The SEC released guidance from the staff of the Division of Investment Management on issues that may arise when mutual funds make payments to financial intermediaries that provide shareholder and recordkeeping services for investors whose shares are held in omnibus and networked accounts maintained with mutual funds. In particular, the guidance addresses whether a portion of those payments are being used to finance distribution and therefore, if paid by a fund, must be paid pursuant to Rule 12b-1 under the Investment Company Act of 1940. The guidance characterizes these payments as “sub-accounting fees,” although it notes that they may also be characterized as sub-transfer agent, administrative, and other shareholder servicing fees.
Key Takeaways: The following are key considerations for the board of directors of a mutual fund:
- Funds should ensure they have policies and procedures reasonably designed to prevent violations of Section 12(b) of the Investment Company Act and Rule 12b-1 regardless of whether they have Rule 12b-1 plans.
- When the recipient of payments for services also finances distribution (for example, an intermediary that distributes fund shares), it raises a question as to the direct or indirect use of fund assets, requiring relevant input from the investment adviser and other relevant service providers and the informed judgment of the board.
- The board should have a process in place reasonably designed to assist directors in evaluating whether a portion of fund-paid sub-accounting fees is being used to pay directly or indirectly for distribution.
- The board should ensure that the investment adviser and other relevant service providers provide sufficient information to inform the board of the overall picture of intermediary distribution and servicing arrangements for the funds, including how the level of sub-accounting fees may affect other payment flows (such as revenue sharing) that are intended for distribution.
- The board should carefully review the following items:
- distribution-related activity that is conditioned on the payment of sub-accounting fees;
- the lack of a Rule 12b-1 plan;
- the use of tiered payment structures, in which payments typically are made first from Rule 12b-1 fees, then sub-accounting fees, and finally by the investment adviser or an affiliate;
- a lack of specificity as to the services provided in exchange for sub-accounting fees, or payments for both sub-accounting and distribution that are bundled into a single contract;
- taking distribution and sales benefits into account when recommending, instituting, or raising sub-accounting fees;
- the use of disparate sub-accounting payment rates to intermediaries that may be providing substantially the same set of services; and
- payments to intermediaries for strategic sales data.