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SEC Pursues Mutual Fund Brokerage Abuses

Jan 13, 2004 | Securities regulators said they believed there were widespread sales abuses in the mutual fund industry after a probe showed many funds were paying extra commissions to brokers to promote their products to investors.

The Securities and Exchange Commission, the chief US financial regulator, said it was now conducting active investigations of eight broker-dealers and 12 mutual fund companies as a result of the findings and planned to examine dozens more. The SEC will also review whether directors at those funds were aware of the arrangements.

The preliminary findings come as the SEC is to discuss new proposals at a meeting today that would force brokers and fund companies to share more information with investors about fees and potential conflicts of interest in their sales arrangements.

"A customer has a right to know where the incentive is [for the broker]," Stephen Cutler, the SEC's head of enforcement said.

The latest findings come as the $7,000bn mutual fund industry is already suffering from a series of trading scandals that have led to criminal investigations and the threat of new regulation from Congress.

The findings follow a case last November in which the SEC imposed a $50m settlement on Morgan Stanley for failing to disclose to investors certain kickbacks that were paid to its brokers to promote particular mutual funds.

The SEC probe of so-called "revenue sharing" practices was initiated last April amid concerns that funds were using aggressive tactics to gain shelf space at broker dealers.

The probe revealed that 14 of 15 brokers that the government examined had received cash payments from funds and that 10 of them had accepted extra trading commissions.

The payments amounted to between $50 and $400 for every new $100,000 mutual fund sale, and then up to $250 for every year those assets remained invested in the fund.

In some cases, the funds paid what are known as "step-outs", in which part of their trading commissions would be directed to brokers that had not executed trades for them but had helped distribute their products.

In exchange for such payments, 13 of the 15 brokers appeared to grant special promotion to those funds, according to the SEC.

"These examinations indicate to us that revenue sharing is a very common practice in the mutual fund industry," said Lori Richards, the director of the SEC's office of compliance and inspections.

Ms Richards said that most mutual fund companies repeatedly denied to her staff that they used broker commissions to pay for distribution.

The new rules to be proposed will force funds and broker-dealers both to publish fee information that can be compared across the industry.

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