12B-1 Plan

The 12B-1 Plan, under the Investment Company Act of 1940, allows mutual funds to charge shareholders for distribution and marketing expenses. Named after the section of the statute that permits them, these fees are designed to cover the costs of advertising, promotion, and selling shares of the mutual fund, including compensating brokers and others who sell fund shares. Though these fees can be beneficial in certain contexts, they remain a controversial aspect of mutual fund management due to their impact on investor returns.

Origins and Regulatory Framework

The plan was introduced by the U.S. Securities and Exchange Commission (SEC) in 1980, when mutual funds were in a nascent stage of their development. The introduction of 12B-1 fees aimed to provide additional revenues and, in theory, help mutual funds grow and deliver better returns through scale. The rule permitted mutual funds to deduct expenses related to distribution directly from the assets of the mutual fund.

Types of 12B-1 Fees

Distribution Fees

Distribution fees, often referred to as “12B-1 fees” colloquially, involve costs that go towards marketing and selling fund shares. These fees can be used for mailings, advertising, and compensating brokers who sell the fund to new investors.

Service Fees

Service fees are used to compensate brokers or other entities for providing ongoing services to fund shareholders. This includes activities such as answering inquiries and providing information to investors.

Fee Structure

12B-1 fees are typically charged as a percentage of a fund’s assets, and the SEC limits these fees to 1% of a fund’s average net assets per year. These fees are further broken down into:

Marketing and Distribution Fees: Limited to 0.75% of the fund’s assets annually.
Service Fees: Limited to 0.25% of the fund’s assets annually.

Many mutual funds offer various share classes, each with different fee structures:

Class A shares: Typically have a front-end load but lower 12B-1 fees.
Class B shares: Often have higher 12B-1 fees and contingent deferred sales charges.
Class C shares: Might have the highest 12B-1 fees but no front-end load.

Criticism and Controversy

The primary criticism of 12B-1 fees revolves around the argument that they often do not result in increased investor returns. Critics argue that these fees effectively reduce the net returns to investors and mainly work to benefit fund managers and brokers. Various studies have shown that mutual funds with high 12B-1 fees do not necessarily perform better than those with lower or no 12B-1 fees.

Alternatives to 12B-1 Fees

No-Load Funds

No-load mutual funds do not charge 12B-1 fees. These funds usually have lower expenses and can be an attractive option for cost-conscious investors.

Advisor Fees

Some investors choose to work with fee-only financial advisors, who charge flat fees rather than commissions, thereby avoiding potential conflicts of interest.

Regulatory Reforms

Given the controversy around 12B-1 fees, the SEC has considered various reforms over the years. In 2010, it proposed significant changes to the 12B-1 fee structure, although the rule has not been significantly altered as of the latest regulatory updates.

Conclusion

The 12B-1 Plan remains a significant component of mutual fund fee structures, having both potential benefits and drawbacks. Investors should be aware of these fees when selecting mutual funds and consider whether the benefits justify the costs. Being an informed investor entails scrutinizing these and other fees to make educated decisions that align with one’s financial goals.

To gain more insight into mutual funds and their fee structures, investors can visit the websites of established mutual fund companies such as Vanguard and Fidelity.