New guidance from SEC aims to help investment management industry respond to fiduciary rule: a closer look

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Investment Management Alert


While not yet in force, the US Department of Labor's new fiduciary rule and related best interest contract exemption (together, the Fiduciary Rule) together are having a profound impact on mutual funds, particularly regarding their sales charge schedules and share classes structures.[1] 

A key aspect of the Fiduciary Rule − and in particular the best interest contract exemption − is the requirement it places on broker-dealers and other firms that receive variable compensation in connection with their clients' investment in funds to make certain findings as to the reasonableness of such compensation.  In order to make these findings, broker-dealers have been putting pressure on fund firms to standardize their compensation arrangements and, to a large extent, to tailor their applicable sales charge and distribution fee elements to the needs of each firm. 

The SEC's Division of Investment Management has taken notice of this development and provided the fund industry with new tools to address some of the pressures imposed by the Fiduciary Rule.  In a recently released Guidance Update,[2] the Division acknowledged the impact that the Fiduciary Rule has been having on funds, noting that funds have been contemplating certain changes to their fee structures that would effectively "level" the compensation provided to financial intermediaries for the sale of fund shares in order to "facilitate [said] intermediaries' compliance with the [Fiduciary Rule]." The staff also noted that some funds are or have been considering streamlined sales load structures "to help address operational and compliance challenges that can exist for intermediaries that sell shares of multiple funds."

New tool: appendix for sales charge variations

As one response to the Fiduciary Rule, funds are starting to create sales load variations that apply uniformly to investors who purchase through a designated intermediary.  Form N-1A requires such funds to specifically identify each intermediary whose investors receive a sales load variation, and include a narrative that alerts investors to the existence of sales load discounts or waivers and provides a cross-reference to the section of the prospectus that describes the arrangement.  As set forth in the Guidance Update, the staff stated that, "given the Commission and staff focus on improving disclosure," it would not object if "lengthy sales load variation disclosure for multiple intermediaries is included in an appendix to the statutory prospectus," provided that certain conditions are satisfied.  In particular, the prospectus must include a prominent statement to the effect that different intermediaries may impose different sales loads and that these variations are described in a specifically described appendix to the prospectus, and any such appendix must specifically identify the intermediary(s) and include information to allow an investor to determine which scheduled variation applies to its investment.

In addition, as stated in the Guidance Update, the staff will permit the appendix to be a stand-alone document, provided certain conditions are met.  These conditions require the fund that wants to use a stand-alone appendix to do the following:

  • incorporate the appendix into the prospectus by reference and file the appendix with the prospectus
  • include a legend on the cover page of the appendix explaining that the appendix is  part of, and incorporated in, the prospectus
  • include a statement on the outside back cover page of the prospectus that information about the different sales load variations is provided in a separate document
  • deliver the appendix with the prospectus and
  • post the appendix on its website (if the fund uses a summary prospectus).

Funds also must update their prospectuses or appendices on an ongoing basis to reflect any new or modified sales load variations.

Procedure for adding new share classes: template relief

The Update also notes that funds are considering and launching new share classes with new sales loads, transaction charges, and ongoing expenses. As with adding an appendix containing scheduled sales load variations, adding a new class requires a filing under Securities Act Rule 485(a). According to the Update, if only certain disclosures about the fund are changing, such as to describe the new share class, the staff is encouraging funds to seek selective review of the filing and to consider whether to request so-called Template Filing Relief.  This relief allows funds to avoid filing multiple filings and instead make a single Rule 485(a) filing (a Template filing), that is paired with a Template Filing Relief request for other funds with substantially identical disclosure.  

In connection with this request, the fund must represent that the disclosure changes in the Template filing are substantially identical to disclosure changes that will be made in the other filings (so-called Replicate filings), and that the Replicate filings will incorporate changes made to the disclosure included in the Template filing to resolve any staff comments thereon.[3] 

As the Updates reminds funds and their counsel, any Rule 485(b) filing relying on Template Filing Relief should include a cover letter explaining that it is relying on this relief.

A helpful approach

Funds are looking at the additions and changes necessary to adapt to the Fiduciary Rule and the requirements of the best interest contract exemption. Under the circumstances, the Division staff's willingness to help funds do so efficiently and economically is welcome.

Learn more about adapting to the Fiduciary Rule by contacting the author.

[1]  Conflict of Interest Rule – Retirement Investment Advice, 81 FR 20946 (Apr. 8, 2016); Best Interest Contract Exemption, 81 FR 21002 (Apr. 8, 2016).

[2]   See this page.          

[3]  In addition, the fund will have to represent that the Replicate filings will not include any other changes that would otherwise render them ineligible for filing under Rule 485(b).