More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
The Securities and Exchange Commission was well aware that 12b-1 fees would be used to compensate brokers for providing services to mutual fund shareholders when it created the rule in 1980, according to former SEC officials.
Joel Goldberg, a partner in the asset management group of Willkie Farr & Gallagher in New York, and a former director of the SEC's Division of Investment Management who was one of the architects of the 12b-1 rule, said at a roundtable discussion at the SEC's headquarters in Washington on June 19 that when the rule was formulated, the SEC did not expect it to be temporary. Nor was the rule intended to address net redemptions, he said.
The amount of 12b-1 fees that shareholders pay through mutual funds reached nearly $12 billion in 2006, according to the Investment Company Institute (ICI)--a huge jump from the few million dollars shareholders paid in the early 1980s.
Critics say use of the 12b-1 fee has been used to pay for a plethora of services that go well beyond its original intended use as a marketing and distribution fee. Andrew "Buddy" Donahue, the current director of the SEC's Division of Investment Management, said that revising 12b-1 is "a top priority" for the Commission. An SEC spokesperson said that SEC staff will recommend changes that Chairman Christopher Cox and the Commissioners should take on the 12b-1 rule by year end. (An earlier version of this article stated that SEC Chairman Christopher Cox has pledged to either repeal the fees or change the 12b-1 rule by year end.) The roundtable was designed, in part, to give the SEC feedback from the industry on whether the rule needs to be revised. Investors and members of the industry have until July 19 to send their comments to the SEC about the 12b-1 rule.
Mellody Hobson, president of Ariel Capital Management, a fund family with $7 billion under management, told the SEC that Ariel, like other small fund families, "could not exist without 12b-1 fees." She said Ariel uses 12b-1 fees in four ways: to pay advisors and consultants to market the fund; the compensate the big mutual fund platforms like Charles Schwab and Fidelity; to pay 401(k) plan administrators (which is a growing piece of Ariel's business); and to offset Ariel's internal marketing and advertising costs.
Many other panelists agreed that 12b-1 fees should not be abolished. "Payment of [12b-1] fees by investors is the best way to go," said Kathryn McGrath, a partner with Mayer, Brown, Rowe & Maw in Washington, and director of the SEC's Division of Investment Management from 1983 to 1990. "Brokers provide a lot of services, and deserve to be paid for that." Michael Sharp, general counsel of Citi Global Wealth Management, added that "12b-1 fees have been a wild success."
Panelist also agreed that the off-putting term 12b-1 needs to change, with Jeffrey Keil, principal of Keil Fiduciary Strategies, noting that 12b-1 sounds like "some kind of plastic explosive." In addition, the panelists agreed that how 12b-1 fees are used needs to be explained more thoroughly to investors.