Embed Size (px)
Citation preview
DC 1477730 v8
Mutual Fund DistributionRobert J. Zutz
Mutual Fund Distribution –Today’s Agenda
Multiple Distribution Channels
Methods of Compensating for Distribution Sales Loads Rule 12b-1 Fees/Service Fees Revenue Sharing Sub-transfer Agent Payments
Omnibus Accounts – Noteworthy Recent Developments
Share Classes
ETF Differences
1
Multiple Distribution Channels Distribution channels:
Direct (No-Load) Channel Broker-Dealer Channel RIA Channel “Supermarket” Channel Retirement Plan Channel Institutional Channel Insurance Company Channel
Each Distribution Channel Level and types of intermediary services vary Distribution costs and payment structures vary
Sales Loads Rule 12b-1 fees current) Service Fees Revenue Sharing Payments Sub-transfer agent-type fees from Funds
Multiple share classes
2
Multiple Shares Classes Rule 18f-3 Permits mutual funds to issue multiple classes of
voting stock representing interests in the same portfolio
Classes must differ in how they distribute their securities, in the services they provide to shareholders, or both
Allocation of income and expenses among classes Master-Feeder Structure – An alternative to multiple
share classes permitted by SEC interpretations
3
Share Classes Class A
Front-end sales load 12b-1 fee (service fee ~ 25 basis points) Breakpoints may be available
Class B CDSL decreases each year (such as to 5%, 4%, 3%, 2%, 1%, 0) 12b-1 fee (asset-based sales charge and service fee ~ 100 basis points) Converts to Class A share after 6-8 years, thus lowering 12b-1 fee
Class C Level 12b-1 fees (asset-based sales charge and service fee ~ 100 basis points) CDSL of 1% in the first year
Institutional No-load and no or low 12b-1 fee Retirement/RIA
Retirement Different levels of fees (Class R Shares)
4
Sales Loads Front-end Sales Load
Upfront fee that decreases amount of investment Section 22(d) – fixes sales load and prevents variations Rule 22d-1 permits disclosed variations in sales loads on class level
(e.g., breakpoints)
Deferred Sales Load (“CDSL” or “back-end”) Investor pays load, if any, at redemption pursuant to Rule 6c-10 Load based on lesser of offering price at purchase or specified % of
NAV
No Load Adviser pays for distribution from its profits Fund can be “no load,” even if charges up to a 25 basis points fee from
fund assets
Amount of loads limited by FINRA Conduct Rule 2830
5
Suitability of Share Class –FINRA Conduct Rule 2310
Considerations for share class suitability include: Investment amount (are load reductions available?) Expected term of the investment Sales loads, fees, and expenses
These factors affect the total return on the investment
An intermediary duty; not a mutual fund duty
6
Rule 12b-1 Fees Rule 12b-1 (adopted in 1980) permits funds to use fund
assets to directly pay for distribution expenses: Written plan
Initially approved by directors (including majority of independent directors) Initially approved by shareholders (unless adopted prior to public sales of
fund shares) Annual approval of directors (including majority of independent directors)
Board approval Finding that there is “reasonable likelihood that plan will benefit fund and
shareholders”
Board quarterly review of written report of amounts spent and reasons for expenditures
7
Rule 12b-1 Fees (continued)
Distribution expenses: Compensate intermediaries for ongoing advice
and/or services to current investors Compensate intermediaries for administrative
services to current investors (e.g., recordkeeping, account statements to investors)
Advertising, printing and mailing prospectuses and sales materials to prospective investors
8
Rule 12b-1 Fees (continued)
Maximum fee limited under FINRA Conduct Rule 2830 100 basis points maximum
75 basis points maximum for asset-based sales charge 25 basis points maximum for service charge
NASD Notice to Member 93-12 defines “service fees”
Rule 2830 limits aggregate amount of sales load and/or 12b-1 fee
Used as alternative or in addition to a sales load Issues: transparency and complexity
9
Rule 12b-1 Fees (continued)
Some 12b-1 plans are structured as so-called “reimbursement’ plans
Some 12b-1 plans are structured as so-called “compensation” plans
10
Revenue Sharing Fund adviser or affiliate pays for fund distribution
Adviser can pay from “legitimate” profits that are not “excessive” per SEC interpretation (although the U.S. Supreme Court suggests otherwise)
Disclosure of revenue sharing arrangements Fund disclosure Possible point of sale disclosure
11
Omnibus Accounts The Growth in Use of Such Accounts
Recent SEC Responses to this Growth
Increased Fees/Source of Payments
SEC Guidance Regarding Payments
Required Findings by Mutual Fund Boards
Developing Due Diligence Activities
SEC Sweep Examinations
12
ETFs ETFs only sell and redeem their shares at NAV
directly to unaffiliated broker-dealers with whom the ETF has entered into an agreement (“Authorized Participants”)
Exemption to Section 22(d): permits price competition by permitting selling brokers to set sales commission for share classes offered at NAV without ongoing sales charge
All “primary market“ transactions by ETFs occur in large blocks of (at least 25,000) shares called “Creation Units”
13
ETFs Authorized Participants purchase and redeem
Creation Units in kind in exchange for the “Creation Basket” Pro rata slice requirement Exceptions to pro rata slice requirement Custom baskets
Authorized Participants who purchase Creation Units sell individual fund shares on the stock exchange
No sales loads (or CDSCs) or Rule 12b-1 fees on ETFs
14
DC 9568152 v2
Compliance and ExaminationsAndras P. Teleki
Discussion OverviewI. Duty to Establish a Compliance Program
II. Chief Compliance Officer
III. Written Policies and Procedures
IV. Annual Review Process
V. SEC Examinations
1
Duty to Establish a Compliance Program
3
Rule 38a-1 Requirements Adopt and implement written policies and
procedures
Designate a Chief Compliance Officer (“CCO”)
Review the compliance program
Report to the Board
Maintain records
Board Approval Compliance program of the Fund
Compliance program of the Fund’s service providers
Reliance on summaries and third-party reports
Amendments and annual re-approval not required
4
Chief Compliance Officer
CCO Requirements Board must designate a CCO
Competent and knowledgeable
Empowered with full responsibility and authority
Position of seniority and authority
Duty to administer the compliance program
6
CCO Duties Ensuring compliance program is comprehensive
and current
Conducting annual compliance review
Reporting to the Board
Implementing any material recommendations
Advising senior management on compliance matters
Being the “go to person” on compliance issues
7
Independence of the CCO Board hires and fires
Board sets compensation
Direct reporting line to the Board
Annual executive session meetings with the Board
8
Written Policies and Procedures
Compliance Program Requirements
Coverage of policies and procedures Culture of compliance Delegation of responsibility Training Monitoring and auditing Response, prevention and evaluation
One size does not fit all Risk assessments Must be dynamic
10
Annual Review Process
Annual Review Compliance rule requirements
Testing schedule
Remediation schedule
Leverage work being done by others
Maintain documentation
12
Annual Report Written report to the board must discuss: Operation of the program Material changes to the program Material compliance matters
Annual report considerations
13
Material Compliance Matter Compliance rule definition any compliance matter about which the board would
reasonably need to know to oversee fund compliance
violations of federal securities laws violations of policies and procedures weakness in design or implementation of policies and
procedures
14
SEC Examinations
Regulatory Environment Ponzi schemes – Madoff
Pressure for OCIE to perform
Enforcement Division – Asset Management Unit
Increasingly complex regulatory environment
Additional voices beyond the SEC
16
Exam results Enforcement actions originate from exams
Enforcement action consequences
Face-to-face interactions with SEC staff
Deficiency letters
17
Exam preparation Contact person Notify management and personnel Prior exam records Examiner work area/resources Opening presentation Office tour Business cards Exit interview
18
Questions?
DC 1477775 v7
Portfolio Brokerage PracticesK. Susan Grafton
1
Market Structure Developments Best Execution Soft Dollars Rule 105 of Regulation M
Discussion Overview
MARKET STRUCTURE DEVELOPMENTS
3
One year pilot program to be developed and filed jointly by FINRA and the exchanges Filed with the SEC: August 25, 2014
Pilot Securities NMS common stocks with (a) a market capitalization of $5 billion or less; (b) an
average daily trading volume of one million shares or less; and (c) a share price of $2 per share or more
No recent IPO stocks Pilot Design: each group has 300 securities
Control Group: Current quote and trading increments Test Group One: Minimum quote increment of $0.05 minimum Test Group Two: Minimum quote and trade increments of $0.05. Exceptions for:
(1) trades at the mid-point, (2) trades that provide price improvement and (3) negotiated trades with performance targets (e.g., VWAP)
Test Group Three: Minimum quote and trade increments of $0.05, plus a “trade-at” requirement to prevent price matching by a trading center not displaying the NBBO
Tick Size Pilot Program
Pending Developments Regulation of high frequency traders Guidance on “traders exception” from the definition of
“dealer” in Section 3(a)(5) of the Securities Exchange Act of 1934
Elimination of exception from FINRA membership Increased Disclosure Institutional investor order routing information
Order types
Payment for order flow and rebates
Alternative trading systems
4
Disruptive Trading Practices In re Athena Capital Research, LLC,
Release No. 73369 (Oct. 16, 2014) First high speed trading manipulation case “Marking the Close”
Development of anti-disruptive trading rule Risk management of algorithmic trading
5
BEST EXECUTION
7
Generally, best execution is the duty to obtain the best price given the portfolio manager’s objective
Derives from common law and the anti-fraud provisions of the federal securities laws, particularly Section 206 of the Investment Advisers Act of 1940
SEC v. Capital Gains Research Bureau, 375 U.S. 180 (1963): Section 206 imposes a fiduciary duty on investment advisers Duty of loyalty and duty of care
Duty of Best Execution
8
Factors in Evaluating Execution Quality; Not Just Price
Price and price improvement Speed Certainty of execution Responsiveness Commission and commission
equivalent rates Order handling capabilities, such
as block and complex trades Expertise with relevant markets or
securities Assistance in finding liquidity and
willingness to commit capital
Access to market centers and other market participants
Low trading errors and willingness to correct mistakes
Value of research Confidentiality Reputation Capital adequacy Back office capabilities, including
automation and trade reporting Past experience
9
Implement and update written compliance policies and procedures addressing best execution: Broker selection Methods and measures for evaluating execution quality Allocation of desk or trader responsibility for particular funds, investing style,
and geographic and industry sectors
Establish a best execution committee with appropriate procedures Committee meetings should be periodic and systematic Minutes should be made and maintained under direction of legal
Implement and test systems for monitoring executions Determine tools that will be used
Broker-dealers’ “dash reports” (Exchange Act Rules 605 and 606) Other vendors (e.g., TAG)
Provide periodic training to relevant personnel
Establishing a Compliance Program
10
Focus should be on obtaining the best price given the portfolio manager’s objective
Trading desks should have the necessary tools, including an: Effective execution management system Timely and accurate market data as needed to determine the best price of a
security Protocols and mechanisms for handling trade aggregation, trade allocation, and
trade sequencing Procedures for complying with regulatory requirements relating to cross and
agency-cross trades and principal transactions Client account instructions, including account objections, use of soft dollars, and
disallowed brokers
Guidance should be provided regarding the number of dealers that should be contacted to obtain a price, particularly for illiquid and thinly-traded securities
Trading Desk Compliance
11
Periodic and systematic meetings of the best execution committee to review execution quality Analyze execution quality based on statistical information Review executing brokers, including with respect to the reasonableness of
commissions and commission equivalents, soft dollar arrangements, potential conflicts of interest, any credit or other financial issues regarding the broker, news relating to litigation, regulatory investigations, and other qualitative factors
Desk errors or mistakes Systems issues Available third-party data
Determine and assign responsibility for pre-meeting preparation
Assign responsibility for implementing any needed changes based on review
Make and keep relevant records
Post-Trade Review and Analysis
SOFT DOLLARS & DIRECTED BROKERAGE
13
Practice by which investment advisers use client commissions, rather than out-of-pocket funds, to pay for brokerage and research services provided by broker-dealers
Reflects the perceived value of research and brokerage services in managing client accounts, notwithstanding fiduciary principles requiring investment advisers to seek the best execution of client trades and to refrain from using client assets for their own benefit
Overview of Soft Dollar Arrangements
14
In 1975, Congress enacted Section 28(e) of the Exchange Act to provide investment advisers with a safe harbor from liability for a breach of fiduciary duty solely because the adviser paid more than the lowest commission rate in order to receive “brokerage and research services” provided by a broker-dealer
The adviser must determine, in good faith, that the amount of the commission is reasonable in relation to the value of the brokerage and research services received
Section 28(e) Safe Harbor
15
The investment adviser must exercise investment discretion for the account;
The adviser must determine in good faith that the amount of commissions is reasonable in relation to the value of products or services received; May be for a particular transaction or with respect to overall responsibilities
Only agency or eligible riskless principal transactions satisfy Section 28(e);
The services received must be eligible brokerage or research services that provide “lawful and appropriate assistance” to the money manager in the performance of its investment decision-making responsibilities; and
Commissions must be paid to a broker-dealer that “effects” the trades and/or “provides” the eligible product or service
Elements of the Section 28(e) Safe Harbor
16
Advice as to the value of securities; the advisability of investing in, purchasing, or selling securities; and the availability of securities or purchasers or sellers of securities
Analyses and reports concerning issuers, industries, securities, economic factors and trends, portfolio strategy, and the performance of accounts
Form is irrelevant – includes paper, electronic, and oral discussions Must be the “expression of reasoning or knowledge” Potentially eligible research includes research reports, market color,
investment seminars, meetings and discussions with research analysts and company executives, trade analytics, proxy services that are reports on issuers and securities, certain software, and market and economic data services
Ineligible research includes mass-market publications (WSJ), operational overhead (salaries, rent, equipment, telephone lines), proxy services relating to the mechanical aspects of proxies, computer hardware, and travel
Section 28(e) Eligible Research
17
Executing securities transactions Performing functions that are incidental thereto
Clearance, settlement, and short-term custody related to particular trades Post-trade matching of information Electronic communications related to trades, allocations, and settlement
Temporal standard for determining if services relate to the execution of trades Begins when the adviser communicates with the broker-dealer for the purpose of
transmitting an order for execution, and Ends at the conclusion of a trade’s clearance and settlement (i.e., when
securities or funds are delivered or credited to the advised account)
Ineligible brokerage services include equipment, portfolio management software, compliance testing, trade financing, long-term custody, and prime brokerage services, including stock loan
Section 28(e) Eligible Brokerage Services
18
“Mixed use” means that eligible products or services have eligible and non-eligible uses
An inherent conflict exists because the non-eligible use benefits the adviser
The conflict is managed by the adviser making a reasonable allocation of the value of the mixed use service between eligible and non-eligible uses
Adequate books and records are needed to support allocations
Mixed Use Research and Brokerage Services
19
A broker-dealer effects a trade if it: Executes, clears, or settles the trade; or Performs one of four specified functions and
allocates the other functions to another broker-dealer Takes financial responsibility for trades until settlement Maintains records Monitors and responds to customer comments concerning
the trading process Monitors trades and settlements
“Effecting” Trades
20
Broker-dealers provide research or brokerage services if they: Prepare the research; Are financially obligated to pay for the research; or Are not financially obligated to pay for the research,
but take reasonable steps to assure themselves that client commissions are used only for eligible research and brokerage (i.e., no red flags)
“Providing” research or brokerage services
21
SEC guidance has facilitated the use of soft dollar aggregators and service providers that are not registered broker-dealers See Goldman, Sachs & Co., SEC No-Action Letter (Jan. 2007)
Conditions of the no-action relief: The adviser must independently value the services; The executing broker may not participate in valuing the services; Payments to the service provider must be from a commission pool that
the executing broker and adviser have agreed to set aside for obtaining services;
Payments may not be conditioned on the execution of transactions in securities that are described in the research; and
Service providers cannot perform other functions typically characteristic of acting as a broker-dealer
Client Commission Arrangements
22
Directed brokerage involves an advisory client directing transactions to a particular broker and receiving products or services directly from the broker
Full and fair disclosure must be provided to advisory clients of: The existence and terms of practice regarding brokerage transactions, and the
effect of such practices on commissions The effect of client directed brokerage on the adviser’s ability to obtain volume
discounts, negotiate commissions, or achieve best execution for some transactions
The potential for disparities in commission charges The potential conflicts of interest
Disclosures should be included in Form ADV, fund prospectuses, and the investment management contract and updated as appropriate
Compliance procedures should address the use of directed brokerage See In re Mark Bailey & Co., Advisers Act Release No. 1105 (Feb. 24,
1988)
Directed Brokerage
23
Written policies and procedures, including recordkeeping
Approval and compliance procedures, including: Confirming the eligibility of products and services Reviewing the eligibility of executions (i.e., agency or eligible riskless principal) Evaluating broker-dealers Analyzing brokers’ soft dollar reports with internal records Reviewing allocations of mixed use products and services Evaluating appropriate use of commissions (e.g., use of commissions paid by
indexed funds) Confirming consistency with disclosures and procedures
Oversight and periodic review of soft dollar and directed brokerage arrangements for compliance
Employee training
Compliance Considerations
RULE 105 OF REGULATION M
25
Rule 105 in a Nutshell Rule 105 prohibits short sales of equity securities that
are the subject of a firm commitment cash offering pursuant to a registration statement by any person who purchases the offered securities from an underwriter or broker-dealer participating in the offering.
Restricted Period: Short sales are prohibited during the shorter of the period beginning (a) five business days before the pricing of the offering and ending with the pricing, or (b) with the initial filing of the registration statement or notification and ending with the pricing.
26
Key points about Rule 105 “Per se” violation; no intent requirement “Short sale” has the same meaning as in Regulation
SHO Rule 200(a) of Regulation SHO defines a “short sale”
as “any security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller.”
Only applies to equity securities
Does not apply to reference securities or to best efforts offerings
27
Excepted Activity –Bona Fide Purchases
Purchases in an offering are permitted notwithstanding a short sale during the restricted period if: The number of shares purchased must at least equal the entire amount
of the shares sold short during the restricted period; The purchase must be bona fide (i.e., even if the purchaser is in
technical compliance with this exception, the purchaser must be subject to the economic risks associated with a purchase for value);
The purchase(s) must be reported transactions and effected during regular trading hours by or before the end of the regular trading session on the business day prior to the day of pricing;
The purchases must occur after the last short sale; and The short seller cannot effect reported short sales during the last 30
minutes of regular trading on the business day before pricing.
28
Excepted Activity –Separate Accounts
Short sales in separate accounts may be disregarded for purposes of determining eligibility to purchase securities in an offering.
“Account” can include “portions of a particular fund,” a “unit,” a “department” or an “identifiable division.”
Decisions regarding securities transactions for each “account” must be made separately and without any coordination of trading or cooperation among or between accounts.
29
SEC Guidance on Separate Accounts
Separate and distinct investment and trading strategies and objectives
Separately assigned personnel with no coordinated trading
Information barriers No sharing of information about securities positions and investment decisions Separate profit and loss statements No allocation of securities between or among accounts
No authority of senior supervisory or managerial personnel to execute or preapprove trades in individual securities for the different accounts
Account owners of multiple accounts cannot execute or have the authority to execute trades in individual securities in the accounts, or pre-approve or have the authority to pre-approve trading decisions for the accounts.
30
Excepted Activity –Investment Companies
A registered investment company may purchase securities in an offering without regard to short sales by an affiliated investment company or series of such a company, or a separate series of the investment company.
This exception is based on the prohibition under 1940 Act Section 17(d) and Rule 17d-1, which generally prohibit any arrangement or concerted action between affiliated persons of registered investment companies.
QUESTIONS?
DC 9870843 v1
Exchange-Traded Funds (ETFs)Stacy L. Fuller
What are ETFs? Registered investment company with
hybrid structure – characteristics of open-end (mutual) and closed-end funds Classified under the 1940 Act as open-end
funds, but trade intra-day on stock exchanges like closed-end funds Retail investors buy and sell on a stock
exchange, rather than in transactions directly with the fund
1
2
Why are ETFs sometimes referred to as ETPs?
Distinguishing ETPs and ETVs ETPs: Commodity funds, currency funds ETVs: Generic
Not ETNs Unsecured, debt securities Unlike ETFs and ETPs, ETNs are not equity
securities
How do ETFs work? ETFs sell and redeem their shares at NAV
directly to unaffiliated broker-dealers with whom the ETF has entered into an agreement (“Authorized Participants”)
These “primary market” transactions occur in large blocks of (at least 25,000) shares called “Creation Units”
3
How do ETFs work? Authorized Participants purchase and
redeem Creation Units in kind in exchange for the “Creation Basket” Pro rata slice requirement Exceptions to pro rata slice requirement “Custom” baskets
Authorized Participants (who purchase Creation Units) sell individual fund shares on the stock exchange
4
5
Primary MarketSecondary Market
How do ETFs work?
PrivateInvestors
Brokers
Stock Exchange
Authorized P
articipants
ETF
Subscription in kind –The AP delivers a basket of
securities and the ETF issuesshares
Buy / SellOrder
Redemption in kind –The ETF delivers the
securities and the shares are redeemed
Bid/offerPrice
Secondary MarketPrimary Market
Securities
Hedging –Futures/ETFs
6
How do retail investors buy ETFs?
Business considerations
7
8
Why have ETFs become more popular?
Changes in Distribution Models Demand (by RIAs) due to Lower Expenses
Enhanced returns
Transparency Tax Efficiency Investor Protections
Intra-day liquidity Market timing
9
Is anyone doing non-transparent active ETFs?
Vanguard – 2007 Guggenheim – 2008 Blackrock – 2011 Precidian – 2013 SSgA – 2013 T. Rowe Price – 2013 Capital Group – 2014 Cohen & Steers – 2014 Fidelity – 2014
How would non-transparent active ETFs work?
Tracking Portfolio Guggenheim
Partial Transparency Vanguard T. Rowe Price Fidelity
Blind Trust Blackrock Precidian SSgA Capital Group
All of the Above Cohen & Steers
Other Eaton Vance
10
Are any of the non-transparent ETF structures patented?
TRACKING PORTFOLIO – “Black Box” Guggenheim (only known licensee)
BLIND TRUST – Precidian Sliding Scale License Fee Blackrock (first licensee), SSgA (second licensee)
NAV-BASED TRADING – Eaton Vance “Low Single Digits” License Fee No known licensees
11
DC 1251690 v8
Federal Tax Aspects Affecting Mutual FundsTheodore L. Press
Receive “pass-through” treatment under Subchapter M
Open-end funds (“mutual funds”) Closed-end funds Most exchange-traded funds (“ETFs”)
Regulated Investment Companies (“RICs”)
1
Requirements for RIC Treatment Domestic corporation (or entity classified as such) Registered under 1940 Act (or BDC election) Election to be a RIC – Form 1120-RIC Gross Income Requirement – 90% of gross income
Passive income Net income derived from an interest in a “qualified publicly traded
partnership” Income from commodities
Revenue rulings; exceptions Private letter rulings (suspended) RIC Modernization Act
2
Requirements for RIC Treatment (continued)
Diversification Requirements – close of each taxable year quarter (different from 1940 Act requirement) 50% of assets 5% of assets in a single issuer 10% of a single issuer’s voting securities Specific instruments (including repos and
government securities) 25% of assets
3
Diversification Requirements (continued) No disqualification for certain failures to
comply Exception for market fluctuations and distributions 30-day cure period RIC Modernization Act – “inadvertent” failure (i.e.,
failure “due to reasonable cause and not due to willful neglect”) and de minimis failure
Requirements for RIC Treatment (continued)
4
Distribution Requirement 90% of investment company taxable income Includes net short-term capital gain Includes net foreign currency gains and losses
90% of net tax-exempt income Net capital gain “Year-end Dividend Rule”
Requirements for RIC Treatment (continued)
5
Tax Treatment of Shareholders Income Dividends Qualified dividend income (individuals) –
15% and 20% maximum tax rates Dividends-received deduction (corporations)
Capital Gain Dividends Former designation requirement (within 60 days after
taxable year-end) replaced, by RIC Modernization Act, with reporting requirement
15% and 20% maximum tax rates for individuals
Undistributed Net Capital Gain
6
Tax Treatment of Shareholders (continued)
Exempt-Interest Dividends 50% diversification requirement
Interest-Related Dividends (“qualified net interest income”) and Short-Term Capital Gain Dividends Foreign shareholders Applicable only for taxable years beginning before
January 1, 2014; possibly extended
Pass-through of Foreign Taxes Paid
7
Disposition of Shares Taxable gain or loss – redemption, sale, or exchange
15% and 20% maximum tax rates for individuals
Disposition of shares within 90 days Limited to acquisitions by following January 31, by RIC
Modernization Act
“Wash” sales Sales after short holding period Basis election/reporting
3.8% tax on “net investment income”
Tax Treatment of Shareholders (continued)
8
9
Tax Treatment of Shareholders(continued)
Disposition of Money Market Fund (“MMF”) Shares Stable NAV – no taxable gain or loss New SEC rules – institutional non-government MMFs
must price shares using market values – “floating NAV” Dispositions could result in taxable gain or loss
Prompt Treasury/IRS response New revenue procedure - “wash” sales rules will not apply Proposed regulations – “NAV method” permits aggregating
gain/loss during a “computation period” (taxable year or shorter period)
Proposed regulations - Form 1099 information reporting not required for disposed shares
Income Tax Treatment of a RIC Investment Company Taxable Income –
taxable income with adjustments Net capital gain excluded No net operating loss or certain other
deductions Dividends-paid deduction Dividends paid during the taxable year Year-end Dividend Rule “Spillover dividends”
10
Excise Tax on Undistributed Income and Gains
4% Tax Measured by calendar year, not taxable year 98% of ordinary income 98.2% of capital gain net income 98% before RIC Modernization Act
100% of “prior year shortfall” Include dividends deemed paid under Year-
end Dividend Rule but not spillover dividends
11
Master-Feeder Structure RICs and other “institutional investors”
invest (as “feeder funds”) in a “master fund” Non-corporate registered management
company Partnership classification – “check-the-box” Publicly traded partnership Not registered under Securities Act of 1933, as
amended Private placement safe harbor
12
Multiple Class Arrangements Preferential Dividend Rule
Within class or between classes RIC Modernization Act – inapplicable to “publicly offered RICs”
Private Letter Rulings 12b-1 fees are shareholder expenses!
Revenue Procedure 96-47 Safe harbor Language similar to Rule 18f-3 under 1940 Act
Revenue Procedure 99-40 Waivers and reimbursements
13
14
Fund of Funds Reimbursement of Upper-Tier Fund of Funds’
Expenses General principle – corporation’s payment of
shareholder’s expense is constructive dividend Private letter rulings – not a preferential dividend
Before RIC Modernization Act, couldn’t use for RICs that wanted to pay exempt-interest dividends or to pass through foreign taxes; now “qualified funds of funds” may do so
DC 9567585 v1
Erisa For Investment AdvisersWilliam A. SchmidtWith appreciation to Bill Wade,
Partner, Los Angeles
1
Overview The Basics
Fund Perspectives
New Disclosure Obligations
ERISA: THE BASICS
What is “ERISA”? Employee Retirement Income Security Act
Federal law regulating benefit plans
State laws preempted
Other Federal laws (Advisers Act) apply
3
What Plans are Covered by ERISA?
Corporate retirement plans
Corporate “welfare” plans
Union retirement/welfare plans
“Taft-Hartley” plans
4
What Plans are Not Covered by ERISA?
Self-employed (“Keogh”) plans
Individual retirement accountsBut, . . .
Internal Revenue Code Section 4975
5
What Plans are Not Covered by ERISA? (continued)
Government plans
Church plans
Foreign plans
6
“Fiduciary” StatusThe key ERISA concept
Fiduciary status is “functional”
Basic fiduciary functions include (but are not limited to): Investment discretion Investment advice
7
Fiduciary Duties – General “Solely in the interest”; “exclusive purpose”
Prudence; diversification
Comply with plan documents
Duty of disclosure – an evolving concept
Avoid prohibited transactions
Employer securities rules
8
Consequences of Breach of Fiduciary Duty
Restore “losses”
Disgorge “profits”
“Equitable relief”
Excise tax under Code Section 4975
“Correction” of prohibited transaction
9
Fiduciary Duties – Prohibited Transactions
Two categories of prohibited transactions:
“Fiduciary” prohibited transactions –transactions involving self dealing or conflicts of interest by plan fiduciaries
“Party in interest” transactions –transactions between a plan and a “party in interest” of the plan
10
“Fiduciary” Prohibited Transactions
Statutory prohibition against fiduciary self dealing and conflicts of interest
General principles in DOL regulation
Examples: Compensation arrangements Cross trades “Kickbacks”
11
“Party in Interest” Prohibited Transactions
Plan fiduciary may not cause plan to engage in any of following transactions if fiduciary knows or should know the transaction is with a “party in interest”: Sale, exchange, lease Loan, extension of credit “Use” of plan assets for benefit of party in interest Services
12
“Party in Interest” Prohibited Transactions
Who is a “party in interest”?
PLAN
And, certain affiliates and parties related to the persons described above
OtherService
Providers(e.g., brokers,
custodians
Plan Sponsor:Employer,
UnionPlan
Fiduciaries(e.g., Investment
Managers)
13
ERISA AND INVESTMENT FUNDS
Fund Perspective Mutual Funds
Bank Collective Trusts
Insurance Company Separate Accounts
Private Investment (Hedge) Funds
15
Does ERISA Apply?(Are Fund Assets “Plan Assets”?)If fund assets are “plan assets” –
Fund manager is an ERISA “fiduciary”
Plans have “undivided interests” in all fund assets
Fund transactions subject to ERISA restrictions, including prohibited transactions
Exculpation, indemnity of fund manager limited
16
“Plan Assets”? Registered investment company – mutual fund
or closed-end fund?
NO
Bank collective trust fund
YES
Insurance company pooled separate account
YES
17
What about Private (Hedge) Funds?
The “25% Test” –
Assets of a private investment fund are treated as “plan assets” if benefit plan investors hold 25% or more of any class of equity interests in the fund – not counting any interests held by the fund manager or its affiliates for their own account.
18
The Numerator: “Benefit Plan Investors”
Defined in ERISA § 3(42): Plans subject to ERISA Plans subject to Code Section 4975 “Plan asset” funds
19
25% Test – The FormulaNumerator:
ERISA plansplus Code 4975 plansplus “Plan-asset” funds (ERISA “portion”)
Denominator:Investments by all investors
less investments by fund manager and “affiliates”
= 25% (or more)per class?
20
NEW DISCLOSURE OBLIGATIONS
Overview Schedule C of Form 5500
“Service Provider Information” Effective for 2009 Form 5500
Service Provider Exemption New Regulations under ERISA 408(b)(2) Effective July 1, 2012
Participant Disclosures New Regulations under ERISA 404(a) Initial disclosures for most plans required by August 31, 2012
22
Initial Considerations Which plans are covered?
Who must disclose?
To whom must disclosure be given?
How must disclosure be made?
When must disclosure be given?
What must be disclosed?
23
Which Plans are Covered?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
“Large Plan” (100 or more participants).
Plans subject to ERISA.
Welfare plans to be addressed later.
IRAs, Keogh plans, “top hat” plans, single participant corporate plans should not be covered.
Participant-directed plans.
24
Who Must Disclose?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
Plan Administratorof plan with 100 or more participants.
However,service providers expected/required to provide information to plan administrator on request.
“Covered Service Provider” who:
contracts with plan,
expects to receive ≥ $1000, and
acts as fiduciary or RIA, or provides certain other services.
Plan Administratorof participant-directed plan.
However,plan administrators will request info from providers of “designated investment alternatives.”
25
To Whom Must Disclosure be Given?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
Plan Administrators file Form 5500 with DOL/IRS.
(Service providers expected/required to provide information to Plan Administrators.)
Service provider required to disclose information to “Responsible Plan Fiduciary” (i.e., fiduciary who causes plan to enter into contract with service provider).
Plan Administrator required to give information to plan participants and beneficiaries.
(Plan Administrators will request investment info from service providers.)
26
How Must Disclosure be Made?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
Plan Administrator must report information on Form 5500.
(Form of service provider disclosure to Plan Administrator not specified – presumably in writing.)
Covered service provider must disclose information to Responsible Plan Fiduciary in writing.
(DOL may clarify whether disclosures may be provided by ADV Part 2 or fund documents.)
Plan Administrator generally must provide information in writing.
Pending further guidance, certain information may be providedelectronically (see Tech Rel. 2011-03).
27
When Must Disclosure be Given?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
Form 5500 is due July 31 of each year (unless extended).
“Covered Service Provider” must provide info within 30 days of receipt of Plan Administrator’s written request.
Service provider must disclose information “reasonably in advance” of date of contract (or contract extension / renewal).
Notice of changes not later than 60 days after service provider is informed of change.
Disclosures required on or before date a participant first may direct investments under the plan.
Participants to receive annual disclosures.
Web site content to be kept up to date.
28
What Must be Disclosed?Schedule C(Form 5500)
Service Provider Exemption
Participant Disclosures
“Compensation” (money or “anything of value”), if ≥ $5000.
Direct compensation
Indirect compensation
Services provided
Status statement
“Compensation” (anything of monetary value) –direct, indirect, termination, “offset” compensation
Plan-related information
Information related to “Designated Investment Alternatives”
29
CONCLUSION
