Are Retail Investors Systematically Disadvantaged by Fund Fees? A Legal Analysis

When retail investors invest in financial products like mutual funds, they often have to add five percent of the invested amount as a sales charge for distribution. Management fees are frequently added, making up another one to two percent of the invested capital. The money then flows as commission, wholly or in part, to the bank that distributed these funds. But insurers or pension companies also benefit when they distribute investment products.

Many private customers simply accept these surcharges: It's just the way it is that a fund costs money. The problem, however, is that institutional investors typically do not have to pay these costs. Precisely in this, Düsseldorf lawyer Jens Graf from the law firm Graf Rechtsanwälte sees unfair discrimination against retail investors. The unequal costs for private and institutional investors would mean a violation of the German Capital Investment Code (KAGB), according to his argument, which obliges fund companies to "treat all investors (...) fairly" (KAGB Paragraph 26, Section 2, Sentence 6).

The Case: A Small Claim with Big Implications

Jens Graf sued a fund company on behalf of a client before the Munich Local Court. And what he achieved is causing a stir, as currently reported by the Süddeutsche Zeitung and Manager Magazin. Although it was only about supposed peanuts, namely a sales charge of around 200 euros that the fund house was supposed to refund. There was neither a court hearing nor a judgment. Nevertheless, Graf can triumph—and more important is the supposed signaling effect of the legal dispute.

The bank transferred the 200 euros back to the investor after the plaintiff demanded the sales charge. But more: The court also obligated the fund company to bear the full court costs. In the specific case, it concerned the investment fund CS MACS Dynamic, share class "B," as the law firm reports. This was distributed in July 2011 on the recommendation of a savings bank and provided for a sales charge of 5 percent plus interest for seven years. Additionally, the investor had to pay an administration fee, which also partly flowed back as commission to the distributing bank.

Now, the investor received the distribution costs refunded. But how is this repayment to be assessed? Here, the views diverge as expected. While lawyer Graf books the result as his success, the fund company wrote in the statement of defense that they had conceded out of goodwill. Thus, the plaintiff's side values the result as a victory in court, the fund provider, however, as voluntary accommodation.

The Court's Preliminary Assessment

According to the Süddeutsche Zeitung, a ruling by the Local Court is noteworthy, stating that the fund company "would likely have lost the legal dispute," according to the judges' assessment. Therefore, they also had to reimburse the court costs. Moreover, the fund company by no means paid voluntarily, as Jens Graf reports on the law firm's website, but indeed resisted. A 13-page lawyer's letter was supposed to convince the court to dismiss the customer's lawsuit. But the fund house finally refunded the disputed claim without objections and thereby expressed that the plaintiff's claim was justified.

However, this assessment should also not be overvalued. The Munich Local Court only conducted a "summary examination" of the facts. Here, the court examines the expected outcome of the proceedings limitedly based on the statement of claim and the available evidence. Thus, a different assessment could certainly come with closer examination.

The Core Debate: What Are Distribution Fees For?

Nevertheless, the question now arises of how to evaluate the commission for retail investors in the fund business and what it must be paid for. Jens Graf rejects in an interview with "Manager Magazin" the assertion that the distribution costs are due for the investment advice provided by the bank, which is not necessary in the case of professional investors. On the contrary: The bank systematically exploits customers' lack of information and trust to burden them with high costs. Thus, his initiative becomes fundamental criticism of commission-based distribution:

"The advising bank receives the sales charge, even if it simply pushes the fund company's products into the market, regardless of whether they are suitable for the investor at all," argues the consumer lawyer. "...and part of a fund's administration fee also flows as an ongoing commission to the bank. This is how the fund company wants to ensure that a bank, whose customer may want to reallocate funds, ensures that he does not sell the fund in question—again regardless of whether the product is suitable for the investor or not."

Broader Implications and Potential Solutions

Ultimately, fund providers also harm themselves because many retail investors switch to index funds from direct banks and ETFs, which are significantly more cost-effective. The solution from Jens Graf's perspective: More fee-based advisory and a commission ban like in the Netherlands and the United Kingdom. The lawyer tells "Manager Magazin": "Strictly speaking, the commission ban has long existed in Germany too. A 5 percent premium for prescribing medication is corruption according to the Federal Court of Justice. Paragraph 70 of the Securities Trading Act prohibits turnover-dependent remuneration of and for financial service providers. The problem is only that this has not been implemented in practice for years, and that the legal restriction is supposed to be the 100-percent rule despite exceptions." He wants to pursue the topic further: Further lawsuits have already been filed.

Insurers and brokers are struggling in claims management with high backlogs, increasing claim frequencies, skilled labor shortages, and growing customer expectations. Manual processes are expensive and slow.