June 2015

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Regulatory Hot Topics and DIG
June 3, 2015

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Current SEC IC Initiatives
• Never-Before-Examined Registered
Investment Company
• Fixed Income Liquidity Review
• Alternative Mutual Funds (“Liquid Alts”)
• Cybersecurity Initiative

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Regulatory Hot Topics
• Gifts and Entertainment (2015-01)
• New Proposed Rules to Modernize Investment
Company/Adviser Reporting
• Recent IC Cases of Note

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SEC Distribution In Guise Sweep
1. Collaborative investigation of fund complexes’
distribution practices by OCIE, Enforcement and IM
2. SEC is concerned that:
• sub-transfer agent fees (and other administrative service fees) are
being used by fund advisers, directly or indirectly, as a vehicle to
pay intermediaries to sell fund shares;
• fund board disclosure of such payments may not be sufficient;
• conflicts are not being vetted or managed appropriately;
• Inadequate supervision/oversight of complexes’ distribution
practices
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Common Request items
 Top 20 intermediaries by fees (12b-1, shareholder
services, omnibus/sub-ta, administrative services,
revenue sharing, marketing/conference support
 Five years of fund data by class w/fees (same as
above)
 A copy of all agreements and amendments with
top 15 intermediaries
 Financial statements, trial balance, detailed
general ledger of advisor, select funds, affiliated
distributor, affiliated transfer agent
 15c presentation to board with supporting
materials
 Evidence that the board considered the 1998 NA
letter to ICI
 Documents evidencing appropriateness and
reasonableness of Omnibus/sub-ta payments
 Focus and extensive email request
 Extensive interviews with key account executives
 Evidence that the funds are complying with 22c-2
1nd 22c-1 in an omnibus environment
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Intermediary Oversight
• 12(b)-1 plan and related expenses paid pursuant to the plan;
• Payments made to third party intermediaries which include payments made in the form of shareholder
services fees (part of the 12b-1 Plan), sub-transfer agent or administration fee, networking fees or
omnibus fees, conference or marketing support fees and revenue sharing payments.
• Documentation maintained by Adviser or sponsor in reviewing the accuracy and propriety of fees paid by
Adviser on behalf of the Funds, or paid by the Funds directly, to third-party intermediaries or institutions
• Adviser, distributor and/or fund policies, procedures and controls relating to review and approval of
financial and non-financial intermediary payment of various shareholder servicing and distribution
arrangements.
• Management reports provided to the Funds’ board of directors regarding compensation payments, and
other fees paid outside of the Fund’s 12b-1 Plan.
• Consistency of disclosures with Adviser’s practices with respect to payment of the distribution and
revenue sharing fees.
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Mutual Fund Distribution: Legal Background
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• Rule 12b-1
• Prohibits a fund from acting as a “distributor” of its securities
except: (i) through an underwriter; or (ii) pursuant to a duly
adopted, written plan of distribution—a “12b-1 Plan”.
• “Distribution”
• Fund deemed to be acting as a “distributor” of its securities if
it “directly or indirectly…[finances] any activity primarily
intended to result in the sale of shares….”

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12b-1 Plans
• Approval
– Approved initially by shareholders (if after fund launch) and majority
of independent directors who have no financial interest in the plan.
– Thereafter approved at least annually by same subset of directors.
– Directors must find that there is a “reasonable likelihood that the plan
will benefit the [fund] and its shareholders.
• Ongoing Review
– Directors must review a written report of amounts expended under the
plan, and reasons for expenditures, at least quarterly.
– Key line of inquiry:
• Has there been an indirect, unauthorized use of fund assets for
distribution?
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Non-Distribution/Intermediary Services
• Menu of services provided by fund intermediaries. Services
include:
– Sub-accounting
– Shareholder account set-up and maintenance
– Ongoing daily shareholder assistance
– Transaction processing and settlement (i.e. “sub-TA services”)
– Preparation and distribution of account statements and
transaction confirms
– Payment of fund dividends
– Prospectus distribution
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Non-Distribution/Intermediary Services
• Often provided by “Fund Supermarkets” and other third parties
that also provide distribution services
– No- or low-transaction fee platforms sponsored by broker-dealers,
offering a large menu of funds for purchase
– Enables investors to consolidate fund holdings at a single custodian
– Streamlines financial reporting
– Supermarkets charge fund complexes an asset-based fee to sell shares
on the platform
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Mutual Fund Supermarket No-Action Letter
• 1998 Letter to the ICI spelled out SEC Staff’s views on payments for “fund
supermarket” fees.
– Guidance has informed analysis of whether and how funds can finance other intermediary
services.
• While a fund must pay for distribution pursuant to the 12b-1 plan, it may pay for
other intermediary services pursuant to or outside the plan.
• **When payments for non-distribution services are made outside of the plan, key
inquiry is whether payments are indirectly for distribution purposes (i.e. “payments
for distribution in guise”) in violation of Rule 12b-1.
• Similarly, intermediary expenses that are paid out of the adviser’s (and not the
fund’s) resources could violate Rule 12b-1 if:
– there is an allowance in the advisory fee for such payments or
– if it otherwise appears that a portion of the advisory fee is for the purpose of compensating
the adviser for paying distribution costs on the fund’s behalf.
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Board Responsibilities for Reviewing
Intermediary Fees Paid by Funds
• If Board determines that entire intermediary fee is for distribution, then entire fee
should be paid pursuant to the 12b-1 plan.
• If Board determines that portion of intermediary fee is for non-distribution, then
Board must determine whether such amounts are reasonable in relation to:
– The value of the services and the benefits received by the fund; and
– The payments that the fund would be required to make to another entity to provide the
same services.
• If Board determines that none of the intermediary’s fee is for distribution, then
Board must “satisfy itself that its determination was supported by” relevant factors,
including:
– Nature of services provided
– Whether services provide any distribution benefits
– Whether services provide non-distribution benefits typically provided by intermediaries
– Costs of comparable services provided by other intermediaries
– Intermediary’s characterization of services provided 12

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Board Responsibilities for Reviewing
Intermediary Fees Paid by Advisers
• Investment Company Act Release No. 16431 (June 13, 1988):
– [W]hen an adviser finances the distribution of fund shares, the directors…must
satisfy themselves either that the management fee is not a conduit for the
indirect use of the fund’s assets for distribution, or that the fund has complied
with Rule 12b-1.”
– “It is appropriate to…view such expenditures as having been made from the
adviser’s profits under the contract. To the extent that such profits are
‘legitimate’ or ‘not excessive’, …no indirect payment for distribution occurs.”
– “If the fund‘s directors are satisfied that any distribution payments by the
adviser are made out of its own resources …, the directors may reasonably
conclude that the advisory contract is not a conduit for the payment of
distribution expenses. If such a conclusion is reached, the fund need not adopt
a 12b-1 plan to cover distribution payments borne by the adviser.”
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Recent Scrutiny
• 2013 and 2014 OCIE Exam Priority:
– “The IA-IC Program is focusing on the wide variety of payments made by advisers and funds
to distributors and intermediaries, the adequacy of disclosure made to fund boards about
these payments, and boards’ oversight of the same. These payments go by many
names…most commonly revenue sharing, sub-TA, shareholder servicing, and conference
support. The staff will assess whether such payments are made in compliance …Rule 12b-1,
or whether they are instead payments for distribution and preferential treatment.”
• OCIE Sweep Exams Begin in 2014-2015
– To date, no enforcement actions against registered fund complexes, but stay tuned…
• Feb. 26, 2015, Julie Riewe, Co-Chief, Asset Management Unit:
– “We …anticipate enforcement action from the Distribution in Guise Initiative, where we are
examining, among other things, conflicts presented by registered fund advisers using the
fund’s assets to grow the fund and, consequently, the adviser’s own fee.”
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Industry Best Practices
• There is inconsistency among industry participates on the implementation and controls
around distribution practices
• A few ‘must do’ activities:
– Review all existing intermediary agreements and amendments
– Assess how funds’ fees and expenses are disclosed to the board and investors
– Follow the money (Assess and understand how fees/expenses flow through organization to
intermediaries)
– Review internal control procedures for review and approval of fees increases, omnibus transitions,
and new intermediaries
– Consider removing business development/sales from the conversations regarding sub-transfer agent
fees and other administrative services fees.
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Questions
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Thank you for attending
CONTACT
Jason Rosenberg
jrosenberg@acacompliancegroup.com
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