Subject: File No. S7-09-04
From: Scott T Hanson, CFP

March 30, 2004


Proposal S7-09-04 that would do away with 12b1 fees entirely would be a major mistake. I believe there needs to be greater disclosure, but eliminating the compensation to monitor an investors portfolio would be detrimental to investors. The investors would receive no on-going advice from his or her broker or advisor.

The mutual fund industry is about to go through the largest makeover since the creation of the mutual fund in 1924. Many practices at the nations largest fund companies have been reprehensible. Brokers and other financial intermediaries have cut all kinds of back-room deals with fund companies that have not been disclosed. And shareholders have paid sales charges and fees that have been excessive.

While it is clear that changes need to be made within the industry, I am concerned that some proposed new regulations could harm mutual fund investors by increased fees and taxes.

To provide some background, I am a principal in a Registered Investment Advisory firm as well as a partner in a Broker/Dealer firm. I not only meet with individual clients on a regular basis, I also have a consulting firm that teaches other brokers and financial planners how to run their businesses. Registered Rep Magazine and Research Magazine, which are industry periodicals, listed me as one of the Top 50 brokers in the nation this past year.

As a financial advisor, my job is to help individuals with their financial planning and investment decisions. Clients come to our firm seeking direction with their investments. They are tired of trying to make money trading stocks and come to us for help in total wealth management.

One of the main investment products our firm uses are mutual funds. Mutual funds can be sold to clients either directly from a fund company of through a financial intermediary, such as a bank, brokerage or investment advisory firm. According to a recent survey by Tiburon Associates, more than 80 of all mutual funds are sold through a financial intermediary.

The most cost-effective method for an individual to purchase a mutual fund is to buy a fund directly from a mutual fund company. However, this is not always the most profitable, given the fact that many individual investors tend to buy the hot funds at the wrong times just look at all the internet funds sold in the late 90s.

Investors, who hire the help of professionals, pay for that help in a variety of ways. Many brokers sell investors mutual funds that pay the broker an up-front commission. These types of funds, typically known as A shares, charge the investor a sales commission, or load, of up to 5.75. This commission is deducted from the investors deposit and is paid to the broker.

Mutual fund companies devised a strategy whereby a broker can receive his or her up-front commission, but the investor never sees it coming. This fund type, known as B shares, have no up-front commission, but add an additional 1 fee to the cost of the mutual fund. The additional fee is known as a 12b1 fee. To ensure that the mutual fund recoups the commissions paid, the B share carries a surrender charge if the fund is sold within six years. The investor has to lock his or her money up for six years.

Obviously there can be many conflicts of interests with both A and B share funds. When an investor uses a broker who sells A and B share funds, the broker is only compensated when a transaction is made. The broker has no incentive to monitor the account after the purchase has been made. In fact, any change the broker might make to the fund could result in another sales charge paid by the investor and another commission paid to the broker. The broker must spend his or her time finding new investors to generate new commissions in order to stay in business. Spending time with existing investors will lead him or her to bankruptcy.

As a financial planning firm, we realized the conflicts with both A and B share funds. In 1993, we began using a system whereby we used no-load funds funds that pay no commissions and charged the investors an annual fee of 1 to 1.85 to monitor and manage their accounts. This system had several benefits. Our clients were not paying us based upon transactions, we had the flexibility of moving from fund to fund without the investors paying commissions and we had a vested interest in growing our clients money as their accounts increased in value, so did our income. If their accounts fell in value, so did our income.

The management of no-load funds with the annual fee to our clients had a couple of drawbacks: 1 many funds carried a 12b1 fee of at least .25, which led to a high overall cost to the clients and 2 our management fee was not tax deductible. Only fees that exceeded 2 of someones Adjusted Gross Income could be deducted.

The problem with lack of tax deductibility was a major problem for us. For example, our clients could receive a 1099 for 2,000, which had to be reported as taxable income. At the same time, our clients may have paid 2,000 in management fees, which were not tax deductible. The client could finish a year with no changes in his or her portfolio, but could get stuck with a tax bill of several hundred or several thousand dollars.

In 1994 we found a solution to our problem. The mutual fund industry created a new type of share class, the C share. With the C share, the investor did not pay any up-front commissions, nor was his or her money tied up for several years. In fact, the C share was similar to the no-load with just two major differences: 1 the C share charged a 1 fee if sold in the first 12 months and 2 the C share levied an additional 1 fee, which was paid to the broker each year.

Using C shares with our clients enabled us to reduce the overall management fee to the client while reducing our clients income taxes. We found that the total portfolio cost of using C shares was less than using no-load funds while adding our management fee. We were able to provide the same ongoing financial advice while reducing the total investors fees.

Our clients tax bills were reduced when we began using C shares. Because the 1 management fee is levied at the fund company in the form of a 12b1 fee, and not from the investment advisor, the fee is deducted prior to any reportable interest or gains. Investors no longer needed to worry about paying taxes on a portfolio that provided little or no real gain.

Today, the vast majority of our clients portfolios are set up in C share mutual funds. We explain to our clients that the fund companies levy a 1, 12b1 fee and we receive that fee to manage the account.

Because our revenue is based upon the assets we manage, not transactions, we spend our time with our existing clients before we look for new ones. We can recommend a change from one fund to another without our clients having to pay a commission. And because we are not compensated based upon transactions, our clients can know that our recommendations are not based upon our income needs.

The current system must be overhauled. I see no benefit for A or B shares. With these share classes, brokers are paid commissions for selling products, not for monitoring accounts. But C shares are in a different class altogether. They align the financial interests of the broker to the clients portfolio. The broker has a financial incentive to grow the account, not generate commissions and added fees that will drag down the portfolio performance.

Eliminating any up-front commissions from the sale of mutual funds would be a good thing for investors. In an ideal world, investors seeking advice on his or her mutual fund investments would have a pay as you go fee, rather than a commission.

Eliminating 12b1 fees would strip away any broker / advisor compensation for the ongoing management of an account. Unless a broker added an additional management fee, there would be a disincentive for a broker to monitor an account. A broker could only generate revenue if he or she made transactions in a clients account. It wouldnt matter if the client made of lost money the broker would be compensated by the transaction alone.

The C share is the best way for an investor to pay for professional advice on his or her mutual funds. Up-front commissions are avoided, long-term commitments are eliminated, taxes are reduced and the broker/advisors goals are the same as the investors growing the investors nest egg.

If 12b1 fees are eliminated, another form of fee must take its place to pay brokers and advisors for ongoing advice. The fee should be deducted from the fund company for tax purposes, but should be disclosed more fully than current 12b1 fees.

I can be contacted at the address and phone number listed below for further discussion or comment.

Scott Hanson, CFP, ChFC, CFS
Hanson McClain, Inc.
3620 Fair Oaks Blvd., Ste. 300
Sacramento, CA 95864

916-482-2196 phone
916-483-9661 fax
shanson@moneymatters.com