• SEC Staff Provides Guidance on Disclosure of Sales Load Variations and Filing of New Share Classes in Light of the DOL Fiduciary Rule
  • January 6, 2017 | Authors: Eric A. Arnold; Frederick R. Bellamy; Cynthia R. Beyea; Thomas E. Bisset; Steven B. Boehm
  • Law Firm: Sutherland Asbill & Brennan LLP - Washington Office
  • I. Introduction

    On December 16, 2016, the Division of Investment Management (IM) of the Securities and Exchange Commission (SEC) published a Guidance Update (the Guidance) providing guidance on disclosure issues and filing requirements regarding variations in mutual fund sales loads and new mutual fund share classes.1 The Guidance addresses certain concerns raised by mutual funds in light of the broker-dealer industry’s response to the Department of Labor’s (DOL) new fiduciary rule. Specifically, mutual funds have indicated to the SEC that broker-dealers have been seeking to standardize the sales commissions that they receive from mutual fund families. In response to broker-dealer requests, a number of mutual funds are considering changes to their fee structures, either through scheduled variations in sales loads or through the addition of new share classes. The Guidance addresses (i) how to properly disclose sales load variations, and (ii) how to efficiently navigate the SEC registration statement filing and staff review process for both sales load variations and new share classes.

    II. Fee Structure Variations Under the 1940 Act

    Pursuant to Rule 18f-3 under the Investment Company Act of 1940, as amended (the 1940 Act), a mutual fund may establish multiple classes of shares, with each class having its own fee structure (which may include its own sales load), provided that the various requirements of the rule are satisfied. A mutual fund may also provide for variations to its fee structure in accordance with Rule 22d-1 under the 1940 Act, which provides that a mutual fund may have scheduled variations to its sales load (including the elimination thereof) for particular classes of investors or transactions, provided that the variations are adequately disclosed and applied uniformly. In all cases, Section 22(d) of the 1940 Act, and the rules and regulations thereunder, require a mutual fund to disclose its sales load in its prospectus.2

    III. Guidance Provided by IM Staff

    A. Disclosure of Scheduled Sales Load Variations Under Rule 22d-1

    The Guidance first provides general guidance to mutual funds that will rely on Rule 22d-1 to implement scheduled sales load variations in connection with the purchase of shares from a specified broker-dealer or other intermediary. The Guidance states that those investors who purchase shares through a specific broker-dealer or other intermediary would be a “class” under Item 12(a)(2) of Form N-1A. Notably, this means that a mutual fund’s prospectus disclosure concerning sales load variations must specifically identify each broker-dealer or other intermediary offering such a variation. The Guidance also confirms that the disclosure should be presented in a clear, concise and understandable manner; include tables, schedules and charts if helpful; and that the narrative explanation to the fee table must alert investors to the existence of the sales load variations and include cross-references to the appropriate portions of the prospectus and the statement of additional information.

    Importantly, to address concerns that the new scheduled sales load variations will result in lengthy prospectus disclosure, the Guidance expressly permits a mutual fund to include its sales load variation disclosure in an appendix to the statutory prospectus. However, in order to use the appendix, a mutual fund must comply with the following requirements:
    • The section of the prospectus that addresses distribution arrangements must include a prominent statement to the effect that different intermediaries may impose different sales loads, and that these variations are described in a specified appendix to the prospectus;
    • The appendix must be cross-referenced in the narrative explanation to the prospectus fee table; and
    • The appendix must specifically identify the name of the relevant intermediary and should include sufficient information, such as account type, to allow an investor to determine which scheduled variation applies to his or her investment.
    In addition, the Guidance states that IM would not object to a mutual fund using the appendix as a standalone document, rather than as a physical part of the statutory prospectus, so long as:
    • The appendix is incorporated into the prospectus by reference and filed with the prospectus;
    • The front cover page of the appendix includes a legend explaining that the information disclosed in the appendix is part of, and incorporated into, the prospectus;
    • The outside back cover page of the prospectus includes a statement that information about the different sales load variations is provided in a separate document that is incorporated by reference into the prospectus;
    • The mutual fund delivers the appendix with the prospectus; and
    • The mutual fund posts the appendix on its website consistent with Rule 498(e) under the Securities Act of 1933, as amended (the 1933 Act), if the mutual fund uses a summary prospectus.
    The Guidance reminds mutual funds that, in order to add disclosure about sales load variations, a fund must file an amendment to its registration statement under Rule 485(a) under the 1933 Act, which is subject to IM staff review. The Guidance also cautions mutual funds that their prospectuses or appendices must be updated on an ongoing basis to reflect any new or modified sales load variations.

    B. Establishing New Share Classes Pursuant to Rule 18f-3

    Mutual funds that choose to provide fee structure variations through the addition of new share classes, rather than sales load variations, will need to list those share classes in the prospectus fee table. Importantly, mutual funds are not required to provide information about each share class in each prospectus; a mutual fund can have a separate prospectus for each available share class, as long as the prospectuses disclose that other share classes are available. The Guidance reminds mutual funds that amendments to registration statements adding new classes of shares must be filed pursuant to Rule 485(a), and are therefore subject to IM staff review.

    C. Selective Review and Template Review Processes

    Regardless of whether a mutual fund chooses to offer fee structure variations through sales load variations or new share classes, or a combination thereof, the Guidance encourages mutual funds to utilize the “selective review” and “template review” processes, when appropriate. These are not new processes; rather the Guidance serves as a reminder/request from IM on how filings should be made to add disclosure regarding fee structure variations. Each process is designed to improve the efficiency of SEC staff review.

    The Guidance encourages mutual funds to request “selective review” to add certain new information to any filing that otherwise contains disclosure that is “not substantially different” from the disclosure contained in one or more prior filings, adding that a request for selective review “may be [particularly] appropriate” for the Rule 485(a) filing of a mutual fund that “first reflects a new share class or sales load variation that is expected to apply to other [f]unds in the [f]und complex.” To request selective review, the cover letter for a filing should include:
    • A statement on whether the disclosure in the filing has been reviewed by SEC staff in another context;
    • A statement identifying prior filings that the fund considers similar to, or intends as precedent for, the current filing; 
    • A summary of the material changes made in the current filing from the previous filings; and 
    • Any specific areas that the registrant believes warrant particular attention.
    The Guidance encourages mutual funds to utilize a “template review” process, which is available pursuant to Rule 485(b)(1)(vii) under the 1933 Act, when a fund family intends to make “substantially identical” changes to the registration statements of multiple funds. Under the template review process, the filer would make a “template” filing pursuant to Rule 485(a) and, in an EDGAR correspondence filing, make the following representations:
    • The disclosure changes in the template filing are substantially identical to disclosure changes that will be made in the replicate filings.
    • The replicate filings will incorporate changes made to the disclosure included in the template filing to resolve any SEC staff comments thereon.
    • The replicate filings will not include any other changes that would otherwise render them ineligible for filing under Rule 485(b) (i.e., they cannot include any “material” changes relative to the template filing).
    As long as a fund family complies with those representations, subsequent filings based on the template may be filed pursuant to Rule 485(b), which would not be reviewed by SEC staff. Such filings should include a cover letter or explanatory note that the filing is eligible to be filed under Rule 485(b) because of template review relief.

    1 SEC Division of Investment Management Guidance Update No. 2016-06 (Dec. 2016), available at https://www.sec.gov/investment/im-guidance-2016-06.pdf.

    2 The SEC staff has provided no-action relief in certain circumstances allowing intermediaries to impose fees on customers that are not specifically disclosed in mutual fund prospectuses. See, e.g., Charles Schwab and Co., Inc. (pub. avail. Aug. 6, 1992). Additionally, in response to the DOL Fiduciary Rule, some industry participants have urged the SEC to provide broader exemptive relief from the requirement in Section 22(d) that funds set sales loads. This Guidance does not address prior no-action relief or the pending requested relief.