Much has been written about the SEC’s proposed changes to the mutual fund 12b-1 rules. The proposed rules have caused quite a stir in the retirement plan world, as so much of the costs of plan administration and distribution are funded by these arrangements.
What is being overlooked, however, is a much more disturbing and fundamental problem with the proposed change: the rules actually treat 401(k) plan participants as “shareholders” under the securities laws, instead of the plan itself. I say “disturbing” because the SEC, though acting with laudable intent, is treading into waters with which its staff has little familiarity and virtually no expertise. Treating the participant instead of the Plan as the shareholder (besides being a legally tenuous position) will inevitably lead to confusion, expense and, ultimately, less protection of plan participants. As demonstrated by the SEC’s similar foray with its “Rule 22c2” which regulated excess trading in mutual funds (including in 401k plans,) these good-meaning SEC efforts cause tremendous expenditures with ineffective compliance “return.”
This is how it is works under the 12b-1 rule: the SEC’s 12b-1 rule change is actually two changes. It proposes a reduction in the 12b-1 marketing fee, while permitting an increase in the sales load fees under Rule 6c-10. The economic question which everyone is properly asking is whether or not those new “sales load” rules will accommodate paying for things for which retirement plans use 12b-1 fees now.
But in making the transition from 12b-1 to 6c-10, the SEC is requiring that the fees charged to each “shareholder account” be individually measured to make sure excessive fees do not end up being charged. This, in concept, is a great idea. In getting there, however, the SEC is not imposing the rule on the true owners of the shares (the 401(k) trustee). Instead, they are requiring that the Plan –as something it calls the “financial intermediary”-track the impact of these changes at the individual participant level. The severe administrative burden this imposes is well described by ASPPA and Spark in their comment letters.
Though I am not a securities lawyer, it seems that the SEC has taken a mistaken view in seeing the 401k Plan only as an intermediary, not as the ultimate owner of the mutual fund share. Claiming the plan is only something called an “omnibus account,” where the true owner of the shares is the 401(k) participant, ultimately leads to the conclusion that 401(k) participants should be treated like 403(b) participants. The result is that all shareholder rights (including proxy voting, prospectus delivery and the like) must be passed through to 401k participants.
There are a couple of problems with the SEC position. First, plan participants have interests in the plan (which are actually securities under securities law, though they usually don’t have to be registered), and this is what the SEC can regulate. Participants do not have anything but a beneficial interest in the accounts holding the mutual fund shares. Secondly, plans are not the typical “omnibus accounts” of the sort held by brokers for their customers. It has been the long established position of the DOL that the Plan owns the shares; the fiduciary is held accountable for the selection of them; and the fiduciary can force participants out of any mutual fund that is inappropriate. Many plans only have unit accounting of the comingled funds, not share accounting. Plan participants have no right to order a distribution of the shares in their names, as they do in a typical omnibus account. In short, these are NOT the characterizations of an omnibus account.
All of this is not to say that the SEC isn’t doing the right thing. It’s just not doing it rightly.
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