In July of 2020, Fidelity, the largest record keeper of defined contribution plans in the nation, agreed to settle a lawsuit over its own 401k for $28.5 million.  The plaintiffs claimed, among other things, that Fidelity breached its fiduciary duty by loading its $15 billion 401(k) plan with proprietary mutual funds, causing the firm and several affiliated entities to benefit financially. The plaintiffs alleged that participants incurred more than $100 million per year in losses compared to the average 401(k) plan due to high fund fees and poor performance. This lawsuit was filed in October of 2018.  Interestingly, in 2014, Fidelity settled a very similar class action lawsuit brought by its own employees or previous employees over the company’s own 401k plan. The plaintiffs claimed that the company’s employee plan was dominated by higher-cost Fidelity mutual funds when lower-fee options were available. The 2014 case was settled for $12 million. 

I am an advocate for an open platform. In my opinion, if you have a good product, you should not be afraid of competition. There would be no reason to restrict the funds available to be only your proprietary products. 

Fidelity is the largest 401k record keeper in the nation, but Nowadays, it does a LOT more than just record keeping, it acts as the wealth manager/financial advisor for many employees managing their assets outside the company’s 401ks, and when those employees retire, many roll over the money from their company’s 401k to Fidelity’s managed accounts. 

As an investor, it is very important for you to do sufficient due diligence on a firm before you trust your life savings with them.  As part of your due diligence, you should read a firm’s regulatory filings with the SEC. In the financial services industry, a firm can do a lot of things that may make you raise your eyebrows, as long as they disclose these practices to the SEC. If you are interested in learning more about an investment advisory firm’s SEC filings, please watch my other video, Do You Know Your Advisor as Well as the SEC does?

I am going to walk you through some of Fidelity’s SEC filings. I will try to make this as interesting as possible. 

Fidelity offers investment advisory services through one of its affiliates, Fidelity Personal and Workplace Advisors LLC (“FPWA”).  This snippet was taken from the SEC’s website on August 12, 2020 showing the regulatory filings of quite a few advisory programs the entity offers. Please note, however, that Fidelity states that   “Our investment advisory programs charge different fees. This creates an incentive for us to recommend advisory programs that pay us or our affiliates higher fees over other programs.”   If you are considering working with Fidelity, I highly recommend you read all the program brochures filed with the SEC thoroughly so you can pick the best ones that suit your needs and have the most reasonable price tags.   Unfortunately, you cannot rely on your Fidelity advisor’s recommendation, because  “Our representatives have an incentive to recommend that you select a program or product that pays them more compensation than those that pay less.” 

 Even after you finally decide on the advisory program in which you want to participate, you can’t sit back and relax just yet.  You need to understand that Fidelity also has conflicts of interest when it comes to recommending the products in which you should invest your money within those programs.  This is clearly disclosed in their own regulatory filing. FPWA or its affiliates earn more fees when your assets are invested in a product that we (or our affiliates) advise, manage, or sponsor, such as a Fidelity mutual fund or ETP. We will apply a fee credit to address the incentive to invest your assets in these products over others. FPWA or its affiliates also earn fees when your assets are invested in some third-party funds and ETPs. We will apply a fee credit to address the incentive to invest your assets in those products over others.”

How exactly do they calculate this fee credit? I don’t know. I bet it is quite complex. As Fidelity states, “It is important to understand that FPWA’s affiliates receive compensation for providing a variety of services to mutual funds and ETPs, as described below in “Client Referrals and Other Compensation.” Such compensation is included in the Credit Amount only to the extent that it is retained as a direct result of investment by Program Accounts. Compensation that is not directly derived from Program Account assets is not included in the Credit Amount”. 

Interestingly, when Fidelity settled the lawsuit involving its own 401k in 2014, as part of the settlement, it agreed to rebate revenue sharing from mutual funds on the plan menu back to the plan. This measure, however, was criticized by plaintiffs in the more recent case as “an accounting gimmick.” 

You might be interested in using Fidelity’s brokerage services instead of their advisory services, so that you don’t have to deal with the complexity of different advisory fees. Well, you need to keep in mind that first,“…you or someone you designate are solely responsible for deciding whether and how to invest in the securities, strategies, products, and services offered by FBS. You or your designee are also solely responsible for the ongoing review and monitoring of the investments held in your FBS Account, even if FBS has made a recommendation to you.”, and “You are responsible for independently ensuring that the investments in your FBS Account remain appropriate given your Investment Profile.” So you are pretty much on your own. Secondly, you might not be able to avoid Fidelity’s conflicts of interest by using their Brokerage Services. As Fidelity discloses itself “ The products and services we offer have different costs to you and different levels of compensation earned by us, our affiliates, and our Representatives. Generally, FBS and our affiliates earn more compensation when you select a product or service offered by us or one of our affiliates (i.e., a “proprietary” product or service), as compared to a product or service offered by a third party. As a result, FBS has a financial incentive to recommend certain accounts, products, and services, including those that are proprietary, over others when working with you. I know, it sounds very familiar. To give you an example, if you are buying mutual funds through FBS, “FBS offers proprietary and third-party mutual funds that do not have a transaction fee, as well as third-party mutual funds available with a sales load and/or a transaction fee. Neither FBS nor its Representatives provide recommendations with respect to mutual funds that have a transaction fee.”

No transaction fee, that sounds great! The question is, why are there funds with a transaction cost and funds without a transaction cost? Why doesn’t Fidelity and its reps recommend mutual funds that have no transaction costs? Is it because the no-transaction-fee funds, NTF, are cheaper for you, the investor? 

I cannot find the answers from Fidelity’s disclosures. However, if you review the disclosures of a firm that shares many similarities with Fidelity, Charles Schwab, you will find some interesting information. 

In Schwab, mutual fund companies are segmented into relationship tiers based on a combination of their fund assets held at Schwab and the asset-based and flat fee paid to Schwab. Just like Fidelity, Schwab offers a selection of no-load, load-waived mutual funds and no-transaction-fee funds. Based on Schwab’s own disclosures, “NTF Funds pay Schwab an asset-based annual fee, which usually equals 0.40% of the average fund assets held at Schwab but may be as high as 0.45%.” So in Schwab, in order to get on to its no transaction fee platform, the fund has to pay usually 0.4%, as high as 0.45% to Schwab.  

As early as September 2010, Kiplinger published an article titled “No Transaction Fund Fees: Are they Really Free?”. The article states that Schwab charges 0.4% to fund families to get on its NTF network, Fidelity charges the same 0.4%, as does TD Ameritrade.  Keep in mind the 0.4% is ONLY the fees paid to Fidelity or Schwab, the mutual fund companies of course have to make money on top of that, so the total expense ratio of the no-transaction-fee funds can get quite expensive. Kiplinger’s article suggested that “If there’s a choice between an NTF fund and a similar fund with a transaction fee, don’t immediately pick the NTF fund. Instead, look up the expense ratios of the two funds, Then do the arithmetic. Ninety times out of 100, the cheaper fund will be the better deal than the “free,” or NTF, fund — assuming you hold the fund with the lower expense ratio for a few years.” It seems not much has changed since the date of that article, which was written ten years ago. Of course, you will have to do the comparison and research yourself, since Fidelity won’t provide recommendations for any funds outside the funds that are not NTF Funds. Besides the no-transaction-fee funds, “ FBS and its affiliates also receive compensation through a fixed annual fee from certain third-party fund companies that participate in an exclusive marketing, engagement, and analytics program. The only third-party fund companies eligible to participate in this program are those that have adequately compensated FBS or its affiliates for shareholder servicing and that have demonstrated consistent customer demand for their funds. “, again, the disclosures don’t specify how much revenue sharing is considered “adequate” to Fidelity. 

I am just giving you examples of mutual funds, there are also conflicts of interest when it comes to ETF, insurance, annuities, private funds and alternative investments, the list goes on and on. You need to read the disclosure booklet; it’s a 12 page long document in a fairly small font. And product choices are just one of the conflicts.  

If you are still interested in reading more, I would suggest two Wall Street Articles. One is “Government Probes Fidelity Over Obscure Mutual-Fund Fees”, and the other is “Advisers at Leading Discount Brokers Win Bonuses to Push Higher-Priced Products”, with the subtitle “At Fidelity, Schwab and TD Ameritrade, employees win extra pay and other incentives to put clients in products that are more lucrative for them, and the firm”. 

Your financial advisory firm is your partner on the way to your financial success. So, it is important for you to choose a partner whose interests are in alignment with yours.