Biggest 12(b)-1 reform losers? These three firms

AllianceBernstein Holding LP, Franklin Resources Inc. and Waddell & Reed Financial Inc. are the three publicly traded mutual fund companies with the most at stake pending the SEC's 12(b)-1 reform. And they are likely to take a hit to revenue if the Securities and Exchange Commission's proposal becomes law, analysts say. The three firms have the largest percentages of fund assets in share classes that have 12(b)-1 fees of more than 0.25%, which would no longer be the case if the SEC's proposal goes through. AllianceBernstein has 27% of its mutual fund assets in these share classes; Franklin has 26% and Waddell & Reed has 20%, according to data culled by Strategic Insight. Other publicly traded firms with significant assets in share classes with 12(b)-1 fees of more than 0.25% are Calamos Investments, at 20%, and Legg Mason Inc., at 19%, according to Strategic Insight. Under the SEC's proposal, firms would be allowed to charge a “marketing and service fee” of up to 0.25%. Anything above that amount would be deemed a continuing sales charge, which would be limited to the highest fee charged by the fund for shares that don't have such a charge. For fund companies, that could mean that they would have to pay brokers out of their own pockets through revenue-sharing agreements, rather than through fund assets, as is the case with 12(b)-1 fees, observers said. “Brokers may say to the fund groups, "Once this converts to A shares, you are going to pay revenue share to us,'” said Jack Murphy, a partner with Dechert LLP. “That comes out of the fund adviser's profits and would decrease the fund adviser's profitability.” In some cases, that distribution cost to fund companies could increase, said Douglas Sipkin, an analyst at Ticonderoga Securities LLC. On Aug. 24, he and Warren Gardiner, another analyst at Ticonderoga, lowered their price target for Legg Mason, which is in the middle of a turnaround effort, saying that the 12(b)-1 reform proposal may derail the firm's initiatives. Using Legg Mason's data, the analysts estimated that C shares with 12(b)-1 fees above 0.25% represent 25% to 30% of assets at affiliates Legg Mason Capital Management and ClearBridge Advisors LLC — and 7% to 10% of their sales. “I just wonder how they are going to do things more efficiently if, all things being equal, their costs are going up,” Mr. Sipkin said. Legg Mason anticipates being able to share some of the expenses with broker-dealers, said spokeswoman Mary Athridge. Given that the proposal process is in such an early stage and there is a five-year grandfather clause, it is too soon to say how it will affect the firm, she said. If the 12(b)-1 proposal comes to pass, it could mean a significant short-term increase in marketing and operational costs for fund firms. The expense would flow from efforts to implement the technology that tracks how sales charges are paid on an individual level and how the changes are communicated to investors, said Jason Weyeneth, an equity analyst at Sterne Agee & Leach Inc. The other potential hit to revenue of these companies is the loss of business, as brokers opt for lower-cost products such as exchange-traded funds, he said. In an e-mail, AllianceBernstein spokesman John Meyers cited the firm's 10-Q language about the reform proposal, in which it said it doesn't anticipate a “material” impact on the firm. He declined to comment further. Bill Weeks, a spokesman for Franklin, and Rodger Hoadley, a spokesman at Waddell & Reed, said they would not comment until the proposal is final. Jennifer McGuffin, a spokeswoman at Calamos, didn't return calls and an e-mail seeking comment. Not everyone thinks that the 12(b)-1 reform proposal will significantly affect the revenue of asset management companies. Observers said that the issue is ultimately one that broker-dealers must address. Under the SEC proposal, broker-dealers would be able to create a new share class, and how they do that will largely determine how this affects fund companies and brokers, said Avi Nachmany, director of research at Strategic Insight. The fact that many of these firms' assets are in level-load C shares, which charge 1% over time, suggests that investors are already accustomed to a fee-based ap-proach, he said. “I contend that such managers will continue to have a high share of sales in the future, through some fee-based approach where investors pay for advice over time,” Mr. Nachmany said. “A current high share of assets/sales through level-load funds is a plus, not a minus, in terms of the future opportunities of these managers.” Michael Kim, an equity analyst for Sandler O'Neill & Partners LP, estimates that if approved, the proposal at most would mean about a 5% hit to fund companies' revenue. “And that estimate is assuming that asset managers bear 100% of the burden, which I don't think is what's going to happen,” he said. E-mail Jessica Toonkel at jtoonkel@investmentnews.com.