Will the SEC's 12(b)-1 plan smack Legg Mason?

The SEC's proposed revision of mutual fund fees has yet to be finalized, but analysts are already analyzing on how reform may affect some fund companies. Case in point: Ticonderoga Securities LLC analysts Warren Gardiner and Douglas Sipkin dropped their price target for Legg Mason Inc., a firm that's in the throes of a turnaround effort. As first reported by Barrons Online, the two analysts lowered their target on Legg Mason from $26 to $24 per share because they believe the SEC's 12(b)-1 proposal, as currently constituted, may derail some of the firm's recovery initiatives. In May, Legg Mason announced that it hopes to save $130 million to $150 million by the fourth quarter of fiscal 2012 by shifting some corporate operations to its affiliates. But the commission's mutual fund fee reform — which would cap “marketing and service fees” at 0.25% — could negate much of those savings, according to the report. Using Legg Mason's data, Mr. Gardiner and Mr. Sipkin estimate that C shares with 12-(b)1 fees above 0.25% represent 25%-30% of assets at affiliates Legg Mason Capital Management and ClearBridge Advisors LLC — and 7%-10% of their sales. “Both ClearBridge and LM Capital have origins in the retail-brokerage sales model,” the analysts said in the report. “If there is a limit on how much they can collect to pay brokers this may impact the appeal of these products in the eyes of retail brokers.” But other analysts disagree. Michael Kim, an equity analyst who covers Legg Mason at Sandler O'Neill & Partners LP, pointed out that the asset manager's cost-savings initiative is due to implemented over the next 15 months. The 12(b)-1 reform proposal, however, is going to be grandfathered over five years. “There is obviously a timing disconnect,” Mr. Kim said. Overall, Mr. Kim doesn't think the 12(b)-1 reform will have a large impact on Legg Mason or other asset managers because the distribution fees collected by these firms are largely passed on to third-party distributors. “This is not a profit center for the asset managers,” he said. Also, much of Legg Mason's assets are institutional, which means the firm shouldn't be hit hard by the 12(b)-1 reform proposal, said Jason Weyeneth, an equity analyst at Sterne Agee & Leach Inc. Sterne estimates that 23% of Legg Mason's assets are in its retail mutual funds. In their report, Mr. Sipkin and Mr. Gardiner concede that it's too early to say definitively if 12(b)-1 reform will affect Legg Mason, but said “it is worth noting that there is some potential risk to LM's retail model in its current form.” Legg Mason officials don't think that the firm would bear the brunt of any 12(b)-1 fee reduction all on its own, said Mary Athridge, a spokesman. “Because of our revenue share, LM wouldn't take the entire hit of any fee reduction that may be implemented because that's shared with affiliates,” Ms. Athridge said in an e-mail. “And presumably, we'd work with the distributors to share equitably any fee reduction as well. “ Also given that the proposal is so early in the process and there is a five-year grandfather clause, it's too soon to say how it will affect the firm, she said. Overall, many analysts don't seem too worried that the proposal will have a severe impact on any of the publicly-traded load mutual fund firms. “I think there is going to be some kind of agreements with the distributors to restructure these products to create new types of share classes so that it would mitigate the economic impact to everyone involved,” Mr. Kim said.