“Like many who bought poorly performing Putnam mutual funds in recent years, Nancy Wessels lost big. One of her investments, Putnam Vista fund, dropped 40% from when she bought it in April 2000, near the stock-market peak, until she sold it in May 2002. That performance was worse than 80% of similar stock funds,” writes Laura Johannes in today’s Wall Street Journal.

“What the 80-year-old widow’s broker, Edward D. Jones & Co., never told her was that it had a strong incentive to sell Putnam funds instead of rivals that performed better. Jones receives hefty payments — one estimate tops $100 million a year — from Putnam and six other fund companies in exchange for favoring those companies’ funds at Jones’s 8,131 U.S. sales offices, the largest brokerage network in the nation.”

“When training its brokers in fund sales, Jones gives them information almost exclusively about the seven “preferred” fund companies, according to former Jones brokers. Bonuses for brokers depend in part on selling the preferred funds, and Jones generally discourages contact between brokers and sales representatives from rival funds. But while revenue sharing and related incentives are familiar to industry insiders, Jones typically doesn’t tell customers about any of these arrangements.”

“The situation ‘gives you the feeling of being violated,’ says Mrs. Wessels’s son, DuWayne, a Waterloo, Iowa, real-estate broker. He says he found out about the fund-company payments to Jones from his mother’s new broker when the son moved her $300,000 account to another firm in 2002.”

“Jones, whose storefront offices are common across much of the country, is one of the nation’s largest distributors of mutual funds, with 5.3 million individual customers who hold more that $115 billion in fund shares. The firm has earned respect for its advocacy of conservative, buy-and-hold investing, and it hasn’t been tarnished by the scandals sweeping the mutual fund and brokerage industries.”

“But Jones, based in St. Louis, is also among the nation’s leading practitioners of a little-understood fund-sales practice now under scrutiny by federal securities regulators. In the industry it’s known by the bland name of ‘revenue sharing’: Fund companies give brokers a cut of their management fees to induce them to sell their products. Critics call it ‘pay to play.’ “

” ‘The deception is that the broker seems to give objective advice,’ says Tamar Frankel, a law professor at Boston University who specializes in mutual-fund regulation. ” ‘In fact, he is paid more for pushing only certain funds.’ “

“If properly disclosed, revenue sharing is legal. But the practice has come under increasing scrutiny as part of the current mutual-fund scandal, and it is now unclear precisely what disclosure is required. In November, Morgan Stanley agreed to pay $50 million to settle Securities and Exchange Commission allegations that its brokers didn’t inform customers about revenue-sharing deals and other incentives to sell certain funds. Morgan Stanley didn’t admit or deny wrongdoing. The money will be distributed to fund investors. The SEC also accused Morgan Stanley of steering customers to the funds of companies that gave Morgan lucrative stock-trading business; Jones doesn’t engage in that practice.”

“Douglas Hill, Jones’s managing partner, this week referred all questions to firm spokesman John Boul, who repeatedly declined to comment. On its Web site, Jones says it favors a handful of funds to help investors sort through the thousands of available offerings. ‘We focus on seven preferred mutual fund families that share our same commitment to service, long-term investment objectives, and long-term performance,’ Jones says.”

“The funds Jones favors are a mixed bag. Some recently have exceeded average performance in their category, while others, like Putnam, have offered inferior returns.”

“The fund companies on the preferred list also pay for Caribbean cruises and African-wildlife tours for Jones brokers, according to former brokers. During these excursions, fund-company representatives make sales pitches to a captive audience of Jones employees, current and former brokers say. More than half of the firm’s brokers are invited on the twice-a-year trips, based on meeting certain overall sales targets.”