As it attempts to crack down on 12(b)-1 fees, the Securities and Exchange Commission is ignoring a raft of mutual fund charges that investors are paying indirectly, critics contend.
Soft dollars, shelf space fees, platform fees and record-keeping fees, among others, are all costs borne by mutual funds that are indirectly charged to investors. And while these expenses are disclosed, they often are buried in legal documents that investors rarely read and often don't understand.
Soft dollars are commissions paid by money managers to executing brokerage firms in exchange for research. The commissions paid through such arrangements are higher than those for transactions alone.
“It's never been clear that soft dollars benefit investors,” said Edward Siedle, founder of Benchmark Financial Services Inc., a consultant to pension plans.
Firms that pay soft dollars disagree, of course. Soft dollars must be used for research, which benefits clients, they argue.
Although mutual funds disclose the aggregate amount of commissions that they pay, the soft-dollar portion isn't disclosed.
Funds' 12(b)-1 fees “are an easier target and somewhat better-understood than soft-dollar brokerage,” said William George, a consultant and critic of undisclosed soft dollars.
John Robinson, owner of Financial Planning Hawaii Inc., which manages assets of about $100 million, said that he is surprised that the SEC doesn't make mutual fund costs in 401(k) plans a higher priority.
The “most obvious” issue with 401(k)s is the use of load-waived A shares, he said, where the 25-basis-point trail goes to the product provider. Institutional classes of shares would be cheaper, Mr. Robinson said. “It's odd they're going after Class C shares [on which 12(b)-1 fees are charged, but] not doing anything on other issues.”
The trail fees are disclosed in legal documents, Mr. Robinson said, “but most [investors] don't read those, and even if they did, they would have a hard time finding” the disclosures and understanding them.
NO DISCLOSURE
Mutual fund advisers and distributors pay a number of other fees to intermediaries which are mentioned in prospectuses or statements of additional information but not specifically disclosed.
So-called revenue-sharing payments, or shelf space fees, are used to “compete for access to the broker,” said Barbara Roper, director of investor protection for the Consumer Federation of America.
Even though revenue-sharing fees are paid by the fund's adviser, rather than out of fund assets, they “tend to drive costs up rather than down,” she said. “The fund complex just turns around and recovers that expense from shareholders.”
Funds also pay record-keeping costs, usually on a per-account basis, as well as fees to use the no-transaction-fee platforms of brokerage firms.
“It seems odd that [the SEC is] talking about [limiting] the service-and-marketing fee to 25 basis points, but they don't say what [mutual fund] supermarkets will be limited to,” said Russ Kinnel, director of research at Morningstar Inc.
“If you put a cap on the load side, shouldn't you put a cap on the supermarket side?” he said. “It seems like at a minimum, the SEC should bring some clarity to that.”
Funds pay supermarket fees with 12(b)-1 revenue as well as from management fees, said Don Phillips, a managing director at Morningstar.
“The current system almost goes out of its way to camouflage [the payments] by allowing it to be paid out of two separate buckets,” he said.
“I've never seen an investor have a qualm with seeing their money going to their money manager or to their adviser,” Mr. Phillips said. “But people might be shocked to see what they're paying cumulatively for record keeping or for a consolidated statement” through a fund supermarket.
According to the Investment Company Institute, all fees and costs are fully reflected in fee tables or performance.
“Investors are primarily concerned about performance and the total level of fees,” said Mike McNamee, a spokesman for the organization, which represents the mutual fund industry
An ICI study in 2006 found that more than two-thirds of fund investors considered costs/fees and historical performance in making investment decisions.
The SEC could address some of the remaining disclosure issues by enacting a 2004 proposal to disclose shelf space fees, among other costs, at the point of sale. The commission solicited comment on the proposal but never acted.
SEC spokesman John Heine declined to comment.
E-mail Dan Jamieson at [email protected].
