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SEC Votes to Propose Revamp of 12b-1 Fees


WASHINGTON-The mutual fund and brokerage industries are revisiting their sales loads structure following the Securities and Exchange Commission's unanimous decision last Wednesday to revamp the 12b-1 sales and distribution fees that have become so prevalent in the industry and to provide better disclosures of these charges to investors.

All five SEC commissioners, including Chairman Mary Schapiro, who has spoken against the misuse of sales loads and strongly in favor of better disclosure, voted on the measure.

The proposal would replace SEC Rule 12b-1 that governs fees mutual fund companies may charge to cover their funds' distribution costs. It will be subject to a 90-day comment period upon publication in the Federal Register.

"Despite paying billions of dollars, many investors do not understand what 12b-1 fees are, and it's likely that some don't even know that these fees are being deducted from their funds or who they are ultimately compensating," Schapiro said. "Our proposals would replace rule 12b-1 with new rules designed to enhance clarity, fairness and competition when investors buy mutual funds."

Level Loads

Under the proposal, a company could not charge more in ongoing fees, known as asset-based sales charges, than the highest fee charged by another of the company's funds using another type of fee - up-front, or "front-end," sales charges - and has no ongoing sales charges.

"For example, if one class of the fund charges a 4% front-end sales charge, another class could not charge more than 4% in total to investors over time," the SEC said in a fact sheet distributed ahead of the vote.

Unlike ongoing fees, front-end sales charges are already limited by Financial Industry Regulatory Authority rules.

The proposal would allow funds to continue to pay up to 0.25% per year out of their assets for advertising and sales compensation.

It also would improve the transparency of distribution fees by requiring funds to disclose any "ongoing sales charges" and any "marketing and service fees" in a fund's prospectus, shareholder reports and investor transaction confirmations.

Key Info in Confirms

Transaction confirmations also would have to describe the total sales charge rate that an investor will have to pay.

Meanwhile, the SEC's proposal aims to encourage retail price competition by allowing funds to sell shares through brokers who determine their own sales compensation rather than under the terms established by the funds.

The fees were developed in the late 1970s when the mutual fund industry was new to individual investors, and funds were losing investor assets faster than they were attracting them. Self-distributed funds were emerging as ways to pay for necessary marketing expenses, and the SEC reasoned that by advertising and marketing, the funds could raise additional assets and then lower fees and eliminate the 12b-1 fees over time.

While the fees amounted to an aggregate of just a few million dollars in 1980 when they were first permitted, that total has ballooned to $9.5 billion in 2009.

Some critics of the SEC's proposal to limit or eliminate 12b-1 fees argue that capping 12b-1 fees will impact firms' ability to bring advice to middle market or small investors.

A 2005 study by the Investment Company Institute found that about 40% of 12b-1 fees went to pay advisers for initial sales, while approximately 52% of the fees were being used by fund companies to provide ongoing support to clients. The ICI says eliminating 12b-1 fees would get rid of any incentives advisers have to provide clients with investment advice.

The ICI has published an information fact sheet on 12b-1 fees on its website. Among the many points made are these: "Intermediaries can be compensated services in a variety of ways. Rule 12b-1."

Matthew E. Lynch, president and chief executive officer of Capital Analysts, echoed that sentiment. "All of the proposals the SEC addressed today, like sales charge limitations and transparency of fees, are good thinking. But when you begin to break them down as a practical matter, they address the symptom but not the underlying illness," Lynch said.

The fundamental problem, he said, is the way the business is built today. For many firms, 12b-1 fees have become the difference between profit and loss. "Smaller firms and advisers have come to count on 12b-1 fees as a material revenue source-and they have built their service model, marketing plan and the minimum assets under management required based on the 12b-1 model," he said.

Lynch believes the impact of capping or eliminating fees will be that advisers will start to move upmarket to larger clients who they can charge larger fees, and lower-end clients will be moved to a self-service approach: "Just like you pay someone to do your taxes, I think the industry will move to a fee-for-service model where you don't pay on an ongoing basis, but imbed fees within products."

- Ruthie Ackerman contributed to this article.

 

 

MSRB To Expand

WASHINGTON - The Municipal Securities Rulemaking Board is considering temporarily expanding its 15-member board, possibly by two to four members, as it transitions to majority-public membership by Oct. 1 to comply with the new financial regulatory reform law.

The expansion is one of several issues the board will discuss at its meeting Thursday and Friday in Chatham, Mass., MSRB Chairman Peter Clarke, managing director and vice chairman of tax-exempt capital markets at JPMorgan, said in an interview.

Board members also will consider the number of new staff and additional amount of money it will need, Clark said, as the MSRB scrambles to implement the numerous mandates it has been given by the bill, which President Obama signed into law. Under the new law, the board may increase in size beyond 15 members beginning fiscal year Oct. 1.