September 6, 1990
TO: BOARD OF GOVERNORS NO. 63-90
SEC RULES MEMBERS NO. 63-90
RULE 12b-1 AD HOC COMMITTEE
RE: NASD PROPOSED RULE REGARDING 12b-1 PAYMENTS
__________________________________________________________
The Board of Governors of the NASD is soliciting a
membership vote on the attached proposed amendment to the mutual
fund sales charge rule. Under this proposal, mutual fund asset-
based sales charges, as well as front-end and deferred sales
charges, would be subject to the maximum limits of the NASD rule.
If approved by its membership, the NASD intends to seek SEC
approval of the proposed amendments, which could become effective
following a one year grace period.
I. Background
The solicitation of a membership vote on the NASD proposal
is the latest in a series of events relating to the regulation of
mutual fund 12b-1 payments which began with the SEC's proposal of
substantial amendments to Rule 12b-1 in June 1988. (See
Institute memorandum to Board of Governors No. 43-88, SEC Rules
Members No. 35-88, Operations Committee No. 20-88, Accounting/
Treasurers Advisory Committee No. 22-88, Marketing Committee No.
21-88, Sales Force Marketing Committee No. 24-88 and Direct
Marketing Committee No. 23-88 dated June 17, 1988.) In its
comment letter on the SEC proposed amendments, the Institute
suggested that the NASD propose a rule governing the payment of
12b-1 fees pursuant to its authority to regulate sales charges on
mutual fund shares. (See Institute memorandum to Board of
Governors No. 59-88, Members - One Per Complex No. 49-88 and SEC
Rules Committee No. 52-88, dated September 21, 1988.)
In April of this year the NASD proposed for comment a rule
that would subject asset-based sales charges to the NASD maximum
sales charge limits. (See Institute memorandum to Board of
Governors No. 27-90 and SEC Rules Members No. 30-90, dated April
18, 1990.) This proposal was designed to achieve economic
equivalence between the maximum permitted front-end sales load
and an asset-based sales charge (possibly combined with a front-
end load and/or a contingent deferred sales charge).
The Institute comment letter on the NASD proposal noted the
strong support of the Institute's ad hoc committee on Rule 12b-1
and urged the adoption of the proposal with certain
clarifications. (See Institute memorandum to Board of Governors
No. 39-90, SEC Rules Members No. 40-90, and Rule 12b-1 Ad Hoc
Committee, dated June 4, 1990). Almost all of the Institute's
suggested clarifications have been included in the attached
proposal.
II. The Proposed Amendment
The proposed amendment revises the current mutual fund sales
charge rule by dividing it into two parts. The first part covers
funds with no asset-based sales charge, and the second part
covers those with an asset-based sales charge.
A. Funds With No Asset-Based Sales Charge
The first part of the rule provides that a fund with no
asset-based sales charge may pay each year a continuing service
fee of up to 25 basis points, provided that aggregate front-end
and/or deferred sales charges do not exceed 7.25 percent of the
offering price.
For purposes of the proposal, service fees are defined as
payments by an investment company for personal service and/or the
maintenance of shareholder accounts. The service fees paid to
any person are limited under the rule to .25 percent of the
average annual net asset value of the shares sold by that person.
In addition, the proposal has been modified to permit a fund
with no asset-based sales charge which reinvests dividends at
offering price to pay a service fee, provided that the fund
offers quantity discounts and rights of accumulation and
aggregate front-end and/or deferred sales charges do not exceed
6.25 percent of the offering price.
B. Funds With an Asset-Based Sales Charge
1. Maximum Caps
The new portion of the sales load limitation rule would
impose two separate caps on sales charges for funds with asset-
based sales charges. The first is an aggregate sales charge cap
of 6.25 percent of new gross sales, plus interest at the rate of
prime plus one, imposed on funds which pay a service fee. This
cap would be 7.25 percent of new gross sales for funds which do
not pay a service fee. In both instances, front-end and/or
deferred sales charges cannot exceed 6.25 or 7.25 percent of the
amount invested by any person. The aggregate cap is to be reduced
over time by front end, deferred and asset-based sales charges
paid and increased by accrued interest. If the aggregate cap of
a fund has been reduced to 0, any deferred sales charges must be
credited to the fund. A second cap of .75 per cent of average
annual net assets would also be imposed on any asset-based sales
charges paid by a fund.
2. Sales Prior to the Effective Date
The rule clarifies the treatment of distribution of expenses
incurred in connection with sales prior to the effective date of
the NASD rule. Thus, a fund that had an asset-based sales charge
in the past could apply the 6.25 or 7.25 cap retroactively to
sales from the date of adoption of the 12b-1 plan until the
effective date of the rule. This cap would be increased by
interest at the rate of prime plus one and decreased by front-
end, deferred or asset-based sales charges paid. The total
remaining balance would be added to the aggregate cap computed
with respect to new gross sales after the effective date of the
rule. The grand total would be adjusted in a similar manner,
i.e., reduced by sales charges received and increased by
interest.
3. Exchanges
The revised NASD proposal includes a provision permitting a
fund to make adjustments to its aggregate cap to reflect
exchanges. Under the rule, a fund could increase its aggregate
cap by treating exchanges into the fund as new gross sales,
provided that the amount of such increase is deducted from the
aggregate cap of the fund or funds with exchanges out.
4. Use of Term No-Load
A fund will not be permitted to describe itself as no-load
if it imposes sales charges, including asset-based sales charges,
and/or a service fee which exceeds 25 basis points a year. The
earlier NASD proposal would have prohibited the use of the term
no-load by a fund with any deferred or asset-based sales charge.
5. Accommodation of Alternatives
The NASD proposal does not provide a procedure for
consideration of exemptions from the rule. However, the preamble
to the rule states that the NASD Board will consider whether any
changes are necessary after the rule has been in place for one
year.
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We will keep you informed of further developments.
Catherine L. Heron
Deputy General Counsel
Attachment