WASHINGTON — Disclosures of 12(b)-1 fees should be made clearer and easier to decipher, but the fees themselves should not be abolished, officials from the mutual fund and brokerage industries said at a Securities and Exchange Commission round table last week.
The 27-year-old fee system needs to be altered to prevent conflicts of interest in broker sales and to provide clearer information on fees, said experts from mutual fund research company Morningstar Inc. of Chicago and the Consumer Federation of America in Washington.
The fees are difficult to understand, so investors have a hard time choosing the types of funds they want, Don Phillips, managing director of Morningstar, said at the round table.
He would like to see mutual fund costs broken down into
portfolio management, client service and advice, as well as administrative costs — mirroring the type of cost accounting used for operating companies.
In Mr. Phillips’ view, 12(b)-1 fees do not fit neatly into any of those categories. They have a variety of uses, including continuing payments to advisers who sell the funds, advertising, and mutual fund supermarket and 401(k) plan administration. “That’s the problem I have with 12(b)-1 fees. I think it confuses the issue,” Mr. Phillips added.
Make fees perfectly clear
To relieve the confusion, he suggested equating the cost of portfolio management to the cost of goods sold at operating companies, the cost of client service and advice to the cost of sales and marketing, and administrative costs to general administration expenses.
Accounting for mutual funds in that way would allow investors to select funds based on their desire for either more client services or for a fund that spent more on investment management, Mr. Phillips suggested.
While 12(b)-1 fees have promoted competition by giving funds access to fund supermarkets and 401(k) plans, the system also “fosters reverse competition” by encouraging brokers to sell funds that pay the highest fees, said Barbara Roper, director of investor protection with the Consumer Federation of America.
The 12(b)-1 system “puts something into the shadows and sort of distorts the other decisions that are made,” she said. The system compensates advisers for the services they provide “in a way that [does] not allow investors to easily put a price tag on those services,” Ms. Roper said.
Share class decisions
Investors decide on share class, based on the advice they receive, she said. “There’s a very good case for decoupling broker compensation from
investment vehicles,” Ms. Roper said. However, that could lead to higher prices for investors who have smaller amounts of money to invest, she added.
While mutual fund companies mail prospectuses and other types of information to his clients, “they never speak to my clients,” said Joseph Russo, chairman and chief executive of Advantage Financial Group Inc., a planning firm in Clearwater, Fla. “They never dialogue with my clients,” as his own broker representatives do, he said.
Simplifying fee reporting with an “all-in-one fee” that includes administrative, operational and other expenses “may indeed be
the answer and may indeed
drive prices to the lowest possible competitive level,” Mr. Russo suggested.
The fee ensures that the broker will be compensated for the sale and for servicing the account, said Mark Fetting, senior executive vice president of Legg Mason Inc. of Baltimore.
“The competition should be on the net return delivered to that client,” he said.
