The Securities and Exchange Commission on Wednesday voted to revamp fees that most mutual funds charge to cover sales and distribution costs, and that have become a source of confusion for investors and industry insiders alike.
Revenue from so-called "12b-1" fees can be used for a wide range of fund services beyond upfront sales costs, and an investor can pay the fees for years after they've gotten into a fund, eroding returns. Even industry pros find 12b-1s confusing, because funds can use the fee revenue in so many different ways.
The commission voted unanimously in Washington on Wednesday to adopt changes proposed by the SEC staff to streamline the fees, limit investor costs, and improve fee disclosure. The rules are subject to a 90-day public comment period.
The proposals, SEC Chairwoman Mary Schapiro said, "are intended to provide clarity and fairness to a mutual fund distribution system that has become confusing and potentially anticompetitive."
The new rules, she said, are aimed at "leveling the playing field for investors," while also minimizing disruptions to the fund industry.
The proposed rules include reducing the cap on how much a fund can charge in 12b-1s, which can make up one component of a fund's overall ongoing expenses. The 12b-1s are separate from the management fees that all funds charge for overseeing an investment portfolio.
About two-thirds of the industry's 8,000 funds charge 12b-1s, which brought in $9.5 billion last year. That's up from a few million dollars when funds were first permitted to charge the fees in 1980, according to the SEC.
Increasingly, the fees have become revenue substitutes for the growing number of funds that draw investors by touting the fact that they don't charge "loads," or one-time sales fees. Funds charging loads compensate brokers and other sales-and-distribution middlemen through fees paid directly by individual investors.
In contrast, funds charging 12b-1s cover sales and distribution costs through ongoing fees that all investors pay as long as they're in the fund. But funds can also use 12b-1s to cover everything from advertising, to sending out fund reports to investors, to other long-term services. They can range as high as 0.75 percent of a fund's assets per year.
Under the SEC proposal, funds would be allowed to charge a "marketing and service" fee of up to 0.25 percent. Funds would be required to disclose what percentage of the fund's assets are being paid to brokers as ongoing sales charges, and separately list costs for marketing and other services.
Among other changes, the industry would do away with the 12b-1 name — a legacy of the SEC rule that allowed funds to begin charging the fees. The fees were created to help a then-struggling fund industry recover from tough times in the 1970s.
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