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Misdirected brokerage

First, the Enron Corp. blowup presaged a cascade of corporate scandals and recriminations. Next, accountants came under siege for purported incompetence and even fraud. Then Wall Street was attacked for tainted research and shady investment banking.

Now it's the turn of mutual fund companies to squirm in the hot seat.

The Securities and Exchange Commission and Congress are both hard at work examining potentially serious conflicts of interest in the buying and selling of America's mutual funds. In particular, investigators are homing in on a common industry arrangement known as revenue-sharing, in which fund companies make substantial and undisclosed payments -- above and beyond traditional loads -- to brokerage firms to encourage them to sell their funds. This increasingly controversial practice, first exposed in a May 2001 cover story in this magazine (see box, page 50), resembles the way in which consumer-products companies pay for supermarket shelf placement, but critics charge that it is little more than a pay-for-play scheme. "This is basically a form of payola," says Edward Siedle, a former SEC attorney who owns Benchmark Financial Services, a Lighthouse Point, Florida, brokerage.

It gets worse. The SEC will soon release its exhaustive assessment of the fund industry. One finding is likely to startle consumers and shake up fund companies. The commission is scrutinizing another widespread industry practice, related to revenue-sharing, in which mutual fund companies are using trading commissions to pay brokerages to distribute their funds. This practice, known as directed brokerage, is close to standard operating procedure in the industry. Nearly every fund company does it, but it may be costing fund customers billions of their own investment dollars, and it is also, except in certain circumstances, against the law, the SEC will say. That's because the money spent on those commissions doesn't belong to the fund company. Legally, it is an asset of the mutual fund shareholders.

"Mutual fund companies using commissions to pay for distribution expenses is one of the worst conflicts of interest in the financial services industry," says John Montgomery, founder and president of Houston's Bridgeway Funds, a $600 million no-load fund family (which does not pay commissions to brokerages). Former SEC attorney Siedle calls "the real use" of commission dollars one of the "best kept secrets on Wall Street."

Regulators use stronger language. Says Douglas Scheidt, associate director of the SEC's Division of Investment Management, who is spearheading the review: "We are seeing some blatant examples of fund companies directing orders to brokers purely as a form of compensation for distribution. That's clearly a violation of securities law."

In the forthcoming report -- expected to be released in the next month or so -- the SEC is likely to recommend sweeping changes in these long-standing if largely covert fund industry practices. "The individual investor has the right to know everything that's inducing a broker to recommend a particular fund," says SEC chairman William Donaldson. "What are the hidden inducements? At the very least, this should be disclosed, particularly if they are a diversion of resources that belong to fund shareholders."

The SEC's findings could have as much of an impact on brokerage houses as on the $6 trillion fund industry. John Webster, managing director of consulting firm Greenwich Associates in Connecticut, points out that "any change to the laws governing how large mutual fund companies are able use their trading commission dollars to pay for distribution has enormous implications for the future of Wall Street." For a start, billions in brokerage sales commissions are at stake: Almost half of all mutual fund shares are sold today through brokerage houses, versus less than a third in 1998.

Nor is the SEC the only government body scrutinizing mutual funds. The House Financial Services Committee, chaired by Republican Representative Michael Oxley of Ohio, has been investigating mutual fund fees, focusing on how fund companies employ their big trading commissions to get brokerages to distribute their funds. The committee recently presented both the SEC and the General Accounting Office with a list of informational requests on the subject. "We're just trying to make sure that fund investors are getting a fair shake," says Peggy Peterson, senior legislative aide to Oxley. "The feeling here is that they are not."

Directed brokerage can have an insidious impact. Start with the fact that commissions belong to the mutual fund's investors. And nickel by nickel, they add up. Fund companies that could avail themselves of cheaper alternatives to do trades for as little as a penny a share pay what amounts to a trading premium to a wire house brokerage in order to obtain shelf space for their funds. "This could be one reason why the average listed commission on an equity trade is still a nickel a share," notes the SEC's Scheidt.

Shelling out all those commissions weighs on a fund's returns, taking money out of the pockets of investors. Critics worry that some fund companies may be tempted to do unnecessary trading to create more commissions, just to fatten the incentive for a brokerage to peddle their wares. In effect, mutual fund investors are -- unbeknownst to them -- subsidizing their mutual fund company's marketing efforts.

What's more, revenue-sharing schemes may adversely affect the quality of the financial advice consumers receive. Individual investors ought to be able to look to their financial advisers for more or less objective advice. But brokerages may push particular funds not because they're the best investments for their clients but because fund companies have paid them commission dollars to see those products moved. When the revenue-sharing tariff is paid in directed brokerage commissions, as it often is, consumers are hit with a double whammy: Fund shareholders are effectively helping to foot the bill to pay the brokerages to sell them potentially inappropriate funds.

Mutual fund companies are allowed to use commissions to pay brokerages -- but only up to a point. The Securities and Exchange Act of 1934 and the Investment Company Act of 1940, along with subsequent amendments, define what funds and money managers can and cannot do with trading commissions. They can, most notably, be used to compensate a brokerage for investment research. The SEC will assert in its forthcoming report that fund companies may also use commissions to pay for brokerage "distribution," but only under certain circumstances and only if properly disclosed. The SEC will argue that the commission payment arrangement must be incorporated into a marketing program known as a 12b-1 plan. Such plans must be approved individually by the SEC, ratified by shareholders and disclosed in the fund prospectus.

The 12b-1 dates to 1980, when the SEC adopted the plan as a temporary measure to help then-struggling mutual funds grow their assets. The agency told fund companies that they could tap up to 1 percent of a fund's assets annually to promote distribution; this marketing charge, the 12b-1 fee, typically runs 25 to 75 basis points at most funds, which use the bulk of the money to compensate brokerages (see box, page 52).

Sources say, however, that in its investigation so far, the SEC has not found a single fund family that uses a 12b-1 plan to account for commissions paid out for brokerage distribution. And although many funds disclose the use of directed brokerage in their prospectuses, the SEC believes that the language is inadequate because it does not meet the standards of a 12b-1 disclosure.

Certainly, fund companies aren't eager for investors to know about commission payments that can depress fund returns even as they increase sales and thus help boost the company's management fees.

But there's another critical reason that fund companies have resisted including commission payments in a 12b-1 marketing plan. Doing so would cause many of them to exceed a NASD limit on how much any fund investor can be asked to pay in brokerage compensation. This cap, spelled out in Section 2830 of the NASD conduct code, ranges from 6.25 percent to 8.5 percent of new gross fund sales. Counting loads and 12 b-1 fees, many fund companies are bumping up against the NASD limit now. Confirms the SEC's Scheidt, "If fund companies had to account for what was additionally being paid out to brokers in commissions, it would put some of them way over the NASD cap."

In its report the SEC will likely recommend that fund companies include commission payments as part of a 12b-1 plan, even if that means many funds would hit the NASD ceiling on brokerage compensation. "We know funds are doing this, and what we are saying is, admit it and account for it properly," says Scheidt.

At that point fund companies would face a tough choice. They could scale back commission payments and risk losing sales, or they could use their own revenues to pay brokerages, driving up their costs and eroding their profit margins.

"Shelf-space payments are already eating into revenues," points out Morgan Stanley analyst Henry McVey, who covers asset managers. "Using a greater portion of fund company revenues to pay for distribution would put even more pressure on margins."

How many fund companies direct commissions to brokerages in exchange for distribution? How much money is involved?

Those questions will be difficult for even the SEC investigators to answer. But begin with a known statistic: The fund industry generated some $6 billion in trading commissions last year. A former fund marketing executive estimates that about 25 percent of that -- $1.5 billion -- is earmarked to pay for distribution. (Broker and former SEC attorney Siedle puts the proportion closer to 75 percent.)

In a roaring bull market, de facto distribution charges of $1.5 billion or more might not sting much. But today's fundholders, nursing an average annual decline of 14 percent in equity funds over the past three years, may well be unhappy to learn that their dwindling assets are being used to generate commissions to build their fund company's business. In any case, they ought to know it's going on.

They aren't the only ones who have cause for resentment. The fund industry's commission-for-distribution tactics compromise "best execution" in trading and prop up brokerage commission rates, making it more expensive for all investors -- institutional or retail -- to buy or sell a security. Fund companies feel they must set aside some proportion of all trades for their most important distributors, so they carve large orders into smaller pieces, reducing economies of scale. Moreover, they feed orders to wire houses that charge 5 cents a share because they're the most crucial to fund distribution, when they have myriad less expensive trading alternatives. The upshot: Fund managers -- and by extension fundholders -- prop up trading costs.

Fund companies can be expected to make a spirited defense of directed brokerage commissions when the SEC presents its case against them. "Everyone is waiting to see where the SEC comes out on this before we can start to debate the topic," says Barry Barbash, outside counsel for the Investment Company Institute, the leading fund trade group, and a former director of the SEC's Division of Investment Management.

The industry's defense will likely center on a 1975 amendment to the 1934 Exchange Act, the so-called safe harbor provision, which allows a fund to direct trades to any brokerage it chooses as long as it's consistent with best execution -- meaning the fund makes an effort to get the best price for a trade. Scheidt says that when he and others at the SEC interviewed fund executives about the commission payments, they heard the same refrain: "Everyone is doing it." To which Scheidt offered a tart reply: "Well, we're going after everyone."

The SEC's study emerges as part of a larger examination of the way fund companies distribute products. Just a decade ago about 40 percent of funds were sold directly to consumers through newspaper and radio ads and toll-free numbers. Today only 18 percent of funds are sold directly. Intermediaries, including financial supermarkets like Schwab One Source and Fidelity Funds Marketplace, deliver most of the industry's sales. And among the middlemen, traditional wire house brokerages like Merrill Lynch & Co. and Smith Barney are far and away the most powerful. Last year brokerages accounted for 45 percent of fund sales, up from 32 percent in 1998, estimates Financial Research Corp., a Boston consulting firm.

In a stubborn bear market like this one, distribution becomes more vital than ever to fund companies. "Besides performance, distribution is the key driver in the mutual fund business," says Ted Truscott, CIO of American Express Funds. It's the industry's No. 2 expense, behind only compensation.

Fund managers rely on various means to underwrite distribution, say sources within the industry and the SEC. They levy sales loads on investors that can legally run as high as 8 percentof assets but average 4.75 percent. The fees are shared by the broker who sells the fund shares and the brokerage that employs him. Additionally, there is the separate fee of up to 100 basis points to pay for marketing and distribution allowed by the 12b-1 rule.

Then there is revenue-sharing. Technically, these payments are for services connected to distribution, such as sales conferences, technology and training seminars. Effectively, they're the cost of persuading brokerages to close the sale. Financial Research Corp. estimates that revenue-sharing payments totaled $2 billion in 2000. Some industry analysts, however, believe that the figure is actually much higher.

Revenue-sharing payments come in two guises. Some are in cash, with the money coming out of the management fee and other fund company revenues. But commissions are also used to pay the bill, with the fund company steering trading to the brokerage that distributes its funds. "It has become standard practice for shelf-space payments to consist of both hard dollars and directed brokerage," explains Cerulli Associates analyst Matthew McGinness.

Revenue-sharing pacts are almost invariably oral agreements, usually between a top fund sales executive and a senior executive at a brokerage firm. Typically, sources say, a fund company begins by making an initial payment of $250,000 just to get in the brokerage's door. Additionally, the fund manager agrees to pay a certain number of basis points of gross fund sales and deliver a certain amount of trading commissions to the brokerage over the course of a year. These payments give the fund wholesalers a precious commodity: privileged access to the brokerage's sales force.

"It's no coincidence," says a former fund company executive. "We gave certain brokers the most trading business because they sold our funds. There's sort of a don't ask, don't tell policy."

Fund companies may make additional payments on top of these basic fees to claim a spot on a brokerage's list of "preferred" funds. A fund company might, for instance, give a brokerage a $3 million cash payment up front, plus 25 basis points of fund sales. Brokerages may make special requests of their own, such as requesting an extra $100,000 to sponsor a sales conference at a tony resort.

When the preferred-list payments are made in cash out of the fund company's revenues, they are legal. But they are increasingly suspect in regulators' eyes. A brokerage need not disclose its list of preferred fund families, so an investor has no way of knowing whether his broker, whose judgment he trusts to be objective, is recommending a particular fund partly because a fund company paid the brokerage a fat distribution fee.

"All of a sudden it's not the list of recommended funds, its the list of recommended funds who will pay," says Thomas Atteberry, a portfolio manager at First Pacific Advisors, a $4 billion, Los Angeles­based fund family that uses brokerages to distribute its funds but makes no revenue-sharing payments. "We don't pay for shelf space as a matter of policy," he says.

The issue is sparking debate throughout the fund business. "Some sunshine on this issue would be disruptive but a healthy thing for the industry," says Harold Bradley, senior vice president in charge of trading at American Century Investments in Kansas City, Missouri.

The SEC is zeroing in on the directed brokerage side of revenue-sharing for a simple but compelling reason: Trading commissions are fund assets that belong to fund shareholders. Nevertheless, securities laws do allow commissions to be used for a variety of purposes.

First, a money manager may employ commissions to compensate a brokerage firm for research. Fund companies may also direct trading commissions to a particular brokerage firm -- even if that firm happens to distribute most of the fund company's products -- if the fund company believes that the brokerage will do the best job of executing trades. And since commission payments are bundled together, neither the brokerage nor the fund company need specify which commissions pay for research and which pay for execution.

The regulations that most directly address the subject of directed trading commissions turn out to be a 1975 amendment to the 1934 Exchange Act and NASD's Conduct Rule 2830(k). Like all NASD rules, this provision was first approved by the SEC before it went into effect. Section 28(e) of the '75 amendment, buttressed by SEC no-action letters over the years, gives fund managers safe harbor, or immunity, from claims that they breached their fiduciary duty to investors if they use a brokerage that doesn't offer the lowest commission rates.

The NASD rule allows its members to sell funds managed by companies that take into account a brokerage's prior record of fund sales when choosing one house over another. The NASD rule says that directed brokerage transactions are "permitted if they are (1) consistent with best execution and (2) appropriate disclosures are made regarding the practice." That is, the fund must reveal the distribution consideration to investors.

In a separate portion of 2830(k), NASD imposes the 8.5 percent cap on what brokerages can accept from fund investors in total compensation.

That cap complicates things for fund companies. They've been operating on the assumption that the Exchange Act's safe-harbor clause authorizes them to engage in directed brokerage to pay for a whole bundle of services -- including distribution. But the SEC study will argue that because directed brokerage actually involves a fund asset -- commission payments -- the fund companies must meet the standards of a different law: the 1980 amendment that established 12b-1 plans. "Most fund companies never make it clear exactly what portion goes for research and what's going for shelf space, but it is all tied in together," says Wayne Wagner, chairman of trading cost consulting firm Plexus Group in Los Angeles.

The agency will likely recommend that any commissions directed to brokerages in exchange for fund distribution come under 12b-1 programs ratified by shareholders and approved by the SEC. "The safe harbor applies to using commissions to pay for research not using directed brokerage to pay for distribution," maintains Scheidt.

As part of 12b-1 programs, fund companies would have to identify -- and quantify -- the proportion of their directed commissions that was intended to gain distribution for their funds. And the program would have to be approved by the fund's board and shareholders and ratified by the SEC.

Most fund companies already admit in prospectuses and registration statements that they direct commissions to brokerages that distribute their funds. But those statements are intended to meet NASD requirements and have nothing to do with 12b-1 programs or compensation caps.

Disclosure, however, won't be so simple. Fund companies don't always quantify for themselves how they divvy up the bundled commission dollars meant for research, execution and distribution. Gregory Sheehan, an attorney with Ropes & Gray in Boston and an expert in mutual fund laws, says that fund companies are using some portion of their commissions to defray distribution costs. But, he asks, "how could one discern what part of the nickel goes for research and what goes for distribution? It would be impossible."

SEC investigators learned about directed brokerage as part of the agency's 1997 investigation into best execution practices, though the agency took no action in the wake of the study. Staffers had come upon several examples of a pas de deux between brokerages and money managers known as a step out. This dance enables the hundreds of small brokerages that sell lots of mutual funds but don't have their own trading desks to receive substantial commission revenue from a fund company.

Here's how it works.

A fund manager executes a large trade through a wire house but in doing so instructs the wire house to "step out" of a portion of the commission, allowing a small brokerage with no trading capacity to "step in" to claim a piece of the commission pie. The small brokerage in this scenario is known as an introducing broker. SEC staffers concluded that because the introducing broker does nothing to execute the trade but still receives commission dollars, the fund company could only be paying the introducing broker for distributing its funds.

"It was clear that the money managers were directing trades to these brokerages simply because they were distributing their funds," Scheidt says.

Some sense of how directed brokerage works can be gleaned by looking at the record of Jersey City, New Jersey­based Lord, Abbett & Co. Lord Abbett is an equity fund family with $50 billion in assets. Like many fund companies, it discusses directed brokerage in its fund prospectuses, meeting the NASD's disclosure standards. However, the SEC, under its new policy, may find that this disclosure is insufficient to meet the standards of 12b-1.

"In selecting dealers to execute portfolio transactions for the fund's portfolio, if two or more dealers are considered capable of obtaining best execution, we may prefer the dealer who has sold our shares or shares of other Lord Abbett­sponsored funds," states the 2002 prospectus for the Lord Abbett Large-Cap Growth Fund.

Institutional Investor could not determine what portion of Lord Abbett's directed brokerage went specifically for shelf space, but it is evident that the fund family directed substantial commission payments to top fund distributors. Between 1999 and 2001 Lord Abbett paid out an average of $22 million per year in commissions to its ten largest brokerages, according to SEC filings compiled by Computershare Analytics, a Rockville, Maryland­based securities data provider. The two firms that received the greatest share of Lord Abbett's orders were Smith Barney and Merrill Lynch, which ranked among Lord Abbett's top three distributors, according to Lord Abbett sources. Together Merrill and Smith Barney reeled in 25 percent of the money manager's total commissions. (Lord Abbett and Merrill declined to comment. Smith Barney did not respond to repeated requests for comment.)

By comparison, Fidelity Investments, which does not rely as heavily on wire houses to sell its funds, directed just 11 percent of its total trades to Smith Barney and Merrill Lynch during that same period, Computershare Analytics reports. (A Fidelity spokesman says that the only thing that determines where its funds trade is best execution.)

A former Lord Abbett executive is convinced that these directed commissions caused trading costs to be higher than the fund family would otherwise pay. "When you earmark order flow, you lose the advantages of scale, and it costs you more to trade," he says.

The relationship between Putnam Investments and St. Louis­based regional broker A.G. Edwards is also revealing. A.G. Edwards ranks as Putnam's ninth-largest trading partner; no other second-tier brokerage its size is among Putnam's top ten trading partners. In 2001 Putnam funds paid A.G. Edwards $15 million in commissions -- half of all commissions that mutual funds reported paying to the brokerage. That same year A.G. Edwards ranked as the No. 2 distributor of Putnam funds.

An A.G. Edwards spokeswoman would not comment on the firm's relationship with Putnam but stressed that the brokerage does not keep a list of preferred funds and "has always encouraged financial consultants to sell the funds that best suit their clients' financial objectives." And a Putnam spokeswoman says: "Putnam trades with all of our counterparties on the basis of obtaining best execution on every trade for our clients. Best execution is unrelated to whatever relationship Putnam may have with a distributor."

New regulations on directed brokerage could shift the balance of power between fund companies and brokerages. Brokerages now have the upper hand simply because they control the critical shelf space. That edge has enabled them to continue to charge their institutional investors a nickel a share.

But if fund companies must account for directed brokerage as part of a 12b-1 plan, they will be forced for the very first time to identify precisely what portion of their total bundled commission payments is earmarked for fund distribution. As a result, they may well decide to direct less commission business to brokerages that distribute their funds to avoid the NASD cap. In this case, they could turn to a wider group of brokerages, including electronic trading networks, that charge far less than 5 cents a share. The collective impact of such a shift may well pressure the nickel-a-share brokerages to reduce their rates.

"If the SEC does propose these changes, it could open the door to unbundling," says Plexus Group's Wagner.

The SEC proposals will spark a strong response from the fund industry, of course. When the agency's specific recommendations become public, the industry will parry with a determined defense of what is, after all, a common business practice. But the "everyone does it" line might not be the smartest ploy. Wall Street firms tried that tack when their research departments came under siege, and all it got them was a bill for $1.4 billion.


Revenue-sharing

WHAT IT IS: An undisclosed industry practice in which fund companies pay brokerage firms to push their products.

HOW IT WORKS: Fund companies use cash and trading commissions to buy the equivalent of eye-level supermarket shelf space.

WHY IT'S CONTROVERSIAL: Investors may not know that their brokers might recommend a fund partly because the fund company paid the brokers' firms to do so.

WHAT THE SEC SAYS: Current disclosure is insufficient. The commission's investigation into the practice continues.

WHAT THE FUND INDUSTRY SAYS:
Revenue-sharing payments are legitimate compensation for shared distribution expenses.


Directed brokerage

WHAT IT IS: Fund companies use trading commissions to pay brokerages to distribute their funds.

HOW IT WORKS: A fund company agrees to direct a specified amount of trades to a brokerage to pay for greater access to its sales force.

WHY IT'S CONTROVERSIAL: Using commissions to pay for distribution may drive up trading costs and depress shareholder returns. Legally, the money spent on commissions belongs to fund shareholders not the fund company. The Securities and Exchange Commission will argue that the commissions may be used for distribution only if properly disclosed under Rule 12b-1.

WHAT THE SEC SAYS: Fund companies should admit to the practice and properly disclose it.

WHAT THE FUND INDUSTRY SAYS: The long-standing industry practice is legal under the terms of Section 28(e), the 1975 amendment to the 1934 Securities Exchange Act. Current disclosure rules governing directed brokerage are adequate.


Sharing secrets

The Securities and Exchange Commission has embarked on a sweeping investigation into a standard fund industry practice known as revenue-sharing, under which companies make undisclosed payments to brokerages -- above and beyond traditional loads -- to induce them to sell their products. Just as consumer-products manufacturers shell out hundreds of millions of dollars a year for prime supermarket shelf space, so, too, do mutual fund companies pay brokerages for the financial services equivalent: greater access to their sales forces.

Well, as they say, you read it here first. In a May 2001 cover story, Institutional Investor published the first exposé of revenue-sharing. The SEC began to study the practice not long after a fall 2001 meeting of an American Bar Association subcommittee during which our article was brought to the attention of Douglas Scheidt, associate director of the agency's Division of Investment Management.

How much money is at stake? Industry experts estimate that revenue-sharing payments total at least $2 billion a year and perhaps run much higher. The payments come in two forms: Some are in cash, with the money coming out of fund company revenues, and some are in the form of trading commissions.

In recent weeks Paul Roye, director of the SEC's Division of Investment Management, has publicly stated that the agency is probing revenue-sharing. Speaking at the annual meeting of the Investment Company Institute, the leading mutual fund industry association, Roye suggested that these payments may need to be disclosed by brokers at the point of sale.

Under current rules and regulations, the brokers needn't say a word.  -- R.B.


The ABCs of 12b-1s

Exchanging brokerage commissions for fund distribution is not the only industry practice coming under the scrutiny of the Securities and Exchange Commission and Congress. Government investigators are also taking a hard look at so-called 12b-1 fees, a once-obscure but increasingly controversial levy on fund shareholders.

Part of a 1980 amendment to the Investment Company Act of 1940, the Section 12b-1 statute allows fund companies to use shareholder assets for marketing expenses, including brokerage compensation, under certain specific circumstances. Funds must define the 12b-1 program in a written plan, which must be approved by both the SEC and shareholders and disclosed in prospectuses and registration statements.

These fees didn't become commonplace until the mid-1990s. That's when the industry started to aggressively sell class-B and C shares, which carry a relatively high 12b-1 fee along with back-end sales loads. Last year about 90 percent of all broker-sold shares were class-B or C.

Until the mid-1990s most broker-sold fund shares were categorized as class-A. These carry a front-end sales load, up to 4.75 percent, along with a small 12b-1 fee, usually about 25 basis points.

The industry concocted class-B and C shares to compensate brokerages without imposing an up-front sales load that might discourage potential customers. Class-B shares, for example, carry a 12b-1 fee of 50 to 75 basis points, as well as a back-end load known as a contingent deferred sales charge. Investors pay this load only if they cash out of the fund within a specified period of time, usually five years.

But when brokerages sell class-B shares, they still collect their commissions up front. Where does the money come from? The fund company pays the brokerage's commission out of its own revenues, but that's not the end of the story. Over the course of the next five years, the fund company uses 12b-1 fees, which come out of shareholder assets, to reimburse itself for a significant portion of that commission payment.

Essentially, then, all fund shareholders end up paying brokerages to sell more funds. It's all perfectly legal -- though maybe not for long. During a hearing of the House Financial Services Committee, representatives questioned whether shareholders' interests have been compromised by 12b-1 fees, and they debated whether reform of the rule might be necessary.

"I am troubled that there may be insufficient transparency of fund fees," wrote Representative Richard Baker in a March 26 letter to SEC chairman William Donaldson. Baker specifically went on to inquire whether rule 12b-1 "should be updated in light of the evolution of fund shares." -- R.B.