Many mutual funds offer volume or "breakpoint" discounts to shareholders who are charged a sales load for their purchases of fund shares. For example, a fund may charge a 5% front-end sales load for an investment up to $50,000, but charge only a 3% front-end sales load for an investment over $100,000. Under a typical "breakpoint" schedule, an investor may not pay any sales load at all for an investment over $1 million.
Many funds that charge sales loads also provide investors with two other ways to reduce the amount they pay in commissions to broker-dealers. First, a fund may permit an investor to sign a letter of intent, in which he or she commits to purchase a specified dollar amount of fund shares over a defined period of time. In this circumstance, the sales load is calculated based on this purchase commitment and it applies to all fund shares purchased by the investor over the time period involved.
A second method for reducing a sales load involves a right of accumulation (or aggregation). In this circumstance, an investor is permitted to include in the breakpoint calculation other shares within the same fund family that he or she owns. The investor may also be permitted to count shares purchased by his or her family members, as well as purchases made in other related accounts.
Each mutual fund establishes its own breakpoint thresholds and procedures for calculating these volume discounts for share purchases. The breakpoint formula and the procedures used to calculate these discounts are disclosed in a fund's prospectus. And it is generally viewed as important to individual funds to have differing breakpoint discount rules for competitive reasons.
When a broker-dealer uses an omnibus accounts structure--in which orders to purchase or redeem fund shares are consolidated each day--a mutual fund and its individual investors have to rely on the broker-dealer to calculate and apply the correct discount, in a manner consistent with fund policies. However, the brokerage firm often will have insufficient information to calculate the appropriate discount. For example, individual shareholders may use different broker-dealers for transactions within the same mutual fund family. And family members qualifying for breakpoint discounts as a group may have a myriad of accounts and relationships with different financial intermediaries. In contrast, when an investor purchases shares directly from a mutual fund, the fund and its compliance personnel have all of the necessary information to apply the discount correctly and without relying on an intermediary.
The proper application of breakpoint discounts is the legal obligation of both the mutual fund and the broker-dealers distributing its shares, although the parties differ in their respective economic interests. It is in a mutual fund's economic interest to calculate these discounts accurately, in order to avoid losing unnecessary investment monies to third-party brokerage commissions. On the other hand, a broker-dealer is the direct beneficiary of an overcharge of a sales load because it receives these amounts as additional commissions. And a broker-dealer is not in the best position to administer each fund's breakpoint discount policies because it does not possess the necessary information to do so, especially when dealing with multiple shareholders and accounts held by different financial intermediaries..
Over the past decade, every study that examined actual mutual fund transactions involving sales loads has concluded that investors are not receiving the correct breakpoint discounts. As an example, a study conducted by the National Association of Securities Dealers (NASD) of mutual fund transactions in 2001-2002 found $86 million in investor overcharges. This NASD study also determined ithat mutual fund investors were overpaying their sales loads in one out of every five eligible transactions.
To remedy this problem, the SEC promulgated new regulations in 2004, requiring each mutual fund to improve the disclosure of its formula and procedures for calculating breakpoint discounts, when charging fromt-end sales loads. Unfortunately, the problem will not be solved until there is more transparency within omnibus accounts controlled by broker-dealers, so that mutual funds are able to calculate and apply these discounts accurately and in accordance with their stated propsectus policies.