You might have thought the mutual-fund scandals put an end to pay-to-play arrangements. But the practice of fund companies paying extra to give brokerage firms an incentive to push their funds or hand them coveted spots on "preferred lists" remains firmly entrenched. Brokerages like these arrangements, which bring in an estimated $2 billion in annual revenue on top of regular commissions, according to Boston consulting firm Financial Research Corp. Fund companies depend on them to gain an edge in a universe of more than 6,400 offerings.
Now, many from both sides are finally starting to say more about these "revenue sharing" deals. But the Securities & Exchange Commission's disclosure rules are minimal -- the only time a brokerage firm must tell you it received revenue sharing from a fund sponsor is when you purchase shares, although a proposed rule could make them stricter. So for now, there's wide variation in how much detail the firms give out, and no two firms do it the same way. This makes it more difficult for investors to track down the information than to find, say, the sales charges and management fees that are laid out in uniform tables in the fund prospectus.
Since fund companies pay for preferred positions out of their own pockets, why should you care? Because you want to be sure that the fund you're buying is the best fund for you, not because it's the best one for the broker to sell.
Revenue-sharing arrangements vary from broker to broker. Though firms often receive higher payments from some fund groups than from others, they rarely say who pays the most. One exception is Smith Barney (C), which on its Web site, smithbarney.com, ranks the fund families from those that paid it the most in 2004 (Smith Barney and Franklin Templeton (BEN)) to the least (Legg Mason (LM) and Nations).
At the other extreme are firms whose disclosure is bare-bones. A.G. Edwards (AGE) acknowledges in a statement prepared for BusinessWeek that it receives payments from "some -- not all -- of the mutual-fund companies." But it does not disclose them, it says, because "these agreements have not influenced the fund recommendations we make." Indeed, as long as a fund's prospectus reveals that the fund's sponsor pays revenue sharing -- and gives some indication of the amount -- a brokerage firm can substitute that prospectus for its own disclosure, says Douglas Scheidt, chief counsel for the SEC's Investment Management Division.
CHECK THE WEB
The prospectus and the more detailed statement of additional information (SAI) -- available upon request and at many fund company Web sites -- don't usually say how much goes to specific brokerage firms. The Jan. 29 SAI for Fidelity Advisor Equity Growth Fund only says that Fidelity Investments anticipates paying "hundreds" of firms amounts that depend, in part, on whether the fund was placed "on a preferred or recommended fund list."
So where can you find out if your brokerage firm gets paid extra by selling you a particular fund? Besides asking your broker, look to the firm's Web site. If you type "revenue sharing" in the search box at UBS Financial Services' (UBS) site, ubs.com, you'll get to a page that lists 21 fund companies in the firm's "Tier 1" group. Together these accounted for "approximately 80%" of UBS's 2004 and first-quarter 2005 mutual-fund sales. (The 21 fund families are a fraction of the approximately 300 that sell "load" shares through brokers, according to Financial Research Corp.) UBS acknowledges that revenue sharing is "a factor in determining whether a fund company is placed in Tier 1," but it adds that "such payment is never the sole determinant."
Likewise, Smith Barney's Web site reveals that it allows about 37 favored fund families into its branch offices to promote their funds to brokers. Perhaps as a result these companies comprised "approximately 94.4%" of Smith Barney's 2004 mutual-fund sales. Fund companies "that do not remit revenue-sharing payments typically will not be provided such access," the Web disclosure adds.
Several other firms -- including Morgan Stanley (MWD), Wachovia (WB), and smaller rivals -- also publish, on the Web and in client literature, the names of the fund companies from which they take payments. Merrill Lynch (MER) simply says it requires all the fund families it sells -- more than 100, according to a spokesman -- to make revenue sharing payments, and that it has no preferred list. "Funds that do not enter into arrangements with Merrill Lynch are generally not offered to clients," states a pamphlet sent to new clients that's also available at ml.com.
One thing even the most candid brokerage firms don't reveal is how much revenue sharing money they collect. At best, they'll show their maximum levies. Smith Barney reports on its Web site that it generally charges fund families up to 0.09% annually of the value of the assets its clients hold in bond funds, and up to 0.12% per year of its clients' stock and balanced-fund assets. You can use that information to approximate how much the firm will get from your investment.
Even if your broker offers good disclosure, you may get a better idea of what your fund is paying in the fund's prospectus and SAI. The May 1 SAI for MFS's Massachusetts Investors Trust says MFS generally pays brokerage firms up to 0.10% of the value of their annual sales of the fund, plus up to 0.05% of the annual value of client assets in the fund. MFS also says it may pay up to $20 to offset "ticket charges." These are fees a broker pays the brokerage firm to process fund orders. Like many of its peers, MFS says it may also foot the bill for broker conferences, seminars, training programs, entertainment, and travel. How much does that come to? MFS declines to say.
Sure, brokerage firms and fund companies are disclosing more about their financial dealings. Dig deep enough, though, and you may unearth more questions than answers.
By Anne Tergesen