The Securities and Exchange Commission is considering point-of-sale disclosure forms that would reveal to investors any revenue sharing or conflicts of interest between broker/agents and mutual fund companies. While fund executives may worry that disclosure will deal a serious blow to sales, industry insiders are skeptical of the forms' value and say revenue sharing is far too critical to the industry for even the most effective disclosure to put an end to it.
After all, 85% of funds are sold through third parties and, as Cerulli Associates of Boston recently reported, getting on a broker's preferred sales list through revenue sharing can boost sales as much as tenfold.
SEC officials declined to comment on the status of the disclosure forms or a timetable for a decision. However, the Commission is considering investor focus group reactions to three versions of the forms designed and tested by the New York consulting firm Siegel & Gale. Investors who participated in the sessions late last year enthusiastically endorsed the jargon-free readability and especially liked how fees are displayed in both dollar amounts and percentages, as well as how those percentages compare to industry averages. However, few understood breakpoints or the difference between upfront and annual fees.
More importantly, many didn't understand how additional payments to a broker for selling a particular mutual fund could create a conflict of interest. In fact, some thought that any extra money a mutual fund pays to a brokerage firm and/or their sales agents could result in better service, and a number felt it was fully appropriate for brokers to earn a sales commission in exchange for the guidance they offer. In addition, very few said that knowing about the additional fees would change their relationship with their broker.
Each of the forms addresses the conflict-of-interest issue through two short, yes/no questions as to whether the brokerage and/or their sales agents are being paid "extra to promote this fund over other funds." They don't tell investors the exact dollar amount or basis points a fund is paying them, let alone any other type of incentive. If an investor wants to obtain additional information, they are directed to the Web or a toll-free telephone number, but most focus group participants said they probably wouldn't bother researching the issue any further.
Exactly how much light the disclosure forms shed on revenue sharing, therefore, is a matter of debate. Industry experts declined to comment on the forms until the SEC delivers its final draft but seemed skeptical of their benefit, echoing a call by members of Congress and shareholder advocates for an outright ban on revenue sharing.
Revenue sharing, however, might be the single most important sales tool for a fund company. So important, in fact, that according to Soundinvesting.com, fund companies pay $2 billion annually through these incentive agreements. It's equally important to brokers who peddle the funds, as demonstrated by the recent revenue-sharing settlement by Edward D. Jones, which said it earned $90 million annually through the practice. Earlier this month, Fidelity Investments began disclosing in about 300 fund prospectus statements of additional information that it makes "substantial" revenue-sharing payments to sales partners. Even in light of increased regulatory scrutiny, the Boston fund giant opted for added disclosure over elimination of the practice.
"Initially, [disclosure] may have an impact on sales," said Geoff Bobroff, president of the mutual fund consulting group Bobroff Consulting of East Greenwich, R.I..
"It's a lot like truth in lending in automobile sales," he explained, referring to the 1968 Congressional Act that requires clear disclosure of key terms in a lending agreement so consumers can compare interest rates and other costs. "Truth in lending was disruptive initially because it was so new, but we got over it, and we'll get over this, too."
Currently, funds have to disclose revenue sharing in fund prospectuses, but not how much they pay or to whom. The fees typically average 20 to 50 basis points for fund shares held for a year or longer, or 10 to 25 basis points for the value of shares sold. These payments and other incentives should be revealed, "and point of sale is where it is the most effective," said Burton J. Greenwald, president of the consulting firm B.J. Greenwald Associates of Philadelphia.
Ben Poor, a senior analyst with Cerulli, said that disclosure will complicate the sale at the outset. Some brokers, he joked, may even be embarrassed to disclose exactly how much they're making off a transaction.
However, there will be investors who just won't care, Poor said. Like the buyer of a new software program who encounters a lengthy disclaimer as they begin downloading it, he said, many investors are confused by, or completely disregard, documents that contain exhaustive legal and accounting rhetoric.
"Right now, the prospectus is nearly 100 pages. Not a lot of people read through the fund prospectus," Poor said.
That's one reason why the SEC is still considering a rule that would put all disclosure information at broker Web sites. A majority of the 6,500 comment letters the SEC has received on this issue are from brokers who claim that a point-of-sale form could cost individual firms upwards of $3 billion a year to implement. As a letter from a registered rep from lst Global Capital of Dallas notes, by the SEC's own estimates, the entire U.S. brokerage industry earned $1.2 billion in annual profits from mutual funds in 2002, making the cost of disclosure totally unfeasible.
"A lot of firms are hoping it will be more of a Web site disclosure, and some not so secretly," Poor noted. "Some firms don't want to spend the money [on forms] and some, quite frankly, don't have the money. Margins have gotten tighter, and business has become more competitive. So you have some companies that don't want to pay, not because they are greedy, but because they are in dire straits."
That doesn't diminish the need for investor education, argued Mercer Bullard, a University of Mississippi law professor and founder and president of Fund Democracy, a shareholder advocacy group in Oxford, Miss.
"The average investor doesn't even know about revenue sharing, but they should care," he said. "If you look at the case of Edward Jones, brokers were receiving up to 20% more for selling a preferred fund. In that case, I'd say the broker has an incentive to offer one fund over another."
While the debate rages on, as the forms stand right now, they aren't likely to get investors up in arms or prompt funds to change the way they do business.