Industry Wary of SEC 12b-1 Proposal

Today marked the deadline for public comment on the SEC's proposed rules regarding 12b-1 fees.

With many of the comments in from large investment managers and brokerage firms, the SEC's proposal is facing fierce opposition from many corners.

The fund industry's trade association, the ICI, levied one of the strongest rebuttals to the proposed rules:

"[W]e believe that the proposal places the agency in the inappropriate role of a ratemaker, and is far more extensive and intrusive than necessary. [The proposed changes] would be done at a great cost that would be reflected in higher expenses borne by shareholders. And the benefits are uncertain and quite possibly illusory."

As Morningstar reported in July, the Commission voted unanimously to propose rules that would bring changes to funds' marketing and distribution fees, which are known as 12b-1 fees. The proposal aims to curb fees on fund share classes that can be significantly more costly for long-term shareholders, such as Class C shares, and could lead to changes in the ways fund supermarkets disclose their distribution costs to shareholders.

Under the proposal, brokers would also be allowed, for the first time, to compete on the sales charges they levy clients. Currently, all brokers are required to charge the same sales fee as specified in a mutual fund's prospectus.

Fund families including  BlackRock (BLK),  AllianceBernstein (AB), Dreyfus, Pioneer, and MFS, among others, have submitted letters to the SEC regarding the proposed rules. (Read Morningstar's letter here.)

In its letter, the ICI urges the SEC to rethink its proposed cap on ongoing sales charges. "We strongly disagree that in every context, a 12b-1 fee that exceeds 25 basis points is the functional equivalent of a front-end sales charge. In many instances a hard cap on aggregate compensation is not warranted. The services in those instances continue; the compensation must as well."

The ICI is also concerned about the timing of the proposal.

BlackRock, the ninth-largest mutual fund manager with more than $110 billion in assets, writes that eliminating Class C shares would hurt smaller investors: "For smaller investors who want assistance from financial intermediaries but who can not afford to invest through a wrap account, are still able to access financial intermediaries using C shares. If the proposed rules take effect, this model will be impacted, and smaller investors either will be driven to wrap account programs that are more expensive than C shares, or may be forced to forego professional investment assistance entirely if C share programs are phased out." The ICI levied a similar argument against Class C Shares in its letter.

With about $25 billion in Class C shares, BlackRock is the third-largest manager of Class C shares, behind American Funds and Franklin Templeton. The company supports renaming 12b-1 fees but opposes allowing broker-dealers to set fund commission rates because it says the change would be costly to implement.

Dreyfus is pushing the Commission to defer further consideration of the proposal because of "the disruptive and transformative effects that the sales charge limitation and associated conversion feature would have on the total mutual fund distribution process."

In its comment letter, AllianceBernstein warns of the unintended consequence the proposal would have on Class R shares that are used in some retirement plans. "Due to the difficulties in offering Class R shares under the SEC's proposed sales charge equivalent approach, this Class of shares will in all likelihood no longer be available for small retirement plans. We suggest that the SEC consider the potential adverse effects of its proposals on these smaller retirement plans and provide more flexibility for structuring appropriate fees for retirement plans."

To see a full list of the public comments, please click here.