Like them or not, 12b-1 fees play a big role in the mutual fund industry. The question now becomes what role, if any, should they play going forward?
   Named for the section of the Investment Company Act of 1940 that allows mutual funds to use fund assets to pay for distribution costs, 12b-1 fees are paid by shareholders to cover various services ranging from marketing expenses to broker advise. Created in 1980, the fees have ballooned in tandem with the burgeoning $11 trillion-plus mutual fund industry. According to the Investment Company Institute, $11.8 billion in 12b-1 fees were collected last year. More than 70% of mutual funds charge 12b-1 fees.
   Meanwhile, critics contend that the fees confuse investors by muddying the fund expense structure and the commission structure associated with buying funds, particularly through intermediaries such as brokers.
   In June, the Securities and Exchange Commission held a roundtable discussion on the future of 12b-1 fees. "When the Commission adopted Rule 12b-1 more than a quarter century ago, the idea was that 12b-1 fees would be a temporary solution to address specific distribution problems as they arose," said SEC Chairman Christopher Cox. "But today's uses of 12b-1 fees have strayed from the original purposes underlying the rule, and it is time for a thorough re-evaluation."
   The roundtable consisted of various financial industry players and looked at the original intended purpose of the rule, its evolution, the costs and benefits of the current use of Rule 12b-1, and possible reform options.
   Opinions were mixed and ranged from leaving things as they are to eliminating the fees and re-working fund expense structures or the way funds compensate brokers. In the end, the likely outcome will be to refine, and not eliminate, 12b-1 fees.
   "Rule 12b-1 plays an instrumental role in helping open the financial markets to millions of investors, and the consequences of curtailing Rule 12b-1 would be detrimental to their interests, as well as to the competitive financial marketplace," Ira Hammerman, senior managing director and general counsel for the Securities Industry and Financial Markets Association, said in a comment letter.
   SIFMA, a trade group representing broker-dealers, favors improving 12b-1 disclosures but opposes restricting the fee arrangements paid to broker-dealers.
   Fees under 12b-1 cover the tab for distribution costs and shareholder service costs, and run the gamut from advertising, mailing and printing expenses to paying brokers and others who sell the funds, the latter comprising 90% of 12b-1 expenditures.
   "While refinements in 12b-1 makes sense, a radical overhaul wouldn't," says Edward Giltenan, a spokesman at the Investment Company Institute, a trade group for the U.S. mutual fund industry.
   Giltenan said 12b-1 fees compensate intemediaries for their service, and they give small mutual fund companies access to distribution channels they otherwise wouldn't have, thereby increasing competition and keeping costs down. He says that ICI research finds that the total expense ratio for owning open-end stock mutual funds-which includes 12b-1 fees-fell to 88 basis points in 2006, its lowest level in 25 years.
   The ICI urged the SEC to improve disclosure both in fund prospectuses and other documents, and for sellers of mutual funds.
   Everybody seems to agree that disclosure needs improvement, but consumer groups and some financial industry trade associations want the SEC to take unequivocal steps to clear up the confusion surrounding 12b-1 fees.
   "Why does everyone want to obscure the facts; if it's a commission, call it a commission," says Dick Bellmer, national chair of the National Association of Personal Financial Advisors. "The Commission is concerned that 12b-1 fees are becoming a replacement for sales fees in no-load funds and we agree."
   To help consumers understand the role 12b-1 fees play in mutual fund investing so they can make better fund buying decisions, NAPFA suggests renaming the fees to reflect their role in brokerage firm compensation. It also recommends disclosing total fees and costs, including 12b-1 fees, in quarterly account statements.
   The SEC hasn't officially said when it will make proposals based on the roundtable, but one published source said the tentative deadline was by year-end.