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.