CharlesSchwab

Ameticas L.agest Discount Broker

THE SCHWAB BUILDING 101 MONTGOMERY STREET SAN FRANCISCO CA 94104 415 627-7000

Via Federal Express

Investment Company Act of 1940

Section 22d

May 28 1992

2t 14- /ô

Section

________ Thomas Harman Esq

Chief Counsel

Division of Investment Managemtu1h111tY

Securities and Exchange Commission

450 Fifth Street N.W

Washington D.C 20549

Dear Mr Harman

This letter requests that the Staff of the Securities and Exchange

Commission advise Charles Schwab Co Inc Schwab that it

would not recommend any enforcement action based on Section 22d

of the Investment Company Act of 1940 if Schwab charges certain of

its customers fees for executing transactions in shares of certain

mutual funds and at the same time receives fees from those mutual

funds based on the value of other shares for services rendered to

those mutual funds all as described below

Schwab proposes to enter into contracts with certain mutual funds

shares of which are currently available through Schwabs Mutual

Fund Marketplaces MFMP pursuant to which Schwab will offer

certain services to the funds in return for fees Service Fees

These Service Fees will differ depending on the level and kind of

services offered to the funds and will be calculated as

percentage of the assets of the funds held by some Schwab customers

in the MFMP and/or per account For those funds which enter into

such contracts the Participating Funds Schwab will make shares

of the funds available through the MFMP without transaction fees to

the vast majority of Schwabs customers the FeeFree

Arrangement For certain very active traders the Active

Traders as defined further below Schwabs standard transaction

fees will continue to apply to purchases and redemptions in all

funds including the Participating Funds However the assets

and/or accounts held by the Active Traders will not be counted in

the calculation of assets and/or accounts in determining the fees

charged to the Participating Funds It is Schwabs opinion that

Schwabs receipt from Active Traders of transaction fees for
transactions in Participating Funds will not constitute sales of

shares of the Participating Funds at price other than public

offering price described in the prospectus as prohibited by

section 22d of the Investment Company Act of 1940 In addition

it is Schwabs view that the proposed Fee-Free Arrangement will not

violate the spirit of the no-action relief granted to Schwab in the

past

PACTS

Schwab

Schwab is broker registered under the Securities Exchange Act of

1934 and is member of the National Association of Securities

Dealers Inc the New York Stock Exchange and other national

securities exchanges Schwab is the largest discount securities

broker in the United States with over 150 offices nationwide

Schwab is affiliated with Charles Schwab Investment Management

Inc an investment advisor registered under the Investment

Advisers Act of 1940 which is the investment manager for the

Charles Schwab Family of Funds and Schwab Investments both of

which are registered openend investment companies Schwab has

entered into Distribution Agreements with both such mutual funds

In addition Schwab has entered into Distribution Agreements with

some fullyloaded funds whose shares are available for sale through

the MFMP Schwab does not charge transaction feesto its customers

for transactions in the shares of Schwabsponsored mutual funds or

for transactions in such fullyloaded funds with which Schwab has

Distribution Agreements

The Mutual Pund Marketplace

Schwab offers its customers service it calls the Mutual Fund

Marketplace MFMP which has been described in previous

noaction requests to the Commission.1 Through the MFMP Schwab

acts for its customers as an agent through which they may purchase

or redeem shares of over 500 mutual funds Customers may place

both purchase and redemption orders with one telephone call

purchase mutual fund shares with margin credit receive single

consolidated statement and have checks for the proceeds of

redemptions sent to their local Schwab branch within one business

day Such conveniences are not typically available when dealing

directly with the funds The program effectively enhances the

liquidity of mutual fund investments by offering easy access to

See for example Charles Schwab Co Inc available

January 1982 Charles Schwab Co. Inc available June 29

1983 Charles Schwab Co. Inc available January 1987 and

Charles Schwab Co Inc available November 30 1987
wide variety of funds and by providing rapid and convenient

execution of transactions in fund securities

Currently for most transactions Schwab is compensated for its

services by customers through transaction fee based on the dollar

size of each transaction Schwabs transaction fee schedule is

identical for all funds As mentioned above Schwab also takes

portion of the load in fully loaded funds Schwab does not charge

transaction fees for transactions in those funds or for

transactions in Schwabsponsored funds

In order to be included in the MFMP funds must include in

their prospectuses disclosure that broker may charge fee if

shares are purchased or redeemed through that broker ii be able

to effect daily transfers of shares and funds at Schwabs volume

levels iii have prospectus that provides that they are able to

redeem shares upon telephonic instructions and iv be able to

perform certain other transferrelated functions in manner

compatible with MFMP operations

The Proposed FeeFree Arrangement

Contracts with Participating Funds

Schwab would offer certain services to funds whose shares are

available for sale through the MFMP These services would include

shareholder servicing sub-accounting and transfer agency services

In addition the Participating Funds would have the opportunity to

benefit from any increase in assets in such funds as result of

Schwabs planned promotion of the FeeFree Arrangement in the MFNP

Schwab currently plans to circulate or publish promotional

materials for the MFMP identifying or highlighting all funds that

are available with no transaction fees Those promotional

materials will not include materials designed to promote any

particular Participating Fund to the exclusion of any other

Participating Fund

The Service Fee as to each Participating Fund would be calculated

as percentage of the assets and/or number of accounts held by

Schwab customers in that Participating Fund with certain

exclusions It would be up to the Participating Funds to determine

whether payments for the various elements of the arrangement be

made by the fund its manager or distributor.2 The arrangement

would be set out in formal written agreement between Schwab and

the Participating Fund

The participating Funds would also choose whether to pay all

or portion of Service Fees through 12b-l plans if they have such

plans
The effect on nonActive Trader customers

Once Schwab has entered into the abovedescribed agreements with

the Participating Funds Schwabs customers would be able to

purchase or redeem shares of Participating Funds free of the

transaction charges currently imposed by Schwab on such trades

Customers would still be able to purchase and redeem shares in ..U

funds offered through the MFMP although only shares of

Participating Funds would be offered feefree to customers

Customers would continue to receive consolidated statements showing

all transactions the efficiency of being able to trade in all MFMP

funds with single phone call liquidity and all other features

of their Schwab accounts Shares of Participating Funds would not

be immediately marginable but would be marginable beginning 30

days after purchase as permitted by SEC Rule 240.lldl-2

The effect on Active Traders

Notwithstanding the treatment of nonActive Traders certain

customers identified by Schwab as Active Traders based on their

trading activity in Participating Funds would upon such

identification be charged transaction fees for purchases and

redemptions of shares in all funds including Participating Funds

These fees are charges for services which are requested by the

Active Traders namely additional transactions in fund shares No

customers would be pre-defined as Active Traders based on

historical trading activity Instead all customers would receive

the benefit of fee-free transactions up to the time that they

executed more than certain trigger number of short term

redemptions in feefree funds during any twelve month period.3

Once the trigger number of short term redemptions was made during

any twelve month period by any customer that customers account

would be coded as an Active Trader account and the customer would

be charged Schwabs normal transaction fees on all purchases and on

most redemptions of mutual funds from that date forward Schwab

woud not charge transaction fees for any redemptions by Active

Traders of shares they initially purchased feefree Once

customer has been identified as an Active Trader Schwab will track

shares purchased by the Active Trader in any account that has been

identified as an Active Trading Account and will charge Service

Fees on shares only when Schwab does not charge transaction fee

Active Traders would pay transaction fees to Schwab only on

accounts in which they do active trading Trades in other non

actively traded accounts belonging to the same individual would not

incur transaction fees For example if person had two accounts

The exact number of short term redemptions that would

trigger Active Trader status is still to be decided short

term redemption is defined for these purposes as redemption of

shares held less than six months from date of purchase
at Schwab one personal brokerage account and one an IRA both

accounts would begin as nonActive Trader accounts If that person

effected more than the trigger nuiither of shortterm redemptions

in the personal account only the personal account would be deemed

an Active Trader account and would be charged transaction fees

The IRA would not automatically be charged transaction fees as

result of the activity in the personal account of the same

individual

Schwab would put some controls in place to prevent abuses of this

system An individual attempting to avoid the imposition of

transaction fees would not be permitted to open multiple accounts

solely for this purpose The means of controlling this abuse have

not been finalized but it is not Schwabs intention to charge

transaction fees to all accounts held by an Active Trader unless

active trading were occurring in all of the accounts

Active Traders would have their accounts reclassified as nonActive

Traders on an exceptiononly basis Schwab would reserve the right

to reverse the Active Trader classification at its discretion but

would only do so upon application by the customer and the

submission of information satisfactory to Schwab that the customer

did not intend to continue past active trading activity Schwab

would not automatically reverse Active Trader status based on

periods of reduced trading activity Of course all customers

would be notified of these conditions of the FeeFree Arrangement

in advance In addition Schwab would advise customers in writing

both when they approach and when they reach Active Trader status

The effect on the NFMP

The Fee-Free Arrangement would effectively divide the MFI4P into two

parts One part would consist of shares purchased by Active

Traders Active Part and would preserve the status quo in the

MFMP as discussed in previous noaction letters

The Active Traders would pay reasonable transaction fees to Schwab

for transactions made after they were identif led as Active Traders

In addition in the Active Part of the MFMP Schwab would continue

to abide by the conditions imposed on it by the Staff in previous

noaction letters namely that Schwab would not charge

transaction fee if it also received any portion of sales load

including contingent deferred sales load charged on the shares

the transaction fees charged by Schwab for transactions in fund

shares would not be unreasonable as that term has been defined by

the Staff in no event would the total of transaction fee

charged by Schwab and the sales loads charged in connection with

the sale or redemption of fund shares exceed the maximum sales

charge that would be allowed under Article III Section 26 of the

NASD Rules of Fair Practice Schwab would charge transaction

fee only for transactions in fund shares that can also be purchased

by the customer directly from the fund its principal underwriter
or its distributor without the intervention of broker and without

the imposition of the transaction fee Schwab would inform each

of its customers in writing that fund shares may be purchased

directly from the fund without incurring the Schwab transaction

fee Schwab would not charge transaction fee for transactions

in the shares of fund unless the funds prospectus discloses both

that transaction fee may be imposed by brokerdealers and that

if fund shares are purchased directly from the fund its principal

underwriter or its distributor without the intervention of such

broker-dealer there will be no such charge and Schwab will

not charge transaction fee if Schwab is affiliated with the fund

its investment advisor or its principal underwriter or

distributor

The second part of the MFMP the Investor Part would consist of

the vast majority of Schwabs customers who will not pay

transaction fees to purchase or redeem shares of Participating

Funds Participating Funds will pay the Service Fees based only on

the assets and/or accounts in the Investor Part of the MFNP

Schwab intends to design an elaborate tracking system for shares of

Participating Funds purchased by its customers Each share will

fall into one or the other parts of the MFNP depending on whether

the customer is an Active Trader or not For example an

individual could purchase or redeem shares of Participating Funds

number of times before being identified as an Active Trader the

shares purchased prior to such identification would be part of the

Investor Part while shares purchased after such identification

would be part of the Active Part An individual could have

accounts in each part of the MFMP or even different shares of the

same Participating Fund in separate parts of the MFMP

DISCUSSION

Schwab believes that the imposition of transaction fees on

purchases and redemptions of mutual funds by Active Traders would

comply with the terms of section 22d of the Investment Company

Act Schwab also believes that the FeeFree Arrangement is in

accord with the spirit of the conditions set forth in past

noaction letters

Background

Section 22d of the Investment Company Act of 1940 the Act

generally prohibits mutual funds underwriters and dealers from

selling fund shares to the public except at current public

offering price described in the prospectus For many years the

Securities and Exchange Commission viewed the imposition of any

charge for transactions in shares of noload fund shares as

violation of section 22d as well as violation of antifraud

provisions because of prospectus representations concerning noload
status In 1974 however the SEC authorized the Staff to permit

brokers acting independently of funds and their underwriters to

charge reasonable fees for services rendered in connection with

transactions in shares of noload funds In taking this position

the SECs stated purposes were to provide brokers with an

incentive to recommend noload fund shares that would be somewhat

comparable to that existing with respect to other securities and

to compensate brokers for services rendered in connection with

noload fund transactions.4

The Staff has granted Schwab three no-action letters with respect

to section 22d and charging transaction fees In the first the

Staff advised Schwab that it would not recommend enforcement action

if Schwab charged transaction fees for services in connection with

the purchase and redemption of noload fund shares In the second

letter the Staff extended this no-action position to include

charging transaction fees In connection with transactions in

lowload fund shares The Staff recognized in this letter that the

services rendered by Schwab were sufficiently separately

identifiable to permit Schwab to charge such fees In the third

letter the Staff stated that it would not recommend enforcement

action if Schwab revised the fee schedule set forth in the previous

two letters

In each of these noaction letters Schwab made certain

representations and the Staff made its response based on certain

conditions The Staff stated that these conditions are designed to

ensure first that the broker acts independently of the fund and

its regular distribution network and second that both the

existence of the transaction fee and the possibility of avoiding

the fee by dealing directly with the fund are adequately disclosed

to investors.5 The second of these concerns is not an issue for

the MFMP and the FeeFree Arrangement because Schwab discloses in

writing that all funds may be obtained without transaction fees by

going directly to the fund Schwab intends to continue this

practice after introduction of the FeeFree Arrangement

When the SEC first permitted brokers to impose transaction fees it

viewed independence as important because it wanted to be sure that

the transaction fee would be viewed as separate from the price of

the fund shares fee that the customer would understand as being

paid voluntarily to broker in order to compensate the broker for

services not provided by the fund There is difference between

this charge for services and sales load or distribution charge

Report of the Division of Investment Management Regulation

Mutual Fund Distribution and Section 22d of the Investment

Company Act of 1940 August 1974 hereafter referred to as the

1974 Report at 114

Kidder Peabody Co available March 30 1987 at Note
imposed by the fund or member of its distribution network.6 The

transaction fee is not part of the price of the shares and

therefore its imposition does not violate section 22d of the Act

Independence of the broker from the mutual fund appears to be

important only because it is test by which the Staff and mutual

fund customers can determine whether transaction fee charged by

the broker is in fact separate charge for the brokers services

to the customer rather than part of payment for fund shares In

effect independence is proxy that makes it possible to test

easily whether the terms of Section 22d are being met Schwab

believes that charging service fees to Participating Funds in the

Investor Part will not alter the nature or method of delivery of

services to Active Traders in the Active Part so as to make

transaction fees charged to Active Traders part of the price of

the Participating Funds paid by Active Traders As to Active

Traders Schwab remains adequately independent of the Participating

Funds for section 22d purposes

Analysis

Overview

There are number of reasons for Schwabs view that imposing

transaction fees on Active Traders coinports with the law and

applicable interpretations

The only variation from the conditions imposed by the Staff in past

noaction letters is that Schwab would have arrangements with

Participating Funds for Service Fees However these arrangements

would relate only to the Investor Part of the MFMP where no

transaction fees would be paid by customers for transactions in

Participating Fund shares Service Fees would be calculated only

on the assets and/or accounts in the Investor Part of the MFMP

Independence of Schwab

Schwab does not believe that the fact that transaction fees are

charged to Active Traders in the Active Part of the MFMP would

violate the condition imposed by the Staff in the past that the

broker charging transaction fees must not have any formal or

informal agreement with the fund its investment advisor or

principal underwriter to distribute fund shares This is because

the two parts of the I4FMP the Active Part and the Investor Part

would be wholly independent of each other

The proposed arrangements with Participating Funds would not change

Schwabs independent status with respect to transactions by Active

Traders in the Active Part of the MFMP First Schwab would

continue to execute Active Traders unsolicited transactions in

1974 Report at pp 112-113
funds in the same fashion as it does currently for all customers

The Active Traders would have no incentive to purchase any

particular fund available through the MFNP because all

transaçtions in any of the funds would be made at equal cost to

them

Second there would be no financial incentive to Schwab to promote

either any particular Participating Fund or the Participating Funds

as group to Active Traders because the amount of the Service Fees

paid by Participating Funds would be unaffected by the number of

shares of the Participating Funds sold to Active Traders Although

Schwab currently plans to circulate or publish promotional

materials for the MFMP identifying or highlighting all funds that

are available with no transaction fees those promotional materials

will not include materials designed to promote any particular

Participating Fund to the exclusion of any other Participating

Fund Those promotions would be aimed at the Investor Part of the

NFMP Therefore Active Traders would not be encouraged by

Schwabs marketing materials to purchase Participating Funds over

non-Participating Funds.7 In addition Schwab believes that

large proportion of Active Traders are likely to be those with

professionally managed accounts or customers who follow

markettiming or market switching newsletters and services

Neither these customers nor their professional financial advisors

are likely to be affected by any advertising or promotional

activities of Schwab because they make purchase and redemption

decisions based on independent analysis and information

Schwab is charging fees to customers that are clearly for the

services it renders rather than part of the sales price of the

mutual fund shares In the case of the Active Traders they would

clearly see that only when they demanded additional services from

Schwab i.e numerous short term redemptions would they be

charged fees by Schwab These fees are unmistakably for services

rendered by Schwab rather than part of the price of the shares so

the concerns underlying section 22d are met by this arrangement

Schwab will not be double dipping

The SEC has stated that broker should not charge transaction

fee ifit also receives any portion of sales load charged on the

Schwab may in the future begin providing new services to

some of its customers possibly including information about or

recommendations as to particular mutual funds including

Participating Funds However Schwab expects that most of such

services would be of types that would be more useful to nonActive

Traders than Active Traders and that it will remain clear to any

Active Traders who may use them that they must pay transaction fees

for transactions in Participating Fund shares
shares or any payments under distribution plan adopted by the

fund in question in accordance with Rule 12bl

In Olde broker wished to charge transaction fees to customers

and accept portion of the load imposed by the funds This would

not occur in the FeeFree Arrangement since Schwab would not be

accepting any portion of sales load from Participating Funds on

shares as to which transaction fee is charged The Staffs

position in Olde was that broker could not charge transaction

fees and accept payments from funds 12bl plan Schwab believes

that the prohibition was intended to apply to accepting 12b-l fees

for distribution of specific shares Schwab will not receive

compensation that would constitute double payment for the same

services in violation of this provision of the Olde noaction

letter Schwab will receive transaction fees from the Active

Traders but the assets and/or accounts held by such Active Traders

will not be counted in the determination of the Service Fees from

Participating Funds The Service Fees received by Schwab will be

paid to Schwab in connection with the sales of shares to customers

who are not Active Traders The proposal outlined by Schwab herein

can be distinguished from that presented by Olde in which the

broker planned to charge transaction fee to its customers and to

charge fee to the mutual funds for sales of the same shares The

share tracking system described above would ensure that at no time

would the Participating Funds pay Service Fees on shares as to

which transaction fees would be charged by Schwab

Active Traders should pay for the services they use

Although the Active Traders would be paying for transactions in

Participating Fund shares while most Schwab customers would not

this payment does not constitute unfair price discrimination

between the Active Traders and the rest of Schwabs customers

Even if the FeeFree Arrangement resulted in discrimination between

investors it would not be unjust within the terms of section 22d

The fact that Schwab would charge Service Fees to Participating

Funds should not preclude it from also charging fees to Active

Traders for additional services rendered to the Active Traders in

the MFMP Indeed one of the two reasons articulated by the SEC

for allowing brokers to charge transaction fees was to enable

brokers to receive reasonable compensation for services rendered in

Olde Co.1 Inc available August 31 1984 footnote in

the 1974 Report on section 22d at 113 note also indicates

that the Commission is concerned with preventing double payments

for the same services

10
connection with noload fund purchases thereby removing any

disincentive for making such fund shares available for sale.9

Active Traders will receive special services not available to

customers in the Investor Part including the ability to make any

number of trades in Participating Funds Active Traders will also

be permitted an extra hour beyond Schwabs normal cutoff time in

which to place orders for all funds in the MFMP and receive that

days net asset value These services are not only benefits

received by Active Traders but place cost burden on Schwab for

which Schwab should be compensated Without the ability to charge

for those services Schwab would be in the position of not being

permitted to charge for services rendered

Policy Arguments

Effect on Cost Structure

Permitting feefree transactions by Active Traders would escalate

Schwabs costs too far to make implementing the Fee-Free

Arrangement possible Each transacti6n involves both direct costs

in taking the order as well as indirect costs such as mailing

trade confirmations and prospectuses subaccounting costs for

tracking dividend payments and reconciliation of the customers

accounts with the funds Heavy transaction activities also mean

greater and more expensive reporting requirements for and to the

funds If Schwab were not permitted to charge Active Traders for

transactions in Participating Funds Schwab would not have

transaction fee revenue to offset its costs

Moreover without the imposition of transaction fees Active

Traders would be likely to change their trading behavior upon the

introduction of the FeeFree Arrangement conducting more

transactions in Participating Funds This would further erode

Schwabs cost structure to the point that the FeeFree Arrangement

would not be feasible from Schwabs point of view In addition

Participating Funds would experience much higher costs related to

the repeated redemption activities of the Active Traders costs

borne by all fund shareholders If such funds withdraw from the

MFNP as result of Active Traders all of Schwabs customers would

suffer and the advantages of liquidity and convenience offered by

the MFMP would be reduced accordingly Alternatively if the funds

make their own determination that Active Traders are likely to

trade heavily in Participating Funds the funds may simply refuse

to enter into contracts with Schwab for the FeeFree Arrangement

1974 Report
Equitable considerations

customer currently faces situation in which s/he may buy

shares of fund directly from the fund and pay no transaction fee

ii buy shares of the same fund through Schwabs MFMP and pay

transaction fees or iii go to hypothetical broker which could

have arrangements with the fund to receive fees for services and

would not charge transaction fees to the customer In this

situation the fund and each broker act independently of each

other What Schwab proposes with the FeeFree Arrangement is to

divide the MFMP into two parts which would resemble situations ii

and iii above This is no different than making shares of

fund available through two separate brokers What is now permitted

to two separate brokers or to broker and the funds ought not to

be prohibited just because the activity is taking place in one

broker Schwab As discussed above the existence of the fee-free

trading in the Investor Part of the MFMP and the Service Fees which

are part of that arrangement would not affect Schwabs

independence with respect to the Active Traders The Active Part

of the MFMP would constitute different base of assets as to which

transaction fees would apply The remaining customer assets in the

Investor Part of the MFMP would be used to calculate the Service

Fees charged to Participating Funds Since Schwab would not be

engaged in unfair price discrimination between customers nor would

it be receiving double payment for the same services principles of

equity require that Schwab be permitted to institute these

arrangements

CONCLUS ION

As the volume of trading through the MFHP attests the services

offered by Schwab have proved valuable to customers The current

program has been made economically feasible because Schwab is able

pursuant to Staff noaction letter authority to charge transaction

fees to its customers Schwab believes that for most customers it

can offer an even lower cost service by eliminating the transaction

fees charged for transactions in Participating Funds Thus for

the vast majority of Schwab customers the benefits of trading

through the MFMP would be made available at no cost Mutual fund

investing will be made more convenient for large number of

investors who will receive Schwabs services for free For Active

Traders Schwab would still permit as many purchases and

redemptions as they wanted to make providing Active Traders with

one of the few places where they can pursue their investment

strategies Many funds do not permit frequent transactions The

FeeFree Arrangement would also provide advantages to Participating

Funds in that they would still be able to offer their shares to

MFMP customers without the disincentive of transaction fees

normally charged by Schwab Hence both Schwab customers and the

Participating Funds would derive benefits from the Fee-Free

Arrangement

12
These benefits will not be available however if Schwab cannot

charge transaction fees to Active Traders As described above the

effect on both Schwabs cost structure and its relationships with

funds would be severely strained if Schwab cannot charge Active

Traders for the services they require Based on current customer

trading patterns Schwab estimates that the Investor Part of the

MFXP would constitute about 97% of Schwabs current MFMP customers

accounting for 78% of the assets currently in the MFMP The Active

Part would constitute 3% and 22% respectively Therefore small

minority of 3% of Schwabs total customers would need services that

would prevent the FeeFree Arrangement from benefitting the

remaining 97% of the MFMP customers

The Staff has the authority to view favorably interpretive

requests with respect to proposals that brokers which act

independently of funds and their underwriters be permitted under

certain circumstances to Æharge reasonable fees for services

rendered in connection with customer transactions in mutual

funds.10 Schwab hereby respectfully requests that the Staff advise

that it will not recommend to the Commission that any action be

taken if Schwab undertakes the FeeFree Arrangement as described

above.11 If you have any questions require further clarification

or are disinclined to issue the requested noaction letter please

call the undersigned Thank you for your attention to this matter

Sincerely

Christina Polischuk

10 SEC Investment Company Act Release No 8570 November

1974

Schwab recognizes that any response to this letter by the

Staff will not in any way vary any obligations Schwab may have to

comply in its role as service provider with terms of any

Commission orders exempting any participating Funds from Sections

18f and of the Investment Company Act

13
1PItIBii111 Our Ref No 92-303-cc

Charles Schwab Co

RESPONSE OF THE OFFICE OF CHIEF COUNSEL Inc

DIVISION OF INVESTMENT MANAGEMENT File No 8-16514

By letter dated May 28 1992 you request our assurance that

we would not recommend any enforcement action to the Commission

under Section 22d of the Investment Company Act of 1940 the

1940 Act if Charles Schwab Co Inc Schwab

registered brokerdealer charges certain of its customers

transaction fees on purchases and redemptions of investment

company shares while also receiving service fees from those

investment companies

Schwab offers customers various services in connection with

purchases and redemptions of shares in over 500 investment

companies through its Mutual Fund Marketplace MFMP Schwab

permits MFMP customers to place purchase and redemption orders in

single telephone call purchase investment company shares with

margin credit receive single consolidated account statement

and obtain redemption proceeds through the local Schwab branch

within one business day These services are typically not

available when dealing directly with investment companies

Customers pay Schwab for these services through fee levied on

each purchase and redemption of investment company shares based

on the dollar size of the transaction .2/

Schwab provides shareholder subaccounting and transfer

agency services to certain investment companies Participating

Funds whose shares are available through MFMP The

Participating Funds or their manager or distributor pay Schwab

service fee calculated as percentage of Schwab customer

assets and/or number of accounts Once Schwab enters into

service agreement with Participating Fund Schwab customers no

longer pay transaction fee on trades in shares of that

investment company but still receive Schwabs MFMP services

The amount of the transaction fees and the MFMP services are

further described in three previous noaction requests

Charles Schwab Co Inc pub avail Jan 1982

Charles Schwab Co Inc pub avail Jan 1987

Schwab II Charles Schwab Co Inc pub avail Nov

30 1987 Schwab customers pay no transaction fee when

trading in shares of investment companies for whom Schwab

acts as dealer or underwriter including two Schwab

sponsored investment companies The Charles Schwab Family of

Funds and Schwab Investments In those instances Schwab

receives portion of the sales load

Participating Fund may pay the service fees under

distribution plan adopted under Rule 12bl of the 1940 Act
Certain customers identified as active traders

eventually will pay the same transaction fees as before Schwab

will identify active traders as those persons who have executed

more than specified number as yet undetermined of short term

redemptions in Participating Funds ./ Schwab will notify

customers in writing as they approach and when they become active

traders ./ In calculating its service fee Schwab will not

include active traders Participating Fund shares or their

accounts Active traders will as stated above incur

transaction fee on all trades of NFMP investment company

shares You state that the transaction fees are justified

because active traders place additional costs on Schwab

Section 22d prohibits an investment company from selling

its securities except at current public offering price

described in the prospectus to any person other than to or

through principal underwriter for distribution It further

states that if such class of security is being currently offered

to the public by or through an underwriter no principal

underwriter of such security and no dealer shall sell any such

security to any person except dealer principal underwriter

or the issuer except at current public offering price

described in the prospectus.t Section 22ds restrictions do

not apply to broker as that term is defined in the 1940

Act 2/ Because Schwab purchases and redeems MFMP investment

Schwab considers short term redØmptionto be redemption

of shares held less than six months Schwab estimates

based on present customer trading patterns that

approximately 3% of MFMP customers will be active traders

and they will account for about 22% of MFMP customer assets

4./ Active traders would pay transaction fees only on

transactions in an actively-traded account These customers

may have other accounts that are infrequently traded that

would not be subject to the fee

Schwab will not charge transaction fee on the redemption

of shares acquired prior to becoming an active trader

Active traders receive special services not available to

other MFNP customers including an additional hour each day

to place orders at that days net asset value

2/ Under Section 2a of the 1940 Act broker means any

person engaged in the business of effecting transactions in

securities for the account of others but does not include

bank or any person solely by reason of the fact that such

person is an underwriter for one or more investment

continued..
company shares on behalf of its customers solely as broker

Section 22ds restrictions do not apply to Schwabs involvement

in these transactions 8/ We do not view the shareholder

subaccounting and transfer agency services as being incompatible

with Schwab acting solely as broker Our position is based in

particular on your representation that Schwab acts as agent for

its customers in the purchase or redemption of MFMP investment

company shares Because this response is based on the

representations made to the Division you should note that any

different facts or circumstances might require different

conclusion

Barbara ChretienDar

Attorney

2/ .continued

companies emphasis added The 1940 Act defines dealer in

Section 2all

United States National Assn of Sec Dealers 422 U.S

694 1975