So let's focus on the fees that are readily apparent.

It's hard – but not impossible – to justify the continued use of 12b-1 fees. There are just so many reasons it makes sense to avoid them.

First, regarding specific funds, in many cases it's possible to select a non-12b-1 share class of the same fund. Think about it. You have an identical portfolio, yet one share class pays more (thereby receiving a lesser return), while another share class pays less (thereby receiving a higher return). It's a no brainer. Who in their right mind would pick the share class that gives the lesser return?

Second, and in more general terms, it is now undeniable, as evidenced by peer-reviewed academic research, that shareholders with “broker-sold” funds (i.e., those with 12b-1 fees and commissions) earn, on average, 1% less than shareholders who bought directly from the mutual fund (i.e., those without 12b-1 fees and commissions).

Granted, these numbers reflect averages, so you're bound to find a few funds with 12b-1 fees and commissions perform well above average and a few funds without 12b-1 fees and commissions that perform well below average. So, theoretically, it is possible for a fund with 12b-1 fees and commissions to produce higher returns than a fund without 12b-1 fees and commissions. It's just not likely.

How many 401(k) plan sponsors will knowingly take the risk that the 12b-1 fee fund they just happen to pick will be the one that beats the average non-12b-1 fee fund? On the other hand, rarely have we seen successful cases brought against plan fiduciaries for picking a poor performing investment.

Since, again, in theory, there's no guarantee the 12b-1 fee fund won't underperform, it's not a slam dunk picking a 12b-1 fee fund represents a fiduciary breach…

…except in one very specific case.

To date, all successful 401(k) class actions have been based on holding more expensive share classes of a specific fund when less expensive share classes are available. (Please note the wording here. Just because a less expensive share class exists doesn't mean it's available to the particular plan. For example, consider low cost share classes that require very large minimum investments – too large for smaller 401(k) plans to meet.)

In the very specific case of index funds, there need not be a cheaper share class within the same fund to prove a fiduciary breach.

The 401(k) plan sponsor needs to methodically justify selecting an index fund family offers a more costly (note again the wording) fund. Why? Because the index portfolios of competing fund families are, by definition, identical. It's possible poor execution will result in dissimilar returns, , but if it's systemic then it should be discovered in the due diligence process.

Now, about the wording I just used. Did you notice I referred to “costs” not “fees”?

That's because, in the explicit case of index funds, not only do 12b-1 fees and commissions matter, but so do expense ratios. Remember that the base performance of all index funds (tracking the same index) should be the same. That means the only differences will arise out of higher fees (i.e., 12b-1 fees and commissions) or higher costs (i.e., expense ratios). It's possible to justify buying the most expensive index fund (if there is measurable value-added as a result of owning it), but, again, any plan sponsor gambling on this justification stands on rather thin ice.

We find ourselves at the dawn of an era where regulators (both the DOL and the SEC) have increased their scrutiny of conflict-of-interest fees like 12b-1 fees. In addition, we have seen a more aggressive class action bar willing to test the legal liability given this more rigorous compliance environment.

Given this backdrop, why have plan sponsors allowed 17% of 401k retirement assets to remain in funds with 12b-1 fees and commissions? Are there that many brothers-in-law out there? Are there that many financial providers out there who don't understand how easy it is to convert from a transaction-fee based business to an asset-fee based business?

If you think this is disquieting, just wait until we see the numbers on IRA plans!