Abusive Mutual Fund Sales Practices

One of the reasons I decided to open Alhambra is that I was fed up with being associated with the brokerage industry. The brokerage industry has a long history of abusing their clients, usually in ways the average investor doesn't even understand. I know many fine individuals in the brokerage industry, but as a whole, it seems to be run by people that are ethically challenged to say the least. Here's another example:

"Regulators took a series of new steps in their efforts against abusive mutual-fund sales practices, as they wind down a crackdown on brokerage firms that allegedly collect special payments to promote favored funds.

Yesterday, the National Association of Securities Dealers said it fined four broker-dealers affiliated with ING America Insurance Holdings Inc., a unit of ING Groep NV, $7 million for taking brokerage commissions from mutual-fund complexes in return for preferential treatment of their funds."

To put this in terms everyone can understand, these firms demanded and received kickbacks, in addition to the regular commisssions they collected, to promote particular mutual funds. The kickbacks were either in the form of brokerage commissions paid by the mutual funds or direct cash payments. The effect was to raise the expense ratios of the funds to the detriment of fund shareholders. The brokerage firms had reason to push these funds on unsuspecting clients regardless of whether they were appropriate or the best funds available. These brokerage firms put their interests ahead of their clients.

Lest you think this is just one small brokerage firms doing this, consider this:

"The penalty was part of a series of actions NASD has taken in recent years to end directed brokerage. In April, it fined American General Securities Inc., a unit of American International Group Inc., $1.1 million, for allegedly engaging in the practice.

Other sanctioned firms include Ameriprise Financial Inc., then known as American Express Financial Advisors; Lord Abbett Distributor LLC; AllianceBernstein Investment Research & Management Inc.; Wells Fargo & Co. affiliate Wells Fargo Investments; and SunAmerica Securities Inc., another subsidiary of AIG that is now called AIG Financial Advisors.

A 2003 action against Morgan Stanley by the NASD and the Securities and Exchange Commission was one of the higher-profile cases in the broader campaign. The firm paid $50 million to resolve the actions by the two agencies."

"It was pretty widespread, in this particular area, but most of the firms, if not all, have gotten this message," said James Shorris, head of enforcement at the NASD. "We're not opening new investigations into directed brokerage, at least not at the rate that we were a few years ago."

Mr. Shorris added that directed brokerage and market-timing cases -- in which firms traded in and out of mutual funds rapidly, letting them benefit from market-moving news and arbitrage when most shareholders didn't -- "seem to be winding down." Still, he said, "the mutual-fund area is still giving rise to other kinds of cases."

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