The 12b-1 fees funds imposed in flush times to compensate brokers for the sale of B shares could begin to haunt fund firms, now that the markets have turned bearish.

At least one fund company has said that the decrease in its Internet and tech sector funds' values have so seriously eroded fund assets that the 12b-1 revenues it expects to receive on its funds' B shares are no longer adequate to reimburse the fund adviser for the up-front commissions it has already paid to brokers that previously sold the funds.

On April 17, Comerica of Detroit announced that it had taken a $26 million write-off related to the erosion of assets of Munder Capital Management, a subsidiary in Birmingham, Mich. The fund group, which had early on invested heavily in both Internet and technology stocks, had suffered significant enough losses in its funds' net asset values that Comerica had to reassess the future 12b-1 revenues it expected to receive on the remaining shares.

"The amount we would get back [through the funds' 12b-1 fees] had dropped dramatically," said Judith Love, senior vice president of finance at Comerica. As of March 31, Comerica had $54 million in net remaining deferred distribution costs.

"I don't think there's ever been volatility like this in such a short period of time since B shares have been around," she said.

The declining market particularly hurt three of Munder's funds - the Munder Net Net Fund, one of the earliest funds to invest exclusively in Internet stocks in 1996, the Munder International Net Net Fund, and the Munder Future Technology Fund. In the first quarter of 2001, the tech and Internet sector of the market declined 26 percent, according to Comerica.

B shares were created in 1980 when the SEC first allowed mutual fund advisers to use up to one percent of fund assets to pay for fund advertising, distribution, sales materials and other charges directly related to the sale of fund shares. The industry began charging a 12b-1 fee on B shares usually in conjunction with contingent deferred sales charges.

B shares carry no initial sales charge when the shares are sold to investors. Rather, they have back-end sales charges that reimburse the fund adviser on a multi-year, declining fee basis, if the investor liquidates shares, usually within six years of purchase.

Investors liked the idea of having 100 percent of their investment put into a fund from the start, without the more common up-front Class A sales charges shaving a percentage off the initial amount being invested.

But in order to motivate brokers and other intermediaries to sell B shares, many funds found themselves having to pay those initial brokerage commissions themselves. Fund advisers planned to then recoup those commissions by retaining a portion of the ongoing 12b-1 asset-based fee that was charged to fund shareholders.

But B share 12b-1 plans can be risky. A fund's board of directors must annually approve the continuation of a fund's 12b-1 plan. A board can terminate a fund's 12b-1 plan if it deems that the plan is no longer in the best interest of shareholders.

The ability of the fund adviser to over time recoup the commissions that have already been paid out to selling brokers can change with the investment climate. Funds that significantly depreciate or fail to attract new assets run the risk of not being able to generate enough in 12b-1 revenues. Since 12b-1 fees are charged as a percentage of assets, falling asset levels translate into lower revenues.

Funds that have been self-financing their brokerage commission payments on B shares and those funds that are narrowly focused on the most volatile sectors of the market may be most at risk, analysts said.

B-shares, with their contingent deferred sales charges and 12b-1 fees, grew out of the anti-sales load sentiment prevalent in the 1980s and 1990s, said Barry Barbash, partner with the law firm of Sherman & Sterling in Washington, D.C. and former director of the SEC's division of investment management.

"No fund company wanted to be caught dead with very visible, front-end loaded shares," he said. So many advisers willingly assumed the risks of selling B-shares in order to sell more funds.

"The assumption [made by fund advisers] was that the pot was always growing," said Barbash. But that certainly is not a given anymore, he said.

"Other than a blip in 1987, B-shares haven't functioned in an environment of high redemptions without great assets being gathered," he said.

Some fund companies wanted to sell more shares but did not want to assume those risks. So they turned to a growing number of outside B share finance companies like Citibank, Constellation Financial Management, Putnam Lovell Securities and CIBC World Markets, all of New York.

A B-share finance company analyzes individual funds' redemption rates and makes projections about future cash flows and 12b-1 revenue streams. Based on those calculations, the finance company will purchase the rights to receive future 12b-1 revenue streams, often in addition to other ongoing fees the adviser agrees to pay, in return for a large cash payment immediately made to the adviser, said Mark Garbin, managing principal of Constellation. That allows the fund adviser to transfer all of the future risks to the finance company.

Federated Investors of Pittsburgh, ING Pilgrim of Phoenix, Ariz., American Skandia of Shelton, Conn. and Pioneer Investments of Boston have obtained 12b-1 financing from Putnam Lovell, according to Putnam Lovell. AIM Management of Houston, has obtained finanacing from Citibank of New York, according to AIM.

In 1998, as part of a major restructuring which split the company into three operating units, Pioneer arranged for Putnam Lovell to handle its B-share financing and up-front commission payments. In return for the rights to receive future 12b-1 revenue streams from Pioneer's B-shares, Putnam Lovell paid Pioneer $62 million, said John Linnehan, senior vice president at Pioneer.

Pioneer used the cash to pay down debt and finance future growth of its business. But the overwhelming reason for obtaining outside financing was the uncertainty of future revenue streams, he said.

"We were very concerned about market volatility," said Linnehan, in an interview earlier this month. "We were concerned about downside risk and [the possibility of] increased redemptions. But Pioneer, which had only begun selling B shares in 1994, never considered discontinuing B share sales which now account for 35 percent of all fund sales."

"You really cannot shut yourselves off from the brokers," he said. "Investors want 100 percent of their money working from day one."

Many fund companies that finance their own B-share commissions, including Putnam Investments and John Hancock Funds both of Boston, are unaffected by the bear market. Neither company reported any financial difficulties related to their recouping commissions through 12b-1 plan fees. Both said they have escaped difficulties largely because of their very diversified lineup of funds.

Industry analysts say it is unlikely that B-share finance companies have been hurt by this market environment. That is because the companies they have been financing are well diversified, said Michael O'Connor, vice president and senior analyst at Moody's Investors Service of N.Y.

The market's volatility may, however, have knocked one player out of the B share financing business. Putnam Lovell is getting out of the business altogether, said sources close to the firm. Calls to Putnam Lovell were not returned.

Other B share financiers are likely to be re-evaluating the arrangements they currently have with mutual fund firms, and that could mean higher costs are imminent, some fund executives said.

"B-share financiers will become stricter with their purse strings," said Barbash. "You can also bet the SEC examination staff will be looking at" whether more details about these financing relationships should be disclosed.

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