Wednesday January 14, 2004

Paying For Shelf Space & The Toothless SEC

For those of you who don't know, I came from the brokerage industry. I served time at three major brokerage oufits, Merrill, Morgan Stanley, & Smith Barney. Each of these firms favored certain fund companies - no surprise that the funds they favored were "loaded" funds. I knew for a fact that these "favored" funds had arrangements with the company and were paying the company a fee for having a "favored" status, everybody knew it. The correct term is "paying for shelf space." It is the practice of paying a broker/Dealer (industry speak for a brokerage firm) to put your fund company on a favored list - it is a classic "pay to play scheme". The arrangements are never explicitly disclosed, but every broker knows they exist in one form or another - if they don't then they are either ignorant or plain stupid. The SEC just released a study saying that it found abuses at 13 of 15 unnamed brokerage firms in a probe of "revenue-sharing." Here's the funny part, reports "As scandals simmered across the $7-trillion mutual fund business, the SEC said it found that "revenue sharing" -- or mutual funds paying brokerages to tout the funds' shares -- is "common practice," based on a probe launched in April 2003." The funny thing is the probe was only launched about 9 months ago, despite the fact that the SEC knew this was going on for probably at least a decade, if not more. Why did the SEC all of a sudden launch this probe? Elliot Spitzer. The NY State Attorney General Elliot Spitzer has ruthlessly gone after fund companies and broker/dealer for conflicts of interest - had the AG not stepped in the SEC would never had started a probe and none of the enforcement activities would be happening. The SEC has not did its job for years and now is trying to play catch up with Elliot Spitzer in order to save face.

I am not defending the practice of "paying for shelf space," simply saying that the practice was well known by the industry and the SEC and the SEC chose to do nothing about it, now they suddently care? There efforts too clean up the industry are a little late, by not enforcing existing rules (or spirit of the rules) they effectively have told the industry that what they are doing is ok, we will look the other way. They are sending a mixed message to Wall Street and mutual fund companies (and inevitabley Variable Annuities) - that message: We will look the other way while you clearly violate shareholders interests, as long as we aren't embarrased by a state attorney general, if we are, then we will enforce and come down on you as if you are evil.

Well, the companies are basically greedy and evil, but the SEC might as well have been a partner in the wrongdoings because they never acted as a regulator and constantly turned there head when they knew bad things were going on. Heck, I knew bad things were going on after only a few months at a brokerage firm - I was only 23 years old....

As stated before, I think it is rather slimy to pay a company to promote your product. It is a huge conflict of interest - but it is an industry norm that has been tolerated by the SEC, basically a tacit endorsement. Now the fund companies are under investigation for paying these fees and there reputations are at stake. I don't promote any of the funds that are implicated, or that will be implicated because the funds I use rarely show up in brokerage firm accounts - the reason: they won't pay for shelf space. However, some of the fund companies being implicated are good, honest fund firms - American funds come to mind. It will be interesting to see how the SEC handles this issue going forward. The have been asleep at the wheel so long, the question is, have they awoken in time to steer the car away from the ditch?

If the SEC truly were an enforcement agency then Elliot Spitzer and his band of publicity hungry state AG's would not be involved in the numerous mutual fund, broker-dealer, & eventually variable annuity scandals that have been unearthed and will be unearthed. Shame on the SEC, they've been toothless for so long - does anyone really believe they suddenly have fangs?

Until next time...