12(b)-1 Fees May Become Extinct

By Lisa Valentine

Mary Schapiro, SEC Chairman, is turning her attention to 12(b)-1 fees – those fees that investors pay to brokers and financial advisors for mutual funds. “We must critically rethink how 12(b)-1 fees are used and whether they continue to be appropriate,” said Schapiro at the Consumer Federation of America’s Annual Financial Services Conference.

These pesky fees are automatically deducted from mutual funds to compensate securities professionals for sales and services provided to mutual fund investors. And these fees are no small change: in 2008, brokers and advisors collected more than $13 billion in 12(b)-1 fees. In 1980, when the fees were first allowed, they amounted to a few million dollars. Clearly the mutual fund industry saw an opportunity for increasing revenues and they ran with it.

Isn’t that what capitalism is all about?

Schapiro feels that these fees are sneaky add-ons that investors have no idea they are even paying. (In the SEC’s world, investors are very dumb indeed.) Eliminating these fees dovetails on several of the SEC’s other pet peeves – that broker-dealers are held to a lower fiduciary standard than registered investment advisors and that financial products are difficult for the average investor to understand. The SEC would like to see a higher fiduciary standard applied to both groups of professionals. The SEC is also putting together a simplified "summary prospectus" for variable annuities that it hopes will help investors understand what an annuity really is and why it may not be an appropriate retirement investment product.

Back in October, when the SEC first announced that it was looking into 12(b)-1 fees, the Financial Services Institute had this to say:

“As financial advisors to middle-class Americans in small towns throughout the U.S., independent financial advisors know that 12b-1 fees provide a tax efficient means to insure investors receive the service and support they need to achieve their financial goals. As a result, FSI believes that the consequences of eliminating or drastically altering the Rule would be disastrous to investors and, therefore, should trump all academic discussions of the relative merits of the Rule.”

How financial advisors can make a living if they don’t charge fees is a mystery. We can understand if the SEC was advocating for increased disclosure of these fees, but they are suggesting eliminating these fees altogether. There’s no timetable for these suggested fee changes to occur, other than sometime in 2010. Hopefully the SEC will take some time to rethink its position on these fees and come to a better solution than banning them.



Australian PJC recommendations for Financial Advisors

On 24 November 2009, Investor Daily reported that the Parliamentary Joint Committee (PJC) on Corporations and Financial Services Inquiry into Financial Products and Services in Australia had released its recommendations. The recommendations focused on, but were not limited to, financial advising. 

The most significant recommendations are detailed below. The recommendations will require changes to legislation, regulations, regulator powers and an increased reliance on industry associations. Key recommendations are:

• Recognition the fiduciary duty by financial planners to put the interests of their clients first
• Overhaul of commission payment system to avoid conflict of interests and volume bonuses
• Making the cost of financial advice tax deductible for consumers.
• ASIC to work together with the industry to form a professional standards board that advisers would be required to join. The body would establish, monitor and oversee competency and conduct standards.
• ASIC to be resourced to perform risk-based surveillance of the advice provided under an Australian financial services licence.
• Extending ASIC powers to remove individuals and licensees from providing financial services.
• The government to investigate options for a last resort compensation scheme

These recommendations were the result of a significant consultation process and have been welcomed by many industry associations. As reported in Investor Daily’s article, FPA chief executive Jo-Anne Bloch said the recommendations will improve professional standards in the industry. "Recognising that duty of care is a fiduciary duty enshrined in law will lift the conduct and standards of the industry. Giving ASIC risk-based surveillance powers is proactive regulation," Bloch said.

For further information please see PJC Article

Hong Kong SFC Proposals to enhance investor protection released

Following the Lehman mini bond scandal in Hong Kong where large numbers of investors appear to have been sold inappropriate financial products, regulators have been going through a process of analyzing what went wrong in order to consider new procedures. A short while ago the Hong Kong Monetary Authority, which regulates banks, set out a number of new rules for those institutions regarding sales and suitability.

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FSA details the enhanced standards people can expect from all investment advisers

The UK FSA has published proposals which they say are to build people’s trust and confidence in the retail investment market. The changes, which will take effect from the end of 2012, are aimed at improving outcomes for savers and investors by enhancing the quality of advice they receive, and prepare both consumers and the industry for the future.

In particular, the FSA is consulting on rules to ensure that:
· Independent advice is truly independent and reflects investors’ needs;
· People can clearly identify and understand the service they are being offered;
· Commission-bias is removed from the system – and recommendations made by advisers are not influenced by product providers;
· Investors know up-front how much advice is going to cost and how they will pay for it; and

All investment advisers will be qualified to a new, higher level, regarded as equivalent to the first year of a degree.

The developments are likely to have an effect in Asia as the SFC in Hong Kong typically watches closely the developments in the UK.