Stop Playing Hide-and-Seek

Brokers and funds still cut deals, they just bury them in the fine print

Mutual fund managers paying for spots on a brokerage's "preferred" list of funds. Investors buying recommended investments while disclosure of potential conflicts of interest involving their brokerage and mutual fund marketers is buried. A major brokerage house that sells virtually only those mutual fund families that pay it annual fees. If this all seems like déja vu, you're right. These practices are called revenue-sharing arrangements, but it might be more apt to call them "pay-to-play lite".

Make no mistake: It's perfectly legal for fund companies and broker/dealers to pen such deals, just as food companies pay for shelf space for their products at local supermarkets. But investors need to know when the financial interests of their brokerage firms diverge from their own -- especially since the estimated $2 billion a year spent on such revenue-sharing deals certainly raises the possibility that the balance could shift away from investors. Existing disclosure requirements are meager at best.

The investment industry for the most part complies with those requirements by making bare-bones information available -- if investors are willing to hunt for it deep within rarely read prospectuses or obscure addenda. Rather than the uniform tables of sales charges and management fees now required of fund companies, much of the revenue-sharing disclosure data is provided in language that is often vague or so dense that many fund buyers never digest it.

All this must change. A good place to start would be the mutual fund sales disclosure rules being considered by the Securities & Exchange Commission. These regulations, proposed by former SEC Chairman William H. Donaldson before his departure earlier this year and still pending at the agency, deserve to move forward. They would require that before a client buys a fund, a brokerage must disclose how much it expects to collect in revenue sharing on that sale.

That would be an improvement over today's hide-and-seek disclosure. But even more information needs to be made available. An excellent model is the data that Smith Barney (C ) provides customers on a voluntary basis. The firm not only discloses the maximum revenue-sharing fee it charges fund families, but also details the hefty percentage of its fund sales that went to 37 favored fund families in 2004 that paid it (94%) and ranks those fund families in order from those that paid the most to the least. That kind of data gives investors a clearer picture of the incentives Smith Barney has to pitch them particular funds and should be required of all broker/dealers.

To be sure, in the four years since the Wall Street scandals, Washington has made huge strides in requiring disclosures for investors about fees, sales practices, and conflicts of interest. But when it comes to mutual fund revenue sharing, the SEC still needs to let a little more sunshine in.

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