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Mutual fund kickbacks should be banned

Imagine you were deathly ill and your doctor prescribed the wrong medicine because its maker had bribed him. You'd want him out of business and behind bars, and the drug company executives, too.

Turns out this kind of thing goes on all the time in the brokerage and mutual fund industries, and the Securities and Exchange Commission isn't inclined to do much about it.

Recently, the SEC said a nine-month investigation had found that 14 of the 15 largest brokerages had been involved in a mutual fund kickback scheme. Fund companies paid the brokers to recommend their funds rather than competitors'.

In many cases, the payola came in cash. In others, the funds, in return for favored treatment, agreed to use the brokers for the stock and bond trading done by fund managers, a service that generates lucrative commissions for the brokerages.

Obviously, the point of the scheme is to corrupt the broker, to get him to recommend a fund he otherwise would not.

The victim is the investor who isn't getting the expert advice he's paying for and who could well get stuck with a fund that does poorly or carries unnecessarily high fees or too much risk.

That's bad enough, but here's the real shocker: These kickbacks aren't illegal _ not if the broker tells the investor about them.

The SEC merely complained that the funds and brokerages had failed to disclose the arrangements, or had said too little.

Although the SEC made much of the value of full disclosure, it hypocritically refused to identify the funds and brokerages involved. We're still investigating, the agency shrugged. More likely it can only stomach so much wrath from an industry with lots of lobbying clout.

So what's the solution?

SEC commissioners have voted to seek public comment on proposed rules to more clearly require brokers and fund companies to tell investors about any special kickba. . . _ I mean "revenue sharing" arrangements.

The commissioners argue that investors will shun brokers who have conflicts of interest, and these unseemly deals will, therefore, wither away.

But that's not likely. Experience shows millions of investors ignore the red flag of conflict by allowing brokers to talk them into buying funds that charge upfront sales commissions called loads, even when there are equally good no-load funds.

People trust their brokers. If the broker says, "Yeah, the fees on this fund are a little higher but it will pay off big anyway," many investors will go along. Disclosing revenue sharing won't change that.

And it's not good enough to say it's up to investors to look out for themselves; when it comes to investments for college and retirement, the stakes are too high.

The fact is, exploiting conflict of interest is a long Wall Street tradition, deeply ingrained in the culture. These companies typically wear many hats, and what's good for one group of customers, or good for the company, may be bad for others.

You may remember the controversy a couple of years ago over the tainted advice from stock analysts. They were urging investors to buy crummy stocks from companies that brought their firms valuable investment banking business.

At the time, the big Wall Street firms were full of remorse and regret. They fired a few offending analysts and assured us they'd be on the lookout, that integrity was job one.

Well, here we are less than two years later finding that big brokerages are doing the same thing with mutual fund companies.

So the remedy has to be more extreme than simple disclosure of conflict of interest; regulators should attack the conflict itself.

At a minimum, revenue-sharing must be banned. Brokers and other investment advisers should have no financial incentive to recommend one fund over another. Advice must be solely based on what's best for the customer.

That means also banning loads, which on some funds come to as much as 5 percent of the amount invested. Load levels are set by the funds, but the money goes to the brokerage.

Those who defend loads, mainly the brokers who get them, say this is fair compensation for the work they do to find good investments for their customers.

Certainly, brokers have to be paid for their service. But payment should come through straightforward commissions that are the same no matter which fund the investor picks. That way the broker would have no reason to push a bad fund over a good one.

There's a good model for this in the commissions charged for stock trades. Regardless of whether you buy shares of Microsoft, General Motors or Pep Boys, the broker gets the same commission. If that's good enough for stocks, it's good enough for funds.

_ Philadelphia Inquirer

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