SEC Provides Guidance for Advisers and Fund Boards After “Distribution in Guise” Sweep

January 7, 2016

Yesterday, the SEC’s Division of Investment Management (“the staff”) released an IM Guidance Update that focuses on mutual fund distribution and sub-accounting fees. The staff’s guidance and viewpoints follow the examination of mutual fund complexes, investment advisers, broker-dealers, and transfer agents under the “Distribution in Guise” sweep. The guidance update also follows the SEC's Division of Enforcement’s first enforcement action in this area, back in September 2015.

The guidance update presents the staff’s view “on issues that may arise when registered open-end investment companies 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” and “…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…”

In summary, the staff appears to expect fund boards to take on a potentially greater role in the review of distribution fees, sub-accounting fees, and any other fee types associated with intermediaries that act on behalf of the funds. The fund board is expected to do this with the assistance of the adviser, distributor, transfer agent, and third-party intermediary by way of increased information flow, including transparency in discussing services provided, the cost of such services, and who is paying for what.

Some additional points of note from the guidance update:

  • The staff mentions the current application of the 1998 staff letter concerning “supermarket fees” in analyzing distribution and sub-accounting fees, and believes that the analysis discussed therein can be enhanced by asking for the following additional pieces of information that should be discussed with and disclosed to the board: (i) distribution-related activity conditioned on the payment of sub-accounting fees, (ii) lack of a 12b-1 plan, (iii) tiered payment structures, (iv) lack of specificity or bundling of services, (v) distribution benefits being taken into account when making recommendations, (vi) large disparities in sub-accounting fees paid to intermediaries, and (viii) the offer or sale of sales data.
  • As part of the fund board’s review process, the staff believes that advisers and other relevant service providers need to provide sufficient information to inform the board of the overall picture of intermediary distribution and servicing arrangements for the mutual fund, including how the level of sub-accounting fees may affect other payment flows (such as 12b-1 fees and revenue sharing) that are intended for distribution. The staff notes several times that an adviser has a fiduciary duty to eliminate relevant conflicts of interest, or to mitigate and to provide full and fair disclosure of the conflict.
  • The staff also emphasizes that to comply with rule 38a-1, compliance programs should be designed to prevent violations of section 12(b) and rule 12b-1, regardless of whether or not a fund has adopted a 12b-1 plan. The staff notes that the fund should have adequate policies and procedures in place for reviewing and identifying any payment that may be for distribution-related services that are not paid through the plan.

Learn More About Distribution in Guise
If you'd like to learn more about Distribution in Guise, you can view our webcast on the subject here.

ACA Contacts
If you have questions about this alert, or would like more information about ACA Compliance Group, please contact Erik Olsen, Senior Principal Consultant, ACA Compliance Group, at (240) 997-9434, or Nick Prokos, Partner, ACA Compliance Group, at (561) 988-3310.