What to Know About Intermediary Channels for Mutual Fund Distribution

Your plan is in place, your team has been assembled, and your investment objectives are set. You are almost ready to launch your mutual fund. Yet, before your fund enters the marketplace, you will need a distribution plan. How will investors find your fund? Who will be your target market? What will the purchase process look like? And who will be your key partners in this new market endeavor?

There are two distribution channels that can be used when launching a mutual fund. Investors can purchase fund shares directly from the fund company via the fund’s transfer agent or by using a fund platform — this is the Direct Channel. Alternatively, investors can enlist an intermediary such as a broker-dealer, bank, or registered investment adviser (RIA) to facilitate their mutual fund transactions — this is the Intermediary Channel.

In today’s market, most fund purchases are facilitated via intermediaries. Consumers are attracted to the intermediary channel because it guides them through a crowded, often complex investment landscape. Intermediaries assist consumers through every point of an investment transaction. Examples include:

• Advice about where and how much to invest
• Access to a wide variety of investment options
• Offer of a single point of purchase for multiple investment products
• Post-purchase transmission of regulatory filings and other reports to the consumer on behalf of the fund

To facilitate the sale of shares, intermediaries enter into agreements with mutual fund companies, advisers, and/or service providers. The type of agreement and the executing parties depend on the nature of the intermediary’s business and their compensation requirements. Those that seek payment only in the form of sales loads and 12b-1 fees typically enter selling agreements (also known as dealer agreements) with the fund’s principal underwriter.

Intermediaries that require compensation other than load and 12b-1 payments enter into operating agreements (also known as servicing agreements). The mutual fund company and/or the fund adviser are a party to these agreements to facilitate such payments. Entering an agreement may take several weeks. The time is spent by the intermediary performing due diligence on the investment product and its sponsor, quantifying internal demand for the product or strategy, and negotiating the terms of the agreement. The intermediary must also collect operational information to establish a fund profile on their back-office systems. They ensure that trading capability exists and that the terms of the prospectus are systematically enforced regarding minimum investment amounts, sales load and breakpoint schedules, and short-term redemption fee details.

Broker - Dealers

A broker-dealer is a regulatory designation that refers to an institution that trades securities on behalf of its clients (acting as a broker) and its own account (acting as a dealer). Broker-dealers can be small boutiques serving a select clientele, large international financial institutions, and many other organizations in between.

Typically, a client interacts with a broker-dealer via one of its financial adviser employees, who advises the client on the purchase or sale of securities. From the other side of the transaction, funds use broker-dealers as a medium for selling shares to investors.

Broker-dealers are regulated by the U.S. Securities and Exchange Commission (SEC), pursuant to the Securities Exchange Act of 1934, and the Financial Industry Regulatory Authority (FINRA) self-regulatory organization. Broker-dealers are also subject to various state securities laws, known as “blue sky laws.” We will discuss in detail the three main categories of broker-dealers: wirehouses, regionals, and independents.

Wirehouses

The term “wirehouse” was coined in the early 20th century to refer to brokerage firms with offices in different cities connected via telegraph and telephone wires. In the networked age, the name can be applied to any large financial institution that uses electronic means to connect branches in different locations. The most common usage of the term wirehouse in today’s financial industry is to refer to a full-service brokerage firm with a national (and often global) reach that offers clients a range of services, including financial advice, research, investment banking, trading, and more. Currently, there are four major wirehouses, known as “the Big Four”: Bank of America’s Merrill Lynch, Morgan Stanley, UBS, and Wells Fargo Advisors.

Examples of wirehouse onboarding requirements may include:

• Existing fund assets that exceed a specific dollar amount (i.e., $50 million or more)
• A quantified demand for the product within the wirehouse
• A track record of a certain length (i.e., one to three years)
• An expense ratio that does not exceed a certain threshold
• A demonstrated national distribution plan

Regionals

As the name suggests, regional broker-dealers are focused on a specific geographical area. They are not as large in size or scope as wirehouses, and their products and services, while varied, are typically more limited than those offered by “the big four.” Investors may choose regional for many reasons, including They may prefer working with a smaller firm. They may like to invest with a company based nearby that shares their culture and values. Lastly, they prefer to work with financial advisers who are generally independent contractors of the regional firm instead of an employee. Examples of regional broker-dealers include Edward Jones, RBC Wealth Management, and Stifel.

Independents

The final category of broker-dealers is the largest of the three: independent broker-dealers. Unlike wirehouses but like regionals, independent broker-dealers are staffed by registered representatives (e.g., financial advisers, brokers) acting as independent contractors rather than employees. The services offered remain largely the same; however, these independent financial advisers are afforded the flexibility to conduct their business outside of a large institution’s oversight. The partnership allows the financial adviser to take advantage of the parent company’s compliance and technological resources while remaining “independent” in its investment focus. Some of the largest independent broker-dealers are LPL Financial LLC, Commonwealth Financial Network, and Raymond James Financial.

Independent and regional broker-dealers typically enter into a selling agreement with a fund’s principal underwriter but may also require a networking fee reimbursement agreement. This is a separate form of agreement between the broker-dealer and fund adviser related to servicing the underlying client’s account. To the extent the broker-dealer assumes responsibility for supplying transaction confirmations, periodic account statements, annual tax reporting, and other shareholder services, they may seek a per account fee to offset the associated costs.

Registered Investment Advisers

RIAs are intermediaries who advise clients on funds as part of a comprehensive financial planning strategy. RIAs can work directly with mutual fund complexes or fund supermarkets to facilitate purchases on behalf of their clients, or work with another intermediary such as a broker-dealer or bank.

Other Intermediaries

Banks also serve as intermediaries in the mutual fund marketplace, offering funds to their retail clients. A bank’s trust department can provide these services, especially for smaller, regional banks. A small bank may also offer mutual funds to its clients via a referral relationship with another intermediary, such as a local independent broker-dealer. Alternatively, a bank can offer mutual funds to its clients using a platform or “fund supermarket,” thereby connecting these consumers to the “direct channel.” A direct channel is common for larger national banks. Insurance companies also act as intermediaries in the mutual fund marketplace via variable insurance products. Variable insurance policies allow the insured to invest a portion of their premium payments into various investment products known as sub-accounts, including mutual funds.

Clearing Firms

Clearing firms (also known as clearing corporations, clearing houses, or carrying firms) work with exchanges to handle the confirmation, settlement, and delivery of transactions and ensure they are executed promptly and efficiently.

Clearing firms maintain mutual fund platforms that provide access to thousands of funds available for purchase. Clearing firm platforms are accessed by broker-dealers who employ their clearing services. These relationships typically require multiple agreements for the introducing broker-dealer to have access to a fund, including a selling agreement between the broker-dealer and the fund’s distributor, and a service or operating agreement between the fund company (or affiliates) and the clearing firm.

Launching a mutual fund?

If you are looking to launch a mutual fund, then download our guide below. Our Mutual Fund Distribution Guide will show you the two channels of mutual fund distribution and introduce you to the key players. We will explain the different types of broker-dealers that participate in this process and how they work with advisers like you to attract and maintain investors. Along the way, we will also discuss aspects of the compensation, regulation, and strategy involved in launching and operating your fund.

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How we help

If you are ready to launch a mutual fund, then contact us today to get started.

ACA Foreside distributes over $1.1 trillion (about $3,400 per person in the US) of mutual fund product for over 240 fund families through our broker-dealers. We serve as the legal underwriter for registered funds (mutual funds, closed-end funds, and ETFs) and placement agent for private funds. We provide our clients with an established broker-dealer framework and ongoing education to meet the changing SEC and FINRA regulatory landscape.

Once launched, we can further support you with our broad range of advisory, managed services, and regulatory technology solutions, to help you grow and protect your business, while also addressing your compliance, ESG, investment performance, and cybersecurity challenges.