Fund payments to brokerages draw SEC scrutiny

Fri Sep 5, 2014 12:01pm EDT
 
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By Jed Horowitz

NEW YORK (Reuters) - (This corrected version of the story fixes 23rd paragraph to show Natixis has paid a nutritionist to make presentations to brokers; it doesn't have a nutritionist on call. Adds "former" to Mary Schapiro's title in additional information at bottom of story).

The tens of millions of dollars in annual fees that mutual fund companies pay to brokerages and their financial advisers to encourage sale of certain funds to retail investors are growing in size and variety, but the phenomenon is largely invisible to investors.

    The U.S. Securities and Exchange Commission, which 18 months ago began a review of fees paid among mutual fund advisers, fund companies and the brokerage firms that sell the funds, has uncovered a complex geometry of payments that may lead to sales of certain funds at the expense of others and is not clearly disclosed under regulators' current requirements, according to a person familiar with the review.

    A final analysis of the fee infrastructure and disclosure holes is expected to be completed by year-end, and could lead to an overhaul of how the industry pays for sales and how the brokerage industry discloses the bounty it collects.  Past attempts by the SEC and the Financial Industry Regulatory Authority to improve disclosure and end certain incentive payments have faltered.

    The failure of regulators to set broad sales practice rules has led to a "very blatant 'pay to play' business model at brokerage firms" and a wide diversity in how much brokers and funds disclose about the payments, said Niels Holch, executive director of the Coalition of Mutual Fund Investors in Washington.

    Gaining a clear understanding of the incentives brokers get for selling certain funds is central to the review, the person familiar with it said, adding that an understanding of how to "follow the money" is beyond the abilities of even a sophisticated investor who reads all disclosures from funds and brokers. Firms vary greatly in what they disclose and how they describe payments from fund companies, according to a Reuters review of disclosures from large and small brokerage firms.

    There is no certainty that regulators can follow the money, either, because the web of payments within the fund and brokerage industries is so complex and embedded. In 2006, the SEC prohibited fund managers from sending commission-generating trades through particular brokers as rewards for their sales efforts. But proposals from the regulator as recently as 2010 to end the billions of dollars of 12b-1 fees that are paid to brokers out of fund assets over the lifetime of an investor’s holdings went nowhere.   Continued...

 
The U.S. Securities and Exchange Commission logo adorns an office door at the SEC headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst