April 11, 1997
I am responding to issues raised in your letter of February 20, 1997 to Larry Kosciulek, Assistant Director, Advertising Regulation Department, NASD Regulation, Inc., ("NASD Regulation"), which were further discussed in our subsequent conversation on March 19, 1997. You request confirmation that a certain mutual fund fee payment arrangement does not violate NASD Rules.
Based on your letter and our conversation, I understand the facts to be as follows: Under the proposed arrangement, [Broker/dealer] would serve as the broker of record and servicing agent for certain employee benefit plan customers ("Plans") which will invest in various mutual funds ("Funds"). As the broker of record, [Broker/dealer] would receive fees paid pursuant to Rule 12b-1 under the Investment Company Act of 1940 ("12b-1 fees") and commissions for amounts invested by the Plans at net asset value. Since customer purchase payments will be effected at net asset value, sales loads will not be deducted from customer purchase payments. 12b-1 fees will be deducted periodically from the Funds' average net assets. Pursuant to an agreement with each of the Plan sponsors, [Broker/dealer] would deposit a certain percentage of the commissions and 12b-1 fees earned by [Broker/dealer] from Plan investments into accounts opened in the names of the various Plans. Such deposits would be invested in a government money-market fund, and the proceeds of such investments would be used from time to time to defray various expenses, including administrative expenses and investment advisory fees, incurred by the Plans.
You expressed concern that such arrangements could be construed as a rebate of commission by [Broker/dealer] to unregistered persons. You request confirmation that such arrangements do not violate NASD Rules.
The staff believes that the proposed payment arrangement described above does not violate NASD Rules.
NASD Rule 2740 prohibits members from granting cash rebates to purchasing customers in connection with members' participation in fixed price public offerings. However, paragraph (h) to NASD Rule 0120 excludes from the definition of "fixed price offering" offerings of redeemable securities of investment companies which are offered at prices determined by the net asset value of the securities. Therefore, the payment arrangement described above would be excluded from Rule 2740 prohibitions.
NASD Rule 2420 precludes members from sharing or paying commissions or concessions with non-member broker-dealers. NASD Rule 2420 has been interpreted by NASD Regulation as preventing members from splitting commissions with or paying transaction-based compensation to entities that may be acting as unregistered broker/dealers. However, NASD Regulation staff does not believe that the Plans are acting as unregistered broker/dealers for purposes of the rule as a result of engaging in the payment arrangement described above.
I hope this letter is responsive to your inquiry. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation, Inc. This letter responds only to the issues that you have raised based on the facts as you have described them, and does not address any other rule or interpretation of the Association or all the possible regulatory and legal issues involved.
Robert J. Smith
Office of General Counsel
NASD Regulation, Inc.