File No. S7-09-04; A.G. Edwards & Sons, Inc. Comment LetterFrom: Shay, James [Shayjw@AGEDWARDS.com] Sent: Monday, May 10, 2004 4:50 PM To: 'rule-comments@sec.gov' Subject: File No. S7-09-04; A.G. Edwards & Sons, Inc. Comment Letter Jonathan G. Katz, Secretary Via Electronic Mail U.S. Securities and Exchange Commission 450 Fifth St. N.W. Washington D.C. 20549-0609 rule-comments@sec.gov Re: File No. S7-09-04, Proposed Amendment to Rule 12b-1 Prohibiting the Use of Brokerage Commissions to Finance Mutual Fund Distribution Dear Mr. Katz: I am writing on behalf of A.G. Edwards & Sons, Inc. ("A.G. Edwards") to comment on the rule proposal referenced above (the "Proposal") regarding amendments to rule 12b-1 that would prohibit the use of brokerage Commissions to finance mutual fund distribution. While A.G. Edwards recognizes the importance of addressing concerns raised by the SEC regarding directed brokerage arrangements, we urge the Commission to require enhanced disclosure requirements for directed brokerage, or in the alternative, to adopt a narrowly tailored rule that addresses these concerns without negatively impacting broker-dealer competition in connection with portfolio trading activity or mutual fund distribution. We also ask that the SEC not adopt the other potential amendments discussed in the Release, including a complete ban on 12b-1 fees or the deduction of 12b-1 fees from individual shareholder accounts. We support the views set out in the comment letter submitted to you by the Securities Industry Association ("SIA") and we wish to expand on selected issues discussed in that letter. Specifically, A.G. Edwards agrees with the SIA that improved disclosure of directed brokerage arrangements is preferable to the Commission's Proposal. The unintended consequences associated with a blanket prohibition on directed brokerage may have a serious impact on investors. For instance, funds may inadvertently be encouraged to select trading partners from a smaller pool of broker-dealers, thereby inhibiting their ability to obtain the best execution possible for fund shareholders. Additionally, investors may find that they have a more limited choice of funds available from their broker-dealer if the broker-dealer is forced to terminate selling agreements in order to maintain trading relationships with those funds. Consequently, there may be less competition among broker-dealers regarding portfolio-trading activities and mutual fund sales, leading to higher commission rates. For these reasons, we believe that enhanced disclosure of directed brokerage arrangements in the fund prospectus and statement of additional information would be preferable to implementing a ban on this activity. Alternatively, if the SEC believes that a prohibition must be implemented, we agree with the SIA that any rule adopted by the SEC should clearly communicate that a fund is not prohibited from directing brokerage business to a broker-dealer with which it has a selling agreement. Without such clarification, investors would be more likely to be negatively impacted as described above. We strongly urge the SEC not to adopt any further amendments to rule 12b-1 at this time, particularly an amendment that would completely prohibit 12b-1 fees. As outlined in the SIA's comment letter and White Paper entitled "Mutual Fund Distribution and Shareholder Servicing Practices", 12b-1 fees provide for a number of valued processing and administrative services provided by broker-dealers to fund shareholders. Prior to the adoption of rule 12b-1, up-front sales loads for mutual funds were approximately 8%-8.5%. Today, class A shares typically have a 4%-5% up-front load, with a .25% annual 12b-1 fee. This fee structure supports the ongoing servicing of shareholder accounts, which, in turn, encourages long-term investment in mutual funds. The lower up-front sales charge also allows the shareholder to invest a greater percentage of funds in the market at the time of purchase. Additionally, because of the complexity of certain aspects of mutual funds (e.g. breakpoints, different share classes, etc.) regulators including the SEC have recently proposed rules for additional requirements to be met during the mutual fund sales process. The revenue stream provided by 12b-1 fees helps to offset the additional time and cost associated with the distribution and sale of these products. The elimination of this revenue stream could lead to an increase in sales charges to cover these additional costs of distribution, and possibly a reduction in some of the processing and administrative services currently provided to mutual fund shareholders. The Commission's alternative proposal requiring the deduction of 12b-1 fees from individual client accounts presents a significant concern regarding fairness to individual fund shareholders. As discussed above, and more fully in the SIA White Paper, broker-dealers provide a broad array of services to a fund's shareholders, as a whole. The 12b-1 fees that support these services cannot be allocated to specific accounts in a manner that would be fair to these individual clients. Therefore, A.G. Edwards joins the SIA in its belief that any such amendment not be adopted. We ask that the SEC adopt an enhanced disclosure regimen using the current prospectus and statement of additional information to address directed brokerage activity. Alternatively, we would support a narrowly tailored rule that protects the fund company's ability to utilize broker-dealers with which it has selling agreements for portfolio transaction executions. Further, we urge the SEC not to adopt a blanket prohibition on 12b-1 fees or an amendment requiring that 12b-1 fees be deducted from individual accounts. Thank you for the opportunity to comment on this important proposal. Respectfully Submitted, Mike Scafati Senior Vice President A.G. Edwards & Sons, Inc. ------------------------------------------------------------------------------ A.G. Edwards & Sons' outgoing and incoming e-mails are electronically archived and subject to review and/or disclosure to someone other than the recipient. ------------------------------------------------------------------------------