Morningstar: SEC's 12(b)-1 fee proposal 'will do no good'

The Securities and Exchange Commission's 12(b)-1 fee proposal “will do no good” as it stands now, according to a letter to the agency from Morningstar Inc. “We urge you to consider a sweeping overhaul of fund expense ratios, from top to bottom, that would break fees into appropriate, easy-to-understand buckets and standardize the accounting,” Karen Dolan, director of fund analysis at Morningstar, wrote in the Oct. 20 letter. “This is a once-in-a-generation opportunity to clean up a broader problem with fund expense ratios and help investors understand how their money is being spent.” Under the proposal, which is open to comments until Nov. 5, firms could charge a “marketing and service fee” of up to 0.25%. Anything above that amount would be deemed “an ongoing sales charge,” which would be limited to the highest fee charged by the fund for shares that have no marketing and service fees. For example, if the most expensive share class of a fund charges a 4% front-end load, another class couldn't charge investors more than that over time. But capping 12(b)-1 fees would cause fund companies to merely shift those expenses to another part of the expense ratio, Ms. Dolan said in an interview. “There is clear evidence that these marketing and distribution costs have ways of gaining new life in other ways,” she said. For example, the Supreme Court ruling in Jones v. Harris showed that the management fees for institutional shares of funds are often less than the retail versions of the funds. “Why? Because mutual fund management fees pay for a lot more than just investment management,” Ms. Dolan wrote in the letter. “When pressed on the differences, fund companies point to service and distribution-related costs, which are unrelated to the research resources needed to manage the money,” Establishing clear labels on which expenses pay for what would also be much easier for the fund industry to comply with than capping 12(b)-1 fees, Ms. Dolan said. “I feel like the mutual fund industry's well-being depends on this because we are already seeing assets go into more transparent vehicles like exchange-traded funds,” she said. “It's going to take an SEC mandate to get the fund industry to fix this issue.”