Eight months after holding a roundtable discussion on its Rule 12b-1, the SEC is planning a “complete overhaul” of the rule, according to SEC Chairman Christopher Cox. Yes, “complete overhaul” are the words Cox used in a speech on February 8 at the SEC Speaks conference in Washington. Cox said that Buddy Donohue, head of the SEC’s Division of Investment Management, is preparing to issue a formal rule proposal sometime this spring.
While the SEC has divulged few details about the changes that are in store, industry officials doubt that any rule would get passed this year since the SEC is down two commissioners and the length of Cox’s stay at the Commission is questionable. But these officials are providing educated guesses about what modifications may be likely.
First, let’s recap how we got to this point in the debate. The SEC began re-examining its 12b-1 rule because critics have argued that it’s gone well beyond its original intended use as a marketing and distribution fee. Instead, 12b-1 fees are used to pay for a wide array of services–mainly compensating brokers, these critics say. When I attended the 12b-1 roundtable at SEC headquarters last June, complaints that were aired included the obscurity of the 12b-1 term itself and its lack of clarity. “The [12b-1] name alone is one that only a ’40 Act attorney could relate to,” Don Phillips, president and CEO or Morningstar, said in a recent interview. “No investor says, ‘Yes, I know exactly where my dollars are going with a 12b-1 fee.’” It’s hard to tell if the 12b-1 fee is “going for operational costs, distribution costs, sales costs?” Phillips continues. So better disclosure of 12b-1 fees may be one area the SEC is focusing on, Phillips says.
“Certainly there is ample room for better disclosure of 12b-1 fees.”
Having said that, however, when told the 12b-1 fee is going to their advisor, or that it pays for services from their mutual fund supermarket or 401(k) recordkeeper, most investors are fine with paying the fee. After getting this type of explanation, investors would likely say, “I get a lot of value from meeting with my advisor and I know I don’t have to write a check out to that person, they’re getting paid through my security, so that’s a good thing,” Phillips says. So outright repeal of 12b-1 fees, he says, seems unlikely. “12b-1 pays for a lot of services that people like and perceive to get value from.”
In his speech Cox said “most retail investors don’t know” that 12b-1 fees permit mutual funds to pay out nearly $12 billion a year in investors’ assets for purposes such as reimbursing brokers for their expenses of marketing the funds to other investors, and for various administrative services. During the roundtable last year, Cox said the Commission “would be conducting a major reevaluation of how [the 12b-1 rule] is or isn’t serving investors.”
A Solution to a Non-Problem?
Dale Brown, president and CEO of the Financial Services Institute (FSI), says he’s not “aware of the major problem [the SEC] is trying to fix” with12b-1 fees. There’s no indication “that there’s been a huge outcry from investors about 12b-1 fees,” Brown says, arguing furthermore that the fees are “hugely important to investors, particularly small investors,” because the fees make it possible for them to “invest and continue to have access to ongoing help and service.” Plus, he says, the 12b-1 fee not only gives an advisor incentive to work with smaller accounts, “12b-1 fees are a very important stream of income that gives independent advisors the capacity to have staff in place and invest in systems and other things to provide the ongoing service [to small investors] and not be dependent on generating more transactions.”