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Melanie Waddell

Regulation and Compliance > Federal Regulation > SEC

SEC 12b-1 Fee, Custody Rules Likely Out by Year-End

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What You Need to Know

  • The SEC said in its Regulatory Flexibility agenda in June that it plans to review five rules this year affecting RIAs.
  • The Investment Adviser Association's Karen Barr says the commission could put forth a rule in late October or November.
  • Amy Lynch of FrontLine Compliance says that Rule 12b-1 fees have been dealt with rather harshly via enforcement actions and are being used less.

Industry watchers are keeping a close eye on likely rulemakings this year by the Securities and Exchange Commission that seek to rein in 12b-1 fees as well as custody rule infractions.

In its Regulatory Flexibility agenda, released in June, the agency said it plans to review five rules this year affecting registered investment advisors.

The SEC said its Division of Investment Management is considering recommending that the SEC propose amendments this year to existing rules and/or propose new rules under the Investment Advisers Act of 1940 to improve and modernize the regulations around the custody of funds or investments of clients by RIAs.

On Friday, the securities regulator brought charges against eight advisory firms for custody rule violations that relate to the audit requirements of the custody rule.

“The custody rule process is well underway,” Karen Barr, president and CEO of the Investment Adviser Association in Washington, told me Friday in an interview. “It’s not unrealistic” that the agency could put forth a rule in late October or November.

Commenting on the custody rule actions taken by the SEC on Friday, Barr said an exam sweep is often “a sign they’re [the SEC is] focusing closely on a rule.” IAA has urged the agency to take a “holistic look” at the custody rule, as there are lots of aspects that are hard to comply with.

Amy Lynch, founder and president of FrontLine Compliance, sees the agency tackling 12b-1 fees via a rulemaking on its agenda dubbed fund fee disclosure and reform.

“Both rules [fees and custody] are currently in the works,” Lynch told me Friday in an email. The “custody rule may come out first, but fund fees are also important to [the SEC’s Investment Management Division] right now. Both rules could come out before year-end.”

Melissa Harke, senior special counsel in the SEC’s IM division, said Thursday at the annual SEC Speaks conference, held in Washington, that “custody is on the SEC’s rulemaking agenda; we are aware of the questions” that the industry has.

The agency’s regulation agenda states that it is considering recommending proposed changes to regulatory requirements relating to registered investment companies’ fees and fee disclosure.

“Fund fees have been on the SEC’s regulatory agenda for quite some time now,” Lynch told me. “As you know, Rule 12b-1 fees have been dealt with rather harshly via the numerous enforcement actions against funds. The industry has certainly received the message and the use of 12b-1 fees is declining.”

In February, I reported that the Investment Company Institute found in March 2021 that the majority of long-term mutual fund gross sales now go to no-load mutual funds (i.e., no front-end or back-end load, nor a contingent deferred sales charge) without 12b-1 fees.

In 2020, according to ICI, 88% of gross sales of long-term mutual funds went to no-load funds without 12b-1 fees, compared with 46% in 2000.

However, Lynch continued, “other fees such as revenue sharing are increasing. The key for funds is to provide clear and consistent disclosure to shareholders regarding the fees charged. I suspect any rulemaking that comes out to focus on descriptive disclosures.”

The SEC said in its exam priorities, released in late March, that it would focus its exams this year on RIAs’ use of 12b-1 fees in wrap fee accounts where the RIA may be responsible for paying transaction fees, along with revenue sharing arrangements.

The agency said that RIA exams will focus on whether advisors “are acting consistently with their fiduciary duty to clients, looking at both duties of care and loyalty, including best execution obligations, financial conflicts of interest and related impartiality of advice, and any attendant client disclosures.”

Ron Rhoades, associate professor of finance at Western Kentucky University and director of its personal financial planning program, told me in another email that he’d be disappointed if the SEC seeks to address 12b-1 fees “only through rules that merely enhance fund fee disclosures in some manner, without severely restricting the utilization of fund share classes with 12b-1 fees.”

These 12b-1 fees, Rhoades said, “don’t benefit fund shareholders, and rather act to their detriment. Shareholders rarely understand 12b-1 fees. Outside of the defined contribution space (where R-1, R-2, etc. shares exist), 12b-1 fees are not negotiable by clients.”

Another problem, he says, “is that 12b-1 fees, particularly of the 1% variety (often seen in Class C shares), are – in essence – ‘investment advisory fees in drag.’ There is no reason for the SEC to permit ‘asset-based fees’ to be charged by brokers, when investment advisory fees would be more appropriate.”


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