In a Guidance Update published on December 15, 2016, the staff of the U.S. Securities and Exchange Commission’s (SEC) Division of Investment Management (Staff) articulated its views as to certain disclosure issues and procedural requirements with which many fund companies are currently grappling in connection with responding to intermediaries’ requests relating to share classes.1 As described in a recent Dechert OnPoint, Mutual Fund Sales by Intermediaries – Fall-Out from DOL Fiduciary Rule and FINRA Enforcement, fund intermediaries are evaluating possible requests for changes to mutual fund sales loads and share class structures in the wake of the U.S. Department of Labor’s “investment advice” regulation (Fiduciary Rule) adopted earlier this year.
The corresponding proposals from fund intermediaries raise a variety of issues for fund companies, including the potential for intermediary-specific disclosures in fund prospectuses and/or statements of additional information (SAIs) with respect to variations in sales loads as well as the possible creation of new share classes. Our prior OnPoint noted that the Staff could consider issuing a Guidance Update with respect to disclosure and other matters involving these proposals as an alternative (or in addition) to formal SEC rulemaking or a Staff no-action letter.
Although the Guidance Update clarifies the Staff’s views on certain matters implicated by intermediary proposals for new share classes and share class structures, it leaves certain questions unresolved and may not offer sufficient flexibility for funds to react in a timely manner to intermediary proposals (which may continue to evolve). This OnPoint summarizes the Guidance Update and certain of its practical implications.
Disclosure Requirements for Sales Load Variations
The Guidance Update acknowledges that funds are contemplating new variations to sales loads for investors that purchase fund shares through a particular intermediary or group of intermediaries, in response to requests from intermediaries. Pursuant to Rule 22d-1 under the Investment Company Act of 1940 (1940 Act) and Item 12(a)(2) of Form N-1A, variations in, or eliminations of, sales loads are permissible provided they are specifically disclosed in a fund’s prospectus and uniformly applied to “classes”2 of investors or transactions.3 The Guidance Update makes clear that the Staff believes that intermediary-specific variations are permissible, provided that the variations are disclosed properly in the prospectus (and the summary prospectus, as applicable) and administered uniformly.
The Guidance Update states that a fund’s prospectus should specifically identify any intermediary to which a particular sales variation applies. Nonetheless, acknowledging industry concerns about lengthy prospectus disclosure regarding sales load variations that may be difficult to understand, the Guidance Update indicates the Staff will not object to the use of an appendix to the statutory prospectus as a means for funds to disclose sales load variations. In order to use an appendix, a fund must:
- Prominently state, in the appropriate portion of its prospectus, that different intermediaries may impose different sales loads, which are described in an appendix to the prospectus (with such appendix specified by name);
- Include a cross-reference to the appendix in the narrative introduction to the fee table; and
- In the appendix, specifically identify the relevant intermediary by name and include sufficient information to allow an investor to determine which scheduled variation applies to the investor’s investment (including any variations based on account type).
In addition, the Guidance Update provides that the appendix can be in the form of a stand-alone document, provided the fund:
- Incorporates the appendix into the prospectus by reference and files it with the prospectus;
- States on the front cover of the appendix that the appendix is part of, and incorporated in, the prospectus;
- States on the outside back cover of the prospectus that information about the different sales loads variations is provided in a separate document that is incorporated by reference into the prospectus;
- Delivers the appendix with the prospectus; and
- Posts the appendix on its website (if the fund uses a summary prospectus).
The Staff states that funds must update their prospectuses or appendices on an ongoing basis to reflect any new or modified sales load variations.4 However, in many cases, the information regarding the sales load structure (or waivers or discounts of sales loads) available through a particular financial intermediary may be updated only upon the receipt of new information from the intermediary.
The Guidance Update specifies that, to add disclosure about sales load variations, a fund must file an amendment under Rule 485(a) under the Securities Act of 1933 (Securities Act) (which, in this case, would be subject to a 60-80 day review period under the rule) to permit Staff review.
The Guidance Update does not specify whether a fund that has already incorporated sales load variation disclosure into its registration statement through the Rule 485(a) process could include additional intermediary-specific sales load disclosure without the need for another Rule 485(a) filing. Where the Staff has had the opportunity to review the structure and content of a fund’s sales load variation disclosure, the addition of new intermediary-specific variations may not automatically trigger the need for a Rule 485(a) filing; funds may wish to consider whether a Rule 485(a) filing is necessary based on the perceived materiality of the changes necessary to add such intermediary.
The Staff encourages registrants to seek selective review of a filing that contains disclosure not “substantially different” from previous disclosures made by the fund or fund complex, including where a fund is the first in its complex to implement the new share class or sales load variation.5 Alternatively, the Staff notes that if a registrant is making “substantially identical” changes to multiple funds, the registrant can request relief under Rule 485(b)(1)(vii) under the Securities Act (Template Filing Relief), to eliminate the need for multiple Rule 485(a) filings containing the same changes (referred to as “replicate filings”). The Guidance Update sets forth specific procedural requirements for selective review requests and seeking Template Filing Relief, including statements and other information that must be provided in cover letters to the “template filing.” In addition, the Staff states that, to rely on Rule 485(b)(1)(vii), funds must represent that, among other things, the replicate filings will incorporate changes made to the disclosure included in the template filing to resolve any Staff comments thereon. In the Guidance Update, the Staff also states that these requests will be considered “as expeditiously as possible.”
As funds consider proposals from intermediaries regarding sales load variations and share class structures, the Guidance Update may provide clarity with respect to the Staff’s views as to certain issues that funds are evaluating. In addition, the Staff’s statements encouraging selective review and Template Filing Relief may be viewed optimistically, and possibly suggest a streamlined and collaborative filing and comment process as funds continue to address requests from fund intermediaries, which may evolve further. When developing disclosure that is responsive to intermediary-specific sales loads and evaluating the appropriate filing process, funds should carefully consider the disclosure surrounding these variations and the representations necessary to take advantage of certain procedural options. In addition, funds may wish to develop a process to obtain confirmation from intermediaries with respect to the accuracy of the disclosure on a periodic basis. Overall, as the sale of fund shares by intermediaries undergoes further evaluation in light of the Fiduciary Rule, funds may wish to take into account the language in, and policy behind, the Guidance Update when structuring a timely, efficient response to requests from intermediaries.