Brokers, not mutual fund companies, should set their own 12(b)-1 distribution fees.
That suggestion was made by Securities and Exchange Commission associate director Robert Plaze at the Feb. 8 "SEC Speaks" conference in Washington.
"What we hope to do is increase the salience of this fee to investors, because, after all, the push-back on fee levels needs to come from the marketplace," said Mr. Plaze, who is associate director of the SEC's division of investment management.
Investors need to understand that 12(b)-1 fees are much like sales charges, he told about 750 participants at the conference, which was sponsored by the Practising Law Institute of New York.
SEC Chairman Christopher Cox pledged that there will be "a complete overhaul of Rule 12(b)-1," which has allowed mutual funds to spend about $12 billion of fund assets a year to pay brokers to distribute their products.
Normally 0.25 percentage points of the 12(b)-1 fee goes to investment advisers to cover servicing costs, and the remaining 0.75 percentage points of the fee usually goes to brokerage firms to cover the cost of distributing the funds. Usually, 12(b)-1 fees are 1% of a fund's assets.
Mutual fund sales differ from sales of other types of investments, such as stocks, where commissions are set by brokerage firms, Mr. Plaze noted. Stock issuers are not involved in setting brokerage firm commissions.
"Mutual funds are distributed by intermediaries, but the amount of the charge and the collection of this charge for retail distribution is collected by the mutual fund and then re-allowed to the intermediary," Mr. Plaze said.
The SEC wants to find out whether this is the only way to organize the distribution of mutual funds and whether distributors should control the distribution expense, leaving management to focus primarily on managing their funds, he said.
The SEC will be looking at proposals along those lines this year, Mr. Plaze said. He would not give further details.
The SEC will also give fund directors new directions for approving the fees, Mr. Plaze said.
"The issue is not fundamentally different from fixed commissions back in the '70s," said Michael Udoff, managing director and associate general counsel of the Securities Industry and Financial Markets Association of New York and Washington.
Fixed trading commissions were ended under the Securities Acts Amendments of 1975.
Mr. Udoff would not predict whether the brokerage industry will support the types of changes in the 12(b)-1 fee system to which Mr. Plaze referred.
However, he said, helping investors better understand what the fees are used for is a good idea.
The Investment Company Institute in Washington also voiced support for clearer disclosure concerning the distribution fees.
"We support disclosure and are continuing to monitor the commission's thinking," ICI spokesman Michael Shore wrote in an e-mail. ICI president and chief executive Paul Schott Stevens has argued in favor of improving disclosure about the fees but keeping the payment system largely unchanged.
Moving distribution fees to brokerage firms makes sense, according to Steve Wallman, chief executive of brokerage firm Foliofn Inc. in Vienna, Va.
He was on the panel with Mr. Plaze at the conference, but he spoke separately to
InvestmentNews.
"You've got an industry that is set up to pay rebates back on distribution of their product," Mr. Wallman said.
"For most of the rest of the industry, whether it's [exchange traded funds] or an issuer of a security, if someone wants to distribute the product, they make their money by charging the person who's buying it," he said. "Bob [Plaze] is suggesting, 'Why not the same construct for mutual funds?' An easy way to do it is just eliminate 12(b)-1 fees and have mutual funds' being distributed by the mutual fund family," Mr. Wallman suggested.
That would eliminate many of the conflicts of interest inherent in the current fund distribution system, in which mutual funds must pay brokerage firms fees to be distributed, he argued. "Investors would buy a fund and pay a fee just like they do with anyone else," Mr. Wallman said.
Yet another idea for dealing with the fees was proposed by David Ruder, law professor emeritus at Northwestern University School of Law in Chicago, who is chairman of the Mutual Fund Directors Forum, a group of independent fund directors based in Washington. He also participated in the panel with Mr. Plaze and Mr. Wallman.
Fund advisers could pay distribution costs out of their own profits, Mr. Ruder suggested. "Maybe the answer is to say, 'Let the adviser pay all the distribution costs, and take the $12 billion off the table,'" Mr. Ruder commented at the conference.
Sara Hansard can be reached at [email protected].
