October 21, 2010
Reference: File Number S7-15-10
Dear Madam Secretary Murphy:
Hope all is well.
THE LAW OF UNINTENDED RESULTS: I am writing you to explain how certain proposed changes to rule 12B-1 would lead to a gross deterioration in the services provided to vast numbers of consumers in the general public (especially smaller investors). The proposed changes would result in an unfortunate shift away from the current business model used to serve smaller investors, which is geared toward quality service with an inherent motivation to provide high quality on-going advice, and back to a 1950's-1970's business model geared towards transactions, and deal of the day - hit and run tactics. The timing of these proposed changes is especially unfortunate because to the immense change in our economic environment. Of course, in some cases, smaller investors would also lose the right to choose between a business model geared for service, and a business model geared for transactions. In some cases, the proposed changes would also result in adverse tax consequences for some some investors.
ECONOMIC ENVIRONMENT HAS CHANGED, AND CONTINUES TO CHANGE - DRIVING ADJUSTMENTS TO INVESTMENT PORTFOLIOS: The world has changed since the 1950's and 1960's when so much of our culture's ideas about the investment world were formed. For example, the United States economy is a much smaller portion of the world's economy than it was 40 years ago. The economies of other nations may continue to emerge. The ratio of our government debt to Gross Domestic Product has more than doubled over the previous decades, and that ratio may potentially reach 100% in the coming months/years. There are questions about what investors may need to do to hedge against changes in the currency in the coming decades as our potentially aging society places strains on social programs and government budgets. One of the most popular type of investments today, government bonds, has been nearing 40 year highs in prices, and some would say 200 year highs. (Some people may think it may be "safe" to invest capital in government bonds at 4% for 30 years, but it would have been much tougher to win that "safety at 4%" argument in 1981, when rates were 14%.) Of course, there continues to be destructive obsolescence in the business world as one product/service replaces another - often with a shorter expected product life. The one thing that is likely to be constant in the business world is change. Change can often drive the potential need for change in one's investment portfolio, which drives the need for on-going monitoring and service (including potential adjustments to the portfolio).
The current fee structure of "C" shares supports a business model that allows an advisor to keep up with conditions, and address those changes, and make exchanges within a family of funds - without additional transaction cost to the consumer. If the advice turns out to be good, then the consumer is helped, and the advisor is helped. If the advice is not good, then future revenue received by the advisor is also damaged. The current fee structure supports a natural financial connection between the consumer, and the advisor with an inherent motivation for the advisor to monitor conditions and provide the best possible advice for the consumer. In contrast, the proposed changes to the fee structure simply do not support a business model that supports on-going monitoring and service. The proposed changes shift business models back to an era when there is transaction revenue generated to the advisor, and transaction cost taken from the consumer, based on the act of the transaction, and there is a natural wedge driven between what is best for the consumer and the advisor.
SOPHISTICATED ARRAY OF CHOICES WITHIN A FAMILY OF FUNDS: Years ago, there were relatively few choices within a family of funds. The "A" share purchase really was a transaction cost for a single fund' or a very limited choice of funds. Even if one wanted to adjust a portfolio within a family of funds, often there were not many ways to accomplish that task. Today, fund families often offer dozens of choices within the family of funds. Choices offer a wide range of tools that may be useful in today's complex business world, and in whatever complex situations we face in the future. There is a lot of work that must be done to monitor economic conditions, and advise adjustments, and then to make the adjustments at no additional transaction cost to the consumer. The current "C" share fee is really a service fee covering the management of assets within a sophisticated, complex array of financial tools over long periods of time, when changes may be needed at any time. The current "C" share fee is not a transaction cost for one entity similar to what would have been encountered in say - 1979.
If the proposed fee structure is adopted, some investors may still be able to get that same advice in managed accounts (using the same managers at roughly the same final costs to the consumer) , but smaller investors may not qualify for those managed accounts. Smaller investors would be left out in service under the proposed rule changes.
SOPHISTICATED ARRAY OF CHOICES FOR CONSUMERS: Today's business world offers an immense array of investment alternatives with many different cost structures. If a consumer wants to make their own decisions, and use a lower cost implement such as a low load - no load mutual fund, or exchange traded funds, then there is wide range of alternative choices readily available to the investor - already. The investor can already chose among a wide range of choices.
THE LAW OF SUPPLY AND DEMAND: The current "C" share market has become popular because a large number of consumers (demand) have chosen (in a free market environment) to manage their assets using advisors facilitating the supply (supply) of entry into large complex families of funds, and then managing the assets on an ongoing basis over time. If the fee structure is changed as proposed, the demand may still be there, but the supply of services will be curtailed once the prices drop. The law of supply and demand has never been repealed. Once the prices drop, there will be less service supplied. An entity may try to give the impression that just has much service, and just as high quality service will be given in year 6 and later at .25% a year as in years 1 thru 5 at 1%, but in the real world the time and attention are going to flow to the areas generating more revenue. By artificially fixing the fees after year 5, the level and quality of service is being limited as well. There are many examples of this in the business world.
The proposed fee structure change would result in damage to both the consumer (lack of service after year 5) and the advisor in a world that is likely to need as much or potentially even more portfolio monitoring and adjusting than the present era.
WHAT WOULD BE AN IMPROVEMENT: There is a family of funds that currently offers their "C" shares with no fee paid up front. Instead, there is a .25% per quarter "12B-1" fee charged to the consumer - at the end of each quarter. There is no surrender charge to the consumer - ever. Instead, the consumer and advisor can conduct business with the consumer having the complete freedom to withdraw at any time, and the advisor has the complete understanding that value must be added each minute in order to continue to earn the business. If a change to the "C" share structure is to be mandated, this would be a step in the right direction.
Please give consideration to these points. Perhaps the rules do get changed, but the law of supply and demand will not be changed.
Mr. William Roberts