Staff members at the SEC will recommend that 12(b)-1 fees be broken into at least two parts.
Staff members at the SEC will recommend that 12(b)-1 fees be broken into at least two parts.
"We would seek to regulate the portion that substitutes for a sales load as a sales load and more appropriately regulate the portion that pays for shareholder servicing and distribution-related administration," Andrew J. "Buddy" Donohue, head of the Securities and Exchange Commission's division of investment management, said April 24 in New York.
His comments, the most detailed to date on the subject, were made before attendees at a conference held by the Practising Law Institute, a New York-based legal education organization.
Mr. Donohue also suggested that the staff would recommend a cap on the 12(b)-1 fees that investors in Class C mutual fund shares are charged.
"The staff wants to make sure that investors are not paying more in asset-based sales charges paid over time, through the payment of 12(b)-1 fees, than they would have paid in a single, one-time sales load under applicable regulations," he said.
FIXED PERCENTAGE
Unlike A shares, which charge a one-time front-end load, or B shares, which charge a back-end load, C shares charge a level load applied annually as a fixed percentage of a fund's average net assets.
Breaking the 12(b)-1 fee up and treating at least a portion of the fee as a sales load would make it more transparent, Mr. Donohue said.
"When viewing Rule 12(b)-1 from the investor's perspective, the staff recognizes that many investors are paying a sizable portion of 12(b)-1 fees, typically [0.75 percentage] points annually, as a substitute for a front-end sales load," he said.
"Unfortunately, investors may not fully appreciate that this fee is being deducted from their fund assets to ultimately compensate the broker who sold them the fund."
During his speech, Mr. Donohue didn't say when recommendations concerning 12(b)-1 fees will be made, but he has said that recommendations will be made by summer.
Reform of Rule 12(b)-1 is being pushed because critics such as Mr. Donohue contend that the primary use of 12(b)-1 fees has shifted from paying for fund marketing to substituting for a sales load.
The detailed nature of his comments could suggest that a proposal revamping 12(b)-1 could come any day, industry watchers said.
"My sense is that Buddy has made a personal commitment that come hell or high water, [a proposal] will come to fruition," said Jeff Keil, president of Keil Fiduciary Strategies LLC, an industry consulting firm in Littleton, Colo.
Whether a proposal eventually results in real change, however, is debatable.
Assuming that it looks anything like what Mr. Donohue suggests, industry insiders are already offering critiques that run from mild to blistering.
At the blistering end of the spectrum are fee-only advisers who believe that 12(b)-1 fees should be abolished.
"The 12(b)-1 fee was a bad idea that has been severely abused," said Frank Armstrong III, president and founder of Investor Solutions Inc., a Miami-based firm with just under $500 million in assets under management. "It's time to eliminate it entirely."
Eliminating it may be a little extreme, but the SEC should at least call it what it is, said Diahann Lassus, chairwoman of the industry issues committee of the National Association of Personal Financial Advisors in Arlington Heights, Ill.
In some instances, it was used improperly as an investment advisory fee, said Ms. Lassus, who is also president of Lassus Wherley & Associates PC, an investment advisory firm in New Providence, N.J., with about $340 million in assets.
"In essence, 12(b)-1 fees are often utilized by brokers ... as compensation for services which are clearly investment advisory in nature," she said.
But the demise last year of the broker-dealer exemption rule made that illegal unless a registered representative obtains a license as an investment adviser, Ms. Lassus said.
It is something the SEC needs to recognize, she said.
"Just because a 12(b)-1 fee may be called a substitute for a sales load or a transaction fee by the SEC does not make it so," Ms. Lassus said.
Registered representatives accused fee-only advisers of needlessly arguing semantics.
"I don't really mind what [the 12(b)-1 fee] is called," said Paul Rogers, a registered representative at Harvest Capital LLC of Wethersfield, Conn.
As long as registered reps will still be able to receive compensation, he's happy with whatever the SEC comes up with, he said.
"The [compensation] model works very well for advisers that may have a lot of modest accounts that the fee-based person would ignore," Mr. Rogers said.
That any 12(b)-1 proposal could also include a cap on the 12(b)-1 fees charged to investors in C shares, however, received mixed results from registered reps.
"I think that's absolutely fair," Mr. Rogers said.
He has seen a number of clients come through the door with C shares who did not receive the service they should have received for the fees they were paying, he said.
SHIFT TO WRAP ACCOUNTS
But capping 12(b)-1 fees charged by C shares could actually hurt investors, said John Robinson, a registered rep in Honolulu, who asked that his firm not be identified.
Many industry watchers believe that if a cap is placed on 12(b)-1 fees, there will be a shift to fee-based brokerage accounts, also known as wrap accounts, he said.
Fees charged in wrap accounts, however, can be higher than C share fees, Mr. Robinson said.
The mutual fund industry has also taken issue with attaching a cap on 12(b)-1 fees charged by C shares.
The Investment Company Institute, a Washington-based mutual fund trade organization, had no comment, said Edward Giltenan, a spokesman for the organization.
POTENTIAL NIGHTMARE?
But Karrie McMillan, the ICI's general counsel, said in March that the proposal is problematic.
If fund companies are forced to ensure that C share investors pay no more in 12(b)-1 fees than investors in Class A shares, it could pose an administrative nightmare for the companies, forcing them to come up with a "conversion rate" for the different share classes, she said.
"It could be very difficult for some companies," Ms. McMillan said.
E-mail David Hoffman at dhoffman@investmentnews.com.
