MUTUAL FUND FRAUD

Mutual fund fraud might be the most insidious type of securities fraud. Mutual funds are intended to be long-term investments, often a way to secure retirement for an investor. Deceptive practices include a variety of activities like urging a client to invest in a fund without explanation of fees, risks, and other costs, ignoring an investor’s goals and advising a client to excessively trade their funds to make more commissions.

The Financial Industry Regulatory Authority (FINRA) is a self-regulated non-profit organization authorized by Congress to oversee the broker-dealer industry. FINRA creates and implements rules and monitors for compliance. When a broker commits mutual fund fraud, they might have violated one or more of the following FINRA rules:

• FINRA Rule 2210: Communications with the Public. There are several ways that a broker can violate Rule 2210 to engage in mutual fund fraud, but the most common violations fall under the mandates outlined in the General Standards section of Content Standards for communication. General Standards state that all communications with clients should be fair and balance and in good faith. Communication cannot include false, exaggerated, or any type of misleading statements. Communication must be clear and provide risks and benefits, and it cannot predict or project performance. All communication must be appropriate to the audience for which it is intended.
• FINRA Rule 2342: Breakpoint Sales. When investing in a mutual fund, the more shares one buys, the bigger discount they receive on commission. The level at which a new commission discount kicks in is referred to as a breakpoint. Your broker is required to tell you about a mutual fund’s commission structure, including breakpoints. Brokers who suggest investors buy small amounts in multiple funds to receive higher commissions are committing breakpoint fraud, a clear violation of Rule 2342.
• FINRA Rule 2122: Charges for Services Performed. Breakpoint fraud creates a situation where brokers are receiving excessive commissions because of excessive trades that aren’t in the best interest of the investor. FINRA also protects investors from excessive commission charges. Rule 2122 states that broker fees for collection, trading, appraisals, and other services must be “reasonable and not unfairly discriminatory among customers.”

FINRA’s authority includes fining, suspending, and expelling individuals and firms who violate their rules. Disciplinary actions vary based on many factors, but FINRA has published the following guidelines for penalizing those who have broken the rules related to mutual fund fraud:

• Violating FINRA Rule 2210: Sanctions involving misleading communications with potential investors typically fall on the firm. Firms might be fined up to $31,000, suspended for six months, and required to seek FINRA approval on all customer communication for some time. In extreme cases, FINRA might suspend firms for up to a year and fine them up to $155,000.
• Violating FINRA Rule 2342: FINRA sanctions for breakpoint sales are the same as those for churning or excessive trading. Fines range between $5,000 and $155,000. Individuals might be suspended from three months to two year. In extreme cases, the firm might be suspended or expelled from the industry.
• Violating FINRA Rule 2122: Fines for the first violation of 2122 range from $5,000 to $77,000. Second and subsequent actions carry six-figure fines that might be in excess of $300,000. In each case the firm is responsible for the amount of excessive charges, the restitution wasn’t ordered. Individuals might be suspended from 10 to 30 business days. In extreme cases, individuals might be suspended for up to two years; and, in the most extreme cases FINRA might bar the individual and/or expel the firm from the industry.

Whether you are considering putting some money into mutual funds, or you have already invested in some funds, some common signs exist that might indicate you are dealing with a fraudulent broker. The following tips will help you avoid and/or detect mutual fund fraud:

• Research the fund. The SEC requires each mutual fund to file a prospectus and submit regular shareholder reports. Read these items to ensure the fund is registered and legit. You can also check that the investment advisor who manages the fund is registered with the SEC.
• Talk about risks and fee structure. If your broker has advised you to invest in particular mutual funds without discussing the risks and fee structure, they are incompetent at best, but quite possibly are trying to benefit from your investment in an unethical manner.
• Check for excessive trades. Investing in mutual funds is typically a long-term, wealth-building investment strategy. If your broker continues to advise you to trade frequently, they might be committing fraud. You should also check your monthly statements from your brokerage account. Your broker might be making unauthorized mutual fund trades.
• Consider the number of funds. As previously mentioned, the more shares you buy in a mutual fund, the less commissions you pay. For this reason, clients of honest brokers have most of their money invested in a small number of funds. If your broker advises you to invest a small amount in multiple funds, you are not getting the benefit of bulk discounts on commission fees. It’s likely your broker is committing breakpoint fraud.