The U.S. Securities and Exchange Commission (SEC) is calling for new limits on use of 12b-1 distribution fee provisions in the mutual funds in variable annuity subaccounts.

Rule 12b-1, a regulation adopted under the Investment Company Act of 1940, lets SEC-registered mutual funds use a portion of fund assets to pay for the cost of promoting sales of fund shares. Fund companies use the provision to eliminate sales load charges.

The SEC decided Wednesday to update Rule 12b-1 and officials say the agency plans to apply the same changes to the funds in VA separate accounts as it applies to ordinary mutual funds.

The conventional wisdom is that mutual fund managers use 12b-1 fees to cover distribution costs and insurers use other types of fees in connection with variable annuities, but many variable annuities now use investment funds that charge 12b-1 fees, officials say.

The proposed regulations would limit fund sales charges and impose tougher disclosure rules.

SEC officials say in a preamble to the new proposed changes that they still want to let funds bear some promotional costs. They also want to let funds continue give investors alternatives to paying sales charges, such as paying charges at the time of purchase, paying at the time of redemption, or paying a continuing fee charged to fund assets.

But money managers would have to hold the ongoing, asset-based sales charges that individual investors pay to the highest fee charged by the fund for shares that have no ongoing sales charge, officials say in a proposal summary.

“For example, if one class of the fund charges a 4% front-end sales charge, another class could not charge more than 4% in total to investors over time,” officials say. “The fund would keep track of how long investors have been paying ongoing sales charges.”

In addition, funds could charge 0.25% of assets per year for “distribution as ‘marketing and service’ fees, for expenses such as advertising, sales compensation and services,” officials say.

The SEC also wants money managers to give clear all sales charges in fund prospectuses, annual and semi-annual reports, and investor confirmation statements.

Officials note that owners of variable insurance contracts may pay distribution costs in the form of a front-end load, a contingent deferred load, or ongoing charges that are deducted from the assets held by the separate account, or a combination of these charges. At variable annuities, annual fund 12b-1 charges rarely exceed 0.25 percentage points, officials say.

The SEC proposal includes provisions that would let money managers offer classes of shares that could be sold with sales charges set at competitively established rates, to better reflect the value investors place on the intermediary’s services. For those classes, the SEC would ease current restrictions on distribution services price competition.

VA issuers that wanted to continue to use 12b-1 fee provisions would have to come up with a way to track and age shares. That might be difficult for some insurers, because insurers generally do not offer underlying funds with contingent deferred sales loads, officials say.

“Under our proposal, insurance companies would either have to develop this capability or offer only shares of classes that do not impose an ongoing sales charge,” officials say.

The SEC is asking for comments about whether it should treat VA funds differently from other funds.

“Given that most distribution activities occur at the separate account-level, is it appropriate to permit underlying funds to impose the marketing and service fee or ongoing sales charges?” officials ask. “How would these fees be used? Should we limit underlying funds to the marketing and service fee? Should we consider some other structure for limiting fees charged by underlying funds?”

Officials say they received a comment in 2007 urging elimination of 12b-1 fees for variable life and variable annuity products because, according to the commenter, “12b-1 fees have become a ‘shell game’ for insurance companies and have allowed them to camouflage their profit margin as investment management fees.”

Comments are due Nov. 5.