The knocking out of SEC Rule 12b-1 is key component of The Mutual Fund Reform Act of 2004 (MFRA), sponsored by Senators Peter Fitzgerald (R- Illinois), Carl Levin (D-Michigan), and Susan Collins (R-Maine).
According to a Monday news release, the 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 (See Senate Panel Convenes to Discuss Fund Fees ). Since 1980, when the fee was instituted, the fund industry’s total assets have increased by some 60 times, but costs have increased even more — by some 90 times, according to the announcement.
Not only that, but nearly two-thirds of 12b-1 fees are paid to brokers. “In other words, 12b-1 fees have largely degenerated into disguised loads,” the Senate announcement said. “Some 12b-1 fees are as high as 1 percentage point per year. Over the life of a retirement plan, that 1% annual 12b-1 fee can cost an investor 35% to 40% of his or her retirement income.”
In addition to the 12b-1 change, MFRA also requires funds to disclose all fund fees including transactions costs. “By making it much easier for shareholders to compare funds on an apples-to-apples basis, the bill would unleash competitive market forces that have until now been bottled up by an obscure and misleading disclosure regime,” Fitzgerald declared in the statement.
Importantly, MFRA does not prohibit distribution expenses or sales charges. MFRA permits charging a load subject to NASD rules. “There’s nothing wrong with an honest load, but funds should call a load a load, make it account-based, and not disguise it as a permanent asset-based distribution fee,” Fitzgerald said.
Soft Dollar and Other “Questionable” Practices
For his part in the Senate announcement, Levin emphasized the importance of eliminating “questionable” industry practices such as soft dollar arrangements, directed brokerage and revenue sharing.
“Mutual funds are a $7-trillion engine of investment for the US economy, and we need to ensure investors in those funds get honest investment advice and reasonable fees if we are to keep that engine humming,” said Levin, in the statement. “The goal of honest advice requires ending the conflicts of interest that exist in current practices involving directed brokerage, revenue sharing and soft dollar arrangements, which too often taint mutual fund investment advice and drive up fees for average investors. Our bill is intended to end those conflicts of interest and to protect the interests of investors.”
Directed brokerage occurs when a mutual fund agrees to use a brokerage firm to buy stock for its holdings if that brokerage firm promotes the fund’s shares to its other customers. In revenue sharing, the mutual fund gives the brokerage firm a share of its revenues if the firm’s brokers promote the mutual fund’s shares to their customers. With soft dollar arrangements, a mutual fund pays a brokerage firm for research or other services, in the expectation that the firm’s brokers will promote the fund’s products.
Finally, the Fitzgerald-Levin-Collins proposal also strengthens and clarifies the fiduciary duties fund directors and fund advisors owe to fund shareholders. MFRA has three titles: Fund Governance, Fund Transparency, and Fund Transactions.
Well-known industry pioneer John Bogle, founder and former CEO of The Vanguard Group, praised the bill in the Senate statement.
“I’ve spent the greater part of my career speaking out on nearly all of the important legislative issues that Senator Fitzgerald’s Mutual Fund Reform Act of 2004 addresses,” said Bogle. “While nothing can solve the industry’s problems overnight, I view the bill as the gold standard in putting mutual fund shareholders back in the driver’s seat, and endorse it in its entirety.”
See Sen. Fitzgerald Bill Summary at http://fitzgerald.senate.gov/legislation/mutualfund/mutualfundonepager.pdf