Feb. 26, 2004
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549-0609
Dear Mr. Katz:
Thank you for taking comment on this rule proposal. The Commission has identified a crucial issue for mutual fund investors and this release describes well the conflicts and issues involved in directed brokerage. My comments to the Commission's questions follow:
- Are our concerns about this practice justified? YES
- Are there alternative measures that we could take to address the use of brokerage commissions to finance distribution? A BAN IS THE BEST APPROACH. EFFECTIVE DISCLOSURE IS VIRTUALLY IMPOSSIBLE DUE TO THE DIFFICULTY OF MEASURING TRADING COSTS.
- Would brokerage commissions be reduced by eliminating the use of commissions to pay for distribution? Would there be greater competition in commission rates? YES AND YES. TRULY COMPETITVE EXECUTION SERVICES WILL FLOURISH BY BEING ABLE TO OBTAIN MORE FUND BUSINESS.
- If we ban this practice, would the primary effect be to increase brokers' demands on advisers to make payments out of their assets, i.e., revenue sharing? Are we correct in our assumption that properly disclosed revenue sharing payments present more manageable conflicts for funds and broker-dealers? INCREASED REVENUE SHARING PAYMENTS OUT OF ADVISERS' ASSETS MAY RESULT. YOU ARE CORRECT IN THAT, WHEN FULLY DISCLOSED (INCLUDING PUBLIC DISCLOSURE--NOT JUST AT POINT OF SALE AND ON CONFIRMS), REVENUE SHARING PAID BY THE ADVISER IS A MANAGEABLE CONFLICT.
- Should we increase or revise the disclosure requirements concerning the use of brokerage commissions to pay brokers for selling fund shares? Instead of banning directed brokerage, is there a disclosure-based alternative that would adequately address the concerns discussed above. If so, what should be the format of these disclosures? Where should these disclosures be located - in the prospectus, the SAI, or the annual reports? A BAN IS THE ONLY WAY TO DEAL WITH THESE CONFLICTS.
- Should the disclosures be quantitative (e.g., discuss the amount of brokerage commissions) or qualitative (e.g., discuss the nature of the arrangements and the potential conflicts of interest), or both? Could a single quantitative measure accurately disclose the costs under the many different arrangements through which brokerage commissions are used to pay for distribution? SUCH DISCLOSURE WOULD BE CONFUSING AND DO LITTLE TO MITIGATE THE CONFLICTS.
- Would the disclosures enable shareholders, either directly or based on assessments by investment analysts, to choose between funds that engage in these types of arrangements? NO.
- What costs would a fund likely incur in making these disclosures? COSTS COULD BE SUBSTANTIAL, AND BE ESTIMATES IN MANY CASES. A BAN IS REQUIRED.
- Should we revise the disclosure requirements and ban the use of brokerage commissions in the manner described above? Should we revise the disclosure requirements and ban only certain types of arrangements under which brokerage commissions are used to finance distribution? IMPLEMENT A COMPLETE BAN. FUNDS SHOULD DIRECT TRADES FOR ONE REASON ONLY-BEST EXECUTION/LOWEST COST.
- Is it appropriate to require funds that execute transactions through their selling brokers to implement policies and procedures to ensure that distribution considerations do not affect execution decisions? YES.
- Is the scope of the proposed policies and procedures appropriate? Should we include different or additional objectives? YES
- Would these policies and procedures be effective in preventing funds and broker-dealers from circumventing the ban on paying distribution-related expenses with brokerage commissions? YES
- Should we adopt other measures to help the fund monitor the use of fund brokerage? The rule would require the board of directors to approve the policies and procedures. Should we also require the board of directors to monitor the fund's adherence to the policies and procedures, or to approve the allocation of brokerage? NO … Should we require the fund's adviser to report to the board on its decisions regarding brokerage allocation? NO … Are there other measures we should require the board to take to ensure that brokerage decisions are not influenced by brokers' distribution efforts? NO
- Should we require a fund's chief trading officer (or another official of the fund or its adviser) to certify periodically that the selection of brokers to execute the fund's portfolio securities transactions was made without taking into account the brokers' promotion or sale of shares issued by the fund or any other fund? YES.
- Should we include a safe harbor in the rule for funds that execute portfolio securities transactions with a selling broker? PROBABLY NOT. FUNDS SHOULD HAVE FLEXIBILITY IN COMPLYING; SAFE HARBORS ARE OFTEN TOO RESTRICTIVE AND/OR INVITE CHEATING … If so, what conditions should we include in the safe harbor? Would the absence of a safe harbor affect the ability of funds to obtain best execution? ABSENCE OF A SAFE HARBOR WOULD NOT AFFECT BEST EXECUTION. FUNDS SHOULD BE GIVEN ROOM TO DEFINE BEST EXECUTION AND CHOOSE PROVIDERS, INCLUDING SELLING BROKERS. SIMPLE DOCUMENTATION SHOULD WORK. THE PRINCIPLE BEHIND THE RULE IS STRAIGHTFORWARD.
- We request comment on these ideas, particularly from shareholders who pay 12b 1 fees and fund directors who are charged with supervising funds' 12b-1 plans. Would a shareholder account-based approach make sense? I AM A SHAREHOLDER PAYING 12B-1 FEES. THIS APPROACH WOULD BE AN IMPROVEMENT OVER THE CURRENT SYSTEM. BETTER YET, THE RULE SHOULD BE RESCINDED.
- If we were to rescind the rule, what would be the consequences for funds, fund shareholders, fund advisers, and brokers that sell fund shares? How would elimination of the rule affect the aggregate amount of shareholder expenses? What alternate methods of financing distribution would funds and advisers use? THE RULE SHOULD BE RESCINDED. CONSEQUENCES WOULD BE MINOR. COSTS WOULD BE SHIFTED TO FAIRER AND MORE TRANSPARENT METHODS. IDEALLY, RECISION WOULD BE ACCOMPANIED BY FULL DEREGULATION OF MUTUAL FUND PRICING, I.E., THE REPEAL OF SECTION 22(d) OF THE ICA. FULLY NEGOTIABLE, TRANSPARENT COMMISSIONS AND FEES, AS IS DONE WITH INDIVIDUAL EQUITIES, WOULD BENEFIT CONSUMERS AS WELL AS THE BROKERAGE AND FUND INDUSTRIES.
- Should the fund's adviser or principal underwriter pay all promotional expenses, or are there certain distribution expenses that should be paid with fund assets? NO MARKETING, DISTRIBUTION OR PROMOTIONAL EXPENSES SHOULD BE PAID OUT OF FUND ASSETS.
- Funds often pay for administrative services provided by third parties with asset-based fees.73 If we were to propose to rescind rule 12b-1, should we also propose restrictions on the use of asset-based fees to ensure that distribution expenses are not improperly characterized as, e.g., shareholder account servicing expenses? THE COMMISSION SHOULD CONSIDER BANNING ASSET-BASED FEES FOR ADMINISTRATIVE PURPOSES. IS THERE NOT A CONFLICT WHEN FUNDS USE SHAREHOLDER ASSETS TO PAY INFLATED PRICES FOR RECORD-KEEPING SERVICES (OMNIBUS PROCESSORS)? IT'S ANOTHER FORM OF PAYOLA THE SEC MUST ADDRESS. MAKE FUNDS PAY FOR THESE SERVICES THEMSELVES, AND THE COSTS WILL COME DOWN.
- If we were to rescind rule 12b-1, would particular types of funds, such as funds with fewer net assets or newer funds, be disproportionately disadvantaged? NO. FUNDS RISE OR FALL ON THEIR OWN. GETTING CUSTOMERS TO PAY FOR MARKETING COSTS IS A DUBIOUS BUSINESS MODEL.
- How would rescission of rule 12b-1 affect distribution arrangements, e.g., fund supermarkets and other arrangements that anticipate the receipt of 12b-1 fees? ADVISERS/DISTRIBUTORS WOULD PAY OUT OF THEIR OWN POCKETS IF THE DISTRIBUTIONS SERVICES ARE OF VALUE.
- If we rescind the rule, should we propose a new rule that would prohibit the use of fund assets to pay for sales and distribution expenses? YES, IF SUCH A RULE IS NEEDED.