Fund investors were promised good medicine to combat the industry's problems. But increasingly the cures of "transparency" and "disclosure" turn out...

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Fund investors were promised good medicine to combat the industry’s problems.

But increasingly the cures of “transparency” and “disclosure” turn out to be placebos, and investors just got the latest example.
As part of settlements with federal regulators, brokerage firms such as Edward D. Jones and Morgan Stanley had to disclose revenue-sharing deals they made with big fund companies.

In addition, fund companies are beginning to disclose how these deals work too, although the information is buried in the “statement of additional information,” the second part of a prospectus that shareholders receive only if they go searching for it.

Revenue-sharing fees are legal, so long as the arrangements are properly disclosed.

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Regulators have an issue with brokerage firms that create “preferred” lists without revealing that the brokerage firm earns extra compensation whenever an investor moves money into the favored funds.

Think of it like paying for shelf space in a grocery, where the maker of cereal or spaghetti gives the grocer a little incentive for getting the best placement on the shelves.

Edward Jones posted its revenue-sharing disclosure on the firm’s Web site Jan. 13, noting that it earned $82.4 million in revenue-sharing dollars during the first 11 months of 2004 from its seven “preferred” fund companies: American, Federated, Goldman Sachs, Hartford, Lord Abbett, Putnam and Van Kampen.

Technically, that money was incidental to shareholders, rather than coming directly from the customer’s pocket. The way revenue-sharing deals work, if a customer deposits $10,000, the fund company takes a part of its management fee and turns it over to the brokerage as a bonus.

The consumer does not directly pay anything extra, although in an industry with the big profit margins of the fund world, you know at least some of the cost eventually trickles down.

In the case of Edward Jones, nearly 60 percent of the money the company earned selling fund and annuity products in 2003 came from revenue-sharing deals.

More than 95 percent of the firm’s fund shares historically have been into the preferred fund companies.

The biggest payment came from the American funds, which actually had the lowest fees; that’s a good sign, showing that brokers were not necessarily out to enrich the mother ship by pushing investors into lesser fund families.

In fact, it’s clear that many Edward Jones brokers — often in one-person offices — were unaware of the way the deals worked, and stuck with the preferred list mostly because those were the only issues for which Jones sponsored educational briefings. That practice of limited briefings has stopped.

But because the disclosure doesn’t make it entirely clear exactly how each revenue-sharing deal works, there is little to be drawn from looking at the numbers.

There’s no way to say that clients who were steered to a firm paying a big incentive were done any form of injustice.

So you get disclosure, but don’t know what to do with it, and it doesn’t help you make any sort of investment decision.

That’s not real help; it’s a placebo.

Chuck Jaffe is senior columnist at CBS Marketwatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.