Putnam Drops Directed Commissions

November 26, 2003 (PLANSPONSOR.com) - A practice of directing mutual fund commissions to the brokers who make the sale is being dropped by Putnam Investments.

The move by Putnam was disclosed in a letter to US Securities and Exchange Commission (SEC) Chairman William Donaldson from the chairman of Putnam fund’s board of trustees – a body that represents the interest of mutual fund shareholders – John Hill.   “We believe that eliminating this long-standing potential conflict of interest in the mutual fund industry would serve the interests of all mutual fund shareholders and urge the commission to make Putnam’s new policy the industry standard,” wrote Hill, according to a Wall Street Journal report.   Hill added he did not believe the current practice at Putnam violated any regulations.

Hill said in the letter he believed the practice created a “potential conflicts of interest” between Putnam and its shareholders.   For this reason, Hill urged Donaldson in the letter either to restrict or end the practice on an industrywide basis.

Putnam’s decision to stop the practice was made by the board in July, and the firm was given until January 1 by the board to stop the practice.   This was to provide time for the company to rework arrangements Putnam has with financial firms that sell Putnam funds, according to Hill’s letter.

The letter comes at Putnam tries to stop the hemorrhaging of cash out of the firm’s mutual funds in the past three weeks as the firm faces state and federal civil-fraud charges related to fund trading (See  Putnam, SEC Reach Securities Fraud Settlement ).   Putnam acknowledged that six fund managers engaged in short-term trading of Putnam funds in their personal accounts that hurt long-term shareholders (See  Putnam Excuses Two More Fund Managers ).   Asked for comments on the letter, an SEC spokesman told the Journal that Donaldson does not comment on correspondence.  

Additionally, Boston-based Putnam’s decision coincides with a broadening focus by regulators on sales practices in the mutual fund business. Last month, SEC Chairman William Donaldson announced the agency was considering reforms in the mutual fund industry to curb late-trading activity and other potential questionable practices (See  SEC to Consider Post-Canary Scandal Trading Reforms ).  Among them were proposals to require the fund, and not intermediaries, to receive trades before the fund sets the day’s prices and additional requirements to reinforce funds’ and advisers’ obligations to comply with their fiduciary duties and to prevent the misuse of non-public information, including the selective disclosure of portfolio holdings information.

In that probe too has been the directed brokerage practice that mutual fund companies employ to rewardbrokerage firms that sell large amounts of their funds by steering trading business to those brokerage firms.   While it is legal for a mutual fund to consider a broker’s record of selling its products when deciding where to direct commissions – as long as the broker is providing “best execution” of trades, or prices in line with those of other brokers – it is illegal if there is a set quid-pro-quo between the broker and mutual fund in which commissions are traded for extra business.