A distribution practice that was first tried in the annuity industry last year is about to migrate to mutual funds.
American Skandia Investment Services of Shelton, Conn., will ask shareholders later this month to approve an arrangement which it hopes will help finance mutual fund distribution without increasing expenses for the adviser or shareholders. Under the proposal, broker/dealers will rebate a portion of commissions they receive from American Skandia funds to an American Skandia affiliate, American Skandia Marketing.
American Skandia Marketing will use the funds' rebates to pay for fund distribution expenses such as advertising and commissions as part of a Rule 12b-1 plan. American Skandia said in a Securities and Exchange Commission filing that it did not expect the cost of commissions to rise because of the arrangement. If the payments result in increased fund sales, shareholders are expected to benefit from reduced expenses.
The American Skandia proposal appears to be a first for mutual funds, according to lawyers and regulators. Endeavor Management Co., an annuity sponsor in Corona Del Mar, Calif., put a similar plan in effect for its products last year.
Endeavor is believed to be the first and only company which has employed such a distribution arrangement so far, executives and regulators said. Mutual fund and annuity executives said the American Skandia/Endeavor approach could be an effective means of surmounting what they say are standard commission rates which broker/dealers charge. Executives said that, for smaller fund companies in particular, it has been virtually impossible to negotiate decreases in commissions with broker/dealers.
American Skandia outlined its plan in a proxy statement it filed with the SEC on April 15. Shareholders are scheduled to vote on the proposal for American Skandia's mutual funds on May 27. Eric Freed, senior counsel for American Skandia, said the company expects to propose a similar arrangement for American Skandia's annuities.
The arrangement offers the possibility of getting "more bang for the buck" by gaining a benefit from an existing expense, Freed said. He declined to identify broker/dealers American Skandia may use if shareholders approve the arrangement.
American Skandia decided to propose the plan after it learned of Endeavor's program, said Freed. Vincent J. McGuinness, Jr., president of Endeavor, said his firm developed its rebate program - which it has dubbed a "brokerage enhancement plan" - after Endeavor found itself unable to negotiate reduced commissions from broker/dealers. While the broker/dealers would not decrease their commissions, they did agree to direct a portion of the commissions back to Endeavor's distribution affiliate which uses it to support sales, McGuinness said.
"In the long run, I think it will be beneficial to the policyholders," McGuinness said of the program. "I'm very hopeful about it."
Endeavor is continuing efforts to negotiate reduced commissions, McGuinness said.
"If we can negotiate the prices down, that's our first priority," McGuinness said.
For broker/dealers, the Endeavor arrangement offers the benefit of continued commissions. The economics of the transaction between a fund marketing affiliate and broker/dealer are similar to the common relationship between an introducing broker and a clearing broker, said Freed. In such relationships, a small broker/dealer which does not have the capacity to execute trades itself - "the introducing broker" - directs a client's transactions to a larger broker/dealer which executes or clears the trade. The introducing broker and the clearing broker then share the commission.
The SEC is requiring companies which want to use the rebate plan to do it under Rule 12b-1. Douglas Scheidt, associate director of the SEC, said the rebated commissions are owned by the funds. Because the rebated commissions are being used to pay for distribution expenses, they are governed by the requirements of Rule 12b-1.
