SEC revisiting of 12(b)-1 fees: About time

The Securities and Exchange Commission is taking another look at 12(b)-1 fees, and 27 years after the commission first authorized them, that, no doubt, is appropriate.
One might even say that it is about time.
The investment world has changed dramatically since 1980. For example, the 401(k) plan as we know it didn’t exist then.
Only the year before, Ted Benna, a pension consultant, realized that that section of the Internal Revenue Service code might be used to fund retirement, and the IRS signed off on it only in 1981.
Now more than 40 million Americans own mutual fund shares through 401(k) and other defined contribution retirement plans, and each year, they buy more automatically when they and/or their employers make their annual contributions.
This almost automatic flow of funds has been an incredible boost for the mutual fund industry.
In addition, in those days, the financial planning industry was in its infancy, and most mutual funds were sold by brokers who generally were paid by an upfront sales load.
Now financial planners and financial advisers provide guidance to individual investors who need help with the investment of their savings.
The mutual fund industry also has changed. Entering 1980, the mutual fund industry still was struggling from the effects of the bear markets of the mid-1970s, for much of which mutual fund net sales, excluding money market funds, were weak.
So the industry needed a boost, and the SEC provided one in the form of the 12(b)-1 fee, which was designed to help mutual fund companies pay for marketing and distribution expenses. The argument was that if a mutual fund could attract more investors, the costs of running the fund per shareholder would decline.
The Investment Company Institute in Washington claims that the cost of investing in mutual funds has declined substantially as more and more mutual funds reduced or eliminated loads, replacing them with 12(b)-1 fees.
Others aren’t convinced, pointing out that although front-end and back-end loads are one-time costs, investors pay 12(b)-1 fees every year they own the funds.
Proponents of the fees — the mutual fund industry in general, brokers and commission-based planners and advisers, who are compensated through 12(b)-l fees when they sell mutual funds to their clients — argue that the fees are necessary, because they compensate the broker or adviser for the guidance given to the investor and for continuing to monitor the investor’s portfolio.
Without such compensation, they argue, the brokers and advisers would have no incentive to provide even initial guidance to those who won’t pay fees for it, and many investors are unwilling to pay such fees.
The SEC’s task is to look at all aspects of 12(b)-1 fees and answer a number of questions.
First, do 12(b)-1 fees serve the purpose for which they were designed? Do they, in fact, reduce costs for existing shareholders overall by improving the fund company’s marketing and distribution efforts?
If they help such efforts, is the maximum 1% fee level still appropriate? Should it be reduced?
If 12(b)-1 fees no longer are needed to help mutual fund companies with their marketing and distribution efforts, are they needed to compensate brokers and advisers for their guidance to investors? Do brokers and advisers actually provide such continuing advice and guidance?
If not, should the level of the 12(b)-1 fee be reduced? Brokers and advisers should be compensated for any initial guidance, but if they aren’t providing guidance, then the 12(b)-1 fee should end after a year.
The SEC must not only talk to those in the industry — mutual fund executives, brokers, planners and advisers — it also must talk to many mutual fund investors to see if they do, in fact, get the continuing advice that they pay for through the 12(b)-1 fee. If they don’t do that, then at least part of the 12(b)-1 fee should go away.
Another question: Should 12(b)-1 fees be allowed on mutual funds sold through 401(k) and other DC plans? Here, if anyone is getting advice — initial and continuing — it is the employer who installed and maintains the plan, not the individual investors in the plan’s funds.
Why should the plan participants pay for advice going to their employer?
My guess is that 12(b)-1 fees won’t escape from this review unchanged.

Related Topics: Just Thinking