August 13, 2010
August 12, 2010
Securities and Exchange Commission
Comment Review Board
RE: 12b-1 Changes
I am a 22 year veteran advisor who began widely uses C-Share mutual funds with my clients some 15 years ago. My decision was based on experience encountered when one fund companies management went bad (IE: Putnam, Colonial Funds, MFS, Oppenheimer, to name a few and there of course have been many smaller fund complex implosions) and my client who had paid a front commission were now stuck with the unattractive option of paying another commission to change or continue forward with poor management of their money. I am commenting for two reasons: 1.) I think that how funds with higher 12b-1 fees are used is misrepresented or misunderstood and 2.) I fear the unintended consequences to the consumer of this right minded thinking that clients need to be protected from excessive costs of doing business. Let me add that I do understand that there are people who abuse the system, but my assertion and belief is that it is impossible to regulate morality. One can only hope to give the consumer choices and present those choices in a clear manner. Disclosures today are too numerous and too complex, it has come to the point they are meaningless as the clients refuse to attempt to read and understand all the lawyer language. Now to my two points:
1.) With regard to how these charges are viewed. I think in general it is just assumed that this is somehow a sales load and a choice of how to be compensated made by the advisor and not the client, as opposed to a well thought out decision made in an effort to get the lowest cost, most appropriate investment program for the client. Properly used, C shares give the consumer a right and access to multiple management expertise, with minimal financial commitment to that management. It also gives the consumer access to new offerings in new asset classes and the option to make decisions on who manages their money without the conflict of what do I have to pay to make this change. One of the fallacies of evaluating fund compensation is based on the assumption that all funds will perform equally. While this isnt possibly going to happen, it is also impossible to assume who will perform better, but with the aid of history, research and analysis educated assumptions can be made. C shares also allow clients to rebalance their portfolios without additional sales charges. Yes, I understand this can be done in A- shares with one fund family, but what is the client sacrificing having all of their assets managed inside one family. It is well known that not one fund family has the top expertise in all areas of money management. One only has to look at the various publications and rankings of top fund families to prove my point as they change from year to year depending on the investment climate that year. C shares provide clients wider access to expertise, more flexibility to change without undo financial harm, ability to rebalance portfolios to maintain constant risk exposure (or at times to reduce or increase risk), adjust their portfolio to their changing circumstances and needs. Again I understand an argument can be made for this being available in A-shares, but the fact is in history that situations, management, and asset flows within a fund family can create an environment where the client is trapped and faced with the decision of do I throw out my previously paid commissions and pay another to escape this situation.
2.) The unintended consequences I believe will occur if there is a limit placed on the total compensation of any share class is multiple. Again this is the bad advisors finding a way around what you are trying to protect the consumer from in the first place. One I think there will be more fund switching which will occur in effort to increase or obtain fair compensation for the services offered. This will be an absolute impossibility to regulate either by your agency or the firm. I understand the burden will be placed on the firm, but this will only serve to drive costs up not down. These costs will be passed on to the consumer. The second way I believe unintended consequences will occur is that more clients will be pushed into advisory or fee accounts where a wrap fee is charged in place of commissions or 12b-1 fees. Or I have seen situations where firms collect both fees and 12b-1 fees inside the same account, yes it is disclosed but disclosures have become so lengthy that this double dipping is artfully disguised. Firms are already trying to steer brokers in this direction. The truth in my opinion from what I have witnessed is the firms make more money, collect fees they otherwise would not get, and feel they are doing what the SEC wants them to do anyway. Some of the big abuses in my mind that occur in wrap fee accounts is the funds are not as professionally advised and clients pay fees on asset s where there is no or very little oversight required, such as CDs or other fixed income products purchased for yield and stability alone, and just the overall cost to the client in these accounts. I can put together a C share account combined with fixed income and ETFs that costs the client less money than any wrap program. It further gives the client greater cash flow than a wrap account to meet their needs and gives the client a greater diversification than just a Mutual fund A share account.
When used properly a C-share based account (which I inform the client is my version of a fee account) is in the long run less expensive than most other alternatives available yet providing the greatest value in terms of offerings and service. This of course assumes proper monitoring of funds and rebalancing is done as part of the service. Whether we are talking A shares, C shares or limited 12b-1 fees, consumers get abused by bad brokers and bad firms lets work harder to punish this behavior. Further I do not charge my clients any additional fees for planning services as I consider my compensation from their asset management sufficient to provide them the ongoing planning and advise they require. Any modification of the C share 12b-1 fees will in the long run cause my clients to pay higher fees.
My solutions would be as follows:
1. A simple disclosure at the time an account is opened or changed which merely allows the client to initial by one of three lines:
I elect to purchase my mutual funds with an upfront commission and I realize this may in the long run give me the cheapest access to professional money management assuming that I do not switch or change management companies, or
I elect to purchase my mutual funds using a fee share approach which will average approximately _______% based on the anticipated assets and total makeup of my account. I realize on the mutual funds alone this will be less expensive on average the first 5 years but more expensive thereafter to A shares or front end commission shares (assuming no changing of mutual fund firms), but I wish to have the right to change my investments without incurring new front charges and acknowledge that other services of ___________________ are being provided to me at no extra fee, or
I may elect to do a combination of the first two choices, or
I elect to purchase my mutual funds in a wrap or fee account where my account will be billed at an annual rate of _______% and I will / will not pay 12 b-1 fees in addition to this charge. I acknowledge that using this type of account may cause me to pay this annual rate on other investments I own other than mutual funds which are held in the account.
This would be simple (short enough it can be read and understood), straight forward, and documented.
2.) In addition to one at the same time this is initialed as to the choice there would be a share class fee analyzer example signed or initialed. This would be familiar to the one on your site and would compare the alternatives of A and C shares. This would be a onetime requirement (not every time a fund is bought or sold) which informs the client of potential charges and more clearly explains this to them at the onset.
3.) To prevent abuses on C shares there is a turnover rule the firm must adhere to and if any CDSC are incurred because of not meeting the 12 month rule, they must be returned to the client account at the expense of the offending broker absent some stated exceptions where the broker acted in the clients best interest (must be defined) and or the change was client initiated.
4.) Do not allow competition where firms are allowed to create their own compensation system , this while maybe in some instances will create consumer savings, in the long run will uneven the playing field allow for even bigger abuses and fraud. You as an enforcement agency have the best ability to control this environment if the rules are applied at the fund level and all firms must play by the same rules.
5.) Abolish B shares they are the biggest consumer rip off. Ripe with all of the worst features of both A and C shares.
6.) Limit share classes to A, C, Institutional, and Fee account shares (no 12b-1s) and mandate that no 12b-1 share class can be held more than one week in a fee account (the one week exemption allows to change classes without having to open more than one account to accommodate transfers).
7.) Offer protection to class action law suits and simplify the prospectus and client disclosure information. This would hopefully reduce and simplify shareholder mailings, which they for the most part do not like and do not read. What mailings they do get then would perhaps be given greater attention.
As you can tell I feel strongly about this issue. I would love to have an opportunity to comment more, give real life examples, and provide more insight from a mid westerners point of view who represents everyday working people, not the financial elite. My clients desire the short straight truth not a 50 page prospectus they would need to spend days with and have the help of a lawyer to fully understand. My feeling is if you cant give an adequate disclosure on one to three pages in large print you cant possibly think that you are doing the consumer a service.
Steven M. Elefson
2812 Wedgewood Drive
Jackson, MO 63755