June 13, 2007
Ladies/Gentlemen:
Irrespective of the variously purported and understood original rationales for and logical underpinnings of 12b-1 trailing commissions, as an undeniably "levelized" or "asset-based" aspect of mutual fund distribution cost and compensation, they are highly congruent with the essence of the once lauded and still largely quite valid, "anti-transaction costs" findings and conclusions of the 1995 Tully Commission Report.
To tamper with (specifically to endanger the existence of) this most consumer friendly compensation modality in the name of consumer protection would be logical and regulatory folly in the extreme, and would have very substantial unintended consequences, most if not all of which would be ultimately born, of course, by consumers.
Do these 12b-1 charges sometimes get "skimmed" and pocketed as business windfalls by master custody providers with so-called NTF platforms, or fund supermarkets, and in those instances not wind up serving the originally intended purpose? Yes. All serious industry participants are aware of that institutionally opportunistic practice. And that unintended use of the dollars in question, while perhaps unfortunate (at least from the perspective of non-master custody providers), still constitutes nowhere near a fatal flaw in the Rule.
As a long time professional fiduciary, student of economics, and careful, active observer, I can opine professionally and unequivocally, that, in my considerable experience, no other development in the modern history of the investment company world has done anywhere near as much to mitigate the inherent, transaction compensation practices-based economic incentive for excess activity, as has the apparently fashionably, yet very oddly maligned Rule 12b-1.
The theoretical damage to consumers from the supposed risk of "reverse churning" far more than pales by comparison to the clearly known and readily empirically identified damage/cost of real churning/excess activity.
A second, and perhaps larger and far more (especially to a thinking American) frightening concern with this entire matter under consideration is the extent to which, in truth, it very thinly veils government price control urges. When duly disclosed compensation costs in privately designed and distributed products such as mutual fund shares, may arbitrarily be formally or informally regulatorially viewed as "excess compensation", what can this possibly be reflective of or construed to be, other than attempts at government price controls? Further, how can these very real, even if somewhat subtly imposed and sadly economically misguided, efforts at price control not have the classic unintended consequence of misallocating resources?
Even if with careful introspection, a proponent of abolishing charges and payments under Rule 12b-1, will honestly concede to himself or herself that price fixing urges are indeed substantially, even if unconciously, at the heart of the motivation, and that such government price fixing is valid policy, then I can only implore you to limit the extent to which you act on that destructive line of thought, and ask you to advocate only for limits (or lower ones) on 12b-1 charges, rather than for their total abolition. That way, the unavoidable damage of this type of policy move would at least be lessened.
I implore you to please not read "market failure" (and therefore "clear indication for regulatory fix") into a situation where such failure, especially measured at a "net" level, truly does not exist. In fact, the converse is the case. Overall, Rule 12b-1 really is a good case of a market success that is curiously codified in regulation.
Thank you very much for reading and thoughtfully considering these comments.
Guy Cumbie