MFS Again
One of the other well-known but even more damaging practices in mutual funds is when brokers are given incentives to push customers into a particular fund or family of funds. True, there are rules requiring brokers to consider whether an investment is appropriate for an investor, but this leaves an awful lot of wiggle room. Also, for example, if an international equity fund is appropriate, is there a problem if the broker recommends a fund that barks, chases cats, and scratches its ear with its hind leg? Not really.
Mutual fund families pay brokerage commissions to get their products sold, but the commissions are pretty much the same for all funds of a particular type, so there has to be some incentive to get the broker to push a fund. One way is what is called "directed brokerage." Under this arrangement, the fund management company agrees to make its portfolio trades through the broker in exchange for their promotional efforts. This is what MFS, among others, used to do, and it just cost them a $50 million fine. The problem with the practice is that they are using the investors' money, in the form of increased trading costs, to benefit the management company. Believe it or not, the practice is currently permitted as long as it is disclosed to investors. If disclosed, it is merely malodorous, not illegal.
Civil suits against mutual fund management companies will be consolidated in Baltimore, according to this article in the Miami Herald. Scroll down for an excellent timeline of the whole nasty business.
I realize I haven't been posting about this, but I have an excuse: I've been working non-stop on this in real life, plus a big dollop of Sarbanes-Oxley work.
What seems to be a recurring theme now is that Spitzer is getting fee reductions as part of the settlements he reaches. This is an excellent thing for individual investors. They actually lost very little in the market timing and late trading activities, but they have been gouged for years in fees. The highest fees, of course, are found in those fund groups sold through a broker. They do not compete on price, which is what the expense ratio really represents. These funds do not move on their own — someone has to push them. No load funds are conspicuously absent from this scandal.
Meanwhile, another writer wonders whether the competition for audiences is driving the SEC and NYAG. Maybe, but so what? In this instance, competition has sharpened all the participants.
