July 27, 2010
A few years ago I wrote to you describing my early years as a financial advisor and how often I came upon investors that had been abandoned by their brokers. They were sold an investment and since the broker did not receive any financial incentive to service the client after the sale, the broker went on and looked for their next sale leaving the client with nobody to help them.
When the 12b-1 fees came about, brokers now had an incentive to service the client as he was paid to answer the clients questions and to hold their hands during the tough markets.
Now you are proposing to limit or eliminate some of these fees. While this is a very noble cause, you need to look deeper to understand what will actually happen to the clients should your proposed changes go into effect?
First, who would be helped by such a proposal? At first glance, you would think that lower costs would help all investors and that is why you are proposing the changes.
Who would be hurt by the changes? Brokerage firms, financial consultants, mutual fund companies, etc. Since many of the injured organizations are public companies required to make profits for their shareholders they will counter your move with two things. One, they would charge more fees and two, they would eliminate the smaller accounts that used to be profitable under the old 12b-1 rules.
Looking at how they would charge more fees, the Wrap accounts that charges 1% per year would be almost required to do business with a major brokerage firm. I currently produce about $550,000 in commissions from an asset base of about $100 million, so it can be said that my average client pays .55% per year, or just over one half of one percent to have their money managed.
If the Wrap style accounts became required, and my $100 million in assets was charged 1%, then that would be $1 million in revenues to the firm, almost a 50% increase. Good for the firm, good for the broker, not so good for the client.
Smaller accounts will be eliminated. As you should be well aware, large brokerage firms have been pushing smaller accounts to call centers or completely out for years. Many firms simply wont pay a broker if a client is under a certain asset amount which, of course, discourages the brokers from helping the client. Implementing the new 12b-1 rules will make these accounts even less profitable and the firms more inclined to push them away. Just who are these accounts with small amounts (some define them as under as $100,000 - $250,000)? Older, retired, non-computer literate investors, just the folks that need our help more than anybody.
In summary, while reducing or eliminating 12b-1 fees sounds like a good idea on the surface, you need to take a more holistic look at how investments and advice are delivered to all clients. Sophisticated investors that know what they want can find no-fee or low-fee programs to invest in now. Investors that seek help and advice know they have to pay something for the services rendered. By taking away the 12b-1 fee, the unintended consequence will be higher overall fees for investors than can get service, and the abandonment of millions of older investors with no one to turn to for help.
You declare that the SECs mission it to protect investors. If you really looked into the repercussions of your 12b-1 ruling, I think you will find the ultimate consequences to be far worse than the benefits that you think investors will receive.
My name is Jim Hergenroeder and I have been advising clients for 24 years.