Posted on: Thursday, February 12, 2004

SEC edges toward ban on incentive payments

By Marcy Gordon
Associated Press

WASHINGTON — Federal regulators are moving closer toward banning payments by mutual fund companies to induce brokers to sell certain funds — a practice critics say creates conflicts of interest and drives up investors' costs.

The Securities and Exchange Commission also voted yesterday to adopt new rules requiring funds to provide investors a twice-yearly "shareholder report" with more detailed information on fees and expenses. The report will include the dollar amount of fund expenses paid by shareholders on a $1,000 investment.

The SEC, which has been making a series of changes in rules governing the mutual fund industry, is promising that dramatic reforms protecting investors from abuses will be in place by early summer.

The agency has been under pressure to act from investor advocates and lawmakers — who are pushing legislation to overhaul the fund industry — as evidence continues to mount that ordinary shareholders are being hurt by trading and marketing abuses.

"It has become painfully clear that the practice of directing ... (fund money) to a broker or dealer as compensation for distribution of the fund's shares presents opportunities for abuse" in recent years, SEC Chairman William Donaldson said.

The practice is all the more troubling, he said, "because its impact is hidden from investors."

Underscoring the proposal's far-reaching impact, Donaldson said: "This one is going to hit them where it hurts."

The proposal will be submitted for public comment for 60 days and likely be adopted by the agency sometime afterward.

The new disclosure will "enable investors to determine the amount of fees they paid on an ongoing basis, as well as to compare the amount of fees charged by other funds," said Paul Roye, head of the SEC division that oversees the mutual fund industry, before the vote.

An annual fee as low as 1 percent can cut an investor's returns by 18 percent over 20 years, noted Commissioner Paul Atkins.

Also under the new rules, fund companies will be required to give investors more information every quarter about the stocks the funds invest in.

Bipartisan legislation by several senators also would outlaw the practice of fund incentive payments to brokers and other industry practices, significantly changing the way mutual fund companies conduct business with investors and the brokers who sell them funds.

The SEC move goes beyond a recent agency proposal to require that fund companies disclose such special arrangements to investors. An investigation by the agency found that the practice was rampant.