The Securities and Exchange Commission is proposing a ban on using brokerage commissions to finance mutual fund distribution. As well, the U.S. regulatorit is contemplating a ban on trailer fees.

The SEC proposed amendments to Rule 12b-1 which would prohibit funds from paying for the distribution of their shares with brokerage commissions. The proposed amendments also would require funds that use a selling broker-dealer to execute portfolio securities transactions to adopt, and the fund’s board of directors to approve, certain policies and procedures.

SEC staff found that the use of brokerage commissions to facilitate the sale of fund shares is widespread among funds that rely on broker-dealers to sell their shares. It notes that the increasing compensation demands of selling brokers has caused funds’ distribution-related fees (sales loads and trailer fees) to reach the NASD limits, so brokerage commissions are used to generate additional revenue to finance distribution. The SEC estimates that brokerage commissions may compose approximately 20% of annual expenditures for fund distribution.

The commission is also requesting comment on whether it should propose additional changes to the rule or propose to rescind the rule altogether. It notes that the use of 12b-1 fees (similar to trailer fees in Canada) as a substitute for a sales load is a substantial departure from the use of the rule envisioned by the commission when it was first adopted.

It contemplates requiring that funds deduct distribution-related costs directly from shareholder accounts rather than from fund assets. It says that this would provide transparency to the investor, existing shareholders would not pay the costs of selling to new fund shareholders, long-term shareholders would no longer pay more than their fair share of distribution costs, and it would eliminate conflicts of interest.

In Canada, the Ontario Securities Commission is considering a similar ban on embedded compensation as part of its proposed Fair Dealing Model.

Comments on the SEC’s proposals must be received on or before May 10.