The Securities and Exchange Commission (the “SEC”) recently announced certain investment management initiatives for the remainder of 2007 as well as regulations that it expects to propose or fi nalize. The following are the announced initiatives thus far. Rule 12b-1 Plans. Chairman Cox recently said that the SEC will undertake a “thorough re-evaluation” of Rule 12b-1. As a preliminary matter, the SEC has announced the formation of a Rule 12b-1 roundtable, which will take place on June 19, 2007 with panels addressing, among other things:
- the historical circumstances that led to the promulgation of Rule 12b-1 and the original intended purpose of the rule;
- the evolution of uses of Rule 12b-1 and the rule’s current role in fund distribution practices;
- the costs and benefi ts of the current use of Rule 12b-1; and
- the options for reform or rescission of Rule 12b-1.
According to Chairman Cox, the roundtable is intended to help the SEC staff (1) evaluate the possibilities for reforming Rule 12b-1; (2) address the concerns of independent directors who must approve Rule 12b-1 plans; and (3) understand the current uses of Rule 12b- 1 fees and their impact on investors.
Rule 12b-1 was adopted in 1980, and authorizes mutual funds to use their assets to pay for marketing and distribution expenses through Rule 12b-1 plans that have been approved by the fund’s directors, including a majority of independent directors. The Rule’s original premise was that Rule 12b-1 plans would be relatively short-lived and used only to solve specifi c and episodic distribution problems. During the early days of Rule 12b-1, funds used 12b-1 fees to offset the costs of advertising and the printing and mailing of prospectuses and sales literature – in other words, traditional marketing costs. As time progressed, however, funds began using 12b-1 fees for other purposes, including as a substitute for front-end sales loads and paying for administrative expenses of existing fund shareholders. According to Chairman Cox, in addition to straying from their original purpose, it is not clear that existing shareholders are benefi ting from Rule 12b-1 plans.
Fund directors, including the independent directors, are responsible for approving Rule 12b-1 plans initially and annually. Their approval must be based on a fi nding that the plans are in the shareholders’ best interests. According to Chairman Cox, the independent directors cannot approve a Rule 12b-1 plan if existing shareholders are not benefi ting from the plan.
Fund Governance Rule. Chairman Cox has stated that the SEC fully intends to re-propose and fi nalize its fund governance rule. The SEC’s original rule was struck down in 2006 by the Court of Appeals for the District of Columbia. The comment period related to two economic studies the SEC released in December 2006 on the subject of fund governance expired in March, and the SEC has apparently been studying the comments received. The SEC has not revealed the content of the re-proposed rule as of the date of this article. 401(k) Plan Investor and Other Investor Disclosure. The SEC has also announced a joint project among the Department of Labor, the SEC’s Investment Management Division and perhaps other regulators that will focus on streamlining fund disclosure for 401(k) plan investors. According to Chairman Cox, the focus of this effort will be, among other things, clarifying expenses and after-tax and after-infl ation returns for investment options under the plans.
The SEC staff is also reviewing fund disclosures more generally. Chairman Cox stated recently that the staff is working on proposals to create a streamlined disclosure document for investors that will have “more succinct, easy-to-understand” disclosure that will highlight key information investors need to know before investing. At the same time, however, the staff is reportedly working on better and more detailed information regarding investment objectives, strategies, risks and costs that could be made available, at the investor’s option, either on-line or in writing.
Soft Dollars. The SEC issued updated soft dollar guidance in 2006. However, according to Chairman Cox, that guidance is not the SEC’s last word on the subject. The SEC is concerned that the independent directors currently do not have suffi cient information by which to assess soft dollar arrangements and best execution. The SEC staff believes that if directors can compare a broker’s execution-only commission rate to the bundled rate, they could make more meaningful inquiries regarding the value of soft dollar services. For that reason, the staff is considering whether it should mandate better disclosure of research and brokerage services that the adviser receives in return for a bundled commission. Bank Broker Exception Rule. The SEC expects to fi - nalize a rule that would provide banks and thrifts with a qualifi ed exception to conduct securities activities on behalf of their customers as part of their trust, fi duciary, custodial and deposit sweep functions, without registering as brokerdealers.
The current exception expires in early July, but the SEC hopes to fi nalize the rule (known as Reg. R) before the expiration date.