Mutual Fund Manager MFS Pays $50 Million Fine To Settle SEC Enforcement Action; Firm Failed To Adequately Disclose Use of Mutual Fund Brokerage Commissions To Pay for "Shelf Space" at Brokerage Firms


Firm Failed To Adequately Disclose Use of Mutual Fund Brokerage Commissions To Pay for "Shelf Space" at Brokerage Firms

Washington, D.C., Mar. 31, 2004 -- The Securities and Exchange Commission today announced a settled enforcement action against Massachusetts Financial Services Company (MFS) related to the company's use of mutual fund assets - namely, brokerage commissions on mutual fund transactions - to pay for the marketing and distribution of mutual funds in the MFS Fund Complex (MFS Funds). The Commission issued an order that found MFS failed to adequately disclose to the Boards of Trustees and to shareholders of the MFS Funds the specifics of its "shelf-space" arrangements with brokerage firms and the conflicts created by those arrangements. As part of the settlement, MFS agreed to a series of compliance reforms and to pay a penalty of $50 million, which will be distributed to the MFS Funds.

The Commission's charges stem from an ongoing industry-wide investigation of mutual fund sales practices begun by the SEC in the Spring of 2003. That investigation previously led to a $50 million settlement with Morgan Stanley DW Inc. in November for that firm's failure to adequately disclose to its customers its receipt of such shelf-space payments from mutual funds.

The Commission found that from at least Jan. 1, 2000, through Nov. 7, 2003, MFS negotiated bilateral arrangements, known as "Strategic Alliances," with approximately 100 broker-dealers. Under these arrangements, MFS directed brokerage commissions on fund portfolio transactions to the brokerage firms in exchange for heightened visibility within the brokerage firms' distribution networks.

Based upon negotiated formulas, MFS paid brokerage firms anywhere from 15 to 25 basis points (bps) on mutual fund gross sales and/or 3 to 20 bps on assets held over one year. MFS satisfied the Strategic Alliances in two ways: by paying cash, or "hard dollars," and by directing brokerage commissions. When MFS satisfied the Strategic Alliances with brokerage commissions, it paid 1.5 times (or some other negotiated multiple) the amount it would have paid in hard dollars. MFS did not adequately disclose to the funds' Boards and shareholders the quid pro quo nature of these arrangements and the attendant conflicts of interest they created.

"A mutual fund manager's use of fund brokerage commissions to pay for the marketing and distribution of the fund creates a conflict of interest that must be fully and fairly disclosed," said Stephen M. Cutler, Director of the Commission's Division of Enforcement. "The Commission continues to investigate whether the managers of other mutual funds and the brokerage firms that sold those funds have similarly failed to disclose such conflicts."

"This represents the first enforcement action against a mutual fund manager for its failure to adequately disclose payments for shelf space with fund brokerage commissions," said Merri Jo Gillette, Associate District Administrator in the SEC's Philadelphia District Office. "This case underscores the fundamental disclosure obligation that investment managers, as fiduciaries, owe to their clients. In this case, the conflict arose because MFS used brokerage commissions, which are paid out of fund assets, rather than its own assets - in other words, cash - to satisfy the Strategic Alliances."

MFS agreed to settle this matter, without admitting or denying the Commission's findings. The Commission's Order censures MFS and orders it to cease-and-desist from committing or causing any violations of Section 206(2) of the Investment Advisers Act of 1940 and Section 34(b) of the Investment Company Act of 1940.

MFS has permanently discontinued its use of fund brokerage commissions to pay for the Strategic Alliances. MFS has also undertaken to direct an independent consultant to conduct a review of, and to provide recommendations concerning, MFS's policies and procedures with respect to its Strategic Alliances including its disclosures to the Boards and shareholders, and to adopt the recommendations of the independent consultant. Finally, MFS will make a nominal disgorgement payment and will pay $50 million in civil penalties.

Pursuant to the Fair Funds provision of the Sarbanes-Oxley Act of 2002, MFS will distribute the penalty to the MFS Funds in accordance with a distribution plan approved by the Commission.

See Also:  In re Massachusetts Financial Services Company Release No. IA-2224
Last modified: 3/31/2004