Merrill Lynch was fined $14 million, while Wells Fargo was fined $3 million and Linsco was fined $2.4 million. The amount of the fines approximate the additional commissions the firms received by selling Class B shares rather than Class A mutual fund shares. In addition, each firm is implementing a remediation plan to compensate affected customers - collectively involving more than 29,000 households and nearly 140,000 transactions.
NASD's investigation examined transactions during an 18-month period between January 2002 and July 2003. Investigators focused on 23,000 households at Merrill Lynch with 105,000 Class B and C share transactions; 4,500 households at Wells Fargo with 12,000 Class B and C share trades; and approximately 2,000 households with 22,400 Class B and C share trades at Linsco.
During this period, the three firms recommended and sold Class B and/or Class C share mutual funds to their customers without considering or adequately disclosing on a consistent basis that an equal investment in Class A shares would generally have been more advantageous to those customers in view of all relevant considerations. Before recommending a share class, brokers must consider the customer's anticipated holding period and all costs associated with each share class including front-end sales charges, annual expenses and contingent deferred sales charges. The firms also had inadequate supervisory and compliance procedures relating to the manner in which the firms' sales personnel recommended and sold Class B and Class C shares.
"In recommending mutual funds with different share classes, brokers must understand, consider and disclose information about which particular share class would be most beneficial for the customer from an expense perspective," said Barry Goldsmith, NASD Executive Vice President and Head of Enforcement. "The failure by these firms to do this resulted in their customers purchasing Class B and C shares when they would have been better served with Class A shares. The firms have agreed to a remediation plan that will give affected customers the opportunity to convert their holdings to a more financially advantageous mutual fund share class."
Class A shares typically charge a front-end sales charge and also may be subject to an asset-based sales charge, but it generally is lower than the asset-based sales charge imposed by Class B or Class C shares. Mutual funds may offer discounts, called breakpoints, on the front-end sales charge for Class A shares if an investor makes a large purchase, already holds other mutual funds offered by the same fund family, or commits to regularly purchasing the mutual fund's shares. To determine the appropriate discounts, an investor is often allowed to aggregate his purchases with holdings of other family members. Class B shares typically do not charge a front-end sales charge, but they do impose asset-based sales charges that may be higher than those associated with Class A shares. Class B shares also normally impose a contingent deferred sales charge (CDSC) which the investor may pay at the time the investor sells the shares. While the investor holds the shares, the CDSC normally declines and eventually is eliminated after a certain number of years. After the CDSC is eliminated, Class B shares often "convert" into Class A shares. When they convert, they will be subject to the same, lower asset-based sales charge as the Class A shares.
Class C shares usually do not impose a front-end sales charge on the purchase but they are often subject to a CDSC if sold within a short time of purchase, usually one year. Class C shares also typically impose higher asset-based sales charges than Class A shares, and since their shares generally do not convert into Class A shares, their asset-based sales charge will not be reduced over time. So even though investors do not pay a front-end sales charge for Class B or Class C shares, the potential CDSCs and the higher ongoing fees significantly affect the return on mutual fund investments, particularly at higher dollar levels.
In resolving this matter, the firms have agreed to a remediation plan that generally covers investors who, between January 1, 2002 and the dates of the settlement with each firm, purchased Class B shares totaling $50,000 or more depending upon the expenses and charges of the fund and who under any ordinary circumstance would have been better off had they purchased A shares instead. The offer will also be extended to a limited number of Class C share investors who, during the same time frame, made purchases of $500,000 or more and who, in view of all relevant circumstances, would have been better off had they purchases A shares instead. A number of mutual fund transaction exclusions from the plan also apply.
NASD has posted a special section on its Web site - Improper Sales of Mutual Fund Class B and Class C Shares - Remediation Information for Investors - to assist investors covered by the remediation plan.
The firms will contact affected customers within five months. Those customers will be given the opportunity to convert their Class B or Class C shares to Class A shares in a way that will restore the customers to the position they would have been in had they originally purchased Class A shares. Affected customers who have sold some or all of their Class B or Class C shares will be eligible to receive a cash payment in addition to, or instead of, receiving Class A shares.
Each firm will establish a response center to assist affected customers. The entire remediation process is expected to take approximately nine months to complete. The three firms settled these actions without admitting or denying the allegations, but consented to the entry of NASD's findings.
Earlier this year, NASD settled similar charges involving sales of Class B and C share mutual funds against Citigroup Global Markets, American Express Financial Advisors (now known as Ameriprise), and Chase Investment Services , and those settlements also involved remediation plans which those firms are currently implementing. In all, NASD's Class B and C share enforcement actions this year will result in the offer of remediation to more than 400,000 mutual fund transactions by more than 79,000 households.
For information about the differences in mutual fund share classes, see the NASD Investor Alerts Understanding Mutual Fund Classes and Class B Mutual Fund Shares: Do They Make the Grade? For information about breakpoint discounts on Class A share investments, see the NASD Investor Alerts Mutual Fund Breakpoints: A Break Worth Taking and Mutual Fund Breakpoints: Are You Owed A Refund? A free NASD video webcast, Mutual Funds: Share Classes and Breakpoint Discounts, provides an overview of Class A, B and C shares as well as discussing breakpoints.
Last month, NASD launched two important online tools for mutual fund investors. NASD's new and improved Mutual Fund Expense Analyzer delivers fee and expense information for virtually all of the more than 18,000 mutual funds and 160 Exchange Traded Funds (ETFs). Among other things, the analyzer will compare the expenses of up to three share classes of the same mutual fund simultaneously.
NASD's new Mutual Fund Breakpoint Search Tool offers users a groundbreaking way to research eligibility for breakpoint discounts. Investors and brokers can look up breakpoint schedules and linkage rules for mutual funds with front-end sales charges, most commonly A shares.
Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2004, members of the public used this service to conduct more than 3.8 million searches for existing brokers or firms and requested more than 190,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at www.nasdbrokercheck.com. Investors can also access this service by calling (800) 289-9999
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and registered firms. For more information, please visit our Web site at www.nasd.com.
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