The Law Planet Blog

The NASD has levied fines against four brokerage firms for mutual fund violations related to B shares. See the NASD press release here. There is a certain amount of hypocrisy involved in these fines.

I remember when B shares were first released. They were marketed as a means to eliminate the broker's self-interest in the mutual fund transaction. This was done with the full knowledge of the SEC and NASD. A broker is supposed to "know the customer." A broker violates that rule when a recommendation is made because a broker would receive a higher or lower commission depending upon the selection of mutual fund family.

B shares, which charge a declining redemption fee based upon years held, charged no upfront fee. A customer was encouraged to buy B shares because "all your money goes to work immediately." That was the sales pitch. In exchange, the brokerage firm received a commission which was financed by the mutual fund sponsor and amortized over the redemption period. This was viewed as a good thing.

But then, one day, someone woke up and said "we're paying these higher fees over the life of the investment, not just during the redemption period." This resulted in a change where B share purchases became A shares, which were eligible for lower ongoing expenses and whose purchasers paid a sales charge upon initial investment. In my experience, the crossover period, where it is a better investment to be an A share purchaser instead of a B share purchaser, is about 7 years.

The regulators have been examining this situation for a number of years. One thing they are looking for is large purchases in a fund family (a group of mutual funds administered by the same company) that would be eligible for a breakpoint (a commission discount). Some funds have breakpoints as low as $100,000. Most funds allow an investment without commission at $1,000,000.

If you are an investor in mutual funds, ask your broker for the most cost-effective way to buy the funds, including using purchases among your household accounts. If you are a broker, it is your job to get the client the best deal.

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