Brokerage executives are slamming the SEC's proposal to allow broker-dealers to set their own sales charges on mutual funds, claiming that it could create problems for both the industry and individual investors.
The pricing proposal, which is one element in the Securities and Exchange Commission's broader plan to replace 12(b)-1 fees, “creates pressure at inconceivable levels,” said Arthur Grant, president and chief executive of Cadaret Grant & Co. Inc., a privately held broker-dealer with 990 independent-contractor representatives and advisers. He said making mutual fund commissions negotiable is a bigger problem for broker-dealers than eliminating 12(b)-1 fees.
Right now, mutual fund companies set the terms for selling fund shares, including sales charges. That means that broker-dealers can't compete with each other by reducing those charges, according to the SEC.
The agency wants to shift that pricing role to broker-dealers, who would “determine their own sales compensation, subject to competition in the marketplace,” the SEC said in a fact sheet on its proposal.
“Broker-dealers could establish their own sales charges, tailor them to different levels of shareholder service, and charge shareholders directly, similar to how commissions are charged on securities such as common stock,” the SEC noted.
But the industry thinks that there is enough competition in the marketplace already.
“The rationale is to foster competition. I don't understand that,” said Dale Brown, president and chief executive of the Financial Services Institute Inc., an industry organization for independent broker-dealers and advisers.
“I don't see where there's any lack of competition,” he said, noting that there are more than 4,600 broker-dealers and hundreds of thousands of registered reps.
Brokerage executives said that securities regulators have long pushed the notion that reps should sell investors mutual funds based on the lowest possible price, with performance often a secondary concern. This proposal confirms that prejudice, they said.
Indeed, SEC Chairman Mary Schapiro emphasized that element of the proposal in her comments last week. “I believe that mutual fund investors, like all consumers, want the ability to engage in comparative shopping based on price,” she said.
Some brokerage executives fear that such an emphasis could encourage unscrupulous broker-dealers to exploit their power to control prices and bilk unwary investors. Others said that making price paramount signals the devaluing of registered reps' counsel or advice to clients, while some noted that large firms could engage in price wars and potentially crush smaller firms.
“The client could play one broker-dealer versus another, and the transaction becomes more of a commodity than based on the quality of the service,” Mr. Grant said. “If the rep knows it's a negotiated commission level, he could be less inclined to spend time working with clients,” particularly those smaller investors with accounts in the range of $20,000, he said.
“This will push everybody to fee-based accounts,” where the price is fixed, Mr. Grant said. “That's not correct for everybody.”
Mr. Grant said that the creation of 12(b)-1 fees 30 years ago was a boon to both investors and advisers. The fees helped “stabilize the business and allow reps to hold their clients' hands” through perilous times in the market, he said.
Before these continuing marketing and service fees were established, many reps would simply exit the securities business during market downturns, Mr. Grant said.
SEC spokesman Kevin Callahan said that the commission couldn't comment further, as the proposal has just entered the public comment period.
Along with the confusion over pricing, broker-dealers could face higher costs due to the proposal's enhanced disclosure requirements, observers said. At the moment, fund transaction confirmation statements delivered to investors typically don't include sales charges, the SEC noted.
The new proposal would require the fund to identify and more clearly disclose distribution fees. “Broker-dealers would have to make system changes to capture this information so that it can be included in transaction confirms, and this is likely an expensive proposition,” said Jack Murphy, a partner with Dechert LLP.
Jessica Toonkel contributed to this story.
E-mail Bruce Kelly at [email protected].
