Interpretive Letter to Barbara A. Mallon, Esq., Mallon & Johnson, P.C.
December 22, 2000
Barbara A. Mallon, Esq.
Mallon & Johnson, P.C.
19 South LaSalle Street
Chicago, IL 60603
Re: Mutual Fund Ticket Charges
Dear Ms. Mallon:
This is in response to your October 5, 2000 letter, and subsequent telephone conversations on October 13, 2000 and November 7, 2000, and E-mails on October 27, 2000 and November 3, 2000. Specifically, you inquire whether your client, which is a registered investment adviser under the Investment Advisers Act of 1940, a registered broker-dealer under the Securities Exchange Act of 1934, and an NASD member (the "Company"), may charge its broker-dealer customers a transaction cost that initially is charged to the Company by its clearing firms (the "Clearing Firms") when a customer redeems his or her shares of open-end investment companies (the "Mutual Funds") through the Company.
Based on your letter, subsequent telephone conversations, and E-mails, I understand the facts to be as follows. Acting as an agent, the Company engages in transactions in shares of the Mutual Funds on behalf of its customers. The Company has both advisory and broker-dealer only customers. When customers of the Company redeem their shares in the Mutual Funds, the Clearing Firms charge the Company a transaction fee (the "Fee"), which you also refer to as a "ticket charge."1 You indicated that the Fee is not a redemption fee charged by the Mutual Funds to shareholders for redeeming their shares. Here, the Fee is charged by the Clearing Firms to the Company and is not disclosed in the Mutual Funds' prospectuses. You also indicated that the Fee is typically in the range of $12 to $14 per transaction. You noted that, currently, the Company's advisory customers pay the Fee, which the Company discloses in the Form ADV as a transaction cost. However, with respect to its broker-dealer only customers, the Company has been absorbing the Fee, but is contemplating charging the Fee to its broker-dealer customers as well. In this regard, you also indicated that, if the Company charges the Fee to its broker-dealer customers, it intends to disclose the Fee in the customer confirmation.
The Fee the Company is contemplating charging to its broker-dealer customers generally would not be prohibited under NASD rules.2 However, as provided in NASD Notice to Members ("NTM") 92-11 (February 1992), a copy of which is attached, members are required under NASD Rule 2110 to provide their customers with written notification of any new or revised service charges, at least 30 days prior to implementing or charging such service charge. Accordingly, the staff believes that the Fee at issue would be considered a type of service charge, and therefore, the Company should notify its broker-dealer customers in writing at least 30 days prior to passing on the Fee to those customers.
Further, in NTMs 94-16 (March 1994) and 95-80 (September 1995), copies of which also are attached, the NASD reminded member firms of their obligations under NASD rules in connection with the purchase or sale of mutual fund shares. In those NTMs, the NASD indicated that member firms must disclose material facts to investors when recommending the purchase or sale of mutual fund shares. The NASD noted that a fact is material in this context "if the circumstances surrounding the investment decision lead one to believe the investor would regard a fact as material to his [or her] decision whether to invest in the fund." Thus, if the Company or an associated person recommends the purchase or sale of mutual fund shares to a broker-dealer customer, and if one would believe that the Fee would be material to the customer's decision whether to invest, the Fee should be disclosed.
I hope that this letter is responsive to your request. 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 you have raised based on the facts as you have described them, and does not address any other rule or interpretation of the NASD, or all the possible regulatory and legal issues involved.
Attachments [Consisting of NTM 92-11, reminding members of their obligations that all fees and charges for services must be reasonable and that adequate notice must be provided; NTM 94-16, reminding members of their obligations in connection with mutual fund sales practices, including their disclosure obligations when recommending the purchase or sale of a mutual fund to customers; and NTM 95-80, providing further explanation of members obligations with respect to mutual fund sales practices]
Carlotta A. Romano, Vice President and Director
1 In your October 5, 2000 letter, you stated that the Fee is charged to the Company by the Mutual Funds. However, in your November 3rd E-mail and our November 7th telephone conversation, you clarified that the Fee is charged to the Company by the Clearing Firms.
2 The staff notes, however, that the imposition of the Fee may raise issues under the federal securities laws, including, for example, Section 22(d) of the Investment Company Act of 1940. In this regard, you may want to consider reviewing Securities and Exchange Commission staff no-action letters interpreting Section 22(d), or contacting the SEC staff for further guidance.