(This article was originally published on the Bloomberg service, written by Chet Currier.)
As much as journalists love anniversaries, we're in danger of letting one slip by unnoticed
this year.
Let's correct that oversight right now. Happy 20th Birthday,
mutual fund 12b-1 fees!
You say your calendar's full and you'll have to skip this
particular celebration, whenever it might be held? Millions of
fund investors are with you.
Since these fees for fund distribution expenses were
authorized in 1980 by the Securities and Exchange Commission,
under Section 12b-1 of the Investment Company Act of 1940, they
have won few friends outside the fund management firms that
collect them.
"One thing that is really important to me is the rip-off to
individual investors of 12b-1 fees," investor
Katy Filicky wrote
SEC chairman
Arthur Levitt Jr. on the regulatory agency's Web site
earlier this year.
The rule that arouses such antipathy permits management firms
to collect an annual fee from the assets of the funds they advise
to pay brokers and others involved in selling shares to investors.
This is separate from, and never to be confused with, the
management fee for running the fund's investments.
The charge can run as high as 1 percent of a fund's assets
per year. If it's 0.25 percent or less, the fund can still call
itself "no-load."
Common Practice
The funds' largest trade association, the
Investment Company
Institute, says more than half of all fund groups have at least
one fund with a 12b-1 plan. The number appears to be on the rise
lately, as numerous fund firms look for ways to induce brokers and
other intermediaries to keep pushing their merchandise.
No-load funds are sold increasingly through paid advisers, or
in discount brokerage "marketplaces" at firms such as Charles
Schwab & Co. that charge fund managements what amounts to a
listing fee. If fund managers want the shareholders to bear this
burden, hey, they can set up a 12b-1 plan.
Load funds, meanwhile, must now sometimes pass up their
customary up-front commission, as when they sell shares through
employer-sponsored 401(k) retirement savings programs. Bring on
the 12b-1!
"Sadly, the clammy hand of 12b-1 fees has grabbed fund
companies that formerly steered clear of such nonsense," said
Peter Di Teresa, a senior analyst at
Morningstar Inc., in a
commentary on the Chicago research firm's Web site at
www.morningstar.com. He cited
Capital Research & Management Co.'s
$333 billion
American Funds, the third largest of all fund groups.
According to an ICI survey, 95 groups with some form of 12b-1
fees at the end of last year spent 63 percent of the money they
collected to pay broker-dealers; 32 percent for administrative
services provided by outside firms for existing fund shareholders,
and the other 5 percent for advertising and sales promotion.
No Minor Issue
Though ICI researchers call this last amount "minor," it's
an especially sore point among 12b-1's non-fans. Why should
existing owners of the fund pay so much as a nickel to help
attract new investors?
Years ago, apologists tried to argue that more money in the
fund brought existing shareholders the benefit of greater
economies of scale -- that is, lower operating costs per dollar
invested. But this idea of a fee that saves you money never flew.
The main benefit of increased assets goes to the manager,
whose fee for running the fund is likewise set as an annual
percentage of the total in the fund. Isn't it logical to ask this
manager, operating in one of the most lucrative businesses
anywhere, to bear the cost of building the pot?
Another situation that only stokes the fire: Funds that close
to most new investors, but continue collecting money in their 12b-
1 plans. "That's right," Di Teresa said, "funds that are no
longer marketing themselves are charging marketing fees."
What's an investor to do? You can check the fee table at the
front of every fund prospectus for 12b-1 fees, and refuse to buy
any fund that even authorizes the practice. That's a fine way to
stand up for a principle. But crossing half the funds on the
market off your list may cost you some good opportunities.
Better, maybe, to compromise and remain willing to consider
12b-1 funds as long as 1) they don't charge more than 0.25
percent, and 2) otherwise go easy on the management fees.
In introductory economics we learn that, one way or another,
the customer pays for everything. But funds are supposed to be a
"mutual" business. Sticking the investors with the bill for
distribution does nothing to enhance that relationship. 
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