Alliance Fee Offer May Alter Industry

In a move that could dramatically affect the mutual fund industry and its millions of investors, Alliance Capital Management has told New York Atty. Gen. Eliot Spitzer that it is willing to cut its fees as part of a settlement of trading-abuse allegations, people familiar with the matter said Thursday.

The offer is significant because the fund industry has steadfastly refused to lower the management fees it charges investors despite years of criticism about how much they have risen. An agreement to do so by Alliance could force other scandal-racked companies to reduce their fees.

The alleged wrongdoing at Alliance -- like that at other fund companies -- is not directly related to fees. That has sparked a heated debate about whether regulators would be overreaching to bring fund expenses into any settlement talks.

But Spitzer, whose investigation of improper fund trading uncovered the scandal three months ago, believes that high fees are the primary force hurting fund investors, and he has proclaimed that fee reduction should be a centerpiece of any settlements.

Spitzer believes that late trading and market timing of mutual funds -- practices that lie at the heart of the scandal -- show that the fund industry has lost sight of its duty to average investors. But high management fees are an even bigger example of how the industry has abused its position, he has said.

Investors paid $51 billion in investment advisory and other fund fees last year, according to the Investment Company Institute, an industry trade group. That doesn’t include upfront sales charges, known as loads.

Fund fees have continued to swell even as rising asset levels have theoretically created economies of scale that would allow for fees to be cut.

Expense ratios averaged 1.4% of fund assets last year, up from 0.9% in 1978, according to fund tracker Lipper Inc. The fees are taken directly from portfolios, lowering investors’ returns.

Alliance has some of the highest fees in the industry, according to Morningstar Inc., another fund research firm.

The news of Alliance’s offer, which was first reported in the Wall Street Journal, reverberated through the industry Thursday.

“The one thing a fund company doesn’t want to do is lower fees -- that’s like the tobacco companies admitting killing people,” said Max Rottersman, editor of FundExpenses.com in New York.

“It shows you how bad this thing is.”

It is unclear whether Spitzer and Alliance can reach a final agreement on fees.

“They’ve agreed to lower fees in concept,” said one source familiar with the matter. “But exactly what funds, [by] how much and over what time frame -- those details need to be worked out.”

Alliance first told Spitzer last week that it would be willing to accept lower fees and reiterated its stance early this week, a source said.

Alliance has said in regulatory filings that it permitted market timing in some of its stock funds and said it was under investigation by Spitzer and the Securities and Exchange Commission.

Alliance spokesman John Meyers declined to comment.

Spitzer’s gambit to lower fees has exposed a rift with the SEC, which is not pushing for outright fee reductions. Rather, the commission is seeking greater disclosure of fees to investors.

The commission has pushed for Alliance to pay a large upfront penalty to settle any SEC action, one source said. The commissioners discussed the Alliance matter at a closed-door meeting Thursday and ordered staff to demand a larger upfront payment, the source said.

SEC Chairman William H. Donaldson has publicly questioned whether regulators should try to force fund companies to cut fees in legal settlements.

Laura Cox, a senior advisor to Donaldson, said she could not discuss the Alliance matter but said that generally, “I do not expect the commission to pursue the capping of fees as a broad policy.”

Many fund companies dispute the idea that regulators should try to limit fees, pointing out that the industry is highly competitive, with more than 8,200 funds.

“As long as the fees are disclosed, I’m not sure Mr. Spitzer should be legislating them,” said Ron Muhlenkamp, manager of the Muhlenkamp Fund in Pittsburgh, which has not been accused of trading abuses. “The New York Times was caught writing fiction -- does that mean they have to lower the price of the newspaper?”

Chris Wloszczyna, spokesman for the Washington-based Investment Company Institute, declined to comment on the Alliance talks. But in general, Wloszczyna said, fund expenses should be set by the marketplace.

Some people within the SEC fear that fee reduction may not help aggrieved investors because they would have to keep their investments at a company charged with wrongdoing to reap lower fees.

There also is concern that Alliance could gain a public relations boost and attract new investors if it were the first company to reduce fees.

Still, some experts say it is appropriate to order fee reductions. One of their main arguments is that some fund companies took in assets from known market timers to boost overall portfolio fees.

“Under the law, a fund manager has a fiduciary duty with respect to fees,” said Mercer Bullard, head of the group Fund Democracy in Oxford, Miss., and an expert witness in a pending civil case against Alliance involving fees.

“It would be willful blindness for a regulator to settle a case like this without taking fees into account,” Bullard said.