SEC Punts On 12b-1 Fees

July 27, 2010

Your article today on 12b-1 fees is way too soft on the Securities and Exchange Commission, Olly.

You note in the article, SEC To Make Changes To 12b-1 Fees, that the new rules will “limit what investors pay in ongoing sales charges and require more clear disclosure of costs by fund companies.”

Bullpuckey. The proposed regulations are a gift to fund companies, which will keep on charging investors a fee they don’t understand for a service that doesn’t benefit them at all.

12b-1 fees were created in the 1970s to allow struggling mutual funds to gain more assets by allowing them to pass on marketing costs to shareholders. The idea was that, as funds increased in size, expenses would come down for investors. But that’s not what’s happened. At least not in a significant way.

Sure, fees have come down. The average mutual fund fee was 2.32 percent in 1980 and is now just 0.99 percent, according to the Investment Company Institute. That’s a decline of 57 percent. Meanwhile, assets invested in mutual funds are up 16,800 percent, from $57 billion at the end of 1979 to $9.6 trillion in 2008.

I think mutual fund companies are doing just fine.

I wouldn’t have a problem with 12b-1 fees if fund companies agreed to pass the savings from asset growth on to shareholders. For instance, fund companies could be permitted to charge 12b-1 fees if they agreed to lock into a pattern of fee reductions based on asset growth: a 10 percent reduction when assets hit $100 million, another reduction when they hit $1 billion, etc.

That’s what 12b-1 fees were designed to do. But it’s not, at all, what is happening. 12b-1 fees have become a backdoor way to charge without the up-front sticker shock you get from the more honest 5.75 percent front-end load. They prey on investor psychology and classic behavioral economics to enrich the owners of mutual fund companies at the expense of the owners of mutual funds.

12b-1 fees were enacted at a time when the mutual fund industry was struggling to survive. That’s no longer the case. The SEC should have taken a cue from the U.S. District Court for the Southern District of Florida’s treatment of the Telephone Excise Tax in 2005, when it realized that a tax designed originally to pay for the Spanish-American War had outlived its utility.

The SEC has been doing a lot of things right recently, but it totally missed on this one.


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