What Is a 12b-1 Fund?

A 12b-1 fund is a mutual fund that charges its holders a 12b-1 fee. A 12b-1 fee pays for a mutual fund’s distribution and marketing costs. It is often used as a commission to brokers for selling the fund.

12b-1 funds take a portion of investment assets held and use them to pay expensive fees and distribution costs. These costs are included in the fund’s expense ratio and are described in the prospectus. 12b-1 fees are sometimes called a “level load.”

Understanding 12b-1 Funds

The name 12b-1 comes from the Investment Company Act of 1940’s Rule 12b-1, which allows fund companies to act as distributors of their own shares. Rule 12b-1 further states that a mutual fund’s own assets can be used to pay distribution charges.

Distribution fees include fees paid for marketing and selling fund shares, such as compensating brokers and others who sell fund shares and paying for advertising, the printing and mailing of prospectuses to new investors, and the printing and mailing of sales literature. The SEC does not limit the size of 12b-1 fees that funds may pay, but under FINRA rules, 12b-1 fees that are used to pay marketing and distribution expenses (as opposed to shareholder service expenses) cannot exceed 0.75% of a fund’s average net assets per year.

12b-1 Fees

Some 12b-1 plans also authorize and include “shareholder service fees,” which are fees paid to persons to respond to investor inquiries and provide investors with information about their investments. A fund may pay shareholder service fees without adopting a 12b-1 plan. If shareholder service fees are part of a fund’s 12b-1 plan, these fees will be included in this category of the fee table.

If shareholder service fees are paid outside a 12b-1 plan, then they will be included in the “Other expenses” category, discussed below. FINRA imposes an annual 0.25% cap on shareholder service fees (regardless of whether these fees are authorized as part of a 12b-1 plan).

Originally, the rule was intended to pay advertising and marketing expenses; today, however, a very small percentage of the fee tends to go toward these costs.

Special Considerations

12b-1 funds have fallen out of favor in recent years. The growth in exchange-traded fund (ETF) options and the subsequent growth of low-fee mutual fund options has given consumers a wide range of option. Notably, 12b-1 fees are considered a dead weight, and experts believe consumers who shop around can find comparable funds to ones charging 12b-1 fees.

What Is a 12B-1 Plan?

A 12B-1 plan is a plan structured by mutual fund companies for the distribution of funds through intermediaries. 12B-1 plans provide mapping for the partnerships between distributors and intermediaries who help to ensure the sale of a fund. Sales commission schedules and 12B-1 distribution expenses are the primary components driving a 12B-1 plan.

Understanding the 12B-1 Plan

12B-1 plans facilitate the partnerships between distributors and intermediaries offering mutual fund shares. 12B-1 plans are primarily focused on open-end mutual funds, which have multiple class structures for sales charges and distribution expenses. Mutual fund companies consider two types of 12B-1 charges in their 12B-1 plans, sales commissions, and 12B-1 expenses.

Sales Commissions

Sales commission schedules are structured to provide compensation to intermediaries for transacting mutual funds. These partnerships can help to increase demand for funds by being marketed from a full-service broker-dealer who facilitates the transaction for a sales load fee. These fees are paid to the broker and are not associated with annual fund operating expenses.

Sales loads are structured to vary across share classes. Share classes can include front-end, back-end, and level-load sales charges. These sales charges are associated with individual retail share classes which typically include Class A, B, and C shares.

12B-1 Expenses

12B-1 expenses paid from the mutual fund to distributors and intermediaries are also a key part of a 12B-1 plan. To market and distribute open-end mutual fund shares, mutual fund companies work with distributors to get their funds listed with discount brokerages and financial advisor platforms. Distributors help fund companies partner with the full-service brokers that transact their funds at the agreed-upon sales load schedule.

Mutual fund companies will pay 12B-1 fees from a mutual fund to compensate distributors. In some cases, funds may also be structured with a low-level load that is paid to financial advisors annually during the course of an investor’s holding period.

Financial industry legislation typically restricts 12B-1 fees to 1% of the current value of the investment on an annual basis, but fees generally fall somewhere between 0.25% and 1%. In most cases, fund companies will have higher 12B-1 fees on share classes paying a lower sales charge, and lower 12B-1 fees on share classes with higher sales charges. This helps to balance out the compensation paid to intermediary brokers while also providing for payment to distribution partners.

Disclosure

Mutual fund companies are required to provide full disclosure on their sales load schedules and 12B-1 annual fund expenses in the fund’s prospectus. The prospectus is one aspect of documentation required for the mutual fund’s registration and is also the key offering document providing information on the fund for investors. 12B-1 plans and any changes to their expense structuring must be approved by the fund’s board of directors and amended in its prospectus filed with the Securities and Exchange Commission.

What Is a 12B-1 Fee?

A 12b-1 fee is an annual marketing or distribution fee on a mutual fund. The 12b-1 fee is considered to be an operational expense and, as such, is included in a fund’s expense ratio. It is generally between 0.25% and 0.75% (the maximum allowed) of a fund’s net assets. The fee gets its name from a section of the Investment Company Act of 1940.

Understanding 12B-1 Fees

Back in the early days of the mutual fund business, the 12b-1 fee was thought to help investors. It was believed that by marketing a mutual fund, its assets would increase and management could lower expenses because of economies of scale. This has yet to be proven. With mutual fund assets passing the $10 trillion mark and growing steadily, critics of this fee are seriously questioning the justification for using it. Today, the 12b-1 fee is mainly used to reward intermediaries for selling a fund’s shares. As a commission paid to salespersons, it is currently believed to do nothing to enhance the performance of a fund.

In 2015, the Securities and Exchange Commission (SEC) began examining the use of 12b-1 fees to determine if the rules for charging these fees are being adhered to and the presence of such fees is being properly disclosed.

12b-1 Fee Broken Down

The 12b-1 fee can be broken down into two distinct charges: the distribution and marketing fee and the service fee. Total 12b-1 fees charged by a fund are limited to 1% annually. The distribution and marketing piece of the fee is capped at 0.75% annually, while the service fee portion of the fee can be up to 0.25%.

Use of 12b-1 in Broker-Sold Shares

Class B and class C shares of broker-sold funds typically have 12b-1 fees, but they may also be charged on no-load mutual fund shares and class A broker-sold shares.

Class A shares, which usually charge a front-end load but no back-end load, may come with a reduced 12b-1 expense but normally don’t come with the maximum 1% fee. Class B shares, which typically carry no front-end but charge a back-end load that decreases as time passes, often come with a 12b-1 fee. Class C shares usually have the greatest likelihood of carrying the maximum 1% 12b-1 fee. The presence of a 12b-1 fee frequently pushes the overall expense ratio on a fund to above 2%.

The Calamos Growth Fund is an example of a fund that carries a smaller 0.25% 12b-1 fee on its class A shares and charges the maximum 1% 12b-1 fee on its class C shares.

What 12b-1 Fees Are Used For

The distribution fee covers marketing and paying brokers who sell shares. They also go toward advertising the fund and mailing fund literature and prospectuses to clients. Shareholder service fees, another form, specifically pay for the fund to hire people to answer investor inquiries and distribute information when necessary, though these fees may be required without the adoption of a 12b-1 plan. Another category of fees that can be charged is known as “other expenses.” Other expenses can include costs associated with legal, accounting, and administrative services. They may also pay for transfer agent and custodial fees.