Mutual Fund Probe Gathers Steam With Prudential Deal

Matthew Goldstein

A promised regulatory crackdown on misleading mutual fund sales practices gathered steam Thursday, with Prudential Securities agreeing to pay $382,000 in fines and restitution to end a Securities and Exchange Commission investigation.

The settlement in the Prudential case comes two months after SEC Chairman William Donaldson said the agency was moving to crack down on deceptive mutual fund sales practices and is looking at a number of Wall Street firms. Donaldson disclosed the investigation during testimony before a congressional panel in May.

In settling with the SEC, Prudential, a division of Prudential Financial (PRU-NYSE) , is paying a $300,000 fine and $82,000 in restitution to resolve charges it had "inadequate systems'' in place to monitor the actions of its mutual fund sales force. As is customary, Prudential neither admitted nor denied the allegations.

The charges against Prudential date from 1998 to 2000 and involve allegations that a Prudential broker pushed his customers into more expensive Class B mutual fund shares over other, less costly mutual fund products.

Lemons

On the surface, Class B shares often look like a good investment because investors generally don't pay any upfront sales charge, or "load.'' But investors in Class B shares often pay higher annual fees than on shares with upfront sales charges, fees that often exceed any initial savings an investor might reap. Additionally, brokers often waive or reduce the upfront fees on so-called Class A "load" shares for large investors.

In recent years, Class B shares increasingly have drawn scrutiny from regulators. In fact, the SEC action against Prudential comes on the heels of an earlier crackdown on Class B shares by the NASD.

Over the past two years, regulators at the NASD have fined more than a half-dozen brokerages for pushing more costly Class B shares on investors without fully disclosing those costs. Just last month, the NASD fined a small brokerage, McLaughlin Piven Vogel Securities, $100,000 for selling more costly Class B shares to its customers.

Shortly after that action, the NASD issued an "investor alert'' warning investors to shy away from Class B mutual fund shares unless their broker had fully discussed the risks associated with them. In the June 25 advisory, the NASD cautioned investors that some brokers like to push Class B shares because they ''receive higher commissions from the sale of Class B shares than other classes of fund shares."

To date, the SEC has not said what firms its investigation is focusing on. Morgan Stanley (MWD-NYSE) has said in regulatory filings that it has received requests for information and documents pertaining to the sale of Class B shares of mutual funds. Within the past few weeks, sources say, the SEC has sought to interview several wealthy Morgan Stanley mutual fund customers.

Rippling

The SEC declined to comment on the Morgan Stanley investigation, which is being led by the agency's Philadelphia office, the same office that investigated the Prudential matter. A Morgan Stanley spokesman also declined to comment.

But New Jersey securities lawyer Morgan Bentley said he represents a Morgan Stanley customer the SEC wants to interview. Bentley said his client, who he did not want to identify, would like to talk to the SEC, but hasn't been able to set up a date.

Debra Speyer, a Philadelphia securities lawyer, said she represents a number of Morgan Stanley mutual customers with pending arbitration claims against the Wall Street firm. Compared to other Wall Street firms, Speyer said Morgan Stanley has been an aggressive promoter of Class B mutual fund shares.

Morgan Stanley, meanwhile, also is being sued by some of its Class B share customers in federal court. The class action filed in Nashville, Tenn., alleges that Morgan Stanley failed to disclose that Class B shares usually "result in the payment of unnecessary and excessive fees."

H. Naill Falls Jr., the attorney for the plaintiffs, said 85% of the money deposited by investors into Morgan Stanley mutual funds goes toward Class B shares. He said that's a far higher percentage of investor dollars going into Class B shares than at any other Wall Street brokerage.

A Morgan Stanley spokesman said the class action is "without merit'' and the firm denies the allegations.