The Securities and Exchange Commission voted unanimously Wednesday to propose limits on mutual fund distribution fees and provide more transparency for investors.

The mutual fund industry collected approximately $9.5 billion through 12b-1 fees last year, according to data from the Investment Company Institute.

The fees, which were developed in the late 1970s when funds were losing investor assets faster than they were attracting new assets, are used to offset a variety of expenses including advertising, broker's commissions and sales and marketing costs. These fees are equal to about 18% of all fund expenses, not counting sales charges, or about $2 for every $1,000 invested.

The SEC's proposal would protect investors by limiting fund sales charges (funds would be allowed to charge a “marketing and service” fee of up to 0.25 percent of a fund's assets per year), improve transparency of fees for investors, encourage retail price competition, and revise fund director oversight duties.

The rules are subject to a 90-day comment period.

“Despite paying billions of dollars, many investors do not understand what 12b-1 fees are, and it's likely that some don't even know that these fees are being deducted from their funds or who they are ultimately compensating,” said SEC Chairman Mary L. Schapiro, in a press release. “Our proposals would replace rule 12b-1 with new rules designed to enhance clarity, fairness and competition when investors buy mutual funds.”

Some critics of the SEC’s proposal to limit or eliminate 12b-1 fees argue that capping 12b-1 fees will impact firms’ ability to bring advice to middle market or small investors.

A 2005 study by the ICI found that about 40% of 12b-1 fees went to pay advisers for initial sales, while approximately 52% of the fees were being used by fund companies to provide ongoing support to clients. The ICI says eliminating 12b-1 fees would get rid of any incentives advisers have to provide clients with investment advice.

“All of the proposals the SEC addressed today, like sales charge limitations and transparency of fees, are good thinking. But when you begin to break them down as a practical matter they address the symptom but not the underlying illness,” said Matthew E. Lynch, president and chief executive officer of Capital Analysts, in a phone conversation on Wednesday.

Lynch said the fundamental problem is the way the business is built today. 12b-1 fees have become the difference between profit and loss for many firms, Lynch explained. “Smaller firms and advisors have come to count on 12b-1 fees as a material revenue source and they have built their service model, marketing plan, and the minimum assets under management required based on the 12b-1 model,” he said.

Lynch believes the impact of capping or eliminating fees will be that advisors will start to move upmarket to larger clients who they can charge larger fees and lower-end clients will be moved to a self-service approach: “Just like you pay someone to do your taxes I think the industry will move to a fee-for-service model where you don’t pay on an ongoing basis, and the fees are unbundled from the products.”

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