12(b)-1 cap could zap Fidelity, other retirement fund providers

American Funds, Fidelity Investments and Lord Abbett & Co. LLC are among a number of fund companies that will have to rethink how they serve the retirement marketplace through advisers if a proposed revamp of 12(b)-1 passes.

American Funds, Fidelity Investments and Lord Abbett & Co. LLC are among a number of fund companies that will have to rethink how they serve the retirement marketplace through advisers if a proposed revamp of 12(b)-1 passes.
Under the Securities and Exchange Commission proposal, firms would be allowed to charge a “marketing and service fee” of up to 0.25%. Anything above that amount would be deemed an continuing sales charge, which would be limited to the highest fee charged by the fund for shares that have no such sales charge.
But in the retirement plan market, many fund companies charge more than 25 basis points in 12(b)-1 fees to compensate advisers for all of the work that goes into serving these plans, experts said.
“Twenty-five basis points is not enough to cover the record-keeping and administrative costs of a 401(k) plan,” said a fund company executive, who asked not to be identified.
While about 50% of all retirement marketplace funds with 12(b)-1 fees charge 25 basis points, about 40% of fund share classes with 12(b)-1 fees in that marketplace have fees that are higher than 0.25%, according to data culled exclusively for InvestmentNews by BrightScope Inc. The highest 12(b)-1 fee is 1%, which occurs in 896 of the share classes, according to BrightScope.
Of the largest 25 retirement marketplace funds with 12(b)-1 fees that top 0.25%, five are marketed by Fidelity, five by American Funds and four by Lord Abbett, according to BrightScope.
American Funds Growth Fund of America has a 12(b)-1 fee that’s three times the cap proposed by the SEC. (Click here to view the Top 25 from Brightscope.)
Traditionally, the share class that fund companies use to sell to retirement plans through advisers are called R shares. There is currently $70 billion of fund assets in R shares that have 12(b)-1 fees higher than 0.25%, according to Strategic Insight. “Two thirds of that is managed by American Funds,” said Avi Nachmany, director of research.

“Mr. Nachmany estimates that there is just under $100 billion in fund share classes with 12(b)-1 over 0.25%”

Mr. Nachmany estimates that, within all retirement plans, there is just under $100 billion in fund share classes with 12(b)-1 over 0.25%. “This is one area of the proposal where there is less clarity of how it will be resolved,” Mr. Nachmany said. “Ultimately, there has to be a way to compensate for the higher costs of running small plans whether it necessitates different share classes or different disclosures around what fees are paid for what purposes.”

Chuck Freadhoff, a spokesman for American Funds, and Sophie Launay, a spokeswoman for Fidelity, said their firms are evaluating the proposal. Chris Dunn, a spokesman at Lord Abbett, didn’t return calls by press time.