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Regulation and Compliance > Federal Regulation > SEC

Producers: 12b-1 Draft Promotes Short-Term Thinking

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WASHINGTON BUREAU – Proposed changes in 12b-1 fund sales fee rules could push advisors away from helping consumers reach long-term financial goals, life agents and other financial advisors are telling the U.S. Securities and Exchange Commission (SEC).

Rule 12b-1, an SEC regulation adopted under the Investment Company Act of 1940, lets a fund charge an ongoing fee to cover promotion, distribution and marketing expenses, and, in some cases, producer commissions.

The SEC wants fund managers to limit total payments made in connection with ongoing, asset-based sales charges to the highest fee charged by the fund for shares that have no ongoing sales charge, according to a 12b-1 update that the SEC proposed in July.

If, for example one class of a fund charged a 4% front-end sales charge, a fund that charged an annual, asset-based fee could collect a total of no more than 4% of account assets over time. In the simplest case, for example, a fund that imposed an ongoing fee of 1% might have turn off the fee requirement after an investor had held the same amount of assets in the fund for more than about 4 years.

The cap for funds that have no classes with loads might be 6.25%, officials say.

A fund also could charge 0.25% of assets per year to cover expenses such as advertising, sales compensation and services, officials say.

SEC officials say they would like to apply the same fee rules to variable annuity separate accounts that they apply to mutual funds.

SEC officials say they believe annual 12b-1 charges at variable annuities rarely exceed 0.25%.

The SEC also calls for detailed fund cost disclosures in shareholder reports and transaction statements.

Comments are due Nov. 5. Most of the 12b-1 comments now posted on the SEC site are from individuals or small financial services firms, rather than from professional groups.

Supporters of the SEC approach say the current fee structure hurts individual investors.

Niels Holch, executive director of the Coalition of Mutual Fund Investors, Washington, says large broker-dealers are gaming the system in a way that imposes $2.2 billion in account maintenance charges on individual investors,

about $4.2 billion in shareholder servicing payments, and about $2.1 billion in revenue-sharing payments.

William Barker of Motley Fool Asset Management L.L.C., Alexandria, Va., says he applauds SEC efforts to make 12b-1 fees more transparent and cap fee payments.

“Although we believe the proposed rules do not go far enough in limiting these fees, and fear that entrenched industry interests may fight to water down these regulations, we are also hopeful that this will be a successful first step toward eliminating 12b-1 fees and ongoing sales charges, which impose costs on fund shareholders that are not offset by corresponding benefits,” Barker says.

Many financial professionals who have commented say income associated with 12b-1 fees helps compensate them for the time they spend providing ongoing services for individual investors and retirement plan sponsors with relatively small accounts.

“Please be aware that there is a lot of ongoing, continuous work associated with these clients, including education programs for their employees and annual meetings, which require travel for a physical presence at each time,” says Robert Miller, a New York investment advisor. “Monitoring the program and fund selections is also ongoing work.”

Stephen Campbell, a Fisherville, Va., advisor, says the SEC seems to think eliminating or altering the 12b-1 fees would help investors by lowering their cost of investment.

“I could not disagree more with this assertion,” Campbell says, noting that he meets with his 300 clients a total of about 900 times a year to handle matters such as reviewing investments.

“Many of these appointments are with older clients, and many are with clients who have assets of under $50,000,” Campbell says. “These appointments average an hour in duration and over my 26 years being securities-licensed, I have never billed my clients for this valuable service I provide.”

If the 12b-1 income falls or goes away, service will suffer, Campbell says.

Howard Townsend, a Bonsall, Calif., planner who holds the Chartered Life Underwriter (CLU) designation, says elimination of the current “C share” structure would force advisors to convert all C share clients into fee-based clients and probably would force advisors to abandon many clients with small C share accounts.

The time, paperwork and fiduciary responsibility involved with handling small C share clients without 12b-1 income would be overwhelming, Townsend says.

“In order to retain business value for your succession planning, only fee-based accounts would have any buyer interest,” Townsend says. “All other accounts would end up being orphaned. The smaller investor falls through the cracks again.”

Edward Mallon, a Portsmouth, N.H., planner who holds the CLU designation, says the proposed change in the fee structure would lead a representative to focus far more on making new sales rather than helping clients track investments they already own.

“With better servicing clients are more likely to stay invested while receiving good advice from the representative,” Mallon says. “As consumers’ needs change they can easily be hurt as they move from representative to representative looking for ongoing advice and buying new A shares. This is not the case with C shares. In selling C shares the representative’s compensation is small and they must be committed to maintaining a client for many years before compensation reaches that of the initial compensation of an A share.”


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