Yet another fund group has decided to pull the plug on offering B-shares to new fund investors.
In a recent Securities and Exchange Commission filing, Dreyfus of New York notified fund investors that it would cease offering B-shares to new investors as of June 1. However, Dreyfus' existing B-share investors won't have to give up or convert their shares, and their reinvested dividends can still go into B-shares. In a separate statement, Dreyfus said that B-shares were being discontinued due to a "lack of significant demand." The firm also acknowledged that the initiative will "simplify fund offerings for shareholders."
Dreyfus spokeswoman Patrice Kozlowski confirmed that the B-share ban applies to a total of 73 funds under the Dreyfus Premier Funds and Dreyfus Founders Funds banners. Both fund groups are sold predominantly through banks, broker/dealers, and other financial institutions, although the Dreyfus Founders Funds also has a share class of grandfathered no-load investors; in 1998, Dreyfus' parent, Mellon Financial, acquired no-load growth-style manager Founders Asset Management.
Dreyfus is the latest in a growing list of fund companies that have thrown in the towel on offering B-shares. Some fund groups have instead launched new funds that lack the back-end loaded class of shares, while others severely limit which investors and/or sizes of purchases will qualify for B-shares.
One year ago, on Feb. 28, 2005, Franklin Templeton of San Mateo, Calif., killed off its B-share offering, although existing accounts were not affected, nor were fund exchanges between B-shares restricted, said company spokesman Matt Walsh. However, B-class shareholders were not allowed to add subsequent investments to their accounts.
Franklin chose to axe the B-share class because, as one of the last major fund groups to offer it, B-shares never gained much traction, Walsh said. "We also believe more simplified pricing alternatives are in everyone's best interest," he added.
Data from Lipper of New York confirms that B-shares have definitely fallen out of favor since at least the beginning of 2004. Among U.S. equity funds, A-shares and C-shares have shown positive net flows over the last two years, but flows to B-shares have been in the red. At year-end 2005, A-shares had $1.42 trillion in assets, while C-shares boasted $282 billion, and B-shares trailed with $237 billion.
The NASD had, for years, been sanctioning the occasional broker where suitability issues were raised as to whether a B-share, versus front-end loaded A-share, was suitable for a fund investor with a sizable investment. Regulators raised concerns that brokers were selling clients B-shares so they could garner a higher commission from the fund group. According to the NASD, a broker's suitability obligation includes the requirement to minimize the sales charge paid for fund shares as consistent with a customer's investment objectives.
In one case dating back to 2001, the NASD found that an Oklahoma broker's placement of a client's $2.1 million fund investment in B-shares resulted in the client paying 64% more in sales charges over an eight-year period.
The wake-up call for the mutual fund industry came in November 2003, when the SEC settled an enforcement action against Morgan Stanley of New York and levied hefty fines. The SEC charged, among other things, that Morgan Stanley had failed to adequately disclose its proprietary funds' higher fees on B-shares at the point of sale to clients. It also charged that the firm failed to tell investors that ongoing 12b-1 fees charged on the B-share class could impact their investment returns.
A-shares charge an upfront sales charge that comes directly off the top of any new investment. A portion of the sales charge is then paid to the broker/dealer as a sales commission, with a slice of that commission eventually trickling down to the selling broker.
There is no up front sales load on B-shares and, consequently, 100% of the customer's money is invested from day one. However, B-shares charge investors an annual asset-based fee that, over several years, can far exceed the amount of an initial sales charge on A-shares and, moreover, is virtually invisible to the shareholder. In addition, B-shares carry a contingent deferred sales charge, or back-end load, which incrementally kicks in if the investor redeems his or her B-shares before the seventh or eighth year. After the B-share sales period ends, the account usually converts to A-shares.
With B-shares, the fund company must reach into its own pocket to pay the selling brokerage firm its commission, and then recoup that cost over several years.
B-shares can work for some people, but it's better to pay an upfront load and not fool people, said Roy Weitz, publisher of fundalarm.com. "Companies have decided that brokers can't be educated, informed or disciplined in the area of B-shares, so they are going to just get rid of the temptation."
B-shares may very well be headed the way of the dinosaurs, but not right away. That's because fund companies that have offered B-shares in the past are still waiting to slowly recoup those out-of-pocket commissions paid years earlier.
"For most modest-sized fund groups, it's an expensive proposition," said Jeff Keil, principal of Keil Fiduciary Strategies in Littleton, Colo. "Most fund groups cannot just discontinue B-shares. They have to recoup costs first and then convert them to A-shares," Moreover, B-shares are no longer an attractive option to brokers because regulators are scrutinizing them more, he added.
"B-shares, in our view, were bad for small mutual fund companies and bad for investors," said Jeffry King, founder and CEO of Quaker Funds of Malvern, Pa., which, in December 2003 discontinued its B-shares after the SEC raised concerns. "There were a lot of sales abuses because shareholders were told there was no upfront sales charge. But if they wanted to redeem, they were hit with a deferred sales charge," he noted.
"B-shares are a real burden on small fund companies that, in order to compete, have to pay out 4.5% or 5% upfront and then either borrow money or recoup it through fees," King added.
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