Risk & Compliance

Funds Ordered to End Broker Incentives

Portfolio managers are also required to reveal investments in funds they supervise.
Ed ZwirnAugust 19, 2004

The Securities and Exchange Commission ordered mutual funds to stop paying higher commissions to brokers who promote the companies’ funds and required portfolio managers to reveal investments in funds they supervise, Bloomberg reported.

Wednesday’s SEC action continues the agency’s crackdown on the mutual fund industry. The agency has now passed 10 new rules in its overhaul of fund regulation, according to the report. Regulators have imposed about $2.5 billion in penalties against fund companies, including Putnam Investments and Alliance Capital Management Holding LP.

“These rules effectively complement the comprehensive mutual reform efforts that have been underway since last fall,” SEC Chairman William Donaldson was quoted as saying at a meeting in Washington. “I think we now have a system that we ought to give a chance to work and see the improvements I hope it will bring.”

Today’s rule on increased commissions, incentive payments known as “directed brokerage,” comes out of an industry-wide probe of fund sales practices regulators began last year. The SEC is probing eight brokerage firms and 12 fund companies for hiding the extra payments from investors, according to Bloomberg.

According to the report, a number of fund companies, including MFS, Franklin Resources Inc. and Putnam Investments, have already said they would stop making directed-brokerage trades. John Hill, chairman of Putnam’s board of trustees, estimated the extra commissions were costing shareholders $30 million to $40 million a year.

Mutual funds pay the incentives by steering their trades to brokers who push the companies’ funds and by paying a higher commission, usually 5 cents a share instead of 2 cents, according to the news service. The commissions come out of the funds’ assets.

In some cases, the mutual-fund company pays the incentive to the broker directly, according to Bloomberg. At other times, the funds reportedly tell brokers to pay the added commission to another broker not involved in the transaction, but who promotes the company’s mutual funds.

The commissions order also targets unseen conflicts of interests at mutual funds. Under the new rule, portfolio managers must reveal their investments in funds they supervise, the new service reported.

The disclosure rule, which will take effect Feb. 28, 2005, orders fund companies to disclose to investors in detail how their managers are paid, according to Bloomberg.

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