Fees on 12 B-1 Mutual Funds (or “B Shares”) Under Renewed SEC Scrutiny

“B Share”, or “back-end load”, mutual fund issues are being reconsidered by The Securities and Exchange Commission. The “B share” nick-name is derived from Rule 12 b-1 of the Investment Company Act of 1949, amended a quarter century ago to allow for the creation of such shares.

To combat a huge growth in “no load” mutual funds in the 1980’s, commission based investment firms lobbied for the creation of a product to compete. In response, the U. S. Congress agreed to amend the Investment Company Act to provide for a new class of mutual funds. On such funds, mutual fund companies can, instead of charging the investor an up-front commission, pay commissions to investment firms and their brokers right away, then charge the investor fees over time to recoup those commissions.

Since that time regulators have been besieged with complaints regarding B Shares. Deception, omission and out-and-out misrepresentations have often been made to lure investors into believing such funds are “no load”. Most observers acknowledge the potential for such abuse, yet little has been done to address the issue.

As well, such funds do not make adjustments to lower commissions on larger investments as do the much older variety of “A shares”. For example, if an investor invests $500,000 into A shares, or a “family” of such funds to diversify, they usually pay smaller percentage commission – perhaps 2% – than someone a total of $25,000, who may pay 4%. An investor usually pays one percent per year for 5 years on B-shares, a total of 5%.

To be sure the commissions already paid by the mutual fund company to investment firms is recovered, a penalty is charged to the investor for cashing out of the fund prior to the five years necessary to recover the sales expense. Many investors discover for the first time that the the fund was indeed not a “no load” fund when they seek to sell.

As further abuse, some brokers used questionable tactics to convinced clients to cash in B shares of one fund, causing a penalty to the client, only to invest the proceeds into B shares of another fund, renewing the period for sales charges and penalty. This is especially prevalent when a client’s account is moved from one investment firm to another. Sometimes it is the same broker making the change, who liquidates at one firm then reinvests at a new firm, thereby avoiding detection.

Another abuse is failing to inform investors seeking changes in their portfolios that, instead of liquidating B shares and incurring the penalty, investor can usually move their funds to a different fund within the same family of funds and avoid the penalty.

Even those investment brokers who properly explain B Share fees to their clients seldom warn the significance of being charged an extra 1% per year on their investment. This “deferred sales charge” comes in addition to other fees and costs charged to the investor by the mutual fund.

Therefore an investor can a total of 2%, or even higher, in annual costs on their assets. This means that, instead of enjoying a growth of perhaps 10%, as their investment rises in value, the investor would only earn 8%. A compounding return of 8% is far lower than compounding at 10%. The effect is even more pronounced in a falling market, since total charges of 10% in 5 years can double market losses of 10%.

Investors investing for income are hurt even more by charges and fees on B Shares because instead of earning a rate of perhaps 6% on their investment, that investor would earn in the range of 4% after paying costs and fees of 2%.

Investors who make withdrawals from mutual funds, such as retirees needing income, can suffer even more through a phenomenon known as “reverse dollar-cost averaging.” Salespersons are often quick to point out to investors who make systematic investments of the same amount that, because of ebbs and flows of the market, more shares are purchased at lower prices than at higher prices. However, they seldom inform clients that the reverse is true when systematic withdrawals are made from an account – more shares are liquidated at low prices than high prices.

Although the SEC’s Chairman admits that the creation of B shares was then to be a “temporary solution to address specific distribution problems”, with $11 billion in annual revenues on B shares now at stake for investment firms, considering their powerful influence over such decisions, it is doubtful that “roundtable discussions” at the SEC will result in any meaningful changes.

The law firm of Shepherd Smith and Edwards has represented many investors who have lost substantial sums in mutual finds, including in “B-shares”. To learn whether we can to assist you to recover your losses contact us to arrange a free confidential consultation with one of our lawyers.