Blame goes around for breakdown on break-point discounts

Tension is rising between federal regulators and the mutual fund industry over who is to blame when brokerages overcharge investors on additional purchases of certain mutual funds.

Everyone agrees that primarily brokers are responsible when major investors fail to get so-called break-point discounts on mutual funds that carry upfront sales charges.

But senior officials at the Securities and Exchange Commission said members of mutual fund boards also should shoulder some responsibility. Meanwhile, some in the fund industry point fingers at investors.

“Can’t we also look to see if there isn’t a responsibility on the part of the individual purchasers to defend themselves and make sure they are not paying too much in terms of a sales load?” said Glen A. Payne, senior vice president and general counsel of INVESCO Funds Group Inc. in Denver.

“When you go to the supermarket and go through the checkout line and see that you are being overcharged, the best way to prevent that from happening is to bring it to someone’s attention,” he added.

Paul F. Roye, director of the SEC’s division of investment management, conceded that investors should keep a close eye on break points. But, he said, it is perfectly reasonable to rely on brokers to make sure those discounts are given.

“This is not a buyer-beware kind of business,” he said. “People are selling these fund shares, and they’ve got an obligation to make them aware of these break points. You can’t just say, `We wash our hands of it because the investor didn’t question the fact that they could have paid a cheaper price.’ I mean, we’re not talking about used cars here.”

Mr. Roye and Mr. Payne made their comments Tuesday at an annual gathering of regulators and mutual fund lawyers. The three-day meeting in Palm Desert, Calif., was co-sponsored by the Investment Company Institute and the Federal Bar Association.

Barbara Roper, director of investor protection for the Consumer Federation of America, a powerful consumer advocacy group in Washington, dismisses the notion that investors are to blame for the hullabaloo around break points.

“It’s a tried-and-true philosophy: blame the victim,” she says. “Investors can’t figure break points out.

“[The fund industry has] created a system that is so complicated, the average person just can’t figure it out.”

Ms. Roper says the fund industry, and regulators, should think twice before blaming investors.

“I thought they were trying to restore investor confidence,” she says. “In this day and age, should investors really be told that no one is looking out for their best interests?”

Last week’s exchange is the latest twist in the controversy surrounding break points. That issue surfaced last fall, when NASD discovered in a routine review that investors weren’t getting the discounts due them.

Since then, NASD, the SEC and the New York Stock Exchange have scrutinized 43 brokerage firms of all sizes. The results of that investigation, which were released last month, found that 41 of the 43 firms didn’t provide discounts available to investors who qualified for them.

The study examined some 9,000 mutual fund transactions between Oct. 1, 2001, and Sept. 30, 2002. Of the 5,515 transactions that appeared to qualify, nearly 32% were never afforded the discount, according to the report.

The report concludes the mistakes appear to be the result of poor controls rather than a deliberate attempt to rip off investors.

NASD has since ordered some 2,000 brokerage firms that sell front-end-load mutual funds to examine two years’ worth of transactions and provide it with the data. The deadline for completing that examination is May 15.

Meanwhile, Lori A. Richards, director of the SEC’s office of compliance inspections and examinations, said the problems surrounding break points was a wake-up call for funds’ boards of directors.

She recommended that boards consider reviewing the selling agreements they have with broker-dealers. At the least, they should familiarize themselves with the results of the self-examination that broker-dealers have been ordered to undergo.

“Mutual fund boards should immediately, in light of the findings of the examination sweep, be asking questions,” she said at last week’s meeting in Palm Desert.

The mutual fund industry balked at the notion of bringing fund directors into the controversy surrounding break points.

difficult assignment

Many fund companies rely on hundreds, if not thousands, of broker-dealers to sell those funds. Going through individual selling agreements, or self-assessments, would be a painstaking process.

“I’m not sure it’s the best use of my funds’ directors’ time, wading through hundreds of individual assessments,” said Jay. S. Neuman, corporate counsel for Federated Investors Inc. in Pittsburgh.

Nevertheless, the SEC expects to see some involvement on the part of directors – even if it is from the sidelines.

“You can’t just bury your head in the sand,” said Mr. Roye. “These are your fund shares, and your investors are being sold those shares. I think the directors have some responsibility.”

Break points aren’t the only mutual fund sales practice in the spotlight. The SEC and NASD are also looking into whether some brokers at Morgan Stanley of New York have been recommending inappropriate share classes of mutual funds for purchase by their clients.

Mr. Roye declined to comment on any investigation involving Morgan Stanley or on whether such an investigation might lead to a broader examination of sales practices at other firms.

“Our antenna is up for that kind of situation,” he said in an interview after the panel discussion last week. “It’s something that we are clearly focusing on in our investigations.”