SEC to Examine Distribution Payment Schemes
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Friday, May 24, 2002

SEC to Examine Distribution Payment Schemes

Harvey Pitt, the chairman of the Securities and Exchange Commission, today told the industry that the SEC will reexamine "certain issues" concerning fund distribution practices. The remarks were made as a part of his keynote address to the annual Investment Company Institute General Membership meeting in Washington, DC.

"Practices that some mutual funds and their investment advisers have implemented to pay for the marketing and distribution of the fund shares have changed since Rule 12b-1 was adopted in 1980. Rule 12b-1 essentially requires fund directors to view a fund's rule 12b-1 plan as a temporary measure even in situations in which the fund's distribution arrangements would collapse if the 12b-1 plan were terminated. Today, many funds adopt a Rule 12b-1 plan as a substitute for, or supplement to, the sales charge or as an ongoing method of paying for marketing and distribution arrangements," said Pitt.

"We will examine certain aspects of the rule in the context of today's distribution practices. We also intend to examine indirect methods of financing distribution that we see emerging to assure that these arrangements are appropriately considered by fund directors," he added.

In comments in a press briefing following his address, Pitt and the SEC's Paul Roye added that the SEC is concerned specifically about whether revenue sharing and specifically directed-brokerage fees are benefiting fund shareholders or just their advisors.

"When people are entrusted with the assets of others, if they are using those assets to benefit themselves when there is a conflict that must be looked into," elaborated Pitt to the media.

The economics of both retail fund supermarkets, broker-dealer distribution and qualified plan recordkeeping are all predicated on revenue-sharing between distributors, recordkeepers and asset managers. Changes to rules governing these practices could shake-up the playing field and change some of the winners and losers in the industry.

Few in attendance at the meeting today seemed overly concerned about the issue, noting that the SEC has looked into fee issues before. Pitt declined to say where he expects the examination to lead to. "It is premature to decide where we go," he said.

The likely result, say industry insiders, is more disclosure requirements about practices. Even disclosure could have an impact on sales as even few institutional buyers of funds are aware of the extent to which revenue-sharing now permeates the industry.

More of a long shot, but apparently a possibility based on Pitt's remarks, would be further rules clarifying the use of 12b-1 fees and enforcement of the current intent of the law that the be temporary in nature.

Still, Pitt may not have the political capital to push this matter as he is currently under attack from Democrats. Political opponents point to his close ties to the accounting industry and his meetings with senior executives of accounting firms in wake of the Enron scandal as reasons why he needs to be replaced at the SEC. To date, he continues to receive the support of the Bush administration.

One other possibility is that those political attacks force Pitt's hand and lead to a more activist SEC, one that takes a more pro-investor stance than many would have thought even just a few months ago. Time will tell.

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