# Mutual Fund Distribution Fees; Confirmations > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2010-18305 ## Record - **Collection:** Federal Register - **Document type:** Proposed Rule - **Published:** August 4, 2010 - **Citation:** 75 FR 47064 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 210, 239, 240, 249, 270, and 274 [Release Nos. 33-9128; 34-62544; IC-29367; File No. S7-15-10] RIN 3235-AJ94 Mutual Fund Distribution Fees; Confirmations AGENCY: Securities and Exchange Commission. ACTION: Proposed rule. SUMMARY: The Securities and Exchange Commission (“SEC” or “the Commission”) is proposing a new rule and rule amendments that would replace rule 12b-1 under the Investment Company Act, the rule that has permitted registered open-end management investment companies (“mutual funds” or “funds”) to use fund assets to pay for the cost of promoting sales of fund shares. The new rule and amendments would continue to allow funds to bear promotional costs within certain limits, and would also preserve the ability of funds to provide investors with alternatives for paying sales charges ( e.g., at the time of purchase, at the time of redemption, or through a continuing fee charged to fund assets). Unlike the current rule 12b-1 framework, the proposed rules would limit the cumulative sales charges each investor pays, no matter how they are imposed. To help investors make better-informed choices when selecting a fund that imposes sales charges, the Commission is also proposing to require clearer disclosure about all sales charges in fund prospectuses, annual and semi-annual reports to shareholders, and in investor confirmation statements. As part of the new regulatory framework, the Commission is proposing to give funds and their underwriters the option of offering classes of shares that could be sold by dealers with sales charges set at competitively established rates—rates that could better reflect the services offered by the particular intermediary and the value investors place on those services. For funds electing this option, the proposal would provide relief from restrictions that currently limit retail price competition for distribution services. The proposed rule and rule amendments are designed to protect individual investors from paying disproportionate amounts of sales charges in certain share classes, promote investor understanding of fees, eliminate outdated requirements, provide a more appropriate role for fund directors, and allow greater competition among funds and intermediaries in setting sales loads and distribution fees generally. DATES: Comments must be received on or before November 5, 2010. ADDRESSES: Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission's Internet comment form ( http://www.sec.gov/rules/proposed.shtml ); • Send an e-mail to rule-comments@sec.gov. Please include File Number S7-15-10 on the subject line; or • Use the Federal eRulemaking Portal ( http://www.regulations.gov ). Follow the instructions for submitting comments. Paper Comments • Send paper comments in triplicate to Elizabeth Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090. All submissions should refer to File Number S7-15-10. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site ( http://www.sec.gov/rules/proposed.shtml ). Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: With respect to rules and forms under the Investment Company Act and Securities Act, Thoreau A. Bartmann, Senior Counsel, Daniel Chang, Attorney, or C. Hunter Jones, Assistant Director, at 202-551-6792, Office of Regulatory Policy, Division of Investment Management, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549. With respect to rule 10b-10 under the Securities Exchange Act, Daniel Fisher, Branch Chief, or Ignacio Sandoval, Attorney, at 202-551-5550, Office of Chief Counsel, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-7010. SUPPLEMENTARY INFORMATION: The Commission is proposing to rescind rule 12b-1 [17 CFR 270.12b-1] under the Investment Company Act of 1940 (“Investment Company Act” or “Act”). 1 The Commission is also proposing for comment: New rule 12b-2 [17 CFR 270.12b-2] under the Investment Company Act; amendments to rules 6c-10 [17 CFR 270.6c-10] and 11a-3 [17 CFR 270.11a-3] under the Investment Company Act; amendments to Form N-1A 2 under the Investment Company Act and the Securities Act of 1933 (“Securities Act”); 3 amendments to rule 6-07 [17 CFR 210.6-07] of Regulation S-X under the Securities Act; amendments to rule 10b-10 [17 CFR 240.10b-10] and Schedule 14A 4 under the Securities Exchange Act of 1934 (“Exchange Act”); 5 technical changes to rule 10b-10; and technical and conforming changes to various rules and forms under the Investment Company Act. 1 15 U.S.C. 80a. Unless otherwise noted, all references to statutory sections are to the Investment Company Act and all references to rules under the Investment Company Act will be to Title 17, Part 270 of the Code of Federal Regulations [17 CFR part 270]. 2 17 CFR 239.15A and 274.11A. 3 15 U.S.C. 77a. 4 17 CFR 240.14a-101. 5 15 U.S.C. 78a. Table of Contents I. Introduction II. Background A. Mutual Fund Sales Charges B. Adoption of Rule 12b-1 C. Developments Following Rule 12b-1's Adoption D. The Current Role of 12b-1 Fees E. Additional Commission Consideration of Rule 12b-1 III. Discussion A. Summary of Our Proposals B. Rescission of Rule 12b-1 C. Proposed Rule 12b-2: The Marketing and Service Fee D. Proposed Amendments to Rule 6c-10: The Ongoing Sales Charge E. Proposed Amendments to Rule 10b-10: Transaction Confirmations F. Shareholder Approval G. Application to Funds of Funds H. Application to Funds Underlying Separate Accounts I. Proposed Amendments to Rule 6c-10: Account-Level Sales Charge J. Amendments To Improve Disclosure to Investors K. Proposed Conforming Amendments to Rule 11a-3 L. Other Proposed Conforming Amendments M. Potential Impact of Proposed Rule Changes N. Transition IV. Paperwork Reduction Act V. Cost-Benefit Analysis VI. Initial Regulatory Flexibility Analysis VII. Consideration of Burden on Competition and Promotion of Efficiency, Competition and Capital Formation VIII. Small Business Regulatory Enforcement Fairness Act IX. Statutory Authority Text of Proposed Rules and Form Amendments I. Introduction More than 87 million Americans, representing slightly less than half of all households, own mutual funds. 6 Some investors buy fund shares directly from mutual fund sponsors without paying a sales charge. 7 However, most fund investors buy through intermediaries. 8 These intermediaries include broker-dealers, banks, insurance companies, financial planners, and retirement plans. When investors use intermediaries to buy fund shares, they typically will pay (either directly or indirectly) some form of sales charge or service fees to compensate the intermediaries for the services they provide. 9 6 Investment Company Institute (“ICI”), Profile of Mutual Fund Shareholders, 2009 (2010) (“Shareholder Profile Report”) ( http://ici.org/pdf/rpt_profile10.pdf ). Mutual funds' share of household financial assets has grown steadily from 3 percent in 1980 to 21 percent in 2009. ICI, 2010 Investment Company Fact Book at 10 (2010) ( http://www.ici.org/pdf/2010_factbook.pdf ) (“2010 ICI Fact Book”). 7 These are referred to as “no-load” funds because no sales charge or “load” is charged in connection with the transaction. See infra notes 16-17 and accompanying text. 8 According to the ICI, 80 percent of U.S. households that own mutual funds outside of retirement plans hold some portion of their fund shares through financial professionals (including brokers, financial planners, insurance agents, bank representatives, and accountants). 2010 ICI Fact Book, supra note 6, at 85. 9 Although the use of the term “intermediary” in this Release is not limited to registered broker-dealers, receipt of the fees addressed in this Release may, depending on the services provided, require the recipient to register as a broker-dealer or rely on an exception or exemption from broker-dealer registration. See also note 168, infra, and accompanying text. Investors use intermediaries for a variety of reasons. Some want help in selecting a particular fund or building a diversified portfolio of investments. Others like the convenience of holding a variety of financial assets together in the same account and receiving a single comprehensive account statement. A growing number of investors use mutual funds as a way to fund their retirement plans, college savings accounts, annuity or life insurance contracts, or other tax-advantaged investment vehicles, which are often offered by an intermediary. 10 In some cases, investors use an intermediary (and pay sales charges) not necessarily for the services they obtain from the intermediary, but simply to be able to invest in shares of a particular fund that they cannot buy directly ( i.e., that are sold only through intermediaries). 10 See 2010 ICI Fact Book, supra note 6, at 97, 118. According to the ICI, U.S. retirement plan assets totaled $16 trillion in 2009. Id. The largest individual components were Individual Retirement Accounts (“IRAs”) and employer-sponsored defined contribution plans, holding assets of $4.2 trillion and $4.1 trillion, respectively. Mutual funds' share of the IRA market has increased from 22 percent in 1990 to 46 percent in 2009. Id. at 98-99 . Assets in section 529 college savings plans have grown from $2.6 billion in 2000 to $111 billion in 2009. Id. at 118. There are over 9,000 funds available to investors, offering a variety of investment strategies to suit different investment needs. 11 Investors can select among many types of intermediaries from which they can purchase fund shares, and have choices as to how they pay for the services of those intermediaries. They may pay a “sales load” at the time they purchase shares, or a deferred sales load when they redeem shares, or they may invest in a fund that pays ongoing sales charges on behalf of investors from fund assets, otherwise known as 12b-1 fees. 12 As an alternative, they may choose to invest through an intermediary that deducts fees directly from the investor's account by a separate agreement ( e.g., “wrap fee programs”). Whether an investor pays sales charges depends upon the fee structure of the fund in which the investor chooses to invest, and how those sales charges are paid depends upon the “class” of fund shares that the investor selects. 13 11 2010 ICI Fact Book, supra note 6, at 16. This figure represents the total number of registered open-end funds, and includes separate series of a fund and ETFs. 12 We will use the term “12b-1 fees” generally to describe fees that are paid out of fund assets pursuant to a plan adopted under rule 12b-1 (“12b-1 plan”). 13 See infra Section II.C.3 of this Release. These sales charge arrangements are disclosed in fund prospectuses, and are governed by a combination of statutory provisions and rules adopted by the Commission and the Financial Industry Regulatory Authority, Inc. (“FINRA”), a self-regulatory organization for broker-dealers. 14 These rules have been in place for many years and, as discussed in more detail below, we believe that they may no longer fully reflect the current economic realities of the mutual fund marketplace or best serve the interests of fund investors. In this Release, we first review how these rules developed, our experience in administering them, changes we have observed in how funds distribute their shares, and the evolving needs of shareholders. We then propose a new framework that would continue to allow funds to give investors choices as to how and when to pay for sales charges, improve disclosure designed to enhance investor understanding of those charges, limit the cumulative sales charges each investor pays, and eliminate uncertainties associated with current requirements while providing a more appropriate role for fund directors. Finally, the proposal would offer funds and their underwriters the option of offering a class of shares that could be sold by intermediaries subject to competition in establishing sales charge rates. 14 FINRA rules do not apply directly to mutual funds, but to registered broker-dealers that are FINRA members, including the principal underwriters of most funds. Most funds therefore structure their sales loads to meet FINRA rules in order for their shares to be distributed and sold by registered broker-dealers in the United States. II. Background A. Mutual Fund Sales Charges When the Investment Company Act was enacted in 1940, investors paid most of the costs of selling and promoting fund shares in the form of a sales charge or sales “load” deducted from the purchase price at the time of sale by the fund's principal underwriter (typically the fund's adviser or a close affiliate). 15 The sales load financed brokers' commissions, advertisements, and other sales and promotional activities. Only a limited number of funds, called “no-load” funds, marketed their shares directly to investors without the assistance of a retail broker, and did not charge sales loads. 16 The selling costs of no-load funds (primarily advertising) typically were subsidized by the funds' investment advisers out of their profits. 17 15 See SEC, Investment Trusts and Investment Companies, H.R. Doc. No. 279, 76th Cong., 1st Sess., pt. 3, at 813, 823 (1939) (“Investment Trust Study”). Principal underwriters typically confine themselves to wholesale transactions and leave the public selling to independent retail dealers under sales agreements, although some underwriters have their own “captive” retail sales organizations. See Tamar Frankel, The Regulation of Money Managers, § 27.01 (2009 supplement) (“The Regulation of Money Managers”). See also Division of Investment Management, U.S. Securities and Exchange Commission, Protecting Investors: A Half Century of Investment Company Regulation 291 (1992) (“1992 Study”). Although the principal underwriter collects the sales load, for convenience, throughout this Release, we will simply refer to “funds” as imposing sales loads or determining the amount of sales load payable. 16 See Investment Trust Study, supra note 15, at 817-18. Some funds also charged low sales loads of one to two percent. Id. 17 See 1992 Study, supra note 15, at 292. In the past, fund sales charges generally were much higher than those customarily charged today and raised concerns for Congress and the Commission. 18 The Commission submitted a report to Congress in 1966 concluding that mutual fund sales charges should be lowered. 19 Following this report, Congress amended the Act in 1970 to give rulemaking authority to the National Association of Securities Dealers, Inc. (“NASD”) (now FINRA) to prescribe limits to prevent excessive sales loads. 20 Under this authority, in 1975, the NASD adopted a rule placing a ceiling of 8.5 percent on the front-end sales load that a fund distributed by NASD members could charge. 21 Today, few funds impose sales loads that approach the maximum limit, in part because of investor resistance to paying high front-end loads, but also because of the availability of other sources of revenue to pay distribution costs. 22 18 During the period of 1927-1935, sales loads for broker-sold funds ranged from five to 10 percent, but by 1935 they were often as high as nine to 10 percent. See Investment Trust Study , supra note 15, pt. 2, 216-17. See also Investment Trusts and Investment Companies: Hearings on S. 3580 Before a Subcomm. of the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess. 799 (1940) (statement of L.M.C. Smith, Associate Counsel, Investment Trust Study, SEC, discussing the “problem” of high sales loads). 19 The Commission recommended that sales loads be limited to a statutory maximum of five percent from the prevailing typical load of 9.3 percent. See SEC, Report on the Public Policy Implications of Investment Company Growth, H.R. REP. No. 2337, 89th Cong., 2d Sess. at 205, 223 (“PPI Report”). 20 Investment Company Act Amendments of 1970 , Public Law 91-547, § 12(a), 84 Stat. 1413, 1422 (1970) (codified as amended at section 22(b) of the Act). Section 22(b) vested this rulemaking authority in a securities association registered under section 15A of the Exchange Act. The NASD (now FINRA) was and is the only such registered securities association. The Commission supported the amendment. See Investment Company Amendments Act of 1970: Hearings on S. 34 and S. 296 Before a Subcomm. of the Senate Comm. on Banking and Currency, 91st Cong., 1st Sess. 6-8 (1969) (statement of Hugh Owens, SEC Commissioner). 21 Order Approving Proposed Rule Change by NASD, Investment Company Act Release No. 8980 (Oct. 10, 1975) (approving predecessor rule to NASD Conduct Rule 2830). 22 See The Regulation of Money Managers, supra note 15, at § 27.03; ICI, Trends in the Fees and Expenses of Mutual Funds, 2009 (Apr. 2010) ( http://www.ici.org/pdf/fm-v19n2.pdf ) (“Fee Trends Report”) (noting that in 2009 the average maximum front-end load on stock funds was 5.3 percent). B. Adoption of Rule 12b-1 The most significant of these alternative revenue sources came about when the Commission adopted rule 12b-1 in 1980. 23 As described in more detail below, rule 12b-1 permits a fund to use fund assets to pay broker-dealers and others for providing services that are primarily intended to result in the sale of the fund's shares. The Commission adopted rule 12b-1 under its authority in section 12(b) of the Investment Company Act, 24 which authorizes the Commission to regulate the distribution activities of funds that act as distributors of their own securities. 25 Section 12(b) was designed to protect funds from being charged excessive sales and promotional expenses. 26 The requirements of the rule are intended, in part, to address the conflicts of interest between a fund and its investment adviser that arise when a fund bears its own distribution expenses. 27 The Commission's adoption of rule 12b-1 arose in the context of two significant developments in the mutual fund market that occurred during the 1970s. 28 First, many funds experienced a prolonged period of net redemptions ( i.e., redemptions exceeded new sales), which reduced the amount of fund assets. 29 Fund company representatives asserted that using fund assets to fuel the sale of fund shares could benefit fund shareholders by increasing economies of scale and reducing fund expense ratios. 30 The second was the development of money market funds and no-load fund groups, including internally managed funds, which did not charge sales loads but required a source of revenue to support their direct selling efforts. 31 By offering a less expensive way for many investors to become fund shareholders, no-load funds promised to introduce greater price competition in the sale of mutual funds to retail investors, which might lower sales loads for all investors. 23 Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 73898 (Nov. 7, 1980)] (“1980 Adopting Release”). 24 Rule 12b-1 was also adopted pursuant to section 38(a) of the Act. Id. 25 Section 12(b) makes it unlawful, with certain exceptions, for any mutual fund “to act as a distributor” of its own shares in contravention of any rules the Commission adopts as “necessary or appropriate in the public interest or for the protection of investors.” 26 See Investment Trusts and Investment Companies: Hearings on H.R. 10065 Before a Subcomm. of the House Comm. on Interstate and Foreign Commerce, 76th Cong., 3d Sess. 112 (1940) (“House Hearings”) (statement of David Schenker, Chief Counsel, Investment Trust Study, SEC) (The purpose of section 12(b) is to prevent mutual funds from incurring “excessive sales, promotion expenses, and so forth.”). 27 When a fund pays promotional costs, the fund's investment adviser or distributor is relieved from bearing the expense itself, and the adviser benefits further if the fund's expenditures result in the growth of the fund's assets and a related increase in advisory fees (because an adviser's fees typically are based on a percentage of fund assets). However, commentators have noted that the benefits to existing fund shareholders from these expenditures may be “speculative at best.” See Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 10252 (May 23, 1978) [43 FR 23589 (May 31, 1978)] (“Advance Notice of Proposed Rulemaking”) at text following n. 3. 28 See Payment of Asset-Based Sales Loads by Registered Open-End Management Investment Companies, Investment Company Act Release No. 16431 (June 13, 1988) [53 FR 23258 (June 21, 1988)] (“1988 Release”) at n.14 and accompanying text. 29 Total redemptions exceeded new sales for six of the seven years between 1971 and 1977. 2010 ICI Fact Book, supra note 6, at 125. 30 See Advance Notice of Proposed Rulemaking, supra note 27, at n.3 and accompanying text. 31 See, e.g., Valuation of Debt Instruments and Computation of Current Price per Share by Certain Open-End Investment Companies (Money Market Funds), Investment Company Act Release No. 13380 (July 11, 1983) [48 FR 32555 (July 18, 1983)]. An investment company is said to have internalized its management functions when most or all of the services traditionally provided by the investment adviser or third parties are performed at cost by salaried employees of the fund or by subsidiaries of the fund. See 1988 Release, supra note 28, at n.8. When the Commission proposed rule 12b-1, an application was pending from The Vanguard Group for exemptions from the Act to permit Vanguard funds to internalize their marketing and distribution functions and to bear distribution costs through a wholly owned subsidiary of the funds. See In the Matter of the Vanguard Group, et al., Opinion of the Commission, Investment Company Act Release No. 11645 (Feb. 25, 1981). The Commission discussed the Vanguard application in the release and asked commenters to address other possible methods whereby funds might be permitted to bear distribution expenses. See Advance Notice of Proposed Rulemaking, supra note 27, at n.5. The Commission previously had allowed other funds with internalized management functions to pay distribution expenses out of fund assets because it believed these arrangements would significantly reduce the conflicts of interest that otherwise are present when fund assets are used to pay for distributions. See 1988 Release, supra note 28, at nn.8-10 and accompanying text. Before the rule's adoption, the Commission generally had opposed the use of fund assets for the purpose of financing the distribution of mutual fund shares, noting that existing shareholders of a fund “often derive little or no benefit from the sale of new shares.” 32 After engaging in a thorough review of the public policy and legal implications of permitting funds to bear these types of expenses, which included a public hearing and two requests for public comment, 33 the Commission ultimately decided that there may be circumstances in which it would be appropriate for a fund to bear its own distribution expenses. 34 32 See Bearing of Distribution Expenses by Mutual Funds: Statutory Interpretation, Investment Company Act Release No. 9915 (Aug. 31, 1977) [42 FR 44810 (Sept. 7, 1977)] (quoting SEC, Future Structure of the Securities Markets (Feb. 2, 1972) [37 FR 5286 (Mar. 14, 1972)]). 33 See Investment Company Act Release No. 9470 (Oct. 4, 1976) [41 FR 44770 (Oct. 12, 1976)] (announcement of hearings); Advance Notice of Proposed Rulemaking, supra note 27; Bearing of Distribution Expenses by Mutual Funds, Investment Company Act Release No. 10862 (Sept. 7, 1979) [44 FR 54014 (Sept. 17, 1979)] (“1979 Proposing Release”). 34 The Commission noted, however, that it and its staff would “monitor the operation of the rules closely and will be prepared to adjust the rules in light of experience to make the restrictions on use of fund assets for distribution either more or less strict.” See 1980 Adopting Release, supra note 23, at section titled “Discussion.” The Commission remained concerned, however, about the inherent conflicts of interest on the part of the fund adviser. 35 Therefore, in crafting the conditions of the rule, we sought to minimize the role of the adviser and its affiliates in establishing both the amount and uses of fund assets to support distribution. 36 As adopted, the rule required the fund's board of directors, and in particular its independent directors, to play a key role in deciding the level of the fund's distribution charges and how the revenue would be spent. 37 35 See id. 36 See id. at section titled “Independence of Directors.” See also 1988 Release, supra note 28, at section titled “The Development and Use of `Compensation' Plans” (“The directors' responsibilities under the rule were designed to provide that the directors, not advisers or underwriters, make the fundamental decisions regarding distribution spending.”). 37 See 1980 Adopting Release, supra note 23, at section titled “Independence of Directors” (“Since rule 12b-1 does not restrict the kinds or amounts of payments which could be made, the role of the disinterested directors in approving such expenditures is crucial.”). Rule 12b-1 requires that, before using fund assets to pay for distribution expenses, a fund must adopt a written plan (a “rule 12b-1 plan”) describing all material aspects of the proposed financing of distribution, 38 which must contain provisions similar to several of those the Act requires for advisory contracts between the fund and its investment adviser. 39 The rule 12b-1 plan must be approved initially by the fund's board of directors as a whole, and separately by the “independent” directors. 40 If the plan is adopted after the sale of fund shares to the general public, it also must be approved initially by a vote of at least a majority of the fund's voting securities. 41 38 Rule 12b-1(b). The plan must cover indirect as well as direct payments for distribution. See rule 12b-1(a)(2). 39 See 1980 Adopting Release, supra note 23, at section titled “Summary” (“The procedures in the rule by which shareholders and directors would approve a plan to use assets for distribution are generally similar to those prescribed by statute for approval of investment advisory contracts.”). See also sections 15(a) and 15(c) of the Act. 40 We generally refer to directors who are not “interested persons” of the fund as “independent directors” or “disinterested directors.” The term “interested person” is defined in section 2(a)(19) of the Act. However, rule 12b-1 requires directors to meet an additional test. In order to be considered independent for purposes of voting on a rule 12b-1 plan, directors must also have no direct or indirect economic interest in the operation of the plan or in any agreements related to the plan. Rule 12b-1(b)(2). In this Release, when we discuss the role of independent directors, the applicable standard for independence depends on the context. 41 Rule 12b-1(b)(1). When we originally adopted rule 12b-1 in 1980, shareholders were required to vote whenever a rule 12b-1 plan was instituted, regardless of whether a public offering of fund shares had occurred. See 1980 Adopting Release, supra note 23, at section titled “Procedural Requirements.” However, if a rule 12b-1 plan is adopted prior to the public offering of shares, a shareholder vote would be a mere procedural formality and approval would be almost automatic because all shareholders voting would typically be the fund's organizers. Any investor who purchased shares in a public offering after the initial adoption of the plan would be on notice that the fund charges 12b-1 fees. Therefore, in 1996 we amended the rule to permit funds to adopt a 12b-1 plan prior to a public offering of shares without a shareholder vote. See Technical Amendments to Rule Relating to Payments for the Distribution of Shares by a Registered Open-End Management Investment Company, Investment Company Release No. 22201 (Sept. 9, 1996) [61 FR 49010 (Sept. 17, 1996)]. The rule does not restrict the amounts of the fees that may be approved under the plan. 42 It also does not specify all of the activities that are “primarily intended to result in the sale of shares” and therefore may be paid by a fund only according to a rule 12b-1 plan. Nor does it specifically prohibit a fund from paying for non-distribution expenses under a rule 12b-1 plan. 43 Instead of limits or restrictions, the rule requires directors (including a majority of the independent directors) to conclude, in exercising their reasonable business judgment and in light of their fiduciary duties, that there is a reasonable likelihood that the plan will benefit both the fund and its shareholders. 44 The directors have a duty to request and evaluate as much information as is reasonably necessary for the directors to make an informed business decision. 45 The rule also requires any person authorized to direct payments under the plan or any related agreement (such as the fund's underwriter) to provide quarterly reports to the board of directors of all amounts expended under the plan and the purposes for which the expenditures were made. 46 The fund's board of directors (including a majority of the independent directors) must decide each year whether to re-approve the plan based on the same considerations as required initially to adopt the plan. 47 Any material increases in the amounts paid under the plan must be approved by the fund's board, the fund's independent directors, and the fund's shareholders. 48 In the 1980 Adopting Release, the Commission provided a list of nine factors that were intended to provide guidance to directors in considering whether the use of fund assets for distribution would benefit the fund and its shareholders. 49 The factors included: (i) The need for independent counsel or experts to assist the board; (ii) the “problems” or “circumstances” that make the plan necessary or appropriate; (iii) the causes of such problems or circumstances; (iv) how the plan would address the problems; (v) the merits of possible alternatives; (vi) the interrelationships between the plan and distributors; (vii) the possible benefits of the plan to other persons relative to the benefits to the fund; (viii) the effect of the plan on existing shareholders; and (ix) in deciding whether to continue a plan, whether the plan has produced the anticipated benefits to the fund and its shareholders. 50 42 However, as discussed in more detail in Section II.C.1 of this Release, rules adopted by the NASD (now FINRA) prohibit broker-dealers from selling funds that pay more than 0.25 percent (25 basis points) per year of fund assets as “service fees,” and more than 0.75 percent (75 basis points) per year of fund assets as “asset-based sales charges,” effectively setting the maximum 12b-1 fees at those amounts or less. NASD Conduct Rule 2830(d)(5) and (d)(2)(E). 43 See 1988 Release, supra note 28, at n.129. 44 Rule 12b-1(e). The rule requires that the fund set forth and preserve in the corporate minutes the factors that the directors considered, together with the basis for the decision to use fund assets for distribution. Rule 12b-1(d) . 45 Rule 12b-1(d). 46 Rule 12b-1(b)(3)(ii). 47 Rule 12b-1(b)(3)(i). 48 Rule 12b-1(b)(4). Any other material changes to the plan must be approved by the fund's board and the fund's independent directors. Rule 12b-1(b)(2). 49 We originally included the factors in the text of the rule when we proposed it for public comment. See 1979 Proposing Release, supra note 33. In order to avoid the appearance of either unduly constricting the directors' decision-making process or of creating a mechanical checklist, we deleted the list of factors from rule 12b-1 at its adoption. Although we decided not to require the directors to consider any particular factors, the adopting release noted that the enumerated factors “would normally be relevant to a determination of whether to use fund assets for distribution.” See 1980 Adopting Release, supra note 23, at section titled “Factors.” 50 See 1980 Adopting Release, supra note 23, at section titled “Factors.” The rule was intended to allow fund boards some latitude to exercise their reasonable business judgment to authorize the distribution arrangements and continue them from year to year as circumstances warranted. 51 The annual re-approval requirement and the factors enumerated in our adopting release reflected an expectation that a fund would use the rule in order to address particular distribution problems, such as periods of net redemption. 52 The rule was also designed to allow distribution arrangements to evolve. 53 However, the rule ultimately resulted in distribution practices that we did not originally anticipate, as described below. 54 51 Id. at sections titled “Discussion” and “Independence of Directors.” See also rule 12b-1(e) (providing that funds may implement or continue 12b-1 plans “only if the directors who vote to approve such implementation or continuation conclude, in the exercise of reasonable business judgment * * * that there is a reasonable likelihood that the plan will benefit the company and its shareholders”); rule 12b-1(b)(3) (requiring that a 12b-1 plan provide in substance that “it shall continue in effect for a period of more than one year from the date of its execution or adoption only so long as such continuance is specifically approved at least annually” by the fund's board of directors as a whole, and separately by the independent directors). 52 See 1980 Adopting Release, supra note 23, at section titled “Factors.” See also Div. of Inv. Mgmt., SEC, Report on Mutual Fund Fees and Expenses (2000) ( http://www.sec.gov/news/studies/feestudy.htm ); Joel H. Goldberg and Gregory N. Bressler, Revisiting Rule 12b-1 under the Investment Company Act, 31 Sec. & Commodities Reg. Rev. 147, 151 (1998) (“Goldberg and Bressler”) (factors “presuppose that the 12b-1 plan is designed to solve a particular distribution `problem' or to respond to specific `circumstances,' e.g., net redemptions”); Lee R. Burgunder and Karl O. Hartmann, The Mutual Fund Industry and Rule 12b-1 Plans: An Assessment, 15 Sec. Reg. L.J. 364 (1988) (“although the rule does not state this directly, the historical circumstances surrounding its preparation as well as its legislative history strongly [indicate] that the rule is aimed at the possible problems associated with periods of stagnant growth or net redemptions, especially for relatively small mutual funds”). 53 See 1980 Adopting Release, supra note 23, at section titled “General Requirements” (“Recognizing that new distribution activities may continuously evolve in the future, and in view of the impracticability of developing an all-inclusive list, the Commission maintains that the better approach is to define distribution expenses in conceptual terms * * *.”). 54 See 1988 Release, supra note 28, at paragraph preceding n.46 (“The use of the rule by the fund industry has resulted in many distribution practices that could not have been anticipated when the rule was adopted.”). C. Developments Following Rule 12b-1's Adoption Initially, some funds adopted limited 12b-1 plans and used the revenue to pay for advertising and sales materials. 55 In time, however, funds began to adopt 12b-1 plans with higher fees and used the revenue to compensate fund intermediaries for sales efforts, rather than simply defraying promotional costs. 56 These 12b-1 plans often were coupled with contingent deferred sales loads, or “CDSLs,” as part of a “spread load” arrangement, and served as an alternative to a front-end sales load. 57 55 See Goldberg and Bressler, supra note 52, at 150. The first 12b-1 plans provided for payments of 0.25 percent or less of average annual net assets and generally were used only to reimburse advisers and underwriters for advertising expenses and the printing and mailing of prospectuses and sales literature. Id. 56 See 1992 Study, supra note 15, at 322. 57 See Exemptions for Certain Registered Open-End Management Investment Companies to Impose Contingent Deferred Sales Loads, Investment Company Act Release No. 16619 (Nov. 2, 1988) [53 FR 45275 (Nov. 9, 1988)] (“Rule 6c-10 Proposing Release”) (proposing to permit funds to impose CDSLs, which were often used in combination with 12b-1 plans “as a substitute for charging investors a front-end sales load”). Unlike a traditional load, which is commonly referred to as a “front-end” load because it is paid at the time of purchase, fund investors pay a CDSL from their proceeds when they redeem shares. 58 The load is “contingent” because the amount payable reduces over time and usually disappears at the end of a stated period. When combined with the payment of 12b-1 fees, a CDSL operates as a deferred payment plan for sales charges. 59 Instead of paying a sales load at the time of purchase, a greater portion of the investor's money is invested in the fund at the outset, and the investor pays sales charges over time, albeit indirectly through charges against fund assets. An investor who redeems early compensates the fund underwriter (which has already advanced payments to intermediaries) by paying the CDSL in place of uncollected revenues from 12b-1 fees attributable to the investor's assets. 58 Rule 22c-1 under the Act requires mutual funds to redeem shares at a price based on their net asset value. In order to impose CDSLs, funds sought and we granted exemptions from this and other provisions to permit shareholders to defer their payment of sales charges until redemption. See, e.g., E.F. Hutton Investment Series, Inc., Investment Company Act Release Nos. 12079 (Dec. 4, 1981) [46 FR 60703 (Dec. 11, 1981)] (notice) and 12135 (Jan. 4, 1982) (order). After issuing numerous exemptions, we codified them in rule 6c-10, which permits funds complying with the rule to impose CDSLs without first having to obtain individual exemptions. Exemption for Certain Open-End Management Investment Companies to Impose Contingent Deferred Sales Loads, Investment Company Act Release No. 20916 (Feb. 23, 1995) [60 FR 11890 (Mar. 1, 1995)]. We later amended the rule to permit other types of deferred sales loads, including a form of account-level sales charge we referred to as an “installment load.” Exemption for Certain Open-End Management Investment Companies to Impose Contingent Deferred Sales Loads, Investment Company Act Release No. 22202 (Sept. 9, 1996) [61 FR 49011 (Sept. 17, 1996)] (“1996 Rule 6c-10 Amendments”). 59 See 1988 Release, supra note 28, at n.69 and accompanying text. These spread load arrangements raised a number of concerns for the Commission. First, the 12b-1 fees were higher than expected 60 and seemed inconsistent with one of the original arguments that fund managers had advanced in support of rule 12b-1, which was to facilitate the creation of economies of scale that would lower expenses for fund shareholders. 61 Moreover, these plans took on the appearance of more permanent arrangements, which threatened to undermine the role of fund directors in managing the use of fund assets for distribution because the arrangements created multi-year business obligations on the part of distributors. As a practical matter, the arrangements limited the ability of fund directors to terminate the plan because ending the plan would deny distributors their future payments. 62 60 Id. at nn.116-23 and accompanying text. See also Goldberg and Bressler, supra note 52, at nn.22-24 and accompanying text. 61 See Advance Notice of Proposed Rulemaking, supra note 27, at n.3 and accompanying text (“Commentators also argued that the use of fund assets to finance distribution activities could lead to increased sales of shares, thereby alleviating the difficulties perceived to result from net redemptions or small asset size,” such as higher expense ratios.). The Commission's concern about the changing uses of 12b-1 fees was later reflected in the 1988 proposal to amend rule 12b-1. The amendments would have required annual shareholder approval of 12b-1 plans, because “while shareholders may see good reason to approve a plan in the early years of a fund to stimulate growth to a sufficient level for economies of scale to be achieved, they may have a quite different opinion of the utility of a 12b-1 plan once a fund has matured.” 1988 Release, supra note 28, at text following n.187. 62 1988 Release, supra note 28 at section titled “The Development and Use of `Reimbursement' Plans.” See also Goldberg and Bressler, supra note 52 (“It would be economic folly * * * for a mutual fund underwriter continually to advance sales commissions to selling dealers as part of a CDSL arrangement if it were not virtually certain that the 12b-1 plan would continue in effect indefinitely.”). The Commission responded to these developments by proposing amendments to rule 12b-1 in 1988, which effectively would have prohibited spread load arrangements. 63 Many commenters opposed the proposed amendments, arguing that spread load plans benefited investors by permitting them to defer their distribution costs and avoid high front-end loads. 64 The Commission never adopted those amendments. Instead, over the years, the Commission sought to address the developing concerns raised by rule 12b-1 by other means, as discussed below. 65 63 See 1988 Release, supra note 28, at nn.144-50 and accompanying text. Among other things, the 1988 proposed amendments would have required that payments under a 12b-1 plan be made on a “current basis,” which would have restricted the ability of a fund to pay for distribution expenses incurred on the fund's behalf in prior years (such as when the underwriter advances payment of the sales load to the broker after completion of the sale). In addition, the proposed amendments would have required payments made under a rule 12b-1 plan to be tied to specific distribution services actually provided to the fund and its shareholders. See also 1992 Study, supra note 15, at 323. 64 See, e.g., Comment Letter of the ICI at 9-12 (Sept. 19, 1988) (File No. S7-10-88). 65 Another concern relates to the recent growth in the frequency and amount of payments made by fund advisers to broker-dealers and others distributing fund shares, a practice commonly known as “revenue sharing.” Because fund advisers derive their earnings from sources including advisory fees paid by the fund, the payment of distribution expenses by advisers could involve the indirect use of fund assets to pay for distribution. Rule 12b-1 explicitly applies to direct and indirect financing of distribution activities. Thus, revenue sharing payments could be construed as an indirect use of fund assets for distribution that is unlawful unless made pursuant to a rule 12b-1 plan. See supra note 38. The Commission has historically taken the position that an adviser's financing of distribution activities would not necessarily involve an indirect use of fund assets if the payments are made from profits that are “legitimate” or “not excessive,” i.e., profits that are “derived from an advisory contract which does not result in a breach of fiduciary duty under section 36 of the Act.” See 1980 Adopting Release, supra note 23, at section titled “General Requirements.” In contrast, for example, an indirect use of fund assets may result if advisory fees were increased in contemplation of distribution payments by the adviser. We are not addressing revenue sharing practices in connection with these proposals. However, we remain concerned that revenue sharing payments may give broker-dealers and other recipients incentives to market particular funds or fund classes, through “preferred lists” or otherwise, and that such incentives create conflicts of interest ( e.g., between a broker-dealer's suitability obligation to its customers and its self-interest in maximizing revenue) that may be inadequately disclosed. We proposed new requirements regarding disclosure of revenue sharing payments in 2004 in connection with our “Point of Sale” proposals. See Confirmation Requirements and Point of Sale Requirements for Transactions in Certain Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments to the Registration Form for Mutual Funds, Investment Company Act Release No. 26341 (Jan. 24, 2004) [69 FR 6438 (Feb. 10, 2004)]. See also Point of Sale Disclosure Requirements and Confirmation Requirements for Transactions in Mutual Funds, College Savings Plans, and Certain Other Securities, and Amendments to the Registration Form for Mutual Funds, Investment Company Act Release No. 26778 (Feb. 28, 2005) [70 FR 10521 (Mar. 4, 2005)] (reopening of comment period and supplemental request for comment). We are continuing to consider further rule amendments related to revenue sharing. 1. Imposition of Sales Load Caps In 1992, the Commission approved amendments to NASD Conduct Rule 2830 (the “NASD sales charge rule”), which had the effect of limiting the maximum amount of 12b-1 fees that many funds could deduct from fund assets pursuant to a rule 12b-1 plan, based roughly on the then-existing NASD limits on sales loads. 66 While it does not directly regulate what funds can charge, the NASD (now FINRA) sales charge rule bars registered broker-dealers who are members from selling funds that impose combined sales charges that exceed certain limits. The limits vary based on whether the fund has a 12b-1 fee, a “service fee,” 67 rights of accumulation, 68 and other features. 66 NASD Conduct Rule 2830(d). The NASD sales charge rule is currently administered by FINRA. FINRA derives its authority to regulate the level of mutual fund sales charges from section 22(b)(1) of the Act. See supra note 20. See Order Approving Proposed Rule Change Relating to the Limitation of Asset-Based Sales Charges as Imposed by Investment Companies, Exchange Act Release No. 30897 (July 7, 1992) [57 FR 30985 (July 13, 1992)] (“1992 NASD Rule Release”). In 2009, FINRA proposed to re-codify the rule, in conjunction with its consolidation of rules issued by the NASD and by the New York Stock Exchange, and to revise the rule with regard to the disclosure of cash compensation. See FINRA, Investment Company Securities: FINRA Requests Comment on Proposed Consolidated FINRA Rule Governing Investment Company Securities, Regulatory Notice 09-34 (June 2009). 67 See infra note 152 and accompanying text for additional information on service fees. 68 Rights of accumulation allow investors to qualify for a reduced sales charge (or “breakpoint”) based on the aggregate value of shares previously purchased or owned plus the securities being purchased. NASD Conduct Rule 2830(b)(7). Prior to 1992, the NASD sales charge rule had not been applied to rule 12b-1 fees that funds deducted from assets as a substitute for a front-end sales load. In 1992, the NASD determined that it was appropriate to amend the rule specifically to encompass all forms of mutual fund sales compensation, including these “asset-based sales charges.” 69 69 The NASD explained that the changes were necessary to: (i) Assure a level playing field among all members selling mutual fund shares; and (ii) prevent the circumvention of its sales charge caps through the use of rule 12b-1 plans, because it had become possible for funds to use 12b-1 plans to charge investors more for distribution than could have been charged as a front-end sales load under the existing sales charge rule. See NASD Notice to Members 92-41; 1992 NASD Rule Release, supra note 66. In its comment letter, the ICI agreed that the proposed expansion of the NASD rule to include asset-based sales charges “appropriately recognizes that Rule 12b-1 fees * * * alone or in combination with [CDSLs], generally serve as the functional equivalent of traditional front-end sales loads.” Comment Letter of the ICI (May 10, 1991) (File No. SR-NASD-90-69). As amended, the rule caps the annual amount of asset-based sales charges that a fund may deduct at 75 basis points. 70 In addition, a fund with an asset-based sales charge is subject to an aggregate cap of 6.25 percent of new gross sales (rising to 7.25 percent of new gross sales if the fund does not pay a service fee), plus interest, on the total sales charges levied ( e.g., asset-based, front-end, and deferred). 71 This aggregate cap requires a fund with an asset-based sales charge to keep a running balance from which all sales charges imposed by the fund are deducted. 72 Because it is calculated at the fund level based on the amount of aggregate new fund shares sold, the aggregate cap does not limit the actual amount of sales charges that a particular investor may pay. 73 Thus, it is possible for a long-term shareholder in a fund with an asset-based sales charge to pay more in total sales charges than would have been the case if that investor had paid a traditional front-end load. 74 70 NASD Conduct Rule 2830(d)(2)(E)(i). 71 New gross sales excludes sales from the reinvestment of distributions and exchanges of shares between investment companies in a single complex, between classes of an investment company with multiple classes of shares, or between series of a series investment company. NASD Conduct Rule 2830(d)(2)(A) and (B). 72 In effect, so long as a fund with asset-based sales charges continues to have new sales, it may never exceed the aggregate cap. 73 For convenience, in this Release we refer to the aggregate cap as a fund-level cap, but FINRA members may treat each class of shares and each series of a fund as a separate investment company for purposes of the sales charge rule and these calculations. See NASD Notice to Members 93-12 at n.1 (1993) (“NASD Sales Charge Rule Q&A”). 74 In our statement on the proposed rule change, we acknowledged this possibility. See 1992 NASD Rule Release, supra note 66, at discussion following n.16 (“Because the proposed rule change contemplates a minimum standard of fund-level accounting rather than individual shareholder accounting, it is possible that long-term shareholders in a mutual fund that has an asset-based sales charge may pay more in total sales [charges] than they would have paid if the mutual fund did not have an asset-based sales charge.”). However, we also noted that individual shareholder accounting would be permitted under the rule amendment, and encouraged its use. See Notice of Proposed Rule Change by National Association of Securities Dealers, Inc. Relating to the Limitation of Asset-Based Sales Charges as Imposed by Investment Companies, Exchange Act Release No. 29070 (April 12, 1991) [56 FR 16137 (Apr. 19, 1991)] (“NASD Notice of Proposed Rule Change”) at section titled “Method of Calculating the Total Sales Charges” (“It is the NASD's intention that fund-level accounting be required at a minimum, thereby not precluding the use of more protective methods. A fund, based upon its particular circumstances and economic perspective, may choose the option of individual shareholder accounting.”). As amended, the NASD rule also places a cap of 25 basis points on the amount of a service fee that a fund may deduct annually from fund assets in order to pay intermediaries for providing follow-up information and account services to clients over the course of their investment in the fund. 75 Unlike the asset-based sales charge, the service fee is not limited by an aggregate cap and, as a result, is almost always paid for an indefinite period ( i.e., for as long as the investor holds the shares). 76 75 NASD Conduct Rule 2830(d)(5). 76 See 1992 NASD Rule Release, supra note 66, at section III.A. 2. Enhanced Disclosure Over the years, the Commission has taken several steps designed to improve investor understanding of 12b-1 fees and the impact they have on fund expenses and investor returns. We required funds to include a fee table in the prospectus identifying, among other things, the amount of any 12b-1 fee paid. 77 As part of the 1992 amendments to the NASD sales charge rule, we also approved a new provision prohibiting registered broker-dealers from describing funds as “no-load” funds if the funds charged 12b-1 fees greater than 25 basis points. 78 We amended our proxy rules to require funds to better describe material facts to shareholders when requesting approval of a rule 12b-1 plan or an amendment to the plan. 79 Through our Web site, we have also provided investors with information and tools designed to enhance their understanding of the fees and distribution expenses they pay as a consequence of owning mutual funds. 80 77 See Consolidated Disclosure of Mutual Fund Expenses, Investment Company Act Release No. 16244 (Feb. 1, 1988) [53 FR 3192 (Feb. 8, 1988)]. 78 See 1992 NASD Rule Release, supra note 66. See also NASD Conduct Rule 2830(d)(4). 79 Amendments to Proxy Rules for Registered Investment Companies, Investment Company Act Release No. 20614 (Oct. 13, 1994) [59 FR 52689 (Oct. 19, 1994)]. 80 See Mutual Fund Cost Calculator ( http://www.sec.gov/investor/tools/mfcc/mfcc-intsec.htm ). 3. Multiple Classes We also permitted funds to offer multiple “classes” of shares, each with its own arrangement for the payment of distribution costs and related shareholder services. 81 These multiple class arrangements were designed to give investors a choice of ways to pay for sales charges. 82 Investors in one class of shares have the same investment experience as investors in the other classes, except for expenses related to distribution and shareholder services. These multiple class arrangements have been adopted by most fund groups that sell through intermediaries. 83 81 See Exemption for Open-End Management Investment Companies Issuing Multiple Classes of Shares; Disclosure by Multiple Class and Master-Feeder Funds; Class Voting on Distribution Plans, Investment Company Act Release No. 20915 (Feb. 23, 1995) [60 FR 11876 (Mar. 2, 1995)] (adopting rule 18f-3). Rule 18f-3 contains requirements that protect the rights and obligations of each class as against all other classes, particularly with regard to shareholder voting rights, and prescribes methods for allocating income, expenses, realized gains and losses, and unrealized appreciation and depreciation among classes in a multi-class fund. 82 See Exemption for Open-End Management Investment Companies Issuing Multiple Classes of Shares; Disclosure by Multiple Class and Master-Feeder Funds, Investment Company Act Release No. 19955, at section titled “Background” (Dec. 15, 1993) [58 FR 68074 (Dec. 23, 1993)] (stating that some funds use different classes “to offer investors a choice of methods for paying for the costs of selling fund shares”). See also Z. Jay. Wang, Vikram K. Nanda & Lu Zheng, The ABCs of Mutual Funds: On the Introduction of Multiple Share Classes, EFA 2005 Moscow Meetings Paper (Feb. 2005) ( http://ssrn.com/abstract=676246 ); Vance P. Lesseig, D. Michael Long & Thomas I. Smythe, Gains to Mutual Fund Sponsors Offering Multiple Share Class Funds, 25 J. Fin. Res. 81 (2002). 83 See ICI, Mutual Fund Distribution Channels and Distribution Costs (July 2, 2003) ( http://www.ici.org/pdf/per09-03.pdf ). Class designations are not standardized by law, although funds often use similar nomenclature. 84 Class “A” shares generally are sold with a front-end sales load, and also often have a 12b-1 fee of about 25 basis points. 85 Class “B” shares typically are sold without a front-end load but charge a spread load consisting of a 12b-1 fee of 100 basis points (the maximum rate under NASD Conduct Rule 2830, including a service fee) and a declining CDSL. Class B shares usually convert automatically to class A shares after a fixed period of time has elapsed (commonly six to eight years from the date of purchase). 86 Class “C” shares typically charge a “level load” consisting of a 100 basis point 12b-1 fee that is imposed for as long as the investor owns the shares, and also may charge a small CDSL of one percent if a shareholder redeems within the first year, but seldom convert to class A shares with lower 12b-1 fees. 87 Other classes may be available only to certain types of investors, such as those who invest in retirement plans, are institutional investors, or purchase through a particular intermediary or type of intermediary, such as a financial planner. 88 84 The Commission staff has prepared information on mutual fund share classes, available on the Commission's Web site. SEC, Mutual Fund Classes ( http://www.sec.gov/answers/mfclass.htm ). While there are many variations, for convenience, throughout this Release we use the terms “A shares,” “B shares,” and “C shares” to refer to the typical share class structures, as described in the text above. 85 Class A shares may also be sold with the load waived. See infra note 93 and accompanying text. 86 See 2010 ICI Fact Book, supra note 6, at 74. While there is no legal requirement for conversion, funds typically provide it. The conversion feature reflects the underlying economics of class B shares. When the underwriter recoups the commission it has advanced to the selling broker, the shareholder is considered to have paid his share of distribution costs. (If the underwriter has advanced a commission to the intermediary, it would retain 75 basis points of the 100 basis points it collects in 12b-1 fees and forward only the 25 basis points to the intermediary.) 87 See supra note 84. 88 Id. D. The Current Role of 12b-1 Fees Rule 12b-1 plans continue to play a significant role in paying for fund distribution costs. The majority of funds have adopted rule 12b-1 plans, which paid a total of $9.5 billion in 12b-1 fees in 2009 (down from a high of $13.3 billion in 12b-1 fees in 2007). 89 89 See 2010 ICI Fact Book, supra note 6, at 75. This figure excludes 12b-1 fees deducted from assets of funds underlying insurance company separate accounts offering variable annuities and mutual funds that invest primarily in other mutual funds. See also Comment Letter of the ICI at Appendix I (July 19, 2007) (File No. 4-538). Unless otherwise noted, references to comment letters in this Release are to letters submitted in response to the Commission's request for comments in connection with a 2007 Commission roundtable on rule 12b-1. See SEC Press Release, Commission Announces Roundtable Discussion Regarding Rule 12b-1 (May 29, 2007) ( http://www.sec.gov/news/press/2007/2007-106.htm ). These comment letters are available in File No. 4-538 ( http://www.sec.gov/comments/4-538/4-538.shtml ). There has been a trend in fund class share ownership away from those that impose the highest sales loads and 12b-1 fees. In recent years, no-load share classes have attracted more net new cash flow than load share classes. 90 According to Investment Company Institute (“ICI”) figures, in 2009, $323 billion flowed into no-load share classes of long-term mutual funds, while in comparison, load share classes only received $39 billion in net new cash flow. 91 In 2009, class B shares experienced net outflow for a seventh consecutive year, with total net outflow of approximately $24 billion. 92 In contrast, net new investment in class A shares was approximately $19 billion, and net new investment in class C shares was approximately $37 billion. 93 90 See 2010 ICI Fact Book, supra note 6, at 76. 91 Id. at 76. 92 Id. at 76. Net outflow from B share classes can result from purchases being exceeded by: (i) Redemptions; and (ii) shares converting to another class after a certain period of time. As a result of their (typically) automatic conversion feature, B shares generally are self-limiting as a class unless they continue to be sold at the same rate as they were sold previously. 93 Id. at 76. Many class A shares today are sold with the load waived or substantially reduced. For example, many funds permit broker-dealers to sell their shares with the front-end load waived or substantially reduced, for use in wrap fee programs. In wrap fee programs, instead of paying a one-time sales charge for each investment purchase, a customer pays the broker an annual percentage of the assets held through that broker in exchange for the ability to buy and redeem securities without additional sales charges. According to one study, in 2008, 60 percent of class A shares were sold at NAV with the load waived. Strategic Insight Mutual Fund Research and Consulting, LLC, Perspectives on Intermediary Sales: Trends in Fund Sales by Distribution Channel and Share Class (May 2009). The ICI found that, although the average maximum front-end sales load on stock funds in 2009 was 5.3 percent, the average sales load actually paid by investors was only 1.0 percent, due to the impact of load-waived class A shares. See 2010 ICI Fact Book, supra note 6, at 65. Although more investors appear to be investing in no-load funds and share classes, these statistics do not reflect a trend away from using intermediaries. 94 According to the ICI, 80 percent of investors who own funds outside of a retirement plan use an intermediary that provides professional financial assistance (“financial advisor”). 95 Of those investors, almost half own funds purchased solely through financial advisors, while the rest own funds purchased through financial advisors as well as directly from fund companies, mutual fund supermarkets, or discount brokers. 96 The data suggest a growing predominance of no-load or load-waived classes in funds that traditionally were sold with a load. 97 In these circumstances, investors do not pay a sales load, but pay distribution expenses through a separate fee arranged between the intermediary and the investor, and/or through the payment of ongoing “service fees.” 98 94 Among households owning mutual funds, only 20 percent of these investors purchased directly from mutual funds in 2009. See Shareholder Profile Report, supra note 6, at 27. The prevalence of mutual fund “supermarkets” (described in note 96, infra ), employer-sponsored retirement plans, and fee-based financial advisers (advisers who charge investors separately for their services rather than through a load or fee assessed at the fund level) has provided investors alternative means of purchasing no-load funds. See 2010 ICI Fact Book, supra note 6, at 65. Many investors now purchase no-load funds through these intermediaries. 95 See 2010 ICI Fact Book, supra note 6, at 85. 96 Id. at 85. Mutual fund supermarkets, which are sponsored by brokerage firms, “permit investors to purchase and hold a broad range of funds from many different fund sponsors through a single brokerage account.” Robert C. Pozen, The Mutual Fund Business (2d Ed., 2002), at 304. The primary benefit of this “one-stop shopping venue” is simplicity: An investor can buy funds from different fund families and receive all of their statements in a single report. Discount brokers allow investors to trade securities at a lower commission rate but provide less individualized service. 97 See 2010 ICI Fact Book, supra note 6, at 76. 98 See generally Carol Gehl, et al., Mutual Fund Regulation § 18:6.1 (May 2008); Fee Trends Report, supra note 22, at 6 (noting that although in the 1980s and 1990s sales loads were a primary means of compensating brokers for services provided to investors, in recent years brokers have increasingly been compensated through “asset-based” fees). A significant use of 12b-1 fees today is for what is typically characterized as “services” provided to investors after the sale by the broker-dealers and other intermediaries who sell the fund. According to the Investment Company Institute, more than half of all 12b-1 fees paid by funds are used for this purpose, 99 with broker-dealers and bank trust departments being the primary recipients. Under the NASD sales charge rule discussed above, up to 25 basis points of fund assets annually may be paid to members as a “service fee.” 100 99 See 2010 ICI Fact Book, supra note 6, at 73. 100 NASD Conduct Rule 2830(d)(5). The NASD rule defines “service fees” as “payments by [a fund] for personal service and/or the maintenance of shareholder accounts.” NASD Conduct Rule 2830(b)(9). These services could include responding to customer inquiries, providing information on investments, and reviewing customer holdings on a regular basis, but would not include sub-transfer agency services, sub-accounting services, or administrative services. See NASD Sales Charge Rule Q&A, supra note 73, at Question #17. The NASD rule does not address whether “service fees” are required to be included in 12b-1 plans. Id. at Question #25. However, we understand that funds continue to include “service fees” as distribution expenses under rule 12b-1, presumably because the stream of payments (often called “trail commissions”) may act as an inducement to intermediaries' sales personnel to sell fund shares and, arguably, because fund intermediaries would provide these services in the ordinary course of business regardless of whether they receive compensation from the fund (which may be just one of many other investments held by the intermediary's clients). Amounts deducted from assets in excess of a service fee are typically charged to support the fund's distribution efforts and operate as an alternative to a front-end sales load. 101 These 12b-1 fees, which are used to pay the selling costs of B and C share classes, are “asset-based sales charges” under the NASD sales charge caps and are limited to a maximum of 75 basis points of fund assets, annually, as discussed above. 101 According to the ICI, approximately 40 percent of 12b-1 fees are used for this purpose. See 2010 ICI Fact Book, supra note 6, at 73. A common use of 12b-1 fees is to pay for the fund to be included on third-party platforms for purchasing mutual funds, such as employer-sponsored retirement plans and fund supermarkets. Supermarkets and retirement plans have become major avenues by which investors purchase mutual funds. They have assumed many of the recordkeeping and ongoing servicing and support functions for shareholders that funds otherwise would perform, and these are often paid for, at least partially, through 12b-1 fees. 102 Under the NASD sales charge rule, no-load funds are able to compensate discount brokers and supermarkets for the costs of servicing shareholders in those channels through asset-based fees of up to 25 basis points annually of the value of fund shares that are held in the intermediary's client accounts. 103 Funds that are offered as investment options in defined contribution retirement plans also may pay 12b-1 fees (often 50 basis points or more annually) to the plan administrator to offset some of the costs of servicing shareholders (and perhaps other participants) who invest through those plans. 104 102 See infra note 153. A representative of a large fund supermarket commented at our roundtable on rule 12b-1 that some fund advisers also pay supermarket fees through revenue sharing arrangements. See Roundtable Transcript, infra note 109, at 84-87 (John Morris, Charles Schwab & Co.). See also supra note 65; infra paragraph following note 286 (requesting comment whether investors in omnibus accounts receive equivalent levels of service relative to investors in retail accounts with similar 12b-1 fees). 103 See NASD Conduct Rule 2830(d)(4). Discount brokers and fund supermarkets typically hold one account with the fund in the name of the broker, and then provide sub-accounting for individual shareholder holdings of fund shares. See Mutual Fund Redemption Fees, Investment Company Act Release No. 26782 (Mar. 11, 2005) [70 FR 13328 (Mar. 18, 2005)] at text following n.10 (“Rule 22c-2 Adopting Release”). 104 See Comment Letter of Charles P. Nelson (June 19, 2007). Employers sponsoring defined contribution plans typically hire third-party administrators to advise them in selecting the investment options offered to employees, perform recordkeeping and administrative functions ( e.g., producing account statements and recording transactions), provide educational materials and seminars, and maintain call centers and Internet Web sites for use by plan participants. See ICI, Mutual Fund Distribution Channels and Distribution Costs, supra note 83. A minor use of 12b-1 fees is to pay expenses of the fund's principal underwriter and for advertising and promotions. Although this was one of the main purposes for which 12b-1 plans originally were intended, in recent years, only about two percent of 12b-1 fees have been used to pay these types of expenses. 105 105 See 2010 ICI Fact Book, supra note 6, at 73. E. Additional Commission Consideration of Rule 12b-1 In 2004, the Commission amended rule 12b-1 to prohibit fund advisers from directing fund brokerage to compensate broker-dealers for selling fund shares. 106 When we proposed those amendments, we invited comment on whether the Commission should consider additional changes to the rule, including potentially rescinding it. 107 We made this request after observing that the current practice of using 12b-1 fees as a substitute for a sales load was a departure from the rule as envisioned in 1980. 108 106 Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26591 (Sept. 2, 2004) [69 FR 54728 (Sept. 9, 2004)] (“2004 Rule 12b-1 Amendments Adopting Release”). Although fund advisers may choose which brokers will execute the fund's transactions when buying and selling portfolio securities, fund brokerage is an asset of the fund. We prohibited the practice of using brokerage to reward sales of fund shares because it produces powerful incentives for advisers, is potentially harmful to fund investors, and “reliance on fund directors to police the use of fund brokerage to promote the sale of fund sales is not sufficient.” Id. at text following n.16. 107 See Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment Company Act Release No. 26356 at section IV (Feb. 24, 2004) [69 FR 9726 (Mar. 1, 2004)] (“2004 Rule 12b-1 Amendments Proposing Release”). Comments are available in File No. S7-09-04, at http://www.sec.gov/rules/proposed/s70904.shtml. 108 Id. See also John A. Haslem, Investor Learning and Mutual Fund Advertising and Distribution Fees, J. Investing 53 (Winter 2009) (“Haslem”) (noting “the transformation of 12b-1 fees from their original primary use for advertising and promotion” and concluding that “Rule 12b-1 fees are now used primarily to reward brokers for sales of adviser mutual fund shares”). To further explore the available options for reforming the rule, we held a roundtable on rule 12b-1 on June 19, 2007, to solicit the views of investor advocates, fund industry representatives, independent directors, current and former regulators, representatives from broker-dealers and other intermediaries who sell fund shares, and interested observers. 109 The participants responded to Commissioners' questions regarding the costs and benefits of 12b-1 plans, the role of 12b-1 plans in current fund distribution practices, and options for reform. The roundtable discussions and the nearly 1,500 comment letters we received on the topic greatly informed our understanding of the operation of rule 12b-1 and the role it plays in the distribution of mutual funds today. 109 See http://www.sec.gov/spotlight/rule12b-1.htm (which provides links to various materials relating to the rule 12b-1 roundtable). An unofficial transcript of the June 19, 2007 Rule 12b-1 Roundtable is available at http://www.sec.gov/news/openmeetings/2007/12b1transcript-061907.pdf (“Roundtable Transcript”). Many of the panelists and commenters representing fund management companies and intermediaries contended that the rule had benefited both funds and investors in substantial ways, and that the central problem lay with the rule's outdated requirements. 110 Some of these commenters asserted that rule 12b-1 provides a cost-efficient way of paying for services that investors want and need ( i.e., by “mutualizing” them), including ongoing services from financial professionals and access to funds through fund supermarkets and retirement platforms. 111 Several participants thought that investors preferred paying rule 12b-1 fees to paying front-end loads, and equated a decision to invest in a class of shares with a 12b-1 fee with a decision to pay a sales load over time. 112 They asserted that rule 12b-1 fees were, at least in part, responsible for bringing down the overall cost of investing in funds. 113 110 See, e.g., Roundtable Transcript, supra note 109, at 172 (Michael Sharp, Citi Global Wealth Management); Comment Letter of the Independent Directors Council (July 19, 2007) (“IDC supports retaining the framework of Rule 12b-1 and believes that changes to the rule should take the form of enhancements and clarifications to adapt the rule to the modern world of fund distribution.”). 111 See, e.g., Roundtable Transcript, supra note 109, at 111-113 (Paul Haaga, Capital Research Management). 112 See, e.g., id. at 64 (Martin Byrne, Merrill Lynch). 113 See, e.g., id. at 171 (Michael Sharp, Citi Global Wealth Management). Many of these panelists emphasized the importance of 12b-1 fees to pay for services that matter to investors. 114 They noted that platforms such as supermarkets and retirement plans use 12b-1 fees to support their service infrastructures, including interactive Web sites, investment allocation tools, and other educational materials that are currently made available to, and benefit, fund investors in those channels. 115 Several roundtable participants and commenters also noted that 12b-1 fees paid to platforms have enabled small funds and no-load funds to compete successfully for a broader segment of the investing population in many distribution channels, which is critical to their distribution strategies. 116 This development, they contended, has been beneficial because it increases competition and helps spur innovation. 117 114 See, e.g., id. at 118-19 (Joseph Russo, Advantage Financial Group); id. at 180 (Barbara Roper, Consumer Federation of America). Commenters also emphasized the importance of 12b-1 fees for investor servicing. See, e.g., Comment Letter of the National Association of Insurance and Financial Advisors (July 13, 2007); Comment Letter of the ICI (July 19, 2007). 115 See, e.g., Roundtable Transcript, supra note 109, at 218 (Don Phillips, Morningstar). 116 See, e.g., id. at 67 (Mellody Hobson, Ariel Capital Management) (“We could not exist without the 12b-1 fee to grow the funds.”). 117 See, e.g., Comment Letter of the ICI (July 19, 2007); Comment Letter of the Securities Industry and Financial Markets Association (July 19, 2007). Other panelists were not as sanguine about rule 12b-1. They argued that even though 12b-1 fees may pay for worthwhile services to investors, the costs of those services are obscured in the fund's expense ratio in a way that makes the costs less transparent and the services less likely to be priced competitively. 118 They questioned the necessity of having these types of distribution charges embedded as a fund expense. In addition, they questioned whether investors are aware of and making informed choices about the services they pay for through the 12b-1 fee, which many panelists agreed lacks the prominence of a front-end load. 119 Most commenters believed that better disclosure and more effective communication of 12b-1 fees, and the manner in which they are used, would be useful to investors. 120 118 See, e.g., Roundtable Transcript, supra note 109, at 181 (Barbara Roper, Consumer Federation of America) and 185 (Richard Phillips, K&L Gates). See also Comment Letter of Bridgeway Funds, Inc. and Bridgeway Capital Management, Inc. (July 19, 2007); Comment Letter of Andrew Reyburn (July 20, 2007). 119 See, e.g., Roundtable Transcript, supra note 109, at 121 (Brad Barber, Univ. of Cal., Davis) (“And I think what you hear from the industry—and the message I hear over and over again—is that investors do not like front-end loads. There is a simple psychological reason for that. It's an in-your-face fee. When you pay a load fee, it comes immediately out and off the top. Whereas, if you pay a spread fee over time, it's less obvious and less salient.”). See also Comment Letter of Michael R. Clancy (June 13, 2007) (“Very few if any clients actually understand the [12b-1] fee, or even know that they are paying it. Of the few who actually understand a front-end load, the overwhelming majority of those clients don't know that there is an ongoing fee as well.”). 120 See, e.g., Comment Letter of National Association of Personal Financial Advisors (July 17, 2007); Comment Letter of Donald H. Pratt (July 19, 2007); Comment Letter of the ICI (July 19, 2007). One panelist argued that 12b-1 fees have the effect of increasing expense ratios and decreasing investment returns for investors. 121 Some suggested that the Commission encourage (or require) that fees to compensate distributors be paid by investors as an account charge (through “demutualization” or “externalization”). 122 They argued that externalizing these “bundled costs” would make them more visible to shareholders and that unbundling costs and services promotes more efficient pricing of those services. 123 Representatives of fund management companies and others countered that such a fee structure already exists in the form of a mutual fund “wrap” account and other types of fee-based service arrangements that charge fees comparable to the maximum 100 basis point 12b-1 fee. They argued that it is more cost-effective and tax-efficient for funds to collect 12b-1 fees and credit the intermediaries, than it is for the intermediaries to charge their clients directly through wrap accounts. 124 As discussed above, although more investors today invest in no-load funds and share classes, this trend does not reflect the decreasing use of intermediaries, but rather the growing use of wrap accounts and other arrangements between intermediaries and investors that entail separate fees. 125 121 See Roundtable Transcript, supra note 109, at 119-120 (Shannon Zimmerman, Motley Fool). 122 See, e.g., id. at 103 (Thomas Selman, FINRA). See also Comment Letter of Michael R. Clancy (June 13, 2007); Comment Letter of Neil J. McCarthy, Jr. (June 19, 2007); Comment Letter of Michael Murray (June 21, 2007). 123 See, e.g., Roundtable Transcript, supra note 109, at 132 (Shannon Zimmerman, Motley Fool); 204-07 (Richard M. Phillips, K&L Gates). See also Comment Letter of Bridgeway Funds, Inc. and Bridgeway Capital Management, Inc. (July 19, 2007) (“Mutualization of [12b-1] fees inhibits an investor from having the necessary information on price vs. value to make economic choices across service providers. This distorts fundamental, free-market economics and restricts valuable competition in the intermediary channel.”). 124 See, e.g., Roundtable Transcript, supra note 109, at 170-72 (Michael Sharp, Citi Global Wealth Management). See also Comment Letter of the ICI (July 19, 2007) (“There are significant tax and operational disadvantages to imposing 12b-1 fees at the account-level that likely would outweigh the benefits of this approach.”). 125 See supra text accompanying notes 97 and 98. Several participants suggested that the term “12b-1 fee” causes confusion because it encompasses so many different activities. 126 Most roundtable participants agreed that greater transparency and better communication of what 12b-1 fees are and how they are used are vital to enabling investors to make optimal choices among the alternatives offered to them. 127 Some panelists were troubled that, according to academic studies, many investors do not appear to have a strong understanding of fund fees and expenses or their impact on investment returns. In particular, some participants were concerned that, because 12b-1 fees are paid automatically in small increments over time, they are much less obvious to investors than front-end sales loads. 128 Unlike traditional loads, 12b-1 fees are deducted from fund assets, and are reflected in lower investment returns, rather than deducted directly from shareholder accounts. 129 As a result, they may not be fully appreciated as a sales charge. 130 In addition, the expanding number of share classes and the overall complexity of fund load structures can further overwhelm and confuse investors. 131 126 See, e.g., Roundtable Transcript, supra note 109, at 58 (Paul Haaga, Capital Research Management). See also Comment Letter of the Independent Directors Council (July 19, 2007) (“IDC recognizes that one term may not be sufficient given the wide variety of usage of 12b-1 fees * * *.”). 127 See, e.g., Roundtable Transcript, supra note 109, at 141-54 (multiple commenters). See also Comment Letter of the ICI (July 19, 2007) (“Many commentators * * * questioned the extent to which investors are aware of the nature and purpose of 12b-1 fees and suggested that disclosure of the fees and other distribution related costs can and should be improved. We agree.”). 128 See, e.g., Roundtable Transcript, supra note 109, at 121-22 (Brad Barber, Univ. of Cal., Davis). 129 One panelist remarked that the spread load exists because “it provided a distribution channel for brokers, one that was an alternative and has many positive characteristics, but also makes the costs quite non-transparent. And I don't think that is a coincidence. The growth and use of these funds, at a time when there was a lot of press around no-load funds, I think there was a reason brokers wanted to receive their compensation for the services they provided in a way that did not allow investors to easily put a price tag on those services.” Id. at 180-81 (Barbara Roper, Consumer Federation of America). See also Comment Letter of the National Association of Personal Financial Advisors (July 17, 2007) (“We believe that individual investors are confused about the purpose of 12b-1 fees and their impact upon their own returns.”). 130 See General Accounting Office (“GAO”), Mutual Fund Fees: Additional Disclosure Could Encourage Price Competition 75 (June 2000) (observing that investors are more aware of sales loads than operating expense fees, and are increasingly resistant to paying the higher front-end loads). See also Todd Houge and Jay Wellman, The Use and Abuse of Mutual Fund Expenses (Jan. 31, 2006) (academic working paper) ( http://papers.ssrn.com/sol3/papers.cfm?abstract_id=880463 ) (“While mutual fund investors are often aware of up-front charges like sales loads, research shows they are often less cognizant of annual operating expenses, even though both types of fees are deadweight costs.”). 131 See, e.g., Comment Letter of Mark Freeland (June 19, 2007) (“The complexity of pricing structures makes it more difficult for the small investor to compare prices and services of different advisers.”). One commenter expressed concern that the proliferation of share classes may increase costs to funds and thereby hinder shareholder returns. See Comment Letter of Bridgeway Funds, Inc. and Bridgeway Capital Management, Inc. (July 19, 2007) (“[T]his increase in share classes increases the fund's cost of accounting, filings, shareholder servicing ( e.g., prospectus review, drafting, printing, mailing), blue sky registration, transfer agency, board review, etc. These costs are a drain to shareholder returns.”). Many roundtable participants and commenters agreed that rule 12b-1 would benefit from revision, but they differed on the best course for going forward. Many participants and commenters suggested that the Commission merely revise the factors for board consideration, or refashion the role of the board in overseeing 12b-1 fees, to better reflect the economic realities of fund distribution in today's market. 132 Others recommended that the Commission improve disclosure of 12b-1 fees by changing the name of the fees or, more significantly, by requiring individualized account statement disclosure of the amount of 12b-1 fees actually paid by individual shareholders. 133 Some suggested, as discussed above, that 12b-1 fees should be “externalized,” that is, deducted directly from shareholder accounts rather than fund assets. 134 Finally, some commenters argued that rule 12b-1 has outlived its original purpose, and should be substantially revised or repealed. 135 132 See, e.g., Roundtable Transcript, supra note 109 , at 50-51 (Joel Goldberg, Willkie Farr & Gallagher) and 201-02 (Mark Fetting, Legg Mason, Inc.). 133 See, e.g., id. at 222-23 (Avi Nachmany, Strategic Insight) and 154 (John A. Hill, Putnam Funds); Comment Letter of Access Data Corp. (July 19, 2007) (account-level disclosure of 12b-1 fees is not cost-prohibitive, and would “ensure that shareholders have full disclosure and fee transparency so that they can make an informed decision related to the fees they pay versus the services they receive.”). See also GAO, Mutual Funds: Greater transparency needed in disclosures to investors at 54 (GAO-03-763) (June 9, 2003) (providing investors with specific dollar amounts of expenses paid or placing fee-related disclosure in quarterly account statements could increase fee transparency). But see Comment Letter of W. Hardy Callcott (June 18, 2007) (individualized disclosure of 12b-1 fees would entail significant costs and would not, standing alone, be meaningful to investors). We discuss the costs associated with rule 12b-1 and our proposed amendments in the Cost Benefit Analysis Section of this Release. See infra Section V. 134 See, e.g., Roundtable Transcript, supra note 109, at 204-06 (Richard Phillips, K&L Gates); Comment Letter of CFA Institute (Aug. 9, 2004) (File No. S7-09-04) (“We also recommend that funds be required to deduct distribution-related costs directly from shareholder accounts as a separate line item, rather than from fund assets.”). 135 See, e.g., Comment Letter of Bridgeway Funds, Inc. and Bridgeway Capital Management, Inc. (July 19, 2007); Comment Letter of Lauren Garland (June 2, 2007); Comment Letter of Andrew Gross (June 9, 2007); Comment Letter of Melvyn H. Mark (June 17, 2007); Comment Letter of Michael Murray (June 21, 2007). See also Comment Letter of JoNell Hermanson (July 9, 2007) (stating that variable insurance products should not be permitted to charge 12b-1 fees); Comment Letter of Steve Wiands (Aug. 6, 2007) (stating that funds closed to new investors should not be permitted to charge 12b-1 fees). Roundtable participants generally agreed that 12b-1 fees currently are used to an extent and in ways that are different than originally envisioned. 136 This has caused a “disconnect” to develop between the requirements of the rule and its application. For example, roundtable participants were in general agreement that the nine “factors” that the Commission provided as guidance to the board are no longer as relevant to the current uses of 12b-1 fees. They stated that the ensuing legal uncertainties have made it more difficult for directors to perform their duties and make their required findings under the rule. 137 They also said that, although directors complete the required analysis, they tend to view 12b-1 fees as a necessity—either to recoup outlays already made or to pay intermediaries at a rate already decided by the intermediary or the marketplace—to the point that 12b-1 plans tend always to be continued from year to year. 138 136 See, e.g., Roundtable Transcript, supra note 109, at 192 (Richard Phillips, K&L Gates) and 194 (Mark Fetting, Legg Mason, Inc.). 137 See, e.g., id. at 105 (Robert Uek, MFS Funds) and 158 (John Hill, Putnam Funds). One panelist did not view the factors as posing a significant obstacle to current distribution arrangements, however. Id. at 33-34 (Matthew Fink, Former President, ICI) (“The rule expressly says these factors are suggestions * * *. So the fact that you may be approving a plan that the purported or suggested factors don't fit, it's totally irrelevant.”). 138 See, e.g., id. at 140 (Jeffrey Keil, Keil Fiduciary Strategies). Fund directors also observed that, in many instances, they and their funds lack the bargaining power to effectively negotiate the level of fees that are paid to financial intermediaries through 12b-1 plans and other sources. 139 This is particularly true in the case of fund supermarkets, where the sponsor may charge all participating funds according to the same rate schedule. These and other statements made at the roundtable and in the comment letters suggest that one of the fundamental premises of rule 12b-1—that independent directors would play an active part in setting distribution fees—does not reflect the current economic realities of fund distribution and the role 12b-1 fees play in it. 139 Cf. Comment Letter of the Independent Directors Council (July 19, 2007) (“We are not aware of any board that has failed to renew a 12b-1 plan (or is likely to do so) * * *.”). III. Discussion We have carefully considered these and other views that emerged from the roundtable discussion and the many comment letters we subsequently received. Many of the letters highlighted issues that have arisen with the current operation of the rule. 140 We heard arguments advocating substantial change in how investors pay distribution costs, most of which are, at their core, arguments for greater transparency. We also heard concerns that significant changes could disrupt arrangements that are today deeply embedded in mutual fund sales and distribution networks, including those that finance the operation of fund supermarkets, retirement plan platforms, and financial planning. These arguments supported the preservation of business models that were developed around an existing regulatory framework, but tended to discount some of the more troubling aspects of distribution arrangements that affect millions of American investors. We have evaluated all of these views in developing this proposal, which is designed, as discussed further below, to enhance transparency and fairness to the benefit of investors. 140 See supra note 89. Of the nearly 1500 comment letters we received, over 1400 were sent by financial planners and registered broker-dealers who opposed substantive reform of rule 12b-1. Of these 1400 letters, almost 1000 were form letters. See Comment Letter Type A; Comment Letter Type B. We received approximately 25 letters from mutual funds, large broker-dealer firms, insurance companies, industry associations, and law firms. The majority of these letters also opposed significant rule reform, but expressed various levels of support for changing the name of the fee, requiring additional disclosure, and revising the role of the fund board in approving the plan. We received approximately 10 letters from investors, most of whom supported substantive reform or repeal of the rule. We do not believe that it would benefit fund investors to return to the era in which they paid a substantial front-end sales load and did not have access to various alternative forms of distribution payment arrangements. Denying investors the ability to select alternate distribution methods or to pay for distribution services over time is not a goal of this rulemaking. Thus, we are not proposing in this rulemaking to prohibit the use of fund assets to pay sales costs. We remain concerned, however, about the conflicts of interest that arise when fund assets are used for distribution, and that fund directors monitor those conflicts. We also do not believe that merely modifying the “factors” for director consideration in order to accommodate existing industry practices would sufficiently address the issues we have identified with the use of fund assets to pay for distribution under rule 12b-1. Therefore, we are proposing a new approach to asset-based distribution fees ( i.e., 12b-1 fees) that is designed to benefit fund shareholders while minimizing disruption of current arrangements. Specifically, our proposal would explicitly recognize that a portion of asset-based distribution fees ( i.e., asset-based sales charges) functions like a sales load that is paid over time, and thus should be subject to the requirements and limitations that apply to traditional sales loads. 141 Limits on asset-based sales charges would be applied to the amounts paid by each investor (rather than amounts paid by the fund) in order to assure that each shareholder would pay only his or her proportionate share of distribution related costs. In addition, we propose to require funds to identify for shareholders that portion of asset-based distribution fees (today's 12b-1 fees) that operates as a substitute for a sales load and thus facilitate comparison with the distribution related costs of other funds or classes of shares. The proposed new rule and rule amendments would replace current rule 12b-1. 141 We acknowledged this, at least implicitly, when we approved the NASD sales charge rule amendments in 1992. We observed that the “purpose of the revised maximum sales charge rule is to create `approximate economic equivalency' as to the maximum sales charges for different types of mutual funds.” See 1992 NASD Rule Release, supra note 66, at section V. The Commission believed the amendments would, among other things, promote fairness by assuring “some degree of parity” between the sales and sales-promotion expenses charged by traditional load classes and classes that assess 12b-1 fees. Id. We describe the details of our proposals in the next sections of this Release. In Section III.M of this Release, we describe the anticipated impact of these proposals on investors, fund managers and directors, broker-dealers, and other intermediaries. A. Summary of Our Proposals The new approach we propose would, like NASD Conduct Rule 2830, differentiate between the two constituent parts of current 12b-1 fees (asset-based sales charges and service fees). Under proposed new rule 12b-2, funds could continue to use a limited amount of fund assets to pay for distribution related expenses. 142 The maximum amount of this “marketing and service fee” would be tied to the service fee limit imposed by the NASD sales charge rule (currently 25 basis points per year). 143 Unlike the service fee, however, funds could use this portion of fund assets for any distribution related expenses. This approach would serve the interests of investors and other members of the fund marketplace by providing a means of paying for participation in fund supermarkets and the maintenance of shareholder accounts, among other things, and allowing funds to support their own marketing and distribution strategies. 142 Proposed rule 12b-2(b). 143 Proposed rule 12b-2(b)(1); NASD Conduct Rule 2830(d)(5). We also propose to permit funds to deduct from fund assets amounts in excess of the marketing and service fee, and we would treat these amounts as an alternative means to pay a front-end sales load. To accomplish this, we propose to amend rule 6c-10 (which permits funds to charge deferred loads) to permit this asset-based sales charge, which we would call an “ongoing sales charge.” The proposed amendments in effect would treat ongoing sales charges as another form of sales load. Our proposed amendment to rule 6c-10 would not require any special board findings (such as those required by rule 12b-1), a written plan, annual renewal, or automatic termination provisions, or impose fund governance requirements. Instead, we would apply limits on asset-based sales charges by referencing the front-end load imposed by the fund or, if none, by referencing the aggregate sales load cap imposed under the NASD sales charge rule for funds with an asset-based sales charge and service fee (currently 6.25 percent). 144 144 NASD Conduct Rule 2830(d)(2)(A). These limits would be based on the cumulative amount of sales charges that an investor pays in any form (front-end, deferred, or asset-based). Under the proposed rule amendment, a fund imposing an ongoing sales charge would be required to automatically convert fund shares to a class of shares without an ongoing sales charge no later than when the investor has paid cumulative charges that approximate the amount the investor otherwise would have paid through a traditional front-end load (or, if none, the NASD rule 6.25 percent cap). 145 The proposed amendment would shift the focus of the limits from how much fund underwriters may collect in asset-based sales charges (a fund-level cap) to how much individual shareholders will pay either directly or indirectly (a shareholder account-level cap). 145 See infra note 171 and accompanying text. We are also proposing to amend rule 6c-10 to permit an alternative, elective distribution model. In this new model, intermediaries of funds could impose charges for sales of the fund's shares at negotiated rates, much like they charge commissions on sales of exchange-traded funds (ETFs) 146 and other equity securities. The proposed rule would permit fund intermediaries to charge sales loads other than those established by the fund underwriter and disclosed in the fund prospectus. 146 ETFs are registered investment companies that offer public investors an undivided interest in a pool of securities. They are similar in many ways to traditional mutual funds, except that shares in an ETF can be bought and sold throughout the day through a broker-dealer, like stocks traded on an exchange. B. Rescission of Rule 12b-1 We propose, first, to rescind rule 12b-1 in its entirety. 147 As we discussed in detail above, rule 12b-1 was adopted in response to a set of problems identified by the Commission in the late 1970s. But many of the assumptions underlying the rule appear to no longer reflect current marketplace realities, including the role that 12b-1 fees play in the distribution of fund shares and the tasks that directors should be required to undertake in considering whether to approve 12b-1 fees. Moreover, the rule has confounded many investors who remain unsure what a “12b-1 fee” is, how it impacts their account, and whether they should be willing to invest in a fund that imposes such a fee. Finally, the application of rule 12b-1 today reflects the confusion that has accumulated over the years as lawyers have sought to provide answers to questions that have arisen in the course of the rule's evolution. 147 As discussed in more detail in Section III.N of this Release, we are proposing a grandfathering provision that would permit funds to deduct existing 12b-1 fees with respect to shares issued prior to the compliance date for the proposed new rule and rule amendments, which we anticipate would be at least 18 months from the effective date in the adopting release. Therefore, we have decided not to propose to amend existing rule 12b-1, but to propose a new regulatory framework to address how fund assets may be used to finance distribution costs. 148 We believe the proposed rules, as described in more detail below, would better address current investor protection concerns raised by the use of fund assets as alternatives to sales loads and as a means of financing other types of distribution costs. 148 Although we propose to rescind rule 12b-1, proposed rule 12b-2 retains the section in rule 12b-1 that restricts certain directed brokerage practices. See 2004 Rule 12b-1 Amendments Adopting Release, supra note 106. We believe that the concerns we discussed in that adopting release regarding using directed brokerage to finance the distribution of fund shares continue to apply under our new proposal, and we propose to retain the section we adopted in 2004 unchanged. See proposed rule 12b-2(c). We note that Regulation R under the Exchange Act, 149 which provides banks exceptions and exemptions from broker-dealer registration, specifically references fees that banks and their employees receive pursuant to plans under rule 12b-1. 150 149 17 CFR Part 247. 150 17 CFR 247.721(a)(4)(iii)(A), 247.760(c). • We have not intended that the proposed rule affect those exceptions and exemptions, and we request comment on whether further rulemaking, clarification, or interpretive guidance is necessary or appropriate in this regard. C. Proposed Rule 12b-2: The Marketing and Service Fee We propose a new rule 12b-2, which would permit funds, with respect to any class of fund shares, to deduct a fee of up to the NASD service fee limit (which is 25 basis points or 0.25 percent annually) from fund assets to pay for distribution activities, without being subject to the limitations on sales loads that we describe in the next section of this Release. 151 Although the fee could be used for any type of distribution cost, we anticipate it primarily would be used to pay for servicing fees of the type currently permitted by the NASD sales charge rule, 152 trail commissions to broker-dealers selling fund shares, and other expenses, such as fees paid to fund supermarkets, that may in part be distribution related. 153 This proposed rule would permit funds to bear expenses similar to those that fund boards generally approved shortly after our adoption of rule 12b-1 in 1980. 154 151 Proposed rule 12b-2(b). 152 See NASD Sales Charge Rule Q&A, supra note 73, at question 17 (explaining the types of activities for which services fees may be used). 153 As discussed above, we have previously stated that funds may pay for non-distribution expenses under rule 12b-1 plans. See supra note 43 and accompanying text. Fund expenditures under current 12b-1 plans often pay for a mixture of distribution and administrative services. For example, some funds may pay their entire fund supermarket fee under a rule 12b-1 plan, even though portions of the fee may pay for administrative services that are not distribution related. A fund need not determine which portion of the fee is primarily for distribution services or which portion is primarily for administrative services, and it may be impractical and burdensome to require funds to allocate expenses. See Martin G. Byrne, The Payment of Fund Supermarket Fees By Investment Companies, 3 Investment Law. 2 (1996) (“[B]ecause the services that are provided to a fund in a supermarket are a combination of distribution, subaccounting, administrative, account maintenance, and other shareholder services, some portion of [a supermarket fee] may be considered a payment ‘primarily intended’ to result in sales of a fund's shares pursuant to Rule 12b-1 .* * * Because a fund with a Rule 12b-1 plan is expressly permitted to pay for distribution services, it is not critical to determine whether a particular service it pays for in connection with [a supermarket fee] is or is not for distribution.”). Similarly, proposed rule 12b-2 would not preclude funds from paying for these types of mixed expenses under rule 12b-2. However, to the extent that funds need not rely on proposed rule 12b-2 to charge expenses that can clearly be identified as not distribution related ( e.g., sub-transfer agency fees), funds could instead characterize those expenses as administrative expenses and thus keep total asset-based distribution fees within the 25 basis point limit of the marketing and service fee. See 1988 Release, supra note 28, at n.126 (“[T]o the extent a fund is paying for legitimate non-distribution services, such payments need not be made under a 12b-1 plan, even if the recipient of the payments is also involved in the distribution of fund shares.”). See also supra Section III.C of this Release. Conversely, simply characterizing an activity as “administrative” would not permit a fund to pay for it entirely outside of proposed rule 12b-2 if all or a portion of the fee is distribution related. See, e.g., In the Matter of BISYS Fund Services, Inc., Investment Company Act Release No. 27500 (Sept. 26, 2006) (Commission order instituting settled administrative and cease-and-desist proceedings arising out of the improper use of fund assets for marketing and other expenses). 154 See supra note 55. Unlike rule 12b-1, rule 12b-2 would not require directors to adopt or renew a “plan” or make any special findings. 155 Rather, fund boards would have the ability to authorize the use of fund assets to finance distribution activities consistent with the limits of the rule and their fiduciary obligations to the fund and fund shareholders. 156 A plan would not be required under our proposal because the proposed rules and rule amendments are structured to impose limits and safeguards on the use of fund assets for distribution, without the need for board approval of a plan. We intend that the board (including the independent directors) would oversee the amount and uses of these fees in the same manner that it oversees the use of fund assets to pay any other fund operating expenses, particularly those that create a potential conflict of interest for the fund's investment adviser or other affiliated persons. 157 The rule would recognize that funds bear ongoing expenses that, although they are distribution related, may benefit the fund and existing fund shareholders in a variety of ways. The marketing and service fee would be specifically identified and fully disclosed in the fund prospectus fee table as a type of operating expense. 158 155 Some funds and fund boards have adopted so-called “defensive” rule 12b-1 plans that do not impose distribution fees on the fund, but are designed to ensure that the board and the fund do not violate the Act if fund expenditures are subsequently determined to be primarily intended to result in the sale of fund shares. See ICI, Report of the Working Group on Rule 12b-1 at n.71 (May 2007) ( http://www.ici.org/pdf/rpt_07_12b-1.pdf ). Although 12b-1 plans (including “defensive” ones) would no longer be required to be entered into under our proposed amendments, the exemption provided by rule 12b-2 could serve the same purpose as a defensive plan to the extent that the amount of assets permitted to be used for distribution under rule 12b-2 has not otherwise been fully utilized. 156 Section 36(a) of the Act “establish[es] a federal standard of fiduciary duty” in dealings between a mutual fund and certain other persons, including its adviser, principal underwriter, officers and directors, among others. See Tannenbaum v. Zeller, 552 F.2d 402, 416 (2d Cir.), cert. denied, 434 U.S. 934 (1977). Section 36(a) applies to acts or practices constituting a breach of fiduciary duty involving “personal misconduct” on the part of the person acting for or serving the fund in the enumerated capacities. This federal standard is at least as stringent as standards of care prescribed for fiduciaries under common law, such as the duty of care and the duty of loyalty. See id. at n.20. See also Commission Guidance Regarding the Duties and Responsibilities of Investment Company Boards of Directors with Respect to Investment Adviser Portfolio Trading Practices, Investment Company Act Release No. 28345 (July 30, 2008) [73 FR 45646 (Aug. 6, 2008)] at section titled “Summary of Law Regarding Fiduciary Responsibilities of Investment Company Directors” (discussing state and federal law fiduciary obligations of fund directors). 157 Congress intended that independent directors play a critical role in overseeing fund operations and protecting the interests of shareholders in view of the substantial conflicts of interest that exist between a fund and its investment adviser. See House Hearings, supra note 26, at 109; Burks v. Lasker, 441 U.S. 471 (1979). When possible conflicts are present, fund management is under a duty to fully and effectively disclose information sufficient for the independent directors to exercise informed discretion on the matters put before them. See, e.g., Tannenbaum, 522 F.2d at 417, citing Fogel v. Chestnutt, 533 F.2d 731, 745 (2d Cir. 1975), cert. denied, 429 U.S. 824 (1976) and Moses v. Burgin, 445 F.2d 369 (1st Cir.), cert. denied, 404 U.S. 994 (1971). 158 We are proposing amendments to the prospectus fee table, which are discussed in Section III.J of this Release, infra. We are also proposing to require funds imposing a new marketing and service fee, or increasing the rate of an existing 12b-1 fee that would be used as a marketing and service fee, to obtain the approval of their shareholders. This requirement is discussed in Section III.F of this Release, infra. Funds may use the proceeds of the marketing and service fee to pay for, for example, the ongoing cost of participation on a distribution platform such as a fund supermarket, giving investors a convenient way of buying shares; for paying trail commissions to broker-dealers in recognition of the ongoing services they provide to fund investors; or for paying retirement plan administrators for the services they provide participants (and which relieve the fund from providing such services). In addition, funds (including no-load funds) may use the marketing and service fee to pay for shareholder call centers, compensation of underwriters, advertising, printing and mailing of prospectuses to other than current ( i.e., prospective) shareholders, and other traditional distribution activities. 159 159 See proposed rule 12b-2(b), (e). Under the proposed rule, the marketing and service fee could not, on an annual basis, exceed the limits on service fees prescribed by the NASD sales charge rule (currently 0.25 percent of fund net assets annually). Any charge in excess of 0.25 percent per year would be considered an asset-based sales charge and subject to the overall sales load limitations established by the NASD sales charge rule and other requirements, as discussed in the next section of this Release. We chose to propose this limit because it would permit, without change, the continuation of many important uses of 12b-1 fees that may benefit investors. It also represents the line the NASD sales charge rule draws between a limited distribution fee and a sales charge—25 basis points currently is the limit that a fund may deduct and still call itself a “no-load” fund. 160 The NASD drew upon its knowledge and expertise as the self-regulatory organization of the brokerage industry to develop these limits, which we approved as an appropriate exercise of the NASD's congressional mandate to prevent excessive sales charges on mutual fund shares. 161 Accordingly, we have used the NASD limit on service fees in formulating our proposal to distinguish a limited distribution fee from a sales charge. 160 Specifically, NASD Conduct Rule 2830(d)(4) prohibits any member from describing a fund as “no-load” if the fund has combined asset-based sales charges and services fees of more than 0.25 percent of average annual net assets. This provision is intended to help investors distinguish between funds that use relatively small 12b-1 fees to finance advertising and other sales promotion activities, similar to traditional no-load funds, and funds that use larger 12b-1 fees as alternatives to front-end sales loads. See 1992 NASD Rule Release, supra note 66. See also The Vanguard Group, supra note 31 (order permitting the Vanguard Group to call its funds no-load even though they made small distribution payments of 0.20% of average annual net assets). 161 See 1992 NASD Rule Release, supra note 66, at section V; 15 U.S.C. 80a-22(b). We request comment on the proposal to limit the marketing and service fee to the maximum service fee permitted under the NASD sales charge rule. • Would a different term, such as “sales/service fee,” be more appropriate? If so, why? Would a different limit be more appropriate? Should the limit be higher ( e.g., 30 or 50 basis points) or lower ( e.g., 10 or 20 basis points)? If so, why? Should the limit be set with reference to the NASD rule, which would allow the NASD (now FINRA) to change the level, pending approval by the Commission? We understand that many share classes either do not currently charge 12b-1 fees in an amount that exceeds 25 basis points, or charge none at all. 162 Many funds use these fees to compensate intermediaries for providing customers with follow-up information and account maintenance services pursuant to the NASD sales charge rule. In such cases, the shareholder service fees may in fact have a significant distribution component, which is why funds often pay them pursuant to a rule 12b-1 plan. 163 We do not propose, however, to limit the use of the marketing and service fee to these types of services ( i.e., those described in the NASD sales charge rule), so that funds may continue to use fund assets to pay for promotional and advertising expenses. 162 See infra Section III.M.2 of this Release. 163 See SEC, Mutual Fund Fees and Expenses (2007) ( http://www.sec.gov/answers/mffees.htm ). Funds may decide that the stream of payments to a broker-dealer for providing client services (that it would have provided anyway) could be viewed as an incentive for the broker-dealer to continue selling the fund. • Should we limit the marketing and service fee to expenses incurred for “shareholder services” as defined in the NASD sales charge rule? More generally, do investors in omnibus accounts receive equivalent levels of service relative to investors who invest directly and pay similar 12b-1 fees? Is there a disparity in service, and if so, why? What implications does this have for our proposal? Under the proposal, “distribution activity” would be defined as “any activity that is primarily intended to result in the sale of shares issued by the fund, including, but not necessarily limited to, advertising, compensation of underwriters, dealers, and sales personnel, the printing and mailing of prospectuses to other than current shareholders, and the printing and mailing of sales literature.” 164 The proposed rule does not attempt to delineate permissible distribution expenses because our experience with rule 12b-1 has shown that new distribution methods continually evolve. 164 Proposed rule 12b-2(e)(2). The proposed definition of “distribution activity” is identical to the description of distribution in rule 12b-1. See rule 12b-1(a)(2). Because funds continually market themselves to investors, many types of activities may potentially be construed as “primarily intended” to result in fund sales. Although the definition provides flexibility, similar to rule 12b-1, distribution activities paid for through asset-based distribution fees under proposed rule 12b-2 and the proposed amendment to rule 6c-10 (as under rule 12b-1) must represent legitimate expenses of the fund. See, e.g., Exemptions for Certain Registered Open-End Management Investment Companies to Impose Deferred Sales Loads, Investment Company Act Release No. 16619 at n. 3 (Nov. 2, 1988) [53 FR 45275 (Nov. 9, 1988)]. • Are the identified activities appropriately considered “distribution activities”? Should we provide more guidance regarding specific expenditures that are distribution expenses and others that are not, as some commenters have suggested? 165 Should we define “distribution activity” differently? If so, how should we define it? Should funds be permitted to classify only certain expenses as marketing and service fees? 166 If so, what types of expenses? 165 See, e.g., Roundtable Transcript, supra note 109, at 167 (Jeffrey Keil, Keil Fiduciary Strategies) (“[D]istribution expenditures should be defined in some way, shape, or form, or [the rule should] say what's not a distribution expenditure.”). 166 See, e.g., 2004 Rule 12b-1 Amendments Adopting Release, supra note 106. D. Proposed Amendments to Rule 6c-10: The Ongoing Sales Charge The proposed amendments to rule 6c-10 would permit funds to deduct asset-based distribution fees in excess of the amount permitted under rule 12b-2 ( i.e., 25 basis points annually), provided that the excess amount is considered an “ongoing sales charge” subject to the sales charge restrictions described below, including an automatic conversion feature. 167 Funds would not have to adopt a “plan” in order to impose an ongoing sales charge, and fund boards would not be required to make any special findings. In short, the proposed rule would treat ongoing sales charges as another form of deferred sales load. 168 167 Proposed rule 6c-10(b). We would title this section of the rule “Fund-Level Sales Charge” to distinguish it from a current provision of rule 6c-10 that provides an exemption to permit funds to deduct a “Deferred Sales Load” ( e.g., CDSL) (rule 6c-10(a) from shareholder accounts, and a proposed alternative that would provide an exemption from section 22(d) of the Act to permit broker-dealers to deduct “Account-Level Sales Charges” (proposed rule 6c-10(c)). 168 As a form of deferred sales load, all payments of ongoing sales charges to intermediaries would constitute transaction-based compensation. Intermediaries receiving those payments thus would need to register as broker-dealers under section 15 of the Exchange Act unless they can avail themselves of an exception or exemption from registration. Marketing and service fees paid to an intermediary may similarly require the intermediary to register under the Exchange Act. Under the proposed provision, a fund could deduct an ongoing sales charge to finance distribution activities at a rate established by the fund, provided that the cumulative amount of sales charges the investor pays on any purchase of fund shares does not exceed the amount of the highest front-end load that the investor would have paid had the investor invested in another class of shares of the same fund. 169 For example, if a fund has class A shares with a six percent front-end sales load, the fund could pay as much as six percent in total ongoing sales charges in class B shares. If another class of shares charges a front-end sales load of, for example, two percent, a total ongoing sales charge of as much as four percent could also be charged (six percent minus the two percent front-end load) with respect to that class. 169 Proposed rule 6c-10(b)(1). We seek comment on whether the Commission should treat ongoing sales charges as a form of deferred sales load subject to the NASD sales charge limitations. We also seek comment on whether the proposed amendments to rule 6c-10, as described in more detail below, accomplish this goal. • Do the sales charge limitations, as we propose to apply them, adequately protect investors from excessive sales loads in accordance with the objectives of section 22(b) of the Act? Would any aspect of these proposed sales charge limitations encour [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2010-18305. Public record. Not legal advice.