What is Mutual Fund Fraud?

Mutual Fund Fraud takes place when a stockbroker causes transactions in mutual funds in a client's account which are not suitable or appropriate for the goals and risk tolerance of the client; or when the risks and costs of a recommended fund transaction are not fully disclosed and approved by the client.

What is a "Load" When Used In Connection with Mutual Funds?

A "Load" is any charge paid by the investor on a Mutual Fund transaction. Loads are added to the net asset value of shares when the offering price is calculated. Remember, this fee is nothing more than a sales commission. Its supporters (who, strangely enough, are usually mutual fund salespeople) argue that a load is the price you pay for a broker's expertise in selecting the correct fund for you. Despite this reasoning, just about every study shows that load funds do not outperform no-load funds.

What is a Mutual Fund Front-End Load?

A Front-End Load is commission or sales fee charged at the time of the initial purchase for an investment, usually mutual funds and insurance policies. It is deducted from the investment amount and thus, lowers the size of the investment. For mutual funds, the use of loads is suggested to prevent frequent trading of the fund, which can hurt a fund if it has to hold large cash reserves to meet payouts. What is a Back-End Load?

A "Back-End Load" is a fee that an investor pays when selling a mutual fund within a certain number of years called the holding period - usually seven. The fee is a shown as a percentage and usually decreases yearly until the seventh year when it drops to zero. Different funds will usually have different options available to investors pertaining to how they want the back-end load to be applied.

Back-End Load mutual funds are okay if you plan on investing for the long-term; otherwise, you'll pay high commission to withdraw early. Remember that almost all mutual funds charge an annual administration fee that is automatically withdrawn from your account, so back-end funds aren't completely free of charges.

What is A Contingent Deferred Sales Charge ("CDSC")?

A Contingent Deferred Sales Charge ("CDSC") is a charge incurred if you sell your shares within a certain number of years. A CDSC is a Back-End Load charged only when a special circumstance occurs. A good example of a CDSC is a charge applied when you decide to move your money from one mutual fund into another company's fund. This sales charge is "contingent" because it's only applied when the funds are prematurely moved out of the original mutual fund.

Depending on the mutual fund that you are switched into, you may be saddled with a new CDSC holding period. This is the amount of time that you must own the mutual fund before you may sell it without penalty.

What is a Mutual Fund Expense Ratio ("MER")?

A Mutual Funds Expense Ratio ("MER") is the percentage of total fund assets that is used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses. The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services and interest expenses. The amount of the MER is usually dependent on how active the portfolio manager is in the trading of the fund; an actively managed fund will have a higher ratio than an index fund, for instance. It is important for investors to be aware of the MER as it affects the rate of return that an investor in the fund achieves. The amount of the MER must be stated in the fund's prospectus.

What Other Financial Impacts Can a Mutual Fund Transaction Have?

In addition to any other type of charge, you can pay a price in a mutual fund transaction in other ways:

You may incur tax consequences from a switch.

The amount you are required to pay for marketing and managing the fund may vary depending on the fund, so a change in funds may cause a higher overall cost of owning the fund.

What is Mutual Fund Switching?

Mutual Funds Switching is when an investor sells one mutual fund to buy another. Mutual Fund Switching is a violation of the securities laws if it is done on the recommendation of a stockbroker who is making a recommendation that is adverse to the best interests of the investor or when the investor has not been provided sufficient information to make an informed decision on whether to follow the recommendation of the broker.

Mutual Funds are meant to be owned over a substantial period of time. They are not meant to be traded like public stocks. This is because investors incur substantial charges when they buy and sell Mutual Funds that do not exist for common stocks.

Brokers may recommend Mutual Fund Switches because they receive kickbacks or other financial incentives if their clients buy and sell mutual funds. If your broker advises you to get out of one mutual fund and into another, it may be because your broker will receive substantial compensation if you follow the advice.

Selling shares of one mutual fund to buy shares of one or more different mutual funds may be appropriate under certain conditions. However, active trading of mutual funds is considered to be harmful and inappropriate in all but the most extreme situations.

Even low frequency transfers between funds may constitute unsuitable switching, particularly if your broker recommends switching funds only to earn a commission from the sale or purchase. This kind of switch, in fact, is a violation of securities laws.

Because improper Mutual Fund Switching is a violation of the securities laws, investors may recover the losses suffered due to the improper switching in a legal action.

What is a Mutual Fund Switch Letter/Prospectus Receipt?

Most firms require brokers to have the client sign what is known as a Mutual Fund Switch letter, which requires the client to acknowledge that the transfer is taking place and that it will result in certain charges to the client. Firms also require the broker to have the client sign a receipt for the Mutual Fund Prospectus, which will contain disclosures regarding the risks and costs of the transaction.

If your broker did not ask you to sign these documents, it may mean that the broker is aware that the risks and costs of the transaction have not been fully disclosed and approved by you.

If you feel you may have been the victim of mutual fund switching, please feel free to contact our firm.