Draft Comment Letter on Processing Fees; Feedback Requested by 10/24

[31438]

October 16, 2018 TO: Processing Fees Working Group
SEC Rules Committee
Small Funds Committee RE: Draft Comment Letter on Processing Fees; Feedback Requested by 10/24

 

As we reported previously, the SEC issued a request for comment on the framework for certain processing fees that broker-dealers and other intermediaries charge funds for delivering fund shareholder reports and other materials to investors that are beneficial owners of shares held in street name through the intermediary.[1] The SEC’s release explains that, with the adoption of Rule 30e-3, the SEC believes it is appropriate to consider more broadly the overall framework for these fees.[2] Comments are due October 31.

Attached for your review is ICI’s draft comment letter, including two appendices. Please provide any comments on the draft letter by email to Linda French (linda.french@ici.org) no later than the close of business on Wednesday, October 24.

A short summary of the letter is as follows:

Current system creates a conflict of interest.

SEC rules require funds to reimburse intermediaries for reasonable expenses incurred in forwarding fund materials to beneficial owners of fund shares. Intermediaries generally outsource forwarding of fund materials to a fulfillment vendor that then invoices the fund to pay the expenses. This reimbursement system creates a disconnect between the party that negotiates the vendor fees (i.e., the intermediary) and the party that pays the vendors’ bill (i.e., the fund).

Since funds bear the cost of shareholder report delivery, intermediaries have no incentive to negotiate lower delivery rates with the fulfillment vendor or otherwise control costs. To make matters worse, the lack of market incentives prevents competition and has created a near-monopoly for the predominant vendor, which now has a financial stake in keeping prices high.

Conflict of interest results in higher fees.

This conflict-ridden environment inevitably has led to significantly higher fees than funds pay when they are able to select their own delivery vendor and negotiate the fee. For accounts held directly with the fund (“direct-held accounts”), vendors compete to offer funds attractive pricing for delivery of fund materials.

A recent ICI member survey found that the median fund pays more than twice as much in processing fees for mailing the same shareholder report to an intermediary-held account as compared to a direct-held account. The median fund pays five times as much to e-mail a shareholder report to an intermediary-held account as compared to a direct-held account.

Higher fees eliminate shareholder cost savings.

Applying NYSE processing fees also has reduced greatly the anticipated cost savings from Rule 30e-3. Without further action from the SEC to reform these fees, the increase in applicable processing fees may largely offset the cost savings from funds no longer printing and mailing shareholder reports.

NYSE fees are irrational.

The NYSE fee schedule attempts to address the conflict of interest inherent in the reimbursement framework. It does this by setting maximum rates for what constitutes “reasonable” delivery expenses (i.e., “processing fees”) that funds must reimburse, in addition to actual out-of-pocket costs such as printing and mailing.

The NYSE fee framework is ill-suited to distribution of fund materials, however, and the fees that apply to funds bear no relation to the actual work of distributing fund materials.[3]

SEC must resolve underlying conflict of interest.

The SEC should permit funds to select the fulfillment vendor and negotiate the price for distribution of fund materials. This will realign incentives and eliminate the conflict of interests. It also will re-introduce market competition, eliminating the need for a regulator-set fee schedule and allowing vendors to compete for funds’ business.

Two potential solutions exist for the SEC to eliminate the conflict of interest.

Our letter describes two possible solutions that would eliminate this disconnect. The first solution has the advantage of eliminating entirely the need for a fee schedule.

• The SEC could make clear that Section 14 rules permit funds to choose how to deliver fund regulatory materials and require intermediaries to provide to funds on request a data file with only the shareholder information necessary for delivering these materials. This would eliminate the need for a fee schedule.
• Or, the SEC could allow funds to choose how to deliver fund regulatory materials by treating all fund shareholders as non-objecting beneficial owners (NOBOs) for the purpose of distributing fund regulatory materials.

Alternative recommendation for reforming NYSE fees.

If the SEC chooses not to pursue either of the two potential solutions and instead retains the existing delivery and reimbursement framework, it must rework the fee schedule to:

• Separate fund fees out from the existing NYSE fee schedule.
• Replace the existing fees and layered application structure with simple flat fees that reflect actual costs, using cost for direct shareholders as a guide.
• Clarify that vendors cannot bill funds for managed accounts since funds are not legally required to forward materials to managed accounts.
• Eliminate unreasonable billing practices, such as remittances, that maximize intermediary and vendor profit at shareholder expense.
• Create a robust regulatory oversight framework.
• Ensure regular independent review of fee rates and vendor billing practices.

Coupled with these reforms, the SEC will have to provide intense, ongoing regulatory scrutiny of these fees to address further issues as they arise.

 

Linda M. French
Assistant Chief Counsel, ICI Global

Joanne Kane
Director, Operations & Transfer Agency
 

Attachment No. 1

Attachment No. 2

Attachment No. 3

endnotes

[1] See ICI memorandum no. 31243, available at https://www.ici.org/my_ici/memorandum/memo31243.

[2] Request for Comments on the Processing Fees Charged by Intermediaries For Distributing Materials Other Than Proxy Materials to Fund Investors, SEC Rel. Nos. 33-10505, 34-83379, IC-33114 (June 5, 2018), available at https://www.sec.gov/rules/other/2018/33-10505.pdf.

[3] Although our letter focuses on distribution of fund materials other than proxies, we note that many of our concerns also apply in the proxy context, and we believe the NYSE fee schedule also is ill-suited for distribution of fund proxy materials.