February 10, 2023
Who may be interested: Investment Advisers, Mutual Fund Boards of Directors
Quick Take: The SEC staff recently issued a bulletin to highlight the requirements of Section 18 of the Investment Company Act of 1940 (1940 Act) and Rule 18f-3 thereunder and to remind mutual funds and their boards of directors of the implications of instituting fee waivers and expense reimbursement arrangements that result in different advisory fees being charged to different share classes of the same fund (“differential advisory fee waivers”).
The bulletin explains that Rule 18f-3 permits funds to issue multiple share classes, provided that, among other things, (i) the classes have specified differences in expenses, rights and obligations (and are permitted, though not required, to have certain other differences), (ii) class voting is required for certain matters, and (iii) income and expenses are allocated across classes. The rule requires a fund’s board of directors to approve a written plan detailing the multi-class structure based on a finding that the plan is in the best interests of each class and the fund.
The bulletin notes that Rule 18f-3 permits fee waivers and expense reimbursements provided that such arrangements do not result in cross-subsidization of fees among classes. One principle underlying Rule 18f-3, as expressed in the bulletin, is that advisory fees charged to all classes of a fund should “generally be the same percentage amount” since shareholders receive the same advisory services regardless of class.
Based on that principle, the bulletin identifies long-term or permanent differential advisory fee waivers as possibly creating a means of cross-subsidization among classes in contravention of Rule 18f-3, but clarifies that this is a “facts-and-circumstances determination” that a fund board should make after considering all relevant factors.
The bulletin provides an illustrative example of how a board might evaluate advisory fee waivers for potential cross-subsidization, suggesting that the board could determine that a long-term waiver for one class does not cause cross-subsidization when a) shareholders in the waived class still pay advisory fees in a fund-of-funds structure, and b) those fees, added to the fees applicable to the waived class, are at least equal to the fees paid by other classes. In this scenario, the waiver would not “demonstrably” be subsidized by the shareholders of other classes and thus would be permissible under Rule 18f-3.
The bulletin further encourages boards of funds that already have differential advisory fee waivers in place to consider whether such waivers present a means for cross-subsidization, whether appropriate steps are being taken to monitor such waivers to guard against cross-subsidization, and whether alternative fee arrangements may be appropriate. Additionally, the bulletin states that funds should consider the extent to which such deliberations should be disclosed to shareholders.
The staff bulletin may be found here.
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The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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