Uncovering Hidden Fees - Part 4: "Understanding 12(b)(1) Fees."

We've been talking about fees and expenses affecting mutual funds inside 401(k), 403(b) and 457 plans. Last time we discussed the problems of multiple share classes and fund re-registration which can impose significant, additional fees on plan participants. The problem with these practices is that, no matter how large your fund or a particular participant's plan balance grows, they eat away at earnings year-after-year-after-year.

Today, I want to talk about a fee that's embedded in "Fund Expenses" but that has the potential to be very beneficial to your Plan's participants: The 12(b)(1) Fee.

12(b)(1) Fees actually provide mutual fund companies with a way to pay to market their investment management through advertising, brokers and other appropriate outlets. By allowing the Fund to bear the cost of marketing the Investment Company Act of 1940 tried to increase the likelihood that the Fund's directors will not enter into questionable arrangements to attract more money to manage. That's a good thing.

However, as a plan sponsor you need to be concerned with whether your participants are being treated fairly and are receiving sufficient value for every charge they pay. In other words, you have a fiduciary responsibility to ensure that 12(b)(1) fees paid to a broker are fair for services being provided to the plan. How can you determine that?

First, ask the question: "Do you receive 12(b)(1) or ANY other compensation from ANY PARTY in connection with your recommending or placing this plan with the vendor?"

Second, do some investigation of your own. We've developed a process for assessing the likely levels of 12(b)(1) and other revenue your plan might be able to collect, both you're your current and alternative vendors. We use a quick "litmus test" to get an idea of whether we might be able to identify untapped revenue, as well as other plan enhancements to your plan. Because we've become so efficient at this, we don't have to charge for it. A process like this, that we call "Three Flags Review," helps you quickly assess how you're really doing.

Third, do a quick calculation. If your Plan has $10 million and the funds pay 0.25%, 25 basis points, in 12(b)(1) fees, add up the dollars ($10 million at ¼ of 1% = $25,000) and divide by the hours or services you receive. Three eight hour days at your office per year, for a broker, would still be $1,000 per hour. Are you receiving $1,000 per hour service? Ask your advisor or broker what value they place on their time and, if you think the number's reasonable, calculate how well they're being paid for what they actually do. Then, NEGOTIATE!!

My philosophy is "If it's being paid you (the Plan Sponsor) are entitled to it." It's YOUR MONEY!! Actually, it's YOUR PARTICIPANTS' MONEY. It's your job to spend it wisely. Nothing that could be collected should be left untouched. I provide my clients with a clear statement of what my services cost. I give each client options, not only so they can choose what services they'll have me provide but also HOW I can be paid.

If the amount of the 12(b)(1) fee is MORE than my fee, we work with our clients to use those fees to pay for other services like record keeping or administration, education or investment advice. Whatever will benefit their Plan's participants. If there's still "excess compensation" available, we work with plan sponsors and vendors to try to have the "excess" credited to the Plan's participants as additional earnings. Ask your advisor to do the same.

Next article ... Part 5 of "Uncovering Hidden Fees"

The accuracy and completeness of this article are not guaranteed. The opinions expressed are those of the author(s) and are not necessarily those of Wachovia Securities or its affiliates. The material is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

Edward M. Lynch, Jr. is a Senior Vice President - Investment Officer with Dietz & Lynch Financial Strategies Group of Wachovia Securities in Newburyport, Massachusetts. For more information, please call Mr. Lynch at 877-609-8476. Wachovia Securities, LLC, member NYSE/SIPC.