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We applaud the SEC’s efforts in connection (see editor’s note) with this proposal, as well as steps it has taken since its original proposal, to improve price transparency and prevent abusive sales practices in the fund industry. The Commission’s decision to ban directed brokerage eliminates a form of sales compensation that simply is not susceptible to the market discipline provided by full disclosure or the investor protection provided by regulatory oversight. While we believe the Commission’s re-proposal makes strides toward meaningful price transparency for mutual funds, we continue to have significant concerns in several areas. In particular, we are concerned that a number of the steps the Commission has proposed to simplify the disclosures have undermined their ability to serve their intended purpose. With comparative information removed, the documents no longer give investors any sense of the extent of the conflict of interest at work or how the costs compare to those of other funds. Because 12b-1 fees are grouped with annual operating expenses, the disclosures even fail to make a clear distinction between what the investor pays for the services of the broker in selling the fund and the costs associated with operating the fund. Finally, by allowing quantitative information about revenue sharing payments to be relegated to the Web site, the proposal risks encouraging increased use of a compensation method that, like the now banned use of directed brokerage, encourages brokers to recommend funds that are not in their customers’ best interests. All of these key shortcomings relate to two general problems with the Commission’s approach to this issue. First, the Commission appears to assume that disclosure requirements must be designed to conform to existing compensation practices, even where those practices are demonstrably harmful to investor interests. As a result, the quality of disclosure is undermined in order to avoid imposing “excessive” costs on brokers. Second, the Commission has approached this issue as a mutual fund issue when it is, in fact, primarily a broker-dealer concern involving issues with implications far beyond the sale of mutual funds. As a result, investors will get information about only those conflicts of interest that bias a broker’s recommendations of mutual funds (and related products covered by the rule) and will not receive information about similar conflicts that may bias the recommendation of those products not covered by the rule. The Commission’s approach to compensation disclosure seems to be based on a fundamental misunderstanding of the relationship between the way in which fees are disclosed and the way in which broker compensation is set. Fee disclosure rules and fee arrangements are not independent variables. Rather, they are mutually dependent variables that continuously interact. The current complex compensation structure for brokers is, in that sense, a direct result of the lack of effective disclosure. Had brokers been forced from the outset to disclose their compensation, they would likely have been considerably less inclined to adopt compensation practices that were inherently costly to disclose. We hope that the Commission will continue its efforts to protect investors from inferior investment products and abusive sales practices that have proliferated in this area. When brokers argue that detailed, written disclosure of the mutual fund fee arrangements would be too burdensome and costly because of the complexity of the compensation arrangements, they are in effect arguing that they, rather than market forces, should determine the structure of compensation arrangements. Similarly, their argument that differential compensation disclosure would be too costly and burdensome is an implicit acknowledgment that current compensation schemes could not survive if required to operate in a truly market-driven (fully disclosed) environment. But fee arrangements that cannot survive transparency-by reason of cost, complexity, or other factors-should be relegated to this secondary position, where it is significantly less likely to be reviewed by the investor. Thus, sound principles of disclosure should dictate that investors’ attention is actively directed to the most critical information, while only requiring that less critical, albeit important, information be easily accessible. Although the problems that led to the proposal of this rule arose in the context of mutual fund sales abuses, similar costs and conflicts apply to other products recommended by brokers. Because the Commission has approached this as a mutual fund issue, rather than as the broker-dealer issue it really is, the proposal creates a disclosure disadvantage for mutual funds compared with these other products. The Securities Industry Association has reportedly argued that, if brokers are subject to “burdensome” disclosure obligations with respect to mutual funds, they will simply recommend other products instead. Brokers have made similar threats in the past -arguing, for example, that they would stop selling wrap accounts if those accounts were regulated as advisory accounts -and failed to follow through. However, the very fact that the brokers’ trade association openly professes that brokers would abandon the sale of mutual funds, regardless of their customers’ best interests, rather than disclose their costs and conflicts of interest is itself the best argument for why these disclosure obligations should apply across the board. Since the primary purpose of the rule proposal is to ensure that investors get adequate information about sales-related costs and conflicts of interest, and since these costs and conflicts are not unique to mutual funds, there is no logical reason why the disclosures should apply to only a sub-set of the products brokers recommend. The solution, however, is not to water down the current proposal to the point of meaninglessness -by relegating all but the most general information to the Web site and eliminating the requirement for affirmative disclosure – nor is it to put the current rule proposal on hold while its requirements can be extended to other product areas. Instead, we urge the Commission to make a commitment to proceed immediately with comprehensive reform of broker-dealer cost and conflict of interest disclosure. As part of that comprehensive reform, the Commission should consider what information should be provided at the outset of the relationship, to help the investor make an appropriate selection among financial professionals, and what should be provided in relation to a specific product recommendation. Notwithstanding our criticisms of the re-proposal, we appreciate that requiring brokers to provide their customers with basic information about funds at the point of sale is by itself a watershed event in the history of the regulation of mutual funds. Our criticisms are driven, not by a failure to recognize and appreciate that progress, but by a desire to make the most of this possibly unique opportunity to improve these critical disclosures.

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