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Mar 20, 2006 2:04 pm

BROKER CENTER

Beware of Revenue Sharing

By Selena Maranjian (TMF Selena)
March 17, 2006

Have you ever heard of a practice called "revenue sharing" by mutual fund companies and brokers? It might sound like a good thing -- it has the word "sharing" in it, after all, and we've all been told how nice it is to share. But the money being shared isn't being shared with you. It's actually your money, and it's being shared with others!

The practice involves a mutual fund company paying a broker that sells shares of one of its funds to a customer. That might sound like a sordid kickback, but it's explained by some as merely a reimbursement for sales expenses. Either way, it presents some problems for the fund investor.

For starters, you might not be guided to the best funds if the person guiding you is being offered an incentive to steer you toward particular funds.

Making matters worse, the revenue-sharing will eat away at some of your profits. In an article at fpanet.org, Kenneth Moon offered this eye-opening example: "According to the McHenry Revenue Sharing Report, a 45-year-old participant with a hypothetical rollover balance of $300,000 could have her balance reduced by as much as $213,000 by a retirement age of 65." He included a graph showing the growth of the investment if $10,000 is added annually and the growth rate is 10% annually, without revenue sharing, vs. 9.5% annually with it.

Supporters of this revenue sharing (and you can probably guess who they are) will likely object to this depiction, explaining that the money is coming from the fund company, not the fund itself. Still, one might ask where the fund company's money comes from. The answer: Us investors, via the fees we pay.

In an MSN Money article, Eric Jacobson reported that Merrill Lynch (NYSE: MER) disclosed on its website its involvement in revenue sharing, explaining that the fees it receives from fund families are simply to cover marketing and administrative costs. Jacobson didn't buy it, noting, "...it's pretty clear that money buys access, full stop ... The reality is that fund companies pay up for precious access to brokers, and those brokers are almost always limited to selling funds that have paid up." He quoted the company, admitting, "Funds that do not enter into arrangements with Merrill Lynch are generally not offered to clients."

As regulators continue to address this issue, look for increased disclosure, such as this statement from Citigroup's (NYSE: C) Smith Barney brokerage and this one from AIG (NYSE: AIG), and some enforcement of higher standards. In 2004, brokerage Edward Jones paid $75 million to settle claims of revenue sharing. In 2003, Morgan Stanley (NYSE: MS) coughed up $50 million. In 2005, American Express (NYSE: AXP) spinoff Ameriprise Financial (NYSE: AMP) agreed to pay $30 million to settle charges of revenue sharing.

In the meantime, don't take your broker's word for it. Look into whether revenue sharing is at work, and see what other funds are available. Take a look at our Broker Center for help.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.

Mar 22, 2006 8:02 am

OMG What a horible job of reporting.  Revenue sharing at 0.5%.  What fund does that?  Franklin Templeton and most other funds I know do revenue sharing at 0.05% and it comes out of their management fees.  It's amazing what can get published with out checking facts.

Mar 22, 2006 12:47 pm

So are you suggesting that the since the reported numbers may be incorrect, the practice is not wrong?

Mar 22, 2006 5:14 pm

I couldn't care less about Edward Jones...but I don't think revenue sharing of 0.05% is the end of the world.

MANY businesses in many industries pay for "shelf space."  Not just the securities industry. 

I wish Spitzer or someone like him would clean up the mortgage and title industry, the problems there are FAR WORSE.  My buddy owns a title company, and he just saw a loan come down the pike with 3.5 points!!!  These companies mortgage companies just rape people, and title companies are no better.

I don't think it's "right", but I don't think it's isolated either.

Mar 23, 2006 1:08 am

BankFC:

I wish Spitzer or someone like him would clean up the mortgage and title industry, the problems there are FAR WORSE. 

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Sorry, Spitzer is now going after radio stations. At least, that's what was reported the other day. It seems that radio stations are taking payments from recording studios to give airtime to certain artists. Say it ain't so Britney Spears, say it ain't so!!!

Oh my, I can see how this would take precedence over a middle class family getting the shaft on their mortgage!

Mar 23, 2006 1:12 am

Who cares about families?  Spitzer is trying to get elected Governor of New York.

Mar 23, 2006 3:09 am

This article is just plain stupid:

1. If you buy XYZ fund from a B/D that revenue shares, you pay the same commissions and fees as someone that buys that fund from a B/D that doesn't revenue share.

2. The revenue sharing money is marketing money.  If funds didn't pay it to firms, they would spend it somewhere else (advertising, wholesalers, etc).  If revenue sharing disappeared tomorrow, fund companies wouldn't just cut their yearly expense by .05% and then cross their fingers and hope people still invest.

I'll give them one valid point, though -- it does help crap fund companies get more money than they deserve.

Mar 23, 2006 10:16 am

Hey Drones and Clones

It's ok to justify bending your clientsover, because everybody does it?    I thought Edward Jones had higher standards?

It appears not..................... and by the way not every Firm has been fined, and none as high of percentage of revenue as Edward Jones.......ask yourself why? 

Some of us would say why not?

Mar 23, 2006 10:19 pm

Dean, I will agree that revenue sharing gives more money to crappy funds. But why does American Funds pay revenue sharing at all? Also, they don't pay any other firm as much as Edward Jones.

Mar 23, 2006 10:40 pm

Just consider the percentage of American Funds business that is done by Jones.  Although they will not disclose the number, I assure you it is very large.  If American stopped paying Jones what do you think those greedy GPs would do???

Mar 23, 2006 10:57 pm

Every firm get’s money from mutual fund companies.  But, as a broker, I don’t know what extra money my firm makes on mutual funds and I don’t see it anyways.  As long as brokers do what’s right for the client, it doesn’t matter about revenue sharing.

Mar 24, 2006 12:23 am

Doesn’t pepsi and coke pay for shelf space at the piggly wiggly. 

Mar 24, 2006 12:32 am

bankrep1:Doesn't pepsi and coke pay for shelf space at the piggly wiggly. 

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Yes, as do countless other products. Those that pay the most are located on the shelf at eye level.

Piggly Wiggly put me through college. Two years of high school and four years of college. I worked my ***-off for $2.25 an hour, which was better than minimum wage! I still have bad dreams about working there. And that was 30 years ago!

Mar 24, 2006 1:37 pm

[quote=bankrep1]Doesn't pepsi and coke pay for shelf space at the piggly wiggly.  [/quote]

Tisk, tisk, this is not an acceptable analogy according to the red sheet. The grocer doesn't have as much responsibility as we do!

Mar 24, 2006 3:30 pm

Tisk, tisk, this is not an acceptable analogy according to the red sheet. The grocer doesn't have as much responsibility as we do!

Well if the food police have their way, there might be consequences.  If you are paid to put all the "bad" food at eye level and encourage your customers to buy things that make them fat.......isn't it then the grocery store's fault that we eat too many twinkies and potato chips?

Just a continuation of the retarded logic that is prevalent in our current Nanny minded society where people are not responsible for their own stupid actions.

Mar 25, 2006 12:23 am

bankrep1:

Doesn't pepsi and coke pay for shelf space at the piggly wiggly. 

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Yes, and the grocer does not disclose that fact. Sounds like a lawsuit that Spitzer would like!

Mar 26, 2006 2:10 am

Don't give him any ideas...