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Putnam Ends 'Directed Commissions'

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Putnam Investments is dropping its practice of rewarding brokers who sell more of the company’s products by directing commissions to their firms, a way of doing business that has recently drawn scrutiny from federal regulators.

John A. Hill, chairman of the Putnam funds’ board of trustees, which represents fund shareholders, disclosed the planned switch in a letter last week to Securities and Exchange Commission Chairman William Donaldson. The move comes at a time when Putnam, the first mutual-fund firm charged in the fund-trading scandal, is seeking to restore its reputation and stem investor defections.

The shift by Putnam, a unit of Marsh & McLennan (MMC), also coincides with a broadening focus by regulators on sales practices in the mutual-fund business. For years, mutual-fund companies have rewarded brokerage firms that sell large amounts of their funds by steering trading business to those brokerage firms, a practice called “directed brokerage.” It is legal for a mutual fund to consider a broker’s record of selling its products when deciding where to direct commissions, as long as the broker is providing “best execution” of trades, or prices in line with those of other brokers. It is illegal if there is a set quid-pro-quo between the broker and mutual fund in which commissions are traded for extra business.

Last week, in settling a suit against Morgan Stanley, the Securities and Exchange Commission and the National Association of Securities Dealers charged that Morgan Stanley failed to disclose that was receiving extra commissions for selling certain mutual funds. After the settlement, Morgan Stanley said that it had such arrangements with 16 firms, including Boston-based Putnam, the nation’s fifth-largest fund firm. Morgan Stanley paid $50 million to settle. The company neither admitted nor denied wrongdoing. In his letter to Donaldson, Hill of Putnam said the practice created “potential conflicts of interest ” between Putnam and its shareholders, saying it was often difficult to determine whether a broker was really offering best execution on trades. Hill, an independent director who doesn’t work for Putnam, also urged Donaldson either to restrict or end the practice on an industrywide basis.