If we’re going to allow 12b-1 fees, let’s make sure fund companies actually pass on the savings to investors.

Jason Zweig’s recent article in the Wall Street Journal (“Will 12b-1 Fees Ever Stop Bugging Investors?”) has renewed discussions of what to do about 12b-1 fees.

As Zweig explains, 12b-1 fees were launched in 1980, a time when “mutual funds were weathering a long winter.” Assets were down, accounts were being closed and the industry was suffering.

“So,” Zweig writes, “the SEC broke with legal tradition and permitted managers to charge shareholders a new fee. In theory, that would help retain existing investors and attract others, enabling funds to grow again and to achieve ‘economies of scale.’ Fund investors would pay lower fees, while fund companies would have more money to manage.”

Except, he notes, that’s not what happened.

“In practice, however, fund companies began using 12b-1 fees to pay brokers a continuing stream of smaller fees instead of the traditional ‘sales load,’ or one-time upfront charge, which in those days ran up to 8.5%. Funds got bigger, fund managers' profits got fatter and investors got more confused,” Zweig explains.

Indeed.

To my mind, 12b-1 fees have become the mutual fund equivalent of the Federal Long Distance Excise Tax. That was a 3 percent tax that the U.S. government levied in 1898 to help pay for the Spanish-American War.

Designed to last about four years, the excise tax persisted for more than 100 years until the Department of Treasury realized in 2006 that we had long ago paid off the debt incurred by the Rough Riders at San Juan Hill. The money (more than $300 billion over the years) was being used to pay for a million other things unrelated to its named goal.

Unlike the excise tax, the funny thing about 12b-1 fees is that, in theory, they’re not a bad idea. Large mutual funds really are cheaper to run than small mutual funds. I can envision a world in which it makes sense for committed investors in small funds to pay for marketing costs as a way to grow fund assets.

But investors would only do that if the fund industry actually made good on its promise of lowering fees. We’ve been paying billions in 12b-1 fees for decades, while the fund industry has been very reluctant to pass along any savings.

They would say otherwise, of course: The Investment Company Institute loves to show this chart, noting how asset-weighted mutual fund fees have fallen significantly since 1980.

It looks good, with stock fees falling from 2.32 percent to 0.99 percent.

But what they don’t tell you is that assets have risen even faster, from $94.5 billion in 1980 to $7.32 trillion in 2009. If you take the average of the expense ratios at both sides, fund industry income has risen from $2.1 billion in 1980 to $63.7 billion today.

Share the wealth, baby.

In Zweig’s article, SEC Commission Chairman Mary Schapiro is quoted saying, "we must critically rethink how 12b-1 fees are used and whether they continue to be appropriate." Many others have called for them to be eliminated.

I have a different idea. Let the fund industry charge 12b-1 fees if it wants. But if it does, let’s make it commit to a stepwise reduction in expenses as fund assets grow. We could cap fund fees at 1 percent for funds with $1 billion in assets, dropping down to 0.50 percent as assets rise above $5 billion.

After all, lowering expenses was the goal of 12b-1 fees in the first place.