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Pitt, Directors Press Brokerages on Billing Issue

Securities and Exchange Commission Chairman Harvey Pitt this month urged mutual fund directors to ensure that their investors are not being overcharged by brokerage houses in the form of fees levied on securities transactions (see MFMN 1/13/03).

The issue has caught the attention of legislators, industry groups, and top SEC officials, such as Pitt, who are all advising financial service companies to identify any problems with the procedures used to grant transaction-fee discounts to investors.

Last week, the SEC and National Association of Securities Dealers (NASD) said they were garnering reports from all NASD member firms and have partnered with the New York Stock Exchange to investigate the practices of firms that sell mutual funds with front-end loads. The SEC has also asked the Investment Company Institute (ICI) to convene a committee under the NASD's purview to find ways to ensure that investors receive these discounts.

"As watchdogs for fund investors, this is a critical issue deserving your time and effort," Pitt said during a meeting of mutual fund directors in Washington this month.

Rep. Michael Oxley [R-Ohio], chairman of the House Financial Services Committee who co-authored the anti-corporate fraud legislation signed by President Bush last summer, and Rep. Richard Baker [R-La.], who chairs the Capital Markets Subcommittee, wrote a letter to regulators earlier this month voicing concern about the issue.

In Late December, the NASD said that some brokerage houses are not recognizing so-called breakpoints, or discounts passed along to fund investors when they conduct transactions, typically involving large sums of up to $1 million or more. In addition, the self-regulatory group said that an investigation revealed that some firms might not have proper practices in place to identify when investors are eligible for the discounts. Last week, the group posted guidelines for mutual fund breakpoints on the Web (, which also serves as a tool for investors to analyze fund expenses.

SIA, ICI, NSCC in on the Act

Another industry group, meanwhile, is assembling a team to investigate the problem. The Securities Industry Association said last week that it will spearhead an investigation into practices involving breakpoints. The group has suggested that large mutual fund complexes, the ICI and the National Securities Clearing Corporation also meet to curb the problem. The SIA said it has also asked its membership to review breakpoint procedures and to fix any problems they find with those practices.

The ICI, meanwhile, has lauded the NASD for its vigilance (see "News Flash," page 7). "The industry strongly supports tough regulation of sales practices involving mutual funds and will cooperate fully in the investigation on behalf of its 95 million shareholders," wrote ICI President Matthew Fink in a letter to the U.S. House of Representatives this month.

There has been no firm calculation of the total amount that investors may have overpaid. But Pitt said investors could have been overcharged "a huge amount of money," possibly in the billions. "Obviously that money went somewhere," he said. The SEC chairman, who resigned late last year, but has not yet left the job, conceded that the alleged overcharging could be miniscule. But, he added, "Every time I assume it's nothing, I'm wrong."

Some wondered why the NASD had not detected the problem sooner. Pitt said he wasn't interested in assigning blame. Some, he said, believe that if the NASD is surprised to find that brokers have been overcharging, "they should all be fired. I don't think that's a constructive way to approach a crisis. The first thing to do is figure out how do we stop the hemorrhaging."

The NASD placed responsibility for making sure that investors benefit from breakpoints with brokers, saying that such transactions are mostly automated, which makes them difficult for funds to monitor. Indeed, Douglas Scheidt, the SEC's associate director and chief counsel for the division of investment management, said this is "mainly the broker's problem."

Marianne Smyth of the Washington practice Wilmer, Cutler & Pickering, said that as much as $2 billion dollars in so-called "soft money" circulates in the industry. The money usually takes the form of discounts and kickbacks that brokers and other parties receive.