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Fund Spy

Fund Middlemen Need to Shape Up

Why shady sales practices result in higher costs and biased advice.

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We’re glad to see the SEC is moving to reform fund sales practices. Inappropriate sales practices have cost investors far more than market-timing. A few common practices that need to change harm investors by driving up costs and biasing recommendations given by advisors. Add up all the fees and biased advice and it becomes clear why so many funds post subpar results.

Regulators and brokers have long played cat and mouse games over systems that reward brokers for favoring in-house funds and those from a select group of fund companies. Originally, investors just paid higher commissions on in-house funds straight to the brokers, but the NASD put a stop to that. In response, the brokerage industry switched to sales contests and other practices that more or less did the same thing. After they got busted for that, the industry switched to preferred lists, which paid branch chiefs and brokers more for selling selected funds.

These practices are bad news for a couple reasons. First, they raise costs because fund companies have to pay to get in. For the most part, these costs are supposed to be borne by the fund companies, not investors. But you can bet it gets priced into the cost of the funds in one way or another.

Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.