Cereal companies pay grocery stores to place their products at eye level on the shelves.  Higher visibility leads to higher sales.

Mutual funds do the same thing.  They pay big brokerage firms big money to tout their products.  So when you call up a firm like UBS or Morgan Stanley Smith Barney and ask for an investment recommendation, they have a list of preferred mutual funds that they want you to buy so they can make more money.

These “revenue sharing” payments can be very big revenue sources for brokerage firms.  For example, nearly one-third (33%) of Edwards Jones’ $481.8 million profit in 2011 came from “revenue sharing” fees.  Note that Edwards Jones is forced to disclose more information on sensitive matters like this than its competitors thanks to a 2004 regulatory settlement.

Though “revenue sharing” payments are legal, many critics question if they are ethical since it calls into question whether recommendations are based solely on what’s in the best interest of the client.  Brokerages are not fiduciaries and have no requirement to put client’s interests first.

“It’s an unholy alliance between mutual-fund firms and brokerages to exploit their customers,” says John Freeman, emeritus professor of business and professional ethics at the University of South Carolina Law School.

Investors who want to avoid questionable practices like “shelf space” and “revenue sharing” should seek advice from a fiduciary such as a registered investment advisor.

Wall Street Journal: Brokers Raise Fees, but Not For Investors: Why You Should Care