August 11, 2010
This response is a direct comment to reconsider and remove the five year across-the-board grandfathering of existing C shares (page 195-200 of the proposal) and permanently grandfather the existing share class as unchanged from its current structure. My comments are directed to existing C shares and some funds that may have other modified trail programs in excess of 25 basis points (e.g. called T shares at Fidelity Advisor Funds or M shares at Putnam Investments). This is based on the preservation of business models and client relationships that were developed around an existing regulatory framework that were regulated and legally disclosed by prospectus.
I am an independent financial consultant with over 800 accounts held directly at mutual funds (without a clearing house middleman account) consisting mostly of small investors (average balance of $40,000 per account) for whom other advisors would otherwise not service. The basis for being able to serve these clients is the ability to offer various share classes where an on-going compensation justifies the ability to carry these clients depending on the client circumstances, objectives and goals. The SEC is trying to update terms and conditions of our current client/broker relationship by modernizing terminology on the basis that it will somehow protect and/or save money to investors.
The effect this grandfathering limit will have is create the exact opposite effect in that the average small investor will face less servicing options, increased costs, and more abandonment for which they will have nowhere to go. Reducing C shares after the five year grandfathering will result in the need to wrap additional fees of up to 2% to clients for fee-based type of accounts which a for the majority of these small-account holders are prohibitive. As a result, a core group of consumers, comprising of small investors under $100,000, who still value the relationships with their advisers, will be lost. This conclusion and the need to permanently grandfather existing trails in excess of 25 basis points is based on the following facts:
1) On an on-going basis, it is impossible to service a majority of small investor with, for example, a $10,000 balance for a mere on-going trail compensation of 25 basis points. After overrides and retentions, the gross pass-through to the advisor would be $6-$20 a year, before advisors own expenses. In most cases, these accounts will be abandoned and left to the fund companies, which will have to hire more people, in most cases not properly licensed, to deal with all the nuances we deal with as registered representatives of record.
2) Current rules and industry standards require an advisers continued compliance with Anti-Money Laundering Laws, Patriot Act, Privacy Policy, Account Document Maintenance, Updating Financial plans, in-office and phone communications. This along with possible upcoming duties of higher fiduciary duty status will increase the time required to carry an investors account regardless of account size.
3) Investors often have to pay income taxes on these wrap fees whereas they do not pay taxes on the current 12(b)-1 "C" share class.
4) There is enough competition from no load funds for this grandfathering adoption to be made permanent. You own example on page 25 of your proposal early states that:
According to Investment Company Institute (ICI) figures, in 2009, $323 billion flowed into no-load share classes of long-term mutual funds, while in comparison load share classes only received $39 billion in net new cash flow.
5) In order to maintain revenues, advisors and their firms will immediately begin looking for ways to replace revenue caused by upcoming losses by making moves which will result in additional cost ultimately passed-through to the investor.
The C share which typically pays an on-going 1% trailer on the value of the investors account, allows the advisor the same opportunity available in the asset-based managed accounts without the need of a middleman or third-party servicing resulting in higher expenses. These accounts allow the smaller investor (e.g. less than $100,000) the ability to participate in an investment product that, over the years, compensates an advisor more as the account goes up in value and less as it comes down in value. This builds a long-term goal of investing and rebalancing by encouraging relationships that stay informed, educated and serviced. It also inherently REDUCES the need for switching after expiration of a C class term as commented in the proposal.
If for definition purposes such terminology (12b-1) needs to be readdressed and defined under a different term (e.g. service fee, trailer, advisor) then I support your goal of addressing this issue. A reasonable compromise to avoid the problems mentioned in this response and the preservation of our businesses is for new accounts opened AFTER the effective date be subject to the new compensation limits proposed by the SEC and leave the existing structure permanently grandfathered.