Investor isn't being told how revenue-sharing affects him

Your Funds

Your Money

February 06, 2005|By CHARLES JAFFE

Fund investors were promised good medicine to combat the industry's problems.

But increasingly the cures of "transparency" and "disclosure" turn out to be placebos, and investors just got the latest example.

As part of settlements with federal regulators, brokerages such as Edward D. Jones & Co. and Morgan Stanley had to disclose revenue-sharing deals they made with big fund companies. In addition, fund companies are beginning to disclose how these deals work too, although the information is buried in the "statement of additional information," the second part of a prospectus that shareholders only see if they go searching for it.

Revenue-sharing fees are legal, as long as the arrangements are properly disclosed. Regulators have an issue with brokerages that create "preferred" lists without revealing that the firm earns extra compensation whenever an investor moves money into the favored funds.

Think of it like paying for shelf space in a grocery store, where the maker of cereal or spaghetti gives the grocer a little incentive for getting the best placement on the racks, the spots seen by the most customers.

Edward Jones posted its revenue-sharing disclosure on the firm's Web site Jan. 13, noting that it earned $82.4 million in revenue-sharing dollars during the first 11 months of 2004 from its seven "preferred" fund companies, American, Federated, Goldman Sachs, Hartford, Lord Abbett, Putnam and Van Kampen.

Technically, that money was incidental to shareholders, rather than coming directly from the customer's pocket. The way revenue-sharing deals work, if a customer deposits $10,000, the fund company takes a part of its management fee and turns it over to the brokerage as a bonus. The consumer does not directly pay anything extra, although in an industry with the big profit margins of the fund world, you know at least some of the cost trickles down eventually.

In the case of Edward Jones, nearly 60 percent of the money the company earned selling fund and annuity products in 2003 came from revenue-sharing deals. More than 95 percent of the firm's fund shares historically have been in the preferred fund companies.

The biggest payment came from the American funds, which actually had the lowest fees; that's a good sign, showing that brokers were not necessarily out to enrich the mother ship by pushing investors into lesser fund families.

In fact, it's clear that many Edward Jones brokers - often in one-person offices - were unaware of the way the deals worked, and stuck with the preferred list mostly because those were the only issues for which Jones sponsored educational briefings. That practice of limited briefings has stopped.

But because the disclosure doesn't make it entirely clear exactly how each revenue-sharing deal works, there is little to be drawn from looking at the numbers. There's no way to say that clients who were steered to a firm paying a big incentive were done any form of injustice.

So you get disclosure, but don't know what to do with it, and it doesn't help you make any sort of investment decision.

That's not real help.

Morgan Stanley, by the way, apparently felt the revenue tallies added so little to the process that it didn't actually disclose them on its Web site, instead making a statement that describes how revenue sharing works and who it has agreements with.

Fund firms aren't giving much more data in their disclosures, and since investors almost never actually call for the statement of additional information, the filings are just more meaningless sugar pills.

Regulators hope to give the information more muscle when they require "point-of-sale" disclosures, where brokers and planners will have to tell a customer at the time of a purchase just where all the dollars go.

Assuming the new disclosures become mandatory, they will make people aware of the issue.

It still won't change anything. Cerulli Associates, a Boston research firm, did a recent study showing that "preferred" investments get as much as 10 times the flow of funds not on a brokerage's list.

Disclosure won't change that.

It's as if the company making the spaghetti put a label on the box saying that 5 cents from every dollar went to pay for better display on the shelves. If there's nothing to indicate that money comes directly from the consumer's pocket - and in point-of-sale disclosures, nothing will say that revenue sharing increases the customer's out-of-pocket cost - buying habits won't change.

"It's a red flag that says: `Oh, you investor, be aware that there are special deals being made here,' " says Geoff Bobroff, an industry consultant. "But there is no way an ordinary consumer can figure out what this translates to. If they don't see that they are directly paying more - and that's not in there - they can't draw any real conclusions from this."

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