From: Gregory A. Keil |
As you think about options to reform what are now labeled "12b-1 fees" - please don't forget how much the Financial Services industry truly has changed - mostly for the better. The brokerage industry was originally a product distribution channel - IPO's, Mutual Funds, and other financial products were sold to "suitable" investors. Commissions are customarily used for selling products - so, commissions were the appropriate means of compensating brokers. As our industry continued - and continues - to evolve, competition - and creativity - crept into commission models - with Mutual Funds, Annuities, and other investment products compensating brokers with basically "financed" front-end loads - in the form of 12b-1 fees that were higher - and back-end loads that would be assessed in the event of a premature sale / withdrawal from the investment - these back-end loads covered the cost of the commission paid to the broker by the Investment company - and this pricing model "felt" better to the consumer. These compensation models were clearly abused and are, for the most part, obsolete - a good thing. Today, the Financial Services industry is more about Financial Planning and Advice - and less about simple product distribution - although, in the end, the sale of products still pays the bills. The current "Class C" share is really the next step toward a more "advice driven" model... removing a "transaction cost" from the equation - and applying an "always-on" Advisory Fee to a DISCRETIONARY investment vehicle - the mutual fund... We have already endured enormous pricing competition - a good thing for the consumer - mostly brought on by technology - and its effect on the availability of information and execution of transactions. Before we make another mistake - let's not forget how the industry dealt with (and continues to deal with) the competition brought on by "low priced" brokers to the commission pricing model on stock transactions: As a broker during much of that period - I remember discussing our "transaction costs" compared to Schwab, ETrade, etc... One response was that we provided superior service - and, "incidental" advice - and that to think of our commission as only a "transaction cost" did not fairly reflect the service and advice. One could easily look at full service brokerage commission rates as the price for our service and advice "a la carte." In this context, one could argue that our "transaction cost" was reasonable... However, one popular solution for the consumer - which frankly may have hurt them - was to remove "transaction costs" from the equation - applying asset based fees to NON DISCRETIONARY accounts... In many cases, this has been a bad solution for the consumer - one driven by their truly not knowing what's best for them - a pretty common thing... Non Discretionary accounts are simply not "always on" accounts - i.e. not always active - so to bill them at a constant rate is not always appropriate. Indeed, in many cases, this billing process actually DOES create a conflict of interest - that being, in order to justify the cost, you must buy or sell - as simply holding resulted in higher costs to the consumer than under the "a la carte" pricing model... As you know, this is being addressed - by calling them "Advisory fees" and documenting the service & advice... but I am not sure the solution is much better for the consumer. A simple 1 to 1.5% rate on equity transactions - $100 to $150 per $10,000 and so on - for service and advice "a la carte" - seems a much better solution... but we'll let the industry work that out. In then end, I think the pricing model should be an OPTION - not a mandate... The commission situation forced our first attempts to separate Advisory fees from the products - thereby making them more "transparent". These attempts have been incredibly flawed and INEFFICIENT - especially at the retail level. Operationally, it creates cash flow issues every time fees are assessed to retail accounts - at times, we literally need to sell investments to cover account debits created by fees - a conflict of interest to the client. Clients also tend to focus on these fees - and, of course, sometimes complain about them - which is fine - except that it seems to result in another conflict of interest in that the best justification for the fee is to make a buy / sell decision - rarely a hold decision - and this "forced" action may not be the right one... I will grant that it motivates Advisors to be more proactive... but not necessarily for the right reasons... The best advisors can deal with this - but the rules should create the best environment for everyone - even the less skilled / efficient - and, most important, the consumer... I think everyone agrees that fee based DISCRETIONARY accounts DO make sense... It removes any conflict of interest that the fund manager has to buy / hold / or sell... That they have "always on" discretion over the account justifies an "always on" asset based fee - similar to the so-named 12b-1 fee... It aligns the interest of the manager with the client - "you make more, I make more" - and there is no conflict to the buy / sell / hold decision... The so-named 12b-1 compensates the Advisor just like any fee-based discretionary account - e.g. the Separately Managed Account (SMA) - and the fee for SMA's is ATTACHED to the product - making it EFFICIENT to collect and distribute to the Advisor - just like the 12b-1 fee. Mutual funds are discretionary investment vehicles - so compensating the Advisor in the same way makes sense. With this in mind consider the following solution: SOLUTION: As 12b-1 fees are EFFICIENTLY collected at the mutual fund / investment vehicle level - and EFFICIENTLY distributed by the mutual funds to the Financial Advisors / brokers, etc. - and as Mutual Funds are DISCRETIONARY investment vehicles - for which an "always on" asset based advisory fee makes sense - we don't need to "reinvent the wheel" to collect these fees. It's about DISCLOSURE not making it harder to do business. If you agree that it's reasonable to have an "always on" asset based fee attached to DISCRETIONARY investment vehicles - which mutual funds are - consider RE-NAMING 12b-1 fees (or a portion of them) to Advisory Fees - that way it is CLEAR to the consumer what their Advisor / Brokerage Firm / Financial Planner is getting paid by the Mutual Fund company to provide service & advice to the client... It keeps an efficient billing / compensation mechanism in place - and provides transparency to the consumer so they can make informed decisions. The only missing piece is breakpoints on these 12b-1 / Advisory fees - as we have on Separately Managed / Wrap accounts - and I bet this wouldn't be too hard to implement... Again, in then end, I think the pricing model should be an OPTION - not a mandate... Thank you. Gregory A. Keil |