In the last couple of years, FINRA has been taking a hard look at brokers that have been selling A shares to retirement plans to make sure they were waiving the load, if the fund allowed such a waiver. Well, it turns out that a lot of brokers have been selling A shares into retirement plans at POP (Public Offering Price), that is, the participants in the plan paid a front end load when the fund’s prospectus allowed those shares to be sold with no load. What’s the result of this activity? A FINRA investigation into broker dealer firms. So why is this happening now? Let’s take a step back and examine the players in this party.
A shares are sort of the granddaddy of mutual fund share classes. They’ve been around for a long time, as opposed to some of the newer R or institutional share classes. A shares generally carry a front end load that is paid by the shareholder at the time of purchase. Having the shareholder pay for the “sales commission,” rather than the fund having to front the money, allows the fund to take out a smaller management fee. So over time, the reduced management fee allows the shareholder to recoup some or all of that upfront commission they had to pay. Many funds, however, have long allowed retirement plans to buy A shares at NAV, that is, no up-front commission. This is a big benefit to the participants in the retirement plan as they get a better return due to the lower management fees than they would say in a B or C share class.
FINRA is now investigating broker dealer firms looking for instances where load-waived A shares have been sold to retirement plans with a load fee. Some broker dealer firms have had to reimburse shareholders in instances when the load was not waived; the reimbursement has included interest and a penalty paid to FINRA. FINRA has stated that if a broker dealer firm initiates a self-policing policy of investigating historical trades to see if the load was not waived, and reimbursing shareholders for the load with interest, then FINRA has said it will not impose a penalty on top of the remediation. In most cases, FINRA is looking for these broker dealer firms to look at all trades for the last seven years in order to make the shareholders whole. In addition to looking at sales of A shares into retirement plans, they are also looking at the sale of B and C shares when an A share with a waiver was available. In this case, FINRA is requiring firms to calculate a 75 basis point “differentiation” on the purchase amount from date of purchase up through the date remediation was made, or until the shares were sold. Oh, and they want interest paid on that amount as well.
Needle, meet haystack. In some broker dealer firms, a seven year review requires looking through millions of trades to find the suspect ones. Then once the suspect trades are found, those lucky broker dealers have to calculate daily compound interest on the load amount. For the B/C share differentiation calculation, they’ll have to calculate 75 basis points per year on the trade amount and then calculate the daily compound interest on that amount. Some firms have attempted to hire temps to pore through millions of trades and then create Excel spreadsheets to perform the calculations. Do the alliterative twins of “error” and “expensive” come to mind?
The A share and the B/C share remediation process is just another form of post trade compliance monitoring. The post trade compliance process can be run on historical trades as well as run on a weekly or monthly process to monitor for A share sales that should have been sold at NAV rather than POP. The key to surviving all this scrutiny and auditing lies in good data. And good data means all historical NAVs as well as a listing of all funds that allow A share waivers. With good data, the post trade compliance monitoring process can find the suspect trades as well as calculate the remediation amount with interest, thus speeding up the process and eliminating most of the errors involved when mere humans are tasked with looking through millions of trades. In short, if broker dealers want to avoid the exercise of looking for flowers in a garden of weeds, they’ll need to learn to plant with better seeds.
L. Burton Keller was a principal founder of the company in 1985 and currently focuses on strategic initiatives for the company. Mr. Keller is a former member of the Bank, Trust and Retirement Advisory Committee of the Investment Company Institute. He has served on numerous committees and task force groups with the ICI over the last 17 years including Co-chair of the Dividend Distribution Task Force.