Abstract
U.S. SEC Rule 18f-3 allows mutual funds to offer multiple share classes that represent claims on the same underlying assets. Share classes differ with respect to distribution arrangements, which are modified by varying the timing and magnitude of load charges and annual distribution fees. For investors, the choice of share classes depends primarily on the expected holding period. Rule 18f-3 has also given rise to broker compensation arrangements that differ among share classes and, consequently, create for brokers a stake in the class of shares clients purchase. In most circumstances and for most share class structures, brokers have monetary incentives to sell the class of shares that is least advantageous to investors. This conflict of interest is especially troubling because of the probable lack of financial sophistication of investors who pay for investment advice about mutual funds. The adverse incentives are potentially damaging to the mutual fund industry and should provoke a reconsideration of multiple share classes and the accompanying broker compensation arrangements.
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