Photographer: JB Reed/ Bloomberg News.
BLOOMBERG NEWSLast week the Wall Street Journal reported the Labor Department was investigating Fidelity Investments regarding fees Fidelity demands from mutual fundfirms to distribute their shares on its FundsNetwork platform, including an additional recently crafted so-called “Infrastructure Fee.” Yesterday Bloomberg reported theMassachusetts Secretary of the Commonwealth said itssecurities division sent a letter on Feb. 27 to Boston-basedFidelity requesting information about those fees.
These Fidelity investigations raise issues regarding mutual fund confidential payments to financial intermediaries similar to those raised in a May 2018 Whistleblower Complaint filed with Securities and Exchange Commission on behalf of the Chattanooga Fire and Police Pension Fund, by me, involving Wells Fargo, the trustee and custodian of the fund.
Unlike the Wells matter, the Wall Street Journal had access to the payment agreement between Fidelity and the fund firms. With respect to Chattanooga, Wells has steadfastly refused to provide the pension with any agreements relating to compensation it has received from mutual funds in which the Chattanooga pension invested—even as the bank initially denied any such compensation and subsequently disclosed limited, then greater compensation.
The glaring questions these cases raise for regulators and investors are: Should major financial intermediaries, such as Wells and Fidelity, be permitted to agree among themselves to withhold, summarily disclose, or even mischaracterize, the payment arrangements between them? Is the answer to this question different when retirement plan assets, protected by the federal ERISA statute, are involved?
By way of background, in 2015, the staff of the SEC conducted asweep examination of a number of mutual fund complexes, investment advisers, brokerdealers, and transfer agents. These exams studied, among other things, the payment of fees to financial intermediaries characterized as non-distribution related sub-transfer agent, administrative, sub-accounting, and other shareholder servicing fees (collectively “sub-accounting fees”).
These exams, which were a joint initiative of the Office of Compliance Inspections and Examinations and a number of other offices and divisions of the Commission, highlighted the need to clarify and update the existing guidance. They also raised questions as to whether, in some cases, a portion of fund-paid subaccounting fees may have been used to pay for activities that are primarily intended to result in the sale of mutual fund shares (“distribution” or “distribution-related activity”).
As a result of the sweep, the Commission brought an enforcement action against a single mutual fund adviser which caused a fund to pay for certain specific distribution-related activities outside of a 12b-1 plan.See In the matter of First Eagle Investment Management, et al., Investment Company Act Release No. 4199 (Sep. 21, 2015).In addition, use of the funds’ assets to pay for these distribution-related services rendered the funds’ disclosures concerning payments for distribution-related services inaccurate, according to SEC. Pursuant to the SEC settlement, First Eagle paid disgorgement, prejudgment interest, and a civil monetary penalty totaling $39,747,879.75.
Notably, in the First Eagle matter, the Commission did not take action against either of the two financial intermediaries which received the prohibited payments from the funds and did not even identify the intermediaries in the settlement release. For all we know, Fidelity and Wells may have been the two intermediaries involved.
In January 2016, the Commission staff issued a public Guidance warning the industry about abuses staff had identified in connection with the sweep examination of payments to intermediaries.
It appears intermediaries, such as Wells and Fidelity, may have modified their business practices in response to the SEC guidance.
Wells Fargo amended its trust agreement with the Chattanooga pension in late 2015 to rebate certain "revenue sharing" payments. Wells has declined to provide Chattanooga with a copy of any agreements with funds and collective investment trusts detailing the myriad types of payments Wells may receive from mutual funds or their affiliates.
As revealed in the Wall Street Journal, Fidelity created its new Infrastructure Fee in 2016- also coinciding with the SEC guidance. This Infrastructure Fee was crafted to reportedly require fund firms to pay Fidelity 15 bps on certain assets at the adviser. Fidelity also demanded secrecy regarding the new payments, i.e., disclosure of the actual dollar amounts to third parties, including, but not limited to investors, was prohibited.
Thus, it appears that in response to the 2016 SEC public Guidance, financial intermediaries and mutual fund firms may have modified their business practices related to distribution fees and retirement accounts.
Regulators and mutual fund investors should be aware that financial intermediaries, such as Fidelity and Wells, aresolely responsiblefor:
- creating complex arrangements which require funds to make distribution-related payments;
- demanding funds withhold full disclosure of the terms and conditions of these distribution-related payment arrangements from regulators and investors; and
- requiring fund firms, if they opt to disclose such agreements at all, use disclosure language specifically prescribed by the intermediary and to refrain from disclosing actual dollar amounts.
Forbes readers may recall that Fidelity is no stranger to retirement platform-related machinations. In 2004, Fidelity ordered third party mutual funds offering their shares on its platform to cut discounts they offered to retirement plans-- discounts that often topped 60 basis points and which in effect go straight to investors. Fidelity admitted to Forbes in 2008, the move was necessary for competitive reasons "to level the playing field." Otherwise, Fidelity would have had to match the hefty cuts to get business for its own funds line.
Here's what I wrote in Forbes about the Fidelity practice:
"When I first got wind of these agreementsinvolving most of the nation’s largest mutual funds in 2008, I was baffled. I had never seen a retirement plan administrator by letter refuse to accept contractually agreed-upon compensation from an unaffiliated mutual fund company—compensation that it had been previously enjoying. Turn away money? It made no sense. This is a capitalist, for-profit world we live in, is it not? In fact, the pervasive abuse I was focused upon at the time was 401(k) record-keepers pocketing payments they received from mutual fund money managers, i.e., not disclosing the revenue sharing amounts to plan clients, as opposed to turning away money. Had the world gone mad?
The explanation for this anomaly soon became apparent: refusing to accept these discounts from non-Fidelity funds ensured that Fidelity funds on its 401(k) administration platform did not have to match them. Allowing the discounts would have been good for, at a minimum, Fidelity’s 401(k) plan clients, saving them perhaps 35 basis points, but not-so-good for Fidelity—a fact which Fidelity apparently admitted to Maiello. “Leveling the playing field” did notbenefit Fidelity’s 401(k) clients one iota.
To my knowledge, Fidelity never disclosed to 401(k) plan sponsors or participants that it had decided from 2004 to 2008, in order to bolster its own bottom line, to refuse to accept the fee discounts, rebates or revenue-sharing fund managers had agreed to pay and had been paying. I also cannot imagine how, when it relented on this policy in 2008, Fidelity could have explained to 401(k) plan fiduciaries its failure to pay rebates for four years and the sudden price discounts related to non-Fidelity fund options. Presumably, when the moment Fidelity dreaded arrived and previously withheld rebates suddenly began to flow to its 401(k) clients (in 2008), Fidelity had to reduce the fees related to its own funds to “level the playing field” or face losing assets under management. It seems to me that under applicable law, ERISA, instituting such a policy, or reversing it,is highly problematic."
As Forbes writer Mike Maiello wrote in his October 13, 2008 piece, Fighting For you Dear Reader:
“After repeated inquiries by Forbes, Fidelity Investments has reversed its fiat that rival mutual funds limit the price breaks they give to get into 401(k) retirement plans Fidelity administers for corporations."
(I have no idea whether Fidelity actually did reverse its policy in 2008.)
It has long been my opinion financial intermediary secret dealings with mutual funds result in tremendous harm to investors and that there is no justification for the lack of disclosure to fiduciaries and asset-owners.
As a result of the SEC 2016 Guidance and subsequent industry changes, the time is ripe for regulatory, as well as retirement plan sponsor and investor scrutiny of the payment arrangements between mutual funds and financial intermediaries and the role intermediaries play in crafting these arrangements.
