Speech by SEC Commissioner:
"Working Toward Fairness and Transparency in Distribution Costs"
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
July 21, 2010
Today's proposal marks a paradigm shift in the regulatory framework addressing how mutual fund assets may be used to finance distribution. The proposed framework recognizes that investors may be paying more in distribution expenses than they would have traditionally paid in a front-end sales load and seeks to rectify the situation while still balancing the need to compensate fund intermediaries for fund distribution and for the other services they provide.
It is clear that a fund bearing its own distribution expenses presents severe conflicts of interest between a fund and its investment adviser. We recognize that when a fund pays promotional costs, the fund's adviser or distributor benefits because it is not footing the bill but rather it is passing the costs to the fund and its shareholders. Moreover, if the fund's expenditures result in the growth of the fund's assets, the adviser also benefits because of the subsequent increase in the advisory fees it collects.
Currently, we allow funds to offer multiple classes of shares. Each class has different arrangements for the payment of distribution and related shareholder services. Investors in one class of shares have the same investment experience as investors in other classes, except as to the expenses related to distribution and shareholder services. As the release indicates, funds typically offer Class A, Class B and Class C shares. The growth among these share classes is clearly in C shares. In 2009 alone, net new investment in C shares was $37 billion, almost twice the amount of Class A shares. Class C shares are the shares that impose a sales load for as long as the shareholder owns the shares. Accordingly, long-term shareholders in C shares are paying distribution expenses or sales loads for the entire time they hold the shares, making it entirely possible that they may be paying more than if those investors had paid a traditional front-end sales load.
It is also problematic that investors are confused about the nature and amount of so-called "Rule 12b-1 fees." Because a 12b-1 fee charge is deducted in smaller amounts, over longer periods of time, and indirectly from fund assets, such fees are less obvious to investors than a front-end sales load. Additionally, the term "12b-1 fee" causes confusion because it encompasses so many different activities — such as payment for distribution activities, payment for shareholder services, etc. Investors have no way of being able to price out the cost of the services provided because of the payment arrangement.
I support the proposal in front of us today, because it recognizes these conflicts and issues and attempts to directly address them. The new framework would allow shareholders to be charged an ongoing marketing and service fee but would cap any asset-based charge in excess of the marketing and service fee. Additionally, future investors would be protected from the imposition of excessive sales loads. This framework promotes a fairer allocation of distribution costs among investors who invest through share classes by limiting the extent to which one class of shares may bear these costs.
Moreover, the proposal before us would also make these fees more transparent. As a result, investors will be better able to understand the purpose and use of the asset-based distribution fees they may pay.
I want to particularly highlight the proposal that would automatically convert, within five years, existing C class shareholders into a share class that does not deduct an ongoing sales charge. I strongly support this sunset. It does not make sense to rectify the situation for future shareholders while allowing existing shareholders to continue to pay ongoing sales loads for an indefinite period of time. Along the same lines, I have concerns that our current proposal would allow new shares, shares that result from reinvestment of dividends, to incur ongoing sales charges. These shares are not the result of an expenditure of sales efforts and I am concerned that investors will be paying ongoing sales charges on these shares. The release asks for extensive comment on this issue and I look forward to the responses we will receive.
Finally, I would like to thank all of the staff who worked to bring this recommendation before us. I have appreciated your dedication and commitment to this project and I look forward to the work you will do to bring forward recommendations for the Commission to adopt.
I have no questions.