November 4, 2010
Dear Ms. Schapiro and SEC Commission Members,
I am writing to protest the SECs proposed rescission and replacement of Rule 12b-1 with the arrangement as outlined in File No. S7-15-10.
From the standpoint of a branch manager and as an active financial planner, I believe the Commissions goals to improve transparency of fees and to promote retail price competition for investors are commendable and appropriate. The problem with this proposed rule though is that after decades of investors and their advisors working together within the current framework, our industry - the mutual fund, financial advisory, broker/dealer, insurance, and 401k business – would be significantly disrupted resulting in a number of negative consequences for the clients we serve. Alternately, I believe the Commission can achieve its goals by making some minor changes to the current system as opposed to a major overhaul.
As the Commission has stated, the 12b-1 fee has evolved over 30 years and, with the SECs explicit approval in 1995, a number of different share classes were allowed which permitted investors to choose how they wanted to compensate the advisors they work with. Operating under that regulatory framework, many advisors (including myself) found the ability to use C-shares as an opportunity to provide ongoing services to clients for an ongoing fee, rather than working on a commission basis. As a fiduciary, my clients understand the costs of this arrangement and appreciate the approach. These services provided include not only asset management services, but also the bundling of other ancillary services such as retirement, estate, tax planning, and more. In the current environment, the 1 % C-share 12b-1 fee is very inexpensive for clients when you compare that with any wrap-account program in the industry today, especially for small to mid-size accounts. Additionally, the C-share model gives clients flexibility not afforded when a client pays an upfront A-share sales load.
I believe that one of the unintended consequences of the Commissions proposed rule would be an INCREASE in costs for the average C-share mutual fund investor that utilizes an advisor. Why is this? Since the industry average fee for wrap accounts is higher than the fees paid on C-shares (especially for small to mid-size accounts), clients will begin to pay more as they are transitioned into these fee-based accounts. That is the reality and that will be the impact. C-shares are a low cost alternative for advisors that work on a fee-basis and appreciate the value of mutual funds to manage client assets. Additionally, eliminating the ongoing fees paid on C-shares would be eliminating one of the choices investors have for paying their advisors for the services they receive. In order to promote price competition, it does not seem logical for the Commission to eliminate one of the lower costs options to pay for financial advice.
Another unintended consequence that I am especially concerned about is that it will no longer be cost-effective for advisors to work with lower net-worth clients and, as stated above, it would not be cost-effective for these clients to work with advisors. Most broker/dealers restrict the account sizes that can be managed in wrap-programs. In the case of my book of business, I have many clients that would not meet the minimums of my firm or even if they do, the fees in relation to their account size would be much too prohibitive. The ultimate result would be that fewer small to mid-size investors would have access to sound financial advice.
Still another unintended consequence of the Commissions proposed rule would be the sheer confusion clients (and most likely advisors) would have understanding the capped-fee system and what they are paying their advisors at any given moment. If fund companies can have numerous share classes, all with varying payout amounts and durations, I cant understand how this will clarify matters for clients compared to the current A, B, C share system. Right now it seems pretty straight-forward and simple (the Commission describes the current scenario in one paragraph in the introduction of this proposed rule). Complicating matters even more will be subsequent purchases of funds and how these lots will each have their own capped-fee schedule. If the Commission wants mutual fund investors to fully understand what they are paying for than simplicity is essential. The new fee system as proposed is not simple.
Finally, the last unintended consequence I see is for the potential churning of customer accounts for those advisors choosing to manage mutual funds under the proposed scenario. For some advisors it may be tempting to recommend exchanging into other funds as the date when the advisor will no longer be paid an ongoing fee approaches. Since clients may very well be unaware what they are currently paying under the new arrangement or how much time is left until their fee decreases, this could leave the client vulnerable to unscrupulous activities. Under the current C-share arrangement there is no incentive to churn accounts.
As stated, I believe the Commissions objectives with this rule for increased disclosure and investor choice are appropriate. Clients should have a complete understanding of what the true costs are for any investment they own and what value they are receiving in return for that expense. Armed with this information, investors can than make the right decision for themselves as to how much they want to pay and what level of service they desire – whether its utilizing a specific share class of mutual funds, no-load funds, wrap programs, or a low-fee online brokerage account. The question is though can the Commission accomplish this objective by tweaking the current structure rather than disrupting the entire system as it currently stands? I think the answer is yes, but just as the 12b-1 has evolved over the last 30 years, so must the Commissions view on the role of what the 12b-1 actually is today from the perspective of clients and their advisors. Since C-share 12b-1 fees have evolved into a valuable fee-for-service arrangement over the last two decades, the Commission simply cannot view these fees as an ongoing sales charge or load. If the Commission understands that there is value in the current structure, then it would make sense not to eliminate it, but instead to address the flaws to make the system better. The flaws as I see it revolve primarily around disclosure. As such, I believe there are a number of different ways the Commission can make sure that investors understand what the true cost of their mutual funds are.
One way that investors could be made aware of these costs is to detail that cost on the confirmation. For example, the confirmation could state that based on the initial amount invested of $10,000, the investor will pay 1.8% total fees or $180 annually of which 1% or $100 will be paid to the firm/advisor for services provided. The confirmation could also state that this fee will increase or decrease depending on the fluctuation of the value of this holding.
Another way to increase disclosure would be to mandate that all providers (fiduciaries or not) annually disclose the total fees paid by the client to the firm and their advisor, whether directly or indirectly through mutual funds, wrap fees, commission, syndicate offerings, or otherwise. Every year clients would get this fee statement and then decide if they are paying the appropriate amount for the advice and service they are receiving regardless of the platform they are utilizing.
Still another way to disclose this information is to require that only those advisors in a fiduciary capacity be allowed to sell C-shares with full fee disclosures through the ADV part II, an investment policy statement, or something similar. The Commission could also require that C-shares only be sold through fee-based wrap accounts, with the C-share fees incorporated as part of the total wrap fee.
I thank you for the opportunity to comment on this proposed rule. I truly hope that Commission understands that the current 12b-1 fee arrangement could certainly be improved, but that there is value in the current arrangement, particularly for small to mid-size investors. I therefore request that the choices mutual fund investors currently have not be eliminated or changed drastically, but rather for the Commission to address within the existing framework what the real issues are – the need for increased disclosure and simplicity which will ultimately lead to more knowledgeable investors who can make the correct choice for themselves.