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ABSTRACT
In the supermarket business, the idea of "pay to play" has been a well understood practice. Product manufacturers have a tradition of paying supermarkets for shelf space. However, the practice of revenue sharing has received considerable attention in recent business press, highlighting the lack of awareness from the average consumer. This paper looks at the current practice and the recent SEC proposed "New Confirmation and Point of Sale Disclosure" requirements and the possible implications for the independent financial planner.
Introduction
A recent Wall Street Journal article1 discussed the predicament of an elderly customer whose investment in a Putnam mutual fund vastly underperformed the market. In isolation the performance of the mutual fund was very similar to other mutual funds during the same time period. However, what was not directly disclosed to the investor was the arrangement that the Putnam family of mutual funds had with Edward D. Jones & Co., the customer's broker. The Wall Street Journal estimated that Putnam paid Jones about $100 million in revenue sharing fees-clearly legal, but circumspect given the lack of full disclosure.
In November 2003. the security and Exchange Commission (sec) settled a securities enforcement action against Morgan Stanley for $50 million in fines and subsequent disgorgement of any related profits. Allegedly Morgan Stanley entered into special marketing arrangements with several funds and was compensated in part through revenue sharing payments and portfolio brokerage commissions. In return Morgan Stanley placed participating funds on preferred lists and otherwise specially promoted these funds through its sales system. Morgan Stanley gave brokers payouts of one to three percentage points more for these preferred products.2
The above cases highlight the problem that accompanies differential compensation paid by mutual funds to broker-dealers in the form of a revenue sharing system. At times, the expenses associated with marketing mutual funds are collected in the form of a sales commission or load. These fees are typically disclosed in a prospectus and are very understandable to the average investor, especially if these fees are uniformly paid to all brokerdealers. However, when mutual fund selectively pays a broker-dealer ostensibly for these same costs in the form of "revenue sharing" payment that is not well understood by the public, and that looks very much like a...