U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Opening Statement at SEC Open Meeting—Mutual Fund Distribution Fees (Rule 12b-1 Fees)


Commissioner Elisse B. Walter

U.S. Securities and Exchange Commission

Washington, D.C.
July 21, 2010

I too would like to thank the staff, and especially the Division of Investment Management, Buddy Donohue, Bob Plaze, Hunter Jones, Diane Blizzard, Thoreau Bartmann, and Daniel Chang, for their hard work on the recommendations before us today. 12b-1 fees have raised thorny issues for many years, and the staff has labored long, and well, to address them. I am glad that we are here today with a proposal before us. I support the staff's recommendations, and believe they take a thoughtful approach to important and longstanding issues relating to 12b-1 fees.

In my view, and I know that the staff shares it as well, reforming our regulatory approach to 12b-1 fees is an initiative whose time has come. In 1980, the Commission adopted rule 12b-1 under the Investment Company Act of 1940 after a period of net redemptions in the fund industry. The rule assigned to fund directors, and independent directors in particular, the responsibility of reconciling the inherent conflicts with the potential benefits of using fund assets to reduce fund expenses. Rule 12b-1 permits funds to use assets to pay for distribution activities if there is a written plan, periodic board approval of the plan based on a determination that it benefits the fund and its shareholders, and shareholder approval of the initial plan and any material increases in distribution spending.

The rule contains no explicit limits on the amount of fund assets that can be used for distribution, and are instead set by directors through consideration of 12b-1 plans. The 1980 release set forth factors intended to provide guidance to fund directors in this regard, such as consideration of the problems or circumstances the plan was intended to address.

Although the Commission appears to have contemplated only temporary use of fund assets under rule 12b-1 to address unusual problems or circumstances, plans under the rule have evolved beyond what the Commission had envisioned and become alternatives to fund sales loads. Also, it has become clear that the amount of 12b-1 fees deducted from fund assets has increased over time, whereas sales charges that investors can more easily appreciate, such as front-end loads, have gone down significantly.

Rule 12b-1 fees today are of significant economic importance. A majority of fund classes charge these fees, which totaled $9.5 billion last year. It is perhaps for this reason that views on 12b-1 fees are rather strong. Some have argued that 12b-1 fees have been a catalyst for significant innovation in share classes and marketing practices that have generally benefitted fund investors. They point to investors with a range of choices on how to pay for distribution expenses.

Others argue that the fees primarily benefit fund managers and broker-dealers, and that any innovations have served to confuse investors instead of help them. Thus, in turn, the fees force investors to rely on intermediaries to help them make investment decisions. There are other concerns, such as whether investors truly appreciate 12b-1 fees, as at least partly evidenced by their seeming willingness to pay increasing 12b-1 fees while sales loads have dropped. Also whether certain expenditures to attract shareholders into are justified and investors are paying more than their fair share of distribution expenses relating to any benefit they receive.

Although FINRA now imposes certain caps on 12b-1 fees, fundamental issues remain. Therefore, in 2007 we held a roundtable to solicit the view of investors, consumer advocates, industry representatives, and other interested persons regarding the issues and possible options to reform our approach.

After considering the suggested approaches and our experience with 12b-1 fees, today our staff is recommending measured proposals to address the issues. Under the proposals, funds would be able to use a limited amount of fund assets, .25%, through what would be called a "marketing and service fee," to finance any distribution activity. They would also be able to deduct amounts in excess of that fee to finance distribution, through what would be called "ongoing sales charges," but those amounts would be treated as substitutes for traditional sales loads. More specifically, regarding any individual shareholder purchase, the ongoing sales charge, combined with any front-end or deferred sales loads, could not be higher than the front-end load the fund charges. Also, when the limit is reached, fund shares would then automatically convert to a share class without the ongoing sales charge so that shareholders would be paying only their proportionate share of distribution expenses.

As an alternative to the ongoing sales charge, funds would have the option of offering a share class that could be sold by dealers subject to competition in establishing sales charge rates. Intermediaries would thus establish their own sales charges that would be charged from shareholders directly, similar to commissions on financial products such as exchange-traded funds. I look forward to hearing comments on this alternative approach, as it has the potential to spur innovation in fund distribution and promote competition in the sale of fund shares.

As existing 12b-1 fees are not well understood by investors, it is also important to enhance disclosure in this area. Thus, the proposals would require funds to disclose these fees as a form of sales charge. Specifically, they would be required to provide enhanced disclosure of the ongoing sales charge and marketing and service fee in the fee table and in shareholder reports. In addition, disclosure would be further enhanced by requiring information about these fees in confirmations of transactions that investors receive. I am very interested in making sure that the disclosure of fees is as meaningful as possible, and look forward to comments on this area.

Once again, I support the staff's recommendations.


Modified: 07/21/2010