On Wall Street

[Community Manager]

Do you think 12b-1 fees should be capped or eliminated? Why or why not?

[ilene]

It seems whenever government interferes in the private sector, the unintended consequences of government "solutions" are almost always worse than the original problem.


The "consumer finance protection act" is most likely going to end up being the "credit elimination act".

The "health insurance for all" act is likely to be the "medical care only for those who can actually pay for it" act.

The CRA mandating banks loan money to people who needed it, rather than could pay it back, almost collapsed our economy.



I remember when there were 8.5% up front commissions. I saw the idea of a 12b-1 fee as a way to give mutual fund sellers an incentive to provide ongoing service (it generally took 10-12 years of 12b1 fees to bring total compensation back to the previous commission level).



I agree that many clients don't understand the effects of the B and C share fees on their overall wealth - nor how paying commissions up front may be in their best interests.



Here is my thought on the 12b1 discussion:

- If they eliminate it, I agree that many investors who really need some guidance will be left on their own.

- I agree with the idea to limit the amount to .25 basis points, which enables advisors to pay for mailings, education, etc even to investors with modest investments.

- In addition, if B and C share higher 12b1 fees are allowed to remain, I would propose that clients be required to receive, and sign that they have read and understood, a document that provides a 15 year, year by year, hypothetical summary of TOTAL EXPENSES of a fund using the 5% year assumed increase, and showing A share costs at different breakpoint levels, and such form would require the client to include an estimated holding period for these funds. This way clients will be able to see the comparative costs of different share class fees side by side and year by year.

[Bradly T.]

Ilene, as usual I agree with much of what you say. However, your cost calculator has the same limitations as FINRA's - what if stock fund goes down 1-3 years first? What if bond fund is distributing dividends so mkt. value is level over time? When I had to justify a B share last year to compliance, they couldn't comprehend a fund without growth....not even a fixed income fund paying out all income. This ain't the 80s anymore.....lots of scenarios will illustrate a B share outcome advantage even with 1 or 2 breakpoints. Some brokers back east won a huge lawsuit/arbitration against FINRA in 07(?) because they clearly demonstrated a B share advantage in an income portfolio compared to a $250,000 breakpoint A share portfolio. American Funds now converts Cs to As after year 9 or 10....all others should follow suit.


Especially agree with your conclusion that no broker income means no ongoing service. And I can't absorb small client managed account solution expenses. I'd like to see your calculator compare ANY share class to managed account costs over 15 years though.....that'd be an eye opener for sure!!

[the observer]

I'm trying to understand what the problem is here.

Essentially, isn't the SEC saying 25 basis points is enough for advertising and mailing and all the other things 12b1 fees were originally created for, and any excess should now carry a label people are actually using 12b1 fees for... ongoing commission payments to the broker. (I'm guessing so they buy a little loyalty from the broker)

Unless I'm missing something, or there's been a change in the proposal, aren't they just asking for a little honesty in labeling?

BTW, in some cases, brokers consider load fund sales a "point of sale transaction" and some just walk away, collect the 12b1's and never see the client again anyway, right? At least with proper labeling, the client could then allege that the broker was paid for ongoing service and advice on the account and never received any, without having to overcome the argument that the 25bp to 1% was just for advertising and mailing costs, not service.

Then again, responses I'm seeing all over the web suggest people have been building a non-fiduciary "fee" like structure for their entire practice using 12b1 fees and some in other forums are demanding mutual fund companies take over the servicing of the accounts because they are not going to work for free... which suggests to me that too many view 12b1 fees as ongoing commissions rather than the purpose for which they were originally intended.

I believe everyone should be paid for their work, but I also believe the client needs to know that they are paying for work, so they can complain when the few just collect and don't do any.

[Lucullus]

Observer,

Excellent observations. I've always regarded 12(b)(1) fees as inherently disingenuoust. If you're asking the customer to pay a commission, SAY SO! There's nothing wrong with saying "we charge you this so that we can compensate your advisor who - we believe - is providing you with valuable advice". But calling it "advertising expense" when it's "servicing commission" is just plain dishonest.

[Bradly T.]

I understand the 25 bp limit for As and have no problem with disclosure of ALL client purchase and ownership costs for every investment, but what effect will this have on B and C shares?? Will this reduce pricing options for smaller accounts?
And will RIAs finally be required to illustrate the forever management fees compared to alternatives? And will there now be a conflict of interest disclosure about AUM compensation for RIAs ("we may not recommend cash reserves, debt acceleration, risk premiums, family or charitable gifts, etc. because our compensation is thereby reduced")?



And not to be argumentative but the funds I use most DO pays ooodles of money for national multi-media advertising and provide very good presentation and marketing materials.....so there must be SOME 12b-1 expenses in addition to on-going servicing comp to rep. The notion that I am paid 85% of one quarter of 1% ($2k per $1mm of AUM) for ongoing service compared to my being paid 85% of 1.5% ($12,750 per $1mm of AUM) for managed money illustrates the absurdity of the consumer "protection" rhetoric in the media today.



I keep seeing comparisons of no-load to load funds - as if that ever happens!! Compare loaded to no-load plus 1.5% forever. If 12b-1s are undesireable due to COST, then lookout managed money! My 12b-1 income is a pittance and so is the cost to investors (by the way, my investors ALSO like to see their funds and families promoted in the media - it's a confidence builder as it is for every other service and product in America today). The reduction of compensation models WILL also reduce access and choice to the working class and make our profession an elitist solution for the wealthy only.

[the observer]

Hi Bradly,

let's not make this into a fee vs commission model debate... It's not...

It's actually a truth in advertising debate.

At fault, more than any others, are the mutual funds and broker dealers for allowing the 12b1 fees to get to the point where their brokers rely on them as an "ongoing commission income stream" while they (mutual funds and broker dealers) obfuscate the nature of the fees. This has little to do with registered reps or their model and far more to do with mutual funds and broker dealers coming clean with their advertising.

[Bradly T.]

Like I said, I fully support FULL disclosure of both purchase and ownership costs of EVERY investment product and service. But if cost "justification" becomes or already is the driving criteria of disclosure, then surely the 12b-1 can be justified. Perhaps all clients should sign off annually on ALL "service" fees to verify value received for expenses charged?


And what about the millions in loaded shares I didn't sell but transferred to us for service - the 12b-1 is the ONLY comp. received for doing what's right and not churning or load exposing this new firm AUM. Call it what you want, disclose it how you want, to say it's unearned by the advisor and that the fund company has zero advertising and marketing costs is inherently incorrect. Is it about truthful advertising really....or just another assault on regreps and small investors? Isn't the impact as important as the ideal? And how do you discern the difference between income-for-service vs. "on-going commissions"? What then becomes the alternative to those of us who DO provide on-going account services? Stop the services? Bill seperately? Or is this a not so subtle push toward managed fees? You claim the issues are unrelated...where you been?

[the observer]

Hi Bradly,

I think you're missing my point...

I'm discussing models of compensation, but truth in advertising. Look up the SEC definition of 12b1 fees to understand why they were permitted and for what purpose. If a fund pays out 1% in 12b1 fees, I don't have a problem with it... but to argue that the compensation flowing to the broker is for the purpose for which it was originally intended is not appropriate. If the fund now states, under expenses, 12b1 fees 0.25%, ongoing compensation to broker 0.75%, the payment is the same, the disclosure is more honest.

It's like saying a Twinkie only has 250 calories... but if 85% is from fat with 75% of that being saturated fat, there's a little obfuscation going on on the part of Twinkie makers.

I'm reasonably sure consumers won't mind brokers earning money for the service they get. It might obviate that question, "I don't get it, how do you get paid for all the years of ongoing service if you only get paid 74% of 4.5% in the first year?"

This is NOT about fees vs. commissions. It's about truth in advertising, can't stress this enough.

Look, I'm sorry for the people who've built their business on non-fiduciary 12b1 fees and C shares etc. I looked at the way things were going many years ago and concluded they would eventually attack 12b1's and C shares. I also believe they'll eventually attack third party money managers where fee-based planners get ongoing referral fees of up to 50-70 basis points for essentially being an account relationship manager rather than an asset manager. I made a decision not to go that route years ago.

[Bradly T.]

To the original question - I am comfortable with both disclosures and maximums and even a form of replacement but I reiterate - I'm earning that cash flow and mutual fund companies DO have marketing and advertising and distribution expenses. There's an implication inherent in the question posed and the consequences of "elimination" which DO go to the heart of both compensation models and business models. Try to separate them all you want. So....are we discussing truth in advertising or ending a comp and business model which will reduce competition and access for small investors?


Is this issue consumer protection or model dominance? Will consumers be better off or less well off by more government "protection" from legitimate costs which offer competitive advantages? Try peeling this onion just another layer or two to seek the"truth" in the motive and urgency of your apparent consumer protection presentation. What will be done next in the cause of consumer "protections"?

[the observer]

"are we discussing truth in advertising or ending a comp and business model which will reduce competition and access for small investors?"

No, I do not think the 12b1 fee model changes will kill access for the small guy... It will merely clarify which portion of the 12b1 fees goes to advertising and which to compensation. Fiduciary liability for series 6 & 7 brokers will kill advice to the small investor and that's why I'm happy the SEC will at least take the time to study this. The sensible course is a middle course.

[northwoodsjoe]

Goodbye to "hidden" service fees (as they like to call the 12b-1) and say hello to transparency and managed money. Clients will now get to pay more over time for serivce and small clients will be left to fend for themselves. Sounds like a good plan for average consumers.
I hope you can sense my sarcasm.

Truth in Advertising doesn't really matter to most clients. My clients like to know how I get paid. I always tell them about the 12b's and have NEVER heard a complaint. Most people feel better that they can call for service and not feel like they are asking for "free" help. They now that I need to eat and be here tomorrow when they call.

Now, they will need to have enough in assets to justify a managed account and they will end up paying more over time. Sounds like a good consumer protection plan.

[Bob H]

The idiots in DC change things. So will we. It's just how the game is played. Always has been.

The pols think they are the smartest guy (girl) in the room when reality shows they are years behind the biz community. As soon as they work out all the details on this, I'll change what I need to change and inform the clients.

[ConsumerAdvocate]

It seems as if they are only changing the labeling on the expenses and putting a time limit on the as yet unlabeled expense portion.
I havent seen where they are prohibiting expenses in excess of 25 bp, just that they cannot be labeled as 12B1.



If they were disclosed properly to clients now I think that the change will have limited impact, at least for a few years.

[Tad Borek]

FYI...anyone who feels strongly one way or another can do something. The proposed rule is in the "notice and comment" period. You can go to the SEC website and submit a comment on the rule, and it will be read and part of the permanent record of this rule-making. Google will forever find you on the SEC website, which can be good or bad so consider that accordingly!

Here's the SEC page with the announcement, including links to both the full PDF about the proposal and the online comment submission form.

-Tad

[Country Boy]

I think there should be some rules on how 12(b)(1)s or any "service" fees are paid out to Advisors. There are investment companies who do not pay the full amount, or any at all, unless new production requirements are met. This makes it look more like an "Investment Bonus." Clients are paying for service, but the Advisor may not be getting paid to perform it. At the same time, orphaned accounts with no advisor are paying for service that they cannot get. Perhaps if a fund is collecting a service fee, it should be required that the accounts be assigned to servicing representatives.

[Bradly T.]

Amen brother!! I agree unasigned and even reassigned accounts should be handled differently. This is a marketing and service fee which should probably be divested too....a fee for marketing and a fee for service, and the latter requires a servicing advisor and client re-approval with every advisor change of record. I have no love for any particular form of on-going service fee income....but I do need and earn the on-going service fee I'm getting....so call it what you want, disclose it how you want, but don't isolate the "problems" as reason for elimination of what is a very reasonable charge and compensation form in most cases.

[hampten]

It seems to me, the issue is not "Load" or "No-Load" - it is "Help" or "No Help".


Consumers wishing "more efficient" management of their retirement nest egg have had, and still have, every ability to open up accounts directly with the direct "No Load" mutual fund families of the world. Low expense. Indexes. No Load. No Help.



Seeking to minimize the ongoing compensation advisors are paid to help (small-) clients, will effectively eliminate the services' availability for the overwhelming majority of those consumers who need good, ongoing, comprehensive, financial planning advice and ongoing comprehensive financial planning services most.



We should (continue to-) disclose and ALLOW CONSUMERS TO CHOOSE what level of service they wish to receive. To force every service provider to scale back the level of ongoing services they can provide clients is not helpful to consumers.



It really concerns me that this effort to govern how much professionals earn will limit the personal availability of those professionals to the higher net worth only. I don't think that is the ultimate objective, but do I fear it will be the ultimate outcome.

[Bob H]

I understand that the SEC will have a "comments" period soon in their review of this issue. Make sure all of you pay attention and when its open, make your comments heard.


Bob

[ConsumerAdvocate]

Country Boy.... You raised an interesting point and was wondering if you could name a mutual fund company that adopts the process of requiring new production. If new production is a BD requirement that is one issue and if it is the investment company that has the requirement then that it another.


I think FINRA will need to address the issue of service and advice and issue some clear cut guidelines on what is what.

[Country Boy]

I don't know if it was the fund or the BD policy, but when I represented Waddell & Reed, they required new production to qualify to be paid 12(b)(1) fees on their proprietary funds. I can't remember the required production levels, but they had a stepped system that paid from 5-20 bps based on new production. I left and went Indie.

[ConsumerAdvocate]

Thanks I think it is very important to the discussion to differentiate between the 12B1 fee charged by the mutual fund and paid to the BD and how the BD pays the money out to the representatives.

[B_B]

The SEC should be doing away with A shares (or more specifically, front end loads) instead of C shares? Small and midsize clients lose up to 5.5% of their initial investment and the "advisor" that sold it to them has little incentive to provide ongoing support/service. At least with a C share the advisor has a stake in their success.

The front end load also encourages people to stick with a fund (or at best, a fund family) regardless of how poorly it performs. It's an ancient business model that encourages poor service and with some unscrupulous advisors, high turnover.

The loss of C shares will be a blow to the small and midsize investor - doing away with the back end load of the C share (in year one) would be an excellent idea, but doing away with the ongoing incentive for an advisor to help these clients is going to have obvious consequences that apparently the SEC is OK with.

C'mon Mary, you really can't think that the RIA industry pushing this reform is truly unbiased?

[Bradly T.]

B_B - Thanx for that last, I thought maybe she was right and I'm just paranoid!!! Let's hope the Supreme Court's last ruling is taken seriously.....mutual funds are competitive and DO NOT overcharge en masse or by formula. Disclosed fees are a free market, competitive service charge. This whole issue smells of the same "holier than thou" stench from the management fee crowd....again!! And journalists and publishers are shills for that crowd. Despite the facts that there is no arrangement so expensive as theirs (so much for sincere consumer protection rhetoric) and the minimums for that model will eliminate professional service to 2/3 of households (again, so much for consumer protection).


Now that most product is sold by unencumbered, neutral and independent reps, aren't most of the self-dealing issues being adequately quashed by model development, competition, and disclosure?? Especially since WE can offer both platforms and solutions where appropriate and provide true choice and comp options to clients?? I used to sell a lot of small B share deals, now it's A or C only for my favorite fund families. My clients are already being punished by mandatory sales charges or endless service fees by Schapiro's formerly misplaced jurisdiction who never let the facts get in the way of "consumer protection". She's going to protect the public right out of access and choice.



Just read two interesting articles: one stating how disenchanted the wealthy are becoming about "managed accounts" for both cost and performance issues; the second, about how poorly ETFs work for average investors - they are NOT delivering their indexes or their tax advantages and shareholders are really being taken advantage of by professional traders who make money moving the indexes by volume, momentum, and timed reversals to their short term advantage. While cheaper may (or may not) be better, I have yet to understand how intra day trading helps any investor while it is obvious that it can and does benefit traders. When is Schapiro going to protect investors from traders and market manipulators and focus on systemic collapse risk due to 21st century technologies/mathematics?? 12b-1 fees are an easy but completely misdirected target....you're wasting ammo on the wrong targets Ms. Schapiro!! Who are you protecting really??!!

[B Smith]

Tad, no offense but I don't think my telling the administration I would like a more free market, stop controlling everything, you make up these false scenarios of calling a fee a 12b-1 in order to have jobs, etc, would be worth my time.

MHO - So what if a 12b-1 was originally something else. Everyone knows what it is used for today. Does your client read the prospectus and say, boy, I thought I was paying this for advertising. If he / she does, they already know what the term 12b-1 means, so who cares. It's one of these ongoing silly things that will lead to the change of a word in a prospectus and cost investors and tax payers alike a pretty penny to come to that conclusion. Which, btw, was created through silly legislative processes like this one.

Don't you love the leaders of our profession are clamoring for this kind of thing?

[Tad Borek]

Tad, no offense but I don't think my telling the administration I would like a more free market, stop controlling everything, you make up these false scenarios of calling a fee a 12b-1 in order to have jobs, etc, would be worth my time.

No offense taken, you're right that it may be a complete waste of time - comments can be ignored even when they're all in agreement. And I'm sure the trade groups on the various sides of the 12b1 issue have their law firms working on comment letters right now.

For those who want to chip in their two cents...FP.com seems to scrub out URLs from the boards, here's the link I'd posted above for submitting comments and reading the full 12b1 proposal:
www.sec.gov/news/press/2010/2010-126.htm

Actually it's open season on investment regulation, they've opened up comments on all sorts of stuff since the Dodd-Frank bill.
www.sec.gov/news/press/2010/2010-134.htm
www.sec.gov/news/press/2010/2010-135.htm

-Tad