Although agreeing with the SEC’s initiative to review Rule 12b-1, the Securities Industry and Financial Markets Association (SIFMA) stipulated that 12b-1 fees were not meant to be a temporary solution, and said that since its inception, “Rule 12b-1 has been a success; curtailing or withdrawing the rule would harm investors and competition in the marketplace.’

Both SIFMA and the Investment Company Institute (ICI) argued that 12b-1 fees (used by over 70% of funds, according to ICI) allow for economies of scale, since they are able to allow smaller intermediaries to offer a broader choice of funds to their clients, and the fees also allow for smaller funds to get increased distribution through larger intermediaries.

In the letter, SIFMA said those participating in the SEC’s recent roundtable seemed to agree that the fees “support legitimate and necessary administrative and investment services for fund shareholders and that the utilization of 12b-1 fees has been impacted by the wholesale shift in shareholder servicing from funds to intermediaries, the substantial decline in front-end sales loads (or the converse) and the increased need of investors for continuous advice.’

“Rule 12b-1 is an integral part of the structure and success of the mutual fund industry,” ICI Acting General Counsel Mary Podesta wrote in the letter. “The rule and its associated fees allow investors the option of paying distribution costs over time, give investors access to funds that otherwise might not be available to them, and compensate financial intermediaries, on whom so many fund investors depend.”

Disclosures

However, although the administrative and investment services offered to shareholders have changed significantly in the 27 years since the rule was enacted, “It may be appropriate to improve disclosures for the benefit of investors and fund boards, but it would be a major mistake for the SEC to withdraw or substantially curtail Rule 12b-1, or otherwise to restrict the fee arrangements that have fostered innovation, flexibility, and investor choice.’

Therefore, transparency enhancements are needed to ensure that the existing disclosures match the current uses of 12b-1 fees, SIFMA said. ICI also asked for new disclosures provided by funds in the prospectus and other documents, and by intermediaries at the point of sale that describe the purpose of the 12b-1 fee, “to give shareholders a better understanding of the nature of the fee and clarification of the responsibilities of mutual fund boards in approving and overseeing 12b-1 plans.’

In regards to the nine factors that should be considered when fund boards are evaluating 12b-1 fees, both SIFMA and ICI suggested that the SEC update the guidance regarding those factors.

Assessing the Fees

Although some have called for making 12b-1 fees levied at the individual account level, instead of taking it from fund assets, according to Podesta, “There are significant tax and operational disadvantages to imposing 12b-1 fees at the account level that likely would outweigh the benefits of this approach” because externalization would increase investors’ tax costs, reduce the tax efficiency of funds, and require extensive overhaul of fund operating and recordkeeping systems.

To read the full text of SIFMA’s comment letter, please visit: http://www.sifma.org/regulatory/comment_letters/48614797.pdf. Prior to the roundtable, SIFMA provided a white paper on the history and purpose of Rule 12b-1 and other revenue streams as background material for the discussion. The full content of the white paper can be found at: http://www.sifma.org/regulatory/pdf/12b-1MFWhitePaper6-13-07.pdf.

ICI’s letter can be read at http://www.ici.org/new/07_sec_12b-1_com.html#TopOfPage. In 2004, according to an ICI study, the bulk of 12b-1 fees were paid to compensate brokers and financial advisers for ongoing shareholder services (52 percent) and for initial assistance in a fund purchase (40 percent). Only 2 percent of the fees were used to pay for promotion and advertising of funds. That study can be found at http://www.ici.org/pdf/fm-v14n2.pdf.