SEC Looks to Prohibit Special Mutual Fund Payments to Brokerages

January 30, 2004 (—The Securities and Exchange Commission (SEC) staff is suggesting that the agency prohibit mutual funds' special payments made to brokerages in exchange for directing clients towards certain funds, in light of investigation findings showing that the practice is widespread, and generally undisclosed to investors, the AP reported.

This practice hurts investors who are encouraged, by brokers, to buy funds that might not be suitable for their portfolio, but for whose sales the brokers are being rewarded.

The SEC had previously released a proposal that would require disclosure of such arrangements to investors in order to address any conflicts of interest.     In November, legislation was passed by the US House of Representatives increasing mandated disclosure from fund companies, and the US Senate will debate similar legislation this year.  

However, Paul Roye, the head of the SEC division that oversees the fund industry, said this new SEC proposal will be presented in February to the five SEC commissioners for a vote, the AP said.     The proposal could face criticism from some commissioners, but the AP reports that SEC Chairman William Donaldson supports this recent idea, hoping it will help to increase confidence in the beleaguered fund industry.  

The recent SEC investigation showed for every $100,000 in sales to customers of favored funds, brokers pocketed between $50 and $400.   Additionally, 14 of 15 brokerages selling mutual funds received cash from funds’ investment advisers, with two-thirds of the brokerages participating in revenue sharing, receiving their payments as commissions on trades, according to the AP.   In exchange, the SEC said 13 of the 15 brokerage firms favored the funds (see  SEC: ‘Revenue Sharing’ Rampant in Mutual Fund Sales ).

The SEC is also investigating cases in which brokerage firms did not reveal that they encouraged clients to buy funds for which they were paid by the mutual fund companies.