From: W. Hardy Callcott |
I am pleased to submit this comment in connection with the Commission's consideration of Rule 12b-1. I am a partner in the broker-dealer and investment management practices at Bingham McCutchen LLP. I was formerly General Counsel at Charles Schwab & Co., Inc., and before that was Assistant General Counsel for Market Regulation in the Commission's Office of General Counsel. I submit this comment solely on my own behalf, and not on behalf of my law firm or any client. My comment focuses on the suggestion that the Commission require individualized mutual fund fee calculations on monthly or quarterly brokerage statements sent to mutual fund investors. The GAO has made this suggestion in several of its reports, and it was recently mentioned in a speech by a Commissioner. I believe this idea of individualized mutual fund fee calculations would be extremely complex and expensive to implement. Investors would bear the costs of such a requirement, and it would not provide meaningful corresponding benefits to investors. SEC Rule 10b-10(b)(2) requires that most brokerage customers be sent a monthly statement within five business days of the end of each month. Because it may be difficult to distinguish customers who must receive a 10b-10(b)(2) statement from those that do not, and the list of such customers changes from month to month, most major firms in the industry provide a 10b-10(b)(2) statement to each customer every month. Compiling, printing and mailing all of the information necessary for customer statements in this very compressed timeframe is a technologically challenging task. This task requires obtaining pricing feeds from a number of different sources (for different asset types), multiplying the prices against each customer's individual holdings, and adding information about transactions during the course of the past month as well as information about balances and rates. Most broker-dealers must outsource the printing, envelope-stuffing and mailing to printing companies, and most of the major printing companies in the country use their entire capacity in those first five days of the month to service the broker-dealer industry. If the SEC were to add individualized mutual fund fee disclosures to the current customer statement requirements, it would make what is already a complex and difficult monthly statement production process even more unmanageable. Take as an example an investor who owns positions in five mutual funds. Today, the mutual fund portion of that customer's monthly statement requires five calculations: the customer's month-end number of shares multiplied times the NAV on the last day of the month, to calculate the value of each of the customer's five holdings. To add individualized fee calculations would increase the number of necessary calculations by more than thirty times. The firm producing the statement would need to obtain a daily fee calculation from the mutual fund company for each day of the month. Then the firm would have to multiply that fee against the individual's number of shares held for each mutual fund on each day of the month. (An investor may of course buy or sell mutual fund shares any business day of the month, so the individualized fee may vary substantially in different parts of the month depending on the customer's investment in that fund on any particular date. For money market funds, often an investor will have a different number of shares virtually every day during the month.) Then the firm producing the statement will have to add up all of the daily fees for each of the mutual funds in the customers' account. For an investor with five mutual fund positions in a thirty-day month, the number of calculations necessary to produce a month-end statement will increase from five to 160. Moreover, doing these calculations would require a data feed concerning daily fees from every mutual fund available at the firm - a data feed that does not exist today. If the data feed from any mutual fund family failed or was otherwise unavailable (or contained errors), it would jeopardize the timely production of customer statements for the firm's entire customer base. In short, adding a requirement of individualized fee calculations would make customer statements exponentially more difficult to produce. If the Commission were to consider requiring individualized mutual fund fee calculations, the Commission would have to decide what fee or fees to include in that calculation. A recent Commissioner's speech suggested requiring disclosure of individualized Rule 12b-1 fees. I would respectfully suggest that Rule 12b-1 fees, standing alone, are not meaningful to individual investors. Indeed, some mutual funds today pay for shareholder servicing in whole or in part out of Rule 12b-1 fees, while other mutual funds pay for exactly the same shareholder servicing functions out of sub-transfer agent fees, or the fund adviser's reasonable profits, or any combination of the three. Rule 12b-1 fees standing alone do not provide an apples-to-apples comparison even for distribution and shareholder servicing expenses. The fee number that is most relevant to individual investors is the entire operating expense ratio - the full amount the customer is paying in connection with ownership of the fund. (Of course, if the Commission required an individualized calculation of both the OER and the 12b-1 fee, this would increase the number of monthly calculations necessary to put out a statement, for our hypothetical investor with five fund holdings, to over 300.) However, the Commission should carefully consider whether individualized mutual fund fee calculations, even for OERs, are actually valuable for investors at all. I believe they are not. Research confirms the common-sense insight that mutual fund fees are negatively correlated with mutual fund performance - all other things being equal, an investor paying 150 basis points to a mutual fund in fees is likely to underperform an investor paying 100 basis points. (Indeed, low fees are a better predictor of future performance than past performance, which is at best weakly correlated to future performance.) This being said, the most important figure for a mutual fund investor is a standardized number that allows the investor to compare OERs for different funds and different fund companies. It is not helpful to an investor to know that he or she paid $76.39 in fees on 2,963.14 shares of Fund A and $52.65 in fees on 1,443.78 shares in Fund B in a given month: that doesn't allow the investor to compare easily the relative expense ratios of the two funds. Mutual funds are already required to disclose, in their prospectuses, fees in two easily comparable formats: as a percentage of fund assets, and in terms of costs per $10,000 invested in the fund. It is this information that allows investors to comparison-shop, and which encourages funds to keep expenses low. Adding individualized fee disclosures adds virtually nothing to the investor's ability to comparison-shop. Indeed, as the Commission's own investor research has indicated, adding additional information that investors do not find useful actually serves to obscure the important information (standardized fees) and confuses investors rather than enlightening them. In sum, the Commission is correct to reopen consideration of Rule 12b-1. At a minimum, it should update the factors fund boards must consider in approving Rule 12b-1 fees. Probably the Commission should rename 12b-1 fees, a title most investors do not currently understand. In my view, the Commission should continue to allow fund boards to authorize a fee to be paid out of shareholder assets for distribution and shareholder servicing: this practice has allowed the emergence of mutual fund supermarkets which allow enhanced investor choice among mutual funds and enhanced competition among mutual funds. Enhanced investor choice and enhanced competition, in a market such as mutual funds without significant industry concentration and with low barriers to entry, ultimately lead to lower fees (which is why the ICI's statistics demonstrate that the effective operating expense ratio paid by investors, weighed by size of mutual fund, has steadily decreased - even as the median mutual fund fee, counting multiple new market entrants, has remained steady). The Commission should continue to investigate the possibility of a simplified mutual fund "profile plus" prospectus, which will make it clear in an easily readable and readily comparable form, exactly what a mutual fund's fees are. However, the Commission should not pursue the suggestion of requiring monthly individualized mutual fee calculations, which will not add meaningfully to investors' ability to comparison-shop, but will be an operational nightmare and will add substantially to the brokerage custodial costs which must be borne by mutual fund investors. W. Hardy Callcott Bingham McCutchen LLP |