In 1980, the Securities and Exchange Commission (SEC) adopted Rule 12b-1 under the Investment Company Act of 1940. This Rule permits funds to compensate brokers and other financial intermediaries out of investor assets for services they provide shareholders related to the sales and distribution of fund shares.
For most of their history, 12b-1 fees have been widely used on a continuing basis as a substitute for sales loads and to pay for ongoing services to shareholders. While some investors prefer to buy mutual funds directly from the company sponsoring them, a majority of investors now seek help from brokers and financial advisors in making investment decisions. These financial intermediaries provide investors with initial and ongoing assistance to help them select individual mutual funds and work towards achieving their financial goals. They also perform various administrative, shareholder servicing, and recordkeeping services on behalf of the funds.
Intermediaries can be compensated for these services in a variety of ways. Rule 12b-1 and the use of multiple share classes allows funds the ability to offer investors greater choice and flexibility in how and when to pay for these services.
Rule 12b-1 fees are reflected in a fund’s expense ratio and are fully disclosed as a separate line item in the fee table near the beginning of each fund’s prospectus. A fund board has to approve a Rule 12b-1 plan and the standard of approval for such a plan is only if the fund directors conclude that “there is a reasonable likelihood that the plan will benefit the [mutual fund] and its shareholders.”
In August 2010, the SEC issued for public comment a comprehensive proposal to reform Rule 12b-1. This SEC proposal would permit funds to use investor assets on a more limited basis for fund sales and distribution activities and would provide investors with several alternatives for paying sales charges to brokers and financial advisors. CMFI commented on these SEC regulatory proposals, and the agency is expected to issue a final rule in late 2011 or early in 2012. Click on the tabs for Documents, Comments, and Blog Entries tab to review the latest developments.
In addition to SEC action on Rule 12b-1 fees, several plaintiff law firms have pending litigation alleging that the use of 12b-1 fees by certain mutual funds has been improper, excessive, and not in the interest of shareholders. These lawsuits also contend that the 12b-1 fees charged to the funds and their shareholders were not reasonably related to the services provided. Click here to learn more about these lawsuits.