To read brokers' comments about a possible new mutual fund rule, you'd think the Securities and Exchange Commission was proposing to help Wall Street fleece small investors.
In reality, the SEC is pushing for modest limits, and a bit of truth in labeling, on certain mutual fund fees. It could, and should, go further.
Even a modest fee limit, though, has the brokers screaming.
James Hergenroeder, a Wells Fargo Advisors representative in Greensburg, Pa., tells the SEC that "the unintended consequence will be higher overall fees for investors that can get service, and the abandonment of millions of older investors with no one to turn to for help."
Hunter Bailey of Sacramento, Calif., worries about the venality of his fellow brokers. They might churn clients' accounts to make up for the lost revenue, he tells the SEC.
These brokers are defending a 30-year-old rule that collected $9.5 billion in fees last year, and one that has been stretched far beyond the SEC's original intent.
Rule 12b-1, as it's called, lets funds charge up to 1 percent a year for marketing costs. In reality, most of the money goes to compensate salespeople. The arrangement allows funds to be promoted as "no-load," even when large sums are moving from the investor's pocket to the salesperson's.
The SEC wants to clearly label the amount that's paid to brokers an "ongoing sales charge," and print the amount on every customer's statement.
The proposal also would make the sales fee go away when it has collected an amount equal to a traditional front-end load. If a fund has one class of shares with a 5 percent load, and another with a 12b-1 fee of 0.5 percent, it could impose that fee for only 10 years. (At least that's a simple interpretation of the rule. The actual math may be more complex.)
Russel Kinnel, Morningstar's director of fund analysis, likes the disclosure change but says the proposal "is kind of an acceptance of reality." In other words, it rocks the boat as little as possible.
Fund supermarkets, operated by the likes of Charles Schwab and Fidelity Investments, will still be able to promote their "no transaction fee" offerings, even though investors pay 0.25 percent a year for the convenience. The charges will be renamed a "marketing and service fee."
"The supermarket investor could be helped out a lot by having greater clarity," Kinnel says. "In a real sense, there is no such thing as zero transaction fee."
The brokers' objection — that fee limits hurt the little guy — can be dismissed easily. If a broker is willing to handle a small account under the 12b-1 arrangement, he or she should be willing to work for the same amount of money paid in a more transparent way.
"They wouldn't handle the small account today unless the fees are big enough to justify their time," says Larry Swedroe, research director at Buckingham Asset Management and author of a new book, "Wise Investing Made Simpler."
Brokerage firms, Swedroe says, profit by keeping fees hidden. "These various share classes are basically a way to rip people off," he alleges.
What the SEC should do is to draw a bright line: Mutual funds should collect fees for money management expenses, period. There should be no kickbacks to advisers, who should be forced to charge the client directly for their advice.
The good ones wouldn't have anything to worry about. The lazy ones would, and that's why opaque compensation arrangements such as the 12b-1 need to disappear.