Brokerages slow to reveal sales pact details

IRVINE, Calif. — Although many brokerage firms are letting investors in on whether they have “shelf space” agreements with certain mutual fund companies, few are disclosing the details of those agreements.
The move toward more disclosure comes as the Securities and Exchange Commission is mulling a rule change that may require brokers to disclose whether they operate so-called shelf space programs, which give preferential treatment to fund companies in return for a fee.
The SEC has been evaluating point-of-sale disclosure since 2004.
“We have no fixed timetable,” said SEC spokesman John Nester on whether the commission is likely to issue a new proposal this year. “We are still evaluating what we learned through testing and the comment process.”
The push toward more disclosure also comes in response to legal uncertainty as the SEC, and other regulators, pay more attention to disclosure-related issues.
“Even though there’s no rule [to disclose revenue sharing], it’s turning into best practice to disclose more, not less,” said David Hearth, a partner at Paul Hastings Janofsky & Walker LLP in San Francisco. “You don’t want to be the odd guy out.”
In 2004, when it first proposed a point-of-sale disclosure rule, the SEC pushed for brokerage firms to disclose the actual amount of money they receive from individual fund companies that participate in their shelf space programs.
By that standard, most brokerage firms still are coming up short.
Indeed, most disclose only the maximum amount of money that they collect from any one agreement — usually as a percentage of new sales and/or existing assets — without identifying particular fund companies.
Investor focus groups conducted by the SEC revealed that investors weren’t terribly concerned about seeing details of revenue-sharing agreements, said Hardy Callcott, a partner in the San Francisco office of Boston-based Bingham McCutchen LLP.
Those results, coupled with staff changes at the SEC, “has caused a whole rethink” of the point-of-sale disclosure rule, he said.
“We believe [our] disclosure is totally adequate. … We receive virtually no client requests for additional information on [revenue sharing],” said James Wiggins, spokesman at Morgan Stanley.
Even though individual brokers generally don’t directly share in the payments, most shelf space deals have at least an indirect effect on sales and should be disclosed to customers, said Mercer Bullard, founder of Fund Democracy Inc., a consumer group, and assistant professor of law at the University of Mississippi in Oxford.
“The [payments can] increase bonuses, go to branch managers or indirectly create incentives in lots of ways,” he said. “If it’s fully disclosed, I don’t think [shelf space fees are] a problem.”
Arrangements vary widely. Most of the larger firms collect a combination of fees, ranging from 0.05% to 0.25% of assets or sales.
Elsewhere in the industry, payments can run as high as 0.4% to 0.5% of sales or assets.
Brokerage firms claim that the money goes to support sales, education and technology. Mutual funds also pay record-keeping or subaccounting fees to large firms, and subsidize ticket charges at the independent firms.
Edward D. Jones & Co. LP of St. Louis is one of the few firms, if not the only firm, to disclose what it collects from each of the nine fund companies that participate in its shelf space program.
At the low end, the American Funds, managed by Capital Research and Management Co. of Los Angeles, pays Edward Jones just 0.03% of assets, while Federated Investors Inc. of Pittsburgh pays 0.25% on both new sales and existing assets.
That some funds pay many multiples of what others pay “is mind-boggling,” Mr. Bullard said, and points to the need for more transparency.
Edward Jones’ detailed approach is driven by a settlement with regulators in 2004 in which it paid $75 million for allegedly failing to make adequate disclosures.
Some fund companies and
broker-dealers still make only minimal reference to revenue-sharing fees.
Boston-based Fidelity Investments, for example, tells investors to ask their brokers about any revenue sharing. A.G. Edwards & Sons Inc. of St. Louis doesn’t disclose any amounts and instead directs clients to their financial advisers for more information.
Indeed, legal liability has forced dealers to come clean about some of the conflicts with shelf space fees, which in the past were strictly under the table.
In a March 2005 settlement with Smith Barney over shelf space payments, the SEC said that most of the firm’s disclosures “lacked sufficient information,” because prospectuses of the funds it sold “did not specifically disclose the magnitude of the revenue-sharing payments.”
Smith Barney is the brokerage unit of Citigroup Inc. of New York.
Other firms hit in recent years by the SEC include Morgan Stanley of New York and Capital Analysts Inc. of Radnor, Pa.
The SEC also has gone after mutual fund firms, including Franklin Templeton Distributors Inc. of San Mateo, Calif.; MFS Investments and Putnam Investments, both of Boston; and Pimco Funds of Newport Beach, Calif.
Smith Barney, UBS Financial Services Inc. of New York and Morgan Stanley say that funds that don’t pay to be in their top tier of providers aren’t allowed to send wholesalers to their branch offices.
In its own disclosure documents, Merrill Lynch & Co. Inc. of New York says funds that do “not enter into [shelf space] arrangements … are generally not offered to clients.”
“I’m not sure [Smith Barney] is really searching for the best funds or it’s just a matter of who’s paying,” said a Smith Barney broker, who asked not to be identified.
The rep said he has encountered several good funds the firm doesn’t offer.
“But out of 5,000 [funds Smith Barney sells], there are still some good ones,” he said.