MUTUAL FUND TROUBLES

Scandal recently has rocked the $7 trillion mutual fund industry, and it’s only the beginning. Chief executives of three fund companies have left their jobs abruptly. Other officers have quit or have been forced out. Many of the departures involve special treatment for certain big investors. They were permitted to engage in late trading and rapid buying and selling known as “market timing,” practices prohibited for ordinary investors.

These maneuvers made big money for the favored few, at the expense of the multitude of little guys. But their losses were spread so widely that individuals suffered little and the abuse was slow to attract attention.

The same goes for the wide variation in management fees. Whether it is 0.2 percent or 1.5 percent makes little difference to an individual small investor but it means big bucks to a fund company. Eliot Spitzer, the New York state attorney general has called the fee system “grossly out of control” and is forcing reductions.

Another abuse now has become known – one that can be costly or even devastating to the individual. Brokers give it the nice name “revenue sharing.” They accept payments from various mutual fund companies in return for advising their customers to buy those companies’ funds. The Securities and Exchange Commission has been quietly investigating the practice for nearly a year. It said this week that it was examining “dozens of broker-dealers and mutual funds that engage in this practice to determine whether they adequately informed investors of the conflicts of interest.” The brokerage group Morgan Stanley, agreed in November to pay $50 million to settle charges that it failed to tell investors of compensation it got for selling certain funds.

One of the nation’s largest brokerage networks, Edward Jones, whose 8,131 U.S. sales offices include storefronts in Bangor, Brewer and Orono, inadvertently became the star of the “revenue sharing” episode. The Wall Street Journal on Jan. 9 published a front-page report on its long investigation of the firm’s practice of steering its 5.3 million customers to seven fund companies including Putnam that made regular payments of up to many millions of dollars a year to the Jones company. The newspaper reported that former Jones brokers said bonuses for brokers depended in part on selling the preferred funds. It said Jones did not disclose the payment system to its customers. The Journal quoted Tamar Frankel, a law professor at Boston University who specializes in mutual fund regulation as saying, “The deception is that the broker seems to give objective advice. In fact, he is paid more for pushing only certain funds.”

A spokesman for the Jones company at its headquarters in St. Louis, said the firm was “extremely disappointed” by the Journal article. It said it had maintained “preferred vendors” for decades, long before the existence of revenue-sharing agreements. It said that, “when revenue sharing became commonplace in the mid 1990s, we believed that participation was appropriate because revenue sharing came from the fees already paid to the fund companies and did not adversely impact investors.” It added that its clients hold their mutual funds four times longer than the industry average.

The company, which had already advised its clients who held Putnam funds to “sit tight for a while” and called publicly for reforms in the industry, said it had discontinued relationship with some funds. And it said that 60 t0 65 percent of its fund business went to “the fund company from which we receive the least revenue sharing.”

The Jones company has come clean and made some modest concessions, but investors can still question the propriety of these payments as a biasing factor when they seek unbiased advice.

“Revenue sharing” might better be called kickbacks. Back in the 1940s, family doctors were criticized for taking payments from specialists to whom they referred patients. And ophthalmologists took heat for accepting kickbacks from opticians. Later, there was a scandal in the recording industry over “payola,” the payments by companies to disk jockeys to induce them to play their records.

Whatever you call it, a payment like that rigs the game. And the customer ought to be told about it.