MUTUAL FUNDS

FROM THE ARCHIVES: June 7, 2002

American Express Slaps Big Fee
On Sales of Outside Fund Group

By TOM LAURICELLA
Staff Reporter of THE WALL STREET JOURNAL

American funds may be the top-performing mutual-fund family sold by American Express Financial Advisors , but the firm's clients shouldn't be surprised if its salespeople soon stop recommending the best-selling American Funds as investment choices.

That is because starting in August, the unit of American Express Co. will start charging its sales representatives, which the company calls financial advisers, as much as $85 every time a client puts money into American Funds. The current fee for such a transaction is $20.

American Express clients also shouldn't be surprised if their advisers recommend buying funds run by American Express itself, long one of the poorest performing fund groups, instead of ones from outside fund companies. That is because the American Express-run funds are the only ones that the firm's advisers will be able to sell without being hit with charges that reduce their commissions.

Big brokerage and other financial firms selling a variety of mutual-fund families prefer customers to buy their in-house funds because the firms stand to make more money that way. Firms also often accept payments from other selected fund companies to put their funds on a "preferred list" of portfolios that their sales people will promote to customers, in part because they don't carry transaction charges.

But what sets American Express apart from the rest of the industry is that it has set up fees so that it is cheaper for its nearly 10,000 financial advisers to sell its in-house funds -- but only those funds -- to clients. And in the case of American Funds, American Express will charge its salespeople far more than the industry norm -- a move the firm says is necessary because American Funds wouldn't make special payments to the company as done by other fund groups.

The American Express fee moves coincide with a major effort by the firm to stop the bleeding from its big fund group, which despite overseeing $73 billion in assets, has a long history of weak returns. Out of 36 funds with three-year track records, only one has performed well enough to land in the top quarter of its category, according to Morningstar Inc. Meanwhile, 14 American Express funds rank among the bottom 25% of their fund categories during that period. The firm's short-term record isn't much better.

American Express has been imposing fees on its advisers that stack the deck in favor of its in-house mutual funds
Q. With the absence of ticket charges for American Express, how can advisors avert accusation that our advice is biased?
A. ... These practices will not leave you open to charges of biased advice. Our goal is to balance the needs of clients, advisors/employees and shareholders. One of the realities of business is that true objectivity is something of a myth, because there is never a true apples-to-apples comparison. In the case of ticket charge pricing and advisor fund recommendations, the economics are never 100% level, so comparisons between nonproprietary and proprietary funds are never 100% objective.



Those returns have led many investors to take money elsewhere, often at the recommendation of their American Express advisers. Since January 2000, investors have pulled a net $2.7 billion out of American Express-operated funds, according to Financial Research Corp. in Boston. During that time, the fund industry overall has seen investors put more money into stock and bond portfolios.

The fees American Express charges its advisers are mainly ones called "ticket charges." While almost unknown to investors, ticket charges are commonly applied in the investment industry to independent sales people such as those working with American Express (most of the firm's advisers are actually franchisees, not American Express employees).

Ticket charges are essentially transaction fees, meant to cover costs such as record-keeping. At most firms the charges usually range between $10 and $20 for each transaction. To boost sales of their products, fund companies frequently pay ticket charges on behalf of brokers or advisers whose customers buy their funds. Typically, the funds on a broker's preferred list will cover all or some of the charges.

But at American Express, it is a different story. American Express advisers have to pay ticket charges on all transactions involving non-American Express funds, including the 18 other fund companies on the firm's "Tier 1" preferred list. In most situations, an American Express adviser is charged $15 or $20 for each transaction, although in some cases, it can be $40 for an order placed over the phone. When customers put money into American Express funds, however, the adviser doesn't have to pay a ticket charge.

American Express says that is because those transactions don't incur the cost of dealing with another fund company. It also says the charges aren't intended to only steer money to its own funds. "We think that the playing field is level or level enough," according to Sarah McKenzie, who oversees brokerage products at American Express. "We do not think these practices impair the advisers' objectivity."

However, American Express spokeswoman Marie Davis said in a later interview that the company is reviewing the fund fees and "plans to make changes." She said she couldn't elaborate at this point, however.

Executives at several major fund companies and consulting firms couldn't recall another instance where only the in-house funds incurred no charge to sales people. "We haven't heard of anything like this before," said Matt McGuinness, a senior analyst at fund consultants Cerulli Associates in Boston. "This is certainly not a common practice."

Because these fees are assessed directly against the adviser and not subtracted from the client's investment, they don't have to be disclosed to the investor. Since 1999, regulations issued by the National Association of Securities Dealers have been in place barring extra compensation for brokers who sell a firm's own mutual funds over outside funds.

American Express says those rules don't apply to the fees since they are considered transaction charges -- even though they are subtracted from an adviser's paycheck.

Still, some investment-industry experts criticize using fees that can influence which funds salespeople recommend to customers. "The [NASD] rules were designed to give investors even-handed service and information," said Tamar Frankel, a professor at Boston University Law School who specializes in investment issues. A system of penalties for advisers "creates hidden pressures that the client does not know about," she said.

These charges "can be a deciding factor as to which fund family a broker works with," said Cerulli's Mr. McGuinness. On a $2,000 fund investment, for example, an Amex adviser earns roughly a $70 commission, so an $85 charge can exceed the income the sale generates.

Normally, American Express imposes a ticket charge of at least $15 every time an American Express client buys, sells or exchanges shares of any mutual fund not run by American Express. While the fee on each transaction is small, they easily can add up to thousands of dollars over the course of a year for the typical adviser. In other cases, the individual fees can be hefty.

The American Express charges were first imposed two years ago, but advisers could avoid them by opening accounts for clients directly with other fund companies, instead of doing the transaction through an American Express brokerage account. Since March 1, however, American Express advisers have been required to place most new fund transactions through a brokerage account, which triggers the charges. American Express says the switch wasn't made to enforce payment of ticket charges but to help with record-keeping and compliance.

In August, American Express will take the charges a step further by raising the fee on American Funds to $85 from $20 in most cases. The American Funds family, operated by Capital Research & Management Co., is a favorite among advisers and for good reason: Just one American Funds portfolio is in the bottom 25% of its Morningstar performance category based on three-year returns while 15 are among the top 25%.

The $85 fee is far higher than the industry range, according to fund executives, who also say it is unusual to single out a company as American Express is doing with American Funds for a higher ticket charge. A spokesman for American Funds declined to comment.

American Express offered American Funds the same arrangement as other fund companies to be included on the firm's fund network, American Express's Ms. Davis said. That included a widespread practice called revenue-sharing, where the fund company makes payments to the brokerage firm in return for a place on the firm's selling list. "They wanted a free ride on our distribution system, and we don't give free rides," she said.

An internal memo, distributed when the ticket charges were first imposed, braced the advisers for criticism. "With the absence of ticket charges for American Express [funds], how can advisors avert accusations that our advice is biased?" the memo asked. Part of the answer, the memo said, is that "one of the realities of business is that true objectivity is something of a myth, because there is never a true apples-to-apples comparison."

Still, the memo assured advisers that "these practices will not leave you open to charges of biased advice," and said, "Our goal is to balance the needs of clients, advisors/employees and shareholders."
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