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SEC steps up scrutiny of 12b-1 mutual fund fees

Oct 16, 2022

With fee disclosures and reform on the SEC’s 2022 agenda as well as continued enforcement action related to Rule 12b-1 fees, it’s important for advisers to ensure there are no conflicts of interest in their fee arrangements and to review their policies and procedures for clarity and transparency.

For the past several years, the Securities and Exchange Commission (SEC) has been taking a close look at undisclosed conflicts of interest between investment advisers and their mutual fund shareholders related to the types of fees and revenue-sharing practices they use.

Several recent enforcement actions are related to the practice of investment advisers purchasing mutual fund share classes with 12b-1 fees when other share classes were available with no fee.

According to the Investment Company Institute, gross sales of no-load, long-term mutual funds increased from 46% in 2000 to 88% in 2020. Although this demonstrates a significant reduction in the share of mutual funds with 12b-1 fees, the SEC continues to keep a watchful eye on investment advisers’ fiduciary duty.

Review fee structures

As part of the SEC’s 2022 Regulatory Flexibility agenda, the agency plans to review conflicts of interests affecting mutual fund shareholders.

Ever since its adoption in 1980, Rule 12b-1 has generated significant controversy. 12b-1 fees are paid from mutual funds to advisers on an ongoing basis for distribution and marketing expenses.

When the 12b-1 fee was initiated, the need to attract investors to mutual funds for the benefit of existing investors was much greater than it is today. Mutual fund investing has grown significantly, and funds have sufficient assets to protect fund managers from having to make forced sales.

In addition, because 12b-1 fees include a percentage-based portion, the increasing size of mutual funds has led to higher fees, even as the justification for the fees has steadily decreased.

In 2016, the Office of Compliance Inspections and Examinations gave notice about its Share Class Initiative in which it noted that its exams would focus on conflicts of interest, recommendations made to clients, fees charged and disclosure practices.

The office provided an example of these conflicts of interest as “situations where the adviser is also a broker-dealer or affiliated with a broker-dealer that receives fees from sales of certain share classes, and situations where the adviser recommends that clients purchase more expensive share classes of funds for which an affiliate of the adviser receives more fees.”

Amnesty initiative

In 2018, the SEC announced its Share Class Selection Amnesty Initiative to provide favorable settlements to advisers that reported, of their own accord, where they had directed clients to purchase mutual fund share classes with Rule 12b-1 fees when other share classes with no fee were also available. The SEC reported that this initiative led to settlements with 79 investment advisers committing to return $125 million to clients.

In March 2021, the SEC proposed a rule that includes improved fee and risk disclosure for mutual funds and exchange-traded funds. This rule focuses on providing clear and consistent information about fees, expenses and principal risks as well as modernizing and enhancing disclosures.

On the SEC’s 2022 agenda is a review of the proposed fund fee disclosure and reform. Fund updates are expected before the end of the year.

As advisers and broker-dealers, it’s important to continue to review fee disclosures for clarity and consistency. Most important, scrutinize the fees to ensure any conflicts of interest are fully and fairly disclosed. Take a step back and consider how you can add value with a holistic review of your entire fee structure framework and determine where adjustments can be made to better align with your firm’s goals.

How Wipfli can help

Our financial services team has deep experience serving the needs of wealth and asset management firms and can address concerns regarding complex SEC rules on fee disclosures among other matters. Our knowledge means you have more time to focus on your core business. Contact us to find out how Wipfli professionals can best support you in serving your firm’s and your clients’ needs.

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Sarah K. Williams, CPA
Senior Manager
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