Investors could receive tens of millions of dollars in refunds from securities brokers who failed to deliver promised discounts on commissions on mutual-fund purchases.
The National Association of Securities Dealers said the practice was widespread and ordered that industry-wide refunds, plus interest, be made. The firms will have to check sales records going back years to determine who is eligible. But the regulator said in a notice to brokers that a survey of 2001 and 2002 fund sales found that “most [NASD] members did not uniformly deliver appropriate breakpoint discounts” to investors.
The NASD had previously said it found that in roughly one-third of the cases examined, investors didn’t get the discounts to which they were entitled, an average of $364 per transaction.
As a result, the refunds could total in the tens of millions of dollars spread among some of the country’s 95 million fund investors, who have a total of $4.28 trillion invested in stock and bond funds. “We are dealing with a very systematic problem in mutual-fund transactions that covers well over 600 firms,” said Marc Menchel, executive vice president at the NASD.
In the past, the NASD’s enforcement actions have mandated one or a handful of firms at a time return commission overcharges to investors, but the latest ruling applies across the industry.
Breakpoints are dollar levels at which investors are supposed to receive discounts when they purchase shares in mutual funds that carry upfront sales charges. Discounts typically start on fund purchases of $25,000 or more, but many investors can qualify because past shares acquired in a single fund family are supposed to be counted.
Regulators don’t believe the mistakes are the result of widespread deception by the industry. They attribute the problem to the complex rules set up by the mutual-fund companies covering these discounts and the failure by brokerage firms to keep track of the commissions that investors were supposed to pay.
In ordering all fund sellers to promptly pay any required refunds with interest, the NASD also signaled that more enforcement actions may be in the cards for Wall Street firms failing to provide breakpoint discounts.
The refunds also are the latest headaches for the fund industry, which while not being swept up in the Wall Street scandals affecting other financial-services firms, has come under fire for the level of portfolio-management fees and disclosure of those fees to investors.
The difference in commissions adds up quickly. For example, on a fund with a normal 5.75% front-end sales charge, the commission often should drop to 5% of assets for a $25,000 fund purchase. It often drops again to 4.5% for $50,000 and then 3.5% for $100,000 and so on. That means an investor purchasing $100,000 in shares would pay $3,500 in commissions, but if the breakpoint discount wasn’t given, the investor would have paid $5,750 in commissions.
The most common type of fund shares that carry front-end loads — and therefore might be eligible for breakpoint discounts — are “A” shares. These shares account for more than $1.3 trillion in fund assets and make up roughly three-quarters of all fund shares, excluding no-load funds, which don’t charge up-front commissions.
While it is difficult to estimate what percentage of A-share investors would qualify for breakpoints, the average fund investor buying funds through a financial intermediary such as brokers had $129,400 in assets invested in mutual funds, according to the most recent data available from the Investment Company Institute. Even though many investors put money into multiple fund families — thus making it less likely they would qualify for breakpoint discounts — that average asset total suggests that many investors would still be likely to qualify from some breakpoint discounts at most fund firms.