Mutual fund brokers officially get paid in a variety of ways, depending on which class of shares an investor buys. On Class A shares, investors pay an upfront charge of about 5 percent, called a load, most of which goes to the broker who sold the fund to them. The commission for B shares is collected at the back end, when the investor withdraws money from the fund, and C shares pay the broker by charging higher annual fees than the other classes.
Bentley College finance professor Leonard Rosenthal warned that unwary investors sometimes confuse broker-sold B and C shares with "no-load" funds that are bought directly from the fund company and charge no commission at all.
The Securities and Exchange Commission, chaired by William H. Donaldson, has moved toward fund accountability.
(Dennis Brack -- Bloomberg News)
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Remember, he warned, "every time you buy or sell, [brokers] earn a commission."
Investors also need to keep a close watch on the annual fees charged by the funds their broker recommends, said Edward S. O'Neal, a professor of finance at Wake Forest University. He said that many of the mutual fund companies that pay high commissions to brokers specialize in actively managed funds -- in which a fund manager continually makes investment decisions, buying and selling -- instead of low-cost funds that simply replicate market indexes by holding the same stocks.
The differences are not trivial: Actively managed funds can charge 2 percent or more a year, while the Vanguard Group's famously cheap fund that mimics the Standard & Poor's 500-stock index charges 0.18 percent.
"All mutual funds have costs that lower your investment returns, and even small differences today can have a dramatic effect over time. Before you invest, be sure to ask your broker or the fund about the fees you'll have to pay . . . as well as ongoing expenses that come out of the fund's assets," said Geraldine Walsh, of the SEC's investor education office. "It's your money, so don't be shy about getting the facts you need to make an informed investment decision."
Still, Taeya Lauer, a Seattle broker with D.A. Davidson & Co., notes that the SEC and NASD require funds and brokers to show potential investors their net returns after all fees.
Investors also need to be aware of the various abuses that the SEC and NASD have recently uncovered. Among them:
• A regulatory examination found that brokerage firms failed to give promised discounted commissions -- in Street shorthand, breakpoints -- to 20 percent of investors who put $25,000 or more into Class A shares. That was 288,300 accounts, with an average overcharge of $243. The entire industry is refunding $64.3 million to customers.
• Some brokers improperly steered customers into Class B shares, which have the back-end load, and failed to point out that they would qualify for breakpoints if they invested another way. In one 2002 case, NASD found that a broker sold $2.1 million in Class B shares -- netting himself a huge commission -- to an investor who would have paid no commission at all if he had bought A shares in the same fund.
