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Regulation and Compliance > Federal Regulation > SEC

The Future of 12b-1 Fees

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On July 21, 2010, the SEC voted to rescind Rule 12b-1 in its entirety and replace it with a new rule, Rule 12b-2.

What does this mean to you, your clients, and your trail commissions? FSI helpfully explains.

Under the current Rule 12b-1, mutual funds can charge a 12b-1 fee of up to 1.00% annually. 12b-1 fees are composed of two parts–a 0.25% service fee (which is the main source of Class A and B-share trail commissions), and a 0.75% distribution fee (aka “asset-based sales charge”). These two parts combined provide funding for 1.00% annual C-share trail commissions.

Effect on Class A and B Shares

Under proposed Rule 12b-2, the 0.25% service fee portion of 12b-1 would essentially be renamed a “marketing and service fee,” but would be otherwise unchanged. Thus, your 0.25% Class A and B-share trail commissions are unaffected and will continue as usual. We worked diligently over the past three years to influence the SEC to retain these trail commissions.

Effect on Class C Shares

However, the proposed Rule would affect Class C shares. The 0.75% distribution fee portion of 12b-1 would essentially be renamed an “ongoing sales charge,” and would also be subjected to certain limitations. Specifically, an investor would not be allowed to pay more “ongoing sales charges” in a C-share than they would have paid upfront had they chosen that same fund’s Class A share (at maximum load). After the break-even time period is reached, the C-share must convert to Class A.

For example, if a certain fund’s maximum Class A load is 5.75%, then its Class C shares must convert to Class A no later than end of the investment’s 92nd month (7 years, 8 months). To do the math to arrive at the conversion month in this example, simply divide 5.75 (A-share load) by 0.75 (ongoing sales charge in C-shares), and multiply by 12.

We have heard widely varying opinions from financial advisors about this proposed C-share conversion requirement. Many advisors say that the proposal makes sense, as C-shares are best-suited for short/mid-term holding periods anyway and clients with longer-term holding periods should be in A-shares. In fact, the American Funds’ C-shares already have a 10-year conversion period for this reason. Others argue that forcing C-shares to convert to Class A would incentivize advisors to churn client accounts to “reset the 1% trail commission clock,” drive clients into more expensive advisory accounts, or deprive investors of access to professional advisors.

New “Account-Level Sales Charges”

In addition to the changes to 12b-1 fees described above, the SEC’s proposal would also amend Rule 6c-10 in such a way to permit fund families to allow broker-dealers to add sales loads of their own choosing to fund NAVs, rather than abiding by the loads printed in the fund’s prospectus. The SEC hopes that this would lead to increased competition between broker-dealers, resulting in lower sales charges for consumers.

Such broker-dealer set loads would be termed “account-level sales charges” and would be charged directly to the investor, who would either pay the broker-dealer directly or have the load debited from their brokerage account. From the fund family’s perspective, the fund would have been sold at NAV–the fund family would not necessarily even have knowledge of what sales load the broker-dealer imposed.

The implementation of account-level sales charges is not required by the proposal. It is an option, which fund families may or may not wish to offer to those broker-dealers with whom they have selling agreements. However, we have serious concerns about this part of the proposal. For example, one could easily imagine inexperienced financial advisors gaining clients by promoting heavily discounted sales loads, only to later exit the business due to insufficient revenues. The orphaned clients of such advisors would likely be hard-pressed to find another advisor to service their account.

Make Your Voice Heard

So what do you think about the proposed changes? FSI says make your voice heard by e-mailing your comment letter to the SEC through our “Take Action” website. Comments must be received by the SEC on or before November 5, 2010.

For more information, listen to the audio replay of FSI’s August 6 Special Briefing, available at the organization’s website,


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