Brokers' discount dilemma

Feb 23, 2004 @ 12:01 am

By Bruce Kelly

Some broker-dealers missed big when it came to giving clients break-point discounts for purchasing certain amounts of mutual funds, according to securities regulators.

In fact, two subsidiaries of SWS Group Inc. in Dallas missed paying such discounts almost 90% of the time, according to estimates the firms reported to NASD.

Similarly, Cresap Inc. of Radnor, Pa., missed 88% of break-point discounts, according to the broker-dealer's projections.

The financial services industry is facing an overhaul of the complex weave of reporting mutual fund sales between broker-dealers, mutual fund companies and clearing firms, industry observers predict.

NASD issued new guidelines about break-point discounts to its broker-dealer members last summer. Therefore, firms are creating new policies and systems for registered representatives to improve the tracking of mutual fund sales.

Such a task is clearly a challenge.

``There's no black box for this stuff,'' said Terry L. Lister, a lawyer in Kansas City, Mo., with the Chicago law firm Sonnenschein Nath & Rosenthal LLP. ``It's just hard.''

Going by the firms' self-audits, NASD estimated that at least $86 million is owed to investors for 2001 and 2002 alone. NASD directed all firms to provide refunds to clients who had been overcharged and directed 174 firms to review individual transactions. Most broker-dealers failed to give clients discounts on purchases of mutual fund shares when their assets in those funds had reached certain designated levels, NASD reported.

The two SWS subsidiaries, SWS Financial Services and Southwest Securities Inc., along with Cresap, were among 15 firms fined this month by the Securities and Exchange Commission and NASD for failing to deliver break-point discounts during 2001 and 2002.

While those three firms missed a large percentage of the break-point discounts, their fines, which were the projected amount clients had been overcharged, were far less than those of the leader, Wachovia Securities LLC of Richmond, Va.

Wachovia was ordered to pay $4.8 million in fines and client restitution, the SWS subsidiaries $103,439 and Cresap $99,458.

A spokesman for SWS said the audit for break points examined a ``relatively small sample'' of the firm's fund trades. SWS is doing a trade-by-trade review, looking for incidences of failure to give discounts for purchases above break points listed in a mutual fund's prospectus.

Mark Cresap, president and owner of Cresap, did not return phone calls seeking comment.

The firms have six months to create systems and procedures ``that can reasonably be expected to prevent and detect failures to provide break-point discounts'' when customers buy certain front-end-load mutual funds, NASD documents say.

Confusion was a common element in firms' missing break-point discounts, Mr. Lister said. ``I think that the systems that were in place just didn't work. And the industry just didn't realize it,'' he said.

Broker-dealers, mutual fund companies and clearing firms routinely thought that each was keeping track of clients' break-point information, he said, and none realized the extent of the problem.

And much of the financial services industry is making changes to keep up with NASD's guidelines. The self-regulatory organization, for example, is providing its broker-dealer members disclosure templates to keep track of break points.

Broker-dealers have to be on top of more information than ever before, industry observers say. Firms need to disclose to customers about break points, and firms are asking customers for account information.

Over the next few months, Pershing LLC of Jersey City, N.J., plans to roll out a number of systems for the registered representatives affiliated with independent broker-dealers that clear trades with Pershing.

The new services include displaying the sales charge on the order confirmation, developing internal systems so broker-dealers can link clients' accounts and calculating the clients' ``right of accumulation'' - total assets in the account potentially owed the discount. This lets the broker see necessary information easily.

All this is being done to keep up with changes recommended by NASD's task force on break points, said Mark Swenarton, Pershing's mutual fund processing director.

Perhaps most important, Pershing is going to include profiles of mutual funds' break-point schedules, with the information coming from the National Securities Clearing Corp. in New York.

New York's National Financial Services LLC, meanwhile, is also increasing its automated services to its correspondent broker-dealers and their registered representatives. It is adding more than a dozen enhancements to its platform to improve risk management concerning break points and other compliance problems.


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