by Lawrence C. Melton, Esq. firstname.lastname@example.org
THE HAYES LAW FIRM, www.dhayeslaw.com
On Tuesday, June 19, 2007, the Securities Exchange Commission will hold a round-table discussion on 12(b)-1 fees. The meeting, held in Washington, D.C., will determine whether to reform 12(b)-1 fees or eliminate them altogether.
12b-1 fees are taken out of a mutual fund's assets annually to cover the costs of marketing and distributing the fund to investors. The shareholder does not pay the adviser directly. Rather the mutual fund company takes the 12b-1 fee out of the funds assets and gives it to the broker or adviser. Like sales charges, 12b-1 fees can be used to pay a broker or other investment professional.
SEC Chairman Christopher Cox has called for either reforming or eliminating 12b-1 fees by the end of 2007. (Sarah Hansard, It is high noon for 12(b)-1fees, Investment News, June 11, 2007). Critics of the 12b-1 fee argue that the fee no longer serves its original purpose. Id. The SEC implemented 12b-1 fees in 1980, at a time when mutual funds were losing money. Id. The SEC intended the 12b-1 fees to pay for marketing and distribution expenses. Id. The SEC viewed the fees as a temporary solution. No one expected 12b-1 fees to be around 27 years later.
During those 27 years the investment climate has changed. Advisers no longer collect 12b-1 fees for marketing purposes. Rather, they collect the fees as compensation for servicing accounts on a continuing basis. As Mr. Cox said last April, the fees have become "a substitute for front-end loads." "98% percent of the fee goes to sales and service today," said Jeff Kiel of Kiel Fiduciary Strategies, one of the participants in tomorrow's round-table. (Sarah Hansard, It is high noon for 12(b)-1fees, Investment News, June 11, 2007).
Many reformers favor a direct compensation approach, which would move the fees to the shareholder level. Right now, the mutual fund company deducts the 12b-1 fees before paying income to shareholders. Under direct compensation, the shareholder would pay the 12b-1 fee directly to the adviser/broker. Barbara Roper of the Consumer Federation of America in Washington, is a participant in the round discussions and an advocate of direct compensation. She said:
It is appropriate to expect investors to pay for the services they receive from brokers...There's no reason to funnel payments to brokers through the product sponsor. Doing that just muddies the water and creates these conflicts of interest.
Sarah Hansard, It is high noon for 12(b)-1fees, Investment News, June 11, 2007.
The 12b-1 fee is currently set by the mutual fund company. The mutual fund company does not actually receive the fees, because the fees ultimately go to the brokers/advisers. Mutual fund companies thus have little incentive to set 12b-1 fees higher than necessary. Presumably, If 12b-1 is reformed, the mutual fund companies will no longer set the fee amount. The advisers would gain the authority to designate the amount of fees owed. As recipients of the 12b-1 fees, advisers obviously have an incentive to charge a higher fee. Therefore, the reform measures discussed tomorrow may very well lead to higher 12b-1 fees.
Opponents of reform also say eliminating 12b-1 fees will result in wrap fee accounts and asset-based fee accounts. Under such circumstances, the customer would likely pay closer to 1 percent, which is four times what they typically pay today.
Proponent of reform says 12b-1fees allowe people to pretend you could have the services of an adviser for free. Moving the fees outside of the fund's expense ratios and charging them directly to shareholders would make the fee visible to investors in the same way as front end loads. This is important. The goal of reform should be to protect the investor. A successful reform will make investors in mutual funds less susceptible to fraud and manipulation.
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