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FEBRUARY 16, 2004
Is There A Leak In Your Index Fund? The SEC is investigating some two dozen funds for unnecessarily large trading fees Thought you had heard the last of the mutual-fund scandals? Wait, there's another installment: Some index funds are paying trading fees that are up to three times higher than necessary. BusinessWeek has learned that the Securities & Exchange Commission, as part of a crackdown on excessive fees, is investigating at least 24 index funds. SEC officials declined to identify them. But on Jan. 29, the agency wrote fund managers to ask why they're paying up to 6 cents a share, vs. the 2 cents brokers typically charge big investors to execute buy and sell orders. Why would a mutual fund pay top dollar? Because paying full fees generates credits, called soft dollars, that it can spend on research to improve its stock-picking prowess. But that rationale doesn't fit index funds, which aim to keep costs low and invest in a predetermined basket of stocks. Says Lori A. Richards, director of the SEC's Office of Compliance Inspections & Examinations: "While the law allows mutual funds to use brokerage commissions to buy research, we question why an index fund would need research." Some may be passing their unused soft credits along to managed funds in the same fund family. Surprisingly, that's legal. Still, the SEC wants the index funds to explain how they're spending the excess commissions. Soft-dollar abuses are nothing new. These thinly disguised kickbacks, which total about $6 billion annually, were enshrined in law after the SEC banned fixed commissions in 1975. Before then, research came free. After the ban, funds could be in breach of their fiduciary duty if they paid too much. So Congress enacted a "safe harbor" rule that lets them pay full freight if they get research in return. Critics have long argued that soft dollars give fund managers an incentive to overpay or overtrade. Because soft dollars are hidden, abuses are, too. While the SEC allows soft dollars to pay for software to help managers pick stocks, it doesn't allow them to be spent on rent, utilities, or overhead. But some fund managers skirt the ban by buying computers to run the software and broadband links to download data. SEC officials plan to shut the door on such practices soon by narrowing the definition of research. But the SEC can't stop fund companies from using their index funds' soft dollars on research that benefits other funds: The safe harbor permits such cross-subsidization. All the more reason for Congress to heed the critics' charge that the harbor isn't safe for shareholders.  By Amy Borrus in Washington Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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