SEC Issues Guidance on Section 22(d) Restrictions

Investment Management Update

Date: February 07, 2017

On January 11, 2017, the U.S. Securities and Exchange Commission’s (SEC) Division of Investment Management issued an interpretive letter indicating that under certain circumstances, Section 22(d) of the Investment Company Act (1940 Act) does not apply to a broker, when the broker, acting as agent for its customers, charges customers a commission for effecting transactions in a class of shares without any front-end load, deferred sales charge or other asset-based fee for sales or distribution (Clean Shares). This guidance alleviates some of the issues raised by the Department of Labor’s fiduciary rule (DOL Rule). The SEC’s interpretive letter was issued in response to a request from the Capital Group Companies, Inc. (Capital Group).

The DOL Rule is designed to mitigate certain perceived conflicts of interest that may arise when a broker recommends one fund over another because of a higher commission payout. Section 22(d) prohibits a mutual fund, the fund’s principal underwriter and dealers in the fund’s shares from selling the fund’s securities except at the current public offering price that is described in the fund’s prospectus. While the plain language of Section 22(d) only applies to “dealers,” many in the mutual fund industry have been uncertain about whether a broker would be deemed a dealer if the broker charged a commission for effecting transactions in Clean Shares. The SEC letter thus confirmed that the Section 22(d) restrictions do not apply to brokers under these circumstances.

The SEC’s conclusions were based on the following representations in Capital Group’s letter:

  • The broker will represent in its selling agreement with the fund’s underwriter that it is acting solely on an agency basis for the sale of Clean Shares.
  • The Clean Shares sold by the broker will not include any form of distribution-related payment to the broker.
  • The fund’s prospectus will disclose that an investor transacting in Clean Shares may be required to pay a commission to a broker, and if applicable, that shares of the fund are available in other share classes that have different fees and expenses.
  • The nature and amount of the commissions and the times at which they would be collected would be determined by the broker consistent with the broker’s obligations under applicable law, including but not limited to applicable FINRA and DOL rules.
  • Purchases and redemptions of Clean Shares will be made at net asset value established by the fund (before imposition of a commission).

The SEC also confirmed that Section 22(d) does not prohibit a principal underwriter of Clean Shares from entering into selling agreements with a broker under those circumstances. Finally, the SEC noted that the letter did not address the effect under Section 22(d) of a broker receiving revenue sharing payments from the fund’s adviser.

FOR MORE INFORMATION

For more information, please contact:

Susan D. Kim
614.469.3261
Susan.Kim@ThompsonHine.com

Andrew J. Davalla
614.469.3353
Andrew.Davalla@ThompsonHine.com

Donald S. Mendelsohn
513.352.6546
Don.Mendelsohn@ThompsonHine.com

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