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Rules that Hurt Investors

Rules that Hurt Investors
Ron DeLegge, Editor
April 20, 2009

SAN DIEGO ( – While the Securities and Exchange Commission’s (SEC) big talk of financial regulatory reforms that protect the interests of the investing public clogs the media airwaves, the agency’s recent actions illustrate a very different agenda.

At a recent Palm Desert, CA golf outing that was dubbed an “industry meeting,” Andrew J. “Buddy” Donohue told a group of mutual fund insiders exactly what they wanted to hear. "I believe that it would be wise in the current market environment for us to defer consideration of Rule 12(b)-1 reform for this year," he said. "We should address a few fundamental matters that directly impact investor protection concerns." That evening, local taverns were teeming with great joy at the news mutual fund executives would be celebrating by purchasing free drinks for everyone in the house.

If Mr. Donohue really believes his own rhetoric, then why doesn’t the mutual fund industry’s $12 billion vacuum machine (12(b)-1 fees) count as something that “directly impact investor protection concerns?” Does the SEC really think investors are that unimportant to overlook a multi-billion problem like 12(b)-1 fees?

History of the Fee Nobody Cares about
The 12(b)-1 rule was originally adopted in 1980 to help once struggling mutual fund companies to offset their costs. The fees are a component of a mutual fund’s total expense ratio used for marketing and distribution purposes. The original intent of rule 12(b)-1 fee was to help mutual fund companies to defer their own marketing/distribution costs until they could reach the point of economic of scale.

Today, fee abuses are to be found everywhere.

Take for example multi-billion funds that have already achieved adequate scale who still charge 12(b)-1 fees, not to mention mutual funds that are closed to new investors doing the same. What's the point of collecting marketing and distribution fees for funds that aren't marketing themselves? It's a contradiction of extraordinary proportions. To be exact, $440 million, according to Standard & Poor’s research.

And how about the confusing mess surrounding load and no-load mutual funds?

By its own rules, the SEC allows mutual funds to call themselves “no-load” even though these very funds can charge up to 0.25% in subversive re-occurring 12(b)-1 fees! Millions of no-load mutual fund investors are being chiseled and they don’t even know it.

The Mutual Fund "Toll Booth"
It’s been widely acknowledged 12(b)-1 fees do not add to fund investor’s returns, but subtract from them. But none of it matters to the SEC. They’re preoccupied with more pressing matters, such as locking away small time criminals like Dennis Kozlowski’s ex-gardener. Indeed, the SEC’s recent regulatory history of ignoring pertinent issues while addressing irrelevant ones are firmly established. (Lest I remind you about the agency’s colossal failure to catch the $50 billion sewer worker, Mr. B.M. after multiple friendly encounters.)

Did I forget to mention that mutual fund fees are on the rise even though shareholder’s assets are down?

Marty Whitman, manager of the Third Avenue Value Fund (Nasdaq: TAVFX) confirms this. He told Forbes Magazine, “Having a mutual fund management company is like having a toll booth on the George Washington Bridge all for yourself.” Are mutual fund investors paying attention to any of this? In 2008, Mario Gabelli collected a $46 million paycheck from the GAMCO Investors toll booth (NYSE: GBL) even though fund assets at the firm fell by 33%. The things you can get away with in the name of wealth management! Mr. Gabelli presides over funds such as the Gabelli Equity Trust (NYSE: GAB) and the Gabelli Asset Fund (Nasdaq: GABAX).

In closing, I’d like to offer a word of congratulations to the Investment Company Institute, the mutual fund industry's Don King. For now, you have what you’ve always wanted: A scarecrow (the SEC and an Investment Management Division) that doesn’t know how to scare crows. Enjoy it while it lasts.

Until the SEC can come up with a “unified fee system” that charges one distinguishable price for all cost and services associated with the purchase of fund shares, investors in mutual funds will continue to be victimized. It looks like John Bogle’s “Designing a New Mutual Fund Industry” will have to wait a few more decades. Sorry Jack.

Abolish Rules that Hurt Investors
Let me make it clear: There is absolutely no way to improve 12(b)-1 fees. From dirt they were made and to dirt they should return. The only real solution is not more disclosure, but rather complete elimination. Abolish 12(b)-1 fees today!

This is not to say that financial intermediaries do not deserve to be compensated for their work. They do. However, 12(b)-1 fees aren't the way to do it. I recommend finding a new way to get paid that doesn’t involve subversive payment schemes.

In the meantime, the SEC should do the public a favor by immediately renaming 12(b)-1 fees what they really are: B-52 fees that bomb the portfolios of mutual fund investors. This of course, spurs two more final questions: Do the mutual funds you own contain B-52 fees? Isn’t it time that you found out?

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