Mutual Funds and Share Class Issues

The share class you were sold can change what you pay for years, and larger purchases may qualify for lower fees, called breakpoint discounts. Share class problems arise when an investor is placed in a class that costs more than the one they qualified for. Losing money in a mutual fund, or paying more in fees than you needed to, is not by itself a claim. The key questions are whether the fund and its share class fit the investor and whether the professional who recommended it fulfilled their duties.

This May Not Be Your Fault

Mutual fund fees are spread across sales charges, annual charges, and fund expenses that appear in different documents. Most investors rely on their broker to explain which share class makes sense. If you did not realize you could have paid less, you are far from alone.

That is exactly why the professional who recommended the fund had a duty to you. Under FINRA (the Financial Industry Regulatory Authority) rules and Regulation Best Interest, a broker’s recommendation must be in your best interest, taking into account costs, your goals, and your circumstances. FINRA has also said firms are obligated to provide every sales charge discount disclosed in a fund’s prospectus. When that does not happen, responsibility may belong with the broker and the firm.

How Mutual Fund Share Classes Work

The SEC’s investor bulletin on mutual fund classes explains that the classes of one fund hold the same investments but charge differently:

• Class A shares may carry a front-end sales load, a fee taken from your purchase when you buy. The load can be reduced for larger purchases.
• Class B shares have no front-end load but have a contingent deferred sales load (CDSL, also called a CDSC), a fee charged if you sell within a set period, and a higher annual 12b-1 fee. The SEC notes they are no longer widely available.
• Class C shares usually have no front-end load but may charge a CDSL on early sales, often within about a year, and generally carry a higher 12b-1 fee than other load classes.

A 12b-1 fee is an ongoing charge, named after the SEC rule that permits it, paid out of fund assets, and the money can go to the firm that sold the fund. Funds also charge ongoing operating costs on top of that. The SEC cautions that “the share class with the lowest initial fees may not be the share class with the lowest fees over time,” and that the right class depends on how much you invest and how long you plan to hold it.

Three problems come up most often. First, breakpoints: FINRA explains that these are volume discounts on the front-end load. Investors may combine their holdings across a fund family through “rights of accumulation,” or commit to future purchases through a “letter of intent.” Second, share class choice: a Class C or Class B fund can cost more over time for a large, long-term investment than Class A with a breakpoint discount. The SEC has also pursued advisers who put clients in a share class that paid fees when a lower-cost class of the same fund was available and the conflict was not disclosed (SEC Share Class Selection Disclosure Initiative). Third, switching: FINRA prohibits moving a customer from one fund to another with no legitimate investment purpose, and firms must weigh the net advantage of a switch after new costs (FINRA Notice 94-16).

Example: an investor with a large sum from a retirement account is placed in Class C shares with a higher annual fee, when buying Class A at a reduced load would have cost less over the years the money stayed invested.

Common Examples of Mutual Fund and Share Class Claims

• A broker failed to apply a breakpoint discount, or never asked about related accounts and prior holdings that would have lowered the sales charge — see Misrepresentation and Omission
• A more expensive share class was recommended than the investor qualified for — see Unsuitable Recommendations
• Class B or Class C shares were sold for a large, long-term investment, where higher ongoing fees added up
• Funds were sold and replaced with new ones, triggering fresh sales charges without a clear benefit — see Churning
• Fees were described as lower than they were, or the extra charges were never explained — see Misrepresentation and Omission
• A large share of an account placed in sector funds tied to one industry — see Overconcentration
• A firm that failed to catch a pattern of costly switches or share class choices — see Failure to Supervise
• A recommendation driven by the commission paid rather than the investor’s needs — see Regulation Best Interest

How Can You Protect Yourself From Mutual Fund Fee Problems?

You do not need to be a fee expert, but a few questions go a long way:

• Ask which share class you are buying, and why. If a different class of the same fund would cost less for your amount and time horizon, you should hear why it was not recommended.
• Ask about breakpoints. Tell your broker about balances held elsewhere, including accounts of family members who may count toward a discount, and ask whether a letter of intent applies.
• Ask for the total cost. Compare the sales charge, the annual 12b-1 fee, and the fund’s ongoing operating costs, not just the first number you are shown.
• Know how long you plan to stay. The cost of a Class C fund grows with time, and a Class B or C fund can charge a fee if you sell early.
• Question a switch. Before selling one fund to buy another, ask what you will pay in new charges and what you gain.

Signs Your Mutual Fund Investment May Have Been Unsuitable

• You paid a sales charge on a large purchase and were never told a discount might apply
• You were placed in Class B or Class C shares for a large amount you planned to hold for years
• No one compared share classes or showed you the total cost
• You were told there were “no fees,” or the fees were never explained
• Your broker sold one fund and bought another shortly after, and you paid new sales charges
• Your account was moved to a different fund family without a clear reason
• A large share of your savings is in funds tied to a single industry or sector
• You were charged a fee when you tried to sell
• Your annual statements show ongoing fees no one ever explained to you