Though Sales Charges Are Fixed, Prices May Vary

The Securities and Exchange Commission deregulated brokerage commissions 22 years ago Thursday--a bold move that allowed investors to shop around for the lowest fees when trading stocks. So how come mutual funds have not had their own May Day deregulation event?

Sales charges, or loads, on mutual funds technically remain fixed, which means you can’t negotiate these costs.

“The fund and money management industries don’t operate in a freely competitive market,” says an article in a recent issue of Registered Representative, a magazine for stock brokers published in Irvine. “Investment companies can’t sell their products to whom they want, at whatever price they want.”

Standardized sales charges harken back to the Investment Company Act of 1940, the main piece of federal legislation that governs mutual funds. Section 22(d) of the act prohibits fund companies from selling shares except at an offering price that’s available to all investors, as described in the prospectus or disclosure document.

“The 1940 act was written with an intense awareness of the abuses of the 1920s,” says John Collins, a spokesman for the Investment Company Institute in Washington, D.C. Legislators “wanted to level the playing field so that a firm couldn’t charge one price to, say, an insider and another price to someone else.”

Fixed sales charges on mutual funds share a historical kinship to fixed commissions on initial public offerings of individual stocks, which are sold at a single price to give all buyers an even shake, says Richard Phillips, a specialist in mutual fund law at Kirkpatrick & Lockhart in Washington, D.C. Since funds continually sell shares to the public, they are in what you might call an ongoing IPO mode.

Although section 22(d) and fixed sales charges remain in force, they don’t hold nearly the sway they did a generation ago.

“Fixed prices hold in theory, but there are so many ways to buy the same fund that there is an enormous amount of price competition,” Phillips says. Regulators, he adds, have approved several rule changes since 1940 that allow de facto price discounts on fund shares.

Geoff Bobroff, a fund industry consultant in East Greenwich, R.I., is even more blunt.

“I’m not sure 22(d) really exists anymore,” he says.

Although fund sales charges can’t be negotiated, investors who choose to work with a broker or financial planner can benefit from price competition in other ways.

For starters, maximum sales charges on most stock funds have dropped to between 3% and 6%, significantly below the 8.5% hit that was once the norm. Also, load funds routinely offer volume discounts for large investors--typically people plunking down $50,000 or more.

In addition, the advent of multiple classes of fund shares offers a way for investors to pay a lower commission, defer it or avoid it altogether.

For example, an investor can opt to buy a fund’s so-called B shares, on which a load is charged only if the person sells his or her stake within five or six years. Or an investor can buy a fund’s C shares, which combine slightly higher ongoing expenses with a modest load of perhaps 1%.

Additional load-shaving options are available, including the ability to buy funds through employer-sponsored 401(k) plans without paying any sales charges. In such cases, employee purchases essentially are lumped together so that they qualify for the volume discounts available to large investors.

Bobroff cites the advent of fund wrap-fee programs as another inducement to price competition. In these, investors typically purchase mutual funds without any sales charges, although they do pay an ongoing account-management fee to their brokers or financial planners that can exceed 1% annually.

But perhaps the most critical factors in cutting fund costs have been greater sophistication among investors and intensified competition from no-load families, which have forced load groups to reduce their sales charges.

“Loads definitely are not negotiable, but there is a lot of competition as load-fund groups have come under pressure from no-load groups and one another,” says Theodore Cohen, a financial services attorney at Spolin & Silverman in Santa Monica.

In short, fund investors enjoy various means to reduce or avoid paying a sales charge, even if they can’t do so by bargaining.

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Russ Wiles is a mutual funds columnist for The Times. He can be reached at [email protected]