Securities regulators and members of Congress have found a new investor-betrayal issue to wrangle over: mutual fund "breakpoints."

Citing a discovery during a routine exam in Philadelphia of breakpoint abuses among brokers who sold mutual funds, the National Association of Securities Dealers (NASD) last month notified member firms as well as the Investment Company Institute (ICI) (see MFMN 1/13/03). Shortly thereafter, NASD floated an advisory to investors to be on the alert for breakpoint abuses.

Most mutual funds that distribute shares through commission-based intermediaries offer breakpoints on front-end loaded fund share purchases. These breakpoints allow investors to receive a discounted sales charge that decreases incrementally at certain "breakpoint" levels as the amount being invested increases.

Mutual funds allow subsequent purchases by the same shareholder, as well as additional investments made by an investor's relatives, such as their spouse or children, to be combined so that a lower sales charge applies to all investments made within a single mutual fund group, even if they are made at different times.

Oops, They Did it Again

If brokers aren't aware that their clients qualify for breakpoint discounts, or neglect to alert a fund group that a purchasing investor is entitled to a lower sales charge investors face being overcharged. Whether that happens by mistake or by design is still to be determined.

Either way, brokerage firms end up winning, as higher front-end sales charges mean higher commission payments to the selling broker/dealer and, consequently, higher commission cuts for individual reps.

To find a fix for why some brokerage firms are not taking advantage of the breakpoint discounts, last Tuesday the NASD assembled a 22-member breakpoint task force (see NewsFlash, page 25). The task force's first meeting is scheduled for early this week.

"It's a complex issue that requires the cooperation of the fund industry and broker/dealers, and possibly input from industry vendors," said Michael D. Udoff, VP and general counsel of the Securities Industry Association of New York, the trade group representing 600 securities firms. Members have raised concerns over what's the most practical solution, whether they will need to look back to spot errors and for how long a period of time, and exactly how that would be accomplished, particularly if customers' activity is scattered, Udoff said.

Householding initiatives, which funds were mandated by the SEC to undertake two years ago as a way to reduce duplicate routine fund mailings to investors (see MFMN 11/29/02), can aid transparency and help funds determine which investors are related to other investors within a fund group. But discovering relationships when Social Security numbers and addresses differ or are absent can prove trickier.

Next Gen: Behavior Detection

Mantas, a technology firm in Fairfax, Va., claims that its next generation of behavior detection technology allows financial service firms to spot accounts that should qualify for sales charge discounts. Mantas' proprietary software uses complex algorithms as well as link analysis to track movement between accounts, checks written as well as other types of money transactions.

While such technology can help track retail investors, the true challenge lies in the omnibus accounts, through which most brokerage firms execute their mutual fund trades.

When a brokerage firm purchases shares of a fund for clients, it will typically do so under a single, collective trade that can represent anywhere from one to several dozen or more individual clients' purchases. The account on the mutual fund's books appears in "Street Name," that is, the name of the brokerage firm - and nowhere on the mutual fund's side of trades are the individual investors ever identified.

Both the Vision program created by DST Systems of Kansas City, Mo., and AdvisorCentral of Boston, the Internet consortium of five mutual fund players (see "Thomson Media's 2003 Fund Operations Awards," pp. 15-16), have facilitated the sharing of information about mutual funds' specs and programs. Both have allowed financial intermediaries to more closely track client accounts, transaction records and holdings.

Vision vs. Fund/SERV

"Vision's fund information features price, rate and yield information as well as the current breakpoint schedule and sales charge information [to give] advisors and back officers access to fund breakpoint schedules," said Kyle Mallot, client services officer, in charge of Vision.

Still, many in the industry are betting on National Securities Clearing Corporation's automated Fund/SERV system to provide the technology solution. Fund/SERV launched in 1986 and soon became the industry standard for transmitting vital information and settling trades between mutual funds and securities firms. NSCC is a subsidiary of The Depository Trust & Clearing Corporation of New York.

"Fund/SERV, which transmits transaction-related information, has several fields that can be populated with information related to various sales charges and dealer commissions," said Ann Bergin, managing director of mutual fund services. In addition, the firm's networking recordkeeping system allows fund companies and broker/dealers to share client information, and the Mutual Fund Profile Service provides databases that allow funds to enter sales charge and breakpoint information, Bergin noted.

Although technology may pave the way for breakpoints to be better known, compelling brokers to utilize them is another issue. "While technology probably has some promise, I don't think there's a panacea or magic bullet here to make sure breakpoints get assessed," said Don Boteler, VP of operations at the ICI.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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