Rebate of SEC Rule 12b-1 fees and commissions to non-member retirement plan and its participants will not violate NASD Rule 2420 if the SEC determines that the rebate recipients are not required to register as broker/dealers.
March 8, 2001
Jay Adams Knight, Esq.
Musick, Peeler & Garrett LLP
One Wilshire Boulevard
Los Angeles, California 90017-3383
Re: Payment of Rule 12b-1 Fees
Dear Mr. Knight:
This responds to your letter of January 22, 2001, in which you seek confirmation that certain mutual fund fee payment arrangements do not violate NASD rules, specifically NASD Rules 2420 and 2740. Based on the facts as you have described them below, the staff does not believe the arrangements violate Rule 2740. However, we cannot determine whether the arrangement might violate Rule 2420, absent a no-action letter from the Securities and Exchange Commission ("SEC") addressing whether the recipient of the fees is required to register as a broker/dealer.
Based on your letter and our conversation of February 6, 2001, I understand the facts to be as follows:
An employer implements a qualified retirement plan ("the Plan") that allows employees to invest in certain mutual funds. The plan is administered by a broker/dealer that will receive payment of fees and commissions pursuant to Rule 12b-1 under the Investment Company Act of 1940. Those fees and commissions will be based on amounts invested by Plan participants at the net asset value of the various available mutual funds in the Plan. Further, the broker/dealer will rebate a portion of the 12b-1 fees and commissions it receives to an account opened in the name of the Plan. The rebated funds will be invested in either equity or bond mutual funds and used to defray expenses incurred by the Plan, including administrative expenses and investment advisory fees. The rebated funds might also be allocated to the accounts of Plan participants based on one of several formulas.
NASD Rule 2420 generally prohibits payment of fees and commissions to non-member broker/dealers. This rule has been interpreted by NASD Regulation to prohibit such payments to entities that operate (or based on the proposed activities, would operate) as unregistered broker/dealers. The determination of whether an entity should be registered as a broker-dealer rests with the SEC. Generally, NASD Regulation does not consider it appropriate to conclude that a particular arrangement would not violate Rule 2420 unless the non-member entity has obtained a no-action letter from the SEC staff indicating that the entity is not required to register as a broker/dealer. Therefore, you should consult with the SEC’s Division of Market Regulation, Office of Chief Counsel, if you have any question as to whether the Plan should be registered. So long as the Plan does not operate as an unregistered broker/dealer, the described arrangement would not violate NASD Rule 2420.
We also note that in other contexts, the NASD has rules that prohibit rebating of fees or commissions to customers. Rule 2740 generally prohibits members from granting concessions, discounts or rebates to anyone other than a broker-dealer in connection with a fixed price offering. However, Rule 2740 would not be applicable to the arrangements you have described because the 12B-1 fees are not paid "in connection with the sale of securities which are part of a fixed price offering."1
I hope this letter is responsive to your inquiry. Please be advised that the opinions expressed in this letter are those of the staff and have not been reviewed or endorsed by the NASD Regulation Board of Directors. This letter responds only to the issues that you have raised based on the facts as you have presented them and does not address any other NASD rules or all the possible regulatory or legal issues involved, including in particular any issues that may be raised under the Investment Company Act of 1940, the Employee Retirement Income Security Act of 1974, or any rules or interpretations thereunder.
Very truly yours,
Philip A. Shaikun
Office of the General Counsel
NASD Regulation, Inc.
1 NASD Rule 0120 exempts from the definition of "fixed price offering" those offerings of redeemable securities of investment companies registered pursuant to the Investment Company Act of 1940 that are offered at prices determined by the net asset value of the securities. The arrangement you have described falls within this exemption.