Published on August 23, 2010 – Ignites – An Information Service of Money-Media, a Financial Times Company- written by Andrew Klausner, Founder and Principal of AK Advisory Partners LLC.
The recently announced SEC proposal to revamp 12b-1 fees has already — not surprisingly — resulted in a public fight between those who advocate that the fee should be changed and those who do not. The general argument of defenders of 12b-1 fees is that they are a way to cover the expense of providing ongoing service to clients. Opponents of the fee argue that they are a needless drag on performance. They say that the ongoing nature of the fee goes against the reason they were developed in the first place: to cover initial marketing costs.
What’s getting less press is the fact that most investors don’t even know what 12b-1 fees are. This lack of investor knowledge about fees is not limited to 12b-1 fees; they just happen to be the fees that are getting the most press today. The problem is not 12b-1 fees per se, but the need for even more transparency in mutual fund pricing, as well as stronger disclosure rules.
Ironically, this debate comes at a time when the following has occurred:
*The popularity of institutional mutual fund shares and exchange-traded funds (ETFs) has also cut into sales of funds carrying 12b-1 fees.
*The SEC will be spending most of its attention and time deciding the much larger issue of determining whether advisors at broker-dealers are fiduciaries. This initiative will no doubt result in more scrutiny of compensation arrangements between funds and intermediaries.
So, cutting through the noise surrounding the current debate, I believe it’s clear that industry professionals can only gain by stopping any strong lobbying against 12b-1 reform. This is because if the SEC implements changes that simplify and increase mutual fund disclosure as it relates to fees, then investors win. Therefore, it would be dangerous for anyone to be perceived as arguing against simplifying fee structures and increasing disclosure. Those investment companies or intermediaries could be painted in a very anti-consumer light by those framing the debate in pro-investor terms, putting the former groups at a competitive disadvantage. Lobbying should concentrate on making sure that the changes do not result in unintended consequences. After all, there is always such a danger when new legislation/regulations are enacted.
Ultimately, the current proposal, though costly to implement, is the right thing to do despite the potential objection of some sponsor firms. (The proposed rule would require that mutual fund companies disclose marketing and service fees as well as continuing sales charges in every prospectus, shareholder report and investor transaction.)
I believe the proposed change to move the setting of pricing terms from the fund companies to the broker-dealers will increase competition, which is a positive thing. The argument that such a move will commoditize the industry and result in price wars fails to recognize the value that the advisor brings to the table. It also runs contrary to the above-mentioned fact that the industry has been evolving away from funds with 12b-1 fees in any case.
However, caution is still needed. There are some elements of the proposal that need further discussion. For example, currently more than 40% of retirement plans charge more than 0.25% to cover their administrative costs. Any changes to 12b-1 fees should not result in higher overall prices for retirement plan participants. Another problem is that the current proposal does not cover revenue sharing, such as when a fund pays a percentage of its fees to a broker as part of the sales agreement. If 12b-1 fees are capped, then revenue-sharing agreements might be used to offset the difference. The idea of making fees more transparent would be negatively impacted — another possible unintended effect.
In the end, change is always difficult, and this debate is sure to continue for at least the next couple months, if not longer. But the goal should be clear: Any changes to 12b-1 fees should increase competition, reduce unnecessary regulation, and, above all else, simplify fee structures so that investors can understand exactly what their fees are and therefore make rational decisions based on complete information.
