As the Securities and Exchange Commission considers what changes, if any, should be made to the rule allowing 12(b)-1 fees, it should keep in mind medicine’s golden rule: First, do no harm.
The SEC should be careful that any change it makes does no harm to investors. But it also should minimize any harm to financial services professionals who sell mutual funds to investors.
Any rule change should recognize that many investors rely on brokers and investment advisers for guidance as to which mutual funds to buy and for follow-up service.
The brokers and advisers, on the other hand, often rely on 12(b)-1 fees for a significant part of their income and the income of the firms that employ them. Flat abolition of 12(b)-1 fees, with no obvious avenue for firms and their advisers or brokers to replace the income, could drive many out of the business, leaving many smaller investors without guidance or assistance.
Investors who should be using mutual funds to gain the protection of diversification might either try to invest in stocks or decide not to invest at all, because it seems too complicated. They might instead put the money into low-yielding bank accounts or certificates of deposit.
Or the loss of a revenue stream might even encourage less scrupulous brokers or advisers to push investors toward individual stocks when such investments aren’t appropriate — or other investment products that pay nice fees.
Despite these concerns, however, changes are needed to 12(b)-1 fees, which provide an estimated $11 billion a year in revenue to brokerage and investment advisory firms.
That is $11 billion coming out of the pockets of mutual fund investors, often without their knowledge, and that is an $11-billion-a-year reduction in investment returns.
Far too often, brokers and advisers fail to disclose clearly the existence of the 12(b)-1 fee. Far too often, they fail to earn the fee by continuing to service the clients after the sale.
The simplest change for the SEC to make is to require brokers and advisers to provide to each investor a statement outlining, individually and in total, the fees and expenses attached to each fund in which the client is considering investing. This statement should also have an example of how the fees and expenses might affect the investment returns over one and five years.
Failure to provide this disclosure should be a serious offense.
Alternatively, the SEC could abolish 12(b)-1 fees but provide another mechanism for advisers and brokers to be paid by fund companies for any continuing services they provide to investors. Ideally, they would be required to provide evidence of that service before the fee was paid.
The 12(b)-1 fee, instituted to help mutual funds through a difficult period, has outlived its original purpose. Now it serves a purpose not originally intended.
A review of its utility and justification is well overdue.
But the SEC must tread carefully. The unintended consequences of the abolition of 12(b)-1 fees could be worse for investors than their continuation if some other provision isn’t made for paying brokers and financial advisers.
