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Fund fees vital but need review, Lipper says

The mutual fund marketing fee that is currently under fire from critics as deceptive and unfair is so crucial to the $7.2 trillion industry that it cannot be eliminated, according to a new study by the mutual fund data research firm Lipper Inc.
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The mutual fund marketing fee that is currently under fire from critics as deceptive and unfair is so crucial to the $7.2 trillion industry that it cannot be eliminated, according to a new study by the mutual fund data research firm Lipper Inc.

Lipper's researchers agreed with critics who argue that the "12b-1 fee" -- named for the section of the federal law that allows fund companies to charge it -- has changed radically since the Securities and Exchange Commission approved it in 1980 as a stopgap measure to cover the costs of advertising to attract new customers.

About two-thirds of funds charge fees of up to 1 percent annually, and between 90 and 95 percent of the money goes to compensate the brokers who sell the funds to retail customers. Without that money, industry officials say, funds would be forced to charge larger sales fees, known as front-end loads, to cover broker commissions and the ongoing services -- such as statements and phone counseling -- that brokers provide. The findings are scheduled to be released later this week.

"The business really does rely on it for payment of services to shareholders," said Lipper Vice President Jeffrey C. Keil.

Keil's research team suggested that the SEC change the rules to make clear to investors exactly what the 12b-1 fees are for and that they are no longer temporary.

Lipper's team also proposed a radical shift in the way 12b-1 fees are assessed. Currently, the fund management each year recommends an across-the-board fee that is approved by the fund's board of directors and then charged to all customers. That means all investors pay the same service fee, whether or not they use a full-service broker.

Keil said investors might be better served if companies simply sold the funds at a set price and left it to each broker to charge a specific commission and services fee. Then customers could shop around and pick the price and service level they want.

"Then you could negotiate with your [broker] the way you shop for a new car," Keil said. The shift would acknowledge that fund boards, which are supposed to be looking out for investors, "are fairly far removed from the third-party distribution agreements and they can't really control them," he said.

The SEC last week proposed new rules that would require brokers to tell their customers up front exactly how much they are receiving in commissions and service fees and how their charges compare with the industry at large. That information could then be used for the kind of comparison shopping that Lipper's team envisions.

The report will be presented to a subcommittee of the Senate Committee on Governmental Affairs hearing on mutual fund fees and governance slated for Jan. 27. Lipper's conclusions may carry significant weight because the firm, along with competitor Morningstar Inc., is generally considered a source of neutral data about the fund industry.