The SEC has conducted several sweeps to gather information for determining whether payments to financial intermediaries were for shareholder servicing and recordkeeping or for distribution, often called “distribution in guise”. Recently, there has been much speculation about potential enforcement actions against some funds as a result of these sweeps. What can funds do to protect themselves on this issue? Three suggestions come to mind:
- The Board first needs to set policies, consistent with the funds’ 12b-1 plan, about what the funds will pay for intermediary based shareholder services.
- Funds should be as specific as possible in their agreements about the services that the intermediary firm will perform specific to SubTA, Servicing and Retirement Fees.
- Funds then need to establish a repeatable process to allocate funding of intermediary fees to the funds, up to the levels agreed by the Board, and then allocate the remainder to another corporate entity.
This approach is supported in our FIA Payment Administration (FIATM) business. Many of our clients have established funding rules for these payments, limiting the amounts to be paid by the individual funds. After validating the fee amounts, we provide reporting to the client splitting the funding of the fee between the fund and a corporate entity, typically the distributor. For example, the fund may agree to pay a SubTA fee up to $19/account or 25 bps, and anything over that is paid by the distributor.
Retirement fees are often allocated into three buckets. Say there is an aggregated 60 bps Retirement Plan Service Fee on a single invoice. It would be split into its underlying components , such as 25 bps for servicing (same as a SubTA fee) paid by the funds, 25 bps for 12b-1fees paid by the funds (under the Board approved 12b-1 plan) and finally 10 bps paid by the distributor.
All of these funding rules can be customized at the fund share class level to accommodate different fee structures for different products. In addition, the process is systematic and results in full documentation to help demonstrate that the policies established by the board have been satisfied.
As the attention of the SEC continues to increase around distribution in guise, the above suggestions may help to provide clearer internal direction relative to payments and their processing. The focus remains on disclosure, transparency and ensuring that intermediary payments are allocated appropriately, correspond to the functions being performed, and follow the guidelines established by the Fund Board.