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Fund Spy

Is 12b-1 on the Chopping Block?

Our comments on the SEC's proposal to amend the 12b-1 rule.

The Securities and Exchange Commission has struck a nerve.

The SEC recently proposed a new rule that would prevent mutual funds from paying for distribution of their shares with mutual fund-brokerage commissions. Mutual funds that do this allocate security trades made by the funds to brokers who, in exchange for the lucrative trading commissions received, agree to sell shares of the fund to the investing public. We think the practice should be banned, and we're not alone. Industry participants from various walks of life, including Fidelity Funds' board of trustees, Morgan Stanley, and the Investment Company Institute, all support the proposed ban.

The reasons for banning directed brokerage are clear. First, the practice means that brokers have incentive to put investors in those funds that send them the most trading business, as opposed to the funds that are most appropriate for the investors. Second, generating more trading commissions ratchets up the incentive for brokers to sell the fund, which helps fund management companies grow their earnings. Thus, directed brokerage gives funds an incentive to trade more rather than less, which generates trading costs and taxable distributions for investors.