It's IRA season, so beware sales-starved fund shops that offer brokers boosted commissions to push their funds.
is offering brokerage A.G. Edwards an extra payout for selling several of its funds in tax-deferred IRAs (individual retirement accounts) from Feb. 1 through April 15, according to paperwork filed with regulators at the end of December and over the past two weeks.
The tactic, which is known as
full dealer reallowance, is particularly common in the first four months of the year when investors try to build their nest egg and perhaps reduce their tax bill by making a contribution to their IRA. That said, few investors are aware of the practice.
Oppenheimer didn't have a comment on the bonus, but critics say it can tempt a broker to sell a fund for its payout rather than its quality.
"I think the practice raises a lot of ethical issues and it's something you should be aware of," says Scott Cooley, a senior fund analyst with Chicago research house Morningstar. "Are you being sold a fund because it's good or because of its payout? A lot of advisers trying to build a business might find the extra money tempting."
With fund sales well off last year's record pace, these questionable pitches will no doubt be popular, so they merit some explanation.
Here's how reallowance works. When you buy shares of a broker-sold fund and pay a sales charge, or load, most of that money pays the brokerage and the selling broker's commission. A small portion, usually between 0.25% and 0.5% of the amount invested, goes to the fund company. But when a fund shop offers a full reallowance promotion, it pays its share of the load to the brokerage for sales made in a specified month or two. Often the extra cash is shared with selling brokers, though not always.
In Oppenheimer's promotion, for fund shares sold between Feb. 1 and April 15, A.G. Edwards will receive an extra 0.5% for sales of Class A shares, an extra 0.5% for sales of Class B shares and an extra 0.25% on sales of Class C shares. The list of Oppenheimer funds being promoted includes
Main St. Growth & Income,
International Small Company,
Quest Opportunity Value,
Quest Capital Value,
Quest Balanced Value and
Because an individual can plunk only $3,000 a year into his or her IRA and a couple tops out at $6,000, you might wonder why fund companies and brokers and brokers even bother with these promotions. For fund companies, though, the appeal is fairly simple. Because IRA investments tend to stay put for years and frequently balloon thanks to 401(k) rollovers as people change jobs, they are often some of the most profitable accounts on a fund company's books, generating fees year after year.
With so many fund companies vying for these dollars, the higher payout can help a company stand out. That's of particular concern today because fund sales have fallen with the
. Through Nov. 30 last year, stock funds netted just $29.2 billion in 2001, compared with $297.9 billion in the same period the year earlier, according to the Investment Company Institute, the fund industry's largest trade group.
And the extra commissions can add up for brokers, too, if an investor rolls a large sum of money into the IRA. For every $50,000 worth of Class A shares sold, brokers receive an additional $250.
Despite the potential conflict of interest, most investors are unaware that they're buying shares of a fund with a higher payout during a promotional period. Boosted commissions are usually only disclosed in a fund's prospectus or statement of additional information, which aren't widely read by investors.
Oppenheimer and A.G. Edwards aren't strangers to these offers, either. New York-based Oppenheimer offered the brokerage a boosted payout on sales of several bond funds from Sept. 1 through Nov. 30 last year, according to regulatory paperwork. And the pitches haven't hurt sales. Oppenheimer, the nation's 11th-largest fund firm with some $80 billion in its retail stock and bond funds according to Boston fund consultancy Financial Research, was the sixth best-selling fund firm last year through Nov. 30.
Oppenheimer is hardly the only firm that offers boosted payouts, however. Early last year, both
Kemper offered higher commissions to their brokers on IRA sales. Other firms that have played the reallowance game and been highlighted on
John Hancock Funds,
The lesson for investors is that if you work with a financial adviser, you need to make sure you ask specifically about how they're paid and whether they're getting a special deal for pitching a given fund. It would be nice if these types of gimmicks were relegated to used-car lots and commemorative plates sold over the phone, but unfortunately, that's not the case.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.