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Wednesday, March 31, 2004
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.

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