By James Hamilton, J.D., LL.M.
According to a recently released transcript of the SEC’s roundtable on Rule 12b-1 fees, Richard Phillips of Kirkpatrick & Lockhart Preston Gates Ellis expressed strong support for externalizing such fees. Importantly, externalization would eliminate what Mr. Phillips believes is the most persistent and misguided criticism of the fund industry, namely that some very sophisticated observers do not seem to understand that 12b-1 fees are really largely a substitute for the front-end load. They condemn it as a hidden subsidy, a view that Mr. Phillips called misguided.
In his view, externalization would provide dollars and cents disclosure at the point of sale and the confirmation, and in account statements; and shareholders would know what they were paying for. Another benefit of externalization would be that directors would not have the duty of determining if a charge is reasonable, which duty makes them uncomfortable. It would also reduce complexity.
While the Kirkpatrick partner believes that the fund industry would be much better off with externalization, he acknowledged that there would be costs, Systems would have to be changed to accommodate each shareholder account. But he added that the fund industry is very sophisticated technologically and could handle it.
In a recent letter to the SEC, the Investment Company Institute raised strong objections to suggestions raised at the roundtable to externalize the fee, assessing it at the individual account level rather than deducting it from fund assets. Proponents have argued that an account level charge would make the fee more transparent and allow investors to more easily make price comparisons, said the ICI, which countered that externalization would increase investors' tax costs, reduce the tax efficiency of funds, and require extensive overhaul of fund operating and recordkeeping systems.