SEC Cranks Up Probe Into Fund Firms’ Fees
Inquiry centers on whether money managers are properly disclosing additional costs to investors
By Kirsten Grind
July 16, 2015 6:54 p.m. ET
U.S. securities regulators are examining whether mutual-fund managers are dipping more deeply than allowed into their investors’ money to compensate the brokerages that distribute their products, according to people familiar with the matter.
OppenheimerFunds, Franklin Templeton and J.P. Morgan Chase & Co. are among more than a dozen fund firms that have been reviewed by the Securities and Exchange Commission, which began a broad sweep of how companies sell their products about two years ago, these people said. In recent weeks the SEC’s examination unit referred some of these firms to its enforcement division, these people said. It isn’t known if the SEC will take action against any money managers.
The SEC examination could have broad implications for how the $16 trillion mutual-fund industry sellsits products to ordinary investors. Money managers rely heavily on Wall Street brokerages, insurers and other middlemen to feed their products to Main Street and employ thousands of salespeople to push their funds.
Regulations allow money managers to spend some of their investors’ money to pay brokers who sell shares in their funds and on marketing with some limits. The SEC now wants to know whether mutual-fund companies are drumming up ways to make extra payments by tapping the assets they manage for investors to pay for services such as consolidating their clients’ trading records, according to the people familiar with the matter. The SEC’s concern is those additional fees aren’t disclosed properly to investors, and that brokers may be more likely to recommend funds that pay for such services, the people said.
“It creates the notion of pay to play,” says Bing Waldert, a director at research firm Cerulli Associates, which gathers data about the financial-services industry. “Funds are recommended to investors not fully on the merit of quality of product, but also because they pay for it.”
Fund companies say they do properly disclose marketing fees, and that the SEC should focus instead on pressure applied by Wall Street brokerages and insurance companies that often demand more money for their services, said people familiar with fund executives’ thinking.
Oppenheimer is among the money managers referred to the SEC’s enforcement division as part of the probe, said people familiar with the situation. An Oppenheimer spokeswoman said the firm pays the cost of record-keeping services and it doesn’t come out of its mutual-fund expenses. “We believe this is a sound and transparent practice,” she said.
Spokeswomen for Franklin Templeton and J.P. Morgan declined to comment. A spokesman for the SEC also declined to comment.
Money managers have had to push harder to get brokerages to sell their products in recent years, as investors have shifted into index funds that claim smaller percentages of their assets as fees. The concern is some money managers may be skirting the rules and making bigger payments to give brokers a stronger incentive to sell their funds.
The SEC allows mutual funds to spend some investors’ assets on marketing and distribution. Wall Street’s self-regulator, the Financial Industry Regulatory Authority, limits that spending to 0.75% of a fund’s average net assets a year.
Fund companies could in theory get around those limits by classifying the payments as another type of allowable fee for record-keeping services, said people familiar with the SEC’s inquiry. The SEC’s inquiry centers on whether mutual funds are appropriately disclosing those additional costs, these people said.
“From an investor standpoint, it’s effectively an incorrect reporting of what’s being paid for fund distribution,” said Barry Barbash, a partner at law firm Willkie Farr & Gallagher LLP and formerly the director of the SEC’s division of investment management.
If extra payments have to be disclosed properly, investors would know more about how their money is spent, and money managers could be forced to use their own money to gain favor with the firms that sell their products.
The trade publication BoardIQ earlier reported the SEC’s review of mutual fund distribution payments and the scrutiny of Oppenheimer.
The SEC signaled as early as 2013 that it would review how mutual funds distribute their products across the U.S., focusing on their arrangements with intermediaries and whether mutual-fund boards have proper oversight of that relationship.
The review is part of a larger push by the SEC and other regulators to eliminate conflicts of interest in the investment industry and ensure investors aren’t steered to products for the wrong reasons.
This year, a top SEC official cited industry conflicts as one of the agency’s biggest priorities for 2015 and highlighted fund distribution as a “particular concern.”
Write to Kirsten Grind at email@example.com
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