Broker Got $82 Million to Push Funds
Los Angeles-based American Funds and six other mutual fund companies paid a total of $82.4 million to brokerage Edward Jones & Co. for selling their products through the first 11 months of last year, according to records disclosed Thursday.
The extremely unusual disclosure was demanded by the Securities and Exchange Commission and other federal regulators, who said the St. Louis-based brokerage failed to tell customers that the funds on its “preferred list” paid millions of dollars to be there.
Edward Jones is licensed to sell mutual funds from 240 families, but more than 95% of its fund sales in recent years have come from the seven preferred fund groups.
California Atty. Gen. Bill Lockyer, who sued Edward Jones last month alleging civil securities fraud, called Thursday’s disclosures “a good step, but inadequate.” The payments pose an inherent conflict of interest, Lockyer said, because brokers know that they will make more money if they steer clients to preferred funds.
“If you want to have a preferred list, OK, but don’t take money for it,” Lockyer said in an interview. “I think they should just discontinue the practice of getting kickbacks.”
Lockyer calls the payments “kickbacks” because the amount paid by the fund companies is tied to the amount of money Edward Jones brokers generate for them. The mutual fund industry refers to the arrangements as “revenue sharing” and says the payments are used to help educate brokers about its products.
Each fund company uses its own formula to determine the payments, although typically the criteria include sales volume.
American Funds, a unit of Capital Group Cos., paid $27.2 million in revenue sharing to Edward Jones through Nov. 30 -- by far the most of any company on the preferred list.
“In general we support more disclosure at the point of sale,” said American Funds spokesman Chuck Freadhoff. “I don’t want to comment on whether this is the best way to do that.”
Freadhoff, however, noted that revenue-sharing funds came from the firm’s sales arm, American Funds Distributors, and not from mutual fund assets. “It does not diminish or impact shareholders’ results.”
The incentive payments, which brokerages get on top of any regular commissions and fees, are legal.
But the SEC said Edward Jones violated securities law by failing to inform investors that it was being paid “undisclosed compensation” for recommending the mutual funds from the seven firms, creating potential conflicts of interest.
Since 1997, the SEC said, the brokerage had told investors on its website: “With nearly 11,000 mutual funds available, it can be difficult to know which fund(s) to pick. That’s why at Edward Jones, we focus on seven preferred mutual fund families that share our same commitment to service, long-term investment objectives, and long-term performance.”
To settle the charges, Edward Jones agreed Dec. 22 to disclose the arrangements and pay $75 million in penalties and restitution, which will be returned to customers.
In addition to American Funds, the preferred families are Federated Investors Inc.; Goldman Sachs Group Inc.; Hartford Financial Services Group Inc.; Lord Abbett & Co.; Putnam Investments, a unit of Marsh & McLennan Cos.; and Van Kampen Investments Inc., owned by Morgan Stanley.
“This group of fund families has greater access to our investment representatives to provide training, marketing support and educational presentations,” the brokerage’s new Web statement says in part. “Consequently, while our investment representatives are free to sell, and our customers are free to select funds from many mutual fund families, virtually all of Edward Jones’ transactions relating to mutual funds involve preferred family funds.”
“While the receipt of revenue sharing is among the factors that determine whether a fund is treated as ‘preferred,’ ” the firm adds, “such payments are not the only factor considered in deciding which fund families are designated as preferred.”
In an e-mail response to questions Thursday, the brokerage said: “We hope this helps investors better understand how revenue sharing works and recommend they consult an Edward Jones investment representative if they have additional questions.”
An Edward Jones spokesman declined to comment further.
With more than 9,000 branch offices in the U.S., Canada and Britain, Edward Jones is one of the largest fund sellers.
For years it had internally designated certain fund families as “recommended,” but in the late 1980s it approached those families and sought to obtain revenue-sharing deals with them, a strategy that led to the preferred list, the SEC said last month.
The deals have boosted its bottom line: In 2003, revenue sharing equaled 33% of the profit of the brokerage’s parent company, Jones Financial, the SEC said.
The brokerage has vowed to “vigorously defend itself” against Lockyer’s suit. Its legal response is due March 3.
American Funds has not been charged with wrongdoing by any regulators, but it is squarely in Lockyer’s sights.
In January 2004, shortly after California law gave Lockyer new clout to pursue securities cases, the attorney general said he would target possible fraud in the sales of mutual funds, putting the brokerage business on notice and singling out three large fund companies: American Funds, Franklin Resources Inc. and PA Distributors.
PA, which markets the Newport Beach-based Pimco Funds, and Franklin Resources, the San Mateo, Calif., parent of the Franklin and Templeton funds, both settled suits with California last year over the practice.
Lockyer said American Funds, the nation’s third-largest fund family, has spent far more on “shelf space” deals than the other two fund firms. Lockyer said a suit or settlement involving American Funds did not appear to be imminent.
“It’s still in the investigation/discussion stage,” he said.
An SEC spokesman declined to comment on whether the agency was also investigating American Funds’ marketing practices.
American Funds could argue that it has done a better job than most of its competitors in disclosing its revenue-sharing deals, said Geoff Bobroff, a fund industry consultant in East Greenwich, R.I. Those disclosures are contained in fund prospectuses and other documents.
What’s more, American’s relatively conservative funds, which generally carry low expense ratios, have performed well in recent years, so customers are unlikely to be mad at their brokers for recommending them, Bobroff said.
The firm was last year’s leader in fund sales, with an estimated $76-billion net inflow through November, or 35% of the industry’s total, according to Financial Research Corp.
This year the SEC may require disclosure of shelf space deals at the point of sale. It proposed such a rule in January 2004 and is considering tweaking it after hearing from investor focus groups, a spokesman said.
Even with that proposal in limbo, brokerages and fund companies have stepped up their disclosures voluntarily.
Last summer, American Funds expanded the information it provided on revenue sharing, Freadhoff said.
Its fund prospectuses list the firm’s formula for determining revenue-sharing payments, and the funds’ statements of additional information list as many as 75 brokers expected to get the payments.
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Share and share alike
American Funds Distributors, the sales affiliate of Los Angeles-based American Funds, paid the most in revenue sharing to brokerage Edward Jones last year, based on data through Nov. 30.
2004 mutual fund payments to Edward Jones (in millions)
American Funds: $27.2
Hartford: $16.6
Van Kampen: $13.2
Lord Abbett: $10.6
Putnam: $9.8
Goldman Sachs: $3.7
Federated: $1.3
Source: Edward Jones
