SEC Gives Tentative OK to 12b-1 Limits, Disclosure Rules

February 11, 2004 ( - Days after a bipartisan US Senate group introduced legislation that would kill 12b-1 marketing and distribution charges, US market regulators have tentatively approved new 12b-1 limits.

The move by the US Securities and Exchange Commission (SEC) also included a request for public comment on whether the 1980-era rule should be limited or killed entirely as in the proposed The Mutual Fund Reform Act of 2004 (MFRA), sponsored by Senators Peter Fitzgerald (R- Illinois), Carl Levin (D-Michigan), and Susan Collins (R-Maine), Reuters reported  (See Senate Fund Reform Bill Would Kill 12b-1 Fees ).  

SEC Chairman William Donaldson called 12b-1 “a rule that maybe has outlived its usefulness.”   The SEC will take a final vote after receiving the public comments. ” Rule 12b-1 fees and directed brokerage quietly generate a lot of money for people in the fund and broker-dealer industries, and unlike some of our other proposals, this one is going to hit them where it hurts,” Donaldson said.

Originally meant to help funds cover their marketing and distribution costs, the rule now imposes fees that substitute for reduced sales loads, or charges, with the revenues coming in often involved in directed brokerage, SEC staffers said. On announcing the MFRA this week, the senators said their proposed 12b-1 repeal grew out of previous Senate committee testimony that 12b-1 fees have been a “bonanza” for brokers and advisors but haven’t lowered shareholder fund costs as they were originally intended.

Since 1980, when the fee was instituted, the fund industry’s total assets have increased by some 60 times, but costs have increased 90 times, according to the Senate announcement.

Directed brokerage, the channeling of brokerage business and commissions to Wall Street brokers that do the best job of selling the funds’ shares, is widespread and “ought to be prohibited because of the conflicts” of interest it poses, said SEC Investment Management Director Paul Roye, according to news reports. MFRA would also ban the practice.

The SEC also voted unanimously Wednesday to require that reports to fund shareholders disclose the cost in dollars to each investor for an investment of $1,000 in the fund based on the fund’s actual expenses. To help investors compare apples to apples, reports will also have to include cost figures for a $1,000 investment adjusted for a hypothetical, 5% annual return.

Also in the SEC’s sights:

  • decicions on hiring advisors. The SEC voted 5 to 0 at its meeting to propose that mutual funds be required to explain any decisions to hire, or recommend hiring, of advisers. The proposal follows attacks claiming that boards often merely rubber-stamp the hiring of advisers from fund management companies. The SEC said it hopes “to encourage fund boards to consider investment advisory contracts more carefully.”
  • fund performance disclosure. The commission further voted 5 to 0 to change its rules so that funds would have to include more information about fund performance in annual reports to shareholders. In addition, the SEC ordered that mutual funds disclose their complete portfolio holdings quarterly to the agency and summaries of their holdings semi-annually to investors.