SEC 12b-1 Fee, Custody Rules Likely Out by Year-End

“Fund fees have been on the SEC’s regulatory agenda for quite some time now,” Lynch told me. “As you know, Rule 12b-1 fees have been dealt with rather harshly via the numerous enforcement actions against funds. The industry has certainly received the message and the use of 12b-1 fees is declining.”

In February, I reported that the Investment Company Institute found in March 2021 that the majority of long-term mutual fund gross sales now go to no-load mutual funds (i.e., no front-end or back-end load, nor a contingent deferred sales charge) without 12b-1 fees.

In 2020, according to ICI, 88% of gross sales of long-term mutual funds went to no-load funds without 12b-1 fees, compared with 46% in 2000.

However, Lynch continued, “other fees such as revenue sharing are increasing. The key for funds is to provide clear and consistent disclosure to shareholders regarding the fees charged. I suspect any rulemaking that comes out to focus on descriptive disclosures.”

The SEC said in its exam priorities, released in late March, that it would focus its exams this year on RIAs’ use of 12b-1 fees in wrap fee accounts where the RIA may be responsible for paying transaction fees, along with revenue sharing arrangements.

The agency said that RIA exams will focus on whether advisors “are acting consistently with their fiduciary duty to clients, looking at both duties of care and loyalty, including best execution obligations, financial conflicts of interest and related impartiality of advice, and any attendant client disclosures.”

Ron Rhoades, associate professor of finance at Western Kentucky University and director of its personal financial planning program, told me in another email that he’d be disappointed if the SEC seeks to address 12b-1 fees “only through rules that merely enhance fund fee disclosures in some manner, without severely restricting the utilization of fund share classes with 12b-1 fees.”

These 12b-1 fees, Rhoades said, “don’t benefit fund shareholders, and rather act to their detriment. Shareholders rarely understand 12b-1 fees. Outside of the defined contribution space (where R-1, R-2, etc. shares exist), 12b-1 fees are not negotiable by clients.”

Another problem, he says, “is that 12b-1 fees, particularly of the 1% variety (often seen in Class C shares), are – in essence – ‘investment advisory fees in drag.’ There is no reason for the SEC to permit ‘asset-based fees’ to be charged by brokers, when investment advisory fees would be more appropriate.”