SEC Promises to Rethink 12b-1 Fees

For years, these fees have irked investors.

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Here's a riddle: What's hidden, questionably used, and capable of costing investors $13 billion in a single year? The answer, reform-minded advocates say, is 12b-1 fees. For years, investors have bemoaned the fees, which are buried in expense ratios and purportedly used for advertising and promotion, but their complaints have yet to yield tangible results. During a conference earlier this month, Securities and Exchange Commission Chair Mary Schapiro indicated that this could be about to change.

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"The problem is that [investors] may have no idea these fees are being deducted or who they are ultimately compensating," Schapiro said during the Consumer Federation of America's annual Financial Services Conference. "We must critically rethink how 12b-1 fees are used and whether they continue to be appropriate." Schapiro further noted that she asked her staff to compile recommendations next year on how to deal with the fees.

Even so, Dan Calabria, a former president and CEO of Templeton Funds and author of the recently published book Mutual Funds Today: Who's Watching Your Money, says he isn't holding his breath. He says that the SEC has been paying "lip service" to changing 12b-1 fees for the past decade but has failed to take any meaningful action. "That same stuff has been going on for over 10 years," he says.

[See Study Shows Investors Pass Over Expense Ratios.]

Conceived of as a way for funds to advertise and to increase their visibility, 12b-1 fees are now used largely to pay commissions to brokers. "There is no discernible benefit to the shareholder as a result of 12b-1 fees," Calabria says.

Still, unless the SEC forces funds to nix them, the fees appear to be here to stay. "As long as the SEC refuses to take action, independent boards of directors are held hostage to 12b-1 plans," Calabria says. That's because if a fund board were to cut the fee, it would risk having brokers jump ship and start steering clients to other funds that still provided 12b-1 commissions. "The brokerage community would simply move the assets," he says. "Why would they give up that revenue when they can simply move [their business] over for whatever excuse they can manufacture?"