Consistency fees weighed
October 26, 1998
The practice of paying brokers fees to reward them for maintaining assets under management for as long as possible may be resurfacing even as regulators weigh whether the practice warrants increased oversight.
So-called "consistency fees" have long been controversial and the National Association of Securities Dealers' regulatory division, in the last year, has been considering imposing new regulations on their use. But, also this year, the fees were cited in a Morgan Stanley Dean Witter report as a legitimate method for investment companies to reward brokers who retain fund assets.
Capital Research and Management Co. of Los Angeles is one company that appears to be reviving the use of such a fee. Although a spokesman for Capital Research, Chuck Freadhoff, did not use the term consistency fee, the fee he said the company is beginning to use fits the definition of a consistency fee. The fee is a cash bonus paid to brokerage companies for selling Capital Research's American Funds, he said. The compensation would be based on 10 to 12 criteria. Two of the most heavily weighted criteria, apart from assets, would be the length of time assets have been under management and the access that the firms give fund wholesalers to systems and personnel.
"We hope that this would help cement a long-term relationship that would lead to greater retention of assets of our company," said Freadhoff.
The compensation agreements Capital Research has recently reached with some brokers is in addition to the 12b-1 sales and marketing fee typically paid to brokers, Freadhoff said. The fee is not deducted from fund assets, but paid directly by the funds' management company to the brokerage firms. It is not necessarily disbursed to the brokerage firm's sales force. Although Capital Research's agreements with brokerage firms were made before current prospectuses were written, information about the incentive will first be included in upcoming American Funds prospectuses, says Freadhoff.
American Funds, with 28 funds and $240 billion in assets under management, are sold only through brokers and charge loads ranging from 4.75 percent to 5.75 percent.
While Capital Research plans to begin using the incentive, NASD Regulation is considering stepping up oversight of them. Current NASD rules prohibit mutual fund underwriters from making payments to NASD members unless the payments are disclosed in the prospectuses. Last year, NASD sought comment on whether such compensation should be prohibited entirely; whether additional disclosure requirements should be imposed and whether such programs are harmful or beneficial to customers and the industry.
The Investment Company Institute, the mutual fund industry's trade association, in a letter to NASD, recommended requiring disclosure by broker dealer firms to their customers as well as disclosure by mutual fund companies in their prospectuses.