Many mutual fund trustees would like to repeal the Securities and Exchange Commission's 12(b)-1 regulation that allows mutual funds to use fund assets to pay for marketing, a Washington lawyer who represents mutual funds reports.
"Many board members are actually in favor of repeal of 12(b)-1," said David Harris, a partner in the Washington office of Philadelphia-based law firm Dechert LLP. Mr. Harris spoke Nov. 1 at a conference in Washington on investment management products sponsored by the Philadelphia-based American Law Institute-American Bar Association Committee on Continuing Professional Education.
He said that assessment was based on reports from SEC officials, who have talked with fund board members about the regulation. The SEC has been reassessing whether the rule should be continued
(InvestmentNews, June 11).
While some opposition to 12(b)-1 fees by fund board directors may be based on the view that fund assets shouldn't be used to pay for marketing, Mr. Harris said, "a lot of that [opposition], I suspect, is more tied to the ministerial aspects, the burden on them" to evaluate the plans on a quarterly basis based on guidelines the SEC issued when the 12(b)-1 program was initially approved in 1980.
Directors aren't well-equipped to make judgments on whether the fees being charged are appropriate, he said. Directors rarely disapprove the plans, primarily be-cause they are necessary to get the funds distributed.
Susan Wyderko, executive director of the Mutual Fund Directors Forum in Washington, said in an interview that she agrees with that assessment.
"Many of the directors that I speak to don't believe that the quarterly review does much to benefit investors," she said. The forum represents independent directors.
There is a consensus among fund directors that the SEC should change its guidance to allow directors to evaluate the value and efficacy of their 12(b)-1 plans in relation to the purposes of their particular plans, Ms. Wyderko said.
"Many 12(b)-1 fees are effectively fixed by competitive forces," she said. Many 12(b)-1 fees are used to pay sales loads to cover payments to brokers who sell the funds, Ms. Wyderko said.
"Those fees are set by the marketplace," she added.
The SEC could rescind the 12(b)-1 program and allow funds to use their assets for distribution, subject to approval of boards, Mr. Harris said at the conference.
Alternatively, the SEC could create a "safe harbor," or protection from liability, for the 0.25% of fee assets commonly paid to brokers for servicing shareholder accounts under 12(b)-1 plans, he said.
Another idea being discussed would be to prohibit broker-dealers that are affiliated with mutual fund underwriters from receiving the fees, Mr. Harris said.
However, that would put such underwriters at a disadvantage when compared with independent fund companies, he said. For the affiliated fund complexes, "that's where most of their sales come from," Mr. Harris added.
Few people think that the SEC will abolish 12(b)-1 plans entirely, as that would lead to mutual funds' being sold solely on the basis of front-end sales charges, as they were before 1980. One reason the fees were adopted initially was the unpopularity of the front-end fees among investors.
"The world has radically changed since 12(b)-1 was adopted," said Rose DiMartino, a partner with New York law firm Willkie Farr & Gallagher LLP, who spoke at the conference.
Mutual fund supermarkets "are not going to go away," she added. "Brokers are not going to stop charging for their services."
Fund boards would be in a more difficult position than they currently are if they couldn't pay 12(b)-1 fees, Ms. DiMartino said, "and you see an increase in advisory fees over time, which will be used to compensate brokers and fund supermarkets."
Directors aren't supposed to approve fees for distribution, said Brian Simon, director of legal affairs for Lazard Asset Management LLC of New York, who spoke at the conference. Directors are required to consider only whether fees are reasonable to cover the cost of investment management, he said.
Abolishing the fees altogether "could have just the opposite effect of what everyone hoped, which is better transparency, better information," since eliminating them could result in fund managements' hiding their distribution costs, Mr. Simon said.
It isn't clear when the SEC will issue a new proposal on 12(b)-1 plans.
It is one of the highest priorities for the division of investment management, Robert Plaze, its associate director, told
InvestmentNews.
Sara Hansard can be reached at [email protected].
