Market Watch : Proposal Could Eliminate Fixed Brokerage Fees

The residents of California’s north coast aren’t the only people in the path of earthquakes.

Federal regulators this month are preparing to shake up the mutual fund industry with a series of proposals that could alter the way brokers and other sales reps charge commissions.

The most revolutionary idea emanating from the investment-management division of the Securities and Exchange Commission would allow negotiable sales fees on load funds.

Currently, all investors pay the same load on a given fund, with the exception of well-specified quantity discounts for larger buyers that are spelled out in the prospectus. Investors are effectively barred from doing any comparison shopping on a particular fund.

The SEC’s investment-management division, which regulates mutual funds, also plans to propose creation of a “unified-fee investment company.” This would be a new type of fund that would lump together all management, sales and service fees as a single number, prominently displayed in the prospectus.

A unified-fee format, which would be voluntary, could spur price competition and make it easier for investors to compare costs on funds that agreed to make this disclosure. Fund Directions, a New York trade newsletter, predicts that it would put cost pressure on custodians, lawyers, accountants and others who service mutual funds.

In addition, the investment-management division will recommend that the SEC approve a plan to limit all types of commissions to a combined maximum of 8.5%, the current top load. This cap would include 12b-1 fees and back-end sales charges. A 12b-1 fee is an overhead charge sanctioned by the SEC.

The 8.5% ceiling was first advanced by the National Assn. of Securities Dealers, an industry group. It’s designed to answer complaints that investors in some funds could wind up paying more than 8.5% in cumulative 12b-1 fees, which are small but ongoing marketing charges that often go to brokers.

Of the three proposals, only the last can be approved directly by the SEC commissioners, according to Marianne K. Smythe, who heads the investment-management division and wrote the report.

Any actions on deregulated loads or unified fees would require congressional modification of the Investment Company Act of 1940, a key piece of legislation that governs the business.

“The commission would first have to vote to send the proposals over to the Hill,” says Smythe.

The rationale behind these proposals is to “remove barriers to competition and improve investor understanding of mutual fund fees,” Smythe says.

Her report was included in a response to Rep. John D. Dingell (D-Mich.), head of the House Committee on Energy and Commerce. Dingell had complained to SEC Chairman Richard C. Breeden about recent media articles that discussed the high costs of the mutual fund business to consumers. The articles noted that average per-share costs have been rising, even on funds whose asset bases have been ballooning.

The negotiated-load idea is the proposal that would most alter the status quo. “This development is very significant,” says Jack White, who heads a San Diego-based discount brokerage. “The mutual fund industry is the last bastion of fixed prices I can think of.”

No-load funds, which sell directly to the public, probably would not be affected by the proposal, if it’s approved. Nor would funds marketed by a “captive” sales force, such as a brokerage’s in-house products.

Rather, the biggest impact would probably be felt at the independent load-fund groups. It’s not that these companies would stand to lose commission revenue, since they typically pay out nearly the entire load to brokers and brokerage firms anyway.

But they would have to revise their sales strategies and ties to the brokerage and financial-planning companies that market their products. “We would have to rethink things, because we would want to maintain good relationships with those firms,” says Anne Patenaude, a spokeswoman for the Pioneer Group in Boston. Patenaude speculates that negotiated rates could confuse investors, the smallest of whom might not have much bargaining power anyway.

But White believes that consumers would be the big winners of any move toward negotiated fees, and he thinks that aggressive brokerages (including discounters) might be able to steal some customers away from high-commission salespeople.

Yet full-service brokerages would certainly survive, just as they have survived, and thrived, in the wake of deregulated stock commissions in the 1970s. Some brokers even think that the proposal, if enacted, could make it easier for them to attract customers. “A lot of people don’t belong in no-loads because they can’t or don’t want to make investment decisions on their own,” says Jeff Young, a broker specializing in mutual funds at WestAmerica Investment Group in Scottsdale, Ariz. “It would be easier to convince these people to come to us if they only had to pay 2% to 3%, rather than 4% to 6%.”