The country's second-largest securities firm, Morgan Stanley, agreed to a $50 million settlement after the SEC found that 16 "preferred" funds compensated Morgan Stanley brokers for an extra marketing push by allowing the firm to handle more of its stock and bond trading. That extra trading business, in turn, resulted in millions of dollars in additional commissions for the broker/dealer.
It's a blow that hits close to home for both the fund and the broker/dealer industries: shelf-space deals are widespread among both wirehouses and large independent shops (see MME 11/24/03). Increased disclosure of shelf-space arrangements has been written into mutual fund reform legislation still being bandied about in Washington.
Still, under current NASD rules, broker/dealers can only sell shares of a fund that sends portfolio trades to the broker if that arrangement is disclosed in the prospectus, and only if the broker is getting best execution. The NASD says there are at least 15 other broker/dealers under investigation for secret marketing arrangements, and some expect that many more could come under scrutiny.
"The question is whether the mutual funds are paying for shelf space," said Terry Lister, an attorney with Sonnenschein Nath & Rosenthal in Kansas City, Mo., who has been representing broker/dealer clients since 1977. "That's certainly going to be the case with some of the independent broker/dealers, as well as some of the wirehouse firms.
"Regardless of whether the money paid funnels down to the individual representative, the NASD, the SEC and Congress are concerned about whether the availability of those additional fees somehow improperly influence the management of those broker/dealers to push the mutual funds that pay those funds to the forefront," he added.
Some broker/dealers have more benign "preferred" arrangements with mutual fund families. Rather than additional trading business or commissions, the funds provide certain educational or adviser training services and might expect to get a more enthusiastic marketing pitch in return.
"I think that in our case, we have a list of mutual funds that we think are particularly worthy, and they're the ones that are likely to be represented at our conferences, and in our newsletters," said Art Grant, president and CEO of independent broker/dealer Cadaret, Grant & Co. in Syracuse, N.Y.
"They are the ones we strive to keep representatives updated on, and that list is determined on the basis of a dozen critical characteristics. But one is not whether or not they give us financial support," Grant said. "We are glad to get that support because it helps us to run better conferences and more frequent education meetings, and keeps up the flow of information to the field. If you get really candid about this, why are funds willing to give you that financial support?
"There are some fund families that think that all this stuff makes for better client relationships. At the same time, they obviously hope to do more business," he said
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