Do You Understand the Fees Charged by Your Mutual Funds? Probably Not.

In a July 31, 2009 article, Sam Mamundi of Marketwatch.com discussed the hidden sales fees charged by mutual funds. As noted in the article, “[t]he majority of retail funds are sold through brokerages, and each brokerage firm levies a range of charges to the fund for every sale. The cost of these agreements is passed on to investors.” These charges come in a variety of forms, including “revenue sharing agreements” and 12b-1 fees.

Many broker-dealers have revenue sharing agreements with mutual fund companies. Under these agreements, the broker-dealers are paid a percentage of the mutual fund sales they generate by the mutual fund companies. Each firm negotiates its own rates of revenue sharing with each mutual fund company.

Over the past few years, there have been lawsuits involving revenue sharing agreements. These cases were brought against broker-dealers and were largely based upon the premise that these undisclosed fees created a conflict of interest because the firms’ brokers (and also the broker-dealers) had a financial incentive to push the funds managed by the companies with whom the broker-dealer had an agreement, and not based upon their clients’ best interests.

Although mutual fund companies specifically report the amount of 12b-1 fees they charge against shareholders in their annual and semi-annual reports, the amount of money charged to shareholders for these revenue sharing agreements are not specifically disclosed. In fact, as noted in the Marketwatch.com article:

“There’s no direct rule requiring funds or brokerage firms to disclose revenue-sharing deals. Funds simply have to state that they pay for these deals, and often that’s tucked away at the back of a prospectus — which many investors don’t read before they buy into a fund.”

The Securities and Exchange Commission is also reportedly looking into the issue of hidden mutual fund sales fees. In her testimony before the Subcommittee on Financial Services and General Government on June 2, 2009, SEC Chairperson Mary Schapiro stated:

I also have asked the staff to prepare a recommendation on rule 12b-1, which permits mutual funds to use fund assets to compensate broker-dealers and other intermediaries for distribution and servicing expenses. These fees, with their bureaucratic sounding name and sometimes unclear purpose, are not well understood by investors. Yet in 2008, rule 12b-1 was used to collect over $13 billion in investors’ funds out of fund assets. It is essential, therefore, that the SEC engage in a comprehensive re-examination of rule 12b-1 and the fees collected pursuant to the rule. If issues relating to these fees undermine investor interests, then we at the SEC have an obligation to step in and adjust our regulations.

President Obama is also focusing on this issue. In a June White Paper (will open in Adobe Acrobat), the President noted that for the country “[t]o rebuild trust in our markets, we need strong and consistent regulation and supervision of consumer financial services and investment markets.” To that end, President Obama recommended “[s]tronger regulations to improve the transparency, fairness, and appropriateness of consumer and investor products and services.” In order to accomplish this goal, the President has set out to increase the power of the SEC so that the agency is better equipped to protect consumers and investors. Whether this will be enough is yet to be determined.

Undisclosed fees and revenue sharing agreements are another example of conflicts of interest between Wall Street firms and Main Street investors. Unfortunately, stockbrokers and financial advisors often lose sight of their clients’ goals and, as a result, their clients suffer unnecessary losses in the value of their IRAs, 401(k)s, college savings plans, or other investments accounts. The Kueser Law Firm represents investors who have suffered losses in their investments as the result of stockbroker or financial adviser misconduct. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

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Firms Asked to Account for Sales of Leveraged ETFs

According to an article on InvestmentNews, Massachusetts securities regulators have subpoenaed four brokerage firms for information related to their sales practices of leveraged ETFs. The subpoenas come only a few weeks after Edward D. Jones, Ameriprise, Linsco Private Ledger (LPL) and UBS restricted the sale of the products or stopped selling leveraged ETFs altogether. This also comes approximately three weeks after FINRA advised firms that leveraged ETFs “typically are unsuitable for retail investors.”

The most widely traded leveraged ETFs are managed by Direxion Funds, ProShares, and Rydex. Because these funds are “leveraged,” they are designed to provide market returns that significantly exceed market indices. For example, the Rydex Inverse Dow 2x Strategy Fund “seeks to provide investment results that inversely correspond to 200% of the daily performance of the Dow Jones Industrial Average.” (from Rydex Funds’ website.*) Therefore, if the Dow Jones Industrial Average increases by 10%, this fund is designed to lose 20%. Conversely, if the DJIA declines by 10%, this fund is designed to gain 20%. Another example is the Direxion S&P 500 Bull 2.5x Fund, which is designed to provide “daily investment results, before fees and expenses, of 250% of the price performance of the S&P 500 Index.” (from the Direxion Funds’ website.*) Therefore, if the S&P 500 Index declines by 10%, this fund is designed to lose 25%. What most investors are not told is that these funds are designed to produce the stated returns on a daily basis. Therefore, these funds are not designed to be bought and held.

The truth is that leveraged ETFs are unsuitable for retail investors because of their level of risk. As stated on Investopedia.com, a leveraged ETF is “an exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.” The fund essentially borrows money and combines this money with investors’ money to purchase derivatives such as options, futures, or swaps. Because of the use of debt and derivatives, these ETFs carry a significant amount of risk. These funds also generally charge higher expenses to shareholders, which results in reduced returns (or increased losses if the market goes against the investment objective of the fund).

From January 2, 2008 through March 6, 2009, the S&P 500 Index declined from 1,447.16 to 683.38. This represents a loss of 52.8% during a 14-month period. As you can imagine, leveraged ETFs that were focused on growth (bullish funds) suffered tremendous declines during this period.

If your financial advisor or stockbroker sold you funds that are managed by Direxion, ProShares, or Rydex and you suffered losses, you may have a claim for recovery of those losses. The Kueser Law Firm represents investors in securities arbitration. If you are concerned that your investments have been mismanaged, contact us to learn more about your rights.

* This blog intentionally refuses to link to the websites of companies that manage and sell leveraged ETFs because of the riskiness of these funds. If you would like to learn more about these funds, use Google to search for the information. If your adviser has recommended these funds to you, get a new adviser or at least a second opinion.

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Considering Investing in Mutual Funds?

The New York Times published an informative article by Tara Siegel Bernard on December 16, 2008 that discusses a lot of the basics of mutual funds.

This is a great article for anyone who is unfamiliar with mutual funds, but who has or is considering incorporating mutual funds into their investment portfolio.

Too often, investors are misled as to key features of the investments they are sold. Having a fundamental understanding of how different investments work serves two important benefits: (1) it allows an investor to better understand and communicate with their stockbroker or financial advisor; and (2) it provides the investor with a better means by which to interpret their periodic statements and other documentation so they can monitor their accounts.

The Kueser Law Firm represents investors that have been the victims of securities fraud, investment fraud, as well as other forms of stockbroker and financial adviser misconduct. In addition, the firm represents consumers that have been defrauded. If you would like to contact the firm for a free consultation, please call 816.374.5865 or visit our website, www.jmkesquire.com, for more information.

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