My name is Roy Weitz. Each month for the past seven years, I have published FundAlarm.com, a free, non-commercial Web site. FundAlarm is generally designed to help investors decide when it is time to sell a mutual fund and, to further that goal, FundAlarm presents fund performance data, as well as various items of interest about the fund industry. FundAlarm is not intended to be balanced or objective journalism. I try to write FundAlarm from the perspective of a well-informed individual investor who is skeptical of fund industry hype, wary of fund industry intentions, and on-guard against fund industry shenanigans. Over the years, FundAlarm has been fortunate to develop a following of about 120,000 readers, including many of the leading financial journalists in the U.S.

Even before the current fund scandals, there was much to criticize about the fund industry, and there were problems in many different areas. After reviewing seven years of recent fund history, I think it’s possible to summarize almost all of the problems with the fund industry in four words: They pushed the limits. During the roaring bull market of the late 1990s, fund companies pushed the limits of investment sense by introducing dozens of doomed gimmick funds, which still managed to generate additional management fees. Fund companies regularly pushed the limits on management fees in existing funds, often justifying higher fees by pointing out that they were merely keeping up with their peer group of funds. (If everyone in a peer group raises fees to the average, the average will increase, and then everyone will need to raise fees again just to keep up with the average, in a never-ending cycle of fee increases. Needless to say, fund companies tend to ignore this simple fact of arithmetic when they ask shareholders to approve higher management fees.) Fund companies have also pushed, relentlessly, to extend the limits of SEC Rule 12b-1, an area that I will examine in more detail below.

Although I believe fund companies have a history of pushing the limits, it’s important to note that such behavior is not necessarily undesirable. In fact, in our economic system, all profit-making entities (including fund companies) are entitled –- even expected -- to push for every financial advantage they can obtain within the system. The real problem with fund companies pushing the limits is that no one has been pushing back. Fund directors, who theoretically represent a strong opposing force, have generally capitulated to the fund companies. The SEC, also a potentially strong counterforce against the fund industry, hasn’t pushed back hard enough, or consistently enough, to prevent the current (and perhaps future) scandals. Finally, individual fund investors have generally failed to push back against the fund industry, in large part because they haven't been provided with sufficient information in a number of critical areas.

The current fund scandals will soon be old news, and we will all move on to other things. And that is when the fund companies, inevitably, will start pushing the limits again. To successfully resolve the current fund crisis – and to prevent future crises – I believe we need directors, regulators, and individual investors who have the tools to effectively push back, and continue to push back, against fund companies. The 12b-1 plan is one key battleground in that struggle.

At the time SEC Rule 12b-1 was enacted (1980), 12b-1 plans were clearly intended as temporary arrangements. Today, 12b-1 plans are essentially a permanent fixture of the mutual fund landscape. Initially, 12b-1 plans had one purpose, and one purpose only: To help mutual funds grow their asset base, so that funds could experience economies of scale, which would then be passed on to investors in the form of reduced fees and expenses. Today, that purpose of 12b-1 plans is all but forgotten, and there is credible research suggesting that mutual fund fees since 1980 have actually increased at a faster rate than fund assets – in effect, there have been diseconomies of scale, which would probably mystify the economics profession if it occurred anywhere other than the fund industry.

Clearly, something has happened to Rule 12b-1 between 1980 and today, and it is not difficult to figure out what that is: Mutual fund companies have pushed Rule 12b-1 to its limits, and fund directors (who have ongoing responsibility to approve or disapprove a 12b-1 plan) have helped the fund companies do so. Specifically, companies that sell mutual funds through brokers have taken certain permissive language in Rule 12b-1, which permits them to charge shareholders for compensation paid to "sales personnel," and these companies have turned Rule 12b-1 into a prop that permanently supports their distribution system of multiple share classes ("A-B-C"). In this context, it would be quaint -- even ludicrous -- to think of 12b-1 fees as a temporary charge designed to benefit shareholders. Other companies, which sell their funds through so-called mutual fund "supermarkets," effectively use their 12b-1 plans to pay for permanent space on those supermarket shelves, a variation on the 12b-1 plan that clearly wasn’t contemplated in 1980, and also bears virtually no relation to the original intent of Rule 12b-1.

In every case, 12b-1 fees are paid out of fund assets, which ultimately means that the fees are paid out of investors' pockets. Yet fund investors typically have little or no idea how much they are paying in 12b-1 fees, because 12b-1 fees are generally presented as part of an overall expense ratio and, like all expenses, 12b-1 fees are expressed as difficult-to-interpret percentages. Even if fund investors do figure out how much they are paying in 12b-1 fees, their funds typically provide no relevant information about their 12b-1 plan -- in particular, how their 12b-1 fees were spent, and what tangible benefits they derived for their money.

In the ideal world, activist fund directors would push back on fund company 12b-1 plans by demanding documentation of specific, tangible shareholder benefits. Directors would view permanent 12b-1 plans as the rare exception, rather than the rule, and directors would communicate the accomplishments of every 12b-1 plan, every year, to shareholders. The day of such activist directors may be coming. Meanwhile, at a minimum, I suggest that Congress, through the SEC, provide fund management and fund directors with renewed, clear guidance on the purpose of 12b-1 plans. Specifically, I believe that Congress should reaffirm the temporary nature of 12b-1 plans, and Congress should also reaffirm the essential -- indeed only -- legitimate purpose of 12b-1 plans, which is to lower investor fees and expenses within a relatively short period of time.

To help investors in mutual funds push back on 12b-1 plans, I suggest several changes to existing practice, which would significantly increase investor access to relevant information:

• Fund companies should be required to provide an annual statement to each investor estimating the pro-rata dollar amount of 12b-1 fees paid by that investor (this statement could be made part of the year-end account statement, and the estimate could easily be based on the year-end account balance);

• Fund companies should be required to describe, in detail, the services or value that shareholders have received from the 12b-1 fees expended by their fund, with a particular emphasis on how the 12b-1 plan is helping to lower fees and expenses (this could appear as part of the fund's annual report);

• Shareholders, rather than directors, should periodically vote on renewing or terminating their fund's 12b-1 plan (this shareholder vote might be conducted every three to five years).

Changing Rule 12b-1 won’t be easy, because (as we have seen), 12b-1 fees support massive corporate structures. But I believe Rule 12b-1 must be changed because, in its current manifestation, Rule 12b-1 is a lie. Investors pour billions of dollars each year into 12b-1 plans, with results that are clearly not what the SEC intended, and with essentially no information about how their plans operate or what their money is used for. The 12b-1 plan has become a symbol of an industry pushed to its limits by fund companies, with virtually no resistance by Congress, regulators, fund directors, or individual investors. Congress has the opportunity to push back on 12b-1 plans, in an important way for investors, and I hope you will seize the moment.