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Incentives For Brokers Under SEC Scrutiny

Jan 14, 2004 | Knight Ridder News Service Federal regulators have begun investigating eight brokerage houses and 12 mutual fund companies for failing to disclose potential conflicts of interest, in the latest twist in the unfolding mutual fund scandal.

The Securities and Exchange Commission said Tuesday that it's looking into brokers who have failed to disclose incentives they receive from mutual fund companies to steer clients their way.

The five-member commission is meeting today and plans to propose rules requiring more detailed disclosure of such broker arrangements than current regulations require. Also on the agenda is a proposal to beef up oversight by mutual fund boards of directors, which are supposed to protect investors.

The SEC fined Morgan Stanley DW $50 million in November for failing to disclose that it received payments or brokerage business from 16 mutual funds in exchange for promoting the sales of those funds.

A subsequent SEC review of 15 brokerages found such practices at most of them, SEC officials said Tuesday. Several received $50 to $400 from mutual fund companies for every $100,000 in sales of that company's funds.

The practice is known as a "shelf space" payment, similar to a company that pays a store for prominent display of its goods.

Only half of the brokers disclosed the arrangements, and some of those did so without providing details. The review led to the new investigations announced Tuesday.

One proposed SEC rule would require that brokers tell customers in writing whether their brokerages get additional compensation for selling a fund.

The statement also would have to detail a broker-related fee charged by some mutual funds. Known as a 12b-1 fee, it's deducted each year from the fund's returns to pay marketing costs, including payments to brokers.

"The most relevant information that we think investors need will be in the hands of investors at the time they commit," said Annette Nazareth, director of the SEC division of market regulation.

A more detailed statement of a fund's brokerage payments and fees, including a comparison to industry averages, would be required in a confirmation statement issued after the sale.

The SEC also plans to propose rules to reinforce what many industry experts say has been a failed line of defense for mutual fund investors: the funds' boards of directors.

"Mutual fund companies have boards of directors who are supposed to fulfill their fiduciary obligations toward their investors," Sen. Susan Collins, R-Maine, said at a hearing on mutual funds last fall. "And yet these abuses occur over and over again. The system is obviously flawed."

The proposed rule would increase the clout of independent directors, those without ties to the funds' management. The changes include requiring that boards be headed by an independent director and that three-fourths of a board's members be outsiders.

Also, to ensure that the independent directors know what's going on at the mutual fund, they would be given the authority to hire their staff.

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