SEC Issues Guidance Update Addressing Disclosure Issues and Procedural Requirements for Mutual Fund Compliance Under the DOL's Fiduciary Investment Advice Rule

Practical Law Legal Update w-005-1980 (Approx. 7 pages)

SEC Issues Guidance Update Addressing Disclosure Issues and Procedural Requirements for Mutual Fund Compliance Under the DOL's Fiduciary Investment Advice Rule

by Practical Law Employee Benefits & Executive Compensation

The Final Fiduciary Rule

The final rule is designed to limit conflicts of interest surrounding the provision of fiduciary investment advice under ERISA Section 3(21)(A)(ii) (29 U.S.C. § 1002(21)(A)(ii)) and Internal Revenue Code (Code) Section 4975(e)(3)(B) (26 U.S.C. § 4975(e)(3)(B)) to ERISA-governed employee benefit plans and individual retirement accounts (IRAs) (retirement investors), subject to specific exclusions for particular types of communications that are non-fiduciary in nature. In doing so, the final rule newly regulates the type of compensation that individuals providing fiduciary investment advice to retirement investors may receive without engaging in a prohibited transaction under ERISA or the Code.

For more information on the final rule, see Practice Notes:

Mutual Fund Compliance Issues Under Final Rule

The final rule includes a broad definition of a fiduciary that includes brokers, advisers, and others who provide investment advice to a retirement investor (advisers). Advisers that provide mutual funds to retirement investors are grappling with several compliance issues under the final rule, including the procedural issues arising from the fact that mutual funds do not pay uniform sales loads. Accordingly, advisers offering funds are considering new variations to sales loads that would apply uniformly to retirement investors that purchase mutual fund shares through a single intermediary or a category of multiple intermediaries.

However, under SEC rules, if a fund sells shares at prices that reflect scheduled variations in, or elimination of, sales loads it must disclose each sales load variation in the prospectus. Rule 22d-1 under the Investment Company Act of 1940 (ICA) and item 12(a)(2) of Form N-1A require a mutual fund to:

Amend its registration statement to disclose any new variations in its sales loads.
File that amendment in accordance with Rule 485(a) under the Securities Act, which requires that each variation be applied uniformly to particular "classes" of investors or transactions and disclosed in the prospectus with specificity.

In these circumstances, item 12(a)(2) of Form N-1A requires that the prospectus:

Briefly describe the arrangements that result in breakpoints in, or elimination of, sales loads.
Identify each class of individuals or transactions to which the arrangements apply.
State each different breakpoint as a percentage of both the offering price and net amount invested.

This means that many mutual funds would be filing lengthy, duplicative amendments before the April 10, 2017 initial compliance deadline for the final rule. Some advisers offering mutual funds have expressed concern that if a fund creates multiple scheduled variations, it could lead to lengthy prospectus disclosure that may be difficult for a retirement investor to navigate and comprehend.

GU for Mutual Fund Compliance

The GU provides guidance on the disclosure and procedural issues that may arise for funds that offer variations in sales loads and new share classes. It addresses these issues by:

Permitting advisers offering mutual funds to include a stand-alone appendix to the statutory prospectus for lengthy sales load variation disclosures applicable to multiple intermediaries, providing the appendix satisfies certain requirements (see Using a Stand-Alone Appendix).
Reminding advisers that they can request selective SEC review and template filing relief for these amendments (see Administrative Review Issues).

Using a Stand-Alone Appendix

In order for advisers offering mutual funds to use an appendix under this approach:

The section of the prospectus that includes disclosure that is required by Item 12 to Form N-1A should include a prominent statement to the effect that different intermediaries may impose different sales loads and that these variations are described in an appendix to the prospectus (the specific appendix must be named).
The cross-reference in the narrative explanation to the fee table must cross-reference the appendix.
The appendix must:
- specifically identify the name of the intermediary as required by item 12(a)(2); and
- include sufficient information to allow an investor that purchases mutual fund shares through a specific intermediary to determine which scheduled variation applies to its investment, which may depend on the type of account held at the intermediary.

For the appendix to be provided as a stand-alone document, the mutual fund must also:

Incorporate the appendix into the prospectus by reference.
File the appendix with the prospectus.
Include a legend on the front cover page of the appendix explaining that the information disclosed in the appendix is part of, and incorporated in, the prospectus.
Include a statement on the outside back cover page of the prospectus that information about the different sales loads variations is provided in a separate document that is incorporated by reference into the prospectus.
Deliver the appendix with the prospectus.
Post the appendix on its website consistent with Rule 498(e) under the Securities Act of 1933 (Securities Act), if the Fund uses a summary prospectus.

To add disclosure about sales load variations, a mutual fund must file the amendment to its registration statement under Rule 485(a) under the Securities Act. To simply and streamline the SEC's review of these amendments, it suggests that mutual funds take the following additional administrative review steps.

Administrative Review Issues

The GU indicates that if only certain disclosures about the mutual fund are changing, such as adding sales load variations, it should seek selective review from the SEC (see Selective SEC Review). In addition, if sales load variation disclosures will be substantially identical across multiple funds within a fund complex, the funds should consider whether it is appropriate to request relief under Rule 485(b)(1)(vii) under the Securities Act (see Template Filing Relief).

Selective SEC Review

The GU encourages registrants to request a selective review of a filing that contains a disclosure that is not substantially different from the disclosure contained in one or more prior filings by the fund or other funds in the mutual fund complex. It notes that a request for selective review may be appropriate for the Rule 485(a) filing for a fund that reflects a new share class or sales load variation that is expected to be introduced for other funds in the complex.

The request for selective review must be made in the cover letter accompanying the filing and should include:

A statement as to whether the disclosure in the filing has been reviewed by the staff in another context.
A statement identifying prior filings that the registrant considers similar to, or intends as precedent for, the current filing.
A summary of the material changes made in the current filing from the previous filings.
Any specific areas that the registrant believes warrant particular attention.

Template Filing Relief

The GU suggests that when a mutual fund complex makes substantially identical changes to multiple funds, the registrant may request Rule 485(b)(i)(vii) relief to avoid the need to file multiple Rule 485(a) filings. Instead, the registrant may file a single Rule 485(a) filing (a template filing) for staff review, together with a template filing relief request for other funds with substantially identical disclosures.

The registrant must request template filing relief in correspondence filed on the EDGAR system under the central index key (CIK) of the template filing. The registrant’s request should state:

The reason for making the post-effective amendment.
The identity of the template filing.
The identity of the registration statements that intend to rely on the relief (replicate filings).

The registrant must also make the following representations:

The disclosure changes in the template filing are substantially identical to disclosure changes that will be made in the replicate filings.
The replicate filings will incorporate changes made to the disclosure included in the template filing.
The replicate filings will not include any other changes that would otherwise render the template ineligible for filing under Rule 485(b).

Any Rule 485(b) filing relying on template filing relief should include a cover letter or an explanatory note in the filing explaining that it is relying on this relief.

The GU encourages mutual funds to submit any template filing requests as soon as possible, and provides that the SEC will consider any requests as expeditiously as possible. A request for template filing relief may be combined with a request for selective review to streamline the amendment process as much as possible.

Practical Implications

This GU provides a mechanism to streamline certain procedural and administrative issues that mutual funds may encounter in attempting to comply with the final fiduciary rule by limiting variations in sales loads while also satisfying SEC registration and filing requirements. However, it does not provide that adopting these procedural mechanisms will satisfy the substantive requirements of the final rule, nor does it address broader substantive issues surrounding the type of compensation that advisers offering mutual funds may receive under the final rule.

SEC Issues Guidance Update Addressing Disclosure Issues and Procedural Requirements for Mutual Fund Compliance Under the DOL's Fiduciary Investment Advice Rule | Practical Law