False Advertising: The Truth About 12b-1 Fees

One example is a widespread industry practice known as "directed brokerage" -- when mutual funds use trading commissions to pay brokerages to distribute their funds. The compensation to broker-dealers, as an in-depth article in the June Institutional Investor noted, "should be done within the context of 12b-1," but it hasn't been, said the SEC's Scheidt. "There are funds that are doing this because they would otherwise be up against a cap."

Scheidt also voices concern about "cross-subsidization" -- when a larger fund's brokerage commission could be used to subsidize a smaller fund within that fund family, for instance.

The SEC is reviewing a variety of such "soft dollar" deals that take place within the industry. "We think soft dollars is a perfect subject to study," said ICI's Collins, who also acknowledged that the industry has to do more work to "reinforce investor confidence."

Cost Matters. Enter the Regulators

Now, regulators have to sort through this muck to determine how to revamp 12b-1 regulations and practices to adjust for the changed mutual fund landscape -- while also cracking down on any malfeasance. Regulators as well as critics and industry insiders acknowledge that that is no small task.

"It would be wonderful to hear that a button could be pushed and all would be revealed," Collins said. "But it isn't that easy."

Nonetheless, reform-minded folks are pressing hard for giving investors greater clarity when it comes to how much they spend when they buy a fund, and how the money is employed. "That's really the role of regulation -- make it clear what you're paying for," said Bullard. "What you should have is a total expense ratio set apart, then a pie chart that shows you how much you pay for marketing."

Swedroe agrees. "I don't have a problem with Fidelity charging 1.5% for a fund. I have a problem with the investor being stupid enough to pay 1.5%," Swedroe said. "Let the consumer judge as long as they're giving clear data. Right now, funds costs are a black box meant to obfuscate."

Meantime, Kinnel noted that 12b-1 fees shouldn't be something investors automatically read as a red flag. "The bottom line is still expense ratio," Kinnel said. "There are some shops that have 12b-1 fees and still have lower costs. American Funds has 12b-1 fees and still gives people a good deal."

While 12b-1 reform may not mean much to most investors, they should understand how much they stand to lose as seemingly nickel-and-dime costs eat into their long-term returns. Consider the difference to an investor's portfolio from a meager 0.5% annual distribution fee.

After 40 years, a $10,000 investment that returns 7% annually would leave you with $149,743. The same $10,000 investment -- minus the 0.5% annual distribution fee -- would be worth $124,160, 17%, or $25,583 less.