Subject: File No. S7-09-04
From: Robert DeFazio

August 25, 2004


Approximately fifteen years ago I left the securities industry where I served successively as a broker, trader, corporate financial consultant, compliance officer, and board member. Having been in the high technology business since then, I have not had as much contact with the changes in the industry as I would like, but I do keep my eye on some of the bigger changes.

When I oversaw compliance, the clear mandate to be gleaned from the corpus of regulation was that facts surrounding the buying and selling of investment products were to be sufficiently clear such that all the affected parties to a transaction could make an informed choice based on adequate disclosure. I was still in the industry when 12B-1 fees were introduced, and I can recall clearly both the contemporaneous comments of fund wholesalers and brokers alike. At first they were scorned because promoters of 12B-1 funds called them no load funds, making brokers and wholesalers look like a band of thieves in the eyes of their investors. Soon afterward, load fund companies introduced their own 12B-1 funds, and the brokers were quickly re-educated as to the benefits of back-end load funds, the brokers common parlance for 12B-1 funds. Resistance to their sale was still present, however, since the industry was still very right here and right now with respect to the payment of commissions. It took another decade of industry transformation to convert sales representatives whose livelihood was predicated on the immediate payment of commissions into investment advisors who could broaden their notion of fair compensation to include smaller initial fees but more durable payment streams based on assets under control.

After reviewing the comments provided by others with respect to the abolition of 12B-1 fees, it seems obvious to me that the arguments for their preservation may be fairly categorized into a very few groups. They are that their elimination will 1. hamper capital formation, 2. adversely affect small investors, and 3. have a strong negative impact on the mutual fund industry in the form of layoffs due to reduced marketing capabilities.

In reflecting on the SECs long history one thing becomes undeniably clear. The SEC is supposed to be a protector of investors. What, then, provides the greatest protection for investors with respect to 12B-1 fees? One could say that their preservation would best protect investors by allowing affected funds to continue their growth thus assuring liquidity for all investors and cost-effective transactions for the small investor. Avoidance of the attrition of financial services workers seems to be a benefit chiefly confined to the mutual funds industry.

What I believe to be the case is that the financial industry in its undisguised rush to become wealth managers by focusing on existing or imminent retirees, corporate executives, and others of means coupled with its relegation of small to moderate investors to call centers where they receive plainly inferior service cannot then in the same breath contend that 12B-1 funds must be preserved primarily for its own benefit by defraying marketing costs. It would perhaps be a different matter if the delivery of services to all investors were of the same quality, but such is obviously not the case. Why, then, should investors as a class foot the bill for all brokers who sell 12B-1 fund products when they do not derive the same benefits of equal investment advice?

The essential matter before the SEC is whether 12B-1 fees should be permitted to mask the flow and division of funds derived from investors assets. I dont think the practice should be allowed. It is offensive to investors whose legitimate requests for information are, in effect, brushed aside by the practice. It is a legacy behavior that does not conform with more reasoned approaches to regulation whose underlying assumptions are that a more open investment process and more easily accessible, precise information collectively contribute to reduced litigation, greater investor profits, and greater investor satisfaction with the industry representatives with whom they deal.

The financial services industry has never been an altruistic endeavor, but it certainly should be transparent in its processes. After all, it uses the funds of others to achieve its own ends. So, if current regulation requires public companies that receive investor capital to make extensive disclosures concerning their finances and legal matters, why should investment companies and the allied broker-dealer community be exempted from the same kind of disclosure especially in the matter of 12B-1 fees? If brokers gather funds for an investment company, affected investors ought to have the right to know if compensation is being paid to their investment representatives, the frequency with which is paid, and the amount that is paid. Moreover, those facts should be stated in the prospectus using terms that can be readily grasped by the small, unsophisticated investor.

I urge the SEC, therefore, to step up to the bar and to do not what is expedient, but what is right. Providing 12B-1 funds with a regulatory blanket that has the effect of permitting the concealment of the details of its relationships with the broker-dealer community is a covert subsidy of that industry sectors interests. As a regulator, the failure to require investment companies to disclose the payment of commissions labeled under any other name represents a breach of the public trust.


Robert DeFazio