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A Whole New Ball Game

What, no more golf balls? No free fancy lunches? Dinner? No drinks? Financial advisors who grew accustomed to the little and sometimes not so little treats that mutual fund wholesalers lavish on them may have noticed a certain lack of swag lately. As regulators look at every possible source of conflict in the securities industry, even fund wholesaler entertainment is coming under scrutiny. Already

What, no more golf balls? No free fancy lunches? Dinner? No drinks? Financial advisors who grew accustomed to the little — and sometimes not so little — treats that mutual fund wholesalers lavish on them may have noticed a certain lack of swag lately. As regulators look at every possible source of conflict in the securities industry, even fund wholesaler entertainment is coming under scrutiny.

Already — even without any formal investigations — fund companies are reining in their wholesalers. John Scully, a veteran road warrior for MFS Distributors, recalls that just a few years ago, he thought nothing of a day at Yankee Stadium for his best advisor clients — and some potential new ones. “We'd rent a luxury box, serve food and do a presentation with a manager,” Scully says. The cost to MFS: about $4,000 per game. “You can't do that anymore,” he says.

Actually, you could. Entertaining clients is not illegal (as long as it isn't “excessive”) and is allowed under the rules that govern the practice that have been in effect, in one form or another, since the 1930s. But in the wake of the mutual fund scandals, the mood on Wall Street has changed. Lavish entertaining and gift giving by mutual fund wholesalers has gone out of fashion. Even though the fund manufacturers depend on reps to bring in 80 percent of total fund assets, which totals around $8 trillion, they have grown cautious. They don't want even the whiff of undue or excessive influence in how their funds are sold.

Neither the NASD nor the SEC has mounted a formal investigation. But regulators are examining how funds are sold, from revenue sharing to 12(b)-1 fees. And an NASD lawyer told Registered Rep. that regulators are concerned that retail advisors may be guilty of a conflict of interest if they accept “excessive” gifts or frequent dinners and don't disclose the arrangements to their clients. “If you are acting as a fiduciary and you derive benefits from your role as a fiduciary, then those benefits are actually the property of the client,” says the NASD lawyer.

Nobody is suggesting that socializing between a wholesaler and a rep be outlawed — or that clients have to be invited along to get their share of the benefits. “Legitimate business entertainment is not the object of our concern,” says SEC spokesman John Heine. “If you take somebody to dinner and talk business, we're not against that. But if the wholesaler hands the broker $300 to take his wife to dinner, then you're getting into questionable territory,” he says.

Given the regulators' activities on the institutional side, it's not surprising that fund companies are trying to get out ahead of any wholesale probe, should one materialize. The SEC and the NASD are both investigating the gift-giving and entertainment practices of at least two-dozen brokerages that are suspected of wining and dining fund-company employees to win institutional-trading business. In a subpoena, the SEC has requested that brokerages provide materials “concerning gifts, gratuities, travel, lodging and entertainment offered or provided by an employee” to Fidelity traders. As a result of the investigation, in late December, Fidelity disciplined 16 traders who were showered with trips on private jets, Super Bowl and Wimbledon tickets, frequent golf trips and cases of wine.

In addition to the trading probe, regulators have mounted a series of investigations into the business practices between asset managers and brokerage firms. Directed trades, the once-established practice of sending trades and commissions to brokerage firms as compensation for selling mutual funds, has already been banned. And regulators are now investigating more potential conflicts of interest, including revenue sharing, in which fund managers share their management fees with the brokerage for its reps selling the company's funds. In December, Edward Jones, without admitting or denying any guilt, agreed to pay $75 million for not disclosing revenue-sharing agreements with its clients.

Noncash Comp Rules

The rules for noncash compensation for brokers is clear: According to NASD Rule 3060, registered reps may not accept gifts worth more than $100 from a single vendor per year. As for entertainment, “the rule is pretty clear: Entertainment has to be ordinary and usual,”says the NASD lawyer. “If it becomes frequent, then that's excessive.”

Before regulators get a chance to draw finer lines, broker/dealers and fund companies have created their own rules that, advisors and wholesalers say, already go beyond NASD Rule 3060. Merrill Lynch, for example, no longer allows fund wholesalers to pay advisors directly for client-appreciation dinners and the like, according to a large fund manager who spoke on the condition that his name not be printed. Wholesalers can still underwrite such events, but all checks have to be made out to Merrill, which will then reimburse the advisor. (Merrill declined to comment.) Wachovia recently told its advisors that seminars and client-appreciation meetings have to be reported to management, be for business purposes only and the vendor has to be present. That ensures that the clients understand where the bread is buttered and who bought it. This is in-line with many other b/d rules.

In fact, wholesalers and advisors say that many firms have limited wholesaler access to branches and discourage off-site lunches. Indeed, some wholesalers complain that brokerages don't want them entertaining advisors at all. Smith Barney, for example, is said to have a rule prohibiting any wholesalers entertaining its brokers except for in-branch “cattle call” lunches. (Smith Barney declined to comment.)

“There is a lot more attention and oversight on both sides,” says Jack Sharry, president of Phoenix Investments' private client group. “There is a much higher level of scrutiny and oversight.”

Or, as one wholesaler puts it: “The firms just don't want any mutual funds paying for dinners because it may look like quid pro quo. But if you don't have those meals out, if you don't have the cocktails, you don't establish a relationship and you don't get the advisors' business.”

The Good Ole Days

Wall Street is legendary for its lavish gifts and “business” lunches and dinners. But until recently few ever questioned the tradition. “We used to give gold-plated golf clubs,” says Trisha Miller, who worked as a fund wholesaler for 14 years before becoming a financial advisor with Armstrong MacIntyre & Severns in Washington last year. “But in my last few years I didn't give any gifts. And most advisors didn't even ask for gifts. That's how much it has changed.”

The atmosphere is so scrooge-like, in fact, it is said that Alliance Capital fired a veteran wholesaler because he contributed to an advisor's client-appreciation dinner — but didn't attend it himself. (Alliance didn't return a phone call seeking comment.)

Still, it was a rule that was not always strictly enforced. According to one wholesaler, to fire a wholesaler outright for this infringement is unprecedented. “That wouldn't have happened two or three years ago,” he says. “That's how serious they are.”

If the steak dinners, Broadway show tickets and golf paraphernalia disappear entirely, it may be a symptom of more than the threat of a regulatory jihad. It may, in fact, reflect the growing sophistication of the fund-wholesaling business. “Wholesaling has changed dramatically,” says Ed Sierawski, president of Sequoia System, a Naperville, Ill., group that trains wholesalers. Sierawski, who was once a wholesaler himself, says wholesaling is changing because the way reps do their jobs has changed. “Until the bear market, advisors were only paying lip service to the consultative approach,” he says. Now, there is more reality behind the rhetoric of financial advisory, and the behavior of the wholesaler now “reflects the changes in the advisor model.”

What does that mean for wholesalers? It means less product pushing and more “value-added” selling — helping advisors build their businesses. This, in theory, aligns the interests of the wholesaler, the rep and the client, which should please the regulators. And, Sierawski says, that reduces the importance of trivial pursuits, such as golf outings.

“That's ancillary to the wholesaling effort,” he says. “It's really just an old stereotype.”

Still, the objective of a wholesaler hasn't changed: The approximately 7,000 wholesalers who represent mutual fund families, insurance companies and other financial services companies, are there to gather assets. Selling is embedded in their DNA. Sierawaski's mission is to show them a better way to do it. And most asset managers have increased the sophistication of their own wholesale training programs.

At the end of the day — the day without a juicy steak, mind you — is the new relationship any cleaner? No matter how much investing savvy and selling strategy the wholesaler provides for the rep, if the result is that the client buys an underperforming fund, then there may be a problem. Of course, no advisor would admit to choosing a fund or managed account simply because the wholesaler for the firm sponsors his seminars and dinners.

“Notice we haven't talked about product yet?” asks Bob Noelke, head of sales for Lord Abbett. “Brokers are sick of product. What they need are more and more allies on their team. We consider ourselves an advisor to the advisor.”

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