alliance where traders can buy certain products, especially ETFs, through either company without paying extra fees. The alliance brought Fidelity in to the ETF game and helps both companies shore up market share against competitor Vanguard Group.

    Fidelity continued to lower fees in February and March, slashing $7.95 trade commissions by $3 to $4.95 on online trading stocks and ETFs, then chopping 10 cents from its options pricing contracts, from $0.75 to $0.65. Fidelity manages assets of just below $2 trillion. The play created a domino effect prompting Vanguard and Schwab to quickly follow suit.

    The Vanguard Group, with AUM hovering over the $3 trillion USD mark, announced in early 2017 that it was also lowering fees on trading stocks and ETFs. Vanguard had already dropped prices on 35 different funds in December of last year.

    Schwab, with $2.6 trillion USD under management, also clearly felt it had to leap into the fray, dropping its prices on trading commissions and index mutual funds, first in early February, lowering its base trade commission to $6.95, and then again to match Fidelity’s hard prune to $4.95.

    Screen shot of Schwab’s commission fees (as of 3/10/17)

    Schwab now boasts having the lowest fees on trading stocks and ETFs—saying that “technology and scale” have lowered operating costs and allow them to pass savings on to their clients . . . well, maybe . . . but one wonders how much the prize of gathering assets and the possible ‘repeal’ of the US Department of Labor’s new fiduciary rule has to do with it.

    One rule to cut them all

    The US DOL Fiduciary Duty Rule is intended to ensure that financial advisors act in an investor’s best interest, and avoid conflicts of interest when they give advice on retirement planning and purchase and sale of assets.

    Brokers and others who work on commission may be most affected as a potential conflict of interest arises.

    At least one AUM firm, Blackrock, has admitted that price drops have been influenced by the impending rule, scheduled to come in to effect on April 10 . . . but just to throw another wrench into the works, President Trump signed a memorandum in February directing the DOL to review its implementation of the fiduciary rule. That likely means it won’t take effect next month anyway. No matter, it seems everyone has jumped into the pool of fee restructuring, whether they wanted to or not.

    Other discount brokerages that have lowered costs include TD Ameritrade (AMTD) and E*Trade Financial (ETFC), both announcing cuts to standard commissions.

    Unsurprisingly, values of the stocks for the brokerages themselves see-sawed in the past few weeks in response to the plummeting fees.

    Could it happen here?

    Could a price war on commission fees happen with Canadian discount brokerages? Technically it already has.

    Canada had a similar price war in 2014 when standard commissions for trading stocks and ETFs nosedived to $9.95 from $29 for online brokerages once RBC Direct Investing changed its fee schedule. Minimum investments thresholds to qualify for cheap commissions were also dropped for most brokerages at the same time.

    The plot twist to the Canadian online brokerage price war story is that Virtual Brokers bowed out of the ultra-low commission pricing competition with Questrade signalling that there may be a floor to what a non-bank owned Canadian online brokerage charges for commission pricing. That said, CIBC Investor’s Edge has had the lowest standard commission pricing ($6.95) amongst major Canadian bank-owned brokerages since 2014 and this hasn’t yet prompted its bank-owned peers to follow suit.

    As for the fiduciary rule, Canada may take its cues from spirit of the DOL plan. There has been an undeniable interest in improving the protections for investors in the face of complex financial products and services.

    For at least the past five years, the Canadian Securities Administrators (CSA) have been toying with the idea of placing a similar obligation on Canada’s financial advisors by setting a regulatory “best interest standard.” The standard would work to ensure that financial advisors act in the best interest of their clients, have appropriate disclosures regarding sales of assets and funds, and otherwise protect the interests of the investor. That said, there are still disagreements from provincial securities regulators that demonstrate just how controversial the notion of acting in the ‘best interest’ of a client is.

    Interestingly, the firestorm surrounding TD Bank this past week put this very topic into the spotlight in Canada with the revelation that staff may have been operating unethically in suggesting or providing financial products or services to bank clients.

    Bottom Line

    Financial services, and investment services in particular, may have different dynamics in the US and Canada but they nonetheless follow some very basic economic principles.

    Competition drives innovation and pricing that favours consumers, however, what also appears to be true is that providers like online brokerages will need to find more creative (and still legal) ways in order to generate profits.

    With fees falling fast and furious, and President Trump with pen in hand, until the dust settles it’s hard to say who will win the race to the bottom in US and whether the trend of ‘deregulation’ in the US will be a counterpoint or inspiration to regulators here. Judging by the fallout in this week’s news, however, Canadians are being vocal in backing investor protection.