In their continuing effort to clean up mutual fund sales, federal and industry regulators yesterday fined three large brokerages and a fund company a total of $81 million for improper sales practices and required them to make restitution to tens of thousands of investors.
The fines covered alleged abuses in two areas but shared a theme: Investors were steered into fund purchases that benefited their brokers, often at the investors' expense. The Securities and Exchange Commission and the industry regulator NASD gathered evidence during a broader investigation of the $7 trillion mutual fund industry.
Enforcement chief Barry R. Goldsmith said the case is the biggest one NASD has undertaken concerning Class B stock.
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Citigroup, J.P. Morgan Chase & Co. and American Express Financial Advisors Inc. paid a total of $21.25 million to NASD, formerly known as the National Association of Securities Dealers, to settle allegations that they collected excess commissions from more than 50,000 households by selling high-fee Class B mutual fund shares when the investors could have bought another class of the same funds for less. In addition to the fines, all three firms will convert the shares into the class with lower ongoing fees and reimburse customers who have sold their shares for the extra fees they paid.
Citigroup also paid $20 million to the SEC to settle similar allegations and a charge that it took secret "shelf-space" payments from more than 70 mutual fund companies to recommend its products.
One fund company, Putnam Investments, agreed yesterday to pay a $40 million penalty for not telling its board and investors that it was rewarding brokerages for promoting Putnam products. That money will be put back into the Putnam funds for distribution to shareholders, the SEC said.
As is customary in securities industry settlements, the firms neither admitted nor denied wrongdoing.
Regulators have been investigating sales of Class B shares since 2003 because of concerns that many investors did not understand how that kind of shares worked. Unlike more common Class A shares, on which investors pay a commission or "load" upfront, Class B shares carry a "back end" commission that must be paid when investors sell their shares. The arrangement allows investors to put off paying the commission -- or avoid it entirely if they hold the shares for six years or longer -- and is legal.
Problems arose because some fund companies discount or waive commissions for Class A shares when the investment exceeds a certain amount, usually $50,000, but do not do so for Class B shares. According to allegations in the settlements, brokers sold Class B shares and did not tell customers that Class A shares would be cheaper.
The case settled yesterday is the largest Class B case the NASD has ever brought, said its enforcement chief, Barry R. Goldsmith.
More cases are imminent, but most of them stem from past sales rather than continuing abuses, the regulators said. Citigroup's Smith Barney brokerage now flags Class B transactions to double-check whether investors would do better buying another class of shares, said Kim Atwater, a spokeswoman.
"Since we've focused on this issue, we've seen positive changes at other firms in how these products are sold," Goldsmith said. "Practices have improved."
The SEC is trying to eliminate under-the-table payments by mutual funds to brokers by banning the most common method of payment, known as "directed brokerage." Fund companies may no longer steer stock and bond transactions to particular brokerages in exchange for having their funds promoted by the brokers to their retail customers. Putnam paid directed brokerage fees, and Citigroup received them, the regulators said.
Investors who were harmed by Class B share sales practices do not have to do anything to be reimbursed. Under the settlements, brokerages must bear the costs of identifying and contacting investors, regulators said.
