Department of Labor Addresses 12b-1 Fees

In what is being perceived as a major development in the debate over 12b-1 fees, the U.S. Department of Labor has delivered an advisory opinion that says banks, brokerage firms and investment firms cannot accept payments from mutual fund firms in exchange for guiding retirement account customers into those funds.

The government's opinion on 12b-1 fees was revealed in a May 11 letter to Country Trust Bank, an Illinois savings institution, according to a report in yesterday's New York Times. The letter stated that a fiduciary like Country Trust must not steer a plan into a transaction that will cause "consideration from a third party in connection with such transaction." If that does occur, the fiduciary must cut other fees charged to the plan participant by the same amount it received from the third party.

"I think this intended to be a shot across the bow," Norman Stein, a professor of law at the University of Alabama, told the New York Times. "They're warning people that this is something they're going to be watching."

Originally intended by the Securities and Exchange Commission to level the playing field for smaller fund firms so they could recoup some of the marketing costs associated with luring new investors, 12b-1 fees have evolved into a major method for covering costs associated with distribution and generating revenue.

Last year, investors paid more than $10 billion in 12b-1 fees, according to the Investment Company Institute. Max Rottersman, president of FundForensics.com, told the Times that number is upwards of $11.6 billion. Critics of the fees argue that they are not properly disclosed to investors and are a major conflict of interest within the industry.

The SEC and NASD have levied millions of dollars in fines to fund firms and intermediaries in recent month for failing to disclose 12b-1 agreements. A revision of the rule is currently under consideration by regulators.

Country Trust, a $9.5 billion money manager, does not accept 12b-1 fees from funds it recommends. It requested guidance on the issue from the Department of Labor because one of its retirement accounts allocates assets based on a customer's risk profile and market performance. Country Trust solicited the opinion more than three years ago.

The Department of Labor has said previously that it is beefing up its investigation of fiduciaries to determine whether investors incurred losses as a result of conflicts of interest. If that is indeed the case, the department will likely demand restitution.