At the request of the Securities and Exchange Commission ("SEC"), NASD convened and led a Joint NASD/Industry Breakpoint Task Force, with representatives from, among others, Investment Company Institute ("ICI"), Securities Industry Association ("SIA"), National Security Clearing Corporation ("NSCC"), broker/dealers, mutual funds, and transfer agents, to examine the difficulties that the financial industry experienced delivering breakpoint discounts on Class A mutual fund share sales and to develop recommendations to facilitate the complete and accurate delivery of breakpoint discounts in the future. The Task Force determined that there was no single "solution" that would ensure the delivery of breakpoint discounts on future mutual fund transactions. Accordingly, the Task Force determined that the most effective course of action would be to recommend improvements to a variety of practices within the financial industry that would facilitate the delivery of breakpoint discounts. These recommendations included enhancements to the systems involved in identifying breakpoint opportunities and processing mutual fund transactions, as well as improvements designed to further public awareness and industry knowledge regarding the terms upon which breakpoint discounts are available and to facilitate the collection and recording of the information necessary for investors to obtain this benefit. Thus, the Task Force made recommendations that will impact virtually every level of the mutual fund distribution chain.
In July 2003, the Task Force published these recommendations in the Report of the Joint NASD/Industry Task Force on Breakpoints (the "Task Force Report"). On behalf of the Task Force, NASD is pleased to provide the following report regarding the progress that has been made toward implementing the recommendations set forth in the Task Force Report.
Immediately after the publication of the Task Force Report, working groups consisting of members of the Task Force and other industry experts, along with ICI and SIA staff, began efforts to implement the recommendations, with the assistance of NASD.1 As a result, the financial industry has taken the steps necessary to fully implement seven of the Task Force's 13 recommendations (Recommendation C - Mutual Fund Prospectus and Web Site Disclosure; Recommendation E - Standardized Checklists or Order Verifications; Recommendation F - Record of Linkage Information; Recommendation G - Prospectus Disclosure Regarding Customer's Role in Assisting in Securing Breakpoint Discounts; Recommendation I - Written Disclosure Statement; Recommendation J - Registered Representative Training; and Recommendation K - Investor Education.). Moreover, substantial progress has been made toward implementing the remainder of the recommendations. NASD expects that the working group developing common definitional terms (Recommendation A) will complete its work by the end of April 2004. In addition, the working group preparing recommendations for a centralized breakpoint schedule and rules database (Recommendation B) has made substantial progress, and anticipates that the NSCC will have completed the work to make the database structure available to mutual fund companies by the end of May 2004, with population of the database with the pertinent schedules and rules by the mutual fund industry to follow. The Task Force also has made substantial progress toward implementing the remaining four recommendations, which involve the content of breakpoint confirmations (Recommendations D and H) and the introduction of automated processing solutions designed to facilitate the delivery of breakpoint discounts (Recommendations L and M). The action taken on these recommendations must be coordinated with recent SEC proposals on point of sale and confirmation disclosure, and mandatory redemption fees.
In this report, we first identify the recommendations that have been implemented and summarize the actions taken to fulfill those recommendations. Next, we describe the progress that has been made toward implementing recommendations where implementation efforts are ongoing.
- Recommendations That Have been Implemented
Recommendation E: Standardized Breakpoint Checklist
The Task Force recommended that broker/dealers require registered representatives to complete "checklists" to ensure that they provided customers with information about the availability of breakpoints and made the necessary inquiries to determine whether customers might be entitled to breakpoint discounts as a result of Rights of Accumulation or Letters of Intent, as well as with respect to the current purchase.
NASD and industry representatives developed a standardized checklist for use by registered representatives at the point of sale to facilitate the identification of breakpoint opportunities. The checklist prompts registered representatives to solicit the appropriate information from customers to ensure that broker/dealers can deliver all available breakpoint discounts to customers. NASD posted this checklist on its Web site on November 3, 2003.
Recommendation F: Record of Account Linkage Information
The Task Force recommended that broker/dealers create a record to memorialize information about account linkage opportunities that could be updated with each transaction.
NASD and industry representatives developed a standardized account information worksheet to record the pertinent data regarding a customer's holdings and the holdings of related parties held at the broker/dealer, at other broker/dealers, and in other platforms. This document is designed to assist broker/dealers in identifying breakpoint discounts that may be available on the customer's current transaction and future transactions, and on transactions by parties related to the customer. NASD posted this record of account information worksheet on its Web site on November 3, 2003.
Recommendation I: Written Disclosure Document
The Task Force recommended that broker/dealers provide a written disclosure to customers summarizing the availability of breakpoint discounts at both the time of purchase and on a periodic basis thereafter. The Task Force concluded that such a document would help educate customers about breakpoint discounts at a time when they could best take advantage of the information.
NASD and industry representatives developed a sample written disclosure document for registered representatives to give to investors at the point of sale, which explains the circumstances under which breakpoints are available and how those potential discounts may impact decisions regarding the appropriate share class for an investor. NASD posted this disclosure document on its Web site on December 23, 2003.
Recommendation K: Investor Education
The Task Force recommended that both regulators and the financial industry commit themselves to providing educational materials to customers, who would then be in a better position to ensure that they received the breakpoint discounts to which they were entitled. Both regulators and those involved in the sale and distribution of mutual funds have made efforts to implement Recommendation K, as summarized below. These efforts are ongoing, but much has been accomplished.
- The SEC, NASD, ICI, and SIA have issued several investor publications on the subject of breakpoint discounts and mutual fund share classes.
The SEC's investor publications include:
NASD's investor publications include:
- Mutual Fund Breakpoints: Are You Owed a Refund? (11/3/03)
- Mutual Fund Breakpoints: A Break Worth Taking (1/14/03)
- Understanding Mutual Fund Classes (1/14/03)
ICI's publications include:
SIA's publications include:
- The SEC, NASD, ICI, and SIA are working to produce an educational brochure for investors on breakpoint discounts. The working group has produced a draft brochure and anticipates that the brochure will be available by May 2004.
- NASD has initiated a national print advertising campaign to alert investors that they may be due refunds as a result of certain firms' failure to provide breakpoint discounts.
Recommendation J: Registered Representative Training
The Task Force recognized that a key component of facilitating the delivery of breakpoint discounts was providing registered representatives with training about the availability of breakpoint discounts. It recommended that firms provide firm element training on the subject of breakpoint discounts and that self-regulatory organizations require regulatory element training on the topic of breakpoint discounts.
Like Recommendation I, Recommendation J will require ongoing efforts to ensure that registered representatives receive sufficient training to understand how breakpoint discounts work and the ways in which these discounts can benefit investors. In furtherance of Recommendation J, NASD developed a training outline of the critical topics that firms should address when training registered representatives about breakpoint discounts. NASD published this outline on its Web site on November 19, 2003.
The Securities Industry/Regulatory Council on Continuing Education ("the Council") acted promptly to enhance training on breakpoint issues. It gave prominent notice of mutual fund breakpoints in the 2003 Firm Element Advisory, which is published annually to provide firms with guidance on Firm Element training topics. It is expected that firms will make breakpoints a major topic in their Firm Element training programs.
The Council also encouraged the Regulatory Element content committees to address breakpoints and mutual fund sales practices in new scenarios that will be released into the Regulatory Element in late 2004.
Recommendations C & G: Mutual Fund Prospectus and Web Site Disclosures/Prospectus Disclosures Regarding Customer's Role in Securing Breakpoint Discounts
The Task Force recognized that a vital step in facilitating the delivery of breakpoint discounts is ensuring that those who buy and sell mutual funds understand the terms upon which mutual funds offer breakpoint discounts and have the means to verify that all available breakpoint discounts were applied to each mutual fund transaction. Accordingly, the Task Force recommended that the SEC promulgate regulations that require mutual funds to disclose critical data regarding pricing methods, breakpoint schedules, and linkage rules in their prospectuses and on their Web sites. Additionally, the Task Force recommended that the SEC require mutual funds to disclose, in their prospectuses, the information that investors may need to provide to their broker/dealers to secure all available breakpoint discounts. In particular, the Task Force recommended that the SEC require mutual fund prospectuses to disclose that investors may need to provide information about the historical cost of their investments and information about accounts that they or related parties hold at other firms or in other platforms to take full advantage of available breakpoint discounts.
NASD and industry representatives have completed their work on this recommendation. On behalf of the Task Force, NASD submitted a rulemaking petition to the SEC in August 2003 that recommended that the SEC revise Form N-1A to require mutual funds to disclose both their breakpoint schedules and key aspects of their aggregation rules in the prospectus that they provide to shareholders upon the purchase of fund shares. NASD's rulemaking petition also requested the SEC to promulgate rules requiring mutual fund prospectus disclosures that explain that investors may need to provide information, such as the existence and extent of other holdings, and the historical costs of those holdings, to their broker/dealers to take full advantage of all available breakpoint discounts. By letter dated November 20, 2003, the ICI provided the SEC with specific comments and suggestions regarding amendments to Form N-1A. NASD voiced its support for ICI's suggestions by letter dated December 4, 2003, and suggested further disclosures for consideration. In particular, NASD recommended that to the extent mutual funds disclose information about breakpoint discounts in their Statements of Additional Information ("SAI"), the SEC should require mutual funds to provide ready access to their SAIs and provide links to their SAIs on their Web sites.
On December 17, 2003, the SEC published a proposal in response to these recommendations for comment. The SEC proposal is available at: http://www.sec.gov/rules/proposed/33-8347.htm. The comment period expired on February 13, 2004.
- The SEC, NASD, ICI, and SIA have issued several investor publications on the subject of breakpoint discounts and mutual fund share classes.
- Recommendations in Progress
Recommendation A: Common Definitional Standards
The Task Force recognized that one of the difficulties in delivering breakpoint discounts was the variety of circumstances under which mutual funds offer these discounts. Without infringing upon mutual funds' ability to set the rules governing the availability of breakpoint discounts, the Task Force wanted to simplify the process of understanding the rules of each mutual fund. Accordingly, the Task Force recommended that mutual funds adopt "common definitions" of terms frequently used to define breakpoint opportunities.
Although mutual funds will remain free to set rules regarding when Rights of Accumulation are available, the common definitional standards will encourage mutual funds to describe these rules with uniform language, which should enhance the delivery of breakpoint discounts. In other words, the Task Force recommended that, in describing aggregation rules, the meaning of terms should be the same when used by different funds; for example, a "minor child" could be defined as any child under the age of 21, regardless of the age of majority recognized by the law of the state in which the child resides.
Shortly after the publication of the Task Force Report, a working group of the Task Force began the process of creating common definitional standards that will be used to describe the circumstances under which a mutual fund offers Rights of Accumulation. Both the Task Force members and NASD staff have reviewed the proposed standards, and the working group has reported that the final version of the common definitional standards will be available by the end of April 2004.
Recommendation B: Central Breakpoint Schedule and Linkage Database
The Task Force recommended that the mutual fund industry create a central database that contains information regarding the breakpoint schedules, pricing methods (net asset value, public offering price, or historical costs), and linkage rules for each mutual fund, which would be accessible from the desks of registered representatives. Such a database would assist registered representatives in understanding the rules of each mutual fund, thereby facilitating the full and accurate delivery of breakpoint discounts to customers.
This recommendation involved a substantial commitment of time and resources to both develop the software and dedicate the hardware necessary to house the database. On May 24, 2004, NSCC will begin to introduce changes to its Mutual Fund Profile Service ("MFPS") to establish the structure of the database. At that time, NSCC will expand the data fields contained in the MFPS Profile II database, which currently contains information about investment levels and breakpoint discount rates. Once NSCC includes these data fields in the database, the mutual funds will begin to populate the database with the rules that govern the availability of breakpoint discounts, including breakpoint schedules and the rules governing Rights of Accumulation and Letters of Intent. Broker/dealers will be able to use the data available on the MFPS to identify breakpoint opportunities that may be available to investors.
In addition, NASD is working with NSCC to determine the most effective way to allow brokers and investors to find the breakpoint opportunities available for a given fund through NASD's public Web site. We intend to make this service available to the public shortly after the mutual funds have populated the expanded data fields contained in the MFPS Profile II database.
Recommendations D and H: Confirmation Disclosure/Confirmation Breakpoint Legend
The Task Force recommended that mutual fund confirmations state the sales load paid on each transaction in percentage terms (Recommendation D), and that a confirmation for a mutual fund transaction contain a statement that alerts investors to the availability of breakpoint discounts and directs them to the appropriate materials for determining their own eligibility for breakpoint discounts (Recommendation H). These recommendations were geared toward providing investors with the ability to determine whether they received all the breakpoints discounts to which they were entitled on each mutual fund transaction.
A working group of the Task Force is developing textual language and numerical representations to include on confirmation statements. This task is complicated by the calculations that mutual funds use to determine the number of shares that an investor will receive, which in turn impacts the calculation of the load that the customer actually pays. Due to the rounding practices associated with these calculations, the actual sales load a customer pays may vary slightly from the sales load listed in the breakpoint schedules in the mutual fund prospectus. The working group anticipates full implementation of these recommendations by October 2004.
The work with respect to implementing this recommendation is being done in consultation with the SEC, which proposed on January 29, 2004, a new rule governing confirmation disclosure requirements, point of sale disclosures, and prospectus disclosures regarding breakpoint discounts. The SEC proposal specifically addresses the potential impact of the mathematical rounding calculations, and suggests that this issue may be addressed by disclosures in the mutual fund prospectus. The SEC has sought comment on its proposal, and the comment period expires on April 12, 2004. The SEC proposal is available at: http://www.sec.gov/rules/proposed/33-8358.htm.
Recommendations L and M: Broker-Dealer Transmission of Taxpayer Identification Number ("TIN")/ Broker Identification Number ("BIN") data to Mutual Funds and Transfer Agent Searches
To enable the financial industry to automate the process of identifying breakpoint opportunities, the Task Force recommended that broker/dealers that do not use "omnibus accounting" transmit the TIN/BIN data to mutual funds or their transfer agents so that related accounts could be electronically identified and linked (Recommendation L). The Task Force also recommended that broker/dealers who use omnibus accounting or Networking Level 3 processing that does not reveal the beneficial owner of the mutual fund shares develop some other mechanism for transmitting TIN/BIN data to mutual funds or their transfer agents. Additionally, the Task Force recommended that transfer agents perform automated searches for TIN/BIN data and Letter of Intent data to identify and calculate available breakpoint opportunities (Recommendation M). Furthermore, the Task Force recommended that broker/dealers have electronic access to customer account information and the ability to update this information prior to order execution (Recommendation M).
A working group of the Task Force is working to add TIN/BIN data to NSCC's Networking system (including Level 3) and to FundSERV. At this time, NSCC anticipates incorporating the fields for TIN/BIN data into its Networking system and FundSERV in phases, and that the process of incorporating these fields into its Networking system and FundSERV should begin by the end of June 2004.
Finally, the SEC's March 5, 2004, proposal on mandatory redemption fees would effectively require financial intermediaries to transmit some of the information at issue in Recommendation L (TIN information for each account, but not related accounts) and give mutual funds and their transfer agents access to the information necessary to perform the automated TIN searches discussed in Recommendation M. To enable mutual funds to impose these redemption fees, the SEC has proposed requiring all financial intermediaries to assist mutual funds in identifying market timers by providing TIN information for every account that purchased or sold mutual funds once a week. The SEC has sought comment on this proposal, and the comment period expires on May 10, 2004. The proposal is available at: http://www.sec.gov/rules/proposed/33-8358.htm.
Thus, under this SEC proposal, all broker/dealers would be obligated to transmit account TIN information to mutual funds or their transfer agents on a regular basis. Although the SEC proposal, which is directed to market timing issues, does not cover linked account information and would not obligate mutual funds or their transfer agents to "search" for common TINs in order to provide breakpoint discounts, providing access to this information would give mutual funds and their transfer agents the ability to perform further monitoring. The working group is closely following the progress on this SEC proposal.
As demonstrated above, NASD, ICI, SIA and representatives of the financial services industry have made substantial progress toward implementing the recommendations of the Task Force. Indeed, work has been completed on several of the recommendations. Further, the working groups anticipate completing work on two of the remaining in the very near future. These efforts will facilitate the delivery of breakpoint discounts and demonstrate a strong commitment to investor protection and market integrity.
1 Attached as Exhibit A is a list of the industry representatives that served on the Working Groups.