SEC Adopts Mutual Fund Redemption Fee Rule
Date: March 31, 2005
On March 3, 2005, the Securities and Exchange Commission adopted new Rule 22c-2 under the Investment Company Act of 1940, as amended. The new rule permits registered open-end investment companies to impose a redemption fee of up to 2% of the amount redeemed. Unlike the proposed rule, Rule 22c-2 does not require a fund to adopt a redemption fee. However, a fund must either approve a redemption fee or affirmatively decide that a redemption fee is not necessary or not appropriate. Rule 22c-2 also requires a fund to enter into written agreements with intermediaries obligating the intermediaries to respond to requests by the fund for certain shareholder identity and transaction information. In addition, the agreements must contain a provision requiring the intermediaries to carry out the fund’s instructions to restrict or prohibit further purchases or exchanges by any shareholder identified by the fund as having engaged in trading that violates the fund’s market timing policies. The rule requires each fund board to consider implementing a redemption fee before October 16, 2006.
Rule 22c-2(a)(1) requires a fund’s board of directors, including a majority of the independent directors, to either:
- Approve a redemption fee that, in its judgment, is necessary or appropriate to recoup the costs the fund may incur as a result of redemptions or to otherwise eliminate or reduce any dilution of the value of the fund’s outstanding securities; or
- Determine that the imposition of a redemption fee is either not necessary or not appropriate.
Because Rule 22c-2 defines the term "fund" to include a separate series of any open-end investment company, the board of directors of any newly established separate series will have to make the determination required under Rule 22c-2(a)(1) with respect to that series.
Amount of the Fee
The redemption fee, which is retained by the fund, may be set at any amount, but may not exceed 2% of the amount redeemed. In a reversal of a prior staff position, the amount of the redemption fee need not be tied to the administrative and processing costs associated with redeeming fund shares. Rather, the rule permits a fund to take into consideration the indirect costs to the fund that arise from short-term trading of fund shares, such as the cost of investing a greater portion of the fund’s portfolio in cash or cash items than would otherwise by necessary. As a result, staff no-action letters linking redemption fees to administrative costs have been rescinded.
The redemption fee may be imposed on shares redeemed within any period after purchase as specified by the board, provided that the period not be less than seven calendar days.
Shareholder Transaction Information
Rule 22c-1(a)(2) requires a fund (or its principal underwriter) to enter into written agreements with its financial intermediaries under which the intermediaries must, upon request, provide the fund with information about the identity of shareholders and their transactions in fund shares. All funds, regardless of whether they impose redemption fees, must enter into such agreements. This requirement is designed to enable a fund to monitor trading and identify shareholders in omnibus accounts that are engaged in frequent trading that is inconsistent with the fund’s market timing policies.
The rule defines the term "financial intermediary" to include (i) broker-dealers, banks or other entities that hold fund shares in nominee name; (ii) unit investment trusts, master-feeder funds, and certain other fund of funds; and (iii) retirement plan administrators or record keepers for participant directed employee plans that own fund shares. An agreement is not needed with intermediaries with respect to shares that are held on a fully disclosed basis.
A fund is required to maintain, in an easily accessible place, a copy of any written agreements that are in effect, or at any time within the past six years, were in effect.
Financial Intermediary Responsibilities
Under the written agreements with the fund, financial intermediaries are required to provide to the fund, upon request, the following shareholder information:
- The Taxpayer Identification Number of all share- holders that purchased, redeemed, transferred or exchanged shares held through an account with the financial intermediary; and
- The amount and date of such shareholder purchases, redemptions, transfers and exchanges.
In addition, Rule 22c-2 requires that the agreements contain a provision under which the intermediary agrees to execute the fund’s instructions to restrict or prohibit further pur- chases or exchanges by specific shareholders (as identified by the fund) who engage in trading that violates the fund’s market timing policies.
Rule 22c-2 does not apply to:
- Money market funds;
- Any exchange traded fund; and
- Any fund that affirmatively permits market timing of fund shares, provided that the fund’s prospectus clearly and prominently discloses that the fund permits short-term trading of its shares and that such trading may result in additional costs for the fund.
This advisory may be reproduced, in whole or in part, with the prior permission of Thompson Hine LLP and acknowledgement of its source and copyright. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions. Some of the design images and photographs in this document may be of actors depicting fictional scenes.