UK: SEC Proposes Changes to Structure for Mutual Fund Distribution Fees

The Securities and Exchange Commission ("SEC") on July 21, 2010 voted unanimously to propose a new rule and rule amendments that would replace rule 12b-1 under the Investment Company Act of 1940 (the "1940 Act"), changing the framework through which funds may use fund assets to pay for the costs of distribution.1 The SEC states that the proposals are designed to protect individual investors from paying disproportionate amounts of sales charges in certain share classes and to promote investor understanding of fees.

As discussed in greater detail below, the proposals would:

  • Rescind rule 12b-1;
  • Permit funds to deduct a fee of up to 0.25% annually from fund assets to pay for distribution activities (the "marketing and service fee");
  • Permit funds to deduct asset-based distribution fees in excess of the marketing and service fee, provided that the excess is treated as a sales charge subject to certain maximums (the "ongoing sales charge");
  • Eliminate the need for special board findings, a written plan, annual renewal or automatic termination provisions or the need to meet specified fund governance requirements;
  • Implement new disclosure requirements in transaction confirmations, registration statements and other fund disclosure documents designed to provide investors with additional transparency about the marketing and service fee, ongoing sales charges and other sales charges; and
  • Permit an alternative distribution model that would allow fund intermediaries to impose charges at negotiated rates in connection with sales of fund shares (the "account-level sales charge").

Rescission of Rule 12b-1

The Proposing Release provides an extensive discussion of the administrative history of rule 12b-1, including the SEC staff's current perspective on the purpose of rule 12b-1. The Proposing Release takes the position that many of the original assumptions underlying rule 12b-1 no longer reflect current market realities, noting in particular the role that 12b-1 fees play in fund distribution, director responsibilities in considering whether to approve 12b-1 fees, and potential investor confusion about rule 12b-1. In this spirit, the proposals would rescind rule 12b-1 in its entirety2 and put forth a new regulatory framework to address the use of fund assets to pay for distribution costs.

Limits on Asset-Based Distribution Fees

Marketing and Service Fees

Proposed rule 12b-2 would permit funds to deduct from fund assets a "marketing and service" fee of up to the FINRA service fee limit (currently 0.25% of net assets annually)3 to pay for distribution activities. Proposed rule 12b-2 would not confine the use of marketing and service fees to the types of services described in NASD Conduct Rule 2830, recognizing that certain shareholder services may have a distribution component. Rather, funds would be able to use these fees to pay for any distribution activity.4 Proposed rule 12b-2 defines "distribution activity" to mean any activity which is primarily intended to result in the sale of shares issued by a fund, including, but not necessarily limited to, advertising, compensation of underwriters, dealers, and sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature. The Proposing Release provides that the marketing and service fee may also be used to pay for the costs of participating in fund supermarkets, trail commissions paid to broker-dealers in recognition of ongoing services they provide to investors, or payments to retirement plan administrators for services they provide to plan participants that relieve the fund from providing such services.

Under the proposals, any asset-based charge for distribution in excess of the FINRA service fee limit (0.25% of net assets annually) would be considered an ongoing sales charge and subject to the sales charge limitations established by FINRA5 and by rule 6c-10 (as amended by the proposals and discussed below). The SEC chose this limit to "distinguish a limited distribution fee from a sales charge."

Proposed rule 12b-2 would require a fund to obtain shareholder approval before it could institute, or increase the rate of, a marketing and service fee after any public offering of the fund's securities. Shareholder approval, however, would not be necessary for a fund to institute a marketing and service fee with respect to a new class or series of shares. In this regard, the Proposing Release explains that, because rule 12b-1 currently requires shareholder approval to adopt a 12b-1 plan or materially increase the amount paid under the plan, proposed rule 12b-2 would not "significantly change the rights of fund shareholders or the obligations of funds and fund underwriters."

Unlike rule 12b-1, proposed rule 12b-2 would not require the adoption of a formal distribution plan and instead would rely on the structural limits on the marketing and service fee embedded in the proposal.6

Ongoing Sales Charges

In addition to the marketing and service fee, a fund would be permitted to impose an asset-based ongoing sales charge. The proposed amendments to rule 6c-107 would permit funds to deduct an asset-based charge for distribution in excess of the marketing and service fee permitted by rule 12b-2, which excess fees would be considered an "ongoing sales charge" subject to certain restrictions.

Maximum Sales Charge Rate. Under proposed amended rule 6c-10, a fund may deduct an ongoing sales charge from fund assets if the cumulative ongoing sales charges imposed on a purchase of fund shares do not exceed the shareholder's maximum sales load. The proposal provides that a fund may satisfy this requirement by converting the shares into shares not subject to an ongoing sales charge on or before the end of a conversion period. The length of the conversion period would be calculated by a formula that utilizes the highest sales load rate that the shareholder would have paid as a front-end sales load to purchase fund shares.

Under the proposed approach, a fund could impose an ongoing sales charge if the cumulative rate of the ongoing sales charge, when combined with the rate of any front-end or deferred sales loads to be imposed on an investor's purchase of fund shares, would not exceed the rate of the highest front-end sales charge that the investor would have paid if investing in another class of shares of the same fund that does not have an ongoing sales charge (the "reference load").8 For example, if a fund offers Class A shares that have a 4.50% maximum front-end sales load, another class of shares that does not impose a front-end sales charge could impose ongoing sales charges totaling 4.50%.

The SEC states in the Proposing Release that the proposed approach is designed to reduce the potential that some long-term shareholders will pay a significantly disproportionate share of a fund's distribution costs. The Proposing Release makes the additional point that, to the extent competitive pressures result in lower front-end sales charges, classes with ongoing sales charges would benefit from lower overall ongoing sales charges. Under proposed amended rule 6c-10, funds would not be required (but would be permitted) to apply breakpoints or scheduled variations in front-end sales loads when determining the reference load. This aspect of the proposal reflects the SEC's concern that such a requirement (which would reduce the level of the reference load) would create greater complexity and cost and, in the SEC's view, could inhibit the use of breakpoints or scheduled variations.

Automatic Conversion of Shares. Shares subject to an ongoing sales charge would be required to convert automatically to another class of shares that does not impose an ongoing sales charge, with the conversion taking place no later than the end of the month during which the cumulative ongoing sales charge rate paid by the investor exceed the investor's maximum sales load rate.9 For example, if a fund's maximum sales load rate is 4.50%, the fund could impose an ongoing sales charge of 0.50% for up to nine years, 0.75% for up to six years, or 1.50% for up to three years10 before automatic conversion of an investor's shares is required. According to the Proposing Release, the SEC is proposing a monthly conversion as a practical accommodation to reflect the current practice of many funds. Under proposed amended rule 6c-10, each purchase of fund shares would have a separate conversion period tied to that purchase date and applicable rates thus, the maximum length of the conversion period would be unaffected by increases or decreases in the value of the shares.11

Operational Matters. The proposal would require shares that are purchased through reinvestment of dividends or other distributions to have the same conversion period as the shares on which the dividend or distribution was declared.12

The Proposing Release states that the SEC expects that funds and intermediaries will be able to utilize existing recordkeeping systems for class B shares to track the aging and conversion of shares with ongoing sales charges as contemplated by the proposals. The Proposing Release acknowledges potential challenges with respect to share aging when accounts are transferred between different financial intermediaries. However, the Proposing Release states that, given the ability of intermediaries to transfer share lot histories in order to service class B shares, the SEC does not believe that the proposals would interfere with the ability of shareholders to transfer shares between intermediaries.

Under proposed amended rule 6c-10, a fund would not be permitted to institute, or increase the rate of, an ongoing sales charge applied to a fund share class or series after any public offering of the fund's voting shares, or to lengthen the period before shares automatically convert, if such action would increase the cumulative amount of ongoing sales charges imposed on the fund's investors. The Proposing Release states that the SEC believes that "permitting increases in ongoing sales charges in existing share classes would negatively impact investors" and that it would be "akin to retroactively renegotiating the terms of the [shareholder's agreement to pay a defined cumulative ongoing sales charge] without the explicit consent of the particular shareholder affected."

Consistent with the approach to marketing and service fees, adoption of a formal plan would not be required in order to charge ongoing sales charges.

Applicability to Certain Types of Funds

Funds of Funds. Provisions in proposed rule 12b-2 and proposed amended rule 6c-10 would address the marketing and service fees and ongoing sales charges that could be imposed when one fund ("acquiring fund") invests in securities of another fund ("acquired fund"). Proposed rule 12b-2 would permit both the acquiring fund and the acquired fund to charge marketing and service fees, so long as the combined total of the marketing and service fees charged by both funds does not exceed 0.25%.13 The proposal, however, would prevent an acquiring fund and an acquired fund from both charging an ongoing sales charge. Accordingly, an acquiring fund relying on rule 6c-10 to deduct an ongoing sales charge from fund assets would not be able to acquire the securities of another fund if that fund imposes an ongoing sales charge on the class of shares to be acquired by the acquiring fund. This is different from the approach in NASD Conduct Rule 2830, which permits both funds to impose asset-based sales charges, but requires the rates to be accumulated in determining compliance with relevant limits. According to the Proposing Release, the SEC chose not to mirror the FINRA approach due to the complexities involved in determining the conversion periods when an acquiring fund invests in multiple acquired funds that impose different sales charges.

Funds Underlying Insurance Company Separate Accounts. The proposals are intended to apply to funds that underlie insurance company separate accounts that offer variable life or annuity contracts ("Insurance Dedicated Funds") in the same manner that they apply to other funds. The SEC notes that owners of these variable contracts may pay distribution costs (i.e., front end sales charges, contingent deferred sales charges, or ongoing charges deducted from separate account assets) and that Insurance Dedicated Funds may also impose 12b-1 fees to support distribution and shareholder servicing activities (although these fees generally do not exceed 0.25% annually). A principal issue for many Insurance Dedicated Funds is whether, or at what cost, they will be able to track share lots attributable to contract owner purchase payments and provide for automatic conversion of shares in the event such funds wish to charge ongoing sales charges. Insurance company separate accounts without this capability would need either to develop that capability or to offer only classes of shares without an ongoing sales charge.

Reducing the Role of Fund Directors

As discussed above, the SEC has proposed to eliminate much of the role of fund directors in the approval and monitoring of fund payments for distribution. Proposed rule 12b-2 and proposed amended rule 6c-10 would not impose explicit responsibilities on boards of directors to approve (or approve the continuation of) asset-based sales charges, and thereby would lessen burdens on boards. The Proposing Release notes, however, that fund directors would continue to have fiduciary duties with respect to their oversight of the use of fund assets under both state law and section 36(a) of the 1940 Act.14 The Proposing Release states that the SEC "intends that the board (including the independent directors) would oversee the amount and use of these fees in the same manner that it oversees the use of fund assets to pay any other fund operating expenses." The SEC believes that funds and their underwriters would have little incentive under the proposals to impose excessive ongoing sales charges because a class of shares with a higher ongoing sales charge would simply convert earlier to a class with no ongoing sales charge.

The SEC expects to provide guidance to directors as part of the adopting release and has requested comment on proposed guidance that directors should consider any ongoing sales charge (amounts and purposes) according to the same procedures they use to consider the amount of other sales charges in the underwriting contract under section 15(c) of the 1940 Act. The proposed guidance states that directors must use their reasonable business judgment to decide if, among other things, the underwriter's compensation is fair and reasonable in light of the nature, quality and extent of underwriting services provided. The proposed guidance indicates that in evaluating the "fairness and reasonableness" of the contract, the directors should consider any factors that may be relevant, including "whether the fund's distribution networks and overall structure are effective in promoting and selling fund shares given current economic and industry trends, any available breakpoints on advisory fees that may be attained from future growth in fund assets, and any economies or diseconomies of scale that may arise from continued growth of fund assets." The Proposing Release notes that many fund boards currently consider these, or similar factors, when evaluating underwriting contracts.

Disclosure Changes: Transaction Confirmations and Registration Statements

Transaction Confirmations

The SEC has proposed amendments to rule 10b-10 under the Securities Exchange Act of 1934, which would require broker-dealers to include information about sales charges in confirmations for transactions in fund shares.15 These changes are intended to make transaction confirmations a more complete record of the transactions and to help investors become more fully aware of the sales charges they are paying.

Confirmations for purchase transactions would be required to disclose:

  • The amount of any sales charge the investor incurred at the time of purchase (in dollars and as a percentage of the public offering price), the net dollar amount invested in the security and the amount of any applicable breakpoint used to calculate the sales charge;
  • The maximum amount of any deferred sales charge the investor may incur in the future (as a percentage of net asset value ("NAV") at the time of purchase or at the time of redemption, as applicable); 16 and
  • The annual amount of any marketing and service fee and any ongoing sales charge (as a percentage of NAV), the aggregate amount of any ongoing sales charge that may be incurred over time (as a percentage of NAV), and the maximum number of months or years over which the investor will incur the ongoing sales charge.

Proposed amended rule 10b-10 would also require confirmations to include the following statement (which may be edited as appropriate):

In addition to ongoing sales charges and marketing and service fees, you will also incur additional fees and expenses in connection with owning this mutual fund, as set forth in the fee table in the mutual fund prospectus; these typically will include management fees and other expenses. Such fees and expenses are generally paid from the assets of the mutual fund in which you are investing. Therefore, these costs are indirectly paid by you.

The Proposing Release indicates that this requirement is designed to address concerns that disclosure of only some ongoing fees or charges may cause investors wrongly to infer that they will incur only those ongoing costs.

The Proposing Release notes that investors do not receive confirmations until after completing their purchase and that presenting information about costs and sales charges (including ongoing sales charges) to investors at the time they make their investment decisions would help investors make more informed investment decisions. To that end, the Proposing Release states that the SEC staff is considering recommendations for future consideration by the SEC to enhance the information provided at the point of sale.17

Prospectuses and Statements of Additional Information ("SAIs")

The SEC has proposed amendments to several disclosure requirements designed to improve investors' understanding of the distribution related charges they directly and indirectly incur from their fund investments.

Proposed amendments to the Form N-1A fee table requirements would remove references to "12b-1 fees" and separate asset-based distribution fees into two component fees. The current heading "Distribution [and/or Service] (12b-1) Fees" would be replaced with the heading "Ongoing Sales Charge," which would be the ongoing sales charge under proposed amended rule 6c-10.18 The SEC believes this should "better convey to investors that this portion of the asset-based distribution fee operates as a substitute for a sales load." The fee table would also be revised to include a new subheading under "Other Expenses" called "Marketing and Service Fee," which would be any amount paid under proposed rule 12b-2.

If the proposals are adopted, funds will no longer be required to have 12b-1 plans, so the SEC has proposed to amend Item 12(b) of Form N-1A to eliminate the requirement to disclose information about the operation of the plans in the prospectus. Instead, a fund would have to disclose:

  • Whether it charges a marketing and service fee or an ongoing sales charge and, if it does, the rates of the fees and purposes for which they are used;
  • If a fund deducts an asset-based distribution fee for services provided to fund investors, a description of the nature and extent of services provided; and
  • For a fund that imposes an ongoing sales charge, the number of months (or years) until shares will automatically convert to a class of shares that does not impose an ongoing sales charge, and after which the shareholder would stop paying the ongoing sales charge.

Funds offering multiple share classes in a single prospectus would also be required to include disclosure that describes generally the circumstances under which an investment in one class of the fund may be more or less advantageous than investment in another class of the fund. The Proposing Release notes that, while differing fees and terms of classes are currently available, "the actual consequences of the decision to purchase a particular class (in terms of overall loads paid, appropriate holding periods, etc.) may not be readily apparent." The SEC believes this disclosure would reduce shareholder confusion and simplify the investment decisionmaking process.

The proposed amendments would also remove certain disclosure requirements regarding 12b-1 plans from Item 19(g) of Form N-1A. Funds would still be required to provide information about principal activities paid for with asset-based distribution fees (both ongoing sales charges and marketing and service fees), but would not be required to disclose actual dollar amounts spent on these activities.

Distribution Alternative: Account-Level Sales Charge

Section 22(d) of the 1940 Act prohibits a fund, its principal underwriter, and dealers from selling the fund's shares except at the current public offering price described in the fund's prospectus. Fund sales loads are part of the selling price of the shares,19 which means that all dealers must sell the shares according to the sales charge structure disclosed in the prospectus. Thus, dealers cannot establish their own pricing schedules for mutual fund shares, as they can for transactions in exchange-traded funds20 or other equity securities. The SEC has granted limited exemptions to section 22(d), including rules that permit funds to have scheduled variations in sales charges, subject to certain conditions and prospectus disclosure.21

The SEC has proposed changes to rule 6c-10 that would exempt certain funds and dealers from the restrictions of section 22(d), permitting (although not requiring) funds to issue shares of a class at NAV and allowing dealers to establish and collect their own sales charges to pay for distribution.22 The amount of the fees charged by dealers would not be governed by the 1940 Act, although those intermediaries registered with FINRA would still be subject to existing limits on excessive compensation. The Proposing Release states that this amendment is designed to benefit investors by providing flexibility to fund underwriters and dealers and encouraging price competition among dealers offering fund shares. The Proposing Release states that the account-level sales charge would "expand the range of distribution models available to mutual funds, enhance transparency of costs to investors, promote greater price competition, and provide a new alternative means for investors to purchase fund shares at potentially lower costs."

In order to rely on the proposed amended rule 6c-10 exemption from the restrictions of section 22(d), a fund would have to meet certain conditions. First, a fund relying on rule 6c-10 to offer a share class with an account-level sales charge would not be permitted to impose an ongoing sales charge on that class, although it could charge a marketing and service fee under proposed rule 12b-2. Second, the fund would have to disclose in its SAI its intention to rely on the exemption in its.

Potential Impact of Proposed Rule Changes

In the Proposing Release, the SEC analyzes how the proposals, if adopted, would affect various market participants.

  • Fund Investors. The SEC states that the proposals are designed to make it easier for fund investors to understand fund expenses and, thus, be better able to select the fund or class that offers the most advantageous combination of costs and services. The Proposing Release describes two benefits for investors: (i) protection from the imposition of excessive sales loads by limiting cumulative amount of sales charges that an investor could bear; and (ii) promotion of a more fair allocation of distribution costs among investors who invest through different share classes by limiting the extent to which one class of shares may bear these costs.
  • Fund Intermediaries and Distributors. The SEC notes that approximately 80% of fund assets that are subject to 12b-1 fees are charged fees of 0.25% or less, meaning that such funds and related intermediaries would not be affected by the ongoing sales charge limits. The Proposing Release acknowledges that intermediaries that sell classes of shares with 12b-1 fees in excess of 0.25% (i.e., C shares) will be principally affected. The Proposing Release also suggests that fund groups may reconsider the economics of Class C shares, acknowledging the likelihood that Class C shares may impose contingent deferred sales loads similar to Class B shares. The SEC believes that the proposed implementation of account-level sales charges will provide intermediaries with greater control over pricing of fund shares.
  • Fund Managers and Principal Underwriters. The Proposing Release states that the proposals largely preserve existing distribution arrangements, but also states that the proposals should provide managers with greater legal certainty regarding distribution financing practices that have developed in recent years, citing as an example the recurring question of whether a fund board can appropriately approve continuation of 12b-1 fees for funds that are no longer selling shares.23 The SEC believes that the proposals, if adopted, would "shift the focus from whether fund expenses are increased by a 12b-1 fee to whether the sales charges imposed by a particular fund are appropriate in light of the services provided by the intermediary."
  • Small Fund Groups. The SEC acknowledges that small fund groups have expressed concerns about the possible effects of changes to rule 12b-1, including their continued ability to use fund assets to pay for participation in fund supermarkets and other similar distribution platforms. The Proposing Release notes that the SEC staff met with a number of representatives of small fund groups to explore ways in which the proposals might address their concerns. The SEC believes that the proposal reflects these considerations and preserves the ability of small fund groups to compete with larger complexes.
  • Retirement Plans. The Proposing Release states that approximately 80% of 401(k) plan assets are held in fund share classes that pay no 12b-1 fees, or 12b-1 fees that are less than 0.25%, and therefore, if the proposals are adopted, these funds could continue to make the payments from the proceeds of the marketing and service fee. For funds that have a higher 12b-1 fee, the Proposing Release notes that it may be possible for the funds to identify a portion of those expenditures as not "distribution related," thus, reducing their distribution related payments so that the marketing and service fee limitation is not exceeded. If that is not possible, these funds would need to treat the excess 12b-1 fee as an ongoing sales charge and provide for a conversion period. The SEC acknowledges that this would likely require plan administrators to develop the capability to track and age fund shares, which may be difficult in light of current practices.

Effective Date, Compliance Date, and Grandfathering Provisions

The SEC expects to provide for an effective date within 60 days of issuing a final rule release. The Proposing Release states that the date for complying with rule 12b-2, amended rule 6c-10 and the other amendments for new shares sold would be at least 18 months after the effective date.

Funds would be required to comply with the changes discussed above with respect to all shares issued after the compliance date of the new rules. For share classes issued prior to the compliance date, which deduct fees pursuant to current rule 12b-1, the SEC has proposed a five-year grandfathering period. After this period, a fund would be required to convert or exchange the grandfathered shares into classes that do not deduct an ongoing sales charge. No new sales would be permitted in grandfathered share classes after the compliance date. To avoid imposing a higher asset-based distribution fee on investors than they agreed to when they purchased the shares, grandfathered shares could not be converted or exchanged into a class of shares with a marketing and service fee in excess of the annual rate of the 12b-1 fee paid in the last fiscal year before the conversion or exchange.24

The SEC believes that the grandfathering period would allow existing 12b-1 classes to wind down in an orderly manner and allow sufficient time for funds and fund boards to prepare to transition these assets to new classes. The SEC is seeking comment on: whether five years is the appropriate length of time for the grandfathering period; various alternative proposals to grandfathering existing shares, including an immediate compliance requirement or a sunset provision; and whether certain share classes (such as R share classes) would encounter special difficulty complying with the grandfathering transition period.

A fund's grandfathered classes could continue to charge 12b-1 fees at the same (or lower) rate as approved under the fund's 12b-1 plan. If the fund wanted to increase the rate of distribution fees, however, it would need to comply with the proposed rules. The SEC believes that, because the level of distribution fees charged on the grandfathered shares could not be increased, no purpose is served by requiring the funds to continue to have a formal 12b-1 plan. Thus, funds and fund boards could eliminate mandatory provisions of 12b-1 plans that require board approval, quarterly reports and allow for board or shareholder termination of 12b-1 plans. Directors would exercise responsibility over the fees charged to these classes in accordance with their general oversight responsibilities.

Any comments on the proposals are to be submitted by November 5, 2010. Included, as an attachment, is a list of the SEC's requests for comment.

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1 Mutual Fund Distribution Fees; Confirmations, Release No. IC-29367 (Jul. 21, 2010) ("Proposing Release").

2 As discussed in greater detail later in this OnPoint, proposed rule 12b-2 includes provisions that will grandfather those classes currently being sold pursuant to rule 12b-1 plans. The Proposing Release also notes that proposed rule 12b-2 retains rule 12b-1(h) unchanged, which restricts certain directed brokerage practices.

3 See NASD Conduct Rule 2830(d)(5). (Legacy NASD Rules that have not yet been consolidated into the FINRA rule book are referred to herein as "NASD [Rule].")

4 The SEC notes that rule 12b-1 does not restrict the use of fees payable under that rule to "distribution" expenses, and that proposed rule 12b-2 would not preclude funds from using the marketing and service fee to pay for mixed expenses under rule 12b-2. See Proposing Release, at n. 153 (citing Payments of Asset Based Sales Loads by Registered Open-End Management Investment Companies, Release No. IC-11431 (June 13, 1988)). The SEC also notes, however, that "to the extent funds need not rely on proposed rule 12b-2 to charge expenses that can clearly be identified as not distribution related (e.g., sub-transfer agency fees), funds could instead characterize those expenses as administrative expenses" and keep total asset-based distribution fees within the 0.25% limit of the marketing and service fee. Id.

5 See NASD Conduct Rule 2830(d)(2)(A).

6 The Proposing Release notes that some funds have adopted "defensive" rule 12b-1 plans, which do not impose distribution fees on the fund, but are designed to ensure that a fund does not violate rule 12b-1 if other expenditures are later determined to have been primarily intended to result in the sale of fund shares. The SEC believes that proposed rule 12b-2 could serve the same purpose to the extent a fund does not fully utilize the maximum 0.25% of net assets permitted by proposed rule 12b-2. See Proposing Release, at n.155.

7 Rule 6c-10 currently permits funds to charge deferred sales loads subject to the limitations of NASD Conduct Rule 2830.

8 The reference load would be the maximum front-end sales charge on another class of the fund that does not charge an ongoing sales charge and for which the investor qualifies according to the fund's registration statement. For funds that do not offer a class with a front-end sales charge (or whose front-end sales charge class has asset-based distribution fees in excess of 0.25%), the reference load would be the maximum sales charge permitted under NASD Conduct Rule 2830(d)(2) for funds with both an assetbased sales charge and a service fee, which is currently 6.25% of the amount invested.

9 Funds could also impose a contingent deferred sales charge, in addition to the ongoing sales charge, but the combined rates of all sales charges could not exceed the maximum sales charge limitation.

10 The Proposing Release notes that the SEC does not propose to specify the annual maximum rate at which a fund can deduct ongoing sales changes, although it notes that the FINRA sales charge rule currently caps these fees at 0.75% annually. The SEC states that this annual cap may become unnecessary if the rule proposals are adopted, given that the cumulative amount of ongoing sales charges would be capped. See Proposing Release, at n.182.

11 The Proposing Release notes that this approach is different from that currently taken under rule 6c-10 with respect to determining the maximum amount of a deferred sales charge, which is limited to a maximum amount specified at the time of purchase.

12 This is different from the current approach taken under NASD Conduct Rule 2830, which does not limit asset-based distribution fees from being charged indefinitely on reinvested dividends, although it does prohibit funds from imposing front-end and deferred sales charges on reinvested dividends. The SEC notes, however, that the proposed approach reflects what the SEC understands to be the practice that most fund groups use with respect to reinvested dividends/distributions on class B shares.

13 This is the same approach taken by current NASD Conduct Rule 2830.

14 The Proposing Release does not address whether ongoing sales charges, which the SEC characterizes as a substitute for front-end sales loads, would be considered "sales loads," as that term is defined in section 2(a)(35) of the 1940 Act (although current rule 6c-10 specifically provides an exemption from that definition). We note that, if ongoing sales charges are considered "sales loads," they would fall outside the scope of section 36(b) pursuant to section 36(b)(4).

15 Currently, transaction confirmations need not include this information under a long-standing SEC staff position. See Investment Company Institute, SEC No-Action Letter (pub. avail. Apr. 18, 1979) (granting no-action relief for brokerdealers that do not provide transaction-specific disclosure about mutual fund loads and related charges, so long as the customer receives a prospectus that discloses sales load information that would allow a customer to calculate the precise amount of those fees). The Proposing Release states that this no-action letter would be withdrawn if the proposals are adopted.

16 Confirmations for redemption transactions would be required to disclose the amount of any deferred sales charges the customer has incurred (in dollars and as a percentage of NAV at the time or purchase or redemption, as applicable).

17 Section 919 of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act grants the SEC authority to issue rules providing for point of sale disclosure. SEC staff members, speaking at the open meeting at which the proposals were approved, suggested that staff recommendations regarding point of sale disclosure would be considered by the SEC in the near future. See Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments to the Registration Form for Mutual Funds, Release No. 33-8358 (Jan. 29, 2004).

18 This line item would remain in the lower portion of the fee table relating to expenses that shareholders pay indirectly as a result of holding an investment in the fund, rather than being moved to the portion of the fee table relating to expense paid directly from a shareholder's investment.

19 See section 2(a)(35) of the 1940 Act, which defines "sales load" by reference to the public offering price.

20 Exchange traded funds routinely receive exemptive relief from section 22(d).

21 See rule 22d-1.

22 The SEC has previously requested comment on an "externalized sales charge" concept. See Prohibition on the Use of Brokerage Commissions to Finance Distribution, Release No. IC-26356 (Feb. 24, 2004). In 2007, the SEC held a roundtable with industry participants regarding rule 12b-1, at which several participants raised concerns with the externalized sales charge concept, including increased transition costs, significant disruptions to current distribution systems, higher distribution costs for small investors, and adverse tax consequences. See Transcript of Roundtable on Rule 12b-1 (June 17, 2007), available at 061907.pdf. The Proposing Release suggests that, due in part to these concerns, the SEC is not proposing to require funds to implement account-level sales charge

23 See Proposing Release, at n.373. The SEC staff has stated in the past that such charges may be appropriate, for example, if used to pay for ongoing services to investors. See Memorandum from Barbara J. Green, Deputy Director, Division of Investment Management, to Arthur Levitt, Chairman, SEC, Chairman Dingell's Inquiry Concerning Rule 12b-1 Fees (Aug. 16, 1993).

24 It is worth noting that the grandfathering provision of proposed rule 12b-2 refers to the rate of the 12b-1 fee paid in the last fiscal year, not to the rate approved as part of the 12b-1 plan. It is unclear how this would affect funds that pay lower 12b-1 fees than authorized by the 12b-1 plan, whether due to fee waivers or lower payment amounts approved by the fund's board.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.