More On Legal & Compliancefrom The Advisor's Professional Library
- Whistleblowers A whistleblower is any individual providing the SEC with original information related to a possible violation of federal securities law. The Dodd-Frank Act established a whistleblower program that enables the SEC to reward individuals who voluntarily provide such information.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
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.