SEC Warns Advisors to Pay Closer Attention to 12b-1, Distribution Fees

Exam sweep prompts agency's IM division to release guidance on how to avoid mischaracterizing distribution fees

The SEC has been cracking down on "distribution in guise." The SEC has been cracking down on "distribution in guise."

A recent Securities and Exchange Commission exam sweep of investment advisor and mutual fund complexes’ distribution fees, including 12b-1 fees, has prompted SEC staff to issue guidance warning advisors and boards to pay closer attention to such fees.

Staff within the SEC’s Division of Investment Management warn in their January guidance that mutual fund fees “have a direct impact on investor returns,” noting that, for example, “because investors may evaluate funds based on the specific levels of 12b-1, management, and other fees, potential mischaracterization of fees may lead them to invest in funds that they would not otherwise have selected.”

Susan Ferris Wyderko, president and CEO of The Mutual Fund Directors Forum, told ThinkAdvisor on Friday that the SEC’s “detailed document will provide guidance for boards and for advisors struggling to apply the previous decades-old staff guidance to today’s vastly different distribution environment.”

The exam sweep was part of the SEC’s “distribution-in-guise” initiative, which is designed to protect investors from improperly paying mutual fund distribution fees. The initiative resulted in the SEC levying its first enforcement action in this area last September against First Eagle Investment Management and FEF Distributors.

In that case, the SEC fined both firms almost $40 million for using fund assets, belonging to shareholders, rather than their own assets to pay distribution costs from January 2008 to March 2014. Once collected, those funds will be distributed to the affected shareholders, according to the SEC.

SEC enforcement director Andrew Ceresney said when the First Eagle action was taken that “First Eagle and FEF [Distributors] inappropriately used money belonging to the shareholders of the funds to pay for services clearly intended to market and distribute the shares.” Unless part of a 12b-1 plan, he said, “the firm should bear those costs, not the shareholders.” FEF is an affiliated distributor of First Eagle funds.

"The IM's January staff guidance basically tells funds’ boards and managers how to assess the permissibility of fees paid to intermediaries, and also requires the fund board to determine whether payments made to intermediaries (such as sub-transfer agent, administrative, sub-accounting or similarly categorized shareholder servicing fees) are disguised distribution payments only permissible pursuant to shareholder-approved 12b-1 distribution plans,” explains Cipperman Compliance Services.

The IM staff requires the fund’s advisor and other service providers “to provide the board with sufficient information to make such determinations,” Cipperman says, with the guidance also outlining the information that the board should receive including services rendered, amounts paid, fee structures and reasonableness.

Several practices also deserve heightened board scrutiny, the guidance states, including “distribution activity conditioned on receipt of fees, the absence of a 12b-1 plan, tiered payment structures, bundling of services, and large disparities in fees paid to different third-party providers.”

The IM staff recommends that funds adopt compliance policies and procedures to review and identify payments that may be made for distribution-related services. 

Fund boards should consider adding “a distribution review similar to the advisory contract review process, whereby the advisor must deliver significant information for the board to deliberately consider any shareholder servicing payment according to the staff's guidance,” Cipperman advises. “Fund CCOs need to get working on policies and procedures and testing protocols.”

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