Most Investors invest through the ownership of own mutual funds. According to the Investment Company Institute, sixty percent of all investable assets, retirement assets approximately $17.2 trillion, are invested in mutual funds.

Financial newspaperAs the mutual fund industry has grown, so has the incidence of fraud or otherwise wrongful practices in connection with the sale of mutual funds. Firms no longer conduct sales competitions, or offer enhanced compensation for their own broker-dealers promoting proprietary mutual funds. Stockbrokers are now sometimes offered enhanced compensation, or a higher commission pay-out, based upon the more proprietary products they sell as part of their total commissions, which generally will also include variable annuities, insurance products and other investments.

Securities broker-dealers not promoting the sale their own mutual funds are offered special compensation by mutual fund sponsors to be included on a platform of preferred funds. These payments are in addition to the 12b-1 fees which are paid to all broker-dealers holding a fund’s shares in their customer accounts, which can range between .25 and 1.25% per year. These extra payments also generally provide the mutual funds access to registered representatives to promote their funds. At mutual fund expense, stockbrokers are invited to lavish “sales presentations.” Mutual fund sponsors also often pay for the customer seminars, the free-lunches, and the free-dinners through which stockbrokers often solicit customers.

NYSE FlagsSecurities broker-dealer supervisory procedures, if implemented, generally prevent the fraudulent diversification of mutual fund sponsor purchases to deliberately avoid breakpoints, or up front commission discounts which may otherwise be available through the purchase or Class “A” shares from the same fund sponsor. These same supervisory procedures generally limit the dollar amount of back-end loaded Class “B” purchases, where the customer, in addition to paying higher 12b-1 fees, will pay a penalty or deferred sales charge depending how long they own the securities.

Customers have a right to believe that a stockbroker is recommending the purchase of any particular mutual fund or any particular fund within a family of mutual funds, not to advance the broker’s financial interest but instead to advance the customer’s investment objective.

Customers also have the right to believe that in connection with any recommendation that they purchase any particular mutual fund that their stockbroker read the prospectus, and conducted some form of due diligence, or product specific suitability concerning the risks and characteristics of the fund prior to recommendation.

scales of justiceAn avalanche of boilerplate disclosure in a prospectus delivered to a customer does not cure these deficiencies. Simply because a customer is delivered a prospectus, it does not insulate the stockbroker from misstatements or not making a fair and balanced disclosure of risk. However, often customers purchasing the most complex mutual fund shares, Exchange Traded Funds, short term bond funds, and quasi-money market funds, may never even be provided a prospectus. Sometimes the information contained in the prospectus is just untrue.

Guiliano Law Group

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