Compensation Practices for Retail Sale of Mutual Funds:1 the Need for Transparency and Disclosure

By Howat, John; Reid, Linda | Fordham Journal of Corporate & Financial Law, July 1, 2007 | Go to article overview

Compensation Practices for Retail Sale of Mutual Funds:1 the Need for Transparency and Disclosure


Howat, John, Reid, Linda, Fordham Journal of Corporate & Financial Law


I. Introduction

Mutual fund firms, also known as investment companies or investment trusts, buy and sell stocks, bonds, and other securities.2 A fund raises money to make its purchases by selling shares in itself. The fund pools the money of many investors - its shareholders - to invest in the securities.3 Those securities are professionally managed by fund managers on behalf of the shareholders. After the trading costs and expenses of managing and administering the fund are subtracted, the earnings realized by the fund on its investment portfolio are paid out pro-rata to the fund's shareholders. Shareholders may also realize investment gains by selling (or redeeming) their shares back to the fund at the shares' net asset value (the total value of the fund's assets divided by the number of shares outstanding).

Mutual funds have recently become increasingly popular vehicles for individual investors in the United States. In 1980 there were 564 funds with assets totaling $134.8 billion.4 As of the end of December 2005 there were 7,977 funds with combined assets of $8,905 trillion.5 Similarly, in 1980, 4.6 million households owned mutual fund shares, representing only 5.7% of all households in the United States.6 As of 2005, 91 million individuals in 54 million households (nearly half of all households) owned mutual funds.7 It should be noted that the majority of household investments in mutual funds occur through employee retirement plans.8 A healthy percentage, however, is purchased by the investors themselves, and of those purchases, more than 80% are made through financial professionals.9

Individual investors can purchase mutual fund shares on the retail market in one of two ways, either directly from the fund, or through an intermediary seller. In the first case, investors purchase "directmarketed funds" via phone, mail, or the internet. In the second instance, the fund's underwriter acts as a wholesaler or distributor to an intermediary firm, (e.g. a brokerage firm, an asset management company, a financial planning firm, an insurance agency, or a bank) which in turn sells to the individual investor via a sales force. 10 Some brokerage firms also sell their own private-label funds.

The typical retail shopper who purchases shares through a financial adviser will be given a fund prospectus. The prospectus includes information regarding the investment objective of the fund, the historical investment performance of the fund, and the costs and expenses the shareholder will pay. The compensation received by the financial adviser for recommending or selling the shares is included in the fee table in the prospectus; however, in most cases it is not identified explicitly. Adviser compensation information is required to be presented explicitly in the Statement of Additional Information (SAI). The SAI must also include a description of potential conflicts of interest which the adviser's method of compensation might create. Notable, however, is the fact that the SAI is provided to the potential shareholders only if they specifically request it.

Brokerage firms and the various financial advisers who sell mutual funds to retail purchasers may be compensated in a variety of ways, including (1) loads, or sales charges paid directly by the purchaser; (2) marketing fees, also known as 12b-(11) fees; and (3) fund servicing and operating expenses.12 Both 12b-l and fund expense fees are paid out of the assets of the fund, and thus are ultimately paid by the shareholders. Payments from each of these sources compensate financial advising firms and their personnel for providing a wide range of services, including the administering of shareholder records, processing transactions, training the advisers who sell the funds, and investor education. While fund firms assert that these services provide advisers and investors with valuable benefits, others, including regulators, criticize the lack of transparency in brokerage firm compensation, since it is practically impossible for investors to know precisely if, and how, financial advisers are paid out of fund assets. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Compensation Practices for Retail Sale of Mutual Funds:1 the Need for Transparency and Disclosure
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.