Last month the Securities and Exchange Commission proposed making big changes to how mutual funds structure fees related to sales and distribution, referred to as 12(b)-1 fees.
Adopted by the SEC in 1980, Rule 12(b)-1 gives mutual funds the ability to charge a fee to investors, much of which is used to compensate financial intermediaries (i.e. brokers). There are about 8,000 mutual funds and about two-thirds of them include this fee in their annual operating expense. Revenue from 12(b)-1 fees has grown exponentially since the fee was introduced, generating $9.5 billion in 2009.
Not all mutual funds charge a 12(b)-1 fee, but those that do are typically “load” funds. As an investor of a load fund, you generally have an option of buying class “A” or “B” shares, which have a sales charge and a relatively lower annual 12(b)-1 charge. However, you can choose to purchase class “C” shares and opt for a lower sales charge, but you will have a higher annual 12(b)-1 charge that continues until you sell the shares.
According to the SEC, new rules are being drafted with three primary objectives: limit the amount a mutual fund can charge as a sales charge, create more fee transparency, and open the door for increased competition among commission-based financial advisors.
The new rules will eliminate the use of the term 12(b)-1 fee and replace it with a “marketing and service fee” that is capped at 0.25 percent. In addition, the new rules will likely lead mutual funds to create a new class of shares by which brokers would determine their own commission rate, creating a more competitive pricing environment.