Mutual funds are the most commonly held investment product.
If you want to protect yourself from securities fraud you need to acquire a rudimentary knowledge on mutual funds. A mutual fund is a registered investment company whose business is to invest in stocks, bonds, and other financial instruments. They offer the advantage of professional money management and portfolio diversification.
There are three types of mutual fund shares: Class A, B and C. In recent years the NASD has fined and censored a considerable number of firms for
improperly recommending the purchase of Class B shares of mutual funds. Frequently Class A shares of mutual funds are more cost effective than Class B shares. Most disciplinary actions occur when a broker places an investor’s assets in Class B shares of mutual fund, when the investor should have been in class A.
CLASS A SHARES
Class A shares impose an initial sales charge or
front-end load, which is taken out of the customer’s purchase price before the investment goes into the fund.
Class A shares provide a
discount< on the front-end load based on the size of a customer’s purchase. The levels at which the discounts become effective are called
breakpoints.
Large Investments are Not Required to Pay Class “A” Front-End Load
The NASD provided the following sample breakpoint schedule.
Sample Breakpoint Schedule
Class A Shares (Front-end Sales Load)
| Investment Amount |
Sales Load |
| Less than $25,000 |
5.0% |
| $25,000 but less than $50,000 |
4.25% |
| $50,000 but less than $100,000 |
3.75% |
| $100,000 but less than $250,000 |
3.25% |
| $250,000 but less than $500,000 |
2.75% |
| $500,000 but less than $1 million |
2% |
| $1 million or more |
0% |
See “Mutual Fund Breakpoints: A Break Worth Taking” NASD Investor Alert (January 14, 2003).
As shown above, investors may be entitled to a reduced front-end sales charge based on a single transaction because of its dollar amount. In addition, investors may become entitled to receive breakpoints by using letters of intent or based on rights of accumulation:
- Investors may become entitled to receive breakpoints by using letters of intent. A letter of intent (“LOI”) is a statement signed by the investor indicating his or her intent to purchase a certain amount of fund shares over a stated period of time.
- Investors may become entitled to receive breakpoints based on rights of accumulation. A right of accumulation (“ROA”) is the discount or breakpoint received in a current mutual fund transaction based on the cumulative value of previous transactions.
The advantage of Class B shares is that they typically do not charge a front-end sales charge. Therefore, a customer investing an amount too small to qualify for a breakpoint discount should invest in Class B shares to avoid the front-end load.
“For small investments, Class B shares are considered more advantageous than Class A shares, because small investments in Class A shares do not qualify for any breakpoints and incur the highest initial sales charge rate.”
Department of Enforcement v. Raghavan Sathianathan, NASD Disciplinary Proceeding No. C9B030076, at p. 11 (November 30, 2004).
For large investments, on the other hand, Class A shares are superior to Class B shares. As one NASD Arbitration Panel stated:
“Members should not recommend Class B or C shares to investors who seek to purchase in large amounts and who would incur significantly lower sales charges for Class A share purchases due to the availability of breakpoints, rights of accumulation, or letters of intent.”
Department of Enforcement v. Wendell D. Belden, NASD Complaint No. C05010012, at p.8 (August 13, 2002).
If your investments were large, say in the millions, your assets should be invested in Class A shares. This is obvious and should have been a no-brainer. As shown in the chart above, you stood to benefit from the breakpoint schedule. If placed in Class A shares, you may have avoided paying anything for the front-end load.
Example of Recent Case:
On June 28, 2007, the
NASD announced that is had settled cases against
MML Investors Services, NYLIFE Securities, Securities America and
Northwestern Mutual Investment Services for the improper sale of Class B and Class C mutual funds. The fines totaled to over $1.2 million.
NASD News Release, June 28, 2007.
In the case of MML, NYLIFE, Securities America and Northwester, the brokerage firms did not take measures to ensure that their clients received the discount on Class A purchases. The NASD said:
During the period 2001 through 2004, many mutual fund families offered Net Asset Value transfer programs that eliminated front-end mutual fund sales charges for certain customers. Under an NAV transfer program, customers who redeemed fund shares for which they paid a sales charge were permitted to use those proceeds within prescribed time periods to purchase Class A shares of a new mutual fund at NAV — that is, without paying another sales charge.
NASD News Release, June 28, 2007.