Compliance April 14, 2007

Cox Says 12b-1 Fees a “Sales Load in Drag"

The Securities and Exchange Commission (SEC) this year plans to turn its attention to fees paid, and how they are disclosed, to 401(k) plan investors, according to Chairman Christopher Cox.

Reported by

Nevin E. Adams

Speaking at the Mutual Fund Directors Forum on Friday, SEC Chairman Christopher Cox cautioned that the rationale underlying 12b-1 fees had long outlived its intended purpose – and said that the SEC was undertaking a broad initiative focused on the industry’s fee disclosures to 401(k) participants.

Noting that when the SEC adopted 12b-1 “…our premise was that 12b-1 plans would be relatively short lived”, Cox recalled “…a very real concern that if funds were not permitted to use at least a small portion of their assets to facilitate distribution, many of them might not survive.”

In fact, Cox said that in 1980 the SEC thought that requiring current investors to subsidize the sale of fund shares to new investors “…could be a good thing – even from the standpoint of the current investors – because increasing overall fund size could help better diversify their holdings, and also proportionally reduce the burden of administrative costs that might now be spread over a wider pool of investors”.

Sales Load in Drag

Cox noted that “very quickly, however,” the 12b-1 fees became a substitute for front-end loads,” describing that transformation as turning those fees – some $11 billion last year – into a “sales load in drag.’

“Now, with nearly three decades of experience under our belts – and with today’s uses of 12b-1 fees barely recognizable in the light of the rule’s original purpose – it is high time for a thorough re-evaluation,’ Cox said – and he challenged the independent mutual fund directors in the audience “to take a fresh look at the way this use of investors’ funds has evolved’.

Specifically since, as Cox noted, the 12b-1 fee must be approved each year – and that it “may be terminated at any time by vote of a majority of the independent directors.’

In prepared remarks, Cox specifically cited the use of 12b-1 fees to pay for administrative expenses in connection with existing shareholders as an example of how they had “veered away from their conceptual basis as distribution subsidies.’ Moreover, he noted the example of funds that were closed to new investors, but that continued to collect 12b-1 fees.

As for how this had evolved, Cox said, “If the size of the fund is increasing, but the expense ratio isn’t falling, then using a 12b-1 fee for marketing and distribution expenses is very likely harming, not helping, the current investors,’ he said. Moreover, Cox said that collecting an annual fee from investors that is supposed to be used for marketing is “no more consumer friendly than forcing cable TV subscribers to pay a special fee of $250 a year so the cable company can advertise HBO and Showtime to lure potential new customers.’

Not surprisingly, Cox said that Rule 12b-1 is an issue the SEC plans to address this year.

401(k) Disclosures

Cox also cited a “broad initiative” to examine the adequacy of investor disclosures by mutual funds and other investment vehicles in a typical 401(k) plan. “With an emphasis on both the disclosures by the constituent investments in the 401(k), and the aggregate disclosures by the plan, we aim to make it far easier for busy Americans to understand the expenses they’re being charged in connection with their investments,’ he said.

Acknowledging that this would require collaboration with the Department of Labor and other investment regulators, he said “we’re confident we can achieve a great deal in the coming months – and that the effort is supremely worthwhile, given what’s at stake.’ Cox said the coming months would include roundtable discussions with the nation’s leading experts, a concept paper outlining the issues and solutions, and a formal rule proposal later this year.

Additionally, Cox said the SEC would be examining the various disclosures that 401(k) participants receive – and continue working to “purge all of the legalese from these disclosures.’

Data & Research April 14, 2007

IMHO: “Self-Fulfilling″ Prophecies

The Employee Benefit Research Institute (EBRI) and Matthew Greenwald&Associates published the 17th Annual Retirement Confidence Index last week – and, for the very most part, it’s probably safe to say it didn’t tell us much we didn’t already know.

Reported by

Nevin E. Adams

More than half (52%) expect to be comfortable, another third categorize their post-retirement income status as “adequate,’ and 6% are looking forward to being “well-off’ – at least in the first five years after retirement. Just 10% say they will be “struggling.’

While they are apparently less confident than they once were in terms of a traditional pension benefit, they remain largely complacent about their overall prospects for a comfortable retirement – more than a quarter are VERY confident, and another 43% are somewhat confident, in fact. Still, only 18% are much less confident about receiving that traditional pension. (Oddly, and perhaps proving that confidence is a relative term, “only’ 29% of those who do not expect to receive a pension are less confident. Can one truly be less confident of receiving something that you don’t expect to receive?) And while 62% say that they expect to see that traditional pension someday, only 41% say they are currently covered by such a program (see

Workers Willing to Get, Not Necessarily Take, Advice)

The survey, well-regarded for its breadth and depth of analysis, also revealed that almost half of the workers who are saving for retirement (bear in mind that only about 60% are at present) have accumulated…less than $25,000. Seven in 10 of these workers have less than $10,000 saved (including more than a quarter of those older than 55). They also continue to misjudge the age at which they will be eligible for full Social Security benefits (it’s no longer 65, by the way), appear to overestimate the existence of long-term health coverage (they think they have it, though only 10% of the population does), and – at least based on current trends – seem to be more optimistic about the availability of employer-provided health care in retirement.

“Agree’ Mien?

But what I found most intriguing about the RCS results from the perspective of advisers – was how survey participants responded to the notion of advice. There have been any number of surveys done in recent months about participants and the need for help in making investment decisions, and they consistently indicate a strong desire on the part of participants for help. Setting aside for a minute the fact that many of those surveys are underwritten by firms interested in providing that help, I’ve heard that exact message from both plan sponsors and advisers in the field (although, more recently, the call hasn’t been for help in making the decision, it has been an interest in having someone just take care of it).

However, in the RCS, fewer than two in 10 workers said they would be very likely to take advantage of investment advice at a modest cost (“modest cost’ was not defined for them), and only about a third (35%) said they would be somewhat likely to do so (the rest broke nearly evenly between would not likely, and would definitely not take advantage). However, advisers might take some comfort in knowing that those who had used an adviser previously, those who were under the age of 55, and those with higher household incomes were more favorably disposed toward the service.

But even among those interested in investment advice, only about one in five (21%) said they would implement all of the recommendations – if they trusted the adviser. A full 11% said they wouldn’t implement any of the recommendations, and two-thirds said they would implement only the recommendations that were in line with their own thinking.

All of this would, unfortunately, seem to portend a rough road ahead for advisers who are trying to get across the importance of retirement savings. After all, if people are feeling this “confident’ about their prospects, no wonder the nation’s savings rate continues to languish. And if participants are only interested in recommendations that match their own thinking – and their thinking is grounded in these feelings of relative optimism – how are they going to be able to ready themselves for what may be a very rough future reality? Ultimately, of course, it will take more than confidence to ensure retirement security: It will take awareness, planning, and action. The RCS should, IMHO, be a wake-up call for us all.

Note: The good news in the RCS is that workers who are saving for retirement, who have taken the time to do a retirement needs calculation (and who have higher incomes) – tend to be more confident than others about their prospects.