Investor Sues Dreyfus For Improperly Using 12b-1 Fees

February 27, 2004 ( - A federal lawsuit has been filed accusing Dreyfus Corp. of misappropriating mutual fund marketing fees to cover costs such as broker incentives.

Noah Wortman, a Dreyfus investor from Delaware, filed the suit in the US District Court in Pittsburgh.   In the lawsuit, Wortman – who currently owns shares of a Dreyfus stock-index fund – says that the Mellon Financial Corp unit violated federal securities laws that govern 12b-1 fees, according to an Associated Press report.

Rather than be used to mutual fund marketing, as 12b-1 fees are intended, Wortman’s lawsuit says the fees were used to pay for sales contests and other incentives for brokers to sell the Dreyfus brand funds.   This misappropriation, in turn, harmed “hundreds of thousands” of investors, the lawsuit contends.   Wortman’s attorney, Alfred Yates, is seeking class action status for the action.

Wortman is seeking unspecified damages from Dreyfus for improperly siphoning assets from his fund to cover Dreyfus’ marketing expenses. The lawsuit also says that 22 Dreyfus funds were closed to new investors so a marketing fee “could not possibly have been used to market and distribute them” to new investors.

12b-1 fees, named for the corresponding section of the laws governing mutual funds, are paid by a mutual fund to a broker or recordkeepers out of the fund’s assets to cover distribution expenses such as advertising and marketing the funds to new investors, as well as paying for shareholder service expenses.   In theory, by liquidating a small percentage of a mutual fund’s assets to pay for increased exposure through marketing, the fund would grow more, helping all of the fund’s investors.   In practice though, as funds have grown, there has been few reductions in 12b-1 fees in line with economies of scale.