A new bill calls for the elimination of 12b-1 fees.

There's no such thing as a free lunch in life or in the mutual fund business.

That, in essence, is the fund industry's Milton Friedmanesque argument in favor of the persistent 12b-1 fee, which is now more popular than ever and generating about $10 billion annually, estimates Lipper Inc. The revenue brought in by this fee is critical to the continuing sale of many funds that depend on third-party channels, including financial planning broker-dealers, the industry says.

"Some 80% of funds are using third parties to distribute these funds. How are these reps going to be compensated if we don't have these fees?" says a spokesman for the Investment Company Institute (ICI). The ICI has consistently argued that the 12b-1 rule is fair and important to its members, many of whom have built their business around it. That's because, in a no- or low-load environment, funds are incurring large expenses that the 12b-1 offsets, industry officials claim.

Still, as Financial Advisor was going to press, three members of Congress were proposing an extensive review of mutual fund charges. The Mutual Fund Reform Act, sponsored by Senators Peter Fitzgerald (R-Ill.), Susan Collins (R-Maine) and Carl Levin (D-Mich.), calls for the abolition of the 12b-1 and soft dollar arrangements.

At the top of the list of issues before Congress and the regulators is the 12b-1 fee. It has become more and more controversial as it has become the charge of choice in much of the industry. The fee is seemingly ubiquitous because of the less frequent use of front-end loads, or the so-called A shares. The latter were once a staple of the fund industry. Now sales loads have been replaced by the fund fee du jour. For example, today about two-thirds of the some-16,000 funds tracked by Morning-star have a 12b-1 charge. The ICI notes that this is part of a long-term trend.

"Since the adoption of the rule," states an SEC pamphlet on the fee, "more than half of all mutual funds have enacted the rule 12b-1 plans, using the charges alone or with sales loads, as the primary means of financing distribution. Other funds, typically funds with front end loads, have added a relatively modest rule 12b-1 to pay for some sale commissions, printing prospectuses and sales literature, advertising and similar expenses."

The 12b-1 charge generally ranges from the pesky (0.01% annually) to the large (1% annually), according to Morningstar. But some suggest this charge, which was adopted by the Securities and Exchange Commission in 1980, has become "abused." The problem, say 12b-1 critics, is that the fee's original purpose-to allow more fees for investment companies so they can help investors-has been distorted. As fund expense ratios continue to rise, the investor is getting stuck with the entire lunch bill, not to mention golf outings galore.

In the 1980s, regulators envisioned this: Investment companies, so the fund industry says, should be allowed to levy these charges so they would be able to market effectively. This would bring in larger amounts of assets. Big asset bases would mean that funds could adopt economies of scale, and would then be able to reward investors in lower expense ratios as the bucks came rolling in. That, in theory, was how it was supposed to work out.

In giving its blessing almost a quarter century ago, just as the Age of Reagan was about to dawn, the SEC said a a registered open end management company could implement or continue a 12b-1 plan if fund directors voted to approve it based on the idea that it would benefit the fund company and its shareholders.

But are these charges benefiting the shareholder or are they a disguised sales charge, designed to help the investment company at the expense of the clients?

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