In a Guidance Update published on January 6, 2016, the staff of the SEC’s Division of Investment Management (the “Staff”) has provided guidance to mutual fund firms on the process that mutual fund directors and investment advisers should follow when evaluating arrangements for payment of fund distribution and “sub-accounting” fees.
The guidance follows the SEC’s recent “distribution-in-guise” sweep examinations that targeted the use of fund assets to pay marketing and distribution expenses. These exams resulted in an enforcement action brought against an investment adviser for causing a fund to pay for certain distribution-related activities outside of a 12b-1 plan. The guidance also follows unclear statements made by senior SEC staff in recent months concerning the proper manner of implementing these arrangements.
In the Guidance Update, the Staff recommended that the following measures be undertaken in evaluating arrangements for payment of fund distribution and sub-accounting fees:
- Whether or not a fund has a 12b-1 plan, the board of directors should have a process reasonably designed to evaluate whether a portion of sub-accounting fees is being used to pay directly or indirectly for distribution;
- As part of this process, advisers and other relevant service providers should provide the board with “sufficient information” to evaluate the intermediary distribution and servicing arrangements for the fund, including how the level of sub-accounting fees may affect other payment flows (e.g., 12b-1 fees and revenue sharing) that are intended for distribution; and
- Advisers and other relevant service providers should inform boards if certain activities and arrangements that are potentially distribution-related exist in connection with the payment of sub-accounting fees, and, if they do, boards should evaluate the appropriateness and character of those payments with heightened attention.
In the Guidance Update, the Staff noted that the same types of factors and analysis described in its 1998 Letter on mutual fund supermarket fees could serve as a useful framework in establishing a process for a mutual fund board to evaluate whether a portion of fund-paid sub-accounting fees is or is not being used to pay directly or indirectly for distribution.
However, in adapting the 1998 Letter framework to a process for evaluating the character of sub-accounting fees, the Staff advised that a fund board also consider requesting the following additional information from the adviser, other relevant service providers, and intermediaries in order to address other issues arising in this context:
- information about the specific services provided under the fund’s sub-accounting agreements;
- the amounts being paid;
- whether the adviser or other service providers are recommending any changes to the fee structure or whether any of the services provided have materially changed;
- whether any of the services could have direct or indirect distribution benefits;
- how the adviser and other service providers ensure that the fees are reasonable; and
- how the board evaluates the quality of services being delivered to beneficial owners (to the extent of its ability to do so).
The Staff also highlighted certain activities and arrangements that may raise concerns that a payment, though ostensibly not for distribution-related activities, may in fact be (at least in part) a payment for such services. These include:
- Distribution-related activities conditioned on the payment of sub-accounting fees;
- The payment of fund distribution expenses when the fund lacks a 12b-1 plan;
- Tiered payment structures (fees paid through a combination of fund assets and revenue sharing);
- Lack of specificity or bundling of services;
- The adviser taking distribution and sales benefits into account when recommending, instituting, or raising sub-accounting fees;
- Large disparities in sub-accounting fees paid to various intermediaries; and
- Fees paid for “sales data” and whether the purchase of such data is distribution-related.
The Guidance Update should help address current mutual fund board concerns about the proper manner of implementing arrangements for the payment of distribution and sub-accounting fees. If the recommendations provided in the guidance are followed, board members should be in a better position to support the satisfaction of their fiduciary obligations when they exercise their business judgment to approve the implementation of these arrangements.
 In the Guidance Update, the Staff described “sub-accounting fees” as fees paid to financial intermediaries and characterized as non-distribution-related sub-transfer agent, administrative, sub-accounting, and other shareholder servicing fees.
 The guidance specifically notes that funds should implement Rule 38a-1 compliance programs that are designed to prevent violations of Section 12(b) of the Investment Company Act and Rule 12b-1.
 See Letter from Douglas Scheidt, Associate Director and Chief Counsel, Division of Investment Management, Securities and Exchange Commission, to Craig S. Tyle, General Counsel, Investment Company Institute (October 30, 1998).