Page 32 - Investment Advisor March 2022

“The result would be that the best Then, more recently, the SEC actions migrate away from product-derived
actively managed funds would only be have applied the duty of best execu- compensation, and toward fee-based
available to institutions and high-net- tion (which brokers possess), which is a accounts, the marketplace will become
worth investors. For better or worse, 12b-1 quasi-fiduciary (limited fiduciary) duty.” more competitive.”
fees — highly regulated and supervised The only way dual registrants “who have James Lundy, partner at Faegre
by boards — is the lesser of all distribu- clients in investment advisory accounts can Drinker’s Chicago office, and a former
tion compensation evils,” he maintained. recommend funds with 12b-1 fees, without SEC attorney, said he’d be very sur-
Aron Szapiro, Morningstar’s head of getting in trouble (or at least ‘gray areas’) is prised to see the SEC tackle a 12b-1 fee
retirement services and policy, added when the 12b-1 fees are rebated back to the rulemaking this year.
that he also sees “a continued long- client (such as by lowering the investment “The 12b-1 fee area may be one of the
term decline in flows to share classes advisory fee),” Rhoades explained. “This SEC’s greatest ‘regulation by enforce-
with 12b-1 fees.” However, Morningstar rebating makes the billing process prone to ment’ successes, from the SEC’s per-
remains “concerned about other kinds errors, however — which in turn could give spective,” Lundy said. “So it is not at all
of revenue sharing that is often not rise to regulatory action.” a surprise that the majority of long-term
disclosed with much specificity, mutual fund gross sales now go
and could also create conflicts.” “Distribution channels will not to no-load mutual funds with-

the industry taking notice of the
DUAL REGISTRANTS AND sell to retail investors without out 12b-1 fees. This is due to
12B-1 FEES compensation, and most retail 12b-1 fee self-reporting initiative
Brokers use Class C shares, from 2018 and proactively revis-
quite often, as well as class A investors won’t pay a load. … ing practices accordingly.”
shares, Rhoades said. Class C Alex Russell, managing direc-
shares charge 12b-1 fees, up to The SEC doesn’t like them, but tor, White Collar, Regulatory &
1% a year. Class A shares charge what’s the alternative? If the Internal Investigations at Bates
a commission of up to 5.75%, Group, agreed that as a result
with breakpoint discounts for SEC just banned 12b-1 fees, of the share class initiative “and
larger investments. These shares the retail investor would have various carry over matters,
also may charge 12b-1 fees, up to firms are focused on reducing
0.25% annually, he explained. access to fewer products.” or eliminating the use of 12b-1
“Nothing is wrong from a fee paying share classes despite
regulatory standpoint with the —Todd Cipperman, Cipperman the clear allowance of those fees
sale of such,” Rhoades said. Compliance Services by law.” As a result, “’regulation
However, “the difficulty comes by enforcement’ is a reasonable
when a broker is a dual regis- description of the recent activity.”
trant, as many are.” 12B-1 FEE REPEAL AHEAD? Cipperman disagrees. “It’s a false
Then, two questions arise: First, While the SEC examined 12b-1 fees just accusation in this area” to say the SEC is
Rhoades said, “are you choosing the over a decade ago, “I would anticipate engaging in regulation by enforcement,
arrangement that is in the ‘best inter- that the SEC move, at some point in the he said. “The SEC has been very clear
ests’ of the customer or client?” In other next few years, to again revisit 12b-1 fees. about how to approve and pay 12b-1 fees.
words, he said: Would the client be bet- A progressive SEC would likely repeal There have been rules, FAQs, speeches,
ter off buying mutual funds in a broker- 12b-1 fees,” Rhoades maintained. reports, etc. The law is pretty clear. I
age account, or paying 12b-1 fees in an Brokers, Rhoades continued, should don’t have a particular issue with the
investment advisory account? “not be building a practice around 12b-1 SEC’s enforcement program in this area.
Second, “if the dual registrant is using fees, given the likelihood of their ter- We don’t need more rules.”
an investment advisory account (as an mination by the SEC at some point in Ken Joseph, head of the Disputes
RIA) for a client, and receiving a fee the future.” practice at Kroll, noted that “regulation
directly paid by the client, can a 12b-1 fee He contended that it’s “far better by enforcement in lieu of rulemaking,
be justified?” he continued. “Typically, for brokers to move toward fee-based guidance, or precedent has been a famil-
no, as 12b-1 fees don’t add any value to accounts, billing clients directly via one iar refrain by some that have landed in
a client,” Rhoades said. “The SEC has of several different types of methods the regulatory crosshairs.”
gone after dual registrants for having (AUM, fixed annual fees paid quar-
clients invest in funds with 12b-1 fees, terly or monthly, hourly, project-based Washington Bureau Chief Melanie Waddell
on the basis of inadequate disclosure. flat fees, etc.). As brokers continue to can be reached at [email protected].

30 INVESTMENT ADVISOR MARCH 2022 | ThinkAdvisor.com