Long-standing bad habits become accepted industry practices. When exposed to outside scrutiny, these routine vices have produced headlines aplenty lately over fraudulent accounting, boardroom abuses, not to mention the tainted securities research that cost Wall Street firms $1.4 billion.
Now America's mutual fund industry is coming under the gaze of concerned regulators for one of its bad habits. The Securities and Exchange Commission has been investigating "revenue-sharing," in which fund companies, unbeknownst to fund shareholders, essentially pay brokerage firms a tariff to distribute their wares. This controversial practice was exposed in a May 2001 Institutional Investor cover story by Staff Writer Rich Blake.
But there's more mischief afoot in the fund world, as you can read in this month's cover story by Blake, "Misdirected Brokerage," which begins on page 47. A portion of that revenue-sharing tariff, it turns out, comes directly out of the pockets of fund shareholders, not from the fund company's coffers.
Fund companies allocate trading commissions to brokerages in exchange for fund distribution. Known as directed brokerage, this use of commissions is allowed under narrow circumstances.
But as Blake reveals in his story, the SEC has concluded that fund companies' directed brokerage payments for distribution are in most cases illegal. They keep company costs down, boosting their profits, but end up costing fund shareholders by cutting into returns and artificially inflating commission charges.
Blake reports that the SEC, in a widely anticipated report due out in a month or so, is poised to recommend measures that ultimately could result in wide-ranging changes in the way mutual funds are marketed. At the very least, the agency is likely to push for wider disclosure of a questionable practice that has passed for business as usual. Until now.
"Having to own up to a hidden profit boost," notes Blake, "is the last thing the fund industry wants to do right now."
