12b-1 Reform and R Shares

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MutualFundWire.com The insiders' edge for 40 Act industry executives!

an InvestmentWires' Publication

Friday, August 20, 2010

12b-1 Reform Could Hit American

Funds and Others Hard in the 401k

Biz

12b-1 fees as we know them may soon be dead, if the Securities

and Exchange Commissionhas its way, and their

quasi-death could have big implications for mutual fund firms

working inside 401(k)s.American Funds,

OppenheimerFundsand other fund firms in the micro market

may face more of an uphill battle than ever before, while

fundsters who reach out to insurance-based 401(k) providersmay see greater success. Fundsters looking for retirement plan

distribution should take heed.

Last month, the SEC proposed killing off the 12b-1 label

altogether, while limiting ongoing, 12b-1-esque "market and

service" fees to 25 basis points per year (see The MFWire,

7/21/2010). Any ongoing sales charges above that 25 bps,

meanwhile, regardless of share class, would not be allowed to

add up, over the years, to more than the maximum sales load for

any share class (usually an A share) of the same fund.

As is, this proposal shouldn't affect institutional share classes

used by many 401(k) plans -- because institutional shares

normally lack 12b-1 fees -- and load-based A shares often have

low enough 12b-1s (25 bps or less) that this shouldn't be a big

MutualFundWire.com: 12b-1 Reform Could Hit American Funds and Others Hard in the 401k Biz http://www.mfwire.com/common/artprint2007.asp?storyID=33177

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change for plans using them, either. Sub-TA fees, often used to

compensate recordkeepers or administrators, may escape

unscathed, too.

But what about R shares? A few asset managers -- including

American Funds, JPMorganand Thornburg-- have rolled

out multiple share classes designed for use inside of advisor-sold

retirement plans. Those R share classes are specifically

differentiated based on different levels of 12b-1 fees used to

compensate the plan's advisor, recordkeeper or TPA.

Spokespeople for American Funds, JPMorgan and Thornburg all

declined to comment for this story.

To examine the potential impact of this proposal, consider the

classic R shares shop, American Funds, which has six classes of R

shares as well as a class of A shares. R-4 shares charge only 25

bps in 12b-1 fees, and R-5 and R-6 charge no 12b-1 fees at all,

meaning that all three classes should be unaffected. R-3 shares

and below, however, charge between 50 and 100 bps of 12b-1

fees, leaving them with 25 to 75 bps above the SEC's proposed

ongoing maximum. A shares for theAmerican Funds 2055

Target Date Retirement Fundcome with a 575 bps load, which

would become the new maximum total ongoing sales charge

above the 25 bps annual fee for the other shares.

So an R-1 share, with 100 bps of 12b-1, would have 75 bps of that

counting as ongoing, asset-based sales charge, meaning that it

would take less than eight years for that fund to hit that 575 bps

maximum dictated by the A shares' load. R2 shares' 75 bps of

12b-1s (50 bps in "excess") would take less than 12 years to hit

the max, R3 shares' 50 bps of 12b-1s (25 bps in "excess") would

max out in 23 years. All of those time frames are shorter than the

career length, say 35 or 40 years, of a participant who could be


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deferring that entire time.

American Funds certainly isn't the only fund company with R

shares that might be affected. JPMorgan's R2 shares charge 50

bps in 12b-1s -- its R5s charge none. Invesco's R and R5 shares

charge 50 bps in 12b-1s. Principal's R-1 and R-2 shares charge

35 and 30 bps, respectively, in 12b-1s -- -3s charge 25 bps, R-4s

10 and R-5s none. And Thornburg's R3 shares charge 50 bps in

12b-1s -- R5s charge none. And one retirement plan advisor

noted that most plain, numberless R shares, which are offered by

many fund firms, charge 50 bps in 12b-1s.

American Funds and OppenheimerFundsoffer not just

mutual funds but fully bundled 401(k) products in the micro-

market, products that are exclusively distributed by advisors who

are compensated via 12b-1 fees. The one-two punch of 12b-1

reform and new 401(k) fee disclosure regulations from the

Department of Laborcould hit such platforms hard.

Meanwhile, much of their competition comes from variable-

annuity-based 401(k) platforms from insurance companies.

Those products will still have to comply with the DoL's new

401(k) fee disclosure regulations, but they will avoid 12b-1 reform

by virtue of not directly using mutual funds. So asset managers

looking for 401(k) distribution may either pull their target market

up a bit, towards small or mid-market plans or larger, or focus

their distribution efforts on variable annuities via insurance

providers instead of defined contribution investment-only slots

on micro-market platforms.

Micro-market offerings used by fee-based RIAs, who don't need

12b-1s, may also see a boost over traditional broker-sold

offerings, and unlike the insurance providers they may not fear

the new 401(k) fee disclosure regulations either. So fund firms


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may also consider focusing their DC I-O efforts in the micro-

market on RIAs and not on the platforms, given that the RIAs are

likely to use open architecture recordkeepers anyway.

Of course, the idea is simply a proposal, and the SEC has opened

up a 90-day window for public comments. 12b-1 fees still survive,

at least for now.

Printed from: MFWire.com/story.asp?s=33177

Copyright 2010, InvestmentWires, Inc.

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12b-1 Reform and R Shares