Will 12(b)-1 plan fizzle without champion?

The announced departure of Andrew J. “Buddy” Donohue from the SEC — along with rising opposition from advisers and fund managers — could substantially change the fate of the 12(b)-1 proposal, according to industry observers. In fact, experts said the final rule will diverge sharply from the current proposal, which is an effort to limit the use of 12(b)-1 fees to their original purpose — helping to expand a fund's shareholder base in order to lower costs to investors. The Securities and Exchange Commission announced last week that Mr. Donohue will leave his job as director of the Division of Investment Management in November. The news came just weeks after the agency put its 12(b)-1 fee proposal out for comment. “Buddy was a driving force be-hind the 12(b)-1 proposal,” said Barry Barbash, a partner in the law firm Willkie Farr & Gallagher LLP and a former director of the SEC unit Mr. Donohue currently heads. “Given the likelihood of negative comments about the proposal, what comes out in the final rule could be very different because of Buddy not being there.” Under the plan, 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 do not have such a charge. The 25-basis-point cap has caused concern among mutual fund industry executives. That's not overly surprising. The proposed cut-off would affect scores of funds in the retirement market, particularly those sold by advisers to pension plans as R shares. According to research firm Strategic Insight, roughly $70 billion of fund assets in R shares have 12(b)-1 fees higher than the SEC's proposed 0.25% cap. Executives at fund companies are particularly worried about what it would take to track the payment of sales charges by individual investors. Keith Hartstein, chief executive officer and president of John Hancock Funds LLC, said the company is working with the Investment Company Institute and is closely following its plans to draft an official response to the proposal. Ianthe Zabel, a spokeswoman for the ICI, which represents the mutual fund industry, said that the institute is planning to issue a response to the SEC 12(b)-1 proposal during the comment period. That period ends Nov. 5. Financial advisers in the retirement segment aren't happy about the SEC's proposal, either. They say that they will have difficulty serving small retirement plans if allowed to charge only 0.25%. That, in turn, may convince advisers that is isn't worth their time to serve such plans, said Bart R. Bonga, a registered investment adviser at Rothschild Investment Corp. “Advisers are going to see it's not worth complying with these regulations and rules for the few dollars they can make,” he said. Experts said the proposal might also encourage advisers to move to an asset-based fee model. If so, some advisers would look for lower-cost investment options for their retirement plan clients. That prospect is worrisome. Jason C. Roberts, a partner at law firm Reish & Reicher, warned that advisers might steer investors to products such as exchange-traded funds and index funds solely because of their low costs — without considering factors such as performance and investment style. “You could certainly see a movement to lower-cost funds, which might not be in the best interest of investors,” he said. John Heine, an SEC spokesman, declined to comment. But some SEC watchers said that despite industry criticisms — and Mr. Donohue's pending exit — they don't expect the commission to overhaul the proposal drastically. “A lot of thought went into this proposal as is evidenced by the 575 footnotes,” said Jay G. Baris, a partner at Kramer Levin Naftalis & Frankel LLP. Robert Kurucza, a partner at Goodwin Procter LLP and a former associate director of the SEC investment management division, said that something as big as the 12(b)-1 proposal is an undertaking involving so many layers of staff that the departure of one person won't grind things to a halt. “It's a collective exercise,” Mr. Kurucza said. Mr. Donohue's absence “clearly is not going to derail the proposal.” Mr. Kurucza did, however, acknowledge that the director's departure might “slow the process.” Meanwhile, there are a few investment industry officials who think that the SEC might actually shelve the controversial proposal. It has happened before. In 1988, the SEC released a proposal that would have severely restricted the use of 12(b)-1 fees. The plan was shelved. In 2007, the SEC held a round table on the issue. The discussion was tabled when the financial crisis struck the next year. “The one thing I can guarantee every financial adviser is that the final rule will be substantially different than the current proposal out there,” Mr. Hartstein said.   E-mail Jessica Toonkel at jtoonkel@investmentnews.com and Mark Schoeff Jr. at mschoeff@investmentnews.com.