The Deception Series, Part 4--The Culture of Deception

Part 4--The Culture of Deception
Business organizations which have a hidden agenda often go to great lengths to disguise the deception or instill a culture which ignores it.

That was the culture I saw at The Principal Funds and its predecessor, the WM Group of Funds, when it came to discussing the merits of the Advisor Paid Fee (APF). That fee was so controversial that it was the elephant in the room, something which was not discussed openly.

For example, at one company dinner party in early 2007, the outgoing president of the WM Group of Funds, Bill Papesh, made a speech about the mutual fund sales records which were achieved during his tenure. The vast majority of these sales were in the SAM Portfolios. As the wine flowed freely, Papesh cited some impressive sales figures, but he never once mentioned the APF and how it was the main engine behind all of those sales and the resulting commissions and bonuses paid to many people in the room. Despite that glaring omission, Papesh received a standing ovation.

To keep the employee intimidation level high about openly discussing the APF with advisers, executive memos were sent throughout the office at certain periods reminding employees to refer to the APF by only using specific language. It was not to be referred to as a commission trail or 12b-1 payment, nor was anyone allowed to comment on when, or if, the fee would be discontinued since that could precipitate a redemption stampede.

People who deviated from the prescribed language were reminded that it “will be considered a violation of company policy and may result in disciplinary action.” These memos were distributed as news of a class action lawsuit or rumors came in from around the U.S. about the company discontinuing the fee. To keep internal wholesalers from saying the wrong things, these memos included verbatim legal language about the definition of the APF which were to be told to advisers.

The underlying motive here was self preservation. Many investment professionals who sold the SAM Portfolios were getting significant APF payments were most concerned about whether a change in company policy or a class action lawsuit would terminate the lucrative quarterly checks. As the WM Funds APF sales literature pointed out, a financial adviser over a 10-year period had a good chance of making more money from the 12b-1 and APF fees combined than the actual shareholder could make from any SAM returns.

Adding Insult to Injury
To add insult to injury, the investment adviser's return was risk-free, while the shareholder assumed all the volatility in SAM Portfolio returns. All the investment adviser had to do was make a deal with the devil to either not disclose their APF deal (which the vast majority of advisers did), and also keep their client invested in the SAM Portfolios for as long as possible. The longer the shareholder was invested in SAM, the greater the fees paid to the adviser. It was a win-win deal for the WM Group of Funds and later, the Principal Funds. For the fund company, it made sales easier, created a better bond with advisers, and reduced the possibility of redemptions. The only loser (by comparison) was the shareholder.

(During its existence, the APF was the target of at least two class action lawsuits.) If that occurred, everyone knew it would be followed by a wave of redemptions, almost in direct proportion to the number of canceled APF payments.

Wholesaler Salaries
Redemptions are anathema to fund companies since they affect assets under management (a revenue-driver), as well as overall company sales for wholesalers and their internal wholesaler counterparts. There was also a ripple effect since industry lore holds that in a load-fund company, about 10 people earn a commission for every mutual fund sale. This includes people ranging from external wholesalers, top executives in management, marketing, and sales support staff.

Fund wholesalers were especially sensitive to the APF since it made their jobs easier. The APF was an extra kicker, like selling mutual funds on steroids. It cut through the chatter about what supposedly made one mutual fund different from another, and was simply communicated as a way to “triple your trails” by selling the SAM Portfolios to get the APF plus the usual 12b-1 fees. Sales flyers were prepared and disseminated which explicitly stated these monetary benefits. They proved wildly popular and helped propel fund sales and wholesaler salaries.

Wholesaler salaries were another especially sensitive topic since financial services wholesalers, including top mutual fund wholesalers, have ranked among the most highly paid professions in the U.S., according to U.S. Department of Labor statistics.

A fund sales organization used this chart in its sales training which showed that according to 2004 U.S. Department of Labor data, financial services wholesalers were paid $200,000 per year, which was more than surgeons ($181,610); anesthesiologists ($174,250); physicians ($145,704); airline pilots ($128,648); and lawyers ($117,988).

Yet although wholesalers earned the top slot, their income was understated since all of their expenses were reimbursable by their employers. For instance, a mutual fund wholesaler had all travel, meal, auto, home office, incidentals, and business entertainment expenses reimbursed by their fund company. In at least one instance, a wholesaler had $2,000 worth of wine delivered to his room for personal consumption, and that was charged off as a meeting expense. In contrast, doctors and lawyers had to pay significant professional practice insurance expenses which never applied to mutual fund wholesalers.