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SEC Probes Brokerages on Mutual Funds

Jan 14, 2004 | AP

The Securities and Exchange Commission is investigating numerous cases in which brokerage firms may have failed to fully disclose that they steered clients toward certain mutual funds in exchange for payments from those fund companies.

The SEC also is moving to ensure that fund investors get more information about such arrangements.

The probes by the market watchdog agency consist of eight inquiries involving brokerages and 12 involving mutual fund companies, some of which are linked as single cases, SEC Enforcement Director Stephen Cutler told reporters Tuesday.

The inquiries, which include the role of mutual fund board directors, are part of the widening investigation of practices in the scandal-tainted mutual fund industry by federal and state regulators.

At the same time, the SEC's "sweep" inspection of brokerages that sell mutual funds has found that 14 of 15 received cash from funds' investment advisers and two-thirds accepted payments in the form of commissions on fund trades, a practice known as revenue sharing. In return for the payments, 13 of the 15 brokerage firms appear to have favored the affected funds by giving them greater visibility on their Web sites and in promotional materials sent to customers, SEC officials said.

Brokerage houses sell some 80 percent of all mutual fund shares and collect billions of dollars in fees for those sales.

On Wednesday, the SEC was proposing new rules tightening disclosure to fund investors of costs and potential conflicts of interest.

The measures build on its tentative adoption last month of a rule imposing a "hard cutoff" of 4 p.m. Eastern time for pricing of fund shares to stem illegal after-hours trading. The agency also was proposing requirements that board chairmen of fund companies be wholly independent from the companies managing the funds, and that three-quarters of the directors on a fund company board also be independent — an increase from the current requirement of 50 percent.

The proposals could be adopted formally after the SEC gathers public comment.

Similar concerns about individual investors prompted the House in November to overwhelmingly pass legislation requiring, among other things, mutual fund companies to disclose more information about fees and operations. The Senate is expected to act on its own version of such proposals early this year.

Cutler said the SEC is examining the practice of buying and selling "shelf space," in which mutual fund companies buy space on a broker's list of recommended purchases, and to what extent investors are adequately informed of the potential conflicts in such arrangements — and whether mutual fund board directors are told about them.

The agency has sharpened its focus on the legal responsibility of directors, last month accusing four directors of investment firm Heartland Advisors of "negligent failure" to adequately monitor the cash flow and pricing of two municipal bond funds sold by the firm.

Inadequate disclosures "give us great cause for concern," regardless of whether investors were harmed financially by being steered toward higher-cost funds, Cutler said at the news briefing. "The customer has a right to know."

In November, major brokerage Morgan Stanley agreed to pay a $50 million civil fine and change its practices in a settlement with the SEC and the National Association of Securities Dealers for an alleged "firm-wide failure" in fully disclosing potential conflicts of interest.

Morgan Stanley also agreed last fall to pay a $2 million fine to settle the NASD's allegations that it held prohibited sales contests offering tickets to Britney Spears concerts and the NBA finals to push its brokers to sell in-house mutual funds and certain annuities.


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