Expats face restrictions on U.S. mutual fund accounts; Charles Schwab, Fidelity, and T.Rowe Price no longer allow overseas residents to buy mutual funds

By Jonathan Lachowitz

Overseas Americans have faced a myriad of challenges in managing their financial lives, especially in the last five to ten years. They have felt unjustly burdened with financial accounts in the U.S. or abroad being closed or restricted, a tremendous amount of paperwork to prove U.S. tax compliance to overseas banks and, to allow those banks to share their private information, as well as increased costs for doing business and staying compliant with U.S. tax regulations.

Now, in a move that is certain to make investing more challenging, buying U.S. based mutual funds has now also come under attack.

Earlier this year Charles Schwab and Company, Fidelity Investment and T.Rowe Price announced that they would no longer allow Americans living overseas, even their own employees, to buy US based mutual funds. There are limited exceptions for 401k plans, but for all other accounts including IRAs and Brokerage accounts, whether self managed, with the company as the advisor or with an independent investment advisor, mutual fund purchases (including dividend re-investments) have come to a halt.

The companyies are not forcing clients to sell the mutual funds (forcing a capital gain or loss) and are not for the most part forcing accounts to be closed, but they are limiting new purchases.

Some of the financial services difficulties that overseas Americans have faced in recent years have been a direct or indirect result of FATCA (Foreign Tax Compliance Act part of the 2010 HIRE Act) or U.S. Federal Tax and Treasury regulations; specifically the increased focus on Foreign Bank Account Forms (FBARs) and the correct income tax reporting of overseas income. However, this latest difficulty on the purchase of mutual funds is not a direct result of FATCA or U.S. Tax and Treasury regulations.

The sale and distribution of mutual funds is separately regulated in the U.S. by the Securities and Exchange Commission (SEC) and in other countries through a variety of regulatory bodies that enforce local legislation that is generally meant to protect consumers in the purchase of financial products.

Because foreign jurisdictions are unable to regulate investment funds that are not registered in their jurisdiction, most prohibit the sale of foreign [including U.S.] mutual funds to residents living in their countries. This includes overseas U.S. citizens trying to buy investment funds back in the United States. New European legislation called the Alternative Investment Fund Managers Directive (AIFMD) further restricts non-registered funds and is an additional consideration for US Mutual Fund Companies and their distributors. To comply with local laws governing the distribution of, foreign funds, including from the U.S., a provider must be registered for sale and marketing in foreign jurisdictions which often means increasing disclosure [to regulators and consumers] requirements too.

The sale of U.S. mutual funds to U.S. citizens not resident in the U.S. has operated in a legal grey area for a long time; a kind of don’t ask, don’t tell. U.S. financial institutions would allow overseas clients to have a U.S. mailing address and a foreign “legal” address, and this gave the U.S. institutions, or specifically their compliance departments, enough reassurance that foreign jurisdictions would not bother them, even if they were in a legal grey area with respect to the distribution of U..S mutual funds (many funds and advisors of which are not registered in foreign jurisdictions).

The recent decisions by U.S. brokerage firms, in late 2014 and early 2015, to prohibit clients overseas to buy U.S. mutual funds is a calculated risk. The percentage of their clients residing overseas is small but the increased potential for fines from foreign jurisdictions is large and increasing, especially in light of the record level of fines that the U.S. government are charging U.S. and non U.S. financial institutions for a variety of misdeeds. Some large U..S firms are fearful, and perhaps rightfully so, of actions by foreign governments for not following foreign law and so would rather inconvenience a small part of their client base rather than risk a large and potentially embarrassing fine.

Using a family member or friend’s address to try and circumvent these rules could be dangerous. U.S. financial institutions are going to great lengths to track their customers and to protect their businesses. They use software to log from where (which country) clients access their website and new software allows them to pinpoint within a very small area where a phone call is coming in from, regardless of what id the phone number is. They scour financial records, social media, and other public and not so public information to keep tabs on their customers.

Luckily, with respect to the mutual fund issue, a reasonable work-around that is generally legal from most countries is to buy ETFs (which trade like stocks; between individual investors) rather than mutual funds where subscriptions and redemptions generally happens between the investor and the investment/fund manager. In the case of Vanguard, many of their ETFs are in fact shares of their mutual funds, a process they have patented. ETFs can have other advantages over mutual funds too such as lower costs, redemption and purchases throughout the trading day and generally a lot fewer capital gains distributions.

Personal financial management for overseas Americans will undoubtedly stay complicated for years to come and American Citizens Abroad will continue to educate our constituency and try to influence decision-making in Washington in order to improve our own government’s treatment of its overseas citizens.

In the case of mutual fund distribution however, this is clearly a business/risk management decision by U.S. financial institutions and not a result of FATCA or U.S. tax policy.

Jonathan Lachowitz is a member of the Executive Committee of ACA, a Certified Financial Planner(tm ), and a professional and a small business owner serving overseas Americans.