• NASD Members are Warned to Give Investors Their Required Breaks
  • July 23, 2003 | Author: Samuel E. Cohen
  • Law Firm: Marshall, Dennehey, Warner, Coleman & Goggin - Philadelphia Office
  • The regulators have warned the brokerage industry that firms have been over charging investors who make large mutual fund purchases, according to the National Association of Securities Dealers ("NASD"). The NASD investigation is centered on whether brokerage firms are giving investors who purchase mutual funds the proper price break on sales charges. The NASD issued Notice to Members 02-85 to alert members to take immediate action to ensure that the customers receive the advantage of breakpoints, namely, a reduction in the sales charges commensurate with the size and nature of the customer's transaction. To explain, mutual funds offer discounts on front-end sales charges or loads for large investment levels called "breakpoints." There are several breakpoints and if you invest more and reach each of these thresholds, the greater the reduction in the sales load.

    Through Notice to Members 02-85, the NASD has directed that each of its member firms must "immediately review the adequacy of its policy and procedures to ensure that they are designed and implemented so that investors are charged the correct sales loads on mutual fund transactions." The NASD requires members to implement any changes to their policies and procedures that are necessary to ensure that investors are charged the correct sales loads on mutual fund transactions. In addition, firms must retain a record of its review and the results for examination by the NASD.

    According to Notice to Members 02-85, a broker-dealer must: (1) ensure that those who process the mutual fund transaction understand the terms of the offerings; (2) ascertain the information which determines the availability and appropriate level of breakpoint; (3) apprise the customer of the breakpoint opportunity and inquire whether the customer has positions or transactions away from the member which should be considered in connection with a pending transaction; (4) ensure that those processing the transactions are trained to transmit all aspects of a mutual fund order, including any applicable breakpoint, to the mutual fund company; and (5) have appropriate and sufficient procedures, including supervisory procedures, with respect to breakpoint calculations. Members cannot rely on the mutual fund company to identify the members' customer and allocate the correct breakpoint for the transaction or override the members failure to do so.

    Further, an investor may receive breakpoints based on Rights of Accumulation "ROA" or by using Letters of Intent ("LOI"). A ROA provides a discount on mutual fund purchases by combining current and previous fund transactions to reach a breakpoint. An LOI expresses an intent to invest an amount over the breakpoint within a given period of time specified by the fund. However, an investor must invest the amount stated in the LOI or the fund can retroactively collect the higher fee.

    In the case of ROAs or LOIs, an investor may credit mutual fund transactions and other related accounts, in different mutual fund classes, or in different mutual funds that are part of the same fund family, toward their discounts. Each mutual fund sets their own breakpoints which can be determined from the mutual fund prospectus or the mutual fund company's web site.

    Notice to Members 02-85 has been a hot topic in the securities industry prompting an NASD investor alert, as well as several other articles in securities related publications, including The Wall Street Journal. Officials at the NASD have stated that the breakpoint problem does not appear to be intentional, but rather the result of the large number of front-load mutual funds that exist in the electronic trading systems which brokerage firms and mutual fund companies employ to handle, buy and sell orders. However, there are suspicions that some brokers are intentionally dividing big purchases into smaller parcels which guarantee a bigger commission for the broker, since the numerous smaller purchases would carry higher loads.

    The issues raised by NASD Notice to Members 02-85 have also been noticed in Washington. It has been reported that two members of Congress, Michael Oxley (R-Ohio) and Richard Baker (R-La), have requested that the NASD and SEC provide them with a report as to (a) how many brokerage firms have engaged in "misconduct" with regard to sales loads; (b) how many investors have been overcharged, and to what extent; (c) to what extent the sales load problem is attributable to willful misconduct or is the result of inadequate systems design and/or oversight; and (d) whether the current regulatory administration is adequate to protect investors. To answer these questions, the NASD and SEC will be required to investigate member firms. Any firm that fails to provide the discounts based upon breakpoints and thus ignoring Notice to Members 02-85, is subject to a range of penalties from the NASD and SEC, which run from fines to expulsion from the industry if the transgressions are blatant and intentional.