Securities and Exchange Commission
continued its cleanup of the mutual fund industry Wednesday, by voting to prohibit fund companies from directing lucrative trading commissions to brokerage firms aggressively pushing their products. The SEC also adopted rules to increase disclosure about fund manager incentives and conflicts.
"The fund industry became addicted to complex interlocking sales deals, relationships and sales structures," says fund industry watchdog Max Rottersman, founder of FundForensics.com. "The SEC is now playing that game by instituting its own complex set of regulations."
The new SEC rules ban mutual fund companies from directing the fund's brokerage transactions to brokers as compensation for promoting the sale of fund shares. The practice of paying for so-called "shelf-space" on top of a broker's ordinary commissions has grown commonplace in the industry in recent years, often times unbeknownst to customers.
Last November, Morgan Stanley reached a $25 million settlement with the SEC over allegations it failed to make the necessary disclosures about the existence of its so-called partners program. The SEC settlement also covered allegations that the firm's brokers improperly steered customers into high-commission "Class B" mutual fund shares without disclosing that they carried higher fees for the customer.
In another ruling, the agency approved a plan to improve the disclosure that mutual funds and other investment companies provide investors about their portfolio managers. The SEC's goal is to provide greater transparency regarding portfolio managers, their incentives in managing a fund, and the potential conflicts of interest that may arise when they also manage other investment vehicles like hedge funds.
According to the new rule, a mutual fund would be required to state in its prospectus basic information including the name, title, length of service, and business experience of each member of a portfolio management team, as well as provide a brief description of each member's role on the management team.
Fund firms also would be forced to disclosure potential conflicts of interest for portfolio managers overseeing more than one fund. For example, portfolio managers who manage a mutual fund and a hedge fund simultaneously would now be required to disclose the methods by which they are compensated. The goal is prevent a manager from favoring the hedge fund's investors at the expense of the mutual fund shareholders because managers of the former are usually better compensated, thanks partly to higher fees.
"It's a really big victory for fund investors," says Russ Kinnell, analyst at Morningstar. "It provides vital information on manager incentives that in many cases investors have been denied until now."