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Proprietary Fund Bonuses Could End

NASD Regulation has postponed indefinitely the idea of adopting new rules which would have changed the way mutual fund companies pay broker/dealers for sales.

The rules that had been considered could have prohibited revenue sharing arrangements between mutual fund companies and broker/dealers who distribute funds, said Larry Kosciulek, assistant director at NASDR.

Instead, this month, the NASDR staff plans to ask the NASDR's board of governors to back a rule which prohibits broker/dealers from paying their registered representatives higher commissions for selling the firm's own funds than those paid for selling funds managed by outside firms.

The rule is intended to eliminate the conflicts of interest that can arise between an investor and a stockbroker when the broker is paid more for selling a proprietary product than an outside fund, Kosciulek said. NASDR is making the proposal at the prompting of SEC Chairman Arthur Levitt, Kosciulek said.

If the board of governors agrees with the proposal, NASDR could publish the rule next month and then solicit comment from the industry, Kosciulek said. It was unclear how quickly the NASDR board of governors might take final action on adopting the proposal. A NASDR spokesperson did not return a call seeking further details on the proposal.

Kosciulek discussed the possible new rule in an interview during the National Association for Variable Annuities' regulatory affairs conference in Washington, D.C. last month. The rule prohibiting higher payouts for proprietary products would not apply to variable annuities, Kosciulek said.

Two years ago, NASDR began to examine how mutual fund companies pay broker/dealers for selling their funds. As part of its inquiry, NASDR solicited comments on whether it should bar revenue sharing, a practice which involves a mutual fund company making ongoing payments to a broker/dealer for fund sales. Fund consultants and industry executives say revenue sharing is a virtually universal practice, although there is no data on the its prevalence. The revenue-sharing payments offer broker/dealers an incentive to sell a particular fund. NASDR decided to forego pressing for broader changes in revenue-sharing practices and instead to concentrate on prohibiting added payouts which some firms make for representatives who sell proprietary funds, Kosciulek said. Kosciulek did not know how many firms or what percentage of firms pay their representatives more for selling proprietary funds than outside funds.

The proposed NASDR rule, if adopted, should have a limited effect on broker/dealers and funds, said Andrew Guillette, a consultant at the fund consulting firm of Cerulli Associates of Boston. The practice of making bigger payouts for proprietary products has become farr less common in recent years, Guillette said. In addition, firms have found that they can use indirect means to encourage such sales, Guillette said. Sales contests, additional compensation and rewards for branch office managers can help aid sales efforts for proprietary funds without requiring a higher direct payment to a registered representative, Guillette said.

"There are subtle and not so subtle ways that sales forces can be influenced," Guillette said.

A special committee of securities industry experts in 1995 criticized the practice of some broker/dealers paying more to sell their own funds. The committee on compensation practices, commonly known as the Tully Committee after committee chairman Daniel P. Tully, recommended that firms pay identical commissions to registered represents for proprietary and non-proprietary funds.

In April, Levitt, the SEC chairman, in a speech cited the issue as an important one.

The NASDR staff also plans to propose two other rules which could have an effect on fund sales practices. One proposal would prohibit sales contests for a single securities product, Kosciulek said. The staff also will recommend that broker/dealers be required to disclose to investors instances where a broker who switches firms receives increased pay for switching his clients to the new firm. Levitt backed both proposals in an April 13 speech to compliance executives at the Securities Industry Association conference in Boca Raton, Fla.

"The SEC has really been focusing on distribution practices generally," said Debra M. Brown, director of investment company services for National Regulatory Services, a compliance consulting firm in Lakeville, Conn. The firm is owned by Securities Data Publishing, publisher of Mutual Fund Market News.

The SEC oversees NASDR and ultimately must approve new rules which NASDR seeks to adopt.