The SEC issued its first enforcement action regarding distribution in guise. The SEC order is helpful because it begins to frame the items that the SEC views as distribution versus shareholder servicing. The end result for mutual fund boards will likely be a more careful policing and understanding of a fund’s marketing and shareholder servicing agreements.

The SEC order notes the following as clearly not marketing or distribution: (1) maintaining separate records for each customer in the omnibus account for each fund; (2) transmitting purchase and redemption orders to the Funds; (3) preparing and transmitting account statements for each customer; (4) transmitting proxy statements, periodic reports, and other communications to customers; (5) providing periodic reports to the Funds to enable each fund to comply with state Blue Sky requirements; and (6) providing standard monthly contingent deferred sales charge reports.

The SEC order then notes two intermediary agreements where the intermediary provided services that the SEC believes are “generally marketing and distribution, not Sub-TA services,” with the SEC concluding that a fund is prohibited from using the fund’s assets to make payments under such agreements unless the payments are made pursuant to a Rule 12b-1 plan. This conclusion suggests that the fund could not use any of its assets to make any portion of the payments under said intermediary agreements. So, with regard to an agreement that covers both distribution and Sub-TA, it begs the question of whether a fund can ever use its assets to make payments under such an agreement for the Sub-TA services that are part of the agreement.

It would seem a strange result to say that a fund can never use its assets to make payments under a mixed services agreement to pay for the Sub-TA services. However, that is a possible read of the SEC order. Another conclusion is that where there is an agreement covering both distribution and Sub-TA, you have to look to see if the agreement is primarily aimed at distribution, as the SEC order suggests that the problematic intermediary agreements it reviewed were primarily for distribution. If you conclude an agreement is primarily for distribution, then a fund may only make payments out of a Rule 12b-1 plan, as suggested in the SEC order. Otherwise, a fund could presumably bifurcate the payments.

With respect to the first intermediary agreement that the SEC found problematic, the SEC identified the services below (in describing the services later in the order, it says they “were generally marketing and distribution, not Sub-TA services”):

  1. Due diligence 
  2. Legal review 
  3. Training 
  4. Marketing

With respect to the second intermediary agreement that the SEC found problematic, the SEC identified the services below (in describing the services later in the order, it says they “were generally marketing and distribution, not Sub-TA services”):

  1. Provide email distribution lists of correspondent broker-dealers that have requested “sales and marketing concepts” from intermediary 
  2. Market the funds on its internal website 
  3. Invite the funds to participate in special marketing promotions and offerings to correspondent broker-dealers 
  4. Invite the investment advisor to participate in the Intermediary’s annual conference 
  5. Provide quarterly statements detailing which correspondent broker-dealers are selling the funds 
  6. Waive all trading fees charged to correspondent broker-dealers relating to the funds