Nearly one in three sales to mutual funds with front-end sales charges don't get the discount they deserve. That's according to a report jointly issued last week by the Securities and Exchange Commission, the National Association of Securities Dealers and the New York Stock Exchange.

Concluding a three-month joint examination of 9,000 mutual transactions at 43 broker/dealers of all sizes, the regulators determined that between Oct. 1, 2001 and Sept. 30, 2002, brokers frequently neglected to provide the information necessary for customers to qualify for a fund's breakpoint discount.

Of the 5,515 transactions that appeared to qualify for sales charge discounts, almost 32% were never afforded that discount, although the mistakes appeared to be inadvertent rather than intentional, according to the report.

The most frequent cause for the breakdown, as cited in 44% of the transactions reviewed, was failure on the part of the broker to link a customer's ownership among different funds within the same fund family. In another 21% of cases, brokers failed to appropriately link the client's investment with those of related family members.

Breakpoint discounts allow investors who make large single purchases or incremental purchases to qualify for a reduced sales charge (MFMN 1/7/03). Most funds reduce front-end sales charges as the amount of an investment increases and hits established asset plateaus. To qualify for the discounts afforded to larger investments, most funds allow investors to link their purchases with purchases of certain family members such as spouses and children made within a single fund complex.

Funds also allow investors to sign a letter of intent before investing in a fund or group, stating that they intend to invest a certain dollar amount spread across several smaller investments made within the next 13-month period. Under such a letter of intent, all purchases made by that investor should automatically qualify for the reduced sales charge applicable to the larger total amount expected to be invested.

Lack of Automation

The report makes clear that technological limitations are often the culprit. Examiners found that most of the broker/dealers do not have automated systems in place that allow the firm's brokers to identify related accounts. Moreover, 16% of brokerage firms admitted that they do not provide training to their reps on mutual fund breakpoints and sales charges.

Regulators also found that purchase orders processed electronically through Fund/SERV were more error-prone.

"It appears that firms that processed most of their transactions using paper applications had a lower number of missed breakpoint opportunities, resulting in a smaller amount of discounts not provided," the report noted. Of the five firms that predominantly used paper applications, the average overlooked discount was $235 versus the average missed discount of $364 for trades processed electronically.

A recent NASD survey found that 52% of mutual fund sales made through broker/dealers are done using a fund prospectus' investment application.

"The report indicated that most of the errors were inadvertent and the result of systems issues," confirmed Chris Wloszczyna, a spokesperson at the ICI.

Members of the ICI are among the participants in a breakpoint task force convened by the NASD a few weeks ago, in hopes of hashing out solutions to the breakpoint dilemma (MFMN 2/19/03). "We are looking forward to working with the task force to address those issues and be sure qualified investors receive the discounts they are entitled to," Wloszczyna added.

For brokerages that sell mutual funds, it's back to the drawing board. This past December, and then again in January, the regulators reminded firms of their obligation to have sufficient supervisory procedures in place to assure clients are afforded breakpoints, to apprise customers of breakpoint opportunities, and to make sure selling representatives are aware of fund offering options.

Copyright 2003 Thomson Media Inc. All Rights Reserved.


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