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SEC Judge Sets Limits on Use of 12b-1 Fees

For the first time, an SEC judge has set some limits on what expenses a mutual fund can include as part of its Rule 12b-1 fee.

Judge Brenda P. Murray has ruled that costs for recruiting personnel, and, in some cases custodial, transfer agent and accounting fees can not be counted as marketing expenses and included under Rule 12b-1 of the Investment Company Act. Murray's 51-page decision dated April 1 marks the first time the SEC has found that a mutual fund adviser used Rule 12b-1 fees improperly, said John S. Yun, the lawyer who led the SEC's prosecution of the case.

Murray ordered that World Money Managers, the investment adviser to the Permanent Portfolio Family of Funds, be barred from doing business for three months. The Permanent Portfolio of Petaluma, Calif., has approximately $200 million in assets under management in four no-load funds, said Michael Joseph Cuggino, Permanent Portfolio's treasurer. Unless World Money Managers appeals the ruling by April 22, the Permanent Portfolio must find a new money manager to run the funds temporarily. Murray also fined World Money Managers and two top executives a total of nearly $3 million.

World Money Managers, World Money Securities an affiliated broker/dealer that went out of business in 1996 Terence Michael Coxon, World Money Managers' general partner, and Alan Sergy, the funds' former treasurer and a fund director, maintain their innocence but have not yet decided whether to appeal the ruling, Cuggino said. He declined to comment further. Coxon did not return a call seeking comment. Sergy could not be reached for comment.

The SEC adopted Rule 12b-1 in 1980 to permit funds to create a special category of fees to pay for marketing expenses. The agency did not explicitly define what marketing expenses funds could charge to Rule 12b-1 plans. In recent years, the charges increasingly have been used to pay commissions to intermediaries who sell funds in addition to expenses for printing and marketing.

Murray acknowledged that there is no definitive standard as to what is an acceptable Rule 12b-1 charge. Nevertheless, she said that an expense for recruiting personnel was "clearly improper" as a 12b-1 charge. In addition, World Money Managers, the funds' investment adviser, had promised to pay fund operating expenses itself such as custodial, accounting and transfer agent fees, Murray said. In light of that promise, World Money Managers' decision to charge those expenses under Rule 12b-1 was illegal, Murray said.

World Money Managers' 12b-1 practices were "aggressive," and auditors' concerns about the practices should have been brought to the attention of the fund directors but were not, she said.

Geoffrey Bobroff, a consultant who testified on the SEC's behalf on the Rule 12b-1 issue, said that should World Money Managers appeal the decision, it will provide an opportunity for the SEC commissioners, who must hear the appeal, to offer more detailed guidance on acceptable Rule 12b-1 practices. An SEC official said last month that the SEC hopes to examine and possibly revise Rule 12b-1 to take into account changes in distribution practices since 1980. (MFMN 3/29)

The SEC's 12b-1 allegations were only one part of a case which largely focused on alleged self-dealing on the part of World Money Managers, Coxon and Sergy, between 1989 and 1995. Murray ruled that Coxon and Sergy did not fully disclose conflicts in a decision to use $950,000 of the funds' money for World Money Securities. Coxon and Sergy had a financial stake in both World Money Managers and World Money Securities, Murray said.

Calling the self-dealing in the case "egregious," Murray ruled that World Money Managers, Coxon and Sergy pay back $1.6 million they improperly received from the funds. She also ordered that they pay interest of $1.2 million. In addition, World Money Managers was ordered to pay a fine of $100,000 and Coxon and Sergy were ordered to pay fines of $20,000 each. Murray barred Coxon and Sergy from associating with any investment adviser and investment company for three months.