Document ID: SEC-2010-1167-0001
Agency: sec
Document Type: Proposed Rule
Title: Mutual Fund Distribution Fees; Confirmations
Posted Date: 2010-08-04T04:00Z

[Federal Register: August 4, 2010 (Volume 75, Number 149)]
[Proposed Rules]               
[Page 47063-47139]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04au10-19]                         

[[Page 47063]]

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Part II

Securities and Exchange Commission

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17 CFR Parts 210, 239, 240 et al.

Mutual Fund Distribution Fees; Confirmations; Proposed Rule

[[Page 47064]]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 239, 240, 249, 270, and 274

[Release Nos. 33-9128; 34-62544; IC-29367; File No. S7-15-10]
RIN 3235-AJ94

 
Mutual Fund Distribution Fees; Confirmations

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or ``the 
Commission'') is proposing a new rule and rule amendments that would 
replace rule 12b-1 under the Investment Company Act, the rule that has 
permitted registered open-end management investment companies (``mutual 
funds'' or ``funds'') to use fund assets to pay for the cost of 
promoting sales of fund shares. The new rule and amendments would 
continue to allow funds to bear promotional costs within certain 
limits, and would also preserve the ability of funds to provide 
investors with alternatives for paying sales charges (e.g., at the time 
of purchase, at the time of redemption, or through a continuing fee 
charged to fund assets). Unlike the current rule 12b-1 framework, the 
proposed rules would limit the cumulative sales charges each investor 
pays, no matter how they are imposed. To help investors make better-
informed choices when selecting a fund that imposes sales charges, the 
Commission is also proposing to require clearer disclosure about all 
sales charges in fund prospectuses, annual and semi-annual reports to 
shareholders, and in investor confirmation statements.
    As part of the new regulatory framework, the Commission is 
proposing to give funds and their underwriters the option of offering 
classes of shares that could be sold by dealers with sales charges set 
at competitively established rates--rates that could better reflect the 
services offered by the particular intermediary and the value investors 
place on those services. For funds electing this option, the proposal 
would provide relief from restrictions that currently limit retail 
price competition for distribution services.
    The proposed rule and rule amendments are designed to protect 
individual investors from paying disproportionate amounts of sales 
charges in certain share classes, promote investor understanding of 
fees, eliminate outdated requirements, provide a more appropriate role 
for fund directors, and allow greater competition among funds and 
intermediaries in setting sales loads and distribution fees generally.

DATES: Comments must be received on or before November 5, 2010.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml);
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-15-10 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-15-10. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for Web site viewing and printing in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549, on official business days between the hours of 10 a.m. and 3 
p.m. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: With respect to rules and forms under 
the Investment Company Act and Securities Act, Thoreau A. Bartmann, 
Senior Counsel, Daniel Chang, Attorney, or C. Hunter Jones, Assistant 
Director, at 202-551-6792, Office of Regulatory Policy, Division of 
Investment Management, Securities and Exchange Commission, 100 F 
Street, NE., Washington, DC 20549-8549.
    With respect to rule 10b-10 under the Securities Exchange Act, 
Daniel Fisher, Branch Chief, or Ignacio Sandoval, Attorney, at 202-551-
5550, Office of Chief Counsel, Division of Trading and Markets, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-7010.

SUPPLEMENTARY INFORMATION: The Commission is proposing to rescind rule 
12b-1 [17 CFR 270.12b-1] under the Investment Company Act of 1940 
(``Investment Company Act'' or ``Act'').\1\ The Commission is also 
proposing for comment: New rule 12b-2 [17 CFR 270.12b-2] under the 
Investment Company Act; amendments to rules 6c-10 [17 CFR 270.6c-10] 
and 11a-3 [17 CFR 270.11a-3] under the Investment Company Act; 
amendments to Form N-1A\2\ under the Investment Company Act and the 
Securities Act of 1933 (``Securities Act''); \3\ amendments to rule 6-
07 [17 CFR 210.6-07] of Regulation S-X under the Securities Act; 
amendments to rule 10b-10 [17 CFR 240.10b-10] and Schedule 14A\4\ under 
the Securities Exchange Act of 1934 (``Exchange Act''); \5\ technical 
changes to rule 10b-10; and technical and conforming changes to various 
rules and forms under the Investment Company Act.
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    \1\ 15 U.S.C. 80a. Unless otherwise noted, all references to 
statutory sections are to the Investment Company Act and all 
references to rules under the Investment Company Act will be to 
Title 17, Part 270 of the Code of Federal Regulations [17 CFR part 
270].
    \2\ 17 CFR 239.15A and 274.11A.
    \3\ 15 U.S.C. 77a.
    \4\ 17 CFR 240.14a-101.
    \5\ 15 U.S.C. 78a.
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Table of Contents

I. Introduction
II. Background
    A. Mutual Fund Sales Charges
    B. Adoption of Rule 12b-1
    C. Developments Following Rule 12b-1's Adoption
    D. The Current Role of 12b-1 Fees
    E. Additional Commission Consideration of Rule 12b-1
III. Discussion
    A. Summary of Our Proposals
    B. Rescission of Rule 12b-1
    C. Proposed Rule 12b-2: The Marketing and Service Fee
    D. Proposed Amendments to Rule 6c-10: The Ongoing Sales Charge
    E. Proposed Amendments to Rule 10b-10: Transaction Confirmations
    F. Shareholder Approval
    G. Application to Funds of Funds
    H. Application to Funds Underlying Separate Accounts
    I. Proposed Amendments to Rule 6c-10: Account-Level Sales Charge
    J. Amendments To Improve Disclosure to Investors
    K. Proposed Conforming Amendments to Rule 11a-3
    L. Other Proposed Conforming Amendments
    M. Potential Impact of Proposed Rule Changes
    N. Transition

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IV. Paperwork Reduction Act
V. Cost-Benefit Analysis
VI. Initial Regulatory Flexibility Analysis
VII. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation
VIII. Small Business Regulatory Enforcement Fairness Act
IX. Statutory Authority
Text of Proposed Rules and Form Amendments

I. Introduction

    More than 87 million Americans, representing slightly less than 
half of all households, own mutual funds.\6\ Some investors buy fund 
shares directly from mutual fund sponsors without paying a sales 
charge.\7\ However, most fund investors buy through intermediaries.\8\ 
These intermediaries include broker-dealers, banks, insurance 
companies, financial planners, and retirement plans. When investors use 
intermediaries to buy fund shares, they typically will pay (either 
directly or indirectly) some form of sales charge or service fees to 
compensate the intermediaries for the services they provide.\9\
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    \6\ Investment Company Institute (``ICI''), Profile of Mutual 
Fund Shareholders, 2009 (2010) (``Shareholder Profile Report'') 
(http://ici.org/pdf/rpt_profile10.pdf). Mutual funds' share of 
household financial assets has grown steadily from 3 percent in 1980 
to 21 percent in 2009. ICI, 2010 Investment Company Fact Book at 10 
(2010) (http://www.ici.org/pdf/2010_factbook.pdf) (``2010 ICI Fact 
Book'').
    \7\ These are referred to as ``no-load'' funds because no sales 
charge or ``load'' is charged in connection with the transaction. 
See infra notes 16-17 and accompanying text.
    \8\ According to the ICI, 80 percent of U.S. households that own 
mutual funds outside of retirement plans hold some portion of their 
fund shares through financial professionals (including brokers, 
financial planners, insurance agents, bank representatives, and 
accountants). 2010 ICI Fact Book, supra note 6, at 85.
    \9\ Although the use of the term ``intermediary'' in this 
Release is not limited to registered broker-dealers, receipt of the 
fees addressed in this Release may, depending on the services 
provided, require the recipient to register as a broker-dealer or 
rely on an exception or exemption from broker-dealer registration. 
See also note 168, infra, and accompanying text.
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    Investors use intermediaries for a variety of reasons. Some want 
help in selecting a particular fund or building a diversified portfolio 
of investments. Others like the convenience of holding a variety of 
financial assets together in the same account and receiving a single 
comprehensive account statement. A growing number of investors use 
mutual funds as a way to fund their retirement plans, college savings 
accounts, annuity or life insurance contracts, or other tax-advantaged 
investment vehicles, which are often offered by an intermediary.\10\ In 
some cases, investors use an intermediary (and pay sales charges) not 
necessarily for the services they obtain from the intermediary, but 
simply to be able to invest in shares of a particular fund that they 
cannot buy directly (i.e., that are sold only through intermediaries).
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    \10\ See 2010 ICI Fact Book, supra note 6, at 97, 118. According 
to the ICI, U.S. retirement plan assets totaled $16 trillion in 
2009. Id. The largest individual components were Individual 
Retirement Accounts (``IRAs'') and employer-sponsored defined 
contribution plans, holding assets of $4.2 trillion and $4.1 
trillion, respectively. Mutual funds' share of the IRA market has 
increased from 22 percent in 1990 to 46 percent in 2009. Id. at 98-
99. Assets in section 529 college savings plans have grown from $2.6 
billion in 2000 to $111 billion in 2009. Id. at 118.
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    There are over 9,000 funds available to investors, offering a 
variety of investment strategies to suit different investment 
needs.\11\ Investors can select among many types of intermediaries from 
which they can purchase fund shares, and have choices as to how they 
pay for the services of those intermediaries. They may pay a ``sales 
load'' at the time they purchase shares, or a deferred sales load when 
they redeem shares, or they may invest in a fund that pays ongoing 
sales charges on behalf of investors from fund assets, otherwise known 
as 12b-1 fees.\12\ As an alternative, they may choose to invest through 
an intermediary that deducts fees directly from the investor's account 
by a separate agreement (e.g., ``wrap fee programs''). Whether an 
investor pays sales charges depends upon the fee structure of the fund 
in which the investor chooses to invest, and how those sales charges 
are paid depends upon the ``class'' of fund shares that the investor 
selects.\13\
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    \11\ 2010 ICI Fact Book, supra note 6, at 16. This figure 
represents the total number of registered open-end funds, and 
includes separate series of a fund and ETFs.
    \12\ We will use the term ``12b-1 fees'' generally to describe 
fees that are paid out of fund assets pursuant to a plan adopted 
under rule 12b-1 (``12b-1 plan'').
    \13\ See infra Section II.C.3 of this Release.
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    These sales charge arrangements are disclosed in fund prospectuses, 
and are governed by a combination of statutory provisions and rules 
adopted by the Commission and the Financial Industry Regulatory 
Authority, Inc. (``FINRA''), a self-regulatory organization for broker-
dealers.\14\ These rules have been in place for many years and, as 
discussed in more detail below, we believe that they may no longer 
fully reflect the current economic realities of the mutual fund 
marketplace or best serve the interests of fund investors. In this 
Release, we first review how these rules developed, our experience in 
administering them, changes we have observed in how funds distribute 
their shares, and the evolving needs of shareholders. We then propose a 
new framework that would continue to allow funds to give investors 
choices as to how and when to pay for sales charges, improve disclosure 
designed to enhance investor understanding of those charges, limit the 
cumulative sales charges each investor pays, and eliminate 
uncertainties associated with current requirements while providing a 
more appropriate role for fund directors. Finally, the proposal would 
offer funds and their underwriters the option of offering a class of 
shares that could be sold by intermediaries subject to competition in 
establishing sales charge rates.
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    \14\ FINRA rules do not apply directly to mutual funds, but to 
registered broker-dealers that are FINRA members, including the 
principal underwriters of most funds. Most funds therefore structure 
their sales loads to meet FINRA rules in order for their shares to 
be distributed and sold by registered broker-dealers in the United 
States.
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II. Background

A. Mutual Fund Sales Charges

    When the Investment Company Act was enacted in 1940, investors paid 
most of the costs of selling and promoting fund shares in the form of a 
sales charge or sales ``load'' deducted from the purchase price at the 
time of sale by the fund's principal underwriter (typically the fund's 
adviser or a close affiliate).\15\ The sales load financed brokers' 
commissions, advertisements, and other sales and promotional 
activities. Only a limited number of funds, called ``no-load'' funds, 
marketed their shares directly to investors without the assistance of a 
retail broker, and did not charge sales loads.\16\ The selling costs of 
no-load funds (primarily advertising) typically were subsidized by the 
funds' investment advisers out of their profits.\17\
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    \15\ See SEC, Investment Trusts and Investment Companies, H.R. 
Doc. No. 279, 76th Cong., 1st Sess., pt. 3, at 813, 823 (1939) 
(``Investment Trust Study''). Principal underwriters typically 
confine themselves to wholesale transactions and leave the public 
selling to independent retail dealers under sales agreements, 
although some underwriters have their own ``captive'' retail sales 
organizations. See Tamar Frankel, The Regulation of Money Managers, 
Sec.  27.01 (2009 supplement) (``The Regulation of Money 
Managers''). See also Division of Investment Management, U.S. 
Securities and Exchange Commission, Protecting Investors: A Half 
Century of Investment Company Regulation 291 (1992) (``1992 
Study''). Although the principal underwriter collects the sales 
load, for convenience, throughout this Release, we will simply refer 
to ``funds'' as imposing sales loads or determining the amount of 
sales load payable.
    \16\ See Investment Trust Study, supra note 15, at 817-18. Some 
funds also charged low sales loads of one to two percent. Id.
    \17\ See 1992 Study, supra note 15, at 292.
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    In the past, fund sales charges generally were much higher than 
those

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customarily charged today and raised concerns for Congress and the 
Commission.\18\ The Commission submitted a report to Congress in 1966 
concluding that mutual fund sales charges should be lowered.\19\ 
Following this report, Congress amended the Act in 1970 to give 
rulemaking authority to the National Association of Securities Dealers, 
Inc. (``NASD'') (now FINRA) to prescribe limits to prevent excessive 
sales loads.\20\ Under this authority, in 1975, the NASD adopted a rule 
placing a ceiling of 8.5 percent on the front-end sales load that a 
fund distributed by NASD members could charge.\21\ Today, few funds 
impose sales loads that approach the maximum limit, in part because of 
investor resistance to paying high front-end loads, but also because of 
the availability of other sources of revenue to pay distribution 
costs.\22\
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    \18\ During the period of 1927-1935, sales loads for broker-sold 
funds ranged from five to 10 percent, but by 1935 they were often as 
high as nine to 10 percent. See Investment Trust Study, supra note 
15, pt. 2, 216-17. See also Investment Trusts and Investment 
Companies: Hearings on S. 3580 Before a Subcomm. of the Senate Comm. 
on Banking and Currency, 76th Cong., 3d Sess. 799 (1940) (statement 
of L.M.C. Smith, Associate Counsel, Investment Trust Study, SEC, 
discussing the ``problem'' of high sales loads).
    \19\ The Commission recommended that sales loads be limited to a 
statutory maximum of five percent from the prevailing typical load 
of 9.3 percent. See SEC, Report on the Public Policy Implications of 
Investment Company Growth, H.R. REP. No. 2337, 89th Cong., 2d Sess. 
at 205, 223 (``PPI Report'').
    \20\ Investment Company Act Amendments of 1970, Public Law 91-
547, Sec.  12(a), 84 Stat. 1413, 1422 (1970) (codified as amended at 
section 22(b) of the Act). Section 22(b) vested this rulemaking 
authority in a securities association registered under section 15A 
of the Exchange Act. The NASD (now FINRA) was and is the only such 
registered securities association. The Commission supported the 
amendment. See Investment Company Amendments Act of 1970: Hearings 
on S. 34 and S. 296 Before a Subcomm. of the Senate Comm. on Banking 
and Currency, 91st Cong., 1st Sess. 6-8 (1969) (statement of Hugh 
Owens, SEC Commissioner).
    \21\ Order Approving Proposed Rule Change by NASD, Investment 
Company Act Release No. 8980 (Oct. 10, 1975) (approving predecessor 
rule to NASD Conduct Rule 2830).
    \22\ See The Regulation of Money Managers, supra note 15, at 
Sec.  27.03; ICI, Trends in the Fees and Expenses of Mutual Funds, 
2009 (Apr. 2010) (http://www.ici.org/pdf/fm-v19n2.pdf) (``Fee Trends 
Report'') (noting that in 2009 the average maximum front-end load on 
stock funds was 5.3 percent).
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B. Adoption of Rule 12b-1

    The most significant of these alternative revenue sources came 
about when the Commission adopted rule 12b-1 in 1980.\23\ As described 
in more detail below, rule 12b-1 permits a fund to use fund assets to 
pay broker-dealers and others for providing services that are primarily 
intended to result in the sale of the fund's shares. The Commission 
adopted rule 12b-1 under its authority in section 12(b) of the 
Investment Company Act,\24\ which authorizes the Commission to regulate 
the distribution activities of funds that act as distributors of their 
own securities.\25\ Section 12(b) was designed to protect funds from 
being charged excessive sales and promotional expenses.\26\ The 
requirements of the rule are intended, in part, to address the 
conflicts of interest between a fund and its investment adviser that 
arise when a fund bears its own distribution expenses.\27\
    The Commission's adoption of rule 12b-1 arose in the context of two 
significant developments in the mutual fund market that occurred during 
the 1970s.\28\ First, many funds experienced a prolonged period of net 
redemptions (i.e., redemptions exceeded new sales), which reduced the 
amount of fund assets.\29\ Fund company representatives asserted that 
using fund assets to fuel the sale of fund shares could benefit fund 
shareholders by increasing economies of scale and reducing fund expense 
ratios.\30\ The second was the development of money market funds and 
no-load fund groups, including internally managed funds, which did not 
charge sales loads but required a source of revenue to support their 
direct selling efforts.\31\ By offering a less expensive way for many 
investors to become fund shareholders, no-load funds promised to 
introduce greater price competition in the sale of mutual funds to 
retail investors, which might lower sales loads for all investors.
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    \23\ Bearing of Distribution Expenses by Mutual Funds, 
Investment Company Act Release No. 11414 (Oct. 28, 1980) [45 FR 
73898 (Nov. 7, 1980)] (``1980 Adopting Release'').
    \24\ Rule 12b-1 was also adopted pursuant to section 38(a) of 
the Act. Id.
    \25\ Section 12(b) makes it unlawful, with certain exceptions, 
for any mutual fund ``to act as a distributor'' of its own shares in 
contravention of any rules the Commission adopts as ``necessary or 
appropriate in the public interest or for the protection of 
investors.''
    \26\ See Investment Trusts and Investment Companies: Hearings on 
H.R. 10065 Before a Subcomm. of the House Comm. on Interstate and 
Foreign Commerce, 76th Cong., 3d Sess. 112 (1940) (``House 
Hearings'') (statement of David Schenker, Chief Counsel, Investment 
Trust Study, SEC) (The purpose of section 12(b) is to prevent mutual 
funds from incurring ``excessive sales, promotion expenses, and so 
forth.'').
    \27\ When a fund pays promotional costs, the fund's investment 
adviser or distributor is relieved from bearing the expense itself, 
and the adviser benefits further if the fund's expenditures result 
in the growth of the fund's assets and a related increase in 
advisory fees (because an adviser's fees typically are based on a 
percentage of fund assets). However, commentators have noted that 
the benefits to existing fund shareholders from these expenditures 
may be ``speculative at best.'' See Bearing of Distribution Expenses 
by Mutual Funds, Investment Company Act Release No. 10252 (May 23, 
1978) [43 FR 23589 (May 31, 1978)] (``Advance Notice of Proposed 
Rulemaking'') at text following n. 3.
    \28\ See Payment of Asset-Based Sales Loads by Registered Open-
End Management Investment Companies, Investment Company Act Release 
No. 16431 (June 13, 1988) [53 FR 23258 (June 21, 1988)] (``1988 
Release'') at n.14 and accompanying text.
    \29\ Total redemptions exceeded new sales for six of the seven 
years between 1971 and 1977. 2010 ICI Fact Book, supra note 6, at 
125.
    \30\ See Advance Notice of Proposed Rulemaking, supra note 27, 
at n.3 and accompanying text.
    \31\ See, e.g., Valuation of Debt Instruments and Computation of 
Current Price per Share by Certain Open-End Investment Companies 
(Money Market Funds), Investment Company Act Release No. 13380 (July 
11, 1983) [48 FR 32555 (July 18, 1983)]. An investment company is 
said to have internalized its management functions when most or all 
of the services traditionally provided by the investment adviser or 
third parties are performed at cost by salaried employees of the 
fund or by subsidiaries of the fund. See 1988 Release, supra note 
28, at n.8. When the Commission proposed rule 12b-1, an application 
was pending from The Vanguard Group for exemptions from the Act to 
permit Vanguard funds to internalize their marketing and 
distribution functions and to bear distribution costs through a 
wholly owned subsidiary of the funds. See In the Matter of the 
Vanguard Group, et al., Opinion of the Commission, Investment 
Company Act Release No. 11645 (Feb. 25, 1981). The Commission 
discussed the Vanguard application in the release and asked 
commenters to address other possible methods whereby funds might be 
permitted to bear distribution expenses. See Advance Notice of 
Proposed Rulemaking, supra note 27, at n.5. The Commission 
previously had allowed other funds with internalized management 
functions to pay distribution expenses out of fund assets because it 
believed these arrangements would significantly reduce the conflicts 
of interest that otherwise are present when fund assets are used to 
pay for distributions. See 1988 Release, supra note 28, at nn.8-10 
and accompanying text.
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    Before the rule's adoption, the Commission generally had opposed 
the use of fund assets for the purpose of financing the distribution of 
mutual fund shares, noting that existing shareholders of a fund ``often 
derive little or no benefit from the sale of new shares.'' \32\ After 
engaging in a thorough review of the public policy and legal 
implications of permitting funds to bear these types of expenses, which 
included a public hearing and two requests for public comment,\33\ the 
Commission ultimately decided that there may be circumstances in which 
it would be appropriate for a fund to bear its own distribution 
expenses.\34\
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    \32\ See Bearing of Distribution Expenses by Mutual Funds: 
Statutory Interpretation, Investment Company Act Release No. 9915 
(Aug. 31, 1977) [42 FR 44810 (Sept. 7, 1977)] (quoting SEC, Future 
Structure of the Securities Markets (Feb. 2, 1972) [37 FR 5286 (Mar. 
14, 1972)]).
    \33\ See Investment Company Act Release No. 9470 (Oct. 4, 1976) 
[41 FR 44770 (Oct. 12, 1976)] (announcement of hearings); Advance 
Notice of Proposed Rulemaking, supra note 27; Bearing of 
Distribution Expenses by Mutual Funds, Investment Company Act 
Release No. 10862 (Sept. 7, 1979) [44 FR 54014 (Sept. 17, 1979)] 
(``1979 Proposing Release'').
    \34\ The Commission noted, however, that it and its staff would 
``monitor the operation of the rules closely and will be prepared to 
adjust the rules in light of experience to make the restrictions on 
use of fund assets for distribution either more or less strict.'' 
See 1980 Adopting Release, supra note 23, at section titled 
``Discussion.''

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[[Page 47067]]

    The Commission remained concerned, however, about the inherent 
conflicts of interest on the part of the fund adviser.\35\ Therefore, 
in crafting the conditions of the rule, we sought to minimize the role 
of the adviser and its affiliates in establishing both the amount and 
uses of fund assets to support distribution.\36\ As adopted, the rule 
required the fund's board of directors, and in particular its 
independent directors, to play a key role in deciding the level of the 
fund's distribution charges and how the revenue would be spent.\37\
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    \35\ See id.
    \36\ See id. at section titled ``Independence of Directors.'' 
See also 1988 Release, supra note 28, at section titled ``The 
Development and Use of `Compensation' Plans'' (``The directors' 
responsibilities under the rule were designed to provide that the 
directors, not advisers or underwriters, make the fundamental 
decisions regarding distribution spending.'').
    \37\ See 1980 Adopting Release, supra note 23, at section titled 
``Independence of Directors'' (``Since rule 12b-1 does not restrict 
the kinds or amounts of payments which could be made, the role of 
the disinterested directors in approving such expenditures is 
crucial.'').
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    Rule 12b-1 requires that, before using fund assets to pay for 
distribution expenses, a fund must adopt a written plan (a ``rule 12b-1 
plan'') describing all material aspects of the proposed financing of 
distribution,\38\ which must contain provisions similar to several of 
those the Act requires for advisory contracts between the fund and its 
investment adviser.\39\ The rule 12b-1 plan must be approved initially 
by the fund's board of directors as a whole, and separately by the 
``independent'' directors.\40\ If the plan is adopted after the sale of 
fund shares to the general public, it also must be approved initially 
by a vote of at least a majority of the fund's voting securities.\41\
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    \38\ Rule 12b-1(b). The plan must cover indirect as well as 
direct payments for distribution. See rule 12b-1(a)(2).
    \39\  See 1980 Adopting Release, supra note 23, at section 
titled ``Summary'' (``The procedures in the rule by which 
shareholders and directors would approve a plan to use assets for 
distribution are generally similar to those prescribed by statute 
for approval of investment advisory contracts.''). See also sections 
15(a) and 15(c) of the Act.
    \40\ We generally refer to directors who are not ``interested 
persons'' of the fund as ``independent directors'' or 
``disinterested directors.'' The term ``interested person'' is 
defined in section 2(a)(19) of the Act. However, rule 12b-1 requires 
directors to meet an additional test. In order to be considered 
independent for purposes of voting on a rule 12b-1 plan, directors 
must also have no direct or indirect economic interest in the 
operation of the plan or in any agreements related to the plan. Rule 
12b-1(b)(2). In this Release, when we discuss the role of 
independent directors, the applicable standard for independence 
depends on the context.
    \41\ Rule 12b-1(b)(1). When we originally adopted rule 12b-1 in 
1980, shareholders were required to vote whenever a rule 12b-1 plan 
was instituted, regardless of whether a public offering of fund 
shares had occurred. See 1980 Adopting Release, supra note 23, at 
section titled ``Procedural Requirements.'' However, if a rule 12b-1 
plan is adopted prior to the public offering of shares, a 
shareholder vote would be a mere procedural formality and approval 
would be almost automatic because all shareholders voting would 
typically be the fund's organizers. Any investor who purchased 
shares in a public offering after the initial adoption of the plan 
would be on notice that the fund charges 12b-1 fees. Therefore, in 
1996 we amended the rule to permit funds to adopt a 12b-1 plan prior 
to a public offering of shares without a shareholder vote. See 
Technical Amendments to Rule Relating to Payments for the 
Distribution of Shares by a Registered Open-End Management 
Investment Company, Investment Company Release No. 22201 (Sept. 9, 
1996) [61 FR 49010 (Sept. 17, 1996)].
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    The rule does not restrict the amounts of the fees that may be 
approved under the plan.\42\ It also does not specify all of the 
activities that are ``primarily intended to result in the sale of 
shares'' and therefore may be paid by a fund only according to a rule 
12b-1 plan. Nor does it specifically prohibit a fund from paying for 
non-distribution expenses under a rule 12b-1 plan.\43\ Instead of 
limits or restrictions, the rule requires directors (including a 
majority of the independent directors) to conclude, in exercising their 
reasonable business judgment and in light of their fiduciary duties, 
that there is a reasonable likelihood that the plan will benefit both 
the fund and its shareholders.\44\ The directors have a duty to request 
and evaluate as much information as is reasonably necessary for the 
directors to make an informed business decision.\45\ The rule also 
requires any person authorized to direct payments under the plan or any 
related agreement (such as the fund's underwriter) to provide quarterly 
reports to the board of directors of all amounts expended under the 
plan and the purposes for which the expenditures were made.\46\ The 
fund's board of directors (including a majority of the independent 
directors) must decide each year whether to re-approve the plan based 
on the same considerations as required initially to adopt the plan.\47\ 
Any material increases in the amounts paid under the plan must be 
approved by the fund's board, the fund's independent directors, and the 
fund's shareholders.\48\
    In the 1980 Adopting Release, the Commission provided a list of 
nine factors that were intended to provide guidance to directors in 
considering whether the use of fund assets for distribution would 
benefit the fund and its shareholders.\49\ The factors included: (i) 
The need for independent counsel or experts to assist the board; (ii) 
the ``problems'' or ``circumstances'' that make the plan necessary or 
appropriate; (iii) the causes of such problems or circumstances; (iv) 
how the plan would address the problems; (v) the merits of possible 
alternatives; (vi) the interrelationships between the plan and 
distributors; (vii) the possible benefits of the plan to other persons 
relative to the benefits to the fund; (viii) the effect of the plan on 
existing shareholders; and (ix) in deciding whether to continue a plan, 
whether the plan has produced the anticipated benefits to the fund and 
its shareholders.\50\
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    \42\ However, as discussed in more detail in Section II.C.1 of 
this Release, rules adopted by the NASD (now FINRA) prohibit broker-
dealers from selling funds that pay more than 0.25 percent (25 basis 
points) per year of fund assets as ``service fees,'' and more than 
0.75 percent (75 basis points) per year of fund assets as ``asset-
based sales charges,'' effectively setting the maximum 12b-1 fees at 
those amounts or less. NASD Conduct Rule 2830(d)(5) and (d)(2)(E).
    \43\ See 1988 Release, supra note 28, at n.129.
    \44\ Rule 12b-1(e). The rule requires that the fund set forth 
and preserve in the corporate minutes the factors that the directors 
considered, together with the basis for the decision to use fund 
assets for distribution. Rule 12b-1(d).
    \45\ Rule 12b-1(d).
    \46\ Rule 12b-1(b)(3)(ii).
    \47\ Rule 12b-1(b)(3)(i).
    \48\ Rule 12b-1(b)(4). Any other material changes to the plan 
must be approved by the fund's board and the fund's independent 
directors. Rule 12b-1(b)(2).
    \49\ We originally included the factors in the text of the rule 
when we proposed it for public comment. See 1979 Proposing Release, 
supra note 33. In order to avoid the appearance of either unduly 
constricting the directors' decision-making process or of creating a 
mechanical checklist, we deleted the list of factors from rule 12b-1 
at its adoption. Although we decided not to require the directors to 
consider any particular factors, the adopting release noted that the 
enumerated factors ``would normally be relevant to a determination 
of whether to use fund assets for distribution.'' See 1980 Adopting 
Release, supra note 23, at section titled ``Factors.''
    \50\ See 1980 Adopting Release, supra note 23, at section titled 
``Factors.''
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    The rule was intended to allow fund boards some latitude to 
exercise their reasonable business judgment to authorize the 
distribution arrangements and continue them from year to year as 
circumstances warranted.\51\ The annual re-approval requirement and the 
factors enumerated in our adopting release reflected an expectation 
that a fund would use the rule in order to address particular 
distribution problems, such

[[Page 47068]]

as periods of net redemption.\52\ The rule was also designed to allow 
distribution arrangements to evolve.\53\ However, the rule ultimately 
resulted in distribution practices that we did not originally 
anticipate, as described below.\54\
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    \51\ Id. at sections titled ``Discussion'' and ``Independence of 
Directors.'' See also rule 12b-1(e) (providing that funds may 
implement or continue 12b-1 plans ``only if the directors who vote 
to approve such implementation or continuation conclude, in the 
exercise of reasonable business judgment * * * that there is a 
reasonable likelihood that the plan will benefit the company and its 
shareholders''); rule 12b-1(b)(3) (requiring that a 12b-1 plan 
provide in substance that ``it shall continue in effect for a period 
of more than one year from the date of its execution or adoption 
only so long as such continuance is specifically approved at least 
annually'' by the fund's board of directors as a whole, and 
separately by the independent directors).
    \52\ See 1980 Adopting Release, supra note 23, at section titled 
``Factors.'' See also Div. of Inv. Mgmt., SEC, Report on Mutual Fund 
Fees and Expenses (2000) (http://www.sec.gov/news/studies/
feestudy.htm); Joel H. Goldberg and Gregory N. Bressler, Revisiting 
Rule 12b-1 under the Investment Company Act, 31 Sec. & Commodities 
Reg. Rev. 147, 151 (1998) (``Goldberg and Bressler'') (factors 
``presuppose that the 12b-1 plan is designed to solve a particular 
distribution `problem' or to respond to specific `circumstances,' 
e.g., net redemptions''); Lee R. Burgunder and Karl O. Hartmann, The 
Mutual Fund Industry and Rule 12b-1 Plans: An Assessment, 15 Sec. 
Reg. L.J. 364 (1988) (``although the rule does not state this 
directly, the historical circumstances surrounding its preparation 
as well as its legislative history strongly [indicate] that the rule 
is aimed at the possible problems associated with periods of 
stagnant growth or net redemptions, especially for relatively small 
mutual funds'').
    \53\ See 1980 Adopting Release, supra note 23, at section titled 
``General Requirements'' (``Recognizing that new distribution 
activities may continuously evolve in the future, and in view of the 
impracticability of developing an all-inclusive list, the Commission 
maintains that the better approach is to define distribution 
expenses in conceptual terms * * *.'').
    \54\ See 1988 Release, supra note 28, at paragraph preceding 
n.46 (``The use of the rule by the fund industry has resulted in 
many distribution practices that could not have been anticipated 
when the rule was adopted.'').
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C. Developments Following Rule 12b-1's Adoption

    Initially, some funds adopted limited 12b-1 plans and used the 
revenue to pay for advertising and sales materials.\55\ In time, 
however, funds began to adopt 12b-1 plans with higher fees and used the 
revenue to compensate fund intermediaries for sales efforts, rather 
than simply defraying promotional costs.\56\ These 12b-1 plans often 
were coupled with contingent deferred sales loads, or ``CDSLs,'' as 
part of a ``spread load'' arrangement, and served as an alternative to 
a front-end sales load.\57\
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    \55\ See Goldberg and Bressler, supra note 52, at 150. The first 
12b-1 plans provided for payments of 0.25 percent or less of average 
annual net assets and generally were used only to reimburse advisers 
and underwriters for advertising expenses and the printing and 
mailing of prospectuses and sales literature. Id.
    \56\ See 1992 Study, supra note 15, at 322.
    \57\ See Exemptions for Certain Registered Open-End Management 
Investment Companies to Impose Contingent Deferred Sales Loads, 
Investment Company Act Release No. 16619 (Nov. 2, 1988) [53 FR 45275 
(Nov. 9, 1988)] (``Rule 6c-10 Proposing Release'') (proposing to 
permit funds to impose CDSLs, which were often used in combination 
with 12b-1 plans ``as a substitute for charging investors a front-
end sales load'').
---------------------------------------------------------------------------

    Unlike a traditional load, which is commonly referred to as a 
``front-end'' load because it is paid at the time of purchase, fund 
investors pay a CDSL from their proceeds when they redeem shares.\58\ 
The load is ``contingent'' because the amount payable reduces over time 
and usually disappears at the end of a stated period. When combined 
with the payment of 12b-1 fees, a CDSL operates as a deferred payment 
plan for sales charges.\59\ Instead of paying a sales load at the time 
of purchase, a greater portion of the investor's money is invested in 
the fund at the outset, and the investor pays sales charges over time, 
albeit indirectly through charges against fund assets. An investor who 
redeems early compensates the fund underwriter (which has already 
advanced payments to intermediaries) by paying the CDSL in place of 
uncollected revenues from 12b-1 fees attributable to the investor's 
assets.
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    \58\ Rule 22c-1 under the Act requires mutual funds to redeem 
shares at a price based on their net asset value. In order to impose 
CDSLs, funds sought and we granted exemptions from this and other 
provisions to permit shareholders to defer their payment of sales 
charges until redemption. See, e.g., E.F. Hutton Investment Series, 
Inc., Investment Company Act Release Nos. 12079 (Dec. 4, 1981) [46 
FR 60703 (Dec. 11, 1981)] (notice) and 12135 (Jan. 4, 1982) (order). 
After issuing numerous exemptions, we codified them in rule 6c-10, 
which permits funds complying with the rule to impose CDSLs without 
first having to obtain individual exemptions. Exemption for Certain 
Open-End Management Investment Companies to Impose Contingent 
Deferred Sales Loads, Investment Company Act Release No. 20916 (Feb. 
23, 1995) [60 FR 11890 (Mar. 1, 1995)]. We later amended the rule to 
permit other types of deferred sales loads, including a form of 
account-level sales charge we referred to as an ``installment 
load.'' Exemption for Certain Open-End Management Investment 
Companies to Impose Contingent Deferred Sales Loads, Investment 
Company Act Release No. 22202 (Sept. 9, 1996) [61 FR 49011 (Sept. 
17, 1996)] (``1996 Rule 6c-10 Amendments'').
    \59\ See 1988 Release, supra note 28, at n.69 and accompanying 
text.
---------------------------------------------------------------------------

    These spread load arrangements raised a number of concerns for the 
Commission. First, the 12b-1 fees were higher than expected \60\ and 
seemed inconsistent with one of the original arguments that fund 
managers had advanced in support of rule 12b-1, which was to facilitate 
the creation of economies of scale that would lower expenses for fund 
shareholders.\61\ Moreover, these plans took on the appearance of more 
permanent arrangements, which threatened to undermine the role of fund 
directors in managing the use of fund assets for distribution because 
the arrangements created multi-year business obligations on the part of 
distributors. As a practical matter, the arrangements limited the 
ability of fund directors to terminate the plan because ending the plan 
would deny distributors their future payments.\62\
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    \60\ Id. at nn.116-23 and accompanying text. See also Goldberg 
and Bressler, supra note 52, at nn.22-24 and accompanying text.
    \61\ See Advance Notice of Proposed Rulemaking, supra note 27, 
at n.3 and accompanying text (``Commentators also argued that the 
use of fund assets to finance distribution activities could lead to 
increased sales of shares, thereby alleviating the difficulties 
perceived to result from net redemptions or small asset size,'' such 
as higher expense ratios.). The Commission's concern about the 
changing uses of 12b-1 fees was later reflected in the 1988 proposal 
to amend rule 12b-1. The amendments would have required annual 
shareholder approval of 12b-1 plans, because ``while shareholders 
may see good reason to approve a plan in the early years of a fund 
to stimulate growth to a sufficient level for economies of scale to 
be achieved, they may have a quite different opinion of the utility 
of a 12b-1 plan once a fund has matured.'' 1988 Release, supra note 
28, at text following n.187.
    \62\ 1988 Release, supra note 28 at section titled ``The 
Development and Use of `Reimbursement' Plans.'' See also Goldberg 
and Bressler, supra note 52 (``It would be economic folly * * * for 
a mutual fund underwriter continually to advance sales commissions 
to selling dealers as part of a CDSL arrangement if it were not 
virtually certain that the 12b-1 plan would continue in effect 
indefinitely.'').
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    The Commission responded to these developments by proposing 
amendments to rule 12b-1 in 1988, which effectively would have 
prohibited spread load arrangements.\63\ Many commenters opposed the 
proposed amendments, arguing that spread load plans benefited investors 
by permitting them to defer their distribution costs and avoid high 
front-end loads.\64\ The Commission never adopted those amendments. 
Instead, over the years, the Commission sought to address the 
developing concerns raised by rule 12b-1 by other means, as discussed 
below.\65\
---------------------------------------------------------------------------

    \63\ See 1988 Release, supra note 28, at nn.144-50 and 
accompanying text. Among other things, the 1988 proposed amendments 
would have required that payments under a 12b-1 plan be made on a 
``current basis,'' which would have restricted the ability of a fund 
to pay for distribution expenses incurred on the fund's behalf in 
prior years (such as when the underwriter advances payment of the 
sales load to the broker after completion of the sale). In addition, 
the proposed amendments would have required payments made under a 
rule 12b-1 plan to be tied to specific distribution services 
actually provided to the fund and its shareholders. See also 1992 
Study, supra note 15, at 323.
    \64\ See, e.g., Comment Letter of the ICI at 9-12 (Sept. 19, 
1988) (File No. S7-10-88).
    \65\ Another concern relates to the recent growth in the 
frequency and amount of payments made by fund advisers to broker-
dealers and others distributing fund shares, a practice commonly 
known as ``revenue sharing.'' Because fund advisers derive their 
earnings from sources including advisory fees paid by the fund, the 
payment of distribution expenses by advisers could involve the 
indirect use of fund assets to pay for distribution. Rule 12b-1 
explicitly applies to direct and indirect financing of distribution 
activities. Thus, revenue sharing payments could be construed as an 
indirect use of fund assets for distribution that is unlawful unless 
made pursuant to a rule 12b-1 plan. See supra note 38. The 
Commission has historically taken the position that an adviser's 
financing of distribution activities would not necessarily involve 
an indirect use of fund assets if the payments are made from profits 
that are ``legitimate'' or ``not excessive,'' i.e., profits that are 
``derived from an advisory contract which does not result in a 
breach of fiduciary duty under section 36 of the Act.'' See 1980 
Adopting Release, supra note 23, at section titled ``General 
Requirements.'' In contrast, for example, an indirect use of fund 
assets may result if advisory fees were increased in contemplation 
of distribution payments by the adviser. We are not addressing 
revenue sharing practices in connection with these proposals. 
However, we remain concerned that revenue sharing payments may give 
broker-dealers and other recipients incentives to market particular 
funds or fund classes, through ``preferred lists'' or otherwise, and 
that such incentives create conflicts of interest (e.g., between a 
broker-dealer's suitability obligation to its customers and its 
self-interest in maximizing revenue) that may be inadequately 
disclosed. We proposed new requirements regarding disclosure of 
revenue sharing payments in 2004 in connection with our ``Point of 
Sale'' proposals. See Confirmation Requirements and Point of Sale 
Requirements for Transactions in Certain Mutual Funds and Other 
Securities, and Other Confirmation Requirement Amendments, and 
Amendments to the Registration Form for Mutual Funds, Investment 
Company Act Release No. 26341 (Jan. 24, 2004) [69 FR 6438 (Feb. 10, 
2004)]. See also Point of Sale Disclosure Requirements and 
Confirmation Requirements for Transactions in Mutual Funds, College 
Savings Plans, and Certain Other Securities, and Amendments to the 
Registration Form for Mutual Funds, Investment Company Act Release 
No. 26778 (Feb. 28, 2005) [70 FR 10521 (Mar. 4, 2005)] (reopening of 
comment period and supplemental request for comment). We are 
continuing to consider further rule amendments related to revenue 
sharing.

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[[Page 47069]]

1. Imposition of Sales Load Caps
    In 1992, the Commission approved amendments to NASD Conduct Rule 
2830 (the ``NASD sales charge rule''), which had the effect of limiting 
the maximum amount of 12b-1 fees that many funds could deduct from fund 
assets pursuant to a rule 12b-1 plan, based roughly on the then-
existing NASD limits on sales loads.\66\ While it does not directly 
regulate what funds can charge, the NASD (now FINRA) sales charge rule 
bars registered broker-dealers who are members from selling funds that 
impose combined sales charges that exceed certain limits. The limits 
vary based on whether the fund has a 12b-1 fee, a ``service fee,'' \67\ 
rights of accumulation,\68\ and other features.
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    \66\ NASD Conduct Rule 2830(d). The NASD sales charge rule is 
currently administered by FINRA. FINRA derives its authority to 
regulate the level of mutual fund sales charges from section 
22(b)(1) of the Act. See supra note 20. See Order Approving Proposed 
Rule Change Relating to the Limitation of Asset-Based Sales Charges 
as Imposed by Investment Companies, Exchange Act Release No. 30897 
(July 7, 1992) [57 FR 30985 (July 13, 1992)] (``1992 NASD Rule 
Release''). In 2009, FINRA proposed to re-codify the rule, in 
conjunction with its consolidation of rules issued by the NASD and 
by the New York Stock Exchange, and to revise the rule with regard 
to the disclosure of cash compensation. See FINRA, Investment 
Company Securities: FINRA Requests Comment on Proposed Consolidated 
FINRA Rule Governing Investment Company Securities, Regulatory 
Notice 09-34 (June 2009).
    \67\ See infra note 152 and accompanying text for additional 
information on service fees.
    \68\ Rights of accumulation allow investors to qualify for a 
reduced sales charge (or ``breakpoint'') based on the aggregate 
value of shares previously purchased or owned plus the securities 
being purchased. NASD Conduct Rule 2830(b)(7).
---------------------------------------------------------------------------

    Prior to 1992, the NASD sales charge rule had not been applied to 
rule 12b-1 fees that funds deducted from assets as a substitute for a 
front-end sales load. In 1992, the NASD determined that it was 
appropriate to amend the rule specifically to encompass all forms of 
mutual fund sales compensation, including these ``asset-based sales 
charges.'' \69\
---------------------------------------------------------------------------

    \69\ The NASD explained that the changes were necessary to: (i) 
Assure a level playing field among all members selling mutual fund 
shares; and (ii) prevent the circumvention of its sales charge caps 
through the use of rule 12b-1 plans, because it had become possible 
for funds to use 12b-1 plans to charge investors more for 
distribution than could have been charged as a front-end sales load 
under the existing sales charge rule. See NASD Notice to Members 92-
41; 1992 NASD Rule Release, supra note 66. In its comment letter, 
the ICI agreed that the proposed expansion of the NASD rule to 
include asset-based sales charges ``appropriately recognizes that 
Rule 12b-1 fees * * * alone or in combination with [CDSLs], 
generally serve as the functional equivalent of traditional front-
end sales loads.'' Comment Letter of the ICI (May 10, 1991) (File 
No. SR-NASD-90-69).
---------------------------------------------------------------------------

    As amended, the rule caps the annual amount of asset-based sales 
charges that a fund may deduct at 75 basis points.\70\ In addition, a 
fund with an asset-based sales charge is subject to an aggregate cap of 
6.25 percent of new gross sales (rising to 7.25 percent of new gross 
sales if the fund does not pay a service fee), plus interest, on the 
total sales charges levied (e.g., asset-based, front-end, and 
deferred).\71\ This aggregate cap requires a fund with an asset-based 
sales charge to keep a running balance from which all sales charges 
imposed by the fund are deducted.\72\ Because it is calculated at the 
fund level based on the amount of aggregate new fund shares sold, the 
aggregate cap does not limit the actual amount of sales charges that a 
particular investor may pay.\73\ Thus, it is possible for a long-term 
shareholder in a fund with an asset-based sales charge to pay more in 
total sales charges than would have been the case if that investor had 
paid a traditional front-end load.\74\
---------------------------------------------------------------------------

    \70\ NASD Conduct Rule 2830(d)(2)(E)(i).
    \71\ New gross sales excludes sales from the reinvestment of 
distributions and exchanges of shares between investment companies 
in a single complex, between classes of an investment company with 
multiple classes of shares, or between series of a series investment 
company. NASD Conduct Rule 2830(d)(2)(A) and (B).
    \72\ In effect, so long as a fund with asset-based sales charges 
continues to have new sales, it may never exceed the aggregate cap.
    \73\ For convenience, in this Release we refer to the aggregate 
cap as a fund-level cap, but FINRA members may treat each class of 
shares and each series of a fund as a separate investment company 
for purposes of the sales charge rule and these calculations. See 
NASD Notice to Members 93-12 at n.1 (1993) (``NASD Sales Charge Rule 
Q&A'').
    \74\ In our statement on the proposed rule change, we 
acknowledged this possibility. See 1992 NASD Rule Release, supra 
note 66, at discussion following n.16 (``Because the proposed rule 
change contemplates a minimum standard of fund-level accounting 
rather than individual shareholder accounting, it is possible that 
long-term shareholders in a mutual fund that has an asset-based 
sales charge may pay more in total sales [charges] than they would 
have paid if the mutual fund did not have an asset-based sales 
charge.''). However, we also noted that individual shareholder 
accounting would be permitted under the rule amendment, and 
encouraged its use. See Notice of Proposed Rule Change by National 
Association of Securities Dealers, Inc. Relating to the Limitation 
of Asset-Based Sales Charges as Imposed by Investment Companies, 
Exchange Act Release No. 29070 (April 12, 1991) [56 FR 16137 (Apr. 
19, 1991)] (``NASD Notice of Proposed Rule Change'') at section 
titled ``Method of Calculating the Total Sales Charges'' (``It is 
the NASD's intention that fund-level accounting be required at a 
minimum, thereby not precluding the use of more protective methods. 
A fund, based upon its particular circumstances and economic 
perspective, may choose the option of individual shareholder 
accounting.'').
---------------------------------------------------------------------------

    As amended, the NASD rule also places a cap of 25 basis points on 
the amount of a service fee that a fund may deduct annually from fund 
assets in order to pay intermediaries for providing follow-up 
information and account services to clients over the course of their 
investment in the fund.\75\ Unlike the asset-based sales charge, the 
service fee is not limited by an aggregate cap and, as a result, is 
almost always paid for an indefinite period (i.e., for as long as the 
investor holds the shares).\76\
---------------------------------------------------------------------------

    \75\ NASD Conduct Rule 2830(d)(5).
    \76\ See 1992 NASD Rule Release, supra note 66, at section 
III.A.
---------------------------------------------------------------------------

2. Enhanced Disclosure
    Over the years, the Commission has taken several steps designed to 
improve investor understanding of 12b-1 fees and the impact they have 
on fund expenses and investor returns. We required funds to include a 
fee table in the prospectus identifying, among other things, the amount 
of any 12b-1 fee paid.\77\ As part of the 1992 amendments to the NASD 
sales charge rule, we also approved a new provision prohibiting 
registered broker-dealers from describing funds as ``no-load'' funds if 
the funds charged 12b-1 fees greater than 25 basis points.\78\ We 
amended our proxy rules to require funds to better describe material 
facts to shareholders when requesting approval of a rule 12b-1 plan or 
an amendment to the plan.\79\

[[Page 47070]]

Through our Web site, we have also provided investors with information 
and tools designed to enhance their understanding of the fees and 
distribution expenses they pay as a consequence of owning mutual 
funds.\80\
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    \77\ See Consolidated Disclosure of Mutual Fund Expenses, 
Investment Company Act Release No. 16244 (Feb. 1, 1988) [53 FR 3192 
(Feb. 8, 1988)].
    \78\ See 1992 NASD Rule Release, supra note 66. See also NASD 
Conduct Rule 2830(d)(4).
    \79\ Amendments to Proxy Rules for Registered Investment 
Companies, Investment Company Act Release No. 20614 (Oct. 13, 1994) 
[59 FR 52689 (Oct. 19, 1994)].
    \80\ See Mutual Fund Cost Calculator (http://www.sec.gov/
investor/tools/mfcc/mfcc-intsec.htm).
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3. Multiple Classes
    We also permitted funds to offer multiple ``classes'' of shares, 
each with its own arrangement for the payment of distribution costs and 
related shareholder services.\81\ These multiple class arrangements 
were designed to give investors a choice of ways to pay for sales 
charges.\82\ Investors in one class of shares have the same investment 
experience as investors in the other classes, except for expenses 
related to distribution and shareholder services. These multiple class 
arrangements have been adopted by most fund groups that sell through 
intermediaries.\83\
---------------------------------------------------------------------------

    \81\ See Exemption for Open-End Management Investment Companies 
Issuing Multiple Classes of Shares; Disclosure by Multiple Class and 
Master-Feeder Funds; Class Voting on Distribution Plans, Investment 
Company Act Release No. 20915 (Feb. 23, 1995) [60 FR 11876 (Mar. 2, 
1995)] (adopting rule 18f-3). Rule 18f-3 contains requirements that 
protect the rights and obligations of each class as against all 
other classes, particularly with regard to shareholder voting 
rights, and prescribes methods for allocating income, expenses, 
realized gains and losses, and unrealized appreciation and 
depreciation among classes in a multi-class fund.
    \82\ See Exemption for Open-End Management Investment Companies 
Issuing Multiple Classes of Shares; Disclosure by Multiple Class and 
Master-Feeder Funds, Investment Company Act Release No. 19955, at 
section titled ``Background'' (Dec. 15, 1993) [58 FR 68074 (Dec. 23, 
1993)] (stating that some funds use different classes ``to offer 
investors a choice of methods for paying for the costs of selling 
fund shares''). See also Z. Jay. Wang, Vikram K. Nanda & Lu Zheng, 
The ABCs of Mutual Funds: On the Introduction of Multiple Share 
Classes, EFA 2005 Moscow Meetings Paper (Feb. 2005) (http://
ssrn.com/abstract=676246); Vance P. Lesseig, D. Michael Long & 
Thomas I. Smythe, Gains to Mutual Fund Sponsors Offering Multiple 
Share Class Funds, 25 J. Fin. Res. 81 (2002).
    \83\ See ICI, Mutual Fund Distribution Channels and Distribution 
Costs (July 2, 2003) (http://www.ici.org/pdf/per09-03.pdf).
---------------------------------------------------------------------------

    Class designations are not standardized by law, although funds 
often use similar nomenclature.\84\ Class ``A'' shares generally are 
sold with a front-end sales load, and also often have a 12b-1 fee of 
about 25 basis points.\85\ Class ``B'' shares typically are sold 
without a front-end load but charge a spread load consisting of a 12b-1 
fee of 100 basis points (the maximum rate under NASD Conduct Rule 2830, 
including a service fee) and a declining CDSL. Class B shares usually 
convert automatically to class A shares after a fixed period of time 
has elapsed (commonly six to eight years from the date of 
purchase).\86\ Class ``C'' shares typically charge a ``level load'' 
consisting of a 100 basis point 12b-1 fee that is imposed for as long 
as the investor owns the shares, and also may charge a small CDSL of 
one percent if a shareholder redeems within the first year, but seldom 
convert to class A shares with lower 12b-1 fees.\87\ Other classes may 
be available only to certain types of investors, such as those who 
invest in retirement plans, are institutional investors, or purchase 
through a particular intermediary or type of intermediary, such as a 
financial planner.\88\
---------------------------------------------------------------------------

    \84\ The Commission staff has prepared information on mutual 
fund share classes, available on the Commission's Web site. SEC, 
Mutual Fund Classes (http://www.sec.gov/answers/mfclass.htm). While 
there are many variations, for convenience, throughout this Release 
we use the terms ``A shares,'' ``B shares,'' and ``C shares'' to 
refer to the typical share class structures, as described in the 
text above.
    \85\ Class A shares may also be sold with the load waived. See 
infra note 93 and accompanying text.
    \86\ See 2010 ICI Fact Book, supra note 6, at 74. While there is 
no legal requirement for conversion, funds typically provide it. The 
conversion feature reflects the underlying economics of class B 
shares. When the underwriter recoups the commission it has advanced 
to the selling broker, the shareholder is considered to have paid 
his share of distribution costs. (If the underwriter has advanced a 
commission to the intermediary, it would retain 75 basis points of 
the 100 basis points it collects in 12b-1 fees and forward only the 
25 basis points to the intermediary.)
    \87\ See supra note 84.
    \88\ Id.
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D. The Current Role of 12b-1 Fees

    Rule 12b-1 plans continue to play a significant role in paying for 
fund distribution costs. The majority of funds have adopted rule 12b-1 
plans, which paid a total of $9.5 billion in 12b-1 fees in 2009 (down 
from a high of $13.3 billion in 12b-1 fees in 2007).\89\
---------------------------------------------------------------------------

    \89\ See 2010 ICI Fact Book, supra note 6, at 75. This figure 
excludes 12b-1 fees deducted from assets of funds underlying 
insurance company separate accounts offering variable annuities and 
mutual funds that invest primarily in other mutual funds. See also 
Comment Letter of the ICI at Appendix I (July 19, 2007) (File No. 4-
538). Unless otherwise noted, references to comment letters in this 
Release are to letters submitted in response to the Commission's 
request for comments in connection with a 2007 Commission roundtable 
on rule 12b-1. See SEC Press Release, Commission Announces 
Roundtable Discussion Regarding Rule 12b-1 (May 29, 2007) (http://
www.sec.gov/news/press/2007/2007-106.htm). These comment letters are 
available in File No. 4-538 (http://www.sec.gov/comments/4-538/4-
538.shtml).
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    There has been a trend in fund class share ownership away from 
those that impose the highest sales loads and 12b-1 fees. In recent 
years, no-load share classes have attracted more net new cash flow than 
load share classes.\90\ According to Investment Company Institute 
(``ICI'') figures, in 2009, $323 billion flowed into no-load share 
classes of long-term mutual funds, while in comparison, load share 
classes only received $39 billion in net new cash flow.\91\ In 2009, 
class B shares experienced net outflow for a seventh consecutive year, 
with total net outflow of approximately $24 billion.\92\ In contrast, 
net new investment in class A shares was approximately $19 billion, and 
net new investment in class C shares was approximately $37 billion.\93\
---------------------------------------------------------------------------

    \90\ See 2010 ICI Fact Book, supra note 6, at 76.
    \91\ Id. at 76.
    \92\ Id. at 76. Net outflow from B share classes can result from 
purchases being exceeded by: (i) Redemptions; and (ii) shares 
converting to another class after a certain period of time. As a 
result of their (typically) automatic conversion feature, B shares 
generally are self-limiting as a class unless they continue to be 
sold at the same rate as they were sold previously.
    \93\ Id. at 76. Many class A shares today are sold with the load 
waived or substantially reduced. For example, many funds permit 
broker-dealers to sell their shares with the front-end load waived 
or substantially reduced, for use in wrap fee programs. In wrap fee 
programs, instead of paying a one-time sales charge for each 
investment purchase, a customer pays the broker an annual percentage 
of the assets held through that broker in exchange for the ability 
to buy and redeem securities without additional sales charges. 
According to one study, in 2008, 60 percent of class A shares were 
sold at NAV with the load waived. Strategic Insight Mutual Fund 
Research and Consulting, LLC, Perspectives on Intermediary Sales: 
Trends in Fund Sales by Distribution Channel and Share Class (May 
2009). The ICI found that, although the average maximum front-end 
sales load on stock funds in 2009 was 5.3 percent, the average sales 
load actually paid by investors was only 1.0 percent, due to the 
impact of load-waived class A shares. See 2010 ICI Fact Book, supra 
note 6, at 65.
---------------------------------------------------------------------------

    Although more investors appear to be investing in no-load funds and 
share classes, these statistics do not reflect a trend away from using 
intermediaries.\94\ According to the ICI, 80 percent of investors who 
own funds outside of a retirement plan use an intermediary that 
provides professional financial assistance (``financial advisor'').\95\ 
Of those investors, almost half own funds purchased solely through 
financial advisors, while the rest own funds purchased through 
financial advisors as well as directly from fund companies, mutual fund 
supermarkets, or discount brokers.\96\ The data suggest a growing

[[Page 47071]]

predominance of no-load or load-waived classes in funds that 
traditionally were sold with a load.\97\ In these circumstances, 
investors do not pay a sales load, but pay distribution expenses 
through a separate fee arranged between the intermediary and the 
investor, and/or through the payment of ongoing ``service fees.'' \98\
---------------------------------------------------------------------------

    \94\ Among households owning mutual funds, only 20 percent of 
these investors purchased directly from mutual funds in 2009. See 
Shareholder Profile Report, supra note 6, at 27. The prevalence of 
mutual fund ``supermarkets'' (described in note 96, infra), 
employer-sponsored retirement plans, and fee-based financial 
advisers (advisers who charge investors separately for their 
services rather than through a load or fee assessed at the fund 
level) has provided investors alternative means of purchasing no-
load funds. See 2010 ICI Fact Book, supra note 6, at 65. Many 
investors now purchase no-load funds through these intermediaries.
    \95\ See 2010 ICI Fact Book,  supra note 6, at 85.
    \96\ Id. at 85. Mutual fund supermarkets, which are sponsored by 
brokerage firms, ``permit investors to purchase and hold a broad 
range of funds from many different fund sponsors through a single 
brokerage account.'' Robert C. Pozen, The Mutual Fund Business (2d 
Ed., 2002), at 304. The primary benefit of this ``one-stop shopping 
venue'' is simplicity: An investor can buy funds from different fund 
families and receive all of their statements in a single report. 
Discount brokers allow investors to trade securities at a lower 
commission rate but provide less individualized service.
    \97\ See 2010 ICI Fact Book, supra note 6, at 76.
    \98\ See generally Carol Gehl, et al., Mutual Fund Regulation 
Sec.  18:6.1 (May 2008); Fee Trends Report, supra note 22, at 6 
(noting that although in the 1980s and 1990s sales loads were a 
primary means of compensating brokers for services provided to 
investors, in recent years brokers have increasingly been 
compensated through ``asset-based'' fees).
---------------------------------------------------------------------------

    A significant use of 12b-1 fees today is for what is typically 
characterized as ``services'' provided to investors after the sale by 
the broker-dealers and other intermediaries who sell the fund. 
According to the Investment Company Institute, more than half of all 
12b-1 fees paid by funds are used for this purpose,\99\ with broker-
dealers and bank trust departments being the primary recipients. Under 
the NASD sales charge rule discussed above, up to 25 basis points of 
fund assets annually may be paid to members as a ``service fee.'' \100\
---------------------------------------------------------------------------

    \99\ See 2010 ICI Fact Book, supra note 6, at 73.
    \100\ NASD Conduct Rule 2830(d)(5). The NASD rule defines 
``service fees'' as ``payments by [a fund] for personal service and/
or the maintenance of shareholder accounts.'' NASD Conduct Rule 
2830(b)(9). These services could include responding to customer 
inquiries, providing information on investments, and reviewing 
customer holdings on a regular basis, but would not include sub-
transfer agency services, sub-accounting services, or administrative 
services. See NASD Sales Charge Rule Q&A, supra note 73, at Question 
17. The NASD rule does not address whether ``service fees'' 
are required to be included in 12b-1 plans. Id. at Question 
25. However, we understand that funds continue to include 
``service fees'' as distribution expenses under rule 12b-1, 
presumably because the stream of payments (often called ``trail 
commissions'') may act as an inducement to intermediaries' sales 
personnel to sell fund shares and, arguably, because fund 
intermediaries would provide these services in the ordinary course 
of business regardless of whether they receive compensation from the 
fund (which may be just one of many other investments held by the 
intermediary's clients).
---------------------------------------------------------------------------

    Amounts deducted from assets in excess of a service fee are 
typically charged to support the fund's distribution efforts and 
operate as an alternative to a front-end sales load.\101\ These 12b-1 
fees, which are used to pay the selling costs of B and C share classes, 
are ``asset-based sales charges'' under the NASD sales charge caps and 
are limited to a maximum of 75 basis points of fund assets, annually, 
as discussed above.
---------------------------------------------------------------------------

    \101\ According to the ICI, approximately 40 percent of 12b-1 
fees are used for this purpose. See 2010 ICI Fact Book, supra note 
6, at 73.
---------------------------------------------------------------------------

    A common use of 12b-1 fees is to pay for the fund to be included on 
third-party platforms for purchasing mutual funds, such as employer-
sponsored retirement plans and fund supermarkets. Supermarkets and 
retirement plans have become major avenues by which investors purchase 
mutual funds. They have assumed many of the recordkeeping and ongoing 
servicing and support functions for shareholders that funds otherwise 
would perform, and these are often paid for, at least partially, 
through 12b-1 fees.\102\ Under the NASD sales charge rule, no-load 
funds are able to compensate discount brokers and supermarkets for the 
costs of servicing shareholders in those channels through asset-based 
fees of up to 25 basis points annually of the value of fund shares that 
are held in the intermediary's client accounts.\103\ Funds that are 
offered as investment options in defined contribution retirement plans 
also may pay 12b-1 fees (often 50 basis points or more annually) to the 
plan administrator to offset some of the costs of servicing 
shareholders (and perhaps other participants) who invest through those 
plans.\104\
---------------------------------------------------------------------------

    \102\ See infra note 153. A representative of a large fund 
supermarket commented at our roundtable on rule 12b-1 that some fund 
advisers also pay supermarket fees through revenue sharing 
arrangements. See Roundtable Transcript, infra note 109, at 84-87 
(John Morris, Charles Schwab & Co.). See also supra note 65; infra 
paragraph following note 286 (requesting comment whether investors 
in omnibus accounts receive equivalent levels of service relative to 
investors in retail accounts with similar 12b-1 fees).
    \103\ See NASD Conduct Rule 2830(d)(4). Discount brokers and 
fund supermarkets typically hold one account with the fund in the 
name of the broker, and then provide sub-accounting for individual 
shareholder holdings of fund shares. See Mutual Fund Redemption 
Fees, Investment Company Act Release No. 26782 (Mar. 11, 2005) [70 
FR 13328 (Mar. 18, 2005)] at text following n.10 (``Rule 22c-2 
Adopting Release'').
    \104\ See Comment Letter of Charles P. Nelson (June 19, 2007). 
Employers sponsoring defined contribution plans typically hire 
third-party administrators to advise them in selecting the 
investment options offered to employees, perform recordkeeping and 
administrative functions (e.g., producing account statements and 
recording transactions), provide educational materials and seminars, 
and maintain call centers and Internet Web sites for use by plan 
participants. See ICI, Mutual Fund Distribution Channels and 
Distribution Costs, supra note 83.
---------------------------------------------------------------------------

    A minor use of 12b-1 fees is to pay expenses of the fund's 
principal underwriter and for advertising and promotions. Although this 
was one of the main purposes for which 12b-1 plans originally were 
intended, in recent years, only about two percent of 12b-1 fees have 
been used to pay these types of expenses.\105\
---------------------------------------------------------------------------

    \105\ See 2010 ICI Fact Book, supra note 6, at 73.
---------------------------------------------------------------------------

E. Additional Commission Consideration of Rule 12b-1

    In 2004, the Commission amended rule 12b-1 to prohibit fund 
advisers from directing fund brokerage to compensate broker-dealers for 
selling fund shares.\106\ When we proposed those amendments, we invited 
comment on whether the Commission should consider additional changes to 
the rule, including potentially rescinding it.\107\ We made this 
request after observing that the current practice of using 12b-1 fees 
as a substitute for a sales load was a departure from the rule as 
envisioned in 1980.\108\
---------------------------------------------------------------------------

    \106\ Prohibition on the Use of Brokerage Commissions to Finance 
Distribution, Investment Company Act Release No. 26591 (Sept. 2, 
2004) [69 FR 54728 (Sept. 9, 2004)] (``2004 Rule 12b-1 Amendments 
Adopting Release''). Although fund advisers may choose which brokers 
will execute the fund's transactions when buying and selling 
portfolio securities, fund brokerage is an asset of the fund. We 
prohibited the practice of using brokerage to reward sales of fund 
shares because it produces powerful incentives for advisers, is 
potentially harmful to fund investors, and ``reliance on fund 
directors to police the use of fund brokerage to promote the sale of 
fund sales is not sufficient.'' Id. at text following n.16.
    \107\ See Prohibition on the Use of Brokerage Commissions to 
Finance Distribution, Investment Company Act Release No. 26356 at 
section IV (Feb. 24, 2004) [69 FR 9726 (Mar. 1, 2004)] (``2004 Rule 
12b-1 Amendments Proposing Release''). Comments are available in 
File No. S7-09-04, at http://www.sec.gov/rules/proposed/
s70904.shtml.
    \108\ Id. See also John A. Haslem, Investor Learning and Mutual 
Fund Advertising and Distribution Fees, J. Investing 53 (Winter 
2009) (``Haslem'') (noting ``the transformation of 12b-1 fees from 
their original primary use for advertising and promotion'' and 
concluding that ``Rule 12b-1 fees are now used primarily to reward 
brokers for sales of adviser mutual fund shares'').
---------------------------------------------------------------------------

    To further explore the available options for reforming the rule, we 
held a roundtable on rule 12b-1 on June 19, 2007, to solicit the views 
of investor advocates, fund industry representatives, independent 
directors, current and former regulators, representatives from broker-
dealers and other intermediaries who sell fund shares, and interested 
observers.\109\ The participants responded to Commissioners' questions 
regarding the costs and benefits of 12b-1 plans, the role of 12b-1 
plans in current fund distribution practices, and options for reform. 
The roundtable discussions and the nearly 1,500 comment letters we

[[Page 47072]]

received on the topic greatly informed our understanding of the 
operation of rule 12b-1 and the role it plays in the distribution of 
mutual funds today.
---------------------------------------------------------------------------

    \109\ See http://www.sec.gov/spotlight/rule12b-1.htm (which 
provides links to various materials relating to the rule 12b-1 
roundtable). An unofficial transcript of the June 19, 2007 Rule 12b-
1 Roundtable is available at http://www.sec.gov/news/openmeetings/
2007/12b1transcript-061907.pdf (``Roundtable Transcript'').
---------------------------------------------------------------------------

    Many of the panelists and commenters representing fund management 
companies and intermediaries contended that the rule had benefited both 
funds and investors in substantial ways, and that the central problem 
lay with the rule's outdated requirements.\110\ Some of these 
commenters asserted that rule 12b-1 provides a cost-efficient way of 
paying for services that investors want and need (i.e., by 
``mutualizing'' them), including ongoing services from financial 
professionals and access to funds through fund supermarkets and 
retirement platforms.\111\ Several participants thought that investors 
preferred paying rule 12b-1 fees to paying front-end loads, and equated 
a decision to invest in a class of shares with a 12b-1 fee with a 
decision to pay a sales load over time.\112\ They asserted that rule 
12b-1 fees were, at least in part, responsible for bringing down the 
overall cost of investing in funds.\113\
---------------------------------------------------------------------------

    \110\ See, e.g., Roundtable Transcript, supra note 109, at 172 
(Michael Sharp, Citi Global Wealth Management); Comment Letter of 
the Independent Directors Council (July 19, 2007) (``IDC supports 
retaining the framework of Rule 12b-1 and believes that changes to 
the rule should take the form of enhancements and clarifications to 
adapt the rule to the modern world of fund distribution.'').
    \111\ See, e.g., Roundtable Transcript, supra note 109, at 111-
113 (Paul Haaga, Capital Research Management).
    \112\ See, e.g., id. at 64 (Martin Byrne, Merrill Lynch).
    \113\ See, e.g., id. at 171 (Michael Sharp, Citi Global Wealth 
Management).
---------------------------------------------------------------------------

    Many of these panelists emphasized the importance of 12b-1 fees to 
pay for services that matter to investors.\114\ They noted that 
platforms such as supermarkets and retirement plans use 12b-1 fees to 
support their service infrastructures, including interactive Web sites, 
investment allocation tools, and other educational materials that are 
currently made available to, and benefit, fund investors in those 
channels.\115\ Several roundtable participants and commenters also 
noted that 12b-1 fees paid to platforms have enabled small funds and 
no-load funds to compete successfully for a broader segment of the 
investing population in many distribution channels, which is critical 
to their distribution strategies.\116\ This development, they 
contended, has been beneficial because it increases competition and 
helps spur innovation.\117\
---------------------------------------------------------------------------

    \114\ See, e.g., id. at 118-19 (Joseph Russo, Advantage 
Financial Group); id. at 180 (Barbara Roper, Consumer Federation of 
America). Commenters also emphasized the importance of 12b-1 fees 
for investor servicing. See, e.g., Comment Letter of the National 
Association of Insurance and Financial Advisors (July 13, 2007); 
Comment Letter of the ICI (July 19, 2007).
    \115\ See, e.g., Roundtable Transcript, supra note 109, at 218 
(Don Phillips, Morningstar).
    \116\ See, e.g., id. at 67 (Mellody Hobson, Ariel Capital 
Management) (``We could not exist without the 12b-1 fee to grow the 
funds.'').
    \117\ See, e.g., Comment Letter of the ICI (July 19, 2007); 
Comment Letter of the Securities Industry and Financial Markets 
Association (July 19, 2007).
---------------------------------------------------------------------------

    Other panelists were not as sanguine about rule 12b-1. They argued 
that even though 12b-1 fees may pay for worthwhile services to 
investors, the costs of those services are obscured in the fund's 
expense ratio in a way that makes the costs less transparent and the 
services less likely to be priced competitively.\118\ They questioned 
the necessity of having these types of distribution charges embedded as 
a fund expense. In addition, they questioned whether investors are 
aware of and making informed choices about the services they pay for 
through the 12b-1 fee, which many panelists agreed lacks the prominence 
of a front-end load.\119\ Most commenters believed that better 
disclosure and more effective communication of 12b-1 fees, and the 
manner in which they are used, would be useful to investors.\120\
---------------------------------------------------------------------------

    \118\ See, e.g., Roundtable Transcript, supra note 109, at 181 
(Barbara Roper, Consumer Federation of America) and 185 (Richard 
Phillips, K&L Gates). See also Comment Letter of Bridgeway Funds, 
Inc. and Bridgeway Capital Management, Inc. (July 19, 2007); Comment 
Letter of Andrew Reyburn (July 20, 2007).
    \119\ See, e.g., Roundtable Transcript, supra note 109, at 121 
(Brad Barber, Univ. of Cal., Davis) (``And I think what you hear 
from the industry--and the message I hear over and over again--is 
that investors do not like front-end loads. There is a simple 
psychological reason for that. It's an in-your-face fee. When you 
pay a load fee, it comes immediately out and off the top. Whereas, 
if you pay a spread fee over time, it's less obvious and less 
salient.''). See also Comment Letter of Michael R. Clancy (June 13, 
2007) (``Very few if any clients actually understand the [12b-1] 
fee, or even know that they are paying it. Of the few who actually 
understand a front-end load, the overwhelming majority of those 
clients don't know that there is an ongoing fee as well.'').
    \120\ See, e.g., Comment Letter of National Association of 
Personal Financial Advisors (July 17, 2007); Comment Letter of 
Donald H. Pratt (July 19, 2007); Comment Letter of the ICI (July 19, 
2007).
---------------------------------------------------------------------------

    One panelist argued that 12b-1 fees have the effect of increasing 
expense ratios and decreasing investment returns for investors.\121\ 
Some suggested that the Commission encourage (or require) that fees to 
compensate distributors be paid by investors as an account charge 
(through ``demutualization'' or ``externalization'').\122\ They argued 
that externalizing these ``bundled costs'' would make them more visible 
to shareholders and that unbundling costs and services promotes more 
efficient pricing of those services.\123\ Representatives of fund 
management companies and others countered that such a fee structure 
already exists in the form of a mutual fund ``wrap'' account and other 
types of fee-based service arrangements that charge fees comparable to 
the maximum 100 basis point 12b-1 fee. They argued that it is more 
cost-effective and tax-efficient for funds to collect 12b-1 fees and 
credit the intermediaries, than it is for the intermediaries to charge 
their clients directly through wrap accounts.\124\ As discussed above, 
although more investors today invest in no-load funds and share 
classes, this trend does not reflect the decreasing use of 
intermediaries, but rather the growing use of wrap accounts and other 
arrangements between intermediaries and investors that entail separate 
fees.\125\
---------------------------------------------------------------------------

    \121\ See Roundtable Transcript, supra note 109, at 119-120 
(Shannon Zimmerman, Motley Fool).
    \122\ See, e.g., id. at 103 (Thomas Selman, FINRA). See also 
Comment Letter of Michael R. Clancy (June 13, 2007); Comment Letter 
of Neil J. McCarthy, Jr. (June 19, 2007); Comment Letter of Michael 
Murray (June 21, 2007).
    \123\ See, e.g., Roundtable Transcript, supra note 109, at 132 
(Shannon Zimmerman, Motley Fool); 204-07 (Richard M. Phillips, K&L 
Gates). See also Comment Letter of Bridgeway Funds, Inc. and 
Bridgeway Capital Management, Inc. (July 19, 2007) (``Mutualization 
of [12b-1] fees inhibits an investor from having the necessary 
information on price vs. value to make economic choices across 
service providers. This distorts fundamental, free-market economics 
and restricts valuable competition in the intermediary channel.'').
    \124\ See, e.g., Roundtable Transcript, supra note 109, at 170-
72 (Michael Sharp, Citi Global Wealth Management). See also Comment 
Letter of the ICI (July 19, 2007) (``There are significant tax and 
operational disadvantages to imposing 12b-1 fees at the account-
level that likely would outweigh the benefits of this approach.'').
    \125\ See supra text accompanying notes 97 and 98.
---------------------------------------------------------------------------

    Several participants suggested that the term ``12b-1 fee'' causes 
confusion because it encompasses so many different activities.\126\ 
Most roundtable participants agreed that greater transparency and 
better communication of what 12b-1 fees are and how they are used are 
vital to enabling investors to make optimal choices among the 
alternatives offered to them.\127\ Some panelists were troubled that, 
according to academic studies, many investors do

[[Page 47073]]

not appear to have a strong understanding of fund fees and expenses or 
their impact on investment returns. In particular, some participants 
were concerned that, because 12b-1 fees are paid automatically in small 
increments over time, they are much less obvious to investors than 
front-end sales loads.\128\ Unlike traditional loads, 12b-1 fees are 
deducted from fund assets, and are reflected in lower investment 
returns, rather than deducted directly from shareholder accounts.\129\ 
As a result, they may not be fully appreciated as a sales charge.\130\ 
In addition, the expanding number of share classes and the overall 
complexity of fund load structures can further overwhelm and confuse 
investors.\131\
---------------------------------------------------------------------------

    \126\ See, e.g., Roundtable Transcript, supra note 109, at 58 
(Paul Haaga, Capital Research Management). See also Comment Letter 
of the Independent Directors Council (July 19, 2007) (``IDC 
recognizes that one term may not be sufficient given the wide 
variety of usage of 12b-1 fees * * *.'').
    \127\ See, e.g., Roundtable Transcript, supra note 109, at 141-
54 (multiple commenters). See also Comment Letter of the ICI (July 
19, 2007) (``Many commentators * * * questioned the extent to which 
investors are aware of the nature and purpose of 12b-1 fees and 
suggested that disclosure of the fees and other distribution related 
costs can and should be improved. We agree.'').
    \128\ See, e.g., Roundtable Transcript, supra note 109, at 121-
22 (Brad Barber, Univ. of Cal., Davis).
    \129\ One panelist remarked that the spread load exists because 
``it provided a distribution channel for brokers, one that was an 
alternative and has many positive characteristics, but also makes 
the costs quite non-transparent. And I don't think that is a 
coincidence. The growth and use of these funds, at a time when there 
was a lot of press around no-load funds, I think there was a reason 
brokers wanted to receive their compensation for the services they 
provided in a way that did not allow investors to easily put a price 
tag on those services.'' Id. at 180-81 (Barbara Roper, Consumer 
Federation of America). See also Comment Letter of the National 
Association of Personal Financial Advisors (July 17, 2007) (``We 
believe that individual investors are confused about the purpose of 
12b-1 fees and their impact upon their own returns.'').
    \130\ See General Accounting Office (``GAO''), Mutual Fund Fees: 
Additional Disclosure Could Encourage Price Competition 75 (June 
2000) (observing that investors are more aware of sales loads than 
operating expense fees, and are increasingly resistant to paying the 
higher front-end loads). See also Todd Houge and Jay Wellman, The 
Use and Abuse of Mutual Fund Expenses (Jan. 31, 2006) (academic 
working paper) (http://papers.ssrn.com/sol3/papers.cfm?abstract_
id=880463) (``While mutual fund investors are often aware of up-
front charges like sales loads, research shows they are often less 
cognizant of annual operating expenses, even though both types of 
fees are deadweight costs.'').
    \131\ See, e.g., Comment Letter of Mark Freeland (June 19, 2007) 
(``The complexity of pricing structures makes it more difficult for 
the small investor to compare prices and services of different 
advisers.''). One commenter expressed concern that the proliferation 
of share classes may increase costs to funds and thereby hinder 
shareholder returns. See Comment Letter of Bridgeway Funds, Inc. and 
Bridgeway Capital Management, Inc. (July 19, 2007) (``[T]his 
increase in share classes increases the fund's cost of accounting, 
filings, shareholder servicing (e.g., prospectus review, drafting, 
printing, mailing), blue sky registration, transfer agency, board 
review, etc. These costs are a drain to shareholder returns.'').
---------------------------------------------------------------------------

    Many roundtable participants and commenters agreed that rule 12b-1 
would benefit from revision, but they differed on the best course for 
going forward. Many participants and commenters suggested that the 
Commission merely revise the factors for board consideration, or 
refashion the role of the board in overseeing 12b-1 fees, to better 
reflect the economic realities of fund distribution in today's 
market.\132\ Others recommended that the Commission improve disclosure 
of 12b-1 fees by changing the name of the fees or, more significantly, 
by requiring individualized account statement disclosure of the amount 
of 12b-1 fees actually paid by individual shareholders.\133\ Some 
suggested, as discussed above, that 12b-1 fees should be 
``externalized,'' that is, deducted directly from shareholder accounts 
rather than fund assets.\134\ Finally, some commenters argued that rule 
12b-1 has outlived its original purpose, and should be substantially 
revised or repealed.\135\
---------------------------------------------------------------------------

    \132\ See, e.g., Roundtable Transcript, supra note 109, at 50-51 
(Joel Goldberg, Willkie Farr & Gallagher) and 201-02 (Mark Fetting, 
Legg Mason, Inc.).
    \133\ See, e.g., id. at 222-23 (Avi Nachmany, Strategic Insight) 
and 154 (John A. Hill, Putnam Funds); Comment Letter of Access Data 
Corp. (July 19, 2007) (account-level disclosure of 12b-1 fees is not 
cost-prohibitive, and would ``ensure that shareholders have full 
disclosure and fee transparency so that they can make an informed 
decision related to the fees they pay versus the services they 
receive.''). See also GAO, Mutual Funds: Greater transparency needed 
in disclosures to investors at 54 (GAO-03-763) (June 9, 2003) 
(providing investors with specific dollar amounts of expenses paid 
or placing fee-related disclosure in quarterly account statements 
could increase fee transparency). But see Comment Letter of W. Hardy 
Callcott (June 18, 2007) (individualized disclosure of 12b-1 fees 
would entail significant costs and would not, standing alone, be 
meaningful to investors). We discuss the costs associated with rule 
12b-1 and our proposed amendments in the Cost Benefit Analysis 
Section of this Release. See infra Section V.
    \134\ See, e.g., Roundtable Transcript, supra note 109, at 204-
06 (Richard Phillips, K&L Gates); Comment Letter of CFA Institute 
(Aug. 9, 2004) (File No. S7-09-04) (``We also recommend that funds 
be required to deduct distribution-related costs directly from 
shareholder accounts as a separate line item, rather than from fund 
assets.'').
    \135\ See, e.g., Comment Letter of Bridgeway Funds, Inc. and 
Bridgeway Capital Management, Inc. (July 19, 2007); Comment Letter 
of Lauren Garland (June 2, 2007); Comment Letter of Andrew Gross 
(June 9, 2007); Comment Letter of Melvyn H. Mark (June 17, 2007); 
Comment Letter of Michael Murray (June 21, 2007). See also Comment 
Letter of JoNell Hermanson (July 9, 2007) (stating that variable 
insurance products should not be permitted to charge 12b-1 fees); 
Comment Letter of Steve Wiands (Aug. 6, 2007) (stating that funds 
closed to new investors should not be permitted to charge 12b-1 
fees).
---------------------------------------------------------------------------

    Roundtable participants generally agreed that 12b-1 fees currently 
are used to an extent and in ways that are different than originally 
envisioned.\136\ This has caused a ``disconnect'' to develop between 
the requirements of the rule and its application. For example, 
roundtable participants were in general agreement that the nine 
``factors'' that the Commission provided as guidance to the board are 
no longer as relevant to the current uses of 12b-1 fees. They stated 
that the ensuing legal uncertainties have made it more difficult for 
directors to perform their duties and make their required findings 
under the rule.\137\ They also said that, although directors complete 
the required analysis, they tend to view 12b-1 fees as a necessity--
either to recoup outlays already made or to pay intermediaries at a 
rate already decided by the intermediary or the marketplace--to the 
point that 12b-1 plans tend always to be continued from year to 
year.\138\
---------------------------------------------------------------------------

    \136\ See, e.g., Roundtable Transcript, supra note 109, at 192 
(Richard Phillips, K&L Gates) and 194 (Mark Fetting, Legg Mason, 
Inc.).
    \137\ See, e.g., id. at 105 (Robert Uek, MFS Funds) and 158 
(John Hill, Putnam Funds). One panelist did not view the factors as 
posing a significant obstacle to current distribution arrangements, 
however. Id. at 33-34 (Matthew Fink, Former President, ICI) (``The 
rule expressly says these factors are suggestions * * *. So the fact 
that you may be approving a plan that the purported or suggested 
factors don't fit, it's totally irrelevant.'').
    \138\ See, e.g., id. at 140 (Jeffrey Keil, Keil Fiduciary 
Strategies).
---------------------------------------------------------------------------

    Fund directors also observed that, in many instances, they and 
their funds lack the bargaining power to effectively negotiate the 
level of fees that are paid to financial intermediaries through 12b-1 
plans and other sources.\139\ This is particularly true in the case of 
fund supermarkets, where the sponsor may charge all participating funds 
according to the same rate schedule. These and other statements made at 
the roundtable and in the comment letters suggest that one of the 
fundamental premises of rule 12b-1--that independent directors would 
play an active part in setting distribution fees--does not reflect the 
current economic realities of fund distribution and the role 12b-1 fees 
play in it.
---------------------------------------------------------------------------

    \139\ Cf. Comment Letter of the Independent Directors Council 
(July 19, 2007) (``We are not aware of any board that has failed to 
renew a 12b-1 plan (or is likely to do so) * * *.'').
---------------------------------------------------------------------------

III. Discussion

    We have carefully considered these and other views that emerged 
from the roundtable discussion and the many comment letters we 
subsequently received. Many of the letters highlighted issues that have 
arisen with the current operation of the rule.\140\ We heard

[[Page 47074]]

arguments advocating substantial change in how investors pay 
distribution costs, most of which are, at their core, arguments for 
greater transparency. We also heard concerns that significant changes 
could disrupt arrangements that are today deeply embedded in mutual 
fund sales and distribution networks, including those that finance the 
operation of fund supermarkets, retirement plan platforms, and 
financial planning. These arguments supported the preservation of 
business models that were developed around an existing regulatory 
framework, but tended to discount some of the more troubling aspects of 
distribution arrangements that affect millions of American investors. 
We have evaluated all of these views in developing this proposal, which 
is designed, as discussed further below, to enhance transparency and 
fairness to the benefit of investors.
---------------------------------------------------------------------------

    \140\ See supra note 89. Of the nearly 1500 comment letters we 
received, over 1400 were sent by financial planners and registered 
broker-dealers who opposed substantive reform of rule 12b-1. Of 
these 1400 letters, almost 1000 were form letters. See Comment 
Letter Type A; Comment Letter Type B. We received approximately 25 
letters from mutual funds, large broker-dealer firms, insurance 
companies, industry associations, and law firms. The majority of 
these letters also opposed significant rule reform, but expressed 
various levels of support for changing the name of the fee, 
requiring additional disclosure, and revising the role of the fund 
board in approving the plan. We received approximately 10 letters 
from investors, most of whom supported substantive reform or repeal 
of the rule.
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    We do not believe that it would benefit fund investors to return to 
the era in which they paid a substantial front-end sales load and did 
not have access to various alternative forms of distribution payment 
arrangements. Denying investors the ability to select alternate 
distribution methods or to pay for distribution services over time is 
not a goal of this rulemaking. Thus, we are not proposing in this 
rulemaking to prohibit the use of fund assets to pay sales costs. We 
remain concerned, however, about the conflicts of interest that arise 
when fund assets are used for distribution, and that fund directors 
monitor those conflicts. We also do not believe that merely modifying 
the ``factors'' for director consideration in order to accommodate 
existing industry practices would sufficiently address the issues we 
have identified with the use of fund assets to pay for distribution 
under rule 12b-1.
    Therefore, we are proposing a new approach to asset-based 
distribution fees (i.e., 12b-1 fees) that is designed to benefit fund 
shareholders while minimizing disruption of current arrangements. 
Specifically, our proposal would explicitly recognize that a portion of 
asset-based distribution fees (i.e., asset-based sales charges) 
functions like a sales load that is paid over time, and thus should be 
subject to the requirements and limitations that apply to traditional 
sales loads.\141\ Limits on asset-based sales charges would be applied 
to the amounts paid by each investor (rather than amounts paid by the 
fund) in order to assure that each shareholder would pay only his or 
her proportionate share of distribution related costs. In addition, we 
propose to require funds to identify for shareholders that portion of 
asset-based distribution fees (today's 12b-1 fees) that operates as a 
substitute for a sales load and thus facilitate comparison with the 
distribution related costs of other funds or classes of shares. The 
proposed new rule and rule amendments would replace current rule 12b-1.
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    \141\ We acknowledged this, at least implicitly, when we 
approved the NASD sales charge rule amendments in 1992. We observed 
that the ``purpose of the revised maximum sales charge rule is to 
create `approximate economic equivalency' as to the maximum sales 
charges for different types of mutual funds.'' See 1992 NASD Rule 
Release, supra note 66, at section V. The Commission believed the 
amendments would, among other things, promote fairness by assuring 
``some degree of parity'' between the sales and sales-promotion 
expenses charged by traditional load classes and classes that assess 
12b-1 fees. Id.
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    We describe the details of our proposals in the next sections of 
this Release. In Section III.M of this Release, we describe the 
anticipated impact of these proposals on investors, fund managers and 
directors, broker-dealers, and other intermediaries.

A. Summary of Our Proposals

    The new approach we propose would, like NASD Conduct Rule 2830, 
differentiate between the two constituent parts of current 12b-1 fees 
(asset-based sales charges and service fees). Under proposed new rule 
12b-2, funds could continue to use a limited amount of fund assets to 
pay for distribution related expenses.\142\ The maximum amount of this 
``marketing and service fee'' would be tied to the service fee limit 
imposed by the NASD sales charge rule (currently 25 basis points per 
year).\143\ Unlike the service fee, however, funds could use this 
portion of fund assets for any distribution related expenses. This 
approach would serve the interests of investors and other members of 
the fund marketplace by providing a means of paying for participation 
in fund supermarkets and the maintenance of shareholder accounts, among 
other things, and allowing funds to support their own marketing and 
distribution strategies.
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    \142\ Proposed rule 12b-2(b).
    \143\ Proposed rule 12b-2(b)(1); NASD Conduct Rule 2830(d)(5).
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    We also propose to permit funds to deduct from fund assets amounts 
in excess of the marketing and service fee, and we would treat these 
amounts as an alternative means to pay a front-end sales load. To 
accomplish this, we propose to amend rule 6c-10 (which permits funds to 
charge deferred loads) to permit this asset-based sales charge, which 
we would call an ``ongoing sales charge.'' The proposed amendments in 
effect would treat ongoing sales charges as another form of sales load.
    Our proposed amendment to rule 6c-10 would not require any special 
board findings (such as those required by rule 12b-1), a written plan, 
annual renewal, or automatic termination provisions, or impose fund 
governance requirements. Instead, we would apply limits on asset-based 
sales charges by referencing the front-end load imposed by the fund or, 
if none, by referencing the aggregate sales load cap imposed under the 
NASD sales charge rule for funds with an asset-based sales charge and 
service fee (currently 6.25 percent).\144\
---------------------------------------------------------------------------

    \144\ NASD Conduct Rule 2830(d)(2)(A).
---------------------------------------------------------------------------

    These limits would be based on the cumulative amount of sales 
charges that an investor pays in any form (front-end, deferred, or 
asset-based). Under the proposed rule amendment, a fund imposing an 
ongoing sales charge would be required to automatically convert fund 
shares to a class of shares without an ongoing sales charge no later 
than when the investor has paid cumulative charges that approximate the 
amount the investor otherwise would have paid through a traditional 
front-end load (or, if none, the NASD rule 6.25 percent cap).\145\ The 
proposed amendment would shift the focus of the limits from how much 
fund underwriters may collect in asset-based sales charges (a fund-
level cap) to how much individual shareholders will pay either directly 
or indirectly (a shareholder account-level cap).
---------------------------------------------------------------------------

    \145\ See infra note 171 and accompanying text.
---------------------------------------------------------------------------

    We are also proposing to amend rule 6c-10 to permit an alternative, 
elective distribution model. In this new model, intermediaries of funds 
could impose charges for sales of the fund's shares at negotiated 
rates, much like they charge commissions on sales of exchange-traded 
funds (ETFs) \146\ and other equity securities. The proposed rule would 
permit fund intermediaries to charge sales loads other than those 
established by the fund underwriter and disclosed in the fund 
prospectus.
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    \146\ ETFs are registered investment companies that offer public 
investors an undivided interest in a pool of securities. They are 
similar in many ways to traditional mutual funds, except that shares 
in an ETF can be bought and sold throughout the day through a 
broker-dealer, like stocks traded on an exchange.

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[[Page 47075]]

B. Rescission of Rule 12b-1

    We propose, first, to rescind rule 12b-1 in its entirety.\147\ As 
we discussed in detail above, rule 12b-1 was adopted in response to a 
set of problems identified by the Commission in the late 1970s. But 
many of the assumptions underlying the rule appear to no longer reflect 
current marketplace realities, including the role that 12b-1 fees play 
in the distribution of fund shares and the tasks that directors should 
be required to undertake in considering whether to approve 12b-1 fees. 
Moreover, the rule has confounded many investors who remain unsure what 
a ``12b-1 fee'' is, how it impacts their account, and whether they 
should be willing to invest in a fund that imposes such a fee. Finally, 
the application of rule 12b-1 today reflects the confusion that has 
accumulated over the years as lawyers have sought to provide answers to 
questions that have arisen in the course of the rule's evolution.
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    \147\ As discussed in more detail in Section III.N of this 
Release, we are proposing a grandfathering provision that would 
permit funds to deduct existing 12b-1 fees with respect to shares 
issued prior to the compliance date for the proposed new rule and 
rule amendments, which we anticipate would be at least 18 months 
from the effective date in the adopting release.
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    Therefore, we have decided not to propose to amend existing rule 
12b-1, but to propose a new regulatory framework to address how fund 
assets may be used to finance distribution costs.\148\ We believe the 
proposed rules, as described in more detail below, would better address 
current investor protection concerns raised by the use of fund assets 
as alternatives to sales loads and as a means of financing other types 
of distribution costs.
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    \148\ Although we propose to rescind rule 12b-1, proposed rule 
12b-2 retains the section in rule 12b-1 that restricts certain 
directed brokerage practices. See 2004 Rule 12b-1 Amendments 
Adopting Release, supra note 106. We believe that the concerns we 
discussed in that adopting release regarding using directed 
brokerage to finance the distribution of fund shares continue to 
apply under our new proposal, and we propose to retain the section 
we adopted in 2004 unchanged. See proposed rule 12b-2(c).
---------------------------------------------------------------------------

    We note that Regulation R under the Exchange Act,\149\ which 
provides banks exceptions and exemptions from broker-dealer 
registration, specifically references fees that banks and their 
employees receive pursuant to plans under rule 12b-1.\150\
---------------------------------------------------------------------------

    \149\ 17 CFR Part 247.
    \150\ 17 CFR 247.721(a)(4)(iii)(A), 247.760(c).
---------------------------------------------------------------------------

     We have not intended that the proposed rule affect those 
exceptions and exemptions, and we request comment on whether further 
rulemaking, clarification, or interpretive guidance is necessary or 
appropriate in this regard.

C. Proposed Rule 12b-2: The Marketing and Service Fee

    We propose a new rule 12b-2, which would permit funds, with respect 
to any class of fund shares, to deduct a fee of up to the NASD service 
fee limit (which is 25 basis points or 0.25 percent annually) from fund 
assets to pay for distribution activities, without being subject to the 
limitations on sales loads that we describe in the next section of this 
Release.\151\ Although the fee could be used for any type of 
distribution cost, we anticipate it primarily would be used to pay for 
servicing fees of the type currently permitted by the NASD sales charge 
rule,\152\ trail commissions to broker-dealers selling fund shares, and 
other expenses, such as fees paid to fund supermarkets, that may in 
part be distribution related.\153\ This proposed rule would permit 
funds to bear expenses similar to those that fund boards generally 
approved shortly after our adoption of rule 12b-1 in 1980.\154\
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    \151\ Proposed rule 12b-2(b).
    \152\ See NASD Sales Charge Rule Q&A, supra note 73, at question 
17 (explaining the types of activities for which services fees may 
be used).
    \153\ As discussed above, we have previously stated that funds 
may pay for non-distribution expenses under rule 12b-1 plans. See 
supra note 43 and accompanying text. Fund expenditures under current 
12b-1 plans often pay for a mixture of distribution and 
administrative services. For example, some funds may pay their 
entire fund supermarket fee under a rule 12b-1 plan, even though 
portions of the fee may pay for administrative services that are not 
distribution related. A fund need not determine which portion of the 
fee is primarily for distribution services or which portion is 
primarily for administrative services, and it may be impractical and 
burdensome to require funds to allocate expenses. See Martin G. 
Byrne, The Payment of Fund Supermarket Fees By Investment Companies, 
3 Investment Law. 2 (1996) (``[B]ecause the services that are 
provided to a fund in a supermarket are a combination of 
distribution, subaccounting, administrative, account maintenance, 
and other shareholder services, some portion of [a supermarket fee] 
may be considered a payment `primarily intended' to result in sales 
of a fund's shares pursuant to Rule 12b-1 .* * * Because a fund with 
a Rule 12b-1 plan is expressly permitted to pay for distribution 
services, it is not critical to determine whether a particular 
service it pays for in connection with [a supermarket fee] is or is 
not for distribution.''). Similarly, proposed rule 12b-2 would not 
preclude funds from paying for these types of mixed expenses under 
rule 12b-2. However, to the extent that funds need not rely on 
proposed rule 12b-2 to charge expenses that can clearly be 
identified as not distribution related (e.g., sub-transfer agency 
fees), funds could instead characterize those expenses as 
administrative expenses and thus keep total asset-based distribution 
fees within the 25 basis point limit of the marketing and service 
fee. See 1988 Release, supra note 28, at n.126 (``[T]o the extent a 
fund is paying for legitimate non-distribution services, such 
payments need not be made under a 12b-1 plan, even if the recipient 
of the payments is also involved in the distribution of fund 
shares.''). See also supra Section III.C of this Release. 
Conversely, simply characterizing an activity as ``administrative'' 
would not permit a fund to pay for it entirely outside of proposed 
rule 12b-2 if all or a portion of the fee is distribution related. 
See, e.g., In the Matter of BISYS Fund Services, Inc., Investment 
Company Act Release No. 27500 (Sept. 26, 2006) (Commission order 
instituting settled administrative and cease-and-desist proceedings 
arising out of the improper use of fund assets for marketing and 
other expenses).
    \154\ See supra note 55.
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    Unlike rule 12b-1, rule 12b-2 would not require directors to adopt 
or renew a ``plan'' or make any special findings.\155\ Rather, fund 
boards would have the ability to authorize the use of fund assets to 
finance distribution activities consistent with the limits of the rule 
and their fiduciary obligations to the fund and fund shareholders.\156\ 
A plan would not be required under our proposal because the proposed 
rules and rule amendments are structured to impose limits and 
safeguards on the use of fund assets for distribution, without the need 
for board approval of a plan. We intend that the board (including the 
independent directors) would oversee the amount and uses of these fees 
in the same manner that it oversees the use of fund assets to pay any 
other fund operating expenses, particularly those that create a 
potential conflict of interest for the fund's investment adviser or 
other affiliated persons.\157\ The rule

[[Page 47076]]

would recognize that funds bear ongoing expenses that, although they 
are distribution related, may benefit the fund and existing fund 
shareholders in a variety of ways. The marketing and service fee would 
be specifically identified and fully disclosed in the fund prospectus 
fee table as a type of operating expense.\158\
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    \155\ Some funds and fund boards have adopted so-called 
``defensive'' rule 12b-1 plans that do not impose distribution fees 
on the fund, but are designed to ensure that the board and the fund 
do not violate the Act if fund expenditures are subsequently 
determined to be primarily intended to result in the sale of fund 
shares. See ICI, Report of the Working Group on Rule 12b-1 at n.71 
(May 2007) (http://www.ici.org/pdf/rpt_07_12b-1.pdf). Although 
12b-1 plans (including ``defensive'' ones) would no longer be 
required to be entered into under our proposed amendments, the 
exemption provided by rule 12b-2 could serve the same purpose as a 
defensive plan to the extent that the amount of assets permitted to 
be used for distribution under rule 12b-2 has not otherwise been 
fully utilized.
    \156\ Section 36(a) of the Act ``establish[es] a federal 
standard of fiduciary duty'' in dealings between a mutual fund and 
certain other persons, including its adviser, principal underwriter, 
officers and directors, among others. See Tannenbaum v. Zeller, 552 
F.2d 402, 416 (2d Cir.), cert. denied, 434 U.S. 934 (1977). Section 
36(a) applies to acts or practices constituting a breach of 
fiduciary duty involving ``personal misconduct'' on the part of the 
person acting for or serving the fund in the enumerated capacities. 
This federal standard is at least as stringent as standards of care 
prescribed for fiduciaries under common law, such as the duty of 
care and the duty of loyalty. See id. at n.20. See also Commission 
Guidance Regarding the Duties and Responsibilities of Investment 
Company Boards of Directors with Respect to Investment Adviser 
Portfolio Trading Practices, Investment Company Act Release No. 
28345 (July 30, 2008) [73 FR 45646 (Aug. 6, 2008)] at section titled 
``Summary of Law Regarding Fiduciary Responsibilities of Investment 
Company Directors'' (discussing state and federal law fiduciary 
obligations of fund directors).
    \157\ Congress intended that independent directors play a 
critical role in overseeing fund operations and protecting the 
interests of shareholders in view of the substantial conflicts of 
interest that exist between a fund and its investment adviser. See 
House Hearings, supra note 26, at 109; Burks v. Lasker, 441 U.S. 471 
(1979). When possible conflicts are present, fund management is 
under a duty to fully and effectively disclose information 
sufficient for the independent directors to exercise informed 
discretion on the matters put before them. See, e.g., Tannenbaum, 
522 F.2d at 417, citing Fogel v. Chestnutt, 533 F.2d 731, 745 (2d 
Cir. 1975), cert. denied, 429 U.S. 824 (1976) and Moses v. Burgin, 
445 F.2d 369 (1st Cir.), cert. denied, 404 U.S. 994 (1971).
    \158\ We are proposing amendments to the prospectus fee table, 
which are discussed in Section III.J of this Release, infra. We are 
also proposing to require funds imposing a new marketing and service 
fee, or increasing the rate of an existing 12b-1 fee that would be 
used as a marketing and service fee, to obtain the approval of their 
shareholders. This requirement is discussed in Section III.F of this 
Release, infra.
---------------------------------------------------------------------------

    Funds may use the proceeds of the marketing and service fee to pay 
for, for example, the ongoing cost of participation on a distribution 
platform such as a fund supermarket, giving investors a convenient way 
of buying shares; for paying trail commissions to broker-dealers in 
recognition of the ongoing services they provide to fund investors; or 
for paying retirement plan administrators for the services they provide 
participants (and which relieve the fund from providing such services). 
In addition, funds (including no-load funds) may use the marketing and 
service fee to pay for shareholder call centers, compensation of 
underwriters, advertising, printing and mailing of prospectuses to 
other than current (i.e., prospective) shareholders, and other 
traditional distribution activities.\159\
---------------------------------------------------------------------------

    \159\ See proposed rule 12b-2(b), (e).
---------------------------------------------------------------------------

    Under the proposed rule, the marketing and service fee could not, 
on an annual basis, exceed the limits on service fees prescribed by the 
NASD sales charge rule (currently 0.25 percent of fund net assets 
annually). Any charge in excess of 0.25 percent per year would be 
considered an asset-based sales charge and subject to the overall sales 
load limitations established by the NASD sales charge rule and other 
requirements, as discussed in the next section of this Release. We 
chose to propose this limit because it would permit, without change, 
the continuation of many important uses of 12b-1 fees that may benefit 
investors. It also represents the line the NASD sales charge rule draws 
between a limited distribution fee and a sales charge--25 basis points 
currently is the limit that a fund may deduct and still call itself a 
``no-load'' fund.\160\ The NASD drew upon its knowledge and expertise 
as the self-regulatory organization of the brokerage industry to 
develop these limits, which we approved as an appropriate exercise of 
the NASD's congressional mandate to prevent excessive sales charges on 
mutual fund shares.\161\ Accordingly, we have used the NASD limit on 
service fees in formulating our proposal to distinguish a limited 
distribution fee from a sales charge.
---------------------------------------------------------------------------

    \160\ Specifically, NASD Conduct Rule 2830(d)(4) prohibits any 
member from describing a fund as ``no-load'' if the fund has 
combined asset-based sales charges and services fees of more than 
0.25 percent of average annual net assets. This provision is 
intended to help investors distinguish between funds that use 
relatively small 12b-1 fees to finance advertising and other sales 
promotion activities, similar to traditional no-load funds, and 
funds that use larger 12b-1 fees as alternatives to front-end sales 
loads. See 1992 NASD Rule Release, supra note 66. See also The 
Vanguard Group, supra note 31 (order permitting the Vanguard Group 
to call its funds no-load even though they made small distribution 
payments of 0.20% of average annual net assets).
    \161\ See 1992 NASD Rule Release, supra note 66, at section V; 
15 U.S.C. 80a-22(b).
---------------------------------------------------------------------------

    We request comment on the proposal to limit the marketing and 
service fee to the maximum service fee permitted under the NASD sales 
charge rule.
     Would a different term, such as ``sales/service fee,'' be 
more appropriate? If so, why? Would a different limit be more 
appropriate? Should the limit be higher (e.g., 30 or 50 basis points) 
or lower (e.g., 10 or 20 basis points)? If so, why? Should the limit be 
set with reference to the NASD rule, which would allow the NASD (now 
FINRA) to change the level, pending approval by the Commission?
    We understand that many share classes either do not currently 
charge 12b-1 fees in an amount that exceeds 25 basis points, or charge 
none at all.\162\ Many funds use these fees to compensate 
intermediaries for providing customers with follow-up information and 
account maintenance services pursuant to the NASD sales charge rule. In 
such cases, the shareholder service fees may in fact have a significant 
distribution component, which is why funds often pay them pursuant to a 
rule 12b-1 plan.\163\ We do not propose, however, to limit the use of 
the marketing and service fee to these types of services (i.e., those 
described in the NASD sales charge rule), so that funds may continue to 
use fund assets to pay for promotional and advertising expenses.
---------------------------------------------------------------------------

    \162\ See infra Section III.M.2 of this Release.
    \163\ See SEC, Mutual Fund Fees and Expenses (2007) (http://
www.sec.gov/answers/mffees.htm). Funds may decide that the stream of 
payments to a broker-dealer for providing client services (that it 
would have provided anyway) could be viewed as an incentive for the 
broker-dealer to continue selling the fund.
---------------------------------------------------------------------------

     Should we limit the marketing and service fee to expenses 
incurred for ``shareholder services'' as defined in the NASD sales 
charge rule? More generally, do investors in omnibus accounts receive 
equivalent levels of service relative to investors who invest directly 
and pay similar 12b-1 fees? Is there a disparity in service, and if so, 
why? What implications does this have for our proposal?
    Under the proposal, ``distribution activity'' would be defined as 
``any activity that is primarily intended to result in the sale of 
shares issued by the fund, including, but not necessarily limited to, 
advertising, compensation of underwriters, dealers, and sales 
personnel, the printing and mailing of prospectuses to other than 
current shareholders, and the printing and mailing of sales 
literature.'' \164\ The proposed rule does not attempt to delineate 
permissible distribution expenses because our experience with rule 12b-
1 has shown that new distribution methods continually evolve.
---------------------------------------------------------------------------

    \164\ Proposed rule 12b-2(e)(2). The proposed definition of 
``distribution activity'' is identical to the description of 
distribution in rule 12b-1. See rule 12b-1(a)(2). Because funds 
continually market themselves to investors, many types of activities 
may potentially be construed as ``primarily intended'' to result in 
fund sales. Although the definition provides flexibility, similar to 
rule 12b-1, distribution activities paid for through asset-based 
distribution fees under proposed rule 12b-2 and the proposed 
amendment to rule 6c-10 (as under rule 12b-1) must represent 
legitimate expenses of the fund. See, e.g., Exemptions for Certain 
Registered Open-End Management Investment Companies to Impose 
Deferred Sales Loads, Investment Company Act Release No. 16619 at n. 
3 (Nov. 2, 1988) [53 FR 45275 (Nov. 9, 1988)].
---------------------------------------------------------------------------

     Are the identified activities appropriately considered 
``distribution activities''? Should we provide more guidance regarding 
specific expenditures that are distribution expenses and others that 
are not, as some commenters have suggested? \165\ Should we define 
``distribution activity'' differently? If so, how should we define it? 
Should funds be permitted to classify only certain expenses as 
marketing and service fees? \166\ If so, what types of expenses?
---------------------------------------------------------------------------

    \165\ See, e.g., Roundtable Transcript, supra note 109, at 167 
(Jeffrey Keil, Keil Fiduciary Strategies) (``[D]istribution 
expenditures should be defined in some way, shape, or form, or [the 
rule should] say what's not a distribution expenditure.'').
    \166\ See, e.g., 2004 Rule 12b-1 Amendments Adopting Release, 
supra note 106.

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[[Page 47077]]

D. Proposed Amendments to Rule 6c-10: The Ongoing Sales Charge

    The proposed amendments to rule 6c-10 would permit funds to deduct 
asset-based distribution fees in excess of the amount permitted under 
rule 12b-2 (i.e., 25 basis points annually), provided that the excess 
amount is considered an ``ongoing sales charge'' subject to the sales 
charge restrictions described below, including an automatic conversion 
feature.\167\ Funds would not have to adopt a ``plan'' in order to 
impose an ongoing sales charge, and fund boards would not be required 
to make any special findings. In short, the proposed rule would treat 
ongoing sales charges as another form of deferred sales load.\168\
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    \167\ Proposed rule 6c-10(b). We would title this section of the 
rule ``Fund-Level Sales Charge'' to distinguish it from a current 
provision of rule 6c-10 that provides an exemption to permit funds 
to deduct a ``Deferred Sales Load'' (e.g., CDSL) (rule 6c-10(a) from 
shareholder accounts, and a proposed alternative that would provide 
an exemption from section 22(d) of the Act to permit broker-dealers 
to deduct ``Account-Level Sales Charges'' (proposed rule 6c-10(c)).
    \168\ As a form of deferred sales load, all payments of ongoing 
sales charges to intermediaries would constitute transaction-based 
compensation. Intermediaries receiving those payments thus would 
need to register as broker-dealers under section 15 of the Exchange 
Act unless they can avail themselves of an exception or exemption 
from registration. Marketing and service fees paid to an 
intermediary may similarly require the intermediary to register 
under the Exchange Act.
---------------------------------------------------------------------------

    Under the proposed provision, a fund could deduct an ongoing sales 
charge to finance distribution activities at a rate established by the 
fund, provided that the cumulative amount of sales charges the investor 
pays on any purchase of fund shares does not exceed the amount of the 
highest front-end load that the investor would have paid had the 
investor invested in another class of shares of the same fund.\169\ For 
example, if a fund has class A shares with a six percent front-end 
sales load, the fund could pay as much as six percent in total ongoing 
sales charges in class B shares. If another class of shares charges a 
front-end sales load of, for example, two percent, a total ongoing 
sales charge of as much as four percent could also be charged (six 
percent minus the two percent front-end load) with respect to that 
class.
---------------------------------------------------------------------------

    \169\ Proposed rule 6c-10(b)(1).
---------------------------------------------------------------------------

    We seek comment on whether the Commission should treat ongoing 
sales charges as a form of deferred sales load subject to the NASD 
sales charge limitations. We also seek comment on whether the proposed 
amendments to rule 6c-10, as described in more detail below, accomplish 
this goal.
     Do the sales charge limitations, as we propose to apply 
them, adequately protect investors from excessive sales loads in 
accordance with the objectives of section 22(b) of the Act? Would any 
aspect of these proposed sales charge limitations encourage broker-
dealers to recommend ``switching'' between fund families once an 
investor has reached the ongoing sale charge limits? If so, does this 
proposal raise any issues (that do not already exist with regard to 
other classes) that would encourage such switching, in light of current 
NASD sales charge limits? What effect could the proposed rule have on 
the various types of share classes currently offered by funds? For 
example, would funds or distributors reduce, eliminate, or increase the 
offering of share classes with asset-based sales charges? To the extent 
that broker-dealers rely on ongoing sales charges as compensation for 
ongoing services to investors, could the quantity or quality of the 
services provided change if the rule results in limits on cumulative 
ongoing sales charges?
1. Automatic Conversion
    Under the proposed amendments, funds or fund intermediaries would 
not be required to keep track of the actual dollar amount of ongoing 
sales charges paid by each individual shareholder account (although 
they may choose to do so) to avoid exceeding the rule's maximum sales 
charge limitation.\170\ A fund could satisfy the maximum sales charge 
limitation by providing that the shares purchased would automatically 
convert to another class of shares without an ongoing sales charge no 
later than the end of the month during which the fund would have paid 
on behalf of the investor the maximum amount of permitted sales load 
based on the cumulative rates charged each year.\171\ In addition, a 
fund could impose a CDSL in combination with an ongoing sales charge, 
but total sales charges could not exceed the maximum sales charge 
limitation.\172\
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    \170\ We understand that many funds lack the ability to track 
dollar amounts of distribution expenses charged to purchases by 
individual investors.
    \171\ Proposed rule 6c-10(b)(1)(i) (providing that a fund may 
comply with the maximum sales charge limits by converting shares on 
or before the end of the conversion period); proposed rule 6c-
10(d)(2) (defining ``conversion period'' as ``the period beginning 
on the day that shares are purchased and ending on the last day of 
the calendar month during which the cumulative ongoing sales charge 
rates exceed the shareholder's maximum sales load rate''). The rule 
would permit conversion periods to be computed as of the end of the 
calendar month because that would conform to the way most funds 
presently compute conversion periods with respect to class B shares.
     Thus, for example, the provision would operate as follows: 
Assume that a fund offers a class A share with a 6% front-end load 
and no ongoing sales charge. The same fund could also offer a class 
of C shares with an annual ongoing sales charge of 0.75%, provided 
that: (i) The class C shares convert to class A shares in 96 months 
or earlier ([6.0% / 0.75%] x 12 = 96 months or 8 years); and (ii) 
the class C shares do not impose any other loads.
    \172\ Using the example in note 171, supra, a fund offering a 
class A share with a 6% front-end load could also offer a class B 
share that is subject to an annual ongoing sales charge of 0.75% 
with a declining CDSL. The maximum CDSL that the fund could charge 
on a purchase of class B shares would be 5.25% in the first year, 
4.5% in the second year, 3.75% in the third year, and so on. At the 
end of the eighth year following the purchase, the fund would be 
required to convert the class B shares to a share class that does 
not charge an ongoing sales charge. Thus, regardless of when the 
shareholder redeems shares, the shareholder's total sales load rate 
would never exceed 6%, the maximum class A front-end load rate.
---------------------------------------------------------------------------

    The maximum number of months a shareholder could remain invested in 
a class of shares paying an ongoing sales charge would depend both on 
the maximum sales load and the rate of the ongoing sales charge. Thus, 
for example, if the maximum sales load for the fund is three percent, 
the ongoing sales charge could be 50 basis points annually for six 
years. Alternatively, the fund could collect 25 basis points annually 
for 12 years, 75 basis points annually for four years, 150 basis points 
annually for two years, and so on.
    We have designed the conversion provisions of the rule so that the 
maximum conversion date is easily determinable at the time the investor 
purchases fund shares (as is a front-end sales load).\173\ As a result, 
the fund or intermediary would be able to provide this information to 
an investor or a prospective investor at the time he or she makes or is 
considering making an investment in the fund.\174\ We propose monthly 
conversions because they reflect the current practices of many funds 
and fund transfer agents, which we anticipate would reduce costs 
associated with complying with the proposed rules.
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    \173\ Funds could sell shares subject to a shorter conversion 
period than the maximum conversion period as defined under the 
proposed rule. In addition, funds could offer scheduled variations 
in the conversion period to a particular class of shareholders or 
transactions if the fund has satisfied the conditions in rule 22d-1. 
Proposed rule 6c-10(b)(1)(iii). Nothing in the rule would prevent a 
fund from offering to existing shareholders a new scheduled 
variation that would reduce the conversion period. Proposed rule 6c-
10(b)(2). These provisions are similar to provisions that currently 
apply to deferred sales loads under rule 6c-10, and which are 
included in proposed rule 6c-10(a). See proposed rule 6c-
10(a)(1)(iii) and (a)(2).
    \174\ See infra Section III.D.1.b of this Release.
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     We request comment on alternatives, such as daily, weekly, 
or quarterly conversions.

[[Page 47078]]

a. Differences From NASD Cap
    Our proposed shareholder account-level cap would effectively 
replace the NASD fund-level cap on asset-based sales charges.\175\ In 
proposing a fund-level cap in 1991, the NASD explained that it had 
considered a shareholder account-level cap but, at the time, it 
believed that an account-level cap would require individual shareholder 
accounting, and in light of the difficulties involved with individual 
shareholder accounting, concluded that an account-level cap was not 
feasible.\176\ The NASD acknowledged, however, that while its' approach 
``protects a majority of shareholders,'' it also ``may result in a 
minority of long-term shareholders paying more than the maximum sales 
charge.'' \177\ To illustrate, a fund shareholder paying a five percent 
front-end load on an investment of $10,000 in a fund will pay a $500 
sales load, but the same investor investing in a fund with a (not 
uncommon) 12b-1 fee of 100 basis points, over a period of 10 years, 
could pay more than $800 in distribution related sales charges 
(resulting from the 75 basis point asset-based sales charge 
component).\178\ After 20 years, the difference becomes more 
significant: The shareholder would have paid $2,292 in asset-based 
sales charges compared with the $500 front-end load.
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    \175\ See supra Section II.C.1 of this Release.
    \176\ See NASD Notice of Proposed Rule Change, supra note 74, at 
section titled ``Method of Calculating the Total Sales Charges'' 
(``Requiring the individual shareholder accounting method would 
mandate extensive and expensive changes in the recordkeeping methods 
and procedures utilized by mutual funds, would disrupt current 
processing of sales and redemptions, and would take several years 
for the industry to achieve.'').
    \177\ Id. The NASD considered fund-level accounting to be the 
``best alternative as a minimum standard at [the] time.'' Id. The 
NASD also noted that the industry as a whole would not be prevented 
from adopting ``more protective methods'' in the future. Id.
    \178\ Assuming a $10,000 initial investment and an annual return 
of five percent, the front-end load shareholder would have an 
account balance after ten years of $15,474; the shareholder in the 
fund with the 12b-1 fee would have an account balance of $15,162--a 
deficit of $312 that is attributable to the 75 basis point asset-
based sales charge component of the 12b-1 fee. Put another way, 
rather than paying a $500 sales load, the shareholder has paid over 
$800 in asset-based sales charges.
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    The NASD's Mutual Fund Task Force, in its report on mutual fund 
distribution issues, expressed similar concerns when it identified 
limitations on the length of B share conversion periods as a potential 
area for regulatory reform.\179\ Our proposal would address both the 
fairness concerns raised by the NASD Task Force in 2005 and the 
operational concerns raised in 1991 by avoiding the need for individual 
shareholder accounting. We view our proposal in many respects as the 
further development of the NASD sales charge rule, which was intended 
to bring total 12b-1 fees into ``approximate economic equivalency'' 
with traditional loads, although this equivalency would not be exact, 
as a result of potential varying volume discounts between share classes 
and differing market returns.\180\
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    \179\ See NASD, Report of the Mutual Fund Task Force: Mutual 
Fund Distribution at 18 (2005) (http://www.finra.org/web/roups/
rules-regs/documents/rules-regs?p013690.pdf).
    \180\ See NASD Notice of Proposed Rule Change, supra note 74.
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b. Implications on Fund Operations
    Our proposed account-level cap would build upon innovations of fund 
management companies that have developed the operational capacity to 
issue, track the aging of, and convert class B shares. As a result, we 
expect that funds and intermediaries will be able to utilize existing 
transfer agency and other recordkeeping systems that administer funds 
issuing class B shares, which we believe operate in a manner similar to 
the proposed conversion provision or could be easily adjusted to do 
so.\181\ In addition, we have sought to provide funds the flexibility 
to design different sales load structures that meet the needs of fund 
investors, funds, and their distribution systems. Accordingly, we do 
not propose to specify the annual maximum rate at which a fund could 
deduct annual ongoing sales charges.\182\
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    \181\ As discussed above, funds today are selling many fewer B 
class shares than just a few years ago. Because systems must remain 
in place to meet the operational requirements of a single 
outstanding B class share, this trend should not affect the ability 
of fund management companies or their service providers to make use 
of existing systems to convert existing class C shares or other 
classes.
    \182\ The NASD sales charge rule currently caps these fees at 75 
basis points annually. However, if our proposed rule changes are 
adopted, the annual cap may be unnecessary because the cumulative 
amount of ongoing sales charges would be capped.
---------------------------------------------------------------------------

    We request comment on the operational implications of the proposed 
automatic conversion.
     Can existing fund and intermediary systems be adapted so 
that conversion periods could be readily determined and implemented at 
the time of purchase? How easy or difficult would this adaptation be? 
How difficult would it be for funds that don't currently offer B shares 
to develop such systems? Is the flexibility we propose advantageous, or 
would a more standardized approach be more easily understood by, and in 
the interest of, investors? How would a more standardized approach 
work?
c. Implications on Transferability of Shareholder Accounts
    The proposed automatic conversion feature, and its attendant 
requirement to track fund shares, may present additional issues when 
shareholder accounts are transferred between different intermediaries. 
We understand that, in some cases, tracking fund shares is a 
responsibility assumed by the fund transfer agent, in which case the 
portability of fund shares (i.e., the ability of an investor to move 
his account from one intermediary to another) should not be affected. 
In other cases (e.g., where the shares are held in omnibus accounts), 
fund intermediaries track share lots and would need to provide share 
lot histories to the new intermediary for the new intermediary to be 
able to determine the remaining maximum sales charge for transferred 
shares.\183\ We understand that fund intermediaries today have the 
ability to transfer share lot histories in order to: (i) Service class 
B shares or classes with contingent deferred sales loads, and (ii) meet 
tax reporting requirements. Thus, we do not believe that our proposals 
would interfere with the ability of a shareholder to transfer shares 
from one intermediary to another.
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    \183\ Such a transfer is unlikely to be an ``offer of exchange'' 
under section 11 of the Act, which applies only to offers by a fund 
or a principal underwriter of a fund. Accordingly, the ``tacking'' 
provisions of rule 11a-3 would not apply, and any aging of fund 
shares that a new intermediary might do would not be done to satisfy 
any requirement of the Act. See infra Section III.K of this Release.
---------------------------------------------------------------------------

    We request comment on our assumptions in this area.
     Would the proposed rule's conversion requirement present 
any special problems when shares are transferred between customer 
accounts held at different intermediaries? Are there different 
implications with respect to different types of intermediaries and, if 
so, what are they? Is there any reason that some intermediaries would 
not be capable of transferring share lot history?\184\ Are there other 
provisions that we should consider that would facilitate 
transferability?
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    \184\ We understand that some intermediaries, such as retirement 
plans and insurance companies, may not even track share lot history. 
Those situations present additional issues, which are discussed in 
Sections III.H and III.M.5 of this Release, infra.
---------------------------------------------------------------------------

2. The Maximum Load
a. The Reference Load
    We propose that the maximum sales load that would apply to any 
purchase of shares in a fund class subject to an ongoing sales charge 
would be the highest front-end load of another class of that fund that 
does not charge an

[[Page 47079]]

ongoing sales charge, and which would act as a ``reference load.'' 
\185\ If a fund offers a class of A shares, the maximum amount of sales 
charges it could collect from an investor in B or C share classes would 
be the amount the investor would have paid had the investor invested in 
A shares with the maximum front-end load.\186\ By setting the maximum 
front-end load, the fund, its board, and the principal underwriter 
would also establish the maximum amount of the cumulative ongoing sales 
charge.\187\
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    \185\ Proposed rule 6c-10(d)(14)(i). In the case of shares 
exchanged within the same fund group, the proposed rule provides 
that the reference load is the highest applicable sales load of the 
exchanged or acquired security. Proposed rule 6c-10(d)(14)(ii).
    \186\ Under the proposed rule, the shareholder's maximum sales 
load would be reduced if the shareholder previously paid a sales 
load on fund shares that the shareholder subsequently exchanged for 
shares of the current fund. Fund shareholders would also be credited 
for any other sales loads they paid on a particular share purchase. 
Thus, the maximum sales load rate that an investor could be charged 
would be defined under the proposed rule as the reference load minus 
the sum of the rates of: (i) Any sales load incurred by the 
shareholder in connection with the purchase of fund shares, and (ii) 
any other sales loads or ongoing sales charges attributable to 
exchanged shares. Proposed rule 6c-10(d)(10). This approach is 
consistent with the approach the Commission has taken in 
implementing section 11 of the Act. Specifically, rule 11a-3 governs 
sales loads and other charges that may be imposed on an exchange 
between funds within the same fund group, and is intended to help 
ensure that shareholders receive credit for all sales charges 
incurred on a particular purchase of fund shares and are protected 
from the sales practice abuse of switching, i.e., the practice of 
inducing shareholders of one fund to exchange their shares for those 
of a different fund solely for the purpose of exacting additional 
sales charges. See Offers of Exchange Involving Registered Open-End 
Investment Companies, Investment Company Act Release No. 17097 (Aug. 
3, 1989) [54 FR 35177 (Aug. 24, 1989)] (``Rule 11a-3 Adopting 
Release''). We have also proposed conforming changes to rule 11a-3, 
as discussed in Section III.K of this Release, infra.
    \187\ See also infra Section III.D.2.d.4.
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    As we noted above, sales loads rarely approach the maximum of 8.5 
percent permitted under the NASD sales charge rule,\188\ yet we 
understand that rule 12b-1 fees often are charged at the maximum rate 
permitted, currently 100 basis points annually.\189\ One reason may be 
that 12b-1 fees are deducted in smaller amounts, over longer periods of 
time, and indirectly from fund assets, and thus, to investors, they may 
be less salient and not as well understood when compared to front-end 
sales loads, and the fees themselves appear to be subject to less 
market pressure.\190\ Thus, some of our roundtable panelists and 
commenters urged that the Commission ``externalize'' asset-based sales 
charges (i.e., require that such charges be paid directly from a 
shareholder's account, rather than indirectly from fund assets) so that 
the amounts investors are paying would be more noticeable and 
transparent.\191\ Our proposed approach in rule 6c-10(b) would, 
instead, tie the maximum amount of the ongoing sales charge to the 
front-end load. To the extent that competitive pressures result in 
funds imposing lower front-end loads, these pressures should transfer 
to ongoing sales charges and could result in lower charges or charges 
that more accurately reflect the value of the distribution services 
provided. In addition, this proposed approach is designed to reduce the 
potential that some long-term shareholders will pay a significantly 
disproportionate share of the distribution costs of a fund.
---------------------------------------------------------------------------

    \188\ See NASD Conduct Rule 2830(d)(1)(A).
    \189\ See supra note 42. According to statistics compiled by our 
staff, 27 percent of funds that impose 12b-1 fees charge a rate of 
exactly 100 basis points.
    \190\ See Brad M. Barber, Terrance Odean, and Lu Zheng, Out of 
Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flows, 78 
J. Bus. 2095 (Dec. 2003) (mutual fund investors are less willing to 
pay higher front-end loads because they are more obvious and 
salient, but are less sensitive to annual operating expenses, 
including rule 12b-1 fees).
    \191\ See, e.g., Roundtable Transcript, supra note 109, at 184-
85 (Richard Phillips, K&L Gates). See infra Section III.I of this 
Release regarding an alternative approach we are proposing that 
would permit externalized sales charges at the election of funds and 
their underwriters.
---------------------------------------------------------------------------

    We request comment on the definition and function of the reference 
load.
     Should we establish a maximum limit on the amount of 
ongoing sales charge that may be deducted? Could this approach 
encourage funds to offer a share class with a high front-end sales load 
in order to charge a higher cumulative ongoing sales charge on other 
classes? Are the NASD rule's limits on sales charges a sufficient or 
appropriate guide for the reference load? The NASD sales charge limits 
apply at the fund level on an aggregate basis, whereas the ongoing 
sales charge limits of our rule proposal would apply at the level of 
individual accounts to limit the cumulative asset-based sales charge 
paid by any single investor. Should the proposed rule's reliance on the 
NASD sales charge limits be adjusted to take into account the 
difference in application? For example, would the proposal's cap have a 
more constraining effect on the amount of cumulative ongoing sales 
charges deducted by a fund? If so, should the proposal's cap be 
increased above the NASD cap to compensate for this? If not, what 
should the limits be?
     Alternatively, should we assign fund boards the 
responsibility of establishing the maximum amount of ongoing sales 
charges that a fund may deduct? If so, what standards or factors would 
be relevant to their determination?
b. Funds Without a Front-End Load Class
    Some funds, of course, might not offer a class of shares with a 
front-end load, or might offer the front-end load class with asset-
based distribution fees of more than 25 basis points (thus 
disqualifying the front-end load from acting as a reference load). We 
are proposing that, in these circumstances, the reference load would be 
the maximum sales charge permitted under NASD Conduct Rule 2830(d)(2) 
for funds with an asset-based sales charge and a service fee, which 
currently is 6.25 percent of the amount invested.\192\
---------------------------------------------------------------------------

    \192\ Proposed rule 6c-10(d)(14)(iii). Some funds, for example, 
offer only a single class of C shares. See also Section II.C.1 of 
this Release, supra, for a discussion of the caps under the NASD 
sales charge rule.
---------------------------------------------------------------------------

    We chose this rate because it is the current limit for funds with 
this type of sales charge structure under the NASD rule, which we 
approved in 1992 as not being excessive.\193\ We believe linking the 
reference load to the NASD limits may minimize operational burdens of 
the amendment because funds, their underwriters, and broker-dealers are 
already familiar with the NASD sales charge rule limits and have 
structured their systems accordingly.\194\ Under our proposal, funds 
could provide for lower sales loads (through shorter conversion 
periods) if they wish.\195\
---------------------------------------------------------------------------

    \193\ See supra Section II.C.1 of this Release.
    \194\ See supra note 161 and accompanying text.
    \195\ The rule requires that, at a minimum, shares must convert 
on or before the end of the maximum conversion period. Proposed rule 
6c-10(b)(1)(i). See also supra notes 171-173 and accompanying text.
---------------------------------------------------------------------------

     We request comment on whether the rule should permit the 
NASD maximum sales charge of 6.25 percent to serve as a default 
reference load for funds that do not offer a class of shares without an 
ongoing sales charge. If the rule should not permit this limit, what 
should be the limit? We are not proposing to use the limits in the NASD 
sales charge rule for investment companies without an asset-based sales 
charge (as much as 8.5 percent).\196\ This is because, under our 
proposed rule, each fund charging an ongoing sales charge by definition 
charges an asset-based sales charge of more than 25 basis points. Would 
there be any reason to designate these higher limits as a default 
reference load under our proposed rule amendment? We note that doing so 
may

[[Page 47080]]

further extend conversion periods and, thus, the period of time that 
some investors may pay ongoing sales charges.
---------------------------------------------------------------------------

    \196\ NASD Conduct Rule 2830(d)(1)-(2) (describing the different 
sales load limits, ranging between 8.5% and 6.25%, depending on 
whether the fund charges an asset-based distribution fee and offers 
rights of accumulation and quantity discounts).
---------------------------------------------------------------------------

     Under our proposal, funds would be permitted to deduct 
total sales charges up to the maximum sales charge permitted under the 
NASD sales charge rule. Would our proposed use of the 6.25 percent NASD 
limit as a default reference load give an advantage to funds that do 
not offer a class of A shares? To avoid this result, should the 
Commission identify a ``typical'' maximum front-end sales load that 
more closely tracks current industry practice (e.g., four, five or six 
percent) and rely on such a sales load as a default reference load when 
a fund does not offer a class of A shares? If so, what should that 
default reference load be?
     We note that in recent years, the costs of trading equity 
securities have declined significantly.\197\ In this regard, should the 
Commission consider proposing a rule that would establish a new limit 
on sales charges, in light of changes in technology and the markets?
---------------------------------------------------------------------------

    \197\ See United States Government Accountability Office, 
Securities Markets: Decimal Pricing Has Contributed to Lower Trading 
Costs and a More Challenging Trading Environment, 8-29 (May 2005) 
(http://www.gao.gov/new.items/d05535.pdf); see also James Angel, 
Lawrence Harris & Chester S. Spatt, Equity Trading in the 21st 
Century, 8-13 (USC Marshall School of Business May 18, 2010) (http:/
/ssrn.com/abstract=1584026).
---------------------------------------------------------------------------

     As an alternative, should we treat the NASD sales charge 
limit of 6.25 percent as the reference load for purposes of determining 
the maximum amount of ongoing sales charge in all cases, even if a fund 
has a front-end load class of shares that can serve as the reference 
load? Such an approach would provide economically equivalent treatment 
of funds that offer a class of A shares and those that do not. It would 
not, however, provide equivalent treatment of investors who choose to 
pay a front-end sales load with those that pay an ongoing sales charge. 
If the maximum front-end sales load is lower than 6.25 percent, 
shareholders in classes with an ongoing sales charge may bear a 
disproportionate amount of distribution costs (compared to shareholders 
in class A shares).
c. Treatment of Scheduled Variations
    The proposed amendments to rule 6c-10 would not require (but would 
permit) funds to apply any quantity discounts or scheduled variations 
in the front-end load for which the investor may qualify when 
determining the reference load for an ongoing sales charge. Investors 
who pay asset-based sales charges today as a substitute for a front-end 
load generally are not offered any discounts or variations in the 
amount of fees they pay indirectly through their investment in the 
fund.\198\ We are concerned that requiring funds and their 
intermediaries to calculate a different reference load for each 
purchase of fund shares would introduce greater cost and complexity and 
could affect the willingness of funds and their underwriters to offer 
quantity discounts or scheduled variations on front-end sales loads to 
investors.
---------------------------------------------------------------------------

    \198\ Investors nevertheless may prefer to defer the payment of 
sales charges rather than paying a front-end sales load in some 
circumstances, because a greater portion of their money is invested 
immediately in the fund. See Rule 6c-10 Proposing Release, supra 
note 57, at section titled ``Discussion.''
---------------------------------------------------------------------------

    We request comment on whether funds should be required to 
incorporate scheduled variations in the front-end load when determining 
a shareholder's reference load.
     How would funds likely react to this requirement if we 
adopted it? Would this requirement discourage funds from offering 
scheduled variations in the front-end load? Would it cause some funds 
to discontinue front-end load share classes entirely? Would it 
encourage funds to offer share classes with high front-end sales loads 
that effectively operate to increase the amount of ongoing sales 
charges the fund collects in other share classes? \199\ How would 
investors react? Would this requirement affect the number of fund 
investors selecting the ongoing sales charge class?
---------------------------------------------------------------------------

    \199\ This could occur, for example, if a fund offered a share 
class with a front-end load of 8.5 percent but with scheduled 
variations at low investment thresholds for investors actually 
purchasing that class. This result may be unlikely, however, because 
funds would have to disclose the maximum front-end load in fund 
performance advertisements and use it to compute the fund's 
performance. See, e.g., Rule 482 under the Securities Act [17 CFR 
230.482], Rule 34b-1 under the Investment Company Act, and Item 
26(b) of Form N-1A. See also NASD Conduct Rule 2210.
---------------------------------------------------------------------------

d. Sales Load on Asset Growth
    Proposed rule 6c-10(b) would operate so that a fund and its 
investors could determine the conversion period at the time the 
investor makes a purchase of shares. Each purchase (or each ``lot'') 
would have a separate conversion period, and the shares associated with 
each lot would be programmed to convert on a particular date. The 
maximum length of the conversion period would be unaffected by any 
subsequent increase or decrease in the value of the shares purchased. 
As a result, the fund underwriter would collect more ongoing sales 
charges if the value of the fund shares increased and collect less if 
the value decreased.\200\ Shareholders would also benefit from the 
growth (or bear the losses) in the value of the fund shares that would 
not have otherwise been purchased had the shareholder paid a front-end 
sales load.
---------------------------------------------------------------------------

    \200\ For example, assume that an investor purchased $10,000 of 
a class of shares with no front-end sales load and an ongoing sales 
charge of 0.75% with an eight-year conversion period. If the 
investor obtained an annual rate of return of 5%, he or she would 
pay $697 in ongoing sales charges over eight years and have an 
account balance of $13,951. If the investor received an annual 
return of 10%, he or she would pay $835 in ongoing sales charges and 
have an account balance of $20,294. If the investor received a 
negative annual return of -5%, he or she would pay $492 in ongoing 
sales charges and have an account balance of $6,227 after eight 
years.
---------------------------------------------------------------------------

    We believe that this approach is straightforward, is easy for 
investors to understand, is easy to administer, protects shareholders' 
interests in the allocation of risks and benefits between the 
shareholder and the fund's principal underwriter, and permits funds to 
deduct fees for distribution in the same manner that they currently 
deduct 12b-1 fees. This approach is different, however, from the 
approach currently taken by rule 6c-10 with respect to determining the 
maximum amount of a deferred sales load such as a CDSL.\201\ Rule 6c-
10(a)(1) limits the maximum amount of a deferred sales load to an 
amount specified at the time the shares were purchased.\202\ Thus, in 
the case of deferred sales loads, investors never pay a higher amount 
as a result of fund performance.
---------------------------------------------------------------------------

    \201\ We are also proposing to make certain non-substantive 
changes to the heading of current rule 6c-10, and parts of 6c-10(a), 
designed to clarify the names and use of the type of sales load 
practice discussed, including deferred, fund level, and account-
level sales loads.
    \202\ See 1996 Rule 6c-10 Amendments, supra note 58. Prior to 
the amendment, rule 6c-10 had required that CDSLs be based on the 
lesser of the NAV of the shares at the time of purchase or the NAV 
at the time of redemption. We eliminated this requirement, deferring 
to the NASD to address such matters in its sales charge rule. At the 
same time, we required that the amount of a deferred sales load not 
exceed a specified percentage of the NAV of the fund's shares at the 
time of purchase so that investors ``be given the benefit, if any, 
of deferring the load payment should there be an increase in the 
shares' NAV.'' Id. at n.16 and accompanying text.
---------------------------------------------------------------------------

     Given that our goal is to treat asset-based sales charges 
the same as other deferred sales loads, should we use the same approach 
for both? If so, which method should be used? If we require that 
ongoing sales charges be based on an amount determined at the time of 
purchase, would funds in effect be required to track each individual 
shareholder dollar paid in ongoing sales charges? Should we instead 
propose to amend rule 6c-10 (proposed rule 6c-10(a)) to permit 
underwriters to collect

[[Page 47081]]

higher deferred sales loads as a result of fund performance?
3. Reinvestment of Dividends and Other Distributions
    The proposal would permit funds to offer to invest shares acquired 
pursuant to a reinvestment of dividends or other distribution in the 
same share class as the shares on which the dividend or distribution 
was declared. If the share class has an ongoing sales charge, however, 
the reinvested shares would have the same conversion period as the 
shares on which the dividend or distribution was declared.\203\ As a 
result, reinvested shares may incur an ongoing sales charge, but would 
convert to a share class without an ongoing sales charge no later than 
the conversion date of the shares on which the dividend or distribution 
was declared.\204\ This approach would directly benefit investors, 
compared to the current approach under the NASD sales charge rule 
(which does not limit asset-based distribution fees from being charged 
on reinvested dividends indefinitely), because any ongoing sales charge 
deducted on reinvested dividends would no longer be charged after the 
conversion date of the original shares. This approach also reflects 
what we understand to be the practice most fund groups use to account 
for reinvestment of distributions on class B shares, and thus would 
permit them to avoid incurring costs associated with revising current 
fund systems--costs that may ultimately be borne by fund shareholders.
---------------------------------------------------------------------------

    \203\ See proposed rule 6c-10(b)(1)(ii).
    \204\ Id.
---------------------------------------------------------------------------

    Our proposed approach would be different, however, from the NASD 
sales charge rule, which prohibits funds from imposing front-end sales 
loads and CDSLs on reinvested dividends.\205\ The reinvestment of 
dividends does not involve the expenditure of sales-related efforts, 
and the NASD viewed such loads as ``duplicative.'' \206\
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    \205\ Proposed rule 6c-10(b)(1)(ii) would address the terms 
under which a fund with an ongoing sales charge could reinvest 
dividends and other distributions in shares of a class with an 
ongoing sale charge.
    \206\ NASD Notice to Members 97-48 (Aug. 1997).
---------------------------------------------------------------------------

     In view of the NASD rule and our intention to treat 
ongoing sales charges as another form of sales load, should we instead 
require funds to reinvest dividends and other distributions in a share 
class that does not have any ongoing sales charge? \207\
---------------------------------------------------------------------------

    \207\ See NASD Conduct Rule 2830(d)(6)(B).
---------------------------------------------------------------------------

     We request comment on whether we should adopt the proposed 
approach or, alternatively, that of the NASD sales charge rule. Would 
there be significant costs associated with reinvesting small amounts of 
retail investor accounts in a different share class? If we adopt the 
proposed approach, should shares acquired through a dividend 
reinvestment plan be required to convert before, after, or at the same 
time as, the shares on which the dividend or distribution was declared?
     More generally, what are the prevailing market practices 
with regard to reinvested dividends and other distributions? What is 
the annual volume of dividends and distributions offered by funds, and 
reinvested by shareholders? What is the magnitude of fees currently 
paid by investors on reinvested dividends? Do funds currently offer the 
option for investors to reinvest dividends in other share classes?
4. Role of Directors--Proposed Guidance
    Unlike rule 12b-1, the proposed amendments to rule 6c-10 would not 
impose any explicit responsibilities on fund boards of directors to 
approve (or re-approve) asset-based sales charges under the proposed 
rule, although we fully expect fund boards would continue to play an 
important role in protecting fund investors, as discussed more fully 
below. Directors would continue to have fiduciary duties with respect 
to the oversight of the use of fund assets under state law and under 
section 36(a) of the Act.\208\ When the Commission adopted rule 12b-1 
in 1980, we sought to address statutory concerns about the conflict of 
interest between fund advisers (who benefit from an increase in the 
amount of fund assets) and fund investors (who may not).\209\ We were 
concerned about whether a fund and its shareholders would benefit from 
a decision to pay distribution costs from fund assets, and viewed such 
a decision as ``a particularly difficult business judgment'' that is 
complicated by the conflicts of interest which are present.\210\ 
Therefore, we made these arrangements subject to the careful scrutiny 
of fund directors.\211\ Under our proposed approach, each shareholder 
would pay indirectly through the deduction of ongoing sales charges by 
the fund only the proportionate expenses associated with the sale of 
his or her fund shares. When those costs are paid, the shares purchased 
would automatically convert to a class of shares not paying an ongoing 
sales charge. The fund paying an ongoing sales charge would, in a 
sense, operate merely as the vehicle by which the fund shareholder pays 
the underwriter what the investor would have paid in the form of a 
front-end load at the time shares were purchased. Funds and fund 
underwriters would have little incentive to collect ongoing sales 
charges at excessive rates--a class of shares paying a higher rate of 
ongoing sales charge would simply convert earlier to a class that does 
not pay an ongoing sales charge.
---------------------------------------------------------------------------

    \208\ See supra note 156.
    \209\ See 1980 Adopting Release, supra note 23, at section 
titled ``Discussion.''
    \210\ Id. at section titled ``Independence of Directors.''
    \211\ See rule 12b-1(e).
---------------------------------------------------------------------------

    We view the treatment of the ongoing sales charge as another form 
of sales load (together with the automatic conversion requirement) as 
critical in our decision not to propose a specific role for the board 
of directors, while addressing the underlying concerns of section 12(b) 
of the Act. Directors will, however, continue to have fiduciary 
obligations under state law and section 36(a) of the Act to consider 
whether use of the fund's assets to pay ongoing sales charges, within 
the proposed caps, is in the best interest of the fund and fund 
investors.\212\ We expect to provide guidance in our adopting release 
for this proposal, to assist fund directors in satisfying their 
fiduciary duties.
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    \212\ See also supra note 156.
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     We request comment on the following proposed guidance.
    We believe that fund directors should consider the amount of the 
ongoing sales charge and the purposes for which it is used according to 
the same procedures they use to consider and approve the amount of the 
fund's other sales charges in the underwriting contract under section 
15(c) of the Act.\213\ We further believe that directors can and should 
view these asset-based distribution fees as integral parts of the 
fund's sales load structure to which they give their assent when they 
annually approve the fund's underwriting contract. In determining 
whether to approve (or re-approve) the underwriting contract, the 
directors must exercise their reasonable business judgment to decide, 
among other things, whether the terms of the contract benefit the fund 
(or its relevant class) and its shareholders, whether the underwriter's 
compensation is fair and reasonable

[[Page 47082]]

(considering the nature, scope and quality of the underwriting services 
rendered), and whether the sales loads (including the ongoing sales 
charge) are fair and reasonable in light of the usual and customary 
charges made by others for services of similar nature and quality. In 
evaluating the ``fairness and reasonableness'' of the contract, the 
directors should consider any factors that may be relevant, including 
whether the fund's distribution networks and overall structure are 
effective in promoting and selling fund shares given current economic 
and industry trends, any available breakpoints on advisory fees that 
may be attained from future growth in fund assets, and any economies or 
diseconomies of scale that may arise from continued growth of fund 
assets.\214\
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    \213\ Section 15(c) provides, in relevant part, that ``it shall 
be unlawful for any registered investment company * * * to enter 
into, renew, or perform any contract or agreement * * * whereby a 
person undertakes regularly to serve or act as * * * principal 
underwriter for such company unless the terms of such contract or 
agreement and any renewal thereof have been approved by the vote of 
a majority of directors, who are not parties to such contract or 
agreement or interested persons of any such party * * *.''
    \214\ We understand that many fund boards currently consider 
these, or similar, factors when evaluating funds' underwriting 
contracts.
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     Is this proposed guidance appropriate? Does it provide 
assistance to fund directors in evaluating ongoing sales charges? Are 
there other factors that would be relevant to the guidance we propose 
to provide? Should the guidance link board approval of the principal 
underwriting contract to board oversight of the use of fund assets for 
an ongoing sales charge? If not, what standard or requirements should 
apply to board oversight of ongoing sales charges?
     We request comment on our proposed overall approach to 
refashioning the role of the board of directors in overseeing asset-
based distribution fees.\215\ Is there a better approach we could take? 
Should we retain a formal role for directors in any rule permitting 
funds to pay for distribution expenses from fund assets? If so, what 
should that role be? Should we retain the current rule 12b-1, but 
update the suggested factors for director consideration in order to 
provide directors with additional guidance? For example, should the 
factors specifically recognize that directors may consider that ongoing 
sales charges provide an alternative to a front-end sales load and, in 
that sense, benefit shareholders who choose to invest in a share class 
that has an ongoing sales charge? Should directors, in addition, 
consider whether these arrangements are structured so that individual 
shareholders do not bear a disproportionate share of distribution 
expenses? In this regard, we are particularly interested in the views 
of fund directors.\216\
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    \215\ Throughout this proposal we use the term ``Asset-Based 
Distribution Fee'' to mean any fee deducted from fund assets to 
finance distribution activities pursuant to rule 12b-2(b) (Marketing 
and Service Fee), rule 12b-2(d) (Grandfathered 12b-1 Shares), or 
rule 6c-10(b) (Ongoing Sales Charge).
    \216\ Our proposed approach was informed by input from 
independent director representatives. See Comment Letter of the 
Independent Directors Council (July 19, 2007) (``IDC believes that 
the role of directors in overseeing 12b-1 plans should be consistent 
with the role of directors in overseeing front-end sales loads and 
fund distribution practices generally.''); Letter from the Mutual 
Fund Directors Forum to Andrew J. Donohue, Director of the Division 
of Investment Management, Securities and Exchange Commission (May 2, 
2008) (http://www.mfdf.com/images/uploads/resources_files/
Director_Duties_MFDF_Letter_May_2_2008.pdf) (``the quarterly 
review of expenditures under a fund's 12b-1 plan by directors serves 
little purpose, particularly since directors can have little impact 
in the first place on 12b-1 costs incurred by funds'').
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E. Proposed Amendments to Rule 10b-10: Transaction Confirmations

    Rule 10b-10 under the Securities Exchange Act requires broker-
dealers to disclose specific information to their customers about 
securities transactions, including the price at which the transaction 
was effected, remuneration such as sales charges paid by the customer 
to the broker-dealer (if it is acting in an agency capacity), and in 
certain circumstances remuneration received by the broker-dealer from 
third parties such as a mutual fund or its affiliates.\217\ The 
Commission and its staff have taken the position, with respect to 
mutual fund transactions, that a broker-dealer may satisfy its rule 
10b-10 obligations without providing customers with a transaction-
specific document that discloses information about sales charges or 
third-party remuneration, so long as the customer receives a fund 
prospectus that adequately discloses that information.\218\ Today, in 
connection with the other amendments we are proposing to limit 
cumulative sales charges and help investors make better choices when 
selecting a fund that imposes sales charges, we are also proposing 
amendments to rule 10b-10 to require disclosure of additional 
information on transaction confirmations in connection with 
transactions involving securities issued by mutual funds.\219\ In 
addition, we are proposing to amend rule 10b-10 to require disclosures 
related to callable debt securities, and to eliminate outdated 
transition provisions.\220\
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    \217\ 17 CFR 240.10b-10. Rule 10b-10 generally requires broker-
dealers that effect transactions for customers in securities, other 
than U.S. savings bonds or municipal securities, which are covered 
by Municipal Securities Rulemaking Board (``MSRB'') rule G-15 (which 
applies to all municipal securities brokers and dealers) to provide 
customers with written notification, at or before the completion of 
each transaction, of certain basic transaction terms. This 
transaction confirmation must disclose, among other information: The 
date of the transaction; the identity, price and number of shares 
bought or sold (see 17 CFR 240.10b-10(a)(1) (the confirmation must 
also include either the time of the transaction or the fact that it 
will be furnished upon written request)); the capacity of the 
broker-dealer (see 17 CFR 240.10b-10(a)(2)); the net dollar price 
and yield of a debt security (see 17 CFR 240.10b-10(a)(5) and (6)); 
and, under specified circumstances, the amount of compensation paid 
by the customer to the broker-dealer, whether the broker-dealer is 
receiving any other remuneration in connection with the transaction, 
and whether the broker-dealer receives payment for order flow (see, 
e.g., 17 CFR 240.10b-10(a)(2)(i)(B), (C), and (D)).
    The rule's requirements, portions of which have been in effect 
for over 60 years, provide basic investor protections by conveying 
information that allows investors to verify the terms of their 
transactions, alerts investors to potential conflicts of interest 
with their broker-dealers, acts as a safeguard against fraud, and 
provides investors a means to evaluate the costs of their 
transactions and the execution quality. See Exchange Act Release No. 
34962 (Nov. 10, 1994) [59 FR 59612, 59613 (Nov. 17, 1994)].
    \218\ See Exchange Act Release No. 49148 (Jan. 29, 2004) [69 FR 
6438 (Feb. 10, 2004)] at section IV.A.2. See also Investment Company 
Institute, SEC Staff No-Action Letter (pub. avail. Apr. 18, 1979) 
(``ICI Letter''). In this letter, the staff of the Commission's 
Division of Market Regulation (now known as the Division of Trading 
and Markets) stated that it would not recommend enforcement action 
against broker-dealers that did not provide transaction-specific 
disclosure about mutual fund loads and related charges, so long as 
the customer received a prospectus that ``disclosed the precise 
amount of the sales load or other charges or a formula that would 
enable the customer to calculate the precise amount of those fees.'' 
This letter reflected a position that the Commission took when it 
adopted rule 10b-10, when it articulated the view that, in the case 
of registered securities offerings, separate confirmation disclosure 
of third-party remuneration would be redundant if the customer 
received a final prospectus disclosing that information. See 
Exchange Act Release No. 13508 at n.41 (May 5, 1977) [42 FR 25318 
(May 17, 1977)].
    \219\ We proposed more comprehensive changes to the broker-
dealer confirmation requirements in 2004 through proposed Exchange 
Act rule 15c2-2 as part of a broader initiative regarding 
disclosures made to investors at the time an investment decision is 
made. See Securities Exchange Act Release No. 49148, (Jan. 29, 2004) 
[69 FR 6438 (Feb. 10, 2004)]. See also Securities Exchange Act 
Release No. 51274 (Feb. 28, 2005) [70 FR 10521 (Mar. 1, 2005)] 
(reopening of comment period). Proposed rule 15c2-2 would have 
governed transactions in mutual funds, unit investment trust 
(``UIT'') interests and 529 college savings plans, and in contrast 
to rule 10b-10, would have prescribed a specific form to be used for 
confirmation disclosure. The more targeted confirmation changes we 
are proposing today, unlike our earlier proposal, involve amendments 
to rule 10b-10 rather than a new confirmation rule and confirmation 
form. This in part reflects comments we received on the rule 15c2-2 
proposal, including commenters' concerns as to the cost of requiring 
a separate confirmation rule and confirmation form for certain 
securities. See, e.g., Comment Letter of Securities Industry 
Association (Apr. 12, 2004) (File No. S7-06-04) (``brokerage firms 
would have to bifurcate what is now a single stream of 
confirmations, and create an entirely new stream of information for 
mutual fund confirmations and a different stream for all other 
securities transactions'').
    \220\ See infra Section III.E.2 of this Release.
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1. Confirmation Disclosure of Sales Charges and Fees
    We are proposing to amend rule 10b-10 to require confirmations to 
set forth

[[Page 47083]]

information regarding front-end and deferred sales charges, as well as 
ongoing sales charges and marketing and service fees (as defined in 
proposed Investment Company Act rules 6c-10 and 12b-2) associated with 
transactions involving mutual fund securities.\221\
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    \221\ The term ``mutual fund security'' would be defined by 
reference to the definition of ``open-end company'' in section 
5(a)(1) of the Investment Company Act (15 U.S.C. 80a-5(a)(1)). While 
exchange-traded funds are typically organized as open-end companies, 
we understand that exchange-traded funds do not typically impose the 
sales charges or other fees that would be subject to these 
disclosure requirements.
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    In making this proposal, we are mindful that while improving 
confirmation disclosure of such fees can be expected to make the 
confirmation a more complete record of the transaction and to promote 
investor understanding of the fees, customers do not receive 
confirmations until after completing their purchases of mutual funds; 
accordingly, providing for improved disclosure of cost information 
prior to the sale may be an additional step that we could consider to 
help investors make better informed investment decisions.\222\
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    \222\ In this regard, the staff is considering recommendations 
for our future consideration to enhance the information provided at 
the point of sale. We also note that Section 919 of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act states 
``[n]otwithstanding any other provision of the securities laws, the 
Commission may issue rules designating documents or information that 
shall be provided by a broker or dealer to a retail investor before 
the purchase of an investment product or service by the retail 
investor.''
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    Under the proposal, transaction confirmations for purchases of 
those securities would disclose the amount of any sales charge that the 
customer incurred at the time of purchase, in percentage and dollar 
terms, along with the net dollar amount invested in the security and 
the amount of any applicable breakpoint or similar threshold used to 
calculate the sales charge.\223\ This information would be expected to 
help make the confirmation a more complete record of the transaction 
and promote investor understanding of associated costs, as well as 
helping customers identify any errors associated with the front-end 
sales charges they incur; inclusion of breakpoint information on the 
confirmation particularly should assist investors in conveniently 
identifying any breakpoint-related errors in the sales charges they 
incurred.\224\
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    \223\ See proposed new paragraph (a)(10)(i) of rule 10b-10. For 
purposes of these rule 10b-10 amendments, the term ``sales charge'' 
is intended to be comparable to the term ``sales load,'' which the 
Investment Company Act generally defines to mean the difference 
between the public price of a security and the portion that is 
invested (less deductions for certain fees). See section 2(a)(35) of 
the Act.
    \224\ See Report of the Joint NASD/Industry Task Force on 
Breakpoints (July 2003) (``Breakpoint Report'') (http://
www.finra.org/web/groups/industry/@ip/@issues/@bp/documents/
industry/p006434.pdf) (``Confirmations should reflect the entire 
percentage sales load charged to each front-end load mutual fund 
purchase transaction. This information would enable investors to 
verify that the proper charge was applied.'').
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    Also, if the customer may pay a deferred sales charge upon 
redemption of the shares (such as a contingent deferred sales charge), 
a transaction confirmation provided to the customer at the time of 
purchase would disclose the maximum amount of any deferred sales charge 
that the customer may pay in the future.\225\ The amount would be 
expressed as a percentage of the net asset value at the time of 
purchase or at the time of redemption or sale, as applicable.\226\ This 
proposed requirement is designed to provide a customer more complete 
information about the deferred sales charge (which may serve as an 
economic substitute for the front-end sales charge) that the customer 
may be obligated to pay in the future.
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    \225\ See proposed rule 10b-10(a)(10)(ii).
    \226\ Id. A mutual fund could decide to calculate the deferred 
sales load as the lower of the net asset value at the time of 
purchase or at the time of redemption. Under rule 6c-10 under the 
Investment Company Act, a deferred sales charge may not exceed ``a 
specified percentage of the net asset value or the offering price at 
the time of purchase.'' Rule 6c-10(a)(1).
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    In addition, if, after the time of purchase, the customer will 
incur any ongoing sales charge or marketing and service fee, purchase 
confirmations would disclose the following information: The annual 
amount of that charge or fee, expressed as a percentage of net asset 
value; the aggregate amount of the ongoing sales charge that may be 
incurred over time, expressed as a percentage of net asset value; and 
the maximum number of months or years that the customer will incur the 
ongoing sales charge. We anticipate that this disclosure could be made 
relatively simply, for example: ``You will pay a maximum total ongoing 
sales charge of 5%, deducted from the assets of the fund in which you 
are investing at an annual rate of 1% over the next 5 years. You also 
will pay marketing and service fees of 0.25% for as long as you own the 
fund.'' \227\
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    \227\ To the extent that the rate of the marketing and service 
fee associated with a particular mutual fund were to increase or 
decrease following the customer's purchase, rule 10b-10 would not 
require the broker-dealer to provide an updated confirmation 
statement to the customer. This information is typically disclosed 
in a supplement to a fund's prospectus filed under rule 497 under 
the Securities Act.
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    Confirmations further would include the following statement (which 
may be revised to reflect the particular charge or fee at issue): ``In 
addition to ongoing sales charges and marketing and service fees, you 
will also incur additional fees and expenses in connection with owning 
this mutual fund, as set forth in the fee table in the mutual fund 
prospectus; these typically will include management fees and other 
expenses. Such fees and expenses are generally paid from the assets of 
the mutual fund in which you are investing. Therefore, these costs are 
indirectly paid by you.'' \228\ This proposal generally is intended to 
help make transaction disclosure more complete by helping to ensure 
that customers are informed about the use of ongoing sales charges that 
serve as a substitute for front-end sales charges, as well as 
additional uses of mutual fund assets to pay for distribution. The 
statement about the presence of additional charges is intended to help 
address the risk that confirmation disclosure of some ongoing charges 
or fees may cause some customers to wrongly infer that those charges or 
fees are all the ongoing costs that the customers would incur in 
connection with owning a mutual fund security.\229\
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    \228\ See proposed new paragraph (a)(10)(iii)(B) of rule 10b-10. 
As discussed above, the term ``ongoing sales charge'' would be 
defined in proposed rule 6c-10 under the Investment Company Act of 
1940, 17 CFR 270.6c-10, and the term ``marketing and service fee'' 
would be defined in proposed rule 12b-2 under that Act, 17 CFR 
270.12b-2.
    \229\ We are not proposing to require that purchase 
confirmations disclose management fees or other operating expenses, 
as those costs are disclosed in the prospectus fee table and are not 
directly implicated by the transaction. We also are not proposing to 
specifically require that purchase confirmations disclose other 
categories of compensation that the broker-dealer receives in 
connection with the particular mutual fund being purchased, such as 
``revenue sharing'' received from a fund's adviser.
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    Finally, confirmations for transactions in which a customer redeems 
or sells a mutual fund security the customer owns would disclose the 
amount of any deferred sales charge the customer has incurred or will 
incur, expressed in dollars and as a percentage of the net asset value 
at the time of purchase or at the time of redemption or sale, as 
applicable.\230\ This information also would be expected to help make 
the confirmation a more complete record of the transaction and help 
customers identify any errors.
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    \230\ See proposed new paragraph (a)(11) of rule 10b-10.
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    We are proposing corresponding changes to the alternative periodic 
reporting provisions of rule 10b-10(b), which in part permit quarterly 
reporting

[[Page 47084]]

for transactions involving investment company plans.\231\ As revised, 
such periodic statements involving mutual fund security transactions 
would include disclosure of sales charges consistent with the proposed 
requirements for other confirmations.\232\
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    \231\ See rule 10b-10(b) (permitting the disclosure of 
transaction-related information in periodic account statements 
rather than in confirmations for securities purchased or sold on a 
periodic basis through ``investment company plans''); rule 10b-
10(d)(6) (defining ``investment company plan'' to include individual 
retirement or pension plans and individual contractual arrangements 
that provide for periodic purchases or redemptions of investment 
company securities).
    \232\ In particular, paragraph (b)(2) of rule 10b-10, as 
revised, would require disclosure of ``any ongoing sales charges or 
marketing and service fees incurred in connection with the purchase 
or redemption of a mutual fund security.'' Consistent with the 
proposed requirements of paragraphs (a)(10) and (a)(11), this would 
encompass disclosure of front-end, deferred, and ongoing sales 
charges.
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    In sum, these proposed requirements are intended to help make the 
confirmation a more complete record of the transaction, help investors 
in mutual fund securities be more fully aware of the sales charges they 
pay, and assist investors in verifying whether they paid the correct 
sales charge set forth in the prospectus. In that regard, these 
proposed requirements seek to take into account support that commenters 
previously have expressed for improved confirmation disclosure of sales 
charges, while also taking into account commenters' concerns regarding 
the costs that would be associated with more extensive changes to 
confirmation disclosure requirements.\233\ We understand that some 
broker-dealers may already provide disclosures about front-end sales 
charges in their mutual fund confirmations, in part in response to the 
recommendations of the Joint NASD/Industry Task Force on 
Breakpoints.\234\
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    \233\ Investor advocates who commented on proposed rule 15c2-2 
generally supported confirmation disclosure of costs. See Comment 
Letter of the Consumer Federation of America, Fund Democracy, 
Consumer Action, and the Consumers Union (Apr. 21, 2004) (File No. 
S7-06-04) (``Confirmation and other post-sale disclosure should 
quantify the costs incurred as a result of the transaction, 
including any costs or payments that may have been estimated in pre-
sale disclosures.''). More generally, the Commission also received a 
number of comments from the public that supported our proposals for 
improving disclosure. See, e.g., Comment Letter of T. Booy (Mar. 16, 
2004) (File No. S7-06-04); Comment Letter of R. Barndt (Mar. 15, 
2004).
    While securities-industry commenters generally opposed expanding 
the scope of confirmation disclosures in other ways (and, as noted 
above, stated that extensive changes to existing broker-dealer 
confirmation systems would be particularly expensive), a number of 
those commenters supported confirmation disclosure of front-end 
sales charges, while not supporting confirmation disclosure of 
ongoing costs of ownership. In the view of those commenters, 
confirmations fundamentally are records of transactions that are 
provided too late to assist investors in making decisions. See, 
e.g., Commenter Letter of Securities Industry Association (Apr. 4, 
2005) (File No. S7-06-04) (supporting confirmation disclosure of 
sales charges in dollar and percentage terms, which would help 
investors determine whether they received correct breakpoint 
discounts; opposing confirmation disclosure of information about 
ongoing fees and conflicts of interest as costly, repetitive and too 
late to be useful); Comment Letter of Legg Mason Wood Walker Inc 
(Apr. 4, 2005) (File No. S7-06-04) (opposing addition of items other 
than sales charge information on confirmations as duplicative and as 
providing information too late to be useful for investors; based on 
their experience, investors look to the confirmation for information 
about the date, amount and price of their mutual fund investments); 
Comment Letter of Charles Schwab & Co., Inc. (Apr. 4, 2005) (File 
No. S7-06-04) (supporting confirmation disclosure of transaction-
specific sales fees in dollar and percentage terms; opposing 
disclosure on purchase confirmations of disclosure of contingent 
deferred sales charges, and strongly opposing confirmation 
disclosure of comprehensive annual costs and of conflict of interest 
information).
    \234\ See Breakpoint Report, supra note 224.
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    In the event we adopt these amendments to provide for confirmation 
disclosure of such sales charges, we intend to withdraw a no-action 
letter that the Commission's staff issued to the Investment Company 
Institute in 1979, related to confirmation disclosure of mutual fund 
sales loads and related fees, as that letter would no longer be 
consistent with the rule.\235\
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    \235\ See ICI Letter, supra note 218; see also Breakpoint 
Report, supra note 224 (``In connection with this recommendation, 
the Task Force also recommends that the SEC staff revisit its April 
18, 1979 No-Action Letter, which permits the omission of sales 
charge information from confirmations.'')
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    We request comment on all aspects of these proposals, including the 
following:
     Would the information we propose to include in transaction 
confirmations be useful to investors? Would confirmation disclosure of 
quantified information about ongoing sales charges and marketing and 
service fees, without quantified information of other ongoing costs 
associated with owning mutual funds, imply that no other ongoing fees 
would be associated with their purchase? Would it imply that other 
ongoing fees are smaller or otherwise less important? If so, should 
confirmations also set forth the percentage amount of other ongoing 
expenses, including, but not limited to: (a) Other shareholder fees, as 
disclosed in the mutual fund prospectus fee table pursuant to Item 3 of 
Form N-1A; (b) management fees, as disclosed in the mutual fund 
prospectus fee table pursuant to Item 3 of Form N-1A; and (c) any other 
expenses, disclosed in the mutual fund prospectus fee table pursuant to 
Item 3 of Form N-1A?
     Conversely, given that marketing and service fees (unlike 
ongoing sales charges) would not act as economic substitutes for front-
end sales charges, should we amend rule 10b-10 to require disclosure of 
quantified information about marketing and service fees? Could 
requiring confirmation disclosure of marketing and service fees lead to 
disparate disclosure to the extent that mutual funds follow disparate 
practices with regard to whether they use the proceeds of marketing and 
service fees to pay for certain types of services?
     Would the statement set forth in proposed rule 10b-
10(a)(10)(iii)(B) be sufficient to put investors on notice that they 
will be subject to additional costs over and above the disclosed front-
end, deferred and ongoing charges and fees? Alternatively, should such 
ongoing fees be disclosed in some document other than the transaction 
confirmation? For example, would the account statement required by 
self-regulatory organization (``SRO'') rules \236\ be a more 
appropriate document for disclosures of ongoing costs, or for 
information about the source and amount of broker-dealer remuneration 
in connection with the mutual fund?
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    \236\ See NASD Conduct Rule 2340 (Customer Account Statements).
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     Would it be helpful to investors to require disclosure of 
front-end and deferred sales charges in dollar terms? Would limiting 
the disclosure to percentage terms be a cost-effective way of 
permitting customers to check the terms of the transaction? Would it be 
helpful to investors to require that confirmations for mutual fund 
purchase transactions set forth the maximum amount of any deferred 
sales charge that the customer may incur upon redeeming the mutual 
fund? \237\
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    \237\ FINRA rules currently require broker-dealers to include 
the following disclosure in transaction confirmations for investment 
company purchases: ``On selling your shares, you may pay a sales 
charge. For the charge and other fees, see the prospectus.'' See 
NASD Conduct Rule 2830(n).
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     Should rule 10b-10 also specify the format and 
presentation of how such cost and fee information should be disclosed 
(e.g., specifically requiring that such information be highlighted on 
the confirmation, or placed in the front of a confirmation if a paper-
based confirmation is used, or be subject to a minimum font size)?
     Should transaction confirmations--or some other document--
seek to quantify the total amount of front-end, ongoing and deferred 
fees the specific investor may expect to incur over time under 
reasonable assumptions; if so, how could such an ``all in'' fee be 
presented most effectively?
     Should purchase confirmations for mutual funds also be 
specifically

[[Page 47085]]

required to set forth quantified information about the source and 
amount of all remuneration that the broker-dealer directly or 
indirectly receives in connection with the mutual fund, including, for 
example, ``revenue sharing'' received from a fund's adviser?
     In addition, we request comment on whether the proposed 
disclosures should be applicable to transactions in other securities 
that may carry sales charges, such as UIT interests, real estate 
investment trust interests or direct participation plan interests. 
Commenters particularly are asked to address any disclosure issues that 
are particular to each of those products; UIT interests, for example, 
may carry a combination of initial sales charges, deferred sales 
charges (deducted in periodic installments) and so-called ``creation 
and development'' fees. To the extent these amendments are applicable 
to UIT interests, would special provisions be needed to address 
transactions involving variable insurance products?
     We further request comment on whether the proposed 
requirement for disclosure of front-end sales charges also should 
require disclosure of equivalent costs (i.e., the difference between 
the public price and the resulting amount invested) incurred in 
connection with purchases made during primary offerings of closed-end 
funds. In addition, we request comment on whether the confirmation 
requirements of rule 10b-10 should be revised to encompass transactions 
in 529 college savings plan interests, which, as municipal securities, 
currently are excluded from the application of rule 10b-10.
2. Additional Changes to the Confirmation Rule
    In addition to proposing confirmation rule changes in connection 
with our proposed replacement of rule 12b-1 with a new regulatory 
scheme, we are also proposing to amend rule 10b-10 to require 
disclosure of the first date on which certain debt securities may be 
called.\238\ Disclosure of the first date upon which a debt security 
may be called will provide customers with meaningful information that 
is intended to help avoid any confusion for investors who are not 
otherwise aware that a bond may be called on a date earlier than the 
one specified on the confirmation. In particular, the rule as revised 
would require disclosure of the first date on which the security may be 
called when a broker-dealer effects a transaction in a debt security on 
the basis of yield-to-call.\239\ Currently, the rule requires a broker-
dealer that had effected a transaction in a debt security on the basis 
of yield-to-call to disclose, among other information, the type of 
call, the call date, and the call price. A bond may be subject to call 
on a series of dates; as a result, although a confirmation may have 
stated what the bond's yield-to-call would be if the bond is called on 
one of those dates, the confirmation may not have informed a customer 
about the first possible date on which a bond is subject to call. That 
may confuse investors who are not otherwise aware that a bond may be 
called on a date earlier than the one specified on the confirmation. 
The possibility of earlier call can subject the investor to additional 
reinvestment risk, because the investor may have worse alternatives for 
reinvesting the proceeds if the issuer calls the security when 
prevailing interest rates decline.
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    \238\ This proposal is consistent with proposed amendments to 
rule 10b-10 that we made in 2004 in conjunction with proposed rule 
15c2-12. See note 219, supra. We received no comments on this aspect 
of the proposal. At that time, we also proposed to amend rule 10b-10 
to require broker-dealers that effect transactions in callable 
preferred stock to disclose to their customers that the stock may be 
repurchased at the election of the issuer and that additional 
information is available upon request. We are not reproposing that 
amendment at this time, but will continue to consider the need for 
such a requirement.
    \239\ See proposed paragraph (a)(6)(i) of rule 10b-10.
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     We request comment on whether this proposal would provide 
useful information to investors.
    Finally, we propose to delete paragraph (e)(2) of rule 10b-10, 
which sets forth transitional provisions related to confirmation 
requirements for security futures products, and which expired in 
2003.\240\
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    \240\ Consistent with that deletion, we also propose to 
redesignate paragraphs (e)(1)(i) through (e)(1)(iv) as paragraphs 
(e)(1) through (e)(4).
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     We request comment on this technical amendment.

F. Shareholder Approval

    Marketing and Service Fee. Under proposed new rule 12b-2, a fund 
would be required to obtain the approval of a majority of its 
shareholders before it could institute, or increase the rate of, a 
marketing and service fee.\241\ However, shareholder approval would not 
be required for a fund to institute a marketing and service fee with 
respect to a new class of fund shares, allowing a fund to institute (or 
increase) a marketing and service fee and apply it only to investments 
in the new class and avoid the cost of soliciting proxies to obtain 
shareholder approval.\242\
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    \241\ See proposed rule 12b-2(b)(2).
    \242\ Under the proposed rule, shareholder approval would only 
be necessary with respect to the class or series affected by the fee 
increase.
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    An existing shareholder in a share class that institutes a 
marketing and service fee may have invested in reliance on disclosure 
that the fund does not charge such fees or charges them at a lower 
rate. In order to avoid paying new marketing and service fees, the 
shareholder's only recourse would be to redeem his shares and risk 
incurring significant additional costs, including potential capital 
gains taxes. Less vigilant investors may only discover new marketing 
and service fees after paying them for some time. Thus, we believe that 
these charges should not be imposed or increased without shareholder 
approval.\243\
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    \243\ See section 1(b)(1) of the Act, which provides, in 
relevant part, that ``the national public interest and the interest 
of investors are adversely affected--(1) when investors purchase * * 
* securities issued by investment companies without adequate, 
accurate, and explicit information, fairly presented, concerning the 
character of such securities. * * *''
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    For similar reasons, rule 12b-1 currently requires shareholder 
approval when a 12b-1 plan is adopted or is amended to increase 
materially the amount to be spent for distribution,\244\ and thus in 
this regard our proposal would not significantly change the rights of 
fund shareholders or the obligations of funds and fund underwriters. 
Fund directors would not (as discussed above) be specifically required 
by the rule to approve the fees, although fund directors may determine 
to solicit proxies in support of (or in opposition to) the imposition 
of the fee or an increase in the fee.
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    \244\ Rules 12b-1(b)(1) and (b)(4).
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    Ongoing Sales Charge. Ongoing sales charges would be treated 
differently, however. Under the proposed amendments to rule 6c-10, a 
fund would not be permitted to institute, or increase the rate of, an 
ongoing sales charge, or lengthen the period before shares 
automatically convert to another class of shares that does not incur an 
ongoing sales charge, after any public offering of the fund's voting 
shares or the sale of such shares to persons who are not organizers of 
the fund.\245\ A new fund (i.e., a fund that has not made a public 
offering), or an existing fund with respect to a new class of shares, 
would not need to obtain shareholder approval before instituting a 
marketing and service fee or an ongoing sales charge (because no 
shareholders that are not affiliated with the fund's sponsor

[[Page 47086]]

would be affected).\246\ However, after the fund or class has been sold 
to the public, an ongoing sales charge would not be permitted to be 
instituted or raised with regard to that fund or class.
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    \245\ See proposed rule 6c-10(b)(3).
    \246\ Similar to rule 12b-1, a fund would not be required to 
obtain shareholder approval for marketing and service fees or 
ongoing sales charges that are implemented prior to the sale of fund 
shares to the public. Rule 12b-1(b)(1). See also supra note 41.
---------------------------------------------------------------------------

    We believe that ongoing sales charges should not be instituted or 
increased in existing funds, or lengthened in duration, regardless of 
shareholder approval. The current regulatory framework does not allow 
for sales charges to be retroactively imposed or increased with regard 
to prior investments, and we believe that permitting increases in 
ongoing sales charges in existing share classes would negatively impact 
investors. Shareholders may select a fund in part based on the level of 
the ongoing sales charge, if any, and the level of services they 
received from the intermediary receiving the ongoing sales charge. 
Under the proposed rules, an institution or increase of an ongoing 
sales charge after a shareholder has agreed to pay a defined cumulative 
ongoing sales charge would be akin to retroactively renegotiating the 
terms of the contract without the explicit consent of the particular 
shareholder affected.
    We request comment on the shareholder approval requirements.
     Should we require shareholder approval to institute or 
increase a marketing and service fee? Would permitting funds to 
institute, increase, or lengthen the period of ongoing sales charges 
negatively impact investors? Should we permit shareholder approval to 
institute, or increase the rate of, an ongoing sales charge, or 
lengthen the period before shares automatically convert to another 
class of shares that does not incur an ongoing sales charge? Should the 
rule specify who should bear the cost of soliciting shareholder proxies 
to approve or increase the rate of an asset-based distribution fee? If 
so, should the fund or the fund underwriter bear the cost?

G. Application to Funds of Funds

    We propose provisions in both rules 12b-2 and 6c-10 that would 
address asset-based distribution fees that could be deducted when one 
fund (the ``acquiring fund'') invests in shares of another (the 
``acquired fund''). Section 12(d)(1)(A) of the Act, our rules, and the 
NASD sales charge rule currently include provisions that restrict the 
layering of sales loads, asset-based sales charges and service fees in 
so called fund of funds arrangements, in which one investment company 
invests in the shares of another.\247\ As described further below, we 
would include similar provisions to restrict the layering of marketing 
and service fees and ongoing sales charges in the amendments we are 
today proposing.
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    \247\ Section 12(d)(1)(A) of the Act prohibits a registered 
investment company (and any investment companies it controls) from: 
(i) Acquiring more than 3 percent of the outstanding voting 
securities of any other investment company; (ii) investing more than 
5 percent of its total assets in any one acquired investment 
company; or (iii) investing more than 10 percent of its total assets 
in all acquired investment companies. Section 12(d)(1)(B) prohibits 
a registered open-end investment company (i.e. an acquired fund) 
from: selling securities to any acquiring investment company if, 
after the sale the acquiring investment company (together with 
investment companies it controls) would (i) own more than 3 percent 
of the acquired fund's outstanding voting securities or (ii) 
together with other acquiring investment companies (and investment 
companies they control) own more than 10 percent of the acquired 
fund's outstanding voting securities. Section 12(d)(1)(F) of the Act 
provides an exemption from the limitations of section 12(d)(1) that 
allows a registered investment company to invest all its assets in 
other investment companies if, among other things, the sales load 
charged on the acquiring investment company's shares is no greater 
than 1.5 percent. Rule 12d1-3 allows acquiring investment companies 
relying on section 12(d)(1)(F) to charge sales loads greater than 
1.5 percent provided that the sales charges and service fees charged 
with respect to the acquiring investment company's securities do not 
exceed the limits of the NASD sales charge rule applicable to funds 
of funds. Rule 12d1-3(a). The NASD sales charge rule requires funds 
of funds to aggregate sales charges and services fees paid by both 
the acquiring and acquired funds in complying with its limits. See 
NASD Conduct Rule 2830(d)(3).
     Section 12(d)(1)(G) provides a similar exemption that permits a 
registered open-end fund or UIT to acquire an unlimited amount of 
shares of registered open-end funds and UITs that are part of the 
same ``group of investment companies'' as the acquiring fund. The 
provision is available only if either: (i) The acquiring fund does 
not pay (and is not assessed) sales loads or distribution related 
fees on securities of the acquired fund (unless the acquiring fund 
does not itself charge sales loads or distribution related fees); or 
(ii) the aggregate sales loads or distribution related fees charged 
by the acquiring fund on its securities, when aggregated with any 
sales load and distribution related fees paid by the acquiring fund 
on acquired fund securities, are not excessive under rules adopted 
under section 22(b) or 22(c) of the Act by a securities association 
registered under section 15A of the Exchange Act, or the Commission. 
The NASD has adopted limits on sales loads and distribution related 
fees applicable to funds as well as to funds of funds. See NASD 
Conduct Rule 2830. See also Section II.C.1 of this Release.
    Under the NASD sales charge rule's provision for funds of funds, 
if neither the acquiring nor acquired investment company has an 
asset-based sales charge (12b-1 fee), the maximum aggregate sales 
load that can be charged on sales of acquiring investment company 
and acquired investment company shares cannot exceed 8.5 percent (or 
7.25 percent if the company pays a service fee). See NASD Sales 
Charge Rule 2830(d)(3)(A). Any acquiring or acquired investment 
company that has an asset-based sales charge must individually 
comply with the sales charge limitations on investment companies 
with an asset-based sales charge, provided, among other conditions, 
that if both companies have an asset-based sales charge, the maximum 
aggregate asset-based sales charge cannot exceed 75 basis points per 
year of the average annual net assets of both companies; and the 
maximum aggregate sales load may not exceed 7.25 percent of the 
amount invested (or 6.25 percent if either company pays a service 
fee). See NASD Conduct Rule 2830(d)(3)(B). The rule is designed so 
that cumulative charges for sales related expenses, no matter how 
they are imposed, are subject to equivalent limitations. See 1992 
NASD Rule Release, supra note 66, at text accompanying n.9. See also 
NASD Notice to Members 99-103 (Dec. 1999) (http://www.finra.org/
RulesRegulation/NoticestoMembers/1999NoticestoMembers/P004026) (``We 
have amended the [sales charge rule] to ensure that, if both levels 
of funds in a fund of funds structure impose sales charges, the 
combined sales charges do not exceed the maximum percentage limits 
currently contained in the rule.'').
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1. Marketing and Service Fee
    Proposed rule 12b-2 would permit both an acquiring fund and an 
acquired fund in a fund of funds arrangement to charge a marketing and 
service fee, as long as the total of the fees charged by the funds 
together does not exceed the NASD service fee limit (25 basis 
points).\248\ Thus, under proposed rule 12b-2(b)(2), if an acquiring 
fund deducts a marketing and service fee of 10 basis points, it would 
be limited to investing in other funds that deduct a marketing and 
service fee of no more than 15 basis points. This is the same approach 
as that taken by the NASD sales charge rule, which limits a fund of 
funds to a combined service fee of 25 basis points, and which limits a 
fund of funds that wishes to hold itself out as a no-load fund to 
combined service fees and asset-based sales charges (12b-1 fees) of 25 
basis points.\249\
---------------------------------------------------------------------------

    \248\ Proposed rule 12b-2(b)(2).
    \249\ NASD Conduct Rule 2830(d)(3)(C).
---------------------------------------------------------------------------

    We request comment on our approach to applying rule 12b-2 to fund 
of funds arrangements.
     Should we, instead, preclude either acquiring funds or 
acquired funds from charging a marketing and service fee rather than 
cumulating the amounts? In the case of an acquiring fund investing in 
multiple acquired funds charging different marketing and service fee 
rates, should the rule's limits apply to the weighted average of the 
marketing and service fees rather than the maximum fee? \250\ Would 
this be feasible? If so, how often should the acquiring fund determine 
such a weighted average for purposes of complying with the limits on 
marketing and service fees in proposed rule 12b-2? What other methods 
could be used to ensure that

[[Page 47087]]

shareholders in funds of funds do not pay excessive fees under proposed 
rule 12b-2?
---------------------------------------------------------------------------

    \250\ See proposed rule 12b-2(b)(2). We understand that the NASD 
sales charge rule's limits on cumulative service fees and asset-
based sales charges (for no-load funds) does not permit weighted 
averaging, and thus applies the maximum rate as would our proposed 
rule. See NASD Conduct Rule 2830(d)(3).
---------------------------------------------------------------------------

2. Ongoing Sales Charges
    We are also proposing that an acquiring fund and an acquired fund 
could not both charge an ongoing sales charge. Under proposed rule 6c-
10(b)(1)(iv), an acquiring fund that relies on the rule to deduct an 
ongoing sales charge could not acquire the securities of another fund 
that imposed an ongoing sales charge.\251\ An acquiring fund that did 
not charge an ongoing sales charge would not be subject to this 
restriction and would therefore be free to invest in funds imposing an 
ongoing sales charge.
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    \251\ An acquiring fund would determine its ongoing sales charge 
as the amount it deducts from fund assets in excess of its marketing 
and service fee, without regard to any acquired fund's marketing and 
service fee. Proposed rule 6c-10(d)(11).
---------------------------------------------------------------------------

    We understand that the classes of shares of most acquired funds do 
not carry 12b-1 fees or, if they do, carry a 12b-1 fee of less than 25 
basis points. We also understand that when funds do acquire shares of 
other funds with a sales load or 12b-1 fee, they often do not charge 
loads or 12b-1 fees themselves.\252\ Thus, if our proposal were 
adopted, we do not expect that it would affect the structure or 
operation of most funds of funds.
---------------------------------------------------------------------------

    \252\ See, e.g., New Century Portfolios, Prospectus at 18 
(http://www.newcenturyportfolios.com/Documents/
Prospectus%203.01.09%20-%20New%20Century%20Portfolios%20Final.pdf) 
(acquiring funds do not charge a sales load, and 12b-1 fees for the 
five series range from 0.10% to 0.22%).
---------------------------------------------------------------------------

     We request comment on our understanding, and how our 
proposal would affect funds of funds.
    Our approach to applying proposed rule 6c-10(b) to funds of funds 
is not the same as the approach taken by the NASD sales charge rule, 
which permits asset-based sales charges at both levels but requires the 
rates to be accumulated in determining compliance with the relevant 
limits.\253\ We have not taken this approach because it would involve 
substantial complexities when an acquiring fund invests in (and over 
time purchases and sells) multiple acquired funds (with different 
ongoing sales charges) that would have to be factored into the length 
of conversion periods that would be required by proposed rule 6c-10(b).
---------------------------------------------------------------------------

    \253\ NASD Rule 2830(d)(3)(B)(ii).
---------------------------------------------------------------------------

     We request comment on this proposed approach. We request 
that commenters who favor an approach that would require accumulating 
of ongoing sales charges (rather than restricting ongoing sales charges 
on either the acquiring or acquired fund), address how accumulation 
might work in a way that is not unduly complicated.

H. Application to Funds Underlying Separate Accounts

    Our proposed rule and rule amendments would apply to funds that 
serve as investment vehicles for insurance company separate accounts 
that offer variable annuities or life insurance contracts.\254\ 
Separate accounts are typically organized as unit investment 
trusts.\255\ They invest the proceeds of premium payments made by 
contract owners in one or more mutual funds (underlying funds) that 
manage the assets that support the insurance contracts.
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    \254\ See section 2(a)(37) of the Act (defining ``separate 
account'').
    \255\ See section (4)(2) of the Act (defining ``unit investment 
trust''). See, e.g., Wendell M. Faria, Variable Annuities & Variable 
Life Ins. Reg. Sec.  3:4.2 (Dec. 2009) (``[P]ractically all separate 
accounts are organized as unit investment trusts under a two-tier 
structure in which the separate account invests in an affiliated or 
unaffiliated underlying fund (or funds) organized as an open-end 
management investment company.'').
---------------------------------------------------------------------------

    Owners of variable insurance contracts may pay substantial 
distribution costs \256\ in the form of a front-end load, a contingent 
deferred load, or ongoing charges that are deducted from the assets 
held by the separate account, or a combination of these charges.\257\ 
In addition, directors of some underlying funds have approved adoption 
of rule 12b-1 plans to support various distribution and shareholder 
servicing activities.\258\ We understand that in most cases these 
charges do not exceed 25 basis points annually.
---------------------------------------------------------------------------

    \256\ The FINRA sales charge rules do not place a maximum sales 
charge limitation on variable contracts. See NASD Notice to Members 
99-103; Order Granting Approval of and Notice of Filing and Order 
Granting Accelerated Approval of Amendments Nos. 4, 5, and 6 to the 
Proposed Rule Change Relating to Sales Charges and Prospectus 
Disclosure for Mutual Funds and Variable Contracts, Exchange Act 
Release No. 42043 (Oct. 20, 1999) [64 FR 58112 (Oct. 28, 1999)] 
(approving NASD rule change eliminating maximum sales charge 
limitations on variable contracts). Until 1996, section 27 of the 
Act effectively limited the amount of the sales load that could be 
charged on a variable contract. When Congress enacted the National 
Securities Market Improvement Act of 1996, it amended section 27 to 
provide an exemption for variable contracts. Public Law 104-290 
(1996).
    \257\ See Goldberg and Bressler, supra note 52, at n.28 (``While 
variable insurance products, like mutual funds, did not pay 
distribution fees prior to the adoption of rule 12b-1, they paid 
mortality and expense charges. These provided a source of revenue to 
reimburse the insurance company for the portion of the sales 
commission not covered by a CDSL.'').
    \258\ See Comment Letter of Sutherland, Asbill & Brennan, on 
behalf of the Committee of Annuity Insurers (July 19, 2007) (similar 
to traditional mutual funds, underlying funds charge 12b-1 fees to 
support activities such as promoting underlying funds to prospective 
contract owners, printing underlying fund prospectuses, and training 
and educating agents).
---------------------------------------------------------------------------

    Under our proposed rule changes, underlying funds would be treated 
like other mutual funds. Thus, an underlying fund could charge a 
marketing and service fee up to the NASD sales charge rule limit on 
service fees. Asset-based distribution fees in excess of the marketing 
and service fee would be deemed ongoing sales charges and subject to 
the requirements of the proposed amendments to rule 6c-10. Like other 
mutual funds, in order to impose an ongoing sales charge under proposed 
rule 6c-10(b), an underlying fund (or the insurance company sponsor) 
would have to keep track of share lots attributable to contract owner 
purchase payments, and provide for the automatic conversion of shares 
by the end of the conversion period. We understand that insurance 
company separate accounts may not currently track and age shares 
because they generally do not offer underlying funds with contingent 
deferred sales loads. Under our proposal, insurance companies would 
either have to develop this capability or offer only shares of classes 
that do not impose an ongoing sales charge.\259\
---------------------------------------------------------------------------

    \259\ We discuss this issue as it arises in the context of 
retirement plans in Section III.M.5 of this Release, infra. We 
discuss the potential costs of implementing a conversion feature in 
Section IV of this Release, infra.
---------------------------------------------------------------------------

    We request comment on whether we should treat underlying funds 
differently than other funds.
     Given that most distribution activities occur at the 
separate account-level, is it appropriate to permit underlying funds to 
impose the marketing and service fee or ongoing sales charges? \260\ 
How would these fees be used? Should we limit underlying funds to the 
marketing and service fee? Should we consider some other structure for 
limiting fees charged by underlying funds?
---------------------------------------------------------------------------

    \260\ See, e.g., Comment Letter of JoNell Hermanson (July 9, 
2007) (urging elimination of 12b-1 fees for variable products 
because ``12b-1 fees have become a `shell game' for insurance 
companies and have allowed them to camouflage their profit margin as 
investment management fees.'').
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I. Proposed Amendments to Rule 6c-10: Account-Level Sales Charge

    We are also proposing to amend rule 6c-10 to provide funds with an 
alternative approach to distributing fund shares through dealers if the 
fund so chooses.\261\ Under the proposed

[[Page 47088]]

elective provision, a fund (or a class of the fund) could issue shares 
at net asset value (i.e., without a sales load) and dealers could 
impose their own sales charges based on their own schedules and in 
light of the value investors place on the dealer's services. In effect, 
this exemption would allow the unbundling of the sales charge 
components of distribution from the price of fund shares, similar to 
the existing ETF distribution model. The proposed rule amendment is, 
among other things, designed to provide flexibility to fund 
underwriters and dealers, encourage price competition among dealers 
offering mutual funds and, ultimately, benefit fund investors.
---------------------------------------------------------------------------

    \261\ Proposed rule 6c-10(c).
---------------------------------------------------------------------------

1. Section 22(d): Retail Price Maintenance
    Section 22(d) of the Investment Company Act prohibits mutual funds, 
their principal underwriters, and dealers from selling mutual fund 
shares to the public except at a current public offering price as 
described in their prospectus. Because mutual fund sales loads are part 
of the selling price of the shares,\262\ this provision essentially 
fixes the price at which mutual fund shares may be sold because all 
dealers in a fund's shares must sell shares at the same sales load 
disclosed in the prospectus.\263\ By requiring that all dealers sell 
shares of a particular fund to the public only at uniform prices as 
established by the fund, section 22(d) effectively prohibits 
competition in sales loads on mutual fund shares at the retail 
level.\264\
---------------------------------------------------------------------------

    \262\ See also section 2(a)(35) of the Act (defining ``sales 
load'' to mean ``the difference between the price of a security to 
the public and that portion of the proceeds from its sale which is 
received and invested or held for investment by the issuer (or in 
the case of a unit investment trust, by the depositor or trustee), 
less any portion of such difference deducted for trustee's or 
custodian's fees, insurance premiums, issue taxes, or administrative 
expenses or fees which are not properly chargeable to sales or 
promotional activities'').
    \263\ See Exemption from Section 22(d) to Permit the Sale of 
Redeemable Securities at Prices that Reflect Different Sales Loads, 
Investment Company Act Release No. 13183 (Apr. 22, 1983) [48 FR 
19887 (May 3, 1983)] (``Rule 22d-1 Proposing Release'') (``This 
section effectively prohibits price competition in sales loads on 
mutual fund shares at the retail level.'').
    \264\ By its terms, section 22(d) only applies to principal 
underwriters and dealers in fund shares and does not apply to 
brokers. See United States v. National Ass'n of Sec. Dealers, Inc., 
422 U.S. 694, 715 (1975). The securities laws draw a distinction 
between dealers and brokers. Generally, a dealer buys and sells 
securities for its own account as part of a regular business; a 
broker acts as an agent by matching buy and sell orders between 
other investors. The same intermediary may act as either a broker or 
a dealer, depending upon the transaction. See 15 U.S.C. 78a-3(a)(4), 
(a)(5); 15 U.S.C. 80a-2(a)(6), (a)(11). Although section 22(d) only 
applies to principal underwriters and dealers in fund shares, funds 
also are able to maintain control over their distribution networks 
through share transfer restrictions permitted under section 22(f) of 
the Act. See National Ass'n of Sec. Dealers, Inc., 422 U.S. at 729.
---------------------------------------------------------------------------

    Our rules have provided limited exemptions from this provision, for 
example, by permitting funds to establish ``scheduled variations'' in 
sales loads that allow for volume discounts, although the amount and 
terms of these discounts must be uniform and set forth in their 
prospectuses.\265\ Section 22(d) continues, however, to preclude 
dealers from competing with each other by establishing their own 
pricing schedules or negotiating different terms with their customers. 
Dealers may offer their customers a choice of alternate funds with 
differing sales loads; they may not, however, offer discounts on sales 
loads established by the funds whose shares they sell.
---------------------------------------------------------------------------

    \265\ See rule 22d-1; Exemption from Section 22(d) to Permit the 
Sale of Redeemable Securities at Prices that Reflect Different Sales 
Loads, Investment Company Act Release No. 14390 (Feb. 22, 1985) [50 
FR 7909 (Feb. 27, 1985)]. We have also provided an exemption from 
section 22(d) for certain insurance company separate accounts, and 
in other circumstances. See, e.g., rule 22d-2 under the Act.
---------------------------------------------------------------------------

    In enacting section 22(d) as part of the original Act in 1940, 
Congress gave funds authority to control their distribution to a degree 
denied most commercial enterprises by the federal antitrust laws.\266\ 
The reasons Congress might have had to achieve such a result are 
unclear, due to the paucity of legislative history or other clear 
indications about Congress's intent when it adopted the provision.\267\ 
Section 22(d) has been the subject of considerable debate because it 
tends to restrict rather than foster competition. Some, including 
roundtable participants and commenters, have identified section 22(d) 
as inhibiting competition and contributing to high distribution 
charges.\268\
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    \266\ See the Sherman and Clayton Acts, 15 U.S.C. 1-7; 15 U.S.C. 
12-27; 29 U.S.C. 52, 53. Although such restrictions on price 
competition would normally be a violation of the antitrust laws, 
section 22(d) provides antitrust immunity for such restrictions. See 
National Ass'n of Sec. Dealers, Inc., 422 U.S. at 701 (``* * * Sec.  
22(d) of the Investment Company Act requires broker-dealers to 
maintain a uniform price in sales in this primary market to all 
purchasers except the fund, its underwriter, and other dealers. And 
in view of this express requirement, no question exists that 
antitrust immunity must be afforded these sales.'').
    \267\ See, e.g., Rule 22d-1 Proposing Release, supra note 263 
(``[T]here is relatively little in the Act's legislative history to 
explain the purpose of section 22(d) * * *.'').
    \268\ See, e.g., Comment Letter of the Consumer Federation of 
America, et al., (May 10, 2004) (File No. S7-09-04) (``The reality, 
however, is that while competition flourishes, that competition does 
not necessarily serve to benefit investors. In fact, in the broker-
sold portion of the market, funds compete to be sold, not bought. 
When funds compete to be bought, they compete by offering a good 
product and good service at a reasonable price. When funds compete 
to be sold, they do so by offering generous financial incentives to 
the sales force. Far from benefiting investors, this reverse 
competition tends to drive costs up, not down, and it allows 
mediocre high-cost funds to survive, and even thrive. The primary 
reason investors are being denied the benefits of competition is the 
legal requirement that funds set the compensation that brokers are 
paid for the services that those brokers provide to the 
investor.''); Roundtable Transcript, supra note 109, at 103 (Thomas 
Selman, FINRA) (``One [area in need of revisiting] is 22(d), the 
retail price maintenance provision in the `40 Act, which, for 
example, prohibits a broker-dealer from simply charging its own 
commission for the sale of a fund at NAV, like they would a stock. 
There is no reason, really, why that restriction still should be in 
place.'').
---------------------------------------------------------------------------

    Commenters have suggested a number of rationales for the enactment 
of section 22(d), including: (i) Eliminating certain ``riskless'' 
trading practices by fund insiders; (ii) preserving an orderly 
distribution of mutual fund shares; and (iii) protecting shareholders 
from price discrimination.\269\ Regulatory and marketplace developments 
that have occurred since 1940, however, have addressed the rationales 
that have been attributed to section 22(d). The Commission addressed 
the harms of riskless trading abuse in 1968 when it adopted rule 22c-1, 
which requires the ``forward pricing'' of mutual fund shares.\270\ The 
Supreme Court also found in 1975 that section 22(f) of the Act permits 
funds to manage any secondary market in fund shares and preserve an 
orderly distribution system.\271\ Finally, as we noted in 1983 in 
connection with a rule proposal under section 22(d), the concern of 
unjust price discrimination among purchasers has been substantially 
dispelled by the results achieved from the unfixing of brokerage 
commission rates in 1975 after our adoption of rule 19b-3 under the 
Securities Exchange Act of 1934.\272\ That rule prohibits

[[Page 47089]]

national securities exchanges from requiring members to charge fixed 
brokerage commissions, and market experience after the rule showed that 
commission rates fell into rational patterns that reflect the sales 
costs involved and the services provided.\273\
---------------------------------------------------------------------------

    \269\ See Rule 22d-1 Proposing Release, supra note 263 at text 
accompanying nn.5-8.
    \270\ See id., at section 1.b; Adoption of Rule 22c-1 under the 
Investment Company Act of 1940 Prescribing the Time of Pricing 
Redeemable Securities for Distribution, Redemption, and Repurchase, 
and Amendment of Rule 17a-3(a)(7) under the Securities Exchange Act 
of 1934 Requiring Dealers to Time-Stamp Orders, Investment Company 
Act Release No. 5519 (Oct. 16, 1968) [33 FR 16331 (Nov. 7, 1968)]. 
Rule 22c-1 requires that mutual fund purchases and redemptions be 
executed at the price next computed after receipt of the order. See 
rule 22c-1(a). The execution of transactions at prices previously 
computed (which had been permitted in the past) thus would violate 
rule 22c-1, in addition to other applicable provisions such as anti-
fraud provisions. See, e.g., In the Matter of Charles Schwab & Co., 
Inc., Investment Company Act Release No. 26595 (Sept. 14, 2004) 
(settlement of a case where a broker-dealer permitted certain 
favored clients to submit ``substitute'' mutual fund trades past the 
4 pm fund pricing deadline).
    \271\ See United States v. National Ass'n of Sec. Dealers, Inc., 
422 U.S. 694 (1975).
    \272\ See Rule 22d-1 Proposing Release, supra note 263, at 
section 1.b of Discussion.
    \273\ See id.; Charles M. Jones & Paul J. Seguin, Transaction 
Costs and Price Volatility: Evidence from Commission Deregulation, 
87 Amer. Econ. Rev. 728, 730 (1997) (``Evidence from Commission 
Deregulation'').
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    As discussed in detail below, we are proposing an elective account-
level sales charge alternative that would exempt certain funds from the 
requirements of section 22(d). We are proposing this account-level 
sales charge alternative pursuant to section 6(c) of the Act, which 
provides broad authority for the Commission to exempt any class of 
persons, securities, or transactions from the Act to the extent that 
such an exemption is ``necessary or appropriate in the public interest 
and consistent with the protection of investors and the purposes fairly 
intended by the policy and provisions of this title.'' \274\ For the 
reasons discussed in this section and below, we anticipate that this 
proposed approach would expand the range of distribution models 
available to mutual funds, enhance transparency of costs to investors, 
promote greater price competition, and provide a new alternative means 
for investors to purchase fund shares at potentially lower costs. Thus, 
we believe that the account-level sales charge approach we are 
proposing today would be necessary and appropriate in the public 
interest, and is consistent with the protection of investors and the 
purposes fairly intended by the policy and provisions of the Act.
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    \274\ 15 U.S.C 80a-6(c). In addition to the authority granted us 
by section 6(c), section 22(d)(iii) of the Act provides an exception 
from retail price maintenance for sales made ``in accordance with 
rules and regulations of the Commission made pursuant to subsection 
(b) of section 12.'' We are also proposing the account-level sales 
charge alternative pursuant to our authority in section 22(d)(iii), 
although for ease of reference we have included the proposed 
provision in rule 6c-10.
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2. Account-Level Sales Charges
    Proposed rule 6c-10(c) would permit a fund in certain circumstances 
to offer its shares or a class of its shares at a price other than the 
current public offering price stated in the prospectus. A fund class 
could offer shares to dealers who would then be free to establish and 
collect their own commissions or other types of sales charges to pay 
for distribution. The amount of these fees (and the times at which they 
would be collected) would not be governed by the Act.\275\ Thus, for 
example, this fee could be paid directly by the investor or could be 
charged to the investor's brokerage account, depending on the 
arrangement between the intermediary and investor. The intermediary 
could charge this fee at the time of sale, over time, or upon 
redemption.
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    \275\ Intermediaries registered with FINRA would continue to be 
subject to existing limits on excessive compensation under NASD 
Conduct Rules 2830 and 2440.
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    This type of sales load arrangement would be similar to the 
``externalized sales charge'' concept on which we requested comment in 
2004,\276\ and which was discussed extensively at our 2007 12b-1 
roundtable.\277\ In light of the many concerns raised by commenters, we 
are not proposing to require funds to externalize their distribution 
expenses.\278\ Rather, we propose to make this available as an option 
for funds that so elect. The commissions or fees charged by the dealers 
to their customers could be determined in the same manner as 
commissions and fees charged on other types of financial products.\279\
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    \276\ See 2004 Rule 12b-1 Amendments Proposing Release, supra 
note 107. In particular, we asked comment on one approach of 
refashioning rule 12b-1 to provide that funds deduct distribution 
related costs directly from shareholder accounts rather than from 
fund assets. We received over 1700 comment letters in response to 
the release's request for comment, many of which presented 
alternatives and suggestions that warranted additional review. We 
deferred proposing any further changes at that time. See 2004 Rule 
12b-1 Amendments Adopting Release, supra note 106, at section II.C.
    \277\ See, e.g., Roundtable Transcript, supra note 109, at 103 
(Thomas Selman, FINRA), 157, 165 (John Hill, Putnam Funds), 204-07 
(Richard Phillips, K&L Gates), and 207-13 (Avi Nachmany, Strategic 
Insight; Barbara Roper, Consumer Federation of America).
    \278\ Among other issues, commenters were concerned that 
requiring all funds to externalize their distribution systems would 
result in high transition costs, significant disruptions to current 
distribution systems, higher distribution costs for small investors, 
and adverse tax consequences. See, e.g., Comment Letter of the ICI 
(May 10, 2004) (File No. S7-09-04); Comment Letter of the Financial 
Planning Association (May 10, 2004) (File No. S7-09-04). See also 
Roundtable Transcript, supra note 109, at 207-209 (Avi Nachmany, 
Strategic Insight). But see id. at 207 (Richard Phillips, K&L 
Gates). Some commenters objected to our requiring externalized 
distribution fees because they assumed that externalization would 
force shareholders to liquidate fund shares to pay the fees, which 
would cause investors to realize capital gains (or losses). See, 
e.g., Comment Letter of Terry Curnes (May 3, 2004) (File No. S7-09-
04); Comment Letter of Legg Mason, Inc. (May 10, 2004) (File No. S7-
09-04). In most cases, however, intermediary-sold funds are held in 
accounts that have alternative sources of cash to pay distribution 
fees, e.g., interests in a money market fund, the use of which would 
not result in adverse tax consequences to investors. See Egon 
Guttman, 28 Modern Securities Transfers Sec.  4:15 (3d ed. 2009).
    \279\ The antitrust immunity provided by section 22(d) for the 
fund's other distribution channels, if any, would not be disturbed 
by this proposed exemption. See, e.g., Rule 22d-1 Proposing Release, 
supra note 263 (``Since the proposed rule would exempt investment 
companies, principal underwriters, and dealers only to the extent 
and under such conditions as determined by the Commission to be 
consistent with the protection of investors, in the Commission's 
view, existing antitrust immunity afforded by section 22(d) would 
not be affected by the proposed rule.'').
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    We believe this alternative approach to distribution may be 
attractive to dealers, funds, and fund shareholders. Dealers offering 
an array of funds from different fund groups could sell each fund to 
their customers according to a single price schedule, which could take 
into consideration the volume of transactions with that dealer (rather 
than the size of the purchase of shares of the particular fund), the 
level and type of services provided, and the type of fund offered. 
Currently, investors pay the same costs for distribution when 
purchasing a fund, regardless of the quality or type of services 
provided by a dealer. Under our proposal, if the dealer and the fund 
elect to permit it, investors would be able to choose the level of 
dealer services they want and pay only for their chosen services. 
Investors might, for example, choose low-cost, low-service plans; high-
cost, high-service plans; or something in between that better matches 
their preferences.
    Such an approach could also simplify the operations of the dealer, 
which could process transactions based on a single, uniform fee 
structure. Such a structure could eliminate or reduce the need to 
educate employees (e.g., broker-dealer representatives) on the myriad 
distribution arrangements offered in today's market, and help avoid 
mistakes that may harm customers and expose the dealer to liability 
when employees make errors.\280\ And it could eliminate (or at least 
ameliorate) dealer conflicts

[[Page 47090]]

that may lead them (or their employees) to recommend funds to customers 
based on the amount of the compensation received from selling the 
funds, rather than on the customer's needs.\281\
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    \280\ On occasion, the complexity and variety of sales load 
arrangements has contributed to the failure of some intermediaries 
to provide their customers with the breakpoints to which they were 
entitled. Report of the Joint NASD/Industry Task Force on 
Breakpoints at 7 (July 2003) (http://www.finra.org/web/groups/
rules_regs/documents/rules_regs/p006434.pdf) (``Thus, a broker-
dealer that sells funds offered by multiple mutual fund families 
must understand the aggregation opportunities offered by each fund 
family in order to deliver all appropriate breakpoint discounts to 
its customers. As broker-dealers increase the number of fund 
families whose funds they offer, fulfilling the obligation to 
understand the aggregation opportunities becomes an increasingly 
complex and burdensome task.''). Another example of the difficulties 
that can arise from a multiplicity of differing fund policies and 
fees was brought to our attention when a number of intermediaries 
commenting on the redemption fee rule supported a uniform redemption 
fee as a means of eliminating the complexity associated with these 
fees. See Rule 22c-2 Adopting Release, supra note 103, at text 
following n.93.
    \281\ See, e.g., Report of the Committee on Compensation 
Practices at 7 (Apr. 10, 1995) (http://www.sec.gov/news/studies/
bkrcomp.txt) (``Some product sales or transactions offer much higher 
commission payouts to [registered representatives] than others. 
$10,000 invested in the typical front-end `load' stock mutual fund, 
for instance, produces over twice as much immediate commission 
revenue to the registered representative as an equal amount invested 
in exchange-listed stocks.''). See also Ruth Simon, Why Good Brokers 
Sell Bad Funds, Money, July 1991 (http://money.cnn.com/magazines/
moneymag/moneymag_archive/1991/07/01/86657/index.htm).
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    An externalized fee structure may appeal to some fund groups as 
well, including small funds and new entrants to the market that are 
eager to attract dealers that wish to sell shares based on their own 
fee schedules. Funds that choose to sell their shares only through an 
externalized fee structure could significantly simplify their 
operations and shorten their prospectuses by eliminating the need for 
multiple classes of shares.
    Fund investors may benefit from buying funds through dealers that 
entered into these distribution arrangements in several ways. By 
reducing conflicts for dealers, these arrangements would reduce the 
risk that investors would be placed in funds that are not suitable for 
their particular circumstances. Sales charges would be more transparent 
and could be imposed or deducted in a manner and at a time that is most 
attractive to the investor.\282\ Investors may be able to negotiate 
lower loads with their dealers by, for example, forgoing some of the 
services that they would otherwise pay for with the distribution 
charges, or by engaging in a substantial amount of business with the 
dealer (although not necessarily with the particular fund or fund 
family). Moreover, externalized fee structures may permit investors to 
invest in dealer-sold funds without purchasing associated (and 
unwanted) services. If negotiable account-level sales charges are 
accepted by market participants, increased competition among dealers 
may result in lower overall distribution costs or more attractive 
services for investors.\283\
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    \282\ Some participants in our roundtable identified 
disadvantageous tax consequences as a reason for retaining asset-
based sales charges rather than externalized sales charges. See, 
e.g., Roundtable Transcript, supra note 109, 208-09 (Avi Nachmany, 
Strategic Insight). Under the proposed approach, however, investors 
purchasing through intermediaries could select a method of payment 
that would yield the best after-tax result for them.
    \283\ See Comment Letter of Bridgeway Funds, Inc., and Bridgeway 
Capital Management (July 19, 2007); see also Hannah Glover, Schwab 
Slashes ETF Expenses in Challenge to Vanguard, BlackRock, Ignites 
(June 15, 2010) (noting that ETF distribution model, which similarly 
permits the unbundling of the sales charge components of 
distribution from fund shares, has seen steady decreases in fees and 
commissions).
---------------------------------------------------------------------------

    Externalized fee arrangements are currently used in a number of 
other contexts and thus appear to be operationally feasible. For 
example, separately managed accounts and wrap accounts operate on an 
externalized distribution model.\284\ In each case, at least part of 
the distribution costs is paid out of the assets of the account. As 
discussed above, recent years have seen the growing predominance of 
wrap accounts and other arrangements that entail separate fees paid by 
investors to intermediaries.\285\ Some of the roundtable participants 
expressed concern that current externalized fee arrangements in other 
contexts (e.g. separately managed accounts and wrap accounts) tended to 
have higher rather than lower fees than mutual funds and thus may be 
disadvantageous to smaller investors.\286\
---------------------------------------------------------------------------

    \284\ See, e.g., Roundtable Transcript, supra note 109, at 76-78 
(Martin Byrne, Merrill Lynch).
    \285\ See supra text preceding notes 97 and 98.
    \286\ See, e.g., Roundtable Transcript, supra note 109. at 207-
13 (Avi Nachmany, Strategic Insight; Barbara Roper, Consumer 
Federation of America). See also Comment Letter of the ICI (July 19, 
2007); Comment Letter of Gary Roth (June 13, 2007); Comment Letter 
of Rick Sany (June 13, 2007). But see Comment Letter of Mark 
Freeland (June 19, 2007) (``But why should a mutual fund wrap 
account cost more if it is only providing the same level of service? 
Moreover, if the levels of service are indeed different, couldn't 
advisers create another tier of service for a lower fee, much as 
mutual fund wrap accounts typically charge less than equity wrap 
accounts?'').
---------------------------------------------------------------------------

     Should this be of concern to us as we consider this 
rulemaking? Are those higher charges related to additional services and 
features that these products and accounts provide, and therefore not 
comparable to the externalized sales charge alternative we are 
proposing?
    We request comment on the advantages and disadvantages of allowing 
an externalized alternative distribution model.
     Would fund investors benefit from this distribution model? 
If so, how would they benefit or otherwise be affected? Are there 
significant drawbacks to investors to permitting this distribution 
model and, if so, what are they? What competitive or anti-competitive 
effects could result from such a model? Would our proposed alternative 
distribution model allow investors to effectively choose among dealers 
for the right balance of price and service when buying mutual funds? 
How else might the availability of this distribution model affect 
investor behavior? We are interested in hearing from retirement plan 
administrators and trustees whether this distribution alternative might 
offer the beneficiaries of the plans increased transparency.
     We request comment on whether the availability of a class 
of fund shares that does not carry fixed distribution charges would 
increase competition among dealers and lead to lower sales charges for 
investors. Since 1975, when we abolished fixed brokerage commission 
rates, the cost of brokerage has decreased significantly for both 
institutional and retail brokerage customers.\287\ Could we expect a 
similar result for fund investors if we permit retail price competition 
for at least some classes of shares of mutual funds?
---------------------------------------------------------------------------

    \287\ See, e.g., Evidence from Commission Deregulation, supra 
note 273.
---------------------------------------------------------------------------

     How would other market participants react to our proposed 
exemption? Would fund managers take advantage of this distribution 
model? Would competition among funds for the interest of dealers induce 
fund managers to offer a class of shares permitting dealers to control 
distribution pricing? Would discount broker-dealers begin offering 
funds that had previously been sold only through ``full-service'' 
brokers? Would ``full-service'' broker-dealers begin offering a class 
of the same shares at lower cost to their customers who, for example, 
bought and sold funds without the assistance of their representatives? 
Would dealers view our proposed exemption as providing an alternative 
that would help them reduce complexities and conflicts in selling fund 
shares? Would the exemption help reduce conflicts of interest by 
permitting dealers to eliminate differences in compensation and thus 
encouraging recommendations based solely on the best interests of their 
customers? If many funds rely on the proposed rule, what would be the 
effects on distribution arrangements, and on distributors that do not 
rely upon the rule?
3. Account-Level Sales Charges: Terms of Proposed Rule 6c-10(c)
    The account-level sales charge alternative would be available to 
any fund with respect to all of its shares, or any class of its 
shares.\288\ As we discussed above, the exemption is optional, and 
funds may choose not to take advantage of it and continue to distribute 
their shares only with sales charges established by the fund.
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    \288\ Proposed rule 6c-10(c).
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    In order for a fund to rely on the section 22(d) exemption provided 
in proposed rule 6c-10(c), it would have to

[[Page 47091]]

meet two conditions. First, the fund (with respect to that share class) 
would not be permitted to impose an ongoing sales charge as defined in 
proposed amendments to rule 6c-10.\289\ We are proposing the account-
level sales charge as an alternative to an ongoing sales charge rather 
than as a supplement to it. The fund could, however, charge a marketing 
and service fee pursuant to proposed rule 12b-2.\290\ Second, the fund 
would have to disclose in its registration statement that it has 
elected to rely on the exemption, which would allow interested 
investors the ability to better understand the distribution structure 
of the fund.\291\ A fund relying on proposed rule 6c-10(c) would be 
permitted to use the marketing and service fee to support the fund's 
marketing and sales efforts, including advertising, sales material, and 
call centers, while permitting dealers to collect loads, fees, and 
other account-based charges to support the dealers' sales assistance 
and other services provided to its customers.
---------------------------------------------------------------------------

    \289\ Proposed rule 6c-10(c)(1).
    \290\ See proposed rule 12b-2(b).
    \291\ See proposed rule 6c-10(c)(2). The disclosure would appear 
in the fund's Statement of Additional Information (``SAI''). See 
proposed Item 25(d) of Form N-1A.
---------------------------------------------------------------------------

    We request comment on all aspects of proposed rule 6c-10(c).
     Should we require that each fund class charge a marketing 
and service fee in order to rely on proposed rule 6c-10(c), or should a 
fund instead be able to offer a class of its shares in reliance on rule 
6c-10(c) without charging such a fee? Alternatively, as we have 
proposed, should proposed rule 6c-10(c) be available to all funds, 
regardless of whether they use fund assets to finance distribution 
pursuant to proposed rule 12b-2? We also request comment on the 
condition that the fund class not deduct an ongoing sales charge 
pursuant to proposed rule 6c-10(b). Are there any circumstances under 
which a fund should be permitted to rely on the exemption under 
proposed rule 6c-10(b) and charge an ongoing sales charge under 
proposed rule 6c-10(c)?
     We request specific comment on whether the fund's election 
to rely on proposed rule 6c-10(c) should be disclosed anywhere other 
than the registration statement. We also request comment on where the 
fund's election should appear in the registration statement. As 
proposed, the election would be disclosed in the fund's Statement of 
Additional Information.\292\ Should it appear in the fund's prospectus 
or summary prospectus? Should the fund's board be required to make or 
specifically approve the election?
---------------------------------------------------------------------------

    \292\ Proposed Item 25(d) of Form N-1A.
---------------------------------------------------------------------------

     Are any other conditions appropriate? Should we limit the 
exemption to funds that sell their shares to dealers at net asset 
value? Are there any additional benefits or problems associated with 
proposed rule 6c-10(c)?
     We also request comment on the interaction between 
proposed rule 6c-10(c) and the other amendments we are proposing in 
this Release. For example, if the Commission does not adopt proposed 
rule 12b-2, proposed rule 6c-10(b) or the proposed rescission of rule 
12b-1, should it nevertheless adopt proposed rule 6c-10(c)? Is any of 
the rationale that supports the Commission's adoption of rule 6c-10(c) 
diminished (or augmented) if the Commission does not adopt any of the 
other amendments it is today proposing?

J. Amendments To Improve Disclosure to Investors

    We are proposing several amendments to our disclosure requirements 
to improve the transparency of sales loads and asset-based distribution 
fees. The amendments, which reflect the new approach we are proposing 
with respect to asset-based distribution fees, are designed to improve 
investors' understanding of the distribution related charges they would 
directly and indirectly incur as a result of investing in a fund.
1. Amendments to Form N-1A
    Form N-1A is the registration form used by funds to register with 
the Commission under the Securities Act and the Investment Company Act. 
Item 3 of Form N-1A sets forth the requirements for the prospectus 
``fee table,'' which lists all fund expenses.\293\ Rule 12b-1 fees 
currently are disclosed as a fund operating expense under the heading 
``Distribution [and/or Service] (12b-1) Fees.'' \294\
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    \293\ We recently amended Form N-1A to require key information 
to appear in plain English in a standardized order in mutual fund 
prospectuses, including information about the fund's investment 
objectives and strategies, risks, costs, and performance. In the 
same release, we also amended rule 498 under the Securities Act to 
allow a fund to satisfy its prospectus delivery obligations under 
section 5(b)(2) of the Securities Act by providing the summary 
prospectus, if the full statutory prospectus is available on an 
Internet Web site. See Enhanced Disclosure and New Prospectus for 
Registered Open-End Management Investment Companies, Investment 
Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26, 
2009)] (``Summary Prospectus Adopting Release''). In the proposing 
release for the summary prospectus, we requested comment as to 
whether we should consider other revisions to the headings in the 
fee table to make them more understandable to investors, including 
eliminating the term 12b-1. See Enhanced Disclosure and New 
Prospectus Delivery Option for Registered Open-End Management 
Investment Companies, Investment Company Act Release No. 28064 (Nov. 
21, 2007) [72 FR 67790 (Nov. 30, 2007)] (``Summary Prospectus 
Proposing Release''). However, in the Summary Prospectus Adopting 
Release, we concluded that it was more appropriate to consider these 
changes in the context of a full reconsideration of sales charges 
and rule 12b-1. See Summary Prospectus Adopting Release at text 
accompanying n.126.
    \294\ See Item 3 of Form N-1A.
---------------------------------------------------------------------------

    The reference in the current fee table to ``12b-1 fees'' is not, of 
course, consistent with the new regulatory approach we are proposing 
for asset-based distribution fees. Moreover, the current fee table may 
not present the fee most effectively. Many of our roundtable panelists, 
as well as a number of commenters on our summary prospectus rule, 
agreed that reference to an SEC rule number is not informative.\295\
---------------------------------------------------------------------------

    \295\ See, e.g., Roundtable Transcript, supra note 109, at 106 
(Bob Uek, MFS Funds). See also Comment Letter of The Honorable 
Donald Manzullo (Feb. 28, 2006) (File No. S7-28-07) (``In keeping 
with the idea of simplified disclosures, a preferential way to begin 
would be by re-naming the fees altogether, as the name `12b-1' is 
esoteric, at best.'').
---------------------------------------------------------------------------

    To address these concerns, we are proposing to amend the fee table 
requirements to separate asset-based distribution fees into two 
component fees. Specifically, we propose to delete the current heading, 
and replace it with the heading ``Ongoing Sales Charge,'' which would 
be the ongoing sales charge we are proposing today. This line item 
would continue to appear in the lower portion of the fee table which 
relates to the expenses that shareholders pay indirectly as a result of 
holding an investment in the fund, expressed as a percentage of net 
asset value.\296\ We would also add a new subheading to the ``Other 
Expenses'' category called ``Marketing and Service Fee.'' \297\ Funds 
would include each of these line items in their fee tables only if they 
charge the relevant fee.\298\
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    \296\ The percentage of the maximum front-end and deferred sales 
loads would continue to be presented in the upper part of the fee 
table related to fees that are paid directly by shareholders upon 
entry to or exit from the fund.
    \297\ The fee table currently requires funds to disclose 
separately only two types of operating expenses--management fees 
(the fee paid to the investment adviser) and 12b-1 fees. The rest of 
a fund's operating expenses are included under the caption ``other 
expenses.'' The instructions permit funds to subdivide this caption 
into no more than three sub-captions that identify the largest 
expense or expenses comprising ``other expenses,'' but the fund must 
include a total of all ``other expenses.'' See Instruction 3(c) to 
Item 3 of Form N-1A.
    \298\ Instruction 1(c) to Item 3 of Form N-1A.
---------------------------------------------------------------------------

    The new heading and subheading correspond to our treatment of these 
charges under the new rule and rule

[[Page 47092]]

amendments we are proposing today,\299\ and are designed to more 
clearly describe the fees to investors.\300\ In particular, the 
``Ongoing Sales Charge'' heading should better convey to investors that 
this portion of the asset-based distribution fee operates as a 
substitute for a sales load. When this heading is used in a prospectus 
offering multiple classes with adjacent fee tables, investors may be 
more likely to understand the nature of the alternatives available to 
them. We view greater investor understanding of this fee as an 
important goal of this rulemaking, and expect that it would lead to 
more informed decisions by investors when selecting among funds and 
fund share classes.
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    \299\ See supra Sections III.C and III.D of this Release.
    \300\ A recent opinion issued by the Second Circuit emphasizes 
the importance of accurate description and categorization of fund 
fees to investors. The court noted that the full and accurate 
description of both the amount and use of fees charged by a fund is 
an important part of the ``total mix'' of information in an 
investor's decision to purchase shares. See Operating Local 649 v. 
Smith Barney Fund Management LLC, 595 F.3d 86 (2d Cir. 2010) (``Few 
facts would likely constitute more important ingredients in 
investors' `total mix' of information than the fact that, in 
violation of these disclosure requirements the expenses categorized 
as transfer agent fees were not transfer agent fees at all * * *. 
The importance of the accurate reporting of categories of fees in 
prospectuses is obvious: A ``comparative'' fee table is not useful 
to an investor if the information in the table is incomplete or 
otherwise misleading * * *.'').
---------------------------------------------------------------------------

    Today, some funds may pay for certain services (e.g., sub-
accounting fees to a retirement plan administrator) in the form of a 
``rule 12b-1 fee,'' while others pay for the same service as an 
ordinary fund operating expense and account for the expense as ``other 
expenses'' in the operating expenses portion of the current fee 
table.\301\ Similarly, under our proposed approach, some funds are 
likely to treat expenses for the same service as a ``marketing and 
service fee'' or ``other expenses.'' Different approaches to the same 
fees do not affect the comparability of fund expense ratios, but will 
affect the subcategories of the fee table. Because of the various uses 
and purposes of the charges that may be included as marketing and 
service fees under our proposal, we believe disclosure of this fee 
would fit best as a subheading to the ``other expenses'' category. We 
believe that it is important for investors to know whether a fund 
charges a marketing and service fee, but do not believe it requires its 
own heading in the fee table.
---------------------------------------------------------------------------

    \301\ See Item 3 of Form N-1A.
---------------------------------------------------------------------------

    We request comment on the proposed location for the marketing and 
service fee disclosure in the fee table.
     Does including the marketing and service fee in the 
``other expenses'' category raise any concerns that it may obscure the 
fact that all or a portion of the marketing and service fee is or may 
be used for distribution purposes? If so, would it matter to most 
investors?
     We request comment on the two headings and the names that 
we have proposed for them.\302\ Would they help investors better 
understand the nature of the fees? Are there better names we could use? 
Should we require the disclosure of additional categories of fees? 
Should we require that additional fee information be provided in the 
fee table? For example, should the fee table indicate fees paid 
initially, annually, and upon redemption? Should we also require that 
the conversion period for the ongoing sales charge be included in the 
fee table (or a footnote to the table), to provide investors with an 
immediate reference for how long the fee would be charged?
---------------------------------------------------------------------------

    \302\ The Commission has long sought to find a descriptive term 
that both informs investors and accurately describes the fees 
deducted pursuant to a 12b-1 plan. In 1988, when we began requiring 
funds to disclose certain fee information in the form of a uniform 
fee table, fees deducted pursuant to a 12b-1 plan were simply listed 
as an annual operating expense called ``12b-1 Fees.'' Consolidated 
Disclosure of Mutual Fund Expenses, Investment Company Act Release 
No. 16244 (Feb. 1, 1988) [53 FR 3192 (Feb. 4, 1988)]. This 
description of 12b-1 expenses was criticized as being uninformative, 
and in 1998 we made a number of amendments to Form N-1A, including 
renaming the ``12b-1 Fee'' heading as ``Distribution [and/or 
Service] (12b-1) Fees.'' Registration Form Used by Open-End 
Management Investment Companies, Investment Company Act Release No. 
23064, at text accompanying n.79 (Mar. 13 1998) [63 FR 13916 (Mar. 
23, 1998)]. Similar to the approach we are proposing today, the 
hypothetical illustrative example that was a part of our summary 
prospectus proposal used separate headings (Distribution Fee and 
Service Fee) in the fee table. See Summary Prospectus Proposing 
Release, supra note 293.
---------------------------------------------------------------------------

     We also request comment on our proposed use of the term 
``marketing and service fee.'' Is it too general a term to provide 
useful disclosure to investors? We are proposing this term instead of 
only the term ``service fee'' because funds could use the marketing and 
service fee for different activities than the ``service fee'' defined 
by the NASD, and because we are concerned that use of only the term 
``service fee'' in some circumstances could mislead investors.\303\ 
Should we permit funds that do not use the fees for distribution 
related purposes to use the term ``service fee'' in lieu of ``marketing 
and service fee''? Would such an alternative diminish the comparability 
of fund fee tables and thus their usefulness to investors in comparing 
expenses among different funds? Would a different term, such as ``sales 
and service fee'' or ``distribution and service fee'' be more 
descriptive or informative to investors? \304\
---------------------------------------------------------------------------

    \303\ See supra note 100 and accompanying text.
    \304\ See supra text following note 161.
---------------------------------------------------------------------------

     Finally, we request comment on fee table disclosure of 
asset-based distribution fees charged under existing 12b-1 plans, as 
permitted by proposed rule 12b-2(d).\305\ Should Item 3 continue to 
require disclosure of ``12b-1 fees'' that are charged in the future? 
\306\ Alternatively, should the 12b-1 fees be disclosed as marketing 
and service fees and ongoing sales charges, as appropriate? Should 
another term be used?
---------------------------------------------------------------------------

    \305\ See infra Section III.N.3 (treatment of ``grandfathered'' 
shares).
    \306\ See Item 3 of Form N-1A (requiring disclosure of 
``Distribution [and/or Service] 12b-1 Fees'').
---------------------------------------------------------------------------

    We also propose to amend Item 12(b) of Form N-1A, which currently 
requires funds that have adopted 12b-1 plans to disclose information 
about the operation of the plan in the prospectus.\307\ Because funds 
would no longer be required to have a ``plan,'' we are proposing to 
eliminate this requirement. Instead, we would require funds to disclose 
whether they charge a marketing and service fee or an ongoing sales 
charge and, if they do, to disclose the rates of the fees and the 
purposes for which they are used.\308\ In addition, if the fund deducts 
an asset-based distribution fee for services provided to fund 
investors, it would need to describe the nature and extent of the 
services provided.\309\ We would also require a fund that imposes an 
ongoing sales charge to disclose the number of months (or years) when 
the shares will automatically convert (to another class without the 
charge) and after which the shareholder would cease paying the 
charge.\310\
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    \307\ This disclosure complements the information presented in 
tabular form in the fee table.
    \308\ Proposed Item 12(b) of Form N-1A.
    \309\ Id.
    \310\ For funds that choose the account-level sales charge 
alternative, existing regulatory provisions would generally require 
the delivery of similar information to investors in their 
confirmation statements. See rule 10b-10 under the Exchange Act [17 
CFR 240.10b-10].
---------------------------------------------------------------------------

    We would also require a fund offering multiple classes of shares in 
a single prospectus (each with its own method of paying distribution 
expenses) to describe generally the circumstances under which an 
investment in one class may be more advantageous than another 
class.\311\ We understand investors often face difficulties when 
deciding which share class they should purchase because the advantages 
and disadvantages of each class are not

[[Page 47093]]

always clearly presented in the prospectus.\312\ Although the differing 
fees and terms of each class currently are readily available, the 
actual consequences of the decision to purchase a particular class (in 
terms of overall loads paid, appropriate holding periods, etc.) may not 
be readily apparent. We believe that requiring funds to provide a clear 
description of the situations in which one class may be more 
advantageous than another would reduce shareholder confusion and 
simplify the investment decision making process, and we understand that 
some funds currently provide this type of disclosure.
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    \311\ Proposed Item 12(b)(2) to Form N-1A.
    \312\ FINRA has addressed, on numerous occasions, the 
responsibilities of its members in helping investors understand and 
evaluate the sales structures of different classes of funds. See, 
e.g., Special Notice to Members 95-80 (Sept. 1995) (http://
finra.complinet.com/finra/display/display_
content.html?rbid=1189&element_id=1159003637). See also FINRA, 
Understanding Mutual Fund Classes (Jan. 14, 2003) (http://
www.finra.org/Investors/protectyourself/InvestorAlerts/MutualFunds/
p006022).
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    We request comment on these proposed amendments to Item 12(b).
     Would the disclosure be useful to investors in identifying 
the appropriate class to purchase? Should we provide more specific 
disclosure requirements? If so, what should they be? Would funds have 
difficulties in providing this information?
    We are also proposing to amend Item 19(g) of Form N-1A, which 
currently requires a fund to describe in detail the material aspects of 
its 12b-1 plans and related agreements, in the Statement of Additional 
Information (SAI). Under our proposals, funds would no longer be 
required to have written ``plans'' that are approved by the board of 
directors, and thus much of this item would no longer serve any 
purpose. We therefore propose to eliminate paragraphs 2 through 6 of 
Item 19(g).\313\ Because these items relate to the specific operation 
of a 12b-1 plan that would no longer be required under our proposal, we 
believe that they should be removed.
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    \313\ Item 19(g)(2) requires a fund to disclose the relationship 
between the amounts paid to the distributor under a 12b-1 plan and 
the expenses it incurs. Item 19(g)(3) requires disclosure of any 
unreimbursed expenses incurred by the plan and carried over to 
future years. Item 19(g)(4) requires disclosure of any joint 
distribution activities with another fund and the method of 
allocating distribution costs (any joint arrangement between funds 
that implicates section 17(d) and rule 17d-1 would require the funds 
to apply for and obtain an exemption from the Commission prior to 
implementing the arrangement). Item 19(g)(5) requires disclosure of 
whether any interested person or director has a financial interest 
in the operation of the 12b-1 plan. Item 19(g)(6) requires 
disclosure of the anticipated benefits of the plan to the fund.
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     We request comment as to whether we should retain any of 
these parts of Item 19(g).
    We believe that some of the other information required to be 
disclosed under Item 19(g) may continue to be useful to investors and 
the Commission. In particular, Item 19(g)(1) which includes a list of 
the principal activities paid for under the plan and the dollar amounts 
spent on each activity over the last year as a material aspect of a 
12b-1 plan, may help investors to more clearly understand how the 
asset-based distribution fees they pay are used. We propose to amend 
Item 19(g) to eliminate references to the 12b-1 plan, and instead 
require disclosure of the principal activities paid for through asset-
based distribution fees (both ongoing sales charges and marketing and 
service fees). As proposed, the amendment would not require disclosure 
of dollar amounts.\314\
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    \314\ We do not believe that disclosure of the actual dollar 
amount spent on these activities would be useful to investors 
because that figure would depend primarily on the size of the fund, 
and not the services purchased.
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    We request comment on the proposed amendments to Item 19(g).
     Specifically, we request comment whether we should retain 
the disclosures required by Item 19(g)(1) as it currently exists, 
including the dollar amounts spent on each activity. Our proposal would 
remove this disclosure because we believe that the information is 
unlikely to be important to investors. Should these disclosure 
requirements be eliminated or retained? Should we require funds to 
disclose the percentage of fees spent on each type of activity instead? 
Are there any other activities that are not disclosed in Item 19(g) 
that should be disclosed under our proposal?
    Finally, we propose to: (i) Amend Item 25 of Form N-1A to add a 
paragraph (d) requiring funds electing to rely on the exemption to 
section 22(d) of the Act provided by rule 6c-10(c) to state that the 
fund has made this election; and (ii) eliminate existing Item 28(m) of 
Form N-1A, which requires a registered fund to attach its rule 12b-1 
plan and any related agreements as an exhibit to its registration 
statement. The exhibit would be unnecessary because proposed rule 12b-2 
would not require a written plan, and funds that charge grandfathered 
fees would not be required to have a written plan.\315\
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    \315\ See infra Section III.N.3 for a discussion of 
grandfathering funds and share classes. We also are proposing 
additional conforming, technical changes to other items of Form N-
1A, including: Instruction 3(b) to Item 3; Item 26(b)(4); and Item 
27(d)(1) (and Instruction 2(a)(i) to Item 27(d)(1)). These changes 
are necessary to delete references to rule 12b-1 and rule 12b-1 
plans and add references to rules 12b-2(b) and (d) and to 6c-10(b) 
as the operative rules regarding asset-based distribution fees.
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     We request comment on these proposed changes to Item 25 
and Item 28(m) of Form N-1A.
2. Amendments to Schedule 14A
    Our proposal would require funds to obtain shareholder approval 
before instituting or increasing the rate of marketing and service fees 
deducted from fund assets in existing share classes.\316\ To obtain 
shareholder approval, funds generally have to solicit proxies from 
their shareholders, and those proxy solicitations must include 
sufficient information to allow shareholders to make an informed 
decision. Item 22(d) of Schedule 14A under the Exchange Act \317\ 
requires funds to disclose information regarding any distribution plan 
adopted under rule 12b-1 and the fees paid under the plan when 
soliciting proxy votes for approval of any material change in that 
plan. This disclosure is designed to provide shareholders with relevant 
information regarding the distribution costs of the fund when they are 
voting on issues that impact their investment.\318\ Our proposal would 
eliminate the need for a distribution plan as currently required by 
rule 12b-1, which would make much of the disclosure required in Item 
22(d) of Schedule 14A no longer relevant. Therefore, we propose to 
amend Item 22(d) of Schedule 14A, as well as replace the term 
``distribution plan'' used in Schedule 14A with the new defined term 
``Marketing and Service Fee.'' \319\
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    \316\ Generally, as allowed by rule 12b-1 (and as our proposal 
would allow), most funds institute a marketing and service fee or an 
ongoing sales charge before a fund is offered for sale to the 
public. See rule 12b-1(b)(1); Section III.F of this Release. If a 
fund wishes to institute a new marketing and service fee after a 
public offering, or increase those fees, the fund would be required 
to disclose in the proxy the information discussed in this section 
of the Release. As discussed in Section III.F, funds may not 
increase or impose an ongoing sales charge in a share class of a 
fund after any public offering of the fund's voting shares or the 
sale of such shares to persons who are not organizers of the fund.
    \317\ 17 CFR 240.14a-101.
    \318\ See Amendments to Proxy Rules for Registered Investment 
Companies, Investment Company Act Release No. 19957 (Dec. 16, 1993) 
[58 FR 67720 (Dec. 22, 1993)] at section II.F.
    \319\ Proposed Item 22(a)(iii) of Schedule 14A would define 
``Marketing and Service Fee'' to mean ``a fee deducted from Fund 
assets to finance distribution activities pursuant to rule 12b-
2(b).''
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    Although our proposal would not require a distribution plan, it 
would permit funds to continue to use fund assets for distribution 
related purposes. In addition, it would require fund shareholders to 
approve any institution of, or increase in the rate of, marketing

[[Page 47094]]

and service fees charged by the fund.\320\ In order for fund 
shareholders to make appropriate and informed decisions, we believe 
that shareholders would continue to find information regarding the rate 
of marketing and service fees, the purposes of the fees, the reasons 
for any proposed increase, and the identity of certain affiliated 
recipients relevant to their voting decisions. Thus, we propose to 
leave these disclosures, which are currently required under Item 22(d), 
substantially unchanged.\321\
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    \320\ See proposed rule 12b-2(b)(2).
    \321\ See Item 22(d)(1)-(3) of Schedule 14A; proposed Item 
22(d)(1), (2) of Schedule 14A.
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    Because our proposal would not require any special action by the 
board of directors in approving marketing and service fees, we do not 
believe that information regarding the board of directors' 
consideration of these fees would be relevant to the shareholder voting 
decision. Therefore, we propose to eliminate the disclosure 
requirements in Item 22(d) regarding director involvement in approving 
asset-based distribution fees.\322\
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    \322\ See Item 22(d)(4) of Schedule 14A.
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    We also propose to eliminate the current requirement that funds 
disclose in Item 22(d) the aggregate dollar amount of distribution fees 
paid by the fund in the previous year. When we initially discussed such 
disclosure in 1979, we envisioned that the disclosure of aggregate 
dollar amounts could be useful for shareholders who were being asked to 
renew a 12b-1 plan.\323\ This information may have been useful for 
shareholders who were evaluating whether the expenditure of dollar 
amounts was helpful to address certain problems or circumstances that 
the 12b-1 plan addressed. In light of our current proposal to eliminate 
12b-1 plans, however, and the fact that the aggregate dollar amount of 
marketing and service fees primarily reflects the rate of the fee and 
the size of the fund (information that is readily available elsewhere), 
we believe this information is unlikely to affect a shareholder's 
decision to approve an increase in a marketing and service fee. Thus, 
we propose to eliminate the requirement to disclose information 
regarding asset-based distribution fees in Item 22(d).\324\
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    \323\ See 1979 Proposing Release, supra note 33, at text 
accompanying n.37 (``If shareholders were being asked to vote on the 
renewal of a plan, it would appear appropriate to include as well 
the amount spent by the fund in the previous fiscal year, as a total 
dollar amount and as a percentage of average net assets during that 
period, and the benefits to the fund from such expenditures.'').
    \324\ See Item 22(d)(2)(iii) of Schedule 14A. This information 
will continue to be available to investors in the financial 
statements that are included in annual and semi-annual shareholder 
reports. See Item 27 of Form N-1A (requiring the inclusion of 
financial statements required by Regulation S-X); 17 CFR 210.6-07 
(Regulation S-X requirement that the statement of operations 
separately state management and service fees); proposed amendment to 
17 CFR 210.6-07 (proposed requirement that Regulation S-X require 
the separate statement of ``all fees deducted from fund assets to 
finance distribution activities'' pursuant to rules 12b-2(b), (d) or 
6c-10(b) under the Investment Company Act). In addition, directors 
will continue to review the amounts charged to funds in the course 
of their oversight of fund expenses.
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    We request comment on our proposed changes to Schedule 14A.
     Should we require disclosure of any other aspects of 
marketing and service fees in the proxy statement? Is information about 
the aggregate amount of marketing and service fees collected relevant 
and meaningful to investors? Should we include any requirement for 
disclosure of director involvement in the setting of marketing and 
service fees?
3. Request for Comment on Account Statement Alternative
    The GAO previously suggested that the Commission consider requiring 
funds to disclose in account statements the actual dollar amount of 
fees and expenses that each shareholder directly or indirectly has paid 
as an investor in the fund.\325\ Many commenters argued, however, that 
such an approach would be unduly costly and may not be helpful to 
shareholders.\326\ We believe that our proposed amendments would 
improve transparency of distribution related expenses without requiring 
funds and intermediaries to incur the costs that these commenters have 
asserted are associated with account statement disclosures.\327\
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    \325\ See GAO, Mutual Fund Fees: Additional Disclosure Could 
Encourage Price Competition, supra note 130. See also Roundtable 
Transcript, supra note 109, at 221 (Richard Phillips, K&L Gates) 
(``[I]f you had [disclosure of 12b-1 fees] in dollars and cents 
terms, if you had it in the account statements * * * I think you 
would get a mutual fund investing public that is more sensitive to 
the issue of sales charge. And, over the long run, it would have a 
competitive effect of a more informed investing public.'').
    \326\ See, e.g., Comment Letter of the ICI (July 19, 2007); 
Comment Letter of W. Hardy Callcott (June 18, 2007). However, 
another commenter argued that account statement disclosure could 
provide useful information to shareholders. See Comment Letter of 
Access Data Corp. (July 19, 2007).
    \327\ We note that we have addressed this issue in part by 
requiring that prospectuses include an example of the costs an 
investor would pay on a hypothetical $10,000 investment in the fund. 
See Item 3 of N-1A.
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     Is our assumption correct? Or should we pursue the 
recommendations made by the GAO and require account statement 
disclosure of the actual dollar amount of asset-based distribution 
fees? Would such account statement disclosure be helpful or useful to 
investors? Have technological advances permitted account statement 
disclosure to be provided to investors without undue costs?

K. Proposed Conforming Amendments to Rule 11a-3

    Section 11(a) of the Act requires exchanges between funds to be 
based on the relative net asset values of the shares to be 
exchanged.\328\ Rule 11a-3 provides a conditional exemption permitting 
funds and fund underwriters to charge a sales load on shares acquired 
in certain exchanges between funds within the same fund group. Among 
other things, the rule limits the total combined sales load that may be 
charged on shares that have been subject to an exchange (i.e., all 
sales loads incurred on both the exchanged and acquired shares) to the 
highest sales load rate applicable to those shares (exchanged or 
acquired) in the absence of an exchange.\329\ This provision is 
designed to give shareholders credit for all sales loads paid in 
connection with a purchase of fund shares, regardless of whether the 
sales load was paid with respect to the exchanged or acquired 
shares.\330\
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    \328\ Section 11(a) of the Act makes it unlawful for a fund or 
its principal underwriter to make an exchange offer to the fund's 
shareholders or to shareholders of another fund on any basis other 
than the relative net asset values of the shares to be exchanged, 
unless the terms of the offer are approved by the Commission or 
comply with Commission rules governing exchanges.
    \329\ Rule 11a-3(b)(4).
    \330\ Offers of Exchange Involving Open-End Investment Companies 
and Unit Investment Trusts, Investment Company Act Release No. 
15494, at text following n.28 (Dec. 23, 1986) [51 FR 47260 (Dec. 31, 
1986)].
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    As discussed above, our proposed amendments to rule 6c-10 would 
treat traditional sales loads and the sales charge component of 
existing 12b-1 fees, (i.e., the ongoing sales charge) similarly under 
the Act.\331\ Accordingly, we propose two changes to rule 11a-3 that 
would conform that rule with our general approach.
---------------------------------------------------------------------------

    \331\ See supra note 141 and accompanying text.
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1. Credit for Ongoing Sales Charges Paid
    Paragraph (b)(4) of rule 11a-3 requires that funds, in determining 
any sales load due upon an exchange, give shareholders credit (i.e., 
reduce the amount of sales load charged on the purchase of new shares) 
for their previous payment of sales loads on the shares exchanged, but 
does not require funds to give shareholders credit for the payment of 
any rule 12b-1 fees. In order to ensure that shareholders are credited 
for all sales charges previously paid in connection with a purchase of 
fund

[[Page 47095]]

shares, we propose to amend rule 11a-3(b)(4) to require funds to also 
give shareholders credit for the payment of ongoing sales charges.
    We request comment on our proposed treatment of ongoing sales 
charges in rule 11a-3.
     Are there reasons not to treat a sales load and an ongoing 
sales charge in the same way when determining the amount of sales load 
due upon an exchange? Should we require funds to also give credit for 
any marketing and service fee paid under rule 12b-2 when calculating 
the sales load due upon an exchange? Should we require funds to also 
give credit for any 12b-1 fees previously paid on the exchanged shares? 
If so, should we limit the credit to fees paid in excess of 25 basis 
points (i.e., the asset-based sales charge component of 12b-1 fees)? 
Would our proposed amendments to rule 11a-3 result in significant 
operational difficulties? Is there a simpler or less costly method of 
accomplishing the goal of ensuring that investors receive credit for 
ongoing sales charges during rule 11a-3 exchanges than the approach we 
are proposing?
2. Deferred Sales Loads Upon Exchange
    Rule 11a-3 prohibits funds from imposing a deferred sales load at 
the time of an exchange.\332\ The provision was designed to remove the 
incentive for fund underwriters to induce shareholders to make 
exchanges in order to accelerate its collection of a deferred sales 
load.\333\ Under the rule, a fund may not treat an exchange as a 
redemption for purposes of assessing a deferred sales load, and thus 
may impose a deferred sales load only when the acquired shares are 
ultimately redeemed.\334\ When the deferred load is imposed, the fund 
must determine the amount of the deferred load by ``tacking'' (i.e., 
adding) the time the shareholder held shares of the exchanged fund to 
the time the shareholder held shares of the acquired fund.\335\ 
However, in determining the amount of the deferred load, a fund may 
toll (i.e., exclude) the time the acquired shares are held if a new 
sales load is not charged upon the exchange and credit is given to the 
investor for any 12b-1 fees paid with respect to the acquired 
shares.\336\
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    \332\ Rule 11a-3(b)(3).
    \333\ See Rule 11a-3 Adopting Release, supra note 186, at text 
following n.28.
    \334\ Rule 11a-3(b)(5).
    \335\ Id.
    \336\ Rule 11a-3(b)(5)(i). The rule provides an analogous 
provision for acquired shares that have a CDSL. Rule 11a-
3(b)(5)(ii). The rule recognizes that CDSLs typically are reduced 
over time to reflect amounts paid by investors indirectly through a 
12b-1 plan. We reasoned that ``if a shareholder is making any 
payments for distributions through a 12b-1 plan, those payments 
should be reflected in a commensurate reduction of the CDSL owed, 
[but] * * * tolling would prevent a shareholder from receiving 
credit for the 12b-1 payments made while holding the acquired 
shares. * * *'' See Offers of Exchange Involving Registered Open-End 
Investment Companies and Unit Investment Trusts, Investment Company 
Act Release No. 16504, at text following n.35 (July 29, 1988) [53 FR 
30299 (Aug. 11, 1988)] (revised proposal of rule 11a-3). Thus, rule 
11a-3 permits tolling of the time the acquired shares are held only 
if ``a credit is given to investors for any 12b-1 fees with respect 
to the acquired shares. * * *'' Rule 11a-3 Adopting Release, supra 
note 186, at text accompanying n.35.
---------------------------------------------------------------------------

    We propose to modify the ``tolling'' provision of rule 11a-3 to 
permit funds, in determining the amount of deferred sales load due upon 
ultimate redemption, to provide credit only for the sales charge 
component of any asset-based distribution fee, i.e., the ongoing sales 
charge. Because the marketing and service fee is not considered to be 
an alternative sales charge under our proposal, we would not require 
funds to give credit for such fees when determining the sales load 
payable upon an exchange. In addition, we propose to modify the rule to 
clarify that funds must provide credit for ongoing sales charges in 
terms of the cumulative rate of the ongoing sales charge previously 
paid rather than the amount of fees paid. As discussed previously, we 
understand that funds generally do not have the ability to track dollar 
amounts of 12b-1 fees that are attributable to individual shareholder 
accounts.\337\ In addition, requiring that credit be given in terms of 
rates rather than dollar amounts would make rule 11a-3 consistent with 
the method of calculating maximum sales loads under rule 6c-10(b).\338\
---------------------------------------------------------------------------

    \337\ See supra note 170 and accompanying text.
    \338\ See supra Section III.D.1 of this Release.
---------------------------------------------------------------------------

     Should rule 11a-3 require funds to give shareholders 
credit for the payment of any marketing and service fee when relying on 
the tolling provisions? We request comment on any aspect of our 
proposed changes to rule 11a-3. Should rule 11a-3 operate in terms of 
dollar amounts instead of rates? Would it be difficult or costly for 
funds to comply with the new requirements? Is it difficult or costly 
for funds today to comply with the tolling provisions of rule 11a-3? Is 
our understanding correct that funds generally do not have the ability 
to track dollar amounts of 12b-1 fees? Would it be difficult or costly 
for funds to track these amounts?

L. Other Proposed Conforming Amendments

1. Rule 17a-8
    Rule 17a-8 provides an exemption from section 17(a) of the Act to 
permit mergers of funds with certain of their affiliated persons, 
including other funds (affiliated funds), subject to certain 
conditions.\339\ Among other requirements, the rule requires the board 
of the merging fund to have made certain determinations, the surviving 
fund to keep certain records, and the shareholders of the merging fund 
to approve of the merger.\340\ The rule allows for affiliated funds to 
merge in the absence of a shareholder vote, if, among other conditions, 
the 12b-1 fees of the surviving company are no greater than the 12b-1 
fees of the merging company.\341\ This condition prevents 12b-1 fees 
from being instituted or increased as a result of a merger on which the 
acquired fund's shareholders have not had an opportunity to vote.\342\ 
We propose to preserve this protection by amending rule 17a-8 to 
replace references to rule 12b-1 with references to rule 12b-2(b) or 
(d) and rule 6c-10(b).\343\
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    \339\ ``Affiliated person'' is defined in section 2(a)(3) of the 
Act.
    \340\ See rule 17a-8(a)(2), (a)(5), and (a)(3), respectively.
    \341\ Rule 17a-8(a)(3)(iv).
    \342\ Investment Company Mergers, Investment Company Act Release 
No. 25666 (July 18, 2002) [67 FR 48512 (July 24, 2002)].
    \343\ See proposed amendments to rule 17a-8(a)(3)(iv).
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     We request comment on this proposed revision. Should we 
continue to permit affiliated funds to merge in reliance on this 
provision in light of our new approach to asset-based distribution fees 
and the different role that fund directors would have in overseeing 
these fees under our proposal? Is there another approach we should take 
in amending rule 17a-8 to conform with our proposal?
2. Rule 17d-3
    When the Commission adopted rule 12b-1 in 1980, it also adopted 
rule 17d-3 because a fund's payments for distribution under a rule 12b-
1 plan may involve it in a ``joint enterprise'' with an affiliated 
person that otherwise would be prohibited by section 17(d) of the Act 
and rule 17d-1 unless an application regarding the joint arrangement 
was filed with the Commission and granted by order.\344\

[[Page 47096]]

The rule grants an exemption for funds to enter into agreements with 
certain affiliated persons and the fund's principal underwriter in 
connection with the distribution of its shares, provided that such an 
agreement is in compliance with rule 12b-1, among other 
requirements.\345\
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    \344\ See 1980 Adopting Release, supra note 23, at section 
titled ``Proposed Rule 17d-3'' (rule 17d-3 was adopted in the same 
release as rule 12b-1). Section 17(d) of the Act and rule 17d-1, in 
general, prohibit an investment company from entering into a ``joint 
enterprise or other joint arrangement or profit-sharing plan'' (as 
defined in the rule) with any affiliated person or principal 
underwriter (or their affiliated persons) unless the Commission by 
order grants an exemption before the agreement goes into effect.
    \345\ The Commission stated that prior review and approval as 
required by rule 17d-1 would not be necessary if the safeguards of 
rule 12b-1 have already been applied to the arrangement. 1979 
Proposing Release, supra note 33. The exemption does not extend to 
arrangements for the joint sharing of distribution costs by funds 
that are affiliates (or affiliates of affiliates) of each other 
(e.g., mutual funds in the same fund complex). 1980 Adopting 
Release, supra note 23, at section titled ``Proposed Rule 17d-3.''
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    We believe that under our proposed new rules, funds should continue 
to be afforded the exemption provided by rule 17d-3 with respect to 
distribution payments made to certain affiliated persons and the 
principal underwriter, so long as those payments are consistent with 
the conditions set forth in proposed rule 12b-2 and amended rule 6c-
10.\346\ We therefore propose to revise rule 17d-3(a) to replace the 
reference to 12b-1 with references to rule 12b-2(b), rule 12b-2(d) and 
rule 6c-10(b) in order to permit a fund to enter into an asset-based 
distribution fee arrangement with an affiliated underwriter.\347\
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    \346\ We note that fund boards would continue to review and 
scrutinize arrangements involving asset-based distribution fees and 
ongoing sales charges, as discussed above. See supra section 
III.D.4.
    \347\ See proposed amendments to rule 17d-3(a).
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     We request comment on any aspect of this proposed 
revision. Would the revised role of directors in approving asset-based 
distribution fees under our proposal make this type of exemption less 
warranted? Is there another approach we should take in revising rule 
17d-3 to conform with our proposal?
3. Rule 18f-3
    Rule 18f-3 permits funds to offer multiple classes of fund shares. 
Section (f) of the rule permits funds to convert shares of one class to 
shares of another class after a specified period of time, provided 
that, among other things, the expenses (including 12b-1 fees) charged 
to the converted class are no higher than the expenses of the original 
share class. We believe that, under our proposed amendments, funds 
should continue to be able to convert shares under the same conditions. 
We believe that expenses attributable to proposed rule 12b-2 and 
proposed amendments to rule 6c-10 should be taken into account when 
making these conversions, much like rule 12b-1 expenses are today. We 
therefore propose that rule 18f-3(f)(ii) be amended to delete the 
reference to 12b-1 fees and replace it with references to fees under 
rule 12b-2(b), rule 12b-2(d) and rule 6c-10(b).\348\
---------------------------------------------------------------------------

    \348\ See proposed amendments to rule 18f-3(f)(ii).
---------------------------------------------------------------------------

     We request comment on any aspect of this revision. Is 
there another approach we should take in revising rule 18f-3 to conform 
with our proposal?
4. Forms N-3, N-4, and N-6
    Form N-3 is the registration form used by insurance company 
separate accounts registered as management investment companies that 
offer variable annuity contracts. Instruction 2 to Item 7(a) requires 
separate accounts to disclose, among other things, the principal 
activities for which 12b-1 payments are made and the total amount spent 
under a 12b-1 plan in the most recent fiscal year, as a percentage of 
net assets. We believe that most of the information required to be 
disclosed by Instruction 2 to Item 7(a) would continue to be useful to 
investors and the Commission, and thus we propose to amend Instruction 
2 to Item 7(a) to replace references to rule 12b-1 and 12b-1 plans with 
references to asset-based distribution expenses incurred under rule 
12b-2(b), rule 12b-2(d) and rule 6c-10(b). The proposal would eliminate 
the requirement that registrants disclose the total amount spent in the 
most recent fiscal year (although this information would continue to be 
available in funds' financial statements), and would instead require 
registrants to provide a description of asset-based distribution fees. 
As discussed above, disclosure of the aggregate total of asset-based 
distribution fees may not be helpful to investors because it primarily 
reflects the size of the fund and not the distribution activities that 
are paid for with these amounts.\349\ The proposal would retain the 
requirement that registrants list the principal types of activities for 
which asset-based distribution fees are charged.
---------------------------------------------------------------------------

    \349\ See supra note 323 and accompanying text.
---------------------------------------------------------------------------

    As discussed above, under our proposals funds would not be required 
to have written ``plans'' that are supervised and approved by the board 
of directors. We therefore propose to eliminate paragraphs (ii) and 
(iii) of Item 21(f) because these items relate to the specific 
operation of a 12b-1 plan that would no longer exist under our 
proposal.\350\
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    \350\ Item 21(f)(ii) requires a registrant to disclose whether 
any interested person or director has a financial interest in the 
operation of the 12b-1 plan. Item 21(f)(iii) requires disclosure of 
the anticipated benefits of the plan to the fund.
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     We request comment whether we should retain any of these 
parts of Item 21(f).
    We believe, however, that the information required to be disclosed 
in paragraph (i) of Item 21(f), which requires registrants to disclose 
the manner in which amounts paid by the registrant under a 12b-1 plan 
were spent, would continue to be useful to investors and the 
Commission. This information may be relevant to an investor making an 
investment decision because it discloses the types of services the fund 
(and its investors) may receive in exchange for these fees. We propose 
to amend Item 21(f) to eliminate references to the 12b-1 plan, and 
instead require disclosure of the principal activities paid for through 
asset-based distribution expenses incurred under rule 12b-2(b), rule 
12b-2(d) and rule 6c-10(b). For the reasons discussed above, we also 
propose to amend Instruction 5 to Item 26(b)(ii) \351\ to delete any 
references to 12b-1 plans.\352\ However, registrants would be required 
to provide the same information with respect to expenses and 
reimbursements accrued pursuant to rule 12b-2(b), rule 12b-2(d) and 
rule 6c-10(b).
---------------------------------------------------------------------------

    \351\ Instruction 5 to Item 26(b)(ii) explains how registrants 
should include expenses related to 12b-1 fees in the calculation of 
their performance data.
    \352\ See proposed amendments to Instruction 5 to Item 
26(b)(ii).
---------------------------------------------------------------------------

     We request comment on any aspect of these proposed 
revisions to Form N-3.
    We are also proposing to amend the fee tables in Forms N-4 and N-6, 
the registration forms used by insurance company separate accounts 
registered as unit investment trusts that offer variable annuity 
contracts and variable life insurance contracts, respectively. We 
propose to replace existing references to ``distribution [and/or 
service] (12b-1) fees'' with a new defined term, ``asset-based 
distribution fees.'' We also propose to add new instructions that would 
define the term ``asset-based distribution fee'' as ``all asset-based 
distribution fees paid under rule 12b-2(b), rule 12b-2(d), and rule 6c-
10(b).''
     We request comment on these proposed revisions to Forms N-
4 and N-6.
5. Form N-SAR
    We are proposing to amend the instructions to Form N-SAR, the

[[Page 47097]]

reporting form that is used by mutual funds for filing annual and semi-
annual reports with the Commission.\353\ Form N-SAR currently requires 
funds to answer a series of five questions about their 12b-1 plans in a 
yes/no or fill-in-the-blank format, which provides the Commission 
information regarding the use and amount of 12b-1 fees. The first of 
these questions asks a fund to state whether it has adopted a rule 12b-
1 plan, and if the answer is ``no,'' the fund need not answer the next 
four questions.\354\ Because under our new approach funds would no 
longer be required to have 12b-1 plans, funds would answer ``no'' to 
the first question, and would not be required to respond to the 
remaining four questions. Under the proposed amended instructions, 
funds with share classes subject to a grandfathered 12b-1 plan (as 
discussed in Section N.3 below) would respond ``yes'' to the first 
question, and provide the information required in the remaining 
questions. Funds that do not have grandfathered 12b-1 plans would 
answer ``no'' to the first question, and would not be required to 
respond to the remaining four questions.
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    \353\ Mutual funds that have effective registrations statements 
for their shares under the Securities Act are required to file 
annual and semi-annual reports with the Commission on Form N-SAR 
under section 30(b) of the Act and rule 30b1-1.
    \354\ Item 40 of Form N-SAR.
---------------------------------------------------------------------------

    Although the operation of grandfathered 12b-1 fees would differ in 
certain ways from current 12b-1 fees if the proposal is adopted 
(primarily because there would no longer be board approval of a 12b-1 
plan), those differences should not affect the disclosures required 
under Form N-SAR, and this information could continue to be useful to 
the Commission and investors.
     We request comment on our proposed changes to Form N-SAR. 
Should we delete the Form N-SAR questions related to 12b-1 plans 
entirely and not require funds with grandfathered share classes to 
answer the questions? Or should we amend the questions so that they 
apply not only to funds with a 12b-1 plan, but also to any fund with 
asset-based distribution fees pursuant to our proposed new rule 12b-2 
and amended rule 6c-10? Is there a continuing need for the information 
to be disclosed in the questions related to 12b-1 plans in Form N-SAR 
if our proposal is adopted?
6. Regulation S-X
    Mutual funds must include in their registration statements and 
shareholder reports the financial statements required by Regulation S-
X.\355\ As part of this requirement, mutual funds file a statement of 
operations listing their income and expenses.\356\ Under the expense 
category, funds currently must state separately all amounts paid in 
accordance with a plan adopted under rule 12b-1.\357\ We propose to 
delete the reference to rule 12b-1 and replace it with a requirement 
that funds list separately, in two line items in the statement of 
operations, the portion of this expense that represents marketing and 
service fees under proposed rule 12b-2(b), and the portion of this 
expense that represents ongoing sales charges under proposed amendments 
to rule 6c-10(b) or other fees under rule 12b-2(d).\358\ Multiple-class 
funds would be permitted to disclose the marketing and service fees and 
ongoing sales charges incurred by each class either in the statement of 
operations or in a note to the financial statements, so that investors 
in each class would have an understanding of the expenses paid by their 
particular distribution arrangement. This change is designed to provide 
investors with information about marketing and service fees and ongoing 
sales charges in a fund's financial statements and is consistent with 
the proposed changes to the prospectus fee table.\359\ In addition, 
funds that receive reimbursements relating to distribution would 
continue to report these reimbursements as a negative amount and deduct 
them from current 6c-10(b), 12b-2(b) or (d) expenses in the statement 
of operations.
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    \355\ Item 27 of Form N-1A. Article 6 of Regulation S-X contains 
special rules applicable to the financial statements of registered 
investment companies. 17 CFR 210.6-01 et seq.
    \356\ Rule 6-07 of Regulation S-X contains the requirements for 
an investment company's statement of operations. 17 CFR 210.6-07. 
The statement of operations reports changes in a fund's net assets 
resulting from the amount of net investment income, net realized 
gains and losses on investments, and net unrealized appreciation or 
depreciation of investments.
    \357\ 17 CFR 210.6-07.2(f).
    \358\ Shares subject to grandfathering under proposed rule 12b-
2(d) would continue to list asset-based fees as a single line item, 
as under current practices.
    \359\ See supra Section III.J of this Release.
---------------------------------------------------------------------------

     We request comment on the proposed amendments. Would 
listing ongoing sales charges in the statement of operations help 
investors understand that they are paying a sales charge as part of 
their investment in the fund? Should this information be presented in 
the statement of operations separately for each class of the fund? Is a 
note to the financial statement the appropriate place to provide this 
information? If not, where should we require disclosure of class-
specific information? Should we also require that the conversion period 
for the ongoing sales charge be included in shareholder reports to 
provide investors with a regular reminder and reference for how long 
the fee would be charged?

M. Potential Impact of Proposed Rule Changes

    Our rule proposals are designed to resolve many of the difficulties 
that investors, as well as fund directors, managers, underwriters, and 
intermediaries, have experienced with rule 12b-1 and 12b-1 fees over 
the years. We also recognize that, if adopted, our proposals would 
affect how some fund groups and their distributors conduct business. 
The benefits and potential impacts of the proposed rule changes on 
various market participants, which we summarize below, are also 
discussed further in the Cost-Benefit Analysis contained in Section V 
of this Release.
1. Fund Investors
    Our proposals are designed to make it easier for fund investors to 
understand fund expenses. As a result, investors would be better able 
to select the fund or fund class that offers the combination of costs 
and services that is most advantageous for them. In addition, our 
proposals would provide for equivalent limitations on sales charges for 
shareholders who invest in a fund through a class of shares that 
charges front-end sales loads and those who choose to invest in a class 
of shares that bears an ongoing sales charge. We believe the proposals 
would yield investors two benefits. First, they would protect investors 
from the imposition of excessive sales loads, in furtherance of the 
goals of section 22(b) of the Act,\360\ by limiting the cumulative 
amount of sales charges that an investor could bear directly or 
indirectly.\361\ Second, they would promote a fairer allocation of 
distribution costs among investors who invest through different share 
classes by limiting the extent to which one class of shares (e.g., 
class C shares) may bear these costs. In addition, the proposed rule 
amendments may lead to lower distribution costs if greater retail price 
competition develops.
---------------------------------------------------------------------------

    \360\ See supra note 20.
    \361\ See infra Section III.N.3 (discussing grandfathered share 
classes).
---------------------------------------------------------------------------

    Some investors wrote to us urging the elimination of rule 12b-1 as 
a way of reducing the cost of owning mutual funds.\362\ Although one 
consequence of

[[Page 47098]]

the proposed rule amendments may be to reduce distribution costs, the 
elimination of asset-based sales charges would not eliminate the need 
to compensate fund intermediaries for fund distribution and for the 
other services they provide. Investors who do not want to pay 12b-1 
fees have available to them a range of funds that do not charge these 
fees, although investors in these funds may pay distribution costs 
through other means. In recent years, expenses of funds as a group have 
begun to decline as more investors have sought funds with lower 
expenses, and as index funds and exchange-traded funds have become more 
popular with investors.\363\ We believe that more transparent 
disclosure of fund expenses may help investors to better evaluate 
different fund options. This transparency also may lead to greater 
competition among funds and ultimately downward pressure on fund costs.
---------------------------------------------------------------------------

    \362\ See, e.g., Comment Letter of Melvyn H. Mark (June 17, 
2007); Comment Letter of Jack Thomas (June 19, 2007); Comment Letter 
of Weiwan Ng (June 19, 2007).
    \363\ See, e.g., Fee Trends Report, supra note 22 (discussing 
the decline in expense ratios during the past 20 years, but noting 
that the expense ratios of stock funds and bond funds increased in 
2009).
---------------------------------------------------------------------------

2. Fund Intermediaries and Distributors
    We received comments from a large number of financial planners, 
broker-dealer representatives, and brokerage firm managers who 
expressed concern that the ``trail commissions'' or ``service fees'' 
they receive from the proceeds of 12b-1 fees might be cut off as a 
result of this rulemaking, and they could no longer provide ongoing 
services to their customers.\364\ These proposals should address these 
concerns.\365\ Approximately 80 percent of fund assets that are subject 
to 12b-1 fees are charged 12b-1 fees of 25 basis points or less. They 
therefore would not be subject to the portion of our rule proposals 
related to ongoing sales charges.\366\
---------------------------------------------------------------------------

    \364\ See, e.g., Comment Letter of Jill Shannon (Aug. 6, 2007); 
Comment Letter of Bernard Smit (Oct. 9, 2007); Comment Letter of 
Eric Connors (June 19, 2007)). See also Comment Letter Type A and 
Comment Letter Type B.
    \365\ But see supra notes 100 and 168 of this Release.
    \366\ According to industry statistics derived from Lipper's 
LANA Database analyzed by our staff, funds that charge 12b-1 fees 
have aggregate assets of $4.86 trillion, which we assume is the 
source of payments for trail commissions or services fees (or a 
combination) to intermediaries. 12b-1 fees of 25 basis points or 
less are charged on approximately 82 percent of these assets ($4.0 
trillion).
---------------------------------------------------------------------------

    Intermediaries that may be affected by our proposed rules are 
primarily broker-dealers that currently receive payments from the sale 
of classes of fund shares that pay 12b-1 fees that exceed 25 basis 
points (e.g., class C shares). Under our rule proposals, funds could 
continue to pay broker-dealers 12b-1 fees at previously approved levels 
for grandfathered shares.\367\ For shares issued after the compliance 
date, fund underwriters would likely reduce the stream of payments when 
the shares convert to a class that pays no more than 25 basis points of 
asset-based distribution expenses (e.g., class A shares) or else find a 
different source of revenue to fund the payments. The amount of time 
before conversion would depend on the amount of sales load charged on 
the class A shares, i.e., the reference load, and the rate of the 
ongoing sales charge (the amount of asset-based distribution fees that 
exceeds 25 basis points). Thus, for example, if a fund offers class A 
shares with a 5.25 percent front-end load and class C shares with an 
ongoing sales charge of 75 basis points, then the class C shares would 
have to convert no later than seven years from the time of 
purchase.\368\ This consequence flows from the premise (discussed 
above) that amounts paid by funds in excess of the marketing and 
service fee are charged as an alternative to sales loads, and thus are 
properly limited by the NASD sales load caps.
---------------------------------------------------------------------------

    \367\ See infra Section III.N of this Release.
    \368\ We calculated the length of the conversion period by 
dividing the rate of the front-end load (5.25%) by the rate of the 
ongoing sales charge (0.75%).
---------------------------------------------------------------------------

    Some commenters and roundtable participants described ``level 
load'' classes of shares as providing for an alternative to front-end 
or spread-load arrangements, and thus acknowledged them as a form of 
sales load designed to support distribution of fund shares.\369\ 
Others, however, have asserted that the 12b-1 fees associated with 
level load funds (often 100 basis points) pay for valuable ongoing 
investment advice provided by the intermediary, and are an alternative 
to mutual fund wrap fee programs, which often charge a 100 basis point 
(or greater) wrap fee.\370\ The use of fund assets to finance personal 
advisory services (rather than support fund distribution), however, 
raises issues regarding whether those advisory services provided by an 
intermediary to a customer years after the sale ought to be payable 
from fund assets. Such expenditures arguably do not relate to the 
operation of the fund or to the distribution of its shares.
---------------------------------------------------------------------------

    \369\ See, e.g., Roundtable Transcript, supra note 109, at 198-
99 (Richard Phillips, K&L Gates) (``I think you have got to separate 
the 25 basis point service fee from the 75 basis point sales 
compensation fee, or broker's compensation fee. * * * The 75 basis 
point substitute for the front-end load * * * is pure sales 
compensation.'').
    \370\ See, e.g., Comment Letter of Gregory A. Keil (June 1, 
2007) (``The current `Class C' share is really the next step toward 
a more `advice driven' model * * * removing a `transaction cost' 
from the equation--and applying an ``always-on'' Advisory Fee to a 
DISCRETIONARY investment vehicle--the mutual fund. * * *''); Comment 
Letter of Daryl Nitkowski (July 19, 2007) (``In fact, I believe the 
typical 1% fee charged on class C shares represents the best option 
for clients who want continuing advice, but do not want to have a 
fee based account.'').
---------------------------------------------------------------------------

     We request comment on these matters. Are asset-based 
distribution fees associated with level load share classes an efficient 
means to pay for ongoing investment advice?
    With respect to level load share class arrangements, roundtable 
panelists and commenters raised questions regarding the applicability 
of the Investment Advisers Act of 1940 (``Advisers Act'') \371\ to 
intermediaries that receive those ongoing fees.\372\
---------------------------------------------------------------------------

    \371\ 15 U.S.C. 80b.
    \372\ Intermediaries that are broker-dealers are excluded from 
the definition of investment adviser under the Advisers Act with 
respect to advice they provide that is ``solely incidental to the 
conduct of [their] business as a broker or dealer'' and for which 
they receive ``no special compensation.'' Section 202(a)(11)(C) of 
the Advisers Act [15 U.S.C. 80b-2(a)(11)(C)]. Some commenters 
asserted that broker-dealers receiving 12b-1 fees are ineligible for 
this exclusion. See, e.g., Comment Letter of Ron A. Rhoades (June 
18, 2007) (``It is clear from various comments recently submitted by 
broker-dealer firm registered representatives, as well as * * * 
industry representatives and the ICI, that 12b-1 fees are being 
utilized as `special compensation' for advice which is ongoing * * * 
and which clearly cannot be considered incidental to the mutual fund 
sales transaction * * *. I would submit that the payment of 12b-1 
fees for such purposes violates the Investment Advisers Act, when 
such fees are paid in connection with brokerage (not investment 
advisory) accounts.''); Comment Letter of Harold Evensky (June 26, 
2007). See also Roundtable Transcript, supra note 109, at 203 
(Barbara Roper) (``The other thing I would just like to point out, 
having listened to today's discussion, this advice we're getting 
doesn't sound remotely like anything I would call solely incidental 
to product sales. And these fees sound a lot like special 
compensation for advice.''). See also Beagan Wilcox Volz, Class 
Action Firm Mounts Legal Attack on 12b-1 Fees, Ignites (Apr. 9, 
2010) (discussing recent lawsuits alleging that broker-dealers may 
not properly receive 12b-1 fees without registration as investment 
advisers).
---------------------------------------------------------------------------

     We request comment on these matters, and whether the 
conversion provisions of our proposed rules would appropriately address 
them by requiring a nexus between the sale of a share of a mutual fund 
and the amount of ongoing sales charges an intermediary's customer pays 
through the fund.
    Finally, we note that our proposed relaxation of restrictions on 
retail price competition could provide fund intermediaries with greater 
control over the pricing of fund shares sold to their customers by 
permitting intermediaries to establish their own sales loads 
specifically tailored for their customers. This may result in greater 
competition

[[Page 47099]]

among intermediaries and in particular may impact smaller broker-
dealers that lack the distribution capacity and negotiating ability of 
larger broker-dealers. However, some smaller broker-dealers may use 
this alternative to create new pricing structures that permit them to 
better compete with larger broker-dealers.
     We request comment on the likely effects on competition 
that may result from our proposal, including the effects with regard to 
smaller broker-dealers.
3. Fund Managers and Principal Underwriters
    Our proposals would largely preserve existing distribution 
arrangements, and should provide fund managers, directors, etc., with 
greater legal certainty regarding many distribution financing practices 
that have developed over the years.\373\ In this regard, our proposals 
would respond to the many calls we have received from mutual fund 
managers and others to revise rule 12b-1 in a way that recognizes that 
12b-1 fees are today a substitute for sales loads, and to eliminate the 
procedural requirements of the rule that they view as outdated.\374\
---------------------------------------------------------------------------

    \373\ One of the uncertainties involves whether fund boards can 
appropriately approve continuation of 12b-1 fees for funds that are 
no longer selling shares. See Standard & Poor's, Closed Funds and 
12b-1 Fees (Aug. 2008) (http://www2.standardandpoors.com/spf/pdf/
index/concept_12B1-Fess&ClosedFunds.pdf) (the existence of 12b-1 
fees in funds closed to new investments may seem ``counter-
intuitive,'' but may be appropriate when viewed as a substitute for 
a sales load).
    \374\ See supra Section II.E.
---------------------------------------------------------------------------

    Today's proposals are designed to address the criticism of funds 
and fund managers expressed by investors, the academic community, and 
the financial press who argue that rule 12b-1 fees may not collectively 
benefit fund shareholders because they do not produce economies of 
scale and, in fact, operate to increase fund expense ratios.\375\ We 
anticipate that the proposed rules, if adopted, would shift the focus 
from whether fund expenses are increased by a 12b-1 fee to whether the 
sales charges imposed by a particular fund are appropriate in light of 
the services provided by the intermediary. This is the issue we believe 
investors should be exploring before they decide to invest in a fund 
and pay sales charges.
---------------------------------------------------------------------------

    \375\ See, e.g., Haslem, supra note 108; William Dukes et al., 
Mutual Fund Mortality, 12b-1 Fees, and the Net Expense Ratio, 29 J. 
Fin. Res. 235 (2006); Charles Trzcinka & Robert Zweig, An Economic 
Analysis of the Cost and Benefits of SEC Rule 12b-1, Monograph 
Series in Finance and Economics 67 (Leonard N. Stern School of 
Business, NYU) (1990). See also William P. Dukes & James B. Wilcox, 
The Difference Between Application and Interpretation of the Law as 
It Applies to SEC Rule 12b-1 Under the Investment Company Act of 
1940, 27 New Eng. L. Rev. 9 (1992).
---------------------------------------------------------------------------

4. Small Fund Groups
    Some fund and broker-dealer industry participants expressed concern 
about the possible effects of changes to rule 12b-1 on smaller fund 
groups. Several asserted that use of fund assets to pay for 
distribution has played an important role in permitting smaller fund 
groups to compete with larger fund groups for the attention of 
intermediaries by permitting them to access a wide array of 
distribution networks.\376\ Of particular importance to small funds is 
their continued ability to use fund assets to pay for participation in 
fund supermarkets,\377\ which are an important means by which investors 
find smaller fund groups.\378\ A number of studies of the role of 
brokers and fund supermarkets in selling shares of mutual funds offered 
by smaller fund groups appear to support these assertions.\379\
---------------------------------------------------------------------------

    \376\ See, e.g., Roundtable Transcript, supra note 109, at 67-68 
(Mellody Hobson, Ariel Capital Management). See also Comment Letter 
of Thornburg Investment Management (July 19, 2007) (``[L]arge 
brokerage firms have increasingly become more open to using funds 
managed by independent advisors, rather than relying entirely on in-
house managed products'' because of compensation from 12b-1 fees); 
Comment Letter of the Securities Industry and Financial Markets 
Association (July 19, 2007) (``[A]vailability of 12b-1 fees makes 
smaller funds more attractive to larger intermediaries, and 
correspondingly smaller intermediaries, that do not enjoy the same 
economies of scale as larger ones, are able to support and offer a 
broader choice of funds for their clients''); Comment Letter of the 
ICI (July 19, 2007) (``[T]he ability of small funds to assess asset-
based distribution fees has enabled these funds to remain 
competitive by allowing them to gain access to a wider array of 
distribution channels * * *'').
    \377\ See supra note 96.
    \378\ See Comment Letter of Charles Schwab & Co., Inc. (July 16, 
2007) (``Repeal of rule 12b-1 would undoubtedly restrict a fund's 
ability to rely on supermarkets and their superior infrastructure, 
and, in particular, we believe it would have a disproportionate 
impact on smaller and new funds that lack the resources outside of 
fund assets to pay for shareholder servicing.'').
    \379\ Conrad S. Ciccotello et al., Supermarket Distribution and 
Brand Recognition of Open-End Mutual Funds, 16 Fin. Servs. Rev. 309 
(Winter 2007) (http://findarticles.com/p/articles/mi_qa3743/is_
200701/ai_n25499878) (fund families that are focused and smaller in 
size are more likely to rely on fund supermarkets for distribution); 
Xinge Zhao, The Role of Brokers and Financial Advisors Behind 
Investments Into Load Funds (August 2003) (http://ssrn.com/
abstract=438700) (brokers and financial advisors are more likely 
than self-directed investors to allocate investment dollars to 
smaller funds).
---------------------------------------------------------------------------

    In developing our proposals, we have considered their potential 
effect on smaller fund groups. A representative of a smaller fund group 
participated in our roundtable discussion, and our staff met with 
representatives from other small fund groups to listen to their 
concerns and explore ways in which we might address them.
    We believe that our proposal reflects consideration of the concerns 
small fund groups shared with us, and would preserve their ability to 
compete with larger fund groups. Based on an analysis of data collected 
from the Lipper LANA Database by our staff, we estimated that 
approximately 108 ``small fund groups,'' offered 189 classes of fund 
shares to the public.\380\ Our analysis found that of these classes, 
166 (88 percent) either charged no 12b-1 fee or charged a 12b-1 fee of 
25 basis points or less.\381\ The remaining 23 classes (12 percent), 
under our proposal, would be required to comply with the limits on 
ongoing sales charges, reduce their distribution expenditures, or 
otherwise change their distribution arrangements. Alternatively, as 
discussed above, where non-distribution related expenses are now paid 
under 12b-1 plans, many funds may be able to allocate that portion of 
their existing 12b-1 fees to administrative expenses, and thus ensure 
that their asset-based distribution expenses fall within the limits of 
the 25 basis points marketing and service fee.\382\
---------------------------------------------------------------------------

    \380\ We are using, for purposes of our estimates, the 
definition of ``small business'' or ``small entity'' that we use for 
purposes of the Regulatory Flexibility Act [5 U.S.C. 601, et seq.]. 
Rule 0-10 under the Act defines a ``small entity'' for purposes of 
the Act as a group of related management companies (funds) that has 
net assets of $50 million or less as of the end of its most recent 
fiscal year.
    \381\ 111 classes (59 percent) do not have a 12b-1 plan in 
effect.
    \382\ See supra Section III.C of this Release. See also 
Roundtable Transcript, supra note 109, at 89 (Mellody Hobson, Ariel 
Capital Management) (explaining that Ariel funds may treat 15 basis 
points of a 40 basis point fund supermarket fee as a sub-transfer 
agent fee.).
---------------------------------------------------------------------------

    Only 11 of the small fund groups (6 percent) offered class C 
shares, and fund assets attributable to these classes amounted to only 
$60 million of assets (0.2 percent of small fund group assets). Based 
on this data, we do not believe that our proposals would require many 
small funds to restructure their fund classes.\383\
---------------------------------------------------------------------------

    \383\ Our staff also evaluated the potential impact of our 
proposal on somewhat larger fund groups--those with less than $250 
million of assets under management--and obtained similar results. 
This group consisted of 191 fund groups that offered 497 share 
classes. Of these classes, 397 (79.9 percent) carried no 12b-1 fee 
or a fee of 25 basis points or less. Only 22 of the 191 fund groups 
offered class C shares (11.5 percent), with total assets of 
approximately $400 million (3.5 percent of the assets of these fund 
groups). See also Section V.B of this Release.
---------------------------------------------------------------------------

     We request comment on the impact of our proposals on small 
fund groups. In particular, we request comment on the competitive 
impact of our rule proposals on smaller fund groups. Is

[[Page 47100]]

this data correct? Should our rules treat small fund groups differently 
than larger fund groups?
5. Retirement Plans
    Many investors invest in mutual funds through tax-advantaged 
retirement plans, such as 401(k) plans.\384\ Some of these funds use 
fund assets to compensate plan administrators for services provided to 
plans and plan participants, including recordkeeping, sub-accounting, 
transaction processing, account maintenance services, and participant 
education.\385\ Many of these payments essentially reimburse plan 
administrators for costs they incurred to provide services (such as 
shareholder recordkeeping) that typically funds would have to bear as 
operational expenses for direct accounts.\386\ Other payments, in whole 
or in part, may be distribution related, and thus many funds today make 
them to plan administrators and financial intermediaries pursuant to a 
rule 12b-1 plan.\387\ Different funds take different approaches to 
paying these expenses. Some funds may specifically identify operational 
costs and pay them outside of rule 12b-1.\388\ Other funds might, for 
convenience, use 12b-1 fees to pay all of these expenses to avoid the 
need to determine exactly which of the expenses contribute to fund 
distribution.\389\
---------------------------------------------------------------------------

    \384\ According to data compiled by the ICI, 36 percent of long-
term mutual fund assets were held in tax-advantaged retirement plans 
as of the end of 2009. See 2010 ICI Fact Book, supra note 6, at 112.
    \385\ See Comment Letter of The Spark Institute, Inc. (July 17, 
2007).
    \386\ See Roundtable Transcript, supra note 109, at 79 (Charles 
P. Nelson, Great-West Retirement Services).
    \387\ See Deloitte Consulting LLP, Inside the Structure of 
Defined Contribution/401(k) Plan Fees: A Study Assessing the 
Mechanics of What Drives the `All-In' Fee (Spring 2009--updated June 
2009) (conducted by Deloitte Consulting LLP for the ICI) (http://
www.ici.org/pdf/rpt_09_dc_401k_fee_study.pdf) (noting portions 
of the distribution fee may be used to compensate financial 
intermediaries and service providers for services provided to the 
plan and its participants and to offset recordkeeping and 
administration costs). To the extent that plan administrators 
receive these fees as compensation for the sale of fund shares, 
broker-dealer registration may be required unless an exemption is 
available. See supra note 168. As discussed previously, broker-
dealer registration would be required if a plan administrator 
received the proceeds of an ``ongoing sales charge'' under the 
proposal.
    \388\ See Thomas P. Lemke & Gerald T. Lins, Mutual Funds Sales 
Practices Sec.  5:1 (Aug. 2009) (noting that third-party services in 
retirement plans may be paid by employer subsidies, direct charges 
to employees, or fees included in mutual fund expenses, such as rule 
12b-1 fees and service fees).
    \389\ See Paul G. Haaga, Jr. & Michele Y. Yang, Practicing Law 
Institute, Distribution of Mutual Fund Shares: Rule 12b-1, Corporate 
Law and Practice Course Handbook Series (June 1998) (indicating that 
rule 12b-1 fees may cover things that are not purely ``sales'' or 
``distribution'' and pointing out that many fund groups subsidize 
the cost of 401(k) recordkeeping).
---------------------------------------------------------------------------

    According to the Investment Company Institute, retirement plan 
assets are typically invested in low cost funds.\390\ Approximately 80 
percent of 401(k) plan assets are held in mutual fund share classes 
that pay no 12b-1 fees or 12b-1 fees of 25 basis points or less.\391\ 
If our proposals are adopted, we would therefore expect that funds 
could continue to make the payments from the proceeds of the marketing 
and service fee.
---------------------------------------------------------------------------

    \390\ See ICI, The Economics of Providing 401(k) Plans: 
Services, Fees and Expenses, 2008 (Aug. 2009) (http://www.ici.org/
pdf/fm-v18n6.pdf).
    \391\ See id. at 9.
---------------------------------------------------------------------------

    Some funds with higher 12b-1 fees may identify a portion of those 
expenditures as not distribution related and treat them accordingly, 
and may thus be able to reduce their distribution related payments so 
that they do not exceed the limits of the marketing and service fee. As 
a result, these funds would not be subject to the ongoing sales charge 
limits discussed above. Other funds, however, may be required by our 
rule proposals to treat a portion of their 12b-1 fee as an ongoing 
sales charge and provide for a conversion period. We understand that 
many plan administrators currently do not track and age shares both 
because plan beneficiaries do not pay taxes on capital gains realized 
on sales of shares in retirement plans and because many (or most) plans 
do not offer share classes that impose CDSLs.\392\ Plan administrators 
would have to either develop this capability, which most other 
intermediaries have, or offer only classes of shares that do not impose 
an ongoing sales charge, i.e., classes of shares that carry an asset-
based distribution fee of only 25 basis points or less.\393\
---------------------------------------------------------------------------

    \392\ See Comment Letter of Charles P. Nelson (June 19, 2007) 
(``B and C shares usually aren't used by group retirement plan 
platforms due to the back-end loads that are assessed, which cause 
recordkeeping problems at the participant level.''). Some retirement 
plans do, however, invest in share classes that require the tracking 
of share lots. See The Economics of Providing 401(k) Plans: 
Services, Fees, and Expenses, supra note 390 at Appendix (the ICI 
estimates that approximately one percent of 401(k) assets invested 
in mutual funds are invested in class B shares). We also understand 
that in light of rule 22c-2, some plan administrators now track the 
holding periods of fund shares to ensure that redemption fees are 
properly assessed.
    \393\ This issue is also raised in the context of insurance 
company separate accounts, as discussed in Section III.H of this 
Release, supra. We discuss the potential costs of implementing a 
conversion feature in Section V of this Release, infra.
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    A small number of funds today issue a class of shares created 
especially for retirement plans, often called ``R shares.'' R type 
shares typically carry a 12b-1 fee of 50 to 100 basis points that 
generates sufficient revenue to pay for a substantial amount of plan 
expenses. The Commission staff estimates that less than two percent of 
plan assets are invested in R shares.\394\ Treating amounts deducted in 
excess of 25 basis points as an ongoing sales charge and eventually 
converting these shares may not be a viable option for retirement plans 
with R share classes because plan expenses are ongoing. Thus, our 
proposal would likely make R shares a less attractive investment option 
for plans to offer.
---------------------------------------------------------------------------

    \394\ The staff's estimate is based in part on information 
obtained from Lipper's LANA Database.
---------------------------------------------------------------------------

    We request comment on the potential consequences of our rule 
proposals on R shares, and whether investors would be harmed.\395\ We 
also note that public policy, as embodied in the securities laws we 
administer and the laws administered by other agencies, favors 
transparency of expenses.\396\
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    \395\ We believe that our proposal will complement disclosure 
initiatives proposed by the Department of Labor (``DOL''), which 
were designed to ensure that retirement plan participants and 
beneficiaries could make informed investment decisions about their 
retirement savings. Fiduciary Requirements for Disclosure in 
Participant-Directed Individual Account Plans, 73 FR 43014 (July 23, 
2008). The proposed DOL regulation would require, among other 
things, enhanced disclosure of the fees and expenses of certain 
retirement plans and their investment options. Id.
    \396\ See, e.g., Employee Retirement Income Security Act of 1974 
(29 U.S.C. 1001, et seq.); U.S. Dept. of Labor, Reasonable Contract 
or Arrangement Under Section 408(b)(2)--Fee Disclosure (Dec. 7, 
2007) [72 FR 70988, 70995 (Dec. 13, 2007)]. See also U.S. Dept. of 
Labor, Reasonable Contract or Arrangement Under Section 408(b)(2)--
Fee Disclosure (July 6, 2010) [75 FR 41600 (July 16, 2010)] (interim 
final rule).
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     Do R share classes subsidize significant plan expenses or 
obscure plan costs by bundling them with mutual fund costs? Are R 
shares most attractive to plan sponsors that either are unable or 
choose not to bear plan expenses as an employee benefit? Does this tend 
to obscure that plan participants are paying the costs themselves 
through their investments? Do payments to plan administrators from the 
proceeds of 12b-1 fees on R shares pay for services that may not be 
exclusively attributable to the funds in which those assets are 
invested? If so, then are fund assets potentially being used to pay for 
services to non-fund investors (i.e., not for exclusive benefit of fund 
investors)? \397\
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    \397\ We understand that representatives from the fund industry 
have asserted that because the plan rather than plan participants is 
the legal owner of the fund shares, the use of plan assets will 
exclusively benefit the fund shareholder. This reliance on legal 
ownership is, however, inconsistent with the justifications given 
for the use of fund assets to pay for sub-accounting, transfer 
agency and other plan expenses. If the plan is the owner for purpose 
of this analysis, then only the cost of effecting plan transactions 
and maintaining records (and not transactions of plan beneficiaries) 
would be legitimate fund expenses.

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[[Page 47101]]

N. Transition

    If we adopt the rule and amendments we are proposing today, we 
expect to provide for a transition period in order to minimize 
disruption and costs to funds, fund shareholders, and those who 
participate in the distribution of fund shares.
1. Effective Date
    We would expect to provide for an effective date within 60 days of 
issuing a release adopting the proposed amendments, which would permit 
(but not require) funds to take advantage of the new rules quickly.
     We request comment on the effective date.
2. Compliance Period
    We would anticipate providing a compliance period of at least 18 
months after the effective date in the adopting release for funds to 
come into compliance with rule 12b-2, amended rule 6c-10, and the other 
amendments, for new shares sold. Although we want to provide fund 
shareholders with the benefits we believe will be afforded by the rule 
amendments as soon as possible, we are sensitive to the operational 
consequences of the changes we are proposing, and the potential 
complexities of altering existing fund distribution arrangements. We 
believe a period of 18 months should be sufficient for funds and fund 
managers to make the necessary changes to their operating systems, 
distribution and other agreements, and registration statements.
     We request comment on the length of the compliance period, 
particularly in light of the ``grandfathering'' provisions we describe 
below.
3. Grandfathering
a. Grandfathered Classes and Shares
    Five-year grandfathering period. Under our proposal, funds would be 
required to comply with the changes discussed above with respect to all 
shares issued after the compliance date of the new rules. We would 
provide a five-year grandfathering period after the compliance date for 
share classes issued prior to the compliance date, and that deduct fees 
pursuant to rule 12b-1 as it exists today, after which those shares 
would be required to be converted or exchanged into a class that does 
not deduct an ongoing sales charge.\398\ New sales would not be 
permitted in grandfathered share classes after the compliance date of 
the new rules.\399\
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    \398\ Proposed rule 12b-2(d).
    \399\ Dividends or other distributions on the old shares, 
however, could be reinvested in the same share class as the shares 
on which the dividend or distribution was declared. These 
investments are not considered ``sales'' of securities for purpose 
of the Securities Act and this grandfathering provision. See 
Interpretation of the Division of Corporation Finance Relating to 
Dividend Reinvestment and Similar Plans, Securities Act Release No. 
5515 (July 22, 1974), 4 SEC Docket 623 (Aug. 6, 1974).
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    We are proposing this five-year grandfathering period so that 
investors, including those in classes currently subject to rule 12b-1 
plans, would benefit from the protections provided by the proposed new 
rules. The grandfathering period is also designed to avoid 
unnecessarily disrupting existing distribution arrangements under which 
fund underwriters may have advanced commissions to pay dealers who have 
sold fund shares, and who may depend upon cash flow from existing rule 
12b-1 fees. The five-year grandfathering period would provide time for 
funds and dealers to revisit and revise existing arrangements to 
reflect the approach to asset-based distribution fees we are proposing 
today. This period could allow the existing 12b-1 classes to wind down 
in an orderly manner. The five-year period is designed to allow 
sufficient time for funds and their boards to institute any necessary 
conversion or exchange procedures, and prepare to transition all 
remaining assets out of grandfathered 12b-1 classes.
    We request comment on the proposed grandfathering period for the 
transition of existing shares into shares that comply with any new 
rules we adopt.
     Does this approach make sense in light of the compelling 
need for the regulatory changes we have discussed in this Release? 
Should we not provide a grandfathering period and instead require 
compliance immediately? Should we provide a shorter or longer period 
than five years (e.g., one, three, eight, or ten years)? Instead of a 
five-year grandfathering period, should we permit the grandfathering of 
12b-1 share classes to continue indefinitely?
     Should the proposed grandfathering period apply only to 
certain types of classes, such as ``level load'' share classes, and not 
apply to other classes, permitting them to convert on their own 
schedules? What benefits might result from such an approach? Should the 
proposed grandfathering period apply only to classes that charge a 
certain level of 12b-1 fees (e.g., 12b-1 fees greater than 50 or 75 
basis points)?
    Alternative transition approaches. We also request comment on 
alternative approaches to carrying out the transition of existing share 
classes into classes that comply with any new rules we adopt.
     Should we adopt a ``sunset'' provision requiring that, by 
a certain date in the future, all share classes that do not conform to 
the new rules must be converted or exchanged into share classes that do 
conform to the new rule? Should we require, in connection with this 
approach, that shares in an existing fund class that are charged 12b-1 
fees at a certain rate per annum be converted or exchanged into shares 
of a class that are charged a total of marketing and service fees and 
ongoing sales charges at the same or lower rate per annum? For example, 
under this approach, shares in an existing class that are currently 
charged a 12b-1 fee of 100 basis points would have to be converted or 
exchanged into a class that charges a marketing and service fee of no 
more than 25 basis points, and an ongoing sales charge of no more than 
75 basis points for a limited time period. Should such an approach also 
take into account the existence of contingent deferred sales loads in 
existing classes or classes into which shareholders may be converted or 
exchanged?
     In addition, if we were to adopt this approach, when 
should we require that all fund shares be converted or exchanged into 
shares that comply with the new rules? By the compliance date of the 
rules (i.e., 18 months), or within a shorter period (e.g., six months 
or one year) or longer period (e.g., two, three, five or seven years) 
of time? Should we exclude from the sunset provision any shares (such 
as certain B shares) that by their terms already convert automatically 
into shares with no ongoing sales charge?
     We request comment whether certain share classes would 
encounter special difficulty in complying with the proposed five-year 
transition period. For example, R share classes (which often charge a 
50 basis point asset-based distribution fee for an indefinite period) 
may not be designed to convert to another class, and are often 
structured to pay certain costs that might otherwise be paid by the 
plan provider or the plan participants. If these classes are required 
to transition into a class that does not charge an ongoing sales charge 
after five years, this may result in a situation in which fees used to 
pay for these services may no longer be available. However, as 
discussed previously, this situation could also arise after the 
conversion period of an ongoing sales charge R

[[Page 47102]]

share class under our proposal.\400\ Does the proposed grandfathering 
period pose any special issues for certain share classes? If so what 
type of issues, and how should we deal with them? Should we exempt any 
funds or share classes from the requirement to eventually end existing 
12b-1 share classes? Should we provide different grandfathering periods 
for different funds or classes? If so, how should we identify and 
define those funds or classes?
---------------------------------------------------------------------------

    \400\ See supra Section III.M.5.
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     Should we take another approach to dealing with the 
problem of old 12b-1 share classes other than grandfathering or a 
sunset provision, and if so what should that approach require? Should 
we instead require funds to make special exchange offers to 
shareholders of old classes?
    Funds could comply with the new rules by adding a conversion 
feature to newly issued shares. These funds would disclose in their 
prospectuses that shares issued before a specified date (the compliance 
date or earlier) will not convert on the same schedule as new shares 
would convert.
     Would this approach confuse shareholders? If so, should we 
require that shares offered under the new rules be issued in a separate 
class from grandfathered shares?
b. Operation of Grandfathered Classes
    During the grandfathering period, under proposed rule 12b-2(d), 
funds could continue to charge 12b-1 fees on grandfathered share 
classes at the same (or lower) rate as was approved in the fund's 12b-1 
plan.\401\ A fund that wants to increase the rate of distribution fees, 
as a result, would have to comply with the proposed new rules. Because 
the level of fees charged on old share classes could not be increased, 
we do not believe any investor protection purpose would be served by 
requiring these funds to continue to have a formal 12b-1 plan, if we 
adopt these proposed rules. Thus, directors could eliminate mandatory 
provisions of 12b-1 plans that require board annual approval, quarterly 
reports, and allow for board or shareholder termination of plans.\402\ 
Directors would continue to exercise responsibility over the 12b-1 
plans in accordance with their general oversight responsibilities. In 
addition, pursuant to their broad authority, directors could terminate 
the plan at any time.
---------------------------------------------------------------------------

    \401\ Proposed rule 12b-2(d)(2).
    \402\ Proposed rule 12b-2(d)(1).
---------------------------------------------------------------------------

    After the expiration of the proposed grandfathering period, 
grandfathered shares would be required to be converted or exchanged 
into a class of shares that does not charge an ongoing sales charge. We 
are concerned that permitting the deduction of an ongoing sales charge 
on grandfathered fund shares could continue to result in shareholders 
overpaying for distribution. In addition, it may lead to operational 
and administrative difficulties in identifying the asset-based 
distribution fees that the shareholders may have already paid and 
providing proper credit for these fees. Not permitting the deduction of 
ongoing sales charges on grandfathered shares that have been exchanged 
or converted is likely to reduce investor confusion and provides equal 
treatment to investors.
    Because under both rule 12b-1 and our proposal a shareholder vote 
is required to materially increase the rate of a 12b-1 fee, we would 
also require that the marketing and service fee of the class that the 
grandfathered shares are exchanged or converted into not be higher than 
the 12b-1 fee charged on the shares in the last fiscal year. This is 
designed to ensure that shareholders are not transitioned into a class 
that charges higher asset-based distribution fees than they agreed to 
when they originally bought the fund.
    We request comment on any aspect of the proposed grandfathering 
provision.
     Should we require that directors continue to have 
specific, annual approval duties pursuant to existing rule 12b-1 until 
those fees are no longer collected? Should the rule provide further 
flexibility in addition to what we propose? We request comment on how 
grandfathered 12b-1 fees should be presented in the prospectus fee 
table. Should classes with grandfathered 12b-1 fees be required to 
separate and label their distribution fees just as they would under our 
proposed amendment to the fee table (i.e., by assigning the first 25 
basis points charged as a marketing and service fee and the remainder 
as an ongoing sales charge)? Is there another label for grandfathered 
12b-1 fees that would be descriptive without a reference to ``12b-1''?
     Instead of providing requirements regarding which class 
grandfathered shares would need to be transitioned into after the 
expiration of the grandfathering period, should we instead leave the 
decision to the discretion of the board? If so, should we provide any 
guidance to the board, and what should that guidance provide? For 
example, should we require that the board take into account the length 
of time that the grandfathered shares have already paid 12b-1 fees, the 
rate of the ongoing sales charge that might be charged, the technical 
capabilities of the fund and its service providers, or other factors?
4. Shareholder Voting
    For funds that decide to convert current 12b-1 share classes to 
conform with the proposed rules, proposed rule 12b-2 would prohibit a 
fund from instituting a marketing and service fee unless the fee has 
been approved by a vote of at least a majority of outstanding voting 
securities.\403\ A shareholder vote would not be required if the fund: 
(i) Currently deducts from fund assets annual 12b-1 fees of 25 basis 
points or less, and does not increase the rate of the fee; or (ii) 
reduces the amount of the 12b-1 fees it currently deducts to an annual 
rate of 25 basis points or less, and renames the 12b-1 fee a 
``marketing and service fee.'' We understand that approximately two-
thirds of fund classes either do not deduct a 12b-1 fee, or deduct a 
12b-1 fee of 25 basis points or less annually. The proposed rule also 
would not require funds that currently impose a 12b-1 fee to obtain 
shareholder approval if the combined ongoing sales charge and marketing 
and service fee would not exceed amounts that could be deducted under a 
12b-1 plan in effect at the time the proposed amendments, if adopted, 
become effective. In those instances, funds only would be required to 
separate the 12b-1 fee into a marketing and service fee and an ongoing 
sales charge, and treat each fee in conformity with the new rule and 
rule amendments.
---------------------------------------------------------------------------

    \403\ See proposed rule 12b-2(b)(3).
---------------------------------------------------------------------------

    We believe that, in the circumstances described above, a 
shareholder vote would serve no useful purpose because shareholders 
have already implicitly approved the fee, and a shareholder vote would 
thus impose unnecessary costs on funds and their shareholders.
     We request comment on whether a shareholder vote would 
serve any purpose in either of these situations.

IV. Paperwork Reduction Act

    Certain provisions of our proposal would result in new or altered 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').\404\ The Commission is 
therefore submitting proposed rule 12b-2 and proposed amendments to 
rule 6c-10 and Form N-SAR under the Act; proposed amendments to Forms 
N-1A and N-3 under the Act and the Securities Act; and proposed 
amendments to Schedule 14A and rule 10b-10 under the Exchange Act to 
the Office of Management and Budget (``OMB'') for

[[Page 47103]]

review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. 
Responses to the collection of information requirements of our 
proposals would not be kept confidential.
---------------------------------------------------------------------------

    \404\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    The proposed amendments to rule 6c-10 would result in a new 
collection of information requirement within the meaning of the PRA. 
The title for the collection of information requirement is ``Rule 6c-10 
under the Investment Company Act of 1940, `Exemptions for Certain Open-
End Management Investment Companies to Impose Deferred Sales Loads and 
Other Sales Charges.' '' If adopted, this collection would not be 
mandatory, but would be required in order for a fund to deduct asset-
based distribution fees in excess of the proposed limits in rule 12b-2.
    Proposed rule 12b-2 would result in a new collection of information 
requirement within the meaning of the PRA. The title for the collection 
of information requirement is ``Rule 12b-2 under the Investment Company 
Act of 1940, `Investment Company Distribution Fees.' '' If adopted, 
this collection would not be mandatory, but would be required in order 
for funds to deduct certain asset-based distribution fees. In addition, 
our proposal would rescind rule 12b-1 and its associated collection of 
information requirement. We are submitting to OMB the proposed 
rescission of rule 12b-1's collection of information requirement.
    The Commission is also proposing amendments to existing collection 
of information requirements titled ``Form N-1A under the Investment 
Company Act of 1940 and Securities Act of 1933, `Registration Statement 
of Open-End Management Companies.' '' Compliance with the disclosure 
requirements of Form N-1A is mandatory. The Commission is also 
proposing amendments to existing collection of information requirements 
titled ``Form N-3 under the Investment Company Act of 1940 and 
Securities Act of 1933, `Registration Statement of Separate Accounts 
Registered as Management Investment Companies.' '' Compliance with the 
disclosure requirements of Form N-3 is mandatory. The Commission is 
also proposing amendments to existing collection of information 
requirements titled ``Form N-SAR under the Investment Company Act of 
1940, `Semi-Annual Report for Registered Investment Companies.' '' 
Compliance with the disclosure requirements of Form N-SAR is mandatory. 
The Commission is further proposing amendments to existing collection 
of information requirements titled ``Regulation 14A under the 
Securities Exchange Act of 1934 and the Investment Company Act of 1940, 
`Commission Rules 14a-1 through 14a-16 and Schedule 14A.'' Compliance 
with the disclosure requirements of Regulation 14A is mandatory. The 
Commission is also proposing amendments to existing collection of 
information requirements titled ``Rule 10b-10.'' Compliance with the 
disclosure requirements of rule 10b-10 is mandatory.
    Finally, the Commission is also proposing a number of technical and 
conforming amendments that would not amend the existing collection of 
information burdens for rules 11a-3, 17a-8, 17d-3, and 18f-3 under the 
Investment Company Act, and Forms N-4 and N-6, and Regulation S-X under 
the Securities Act and the Investment Company Act. These technical and 
conforming amendments would not constitute new or altered collections 
of information because they would not alter the legal requirements of 
these rules and forms.\405\ We estimate that the approved burdens for 
these rules and forms would not change if our proposal is adopted.
---------------------------------------------------------------------------

    \405\ As discussed in the cost-benefit analysis in Section V of 
this Release, infra, we have estimated that complying with these 
amended rules and forms would take the same amount of time and cost 
the same amount of money as complying with the existing rules and 
forms, with the exception of rule 11a-3. The additional costs that 
the staff has estimated that funds may incur as a result of our 
proposed amendments to rule 11a-3 are not related to collections of 
information in the rule (certain disclosure, recordkeeping, and 
notice requirements), but are instead a result of system changes 
that funds may undertake. As a result, we do not expect that these 
proposed technical and conforming rule and form amendments would 
change existing approved collection of information burdens for any 
of these rules and forms.
---------------------------------------------------------------------------

    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid control number. OMB has not yet assigned control 
numbers to the new collections for proposed rule 12b-2 and amended rule 
6c-10. The approved collection of information associated with Form N-
1A, which would be revised by the proposed amendments, displays control 
number 3235-0307. The approved collection of information associated 
with Form N-SAR, which would be revised by the proposed amendments, 
displays control number 3235-0330. The approved collection of 
information associated with Form N-3, which would be revised by the 
proposed amendments, displays control number 3235-0316. The approved 
collection of information associated with Schedule 14A, which would be 
revised by the proposed amendments, displays control number 3235-0059. 
The approved collection of information associated with rule 10b-10, 
which would be revised by the proposed amendments, displays control 
number 3235-0444.

A. Rule 6c-10

    Proposed rule 6c-10(c) would give funds and their underwriters the 
option of offering classes of shares that could be sold by dealers 
subject to competition in establishing sales charge rates. A fund could 
rely on this provision if it discloses its election on Form N-1A. This 
disclosure would be a collection of information within the meaning of 
the PRA. The collection of information for rule 6c-10(c), however, is 
incorporated into the total collection of information burden for our 
amendments to Form N-1A, discussed below. As a result, the collection 
of information burden for proposed rule 6c-10(c) is not a separate 
collection of information within the meaning of the PRA.

B. Rescission of Rule 12b-1

    We are proposing to rescind rule 12b-1. If adopted, the rescission 
would eliminate the current collection of information requirement for 
rule 12b-1 in its entirety. Therefore, there would no longer be a 
collection of information burden for rule 12b-1.

C. Rule 12b-2

    Proposed rule 12b-2(b) would permit funds to deduct a ``marketing 
and service fee'' from fund assets that is limited to the maximum rate 
permitted by NASD Conduct Rule 2830 for ``service fees.'' In order to 
institute or increase the rate of a marketing and service fee after the 
initial public sale of class shares, proposed rule 12b-2(b)(3) would 
require a fund to obtain approval from a majority of the class's 
shareholders. As under proposed rule 6c-10(b)(3), funds would obtain 
shareholder approval by soliciting proxies from shareholders, which 
would be a collection of information under the PRA on Schedule 14A 
under the Exchange Act. As noted above, Schedule 14A has an approved 
collection of information which our proposed amendments would change. 
As a result, the collection of information burden for proposed rule 
12b-2(b)(3) is not a separate collection of information, but is 
incorporated into the estimated paperwork burden for Schedule 14A.
    Proposed rule 12b-2(c) would maintain the restrictions in current 
rule 12b-1(h) that prohibit funds from using brokerage commissions to 
finance distribution. Among other things, proposed rule 12b-2(c) would 
maintain

[[Page 47104]]

the requirement that a fund (and its board of directors) approve 
policies and procedures designed to prevent: (i) The persons 
responsible for selecting brokers and dealers to effect the fund's 
portfolio securities transactions from taking into account the brokers' 
and dealers' promotion or sale of shares issued by the fund or any 
other registered investment company; and (ii) the fund, or any 
investment adviser or principal underwriter of the fund, from entering 
into any agreement or other understanding under which the fund directs 
portfolio securities transactions to a broker or dealer to pay for the 
distribution of fund shares. The requirement to adopt these policies 
and procedures would be a collection of information under the PRA, and 
would be mandatory in order to direct brokerage transactions to a 
broker or dealer that distributes fund shares. The Commission has 
determined that these collections of information would continue to be 
necessary to protect against the inappropriate use of fund assets to 
finance distribution, and would continue to be used by the Commission 
and its examination staff to monitor these activities.
    As discussed in the most recent PRA update to rule 12b-1, we 
understand that funds (if they intend to pay brokerage commissions to 
brokers and dealers who distribute their shares) generally adopt these 
policies and procedures when the fund is created, and incur any burden 
associated with this collection of information at that time. We assume 
that all funds that are currently operating have already adopted these 
policies and procedures (if relevant), and therefore only new funds 
that begin to operate in the future will incur this burden. As 
previously estimated in the most recent update to the rule 12b-1 PRA, 
the staff estimates that approximately 300 new funds would begin 
operations annually that would comply with proposed rule 12b-2(c) and 
adopt these policies and procedures. Based on information received 
during conversations with fund representatives, the staff estimates 
that adopting these policies and procedures would take a total of 
approximately 1 hour of the board of directors' time as a whole, at an 
internal time cost equivalent rate of $4500 per hour.\406\ The staff 
further estimates that preparing these policies and procedures for 
adoption would take approximately 3 hours of internal fund counsel 
time, at an internal time cost equivalent rate of $316 per hour.\407\ 
Finally, the staff estimates that it would cost funds approximately 
$800 in outside counsel time (2 hours multiplied by an estimated $400 
per hour for outside counsel time)\408\ to adopt these policies and 
procedures.
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    \406\ The staff has estimated the average cost of board of 
director time as $4500 per hour for the board as a whole, based on 
information received from funds, intermediaries, and their counsel.
    \407\ The staff estimates that the internal time cost equivalent 
for time spent by internal counsel is $316 per hour. This estimate, 
as well as all other internal time cost estimates made in this 
analysis (unless otherwise noted) is derived from SIFMA's Management 
& Professional Earnings in the Securities Industry 2009, modified by 
Commission staff to account for an 1800-hour work-year and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead or from SIFMA's Office Salaries in the 
Securities Industry 2009, modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 2.93 to account for 
bonuses, firm size, employee benefits and overhead.
    \408\ The staff has estimated the average cost of outside 
counsel as $400 per hour based on information received from funds, 
intermediaries, and their counsel.
---------------------------------------------------------------------------

    Therefore, the collection of information related to adopting 
directed brokerage policies and procedures pursuant to proposed rule 
12b-2(c) would require a total annual burden of 300 hours of director 
time (at a total internal time cost equivalent of $1,350,000),\409\ 900 
hours of inside counsel time (at a total internal time cost equivalent 
of $284,400),\410\ and $240,000 in outside counsel expenses.\411\ The 
total annual number of respondents would be 300, the total number of 
responses would also be 300, and the annual burden per respondent would 
be 4 hours and $800 in costs.
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    \409\ This estimate is based on the following calculations: (1 
hour of directors time x 300 newly formed funds = 300 hours); (300 
hours x $4500 per hour = $1,350,000).
    \410\ This estimate is based on the following calculation: (3 
hours of inside counsel time x 300 newly formed funds = 900 hours); 
(900 hours x $316 per hour = $284,400).
    \411\ This estimate is based on the following calculation: ($800 
cost of outside counsel time x 300 newly formed funds = $240,000).
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     We request comment on these estimates and assumptions. If 
commenters believe these estimates and assumptions are not accurate, we 
request they provide specific data that would allow us to make a more 
accurate estimate.

D. Form N-1A

    Form N-1A is the form that funds use to register with the 
Commission under the Investment Company Act and to offer their shares 
under the Securities Act.\412\ As discussed previously, the proposed 
amendments would require funds that file Form N-1A to: (i) Eliminate 
the line item currently titled ``Distribution and/or Service (12b-1) 
Fee'' and include two new line items (as relevant) titled ``Marketing 
and Service Fee'' and ``Ongoing Sales Charge;'' (ii) revise prospectus 
narrative disclosure on asset-based distribution fees; and (iii) revise 
the SAI disclosure regarding asset-based distribution fees. The 
Commission believes that these changes in the collection of information 
should better enable fund investors to understand the purpose and use 
of the asset-based distribution fees that they may pay. These changes 
will be used to better monitor and oversee the use of asset-based 
distribution fees by funds, and assist investors in obtaining 
information about the use of fund assets. Preparing Form N-1A is a 
collection of information under the PRA and is mandatory.
---------------------------------------------------------------------------

    \412\ There are two types of Form N-1A filings: (i) Initial 
filings; and (ii) annual post-effective amendments. Funds usually 
incur significantly more time and incur greater costs when first 
registering a fund under their initial N-1A filings than when filing 
their annual post-effective updates. Therefore, we separately 
estimate the burden for each type of filing.
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1. New Defined Term
    The proposed amendments would add the defined term ``Asset-Based 
Distribution Fee'' to the general instructions of Form N-1A.\413\ This 
term would be used in other parts of our proposed amendments to the 
form. The additional definition would not affect the form's collection 
of information requirements and therefore would not change current 
paperwork burden estimates.
---------------------------------------------------------------------------

    \413\ The proposal would define an ``Asset-Based Distribution 
Fee'' as ``a fee deducted from Fund assets to finance distribution 
activities pursuant to rule 12b-2(b) (``Marketing and Service 
Fee''), rule 12b-2(d), or rule 6c-10(b) (``Ongoing Sales 
Charge'').'' Proposed General Instructions to Form N-1A.
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2. Revised Fee Table
    The proposed amendments would require funds, in the fee table of 
Form N-1A, to replace the current line item titled ``Distribution and/
or Service (12b-1) Fees'' with two line items titled ``Marketing and 
Service Fee'' and ``Ongoing Sales Charge,'' as relevant. Only funds 
that charge asset-based distribution fees would be affected by these 
proposed amendments. Funds would be able to refer to the same 
information about asset-based distribution fees that they use to 
complete the 12b-1 line item currently in the fee table. All 
information necessary to disclose these fees in the fee table would be 
readily available, and the staff estimates that funds would not require 
any additional resources to disclose the fees on two lines, instead of 
one. Therefore, the staff estimates that

[[Page 47105]]

funds would not incur any additional hourly burdens or costs to 
complete the fee table as we propose to amend it. As a result, the 
staff estimates that the proposed amendments to the fee table would not 
change the collection of information currently approved by OMB to 
complete the fee table in Form N-1A, either initially or when 
submitting a post-effective amendment.
     We request comment on these assumptions. If commenters 
believe these assumptions are not accurate, we request they provide 
specific data that would allow us to make a more accurate estimate.
3. Prospectus Revisions
    The proposal would amend Item 12(b) of Form N-1A, which currently 
requires funds that have adopted 12b-1 plans to disclose information 
about the operation of the plan in the prospectus. The proposal would 
eliminate this requirement, and instead require funds to disclose 
whether they charge a marketing and service fee or an ongoing sales 
charge, and if they do, to disclose the rate of the fees and the 
purposes for which they are used. A fund that imposes an ongoing sales 
charge would be required to disclose the number of months (or years) 
before the shares would automatically convert to another class without 
an ongoing sales charge. In addition, we would require a fund offering 
multiple classes of shares in a single prospectus (each with its own 
method of paying distribution expenses) to describe generally the 
circumstances under which an investment in one class may be more 
advantageous than an investment in another class.
    Based on information received during conversations with fund 
representatives, the staff estimates that funds filing initial Form N-
1A registrations would expend approximately the same amount of time and 
costs to provide the narrative prospectus disclosure on asset-based 
distribution fees under our proposal as they expend under the current 
disclosure requirements.
    The proposed amendments would also require funds that deduct asset-
based distribution fees to revise their narrative prospectus disclosure 
in post-effective amendments. The staff further estimates that the 
funds would need to incur a one-time cost and time expenditure to 
revise and update existing narrative prospectus disclosure to comply 
with the proposal. After this one-time revision and update is complete, 
the staff estimates that ongoing costs and time expenditures would 
remain the same as current estimates because we expect the revised 
disclosures to be of similar length and complexity as the previous 
disclosure. The staff expects that the revised narrative prospectus 
disclosure would be similar in length to the current narrative, and 
thus would not change the number of pages in the prospectus or change 
printing costs of the prospectus.\414\ The staff estimates that funds 
would use outside legal resources to prepare this one-time amendment to 
reflect the proposed new framework. The staff expects that all funds in 
a fund family would engage in this one-time update at the same time, 
and therefore the costs for revising a series prospectus would be 
shared among all funds in the family, thereby reducing the cost for 
each post-effective update filer. Based on an analysis of data received 
on Form N-SAR and information received from fund representatives, the 
staff estimates that there are approximately 379 fund families that may 
be affected by this proposed change. The staff further estimates that, 
on average, each of these fund families would incur approximately $2000 
in one-time costs (for outside legal counsel drafting and review) and 
expend 10 hours in internal personnel time (at an internal time cost 
equivalent rate of $316 per hour) to revise item 12(b) of Form N-1A to 
comply with the proposed changes. The staff therefore estimates that 
funds will incur a one-time burden of 3710 hours (at an internal cost 
equivalent of $1,197,640) and $758,000 in outside costs associated with 
this proposed revision to Item 12(b) of Form N-1A.\415\ The staff 
estimates that the proposed amendments would not change the ongoing 
currently approved collection of information for Item 12(b) of Form N-
1A.
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    \414\ Based on conversations with fund representatives, the 
staff understands that, in general, unless the page count of a 
prospectus is changed by at least 4 pages, the printing costs would 
remain the same.
    \415\ These estimates are based on the following calculations: 
(379 x 10 hours = 3790 hours); (3790 hours x $316 per hour = 
$1,197,640); (379 x $2000 = $758,000).
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     We request comment on these estimates and assumptions. If 
commenters believe these estimates and assumptions are not accurate, we 
request they provide specific data that would allow us to make a more 
accurate estimate.
4. Statement of Additional Information
    The proposal would amend a number of items contained in the SAI 
portion of Form N-1A. Item 19(g) currently requires funds to describe 
in detail the material aspects of their 12b-1 plans, and related 
agreements, in the SAI. Under the proposal, 12b-1 plans would no longer 
be required, and grandfathered funds would no longer be required to 
have written ``plans'' that are supervised and approved by the board of 
directors; therefore, the proposal would eliminate paragraphs 2 through 
6 of Item 19(g).\416\ However, Item 19(g)(1) (which requires disclosure 
of the material aspects of a 12b-1 plan, including a list of the 
principal activities paid for under the plan and the dollar amounts 
spent on each activity over the last year), may help investors to 
better understand how the fund uses asset-based distribution fees, and 
the proposal would retain it in substance. The proposal would amend 
Item 19(g)(1) to eliminate references to a 12b-1 plan, and instead 
require disclosure of the principal activities paid for through asset-
based distribution fees (both ongoing sales charges and marketing and 
service fees).
---------------------------------------------------------------------------

    \416\ See supra note 313 and accompanying text.
---------------------------------------------------------------------------

    The proposal would add new paragraph (d) to Item 25, which would 
require funds that have elected to externalize the sales charge 
pursuant to proposed rule 6c-10(c) to disclose this election on Form N-
1A. This disclosure is designed to inform interested investors of the 
fund's election. The proposal would also make technical conforming 
changes to Instruction 3(b) to Item 3; Instruction 5 to Item 26(b)(4); 
and Item 27(d)(1) (and Instruction 2(a)(i) to Item 27(d)(1)) to replace 
references to 12b-1 fees and plans with references to the appropriate 
types of asset-based distribution fee under the proposal. Finally, the 
proposal would eliminate existing Item 28(m) of Form N-1A, which 
requires a fund to attach its rule 12b-1 plan and any related 
agreements as an exhibit to its registration statement. The exhibit 
would be unnecessary because proposed rule 12b-2 does not require a 
written plan.
    The staff estimates that the proposed amendments to the SAI would 
result in overall time and cost savings for funds. Funds would incur 
savings because of the reduced time required and lower costs to prepare 
disclosure materials for Item 19(g).\417\ The staff further estimates 
that responding to proposed paragraph (d) of Item 27 would entail 
little additional time and no costs, as it would only require a fund to 
make a single affirmative statement (if

[[Page 47106]]

applicable) that the fund has taken the election. The staff estimates 
that the other proposed technical and conforming amendments to the SAI 
would not result in changes in the hourly burdens or cost because they 
would not change the legal or disclosure obligations of funds.
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    \417\ Generally, most SAIs are not printed in advance, but are 
instead printed on demand when requested. The staff estimates that 
the proposal would not result in a change in printing costs because 
the staff does not expect that the number of pages of the SAI would 
be reduced as a result of the proposal, and if there were any 
reduction; any savings would be minimal due to the few occasions on 
which the SAI is printed.
---------------------------------------------------------------------------

    Therefore, based on conversations with fund representatives, the 
staff estimates that the proposed amendments to the SAI would result in 
a net time savings of approximately 10 hours for each fund's initial 
filing and of 1 hour for each post-effective amendment (all of which 
time would be spent by fund counsel at a time cost equivalent rate of 
$316 per hour). Based on a review of information filed with the 
Commission on Form N-SAR, the staff estimates that there are 
approximately 300 funds with a 12b-1 plan that newly file each year and 
7367 funds that have adopted a 12b-1 plan that file post-effective 
amendments. The staff further estimates that the amendments would 
reduce costs incurred for outside counsel associated with completing 
the SAI, by $500 for each initial filing and $150 for each post-
effective amendment. Therefore, the staff estimates that all funds 
submitting their initial SAI filing would experience a reduction of 
3000 hours (at an internal cost equivalent of $948,000) and a cost 
savings of $150,000.\418\ The staff also estimates that all funds 
filing post-effective amendments will experience a reduction of 7367 
hours (at an internal cost equivalent of $2,327,972) and cost savings 
of $1,105,050.\419\
---------------------------------------------------------------------------

    \418\ These estimates are based on the following calculations: 
(300 x 10 hours = 3000 hours); (3000 hours x $316 per hour = 
$948,000); (300 x $500 = $150,000).
    \419\ These estimates are based on the following calculations: 
(7367 x 1 hour = 7367 hours); (7367 hours x $316 per hour = 
$2,327,972); (7367 x $150 = $1,105,050).
---------------------------------------------------------------------------

5. Change in Burden
    In the most recent Paperwork Reduction Act submission for Form N-
1A, the staff estimated that for each fund portfolio or series, the 
initial filing burden is approximately 830.47 hours at a cost of 
$20,300, and the post-effective amendment burden is approximately 111 
hours at a cost of $8894. This hourly burden includes time spent by in-
house counsel, back office personnel, compliance professionals, and 
others in preparing the form. The costs include that of outside counsel 
to prepare and review these filings.
    As discussed above, in total the staff estimates that our proposed 
amendments to Form N-1A would result in net time savings of 
approximately 10 hours for each fund's initial filing (for a new total 
estimate of 820.47 hours) and of 1 hour for each post-effective 
amendment (for a new total estimate of 110 hours).\420\ The staff 
further estimates that the proposed amendments would reduce costs spent 
on outside counsel associated with completing Form N-1A, by $500 for 
each initial filing (for a new total estimate of $19,800) and $150 for 
each post-effective amendment (for a new total estimate of $8744). The 
staff also estimates that the proposed amendments would require each 
fund family with any funds that would file a post-effective amendment 
to incur approximately $2000 in one-time costs and expend 10 hours in 
internal personnel time.
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    \420\ This is based on the estimates made previously in this 
section that there would be no burden change as a result of our 
proposed amendments to the prospectus portion of N-1A and that the 
proposed changes to the SAI portion would result in the savings 
indicated.
---------------------------------------------------------------------------

    The staff assumes that only funds that charge asset-based 
distribution fees would be affected by our proposed amendments to Form 
N-1A and would realize these reduced burdens and cost savings. The 
staff estimates that, each year, there are approximately 7367 funds 
with 12b-1 plans that file post-effective amendments, and would 
therefore be affected by our proposed amendments. The staff estimates 
that an additional 300 funds with asset-based distribution fees would 
file an initial Form N-1A each year after our proposed amendments would 
go into effect. Based on these estimates, the staff estimates that 
funds would save a total of 3000 hours and $150,000 when submitting 
initial Form N-1A filings each year.\421\ In addition, the staff 
anticipates that funds would save approximately 7367 hours, and 
$1,105,050 annually when preparing post-effective updates to Form N-
1A.\422\
---------------------------------------------------------------------------

    \421\ This is based on the following calculations: (300 new 
filers x 10 hours savings = 3000 hours in total savings); (300 new 
filers x $500 savings = $150,000 total savings).
    \422\ This estimate is based on the following calculations: 
(7367 amendments x 1 hour savings = 7367 hours in total savings); 
(7367 amendments x $150 savings = $1,105,050 total savings).
---------------------------------------------------------------------------

    Finally, as discussed above, the staff further estimates that all 
fund families that file post-effective amendments and have adopted 12b-
1 plans would incur a one-time burden of 3790 hours (at an internal 
cost equivalent of $1,197,640) and $758,000 in outside costs when 
preparing post-effective amendments to comply with the proposed 
amendments for the first time.\423\
---------------------------------------------------------------------------

    \423\ These estimates are based on the following calculations: 
(379 x 10 hours = 3790 hours); (3790 hours x $316 per hour = 
$1,197,640); (379 x $2000 = $758,000).
---------------------------------------------------------------------------

     We request comment on any of these estimates or 
assumptions.

E. Form N-SAR

    Form N-SAR is the form that registered investment companies use to 
make periodic reports to the Commission. Completing Form N-SAR is a 
collection of information under the PRA and is mandatory. Our proposed 
amendments would add an instruction to Form N-SAR to disregard, for 
funds that no longer have 12b-1 plans, four questions (Items 41-44) 
that relate to the operation of rule 12b-1 plans (because they would be 
irrelevant in light of our proposed new framework for asset-based 
distribution fees). However, funds that maintain grandfathered fund 
classes would continue to respond to these items.
    The total annual hour paperwork burden estimate for Form N-SAR is 
107,213 hours. The current approved total number of respondents is 
4142, and the total annual number of responses is 7461.\424\ The staff 
estimates that there are approximately 1292 management investment 
companies that respond to Items 40-44 of Form N-SAR.
---------------------------------------------------------------------------

    \424\ The staff estimates the number of filers and filings based 
on the actual number of EDGAR filings and on other Commission 
records.
---------------------------------------------------------------------------

    The staff estimates that our proposed amendments would reduce the 
time it takes funds that do not have grandfathered share classes to 
complete Form N-SAR by 0.25 hours, and that there would be no change 
for funds that maintain grandfathered share classes. The staff 
estimates that, if these amendments are adopted, in the first three 
years after adoption, approximately 20% of these 1292 management 
investment companies (or 258) will no longer maintain grandfathered 
share classes and experience the estimated savings, while the remaining 
80% (or 1034) will continue to have grandfathered share classes and 
respond to these items. Because Form N-SAR is completed twice a year, 
the staff estimates that each filer that no longer responds to these 
items would save approximately 0.5 hour annually (at an internal time 
cost equivalent rate of $316 per hour). The staff therefore estimates 
that our proposed amendments to Form N-SAR would result in an aggregate 
incremental time savings of approximately 129 hours (with a total 
internal time equivalent cost savings of

[[Page 47107]]

$40,764) \425\ annually compared to the current approved hour burden.
---------------------------------------------------------------------------

    \425\ This estimate is based on the following calculation: (258 
x 0.5 hour = 129 hours); (129 hours x $316 per hour = $40,764).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.

F. Schedule 14A

    Funds must comply with the requirements of Schedule 14A when they 
solicit proxies from their shareholders. Our proposal would amend the 
required disclosures under Schedule 14A when a fund seeks approvals 
from its shareholders to institute or increase the rate of a marketing 
and service fee after shares have been offered to the public. The 
proposed amendments would remove items regarding asset-based 
distribution fees that would be superfluous in light of our proposed 
rescission of rule 12b-1 and new rule and rule amendments on asset-
based distribution fees, and would amend certain other items.
    Based on conversations with fund representatives and the most 
recent PRA update to Schedule 14A, the staff estimates that 75% of the 
burden of preparing Schedule 14A filings is undertaken by the fund 
internally and that 25% of the burden is undertaken by outside counsel 
retained by the fund at an average cost of $400 per hour.\426\ The 
staff estimates that 3 funds would solicit proxies each year for the 
purposes of seeking approval to implement or increase a fee as required 
under proposed rules 6c-10(b)(3) and 12b-2(b)(3) (the same number that 
the staff has estimated would solicit proxies under rule 12b-1) because 
the staff believes the proposed amendments are unlikely to affect the 
number of funds that seek proxy approval from their shareholders. For 
each of these 3 funds, the staff estimates that our proposed amendments 
to Schedule 14A would create an incremental reduction in burden of 3 
hours of fund personnel time (at an internal time cost equivalent rate 
of $316 per hour) and reduced costs of $400 for the services of outside 
counsel, as a result of the proposed amended disclosures relating to 
marketing and service fees on Schedule 14A. The staff therefore 
estimates that these amendments would reduce the total annual paperwork 
burden of Schedule 14A by approximately 9 hours of fund personnel time 
(3 funds x 3 hours) at an internal time cost equivalent of $2844,\427\ 
and by approximately $1200 (3 funds x $400) for the services of outside 
counsel.
---------------------------------------------------------------------------

    \426\ This cost estimate is based on consultations with several 
registrants and law firms and other persons who regularly assist 
registrants in preparing and filing proxies with the Commission.
    \427\ This estimate is based on the following calculation: (9 
hours x $316 per hour = $2844).
---------------------------------------------------------------------------

    In our most recent PRA submission for Regulation 14A (which 
includes Schedule 14A), the staff estimated that there are a total of 
7300 respondents who use Schedule 14A, each of whom responds once a 
year, for a total of 7300 responses annually. The staff estimates that 
this number of respondents would remain the same under the proposed 
amendments because the staff does not expect our proposed amendments to 
affect the number of funds that seek approval from their shareholders 
to institute or increase marketing and service fees. The current 
approved aggregate time burden for these respondents is 669,026 hours 
and the cost burden is $78,822,387. The staff estimates that the 
proposed amendments would reduce this time burden by a total of 9 hours 
(3 hours times the 3 respondents affected by our proposed amendments) 
for a new total of 669,017 hours, and would reduce the cost burden by a 
total of $1200, for a new aggregate total of $78,821,187. This would 
represent an average per respondent time burden of 92 hours, and a cost 
burden of $10,797.\428\
---------------------------------------------------------------------------

    \428\ This is based on the following calculations: (669,017 
hours / 7300 respondents = 92 hours); ($78,821,187 / 7300 
respondents = $10,797).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions. If 
commenters believe these estimates and assumptions are not accurate, we 
request they provide specific data that would allow us to make a more 
accurate estimate.

G. Form N-3

    Form N-3 is the registration form used by insurance company 
separate accounts registered as management investment companies that 
offer variable annuity contracts.\429\ The proposed amendments would 
require separate accounts that file Form N-3 to: (i) Revise prospectus 
narrative disclosure on asset-based distribution fees; and (ii) revise 
the SAI disclosure regarding asset-based distribution fees. Preparing 
Form N-3 is a collection of information under the PRA and is mandatory.
---------------------------------------------------------------------------

    \429\ There are two types of Form N-3 filings: (i) Initial 
filings; and (ii) annual post-effective amendments. Funds usually 
incur significantly more time and incur greater costs when first 
registering a fund under their initial N-3 filings than when filing 
their annual post-effective updates. Therefore, the staff separately 
estimates the burden for each type of filing.
---------------------------------------------------------------------------

    The proposal would amend Instruction 2 to Item 7(a) of Form N-3, 
which currently requires registrants to list the principal types of 
activities for which 12b-1 payments are made and the total amount spent 
in the most recent fiscal year, as a percentage of net assets (or, if 
the plan has not been in effect for a full fiscal year, a description 
of the payments). The proposal would eliminate the requirement that 
registrants disclose the total amount spent in the most recent fiscal 
year, and instead require registrants to provide a description of 
asset-based distribution fees, as defined in the new proposed rule. The 
proposal would retain the requirement that registrants list the 
principal types of activities for which asset-based distribution fees 
are deducted.
    As discussed above, funds would no longer be required to have 
written plans that are supervised and approved by the board of 
directors under our proposed rule amendments. Therefore, the proposal 
would eliminate paragraphs (ii) and (iii) of Item 21(f), which relate 
to the specific operation of a 12b-1 plan.\430\ Paragraph (i) of Item 
21(f) requires registrants to disclose the manner in which amounts paid 
by the registrant under a 12b-1 plan were spent. We believe that the 
information required to be disclosed in paragraph (i) of Item 21(f) 
would continue to be useful to investors and the Commission. Therefore, 
we are proposing to amend Item 21(f) to require disclosure of the 
principal activities paid for through asset-based distribution expenses 
incurred under rule 12b-2(b) and (d) and rule 6c-10(b), deleting 
references to 12b-1 plans. For the reasons discussed above, we are also 
proposing to amend Instruction 5 to Item 26(b)(ii) to delete any 
references to 12b-1 plans. However, registrants would be required to 
provide the same information with respect to expenses and 
reimbursements accrued pursuant to rule 12b-2(b), rule 12b-2(d), and 
rule 6c-10(b).
---------------------------------------------------------------------------

    \430\ Item 21(f)(ii) requires a registrant to disclose whether 
any interested person or director has a financial interest in the 
operation of the 12b-1 plan. Item 21(f)(iii) requires disclosure of 
the anticipated benefits of the plan to the fund.
---------------------------------------------------------------------------

    The current approved aggregate time burden to comply with the 
collection of information requirements in Form N-3 is 13,024 hours. The 
current approved aggregate cost burden is $601,400.
    Only registrants that charge asset-based distribution fees would be 
affected by our proposed amendments to Form N-3. Based upon a review of 
filings with the Commission, the staff estimates that 1 registrant that 
currently files on Form N-3 charges asset-based distribution fees, and 
would file a post effective amendment. Based upon

[[Page 47108]]

conversations with fund representatives, the staff estimates that it 
would cost this registrant approximately $2,000 in one-time costs (for 
outside legal counsel drafting and review) and require an expenditure 
of 10 hours in internal personnel time (at an internal time cost 
equivalent rate of $316 per hour) to revise its prospectus to comply 
with the proposed amendments. The staff further estimates, based on 
those conversations, that the proposed amendments to Item 21 and 
Instruction 5 of Item 26 would result in time savings when completing a 
post-effective amendment of a Form N-3 filing. The staff estimates that 
this registrant would save approximately 1 hour (at an internal time 
cost equivalent of $316 per hour) annually as a result of the proposed 
amendments.
    The staff further estimates that no new registrants that file on 
Form N-3 are likely to charge asset-based distribution fees under 
proposed rule 12b-2 and the proposed amendments to rule 6c-10. 
Accordingly, the staff estimates that there will be no other changes in 
burden hours or costs for Form N-3 as a result of the proposed rule and 
rule amendments.
     We request comment on these estimates and assumptions.

H. Rule 10b-10

    Rule 10b-10 requires broker-dealers to convey basic trade 
information to customers regarding their securities transactions. The 
proposed amendments would revise rule 10b-10 by requiring disclosure of 
additional information related to sales charges in connection with 
transactions involving mutual funds, requiring disclosure of certain 
additional information in connection with callable debt securities, and 
removing certain outdated transitional provisions from the rule. This 
collection of information would be mandatory. The information would be 
used by broker-dealer customers to evaluate the terms of their own 
securities transactions. In addition, the information contained in the 
confirmations may be used by the Commission, self-regulatory 
organizations, and other securities regulatory authorities in the 
course of examinations, investigations, and enforcement proceedings. No 
governmental agency regularly would receive any of this 
information.\431\
---------------------------------------------------------------------------

    \431\ Exchange Act Rule 17a-4(b)(1), 17 CFR 240.17a-4(b)(1), 
requires broker-dealers to preserve confirmations for three years, 
the first two years in an accessible place.
---------------------------------------------------------------------------

    The proposed amendments to rule 10b-10, in part, would require 
transaction confirmations to disclose additional information about 
sales charges associated with purchases and redemptions of mutual fund 
shares. The purpose of these changes is to help make the confirmation a 
more complete record of the transaction, help mutual fund investors 
more fully understand the sales charges they pay, and assist investors 
in verifying whether they paid the correct sales charge as set forth in 
the prospectus. The proposed amendments to rule 10b-10 also would 
require confirmation disclosure of certain additional information about 
callable debt securities. The purpose of these proposed amendments is 
to provide investors with information necessary to evaluate their 
transactions involving callable debt securities, by helping to alert 
investors to misunderstandings, avoid confusion, promote the timely 
resolution of problems, and better enable investors to evaluate 
potential future transactions.\432\
---------------------------------------------------------------------------

    \432\ The proposal also would delete certain expired 
transitional provisions of rule 10b-10 related to securities futures 
products; there would be no burden associated with this deletion.
---------------------------------------------------------------------------

    The rule would apply to the approximately 5,035 broker-dealers 
registered with the Commission. The Commission staff understands, 
however, that under the current industry practice confirmations are 
customarily generated and sent by clearing broker-dealers (``clearing 
firms'') subject to agreements (``clearing agreements'') with 
introducing broker-dealers (``introducing firms''). Under this industry 
practice, the Commission staff understands that clearing firms would 
bear most of the costs associated with updating back-office operations 
to accommodate the proposed changes to rule 10b-10.\433\
---------------------------------------------------------------------------

    \433\ For purposes of this analysis, the staff assumes that all 
registered broker-dealers effect transactions in mutual fund shares. 
To the extent that some broker-dealers may not effect transactions 
in mutual fund shares, the paperwork burdens and costs may be 
overstated. Furthermore, for the purposes of this analysis, broker-
dealers that have not entered into clearing agreements with 
introducing firms yet generate and send confirmations, are included 
as clearing firms in the staff's estimates.
---------------------------------------------------------------------------

    Based on filings with the Commission, the staff estimates that of 
the 5,035 broker-dealers registered with the Commission, approximately 
530 are clearing firms. The Commission staff understands that 
approximately 30% of clearing firms, or 160 firms, have developed their 
own proprietary systems for generating and inputting the information 
necessary to generate and deliver a confirmation. The staff further 
understands that the other approximately 70% of clearing firms, or 370 
firms,\434\ license platforms from third-party service providers (or 
vendors) that, among other things, generate the data necessary to 
produce and send confirmations.\435\
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    \434\ The staff's understanding is that these firms are usually 
small and medium-sized clearing firms, but may also include some 
larger firms as well.
    \435\ The staff's understanding is that there are three primary 
vendors that license platforms used by clearing firms to generate 
and send confirmations. In addition to licensing platforms, many 
clearing firms may also use vendors to separately print and mail 
confirmations to investors.
---------------------------------------------------------------------------

    Based on the industry's current practices, the staff understands 
that the 160 clearing firms with proprietary systems would have a one-
time burden associated with reprogramming software and otherwise 
updating back-office systems and platforms to enable confirmation 
delivery systems to generate the information required under the 
proposed amendments.\436\ The Commission staff further estimates, based 
on discussions with industry representatives, that this one-time 
programming burden for clearing firms with proprietary back-office 
systems would amount to, on average, approximately 4,500 hours per 
clearing firm, for a total of 720,000 burden hours.\437\
---------------------------------------------------------------------------

    \436\ The staff notes that these estimates are based on the 
assumption that ongoing sales charges and marketing and service fees 
commonly will not change over time for any particular mutual fund. 
The staff also assumes that the information necessary to comply with 
the proposed changes to rule 10b-10 will be readily available to 
clearing firms from various third-party service providers.
    \437\ 160 clearing firms with proprietary systems x 4,500 burden 
hours = 720,000 burden hours.
---------------------------------------------------------------------------

    With respect to clearing firms that license vendor platforms 
(``clearing firm licensees''), the staff estimates that these vendors 
will incur costs similar to those incurred by clearing firms with 
proprietary systems to reprogram and update their platform. Thus, staff 
estimates that the burden to vendors would be approximately 4,500 
burden hours per vendor, resulting in one-time costs to these vendors 
of approximately $3.4 million dollars.\438\ Based on discussions with 
industry representatives, the staff also understands that clearing firm 
licensees would still incur approximately 800 burden hours per firm to 
adopt the changes to a vendor's platform and determine that the output 
satisfies the requirements of the proposed amendments to the rule. The 
staff estimates that the total burden for clearing firm licensees would 
be approximately 296,000 total hours.\439\ When we sum the labor hours 
borne by clearing firms with proprietary systems with those borne by 
clearing firm

[[Page 47109]]

licensees, we estimate that the total one-time hour burden as a whole 
for entities registered with the Commission will be 1,016,000 burden 
hours.\440\
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    \438\ 3 vendors x 4,500 burden hours x $251 dollars per hour = 
$3,388,500. The staff estimates per hour costs to be $251.
    \439\ 370 clearing firm licensees x 800 burden hours = 296,000 
total burden hours.
    \440\ (160 clearing firms with proprietary systems x 4,500 
burden hours) + (370 clearing firm licensees x 800 burden hours) = 
1,016,000 total burden hours.
---------------------------------------------------------------------------

    The Commission staff understands that once completed, this 
reprogramming and systems updating should permit clearing firms to have 
automated access to the additional information that would be disclosed 
in confirmations. Accordingly, the staff does not believe that there 
will be a material increase in the ongoing costs associated with 
producing and sending confirmations once the initial one-time 
reprogramming costs are completed.

I. Request for Comments

    We request comment on whether the estimates provided in this PRA 
are accurate. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission 
solicits comments in order to: (i) Evaluate whether the proposed 
collections of information are necessary for the proper performance of 
the functions of the Commission, including whether the information will 
have practical utility; (ii) evaluate the accuracy of the Commission's 
estimate of the burden of the proposed collections of information; 
(iii) determine whether there are ways to enhance the quality, utility, 
and clarity of the information to be collected; and (iv) minimize the 
burden of the collections of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements of the proposed amendments should direct them to the 
Office of Management and Budget, Attention Desk Officer for the 
Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. S7-15-10. OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to these 
collections of information should be in writing, refer to File No. S7-
15-10, and be submitted to the Securities and Exchange Commission, 
Office of Investor Education and Advocacy, 100 F Street, NE., 
Washington, DC 20549-0213.

V. Cost-Benefit Analysis

A. Background

    The Commission is sensitive to the costs and benefits imposed by 
its rules. We recognize that if adopted, the proposed new rule and rule 
amendments would result in costs for some funds and other marketplace 
participants.\441\ We have identified certain costs and benefits of the 
proposed rule and rule amendments and request comment on all aspects of 
this cost-benefit analysis, including identification and assessment of 
any costs and benefits not discussed in this analysis. We seek comment 
and data on our estimates of the costs and benefits identified. We also 
welcome comments on the accuracy of the cost estimates in each section 
of this analysis, and request that commenters provide data that may be 
relevant to these cost estimates. In addition, we seek estimates and 
views regarding these costs and benefits for funds and their 
intermediaries, including small entities, and for investors, as well as 
any other costs or benefits that may result from the adoption of the 
proposed rule and rule and form amendments.
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    \441\ Although we discuss many of these costs in terms of the 
fund, the preparation of these reports is most likely done by 
employees of the fund's adviser, because most funds do not have any 
employees of their own.
---------------------------------------------------------------------------

    The proposal is designed to protect individual investors from 
paying disproportionate amounts of sales charges in certain share 
classes, promote investor understanding of fees, eliminate outdated 
requirements, provide a more appropriate role for fund directors, and 
introduce greater competition among funds in setting sales loads and 
distribution fees generally. As discussed in greater detail above, we 
are proposing to: (i) Rescind rule 12b-1 under the Act; (ii) adopt new 
rule 12b-2 under the Act, which would permit funds to deduct a 
marketing and service fee at a rate no greater than the maximum rate 
permitted as a service fee under the NASD sales charge rule (currently 
25 basis points) annually; (iii) adopt amendments to rule 6c-10, which 
would permit funds to deduct asset-based sales charges in excess of the 
marketing and service fee in the form of an ``ongoing sales charge'' 
(up to certain limits); (iv) as an alternative to the ongoing sales 
charge, provide an elective alternative that would allow funds to sell 
their shares through intermediaries subject to competition in 
establishing sales charge rates; (v) amend Form N-1A and N-3 under the 
Securities Act and the Investment Company Act, and Schedule 14A under 
the Exchange Act to reflect the proposed rule and rule amendments, (vi) 
make conforming amendments to rule 11a-3 under the Investment Company 
Act; and (vii) make technical amendments to rules 17a-8, 17d-3, and 
18f-3, and Forms N-SAR, N-4 and N-6 under the Investment Company Act, 
and rule 6-07 of Regulation S-X under the Securities Act.
    In general, for each aspect of the proposal, we have attempted to 
estimate the potential costs and benefits in dollars for each entity 
that may be affected. Some of the expected costs and benefits from our 
proposals cannot be measured in dollars, but are effects nonetheless, 
such as the benefits of improved investor understanding of distribution 
charges and the costs and benefits of greater equity in the cumulative 
amount of sales charges paid by individual investors. When actual 
dollar costs and benefits would likely result (such as from the 
elimination of certain disclosure requirements that would be eliminated 
under the proposal, such as descriptions of 12b-1 plans) we have 
estimated the relevant costs and savings.\442\
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    \442\ We have discussed many of the benefits of this proposal 
previously in this Release, and therefore, we will focus more on the 
proposal's costs in this section, and will refer back to previous 
discussions of our proposal's anticipated benefits when appropriate.
---------------------------------------------------------------------------

    In this analysis, Commission staff has estimated the percentage of 
funds or other parties that are likely to change their operations in 
response to our proposal. These and other estimates and assumptions are 
based on interviews with representatives of funds, their 
intermediaries, investor advocates, and the experience of Commission 
staff. In addition, in preparing this cost-benefit analysis, Commission 
staff reviewed fund prospectuses, periodic reports made to the 
Commission pursuant to Form N-SAR and other fund filings, and a 
commercial database of information on funds.\443\ Throughout this 
analysis, unless otherwise stated, the estimates are based on these 
interviews, reviews, and examinations.
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    \443\ The Commission staff's review is based in part on 
information obtained from Lipper's LANA Database.
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B. Impact of the Proposal

    We have designed our proposal to minimize the cost impact on funds,

[[Page 47110]]

intermediaries, and service providers while maximizing the investor 
protection and other benefits. As further discussed below, the staff 
anticipates that funds representing approximately 93% of all assets 
under management will incur minor or no expenses in complying with our 
proposal. This section contains some basic estimates about the size of 
the fund marketplace and its use of 12b-1 fees, and a general outline 
of what we believe our proposal's impact will be on certain market 
segments. Much of the information described in this section is included 
in two tables at the end of this section. The information is based on 
an analysis of data received on Form N-SAR and other filings and a 
review of a Lipper database.
    The staff estimates that as of the end of 2009, there were 
approximately 9427 funds (consisting of 8611 traditional mutual funds 
and 816 ETFs) sponsored by 682 investment advisers.\444\ Approximately 
7367 of these funds have adopted a 12b-1 plan for one or more of their 
share classes.\445\ Assets managed by all funds, as of the end of 2009, 
totaled approximately $12.2 trillion.\446\
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    \444\ Like mutual funds, most ETFs are registered open-end 
management investment companies (a small number of ETFs are UITs). 
However, ETFs are counted separately from mutual funds in ICI 
statistics. The number of funds above reflects each separate series 
of a fund (many funds consist of more than one series or portfolio). 
Costs incurred in complying with the proposal may often be incurred 
at the fund ``complex'' or ``family'' level, and not at the series 
or class level, and, when appropriate, the staff has based its 
estimates on the number of sponsors or families affected rather than 
the number of series or classes.
    \445\ A fund may have a 12b-1 plan, but not charge 12b-1 fees on 
one or more particular share classes of the fund.
    \446\ This figure is based on staff examination of industry 
data, and includes traditional mutual funds, funds of funds, ETFs, 
and funds underlying insurance company separate accounts.
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    The number of sponsors is roughly equivalent to the number of 
``fund families,'' which are groups of funds that share the same 
investment adviser or principal underwriter and hold themselves out to 
investors as related companies. Therefore, on average, each fund family 
has approximately 14 funds.\447\ Of the 682 fund families, the staff 
estimates that approximately 379 (or 56%) have at least one fund in the 
family that currently has a 12b-1 plan. These fund families may be 
affected in some way by our proposal. The staff estimates that 172 of 
these 379 fund families (or 45%) only have funds that charge no more 
than 25 basis points in 12b-1 fees, and the remaining 207 (or 55%) have 
at least one fund that charges 12b-1 fees in excess of 25 basis points. 
The 207 fund families that have at least one fund that charges 12b-1 
fees in excess of 25 basis points average 37 funds per fund family, a 
significantly higher average number of funds per family than the 
typical fund family.\448\ As discussed previously, and in more detail 
below, we anticipate that funds that charge 25 basis points or less in 
12b-1 fees would incur minimal costs under our proposal, while those 
that charge more than 25 basis points may be more significantly 
affected by our proposal.
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    \447\ This is based on the following calculation: (9427 funds / 
682 advisers = 14 funds per adviser). This number can and does vary 
widely, with some advisers managing only a single fund, and others 
managing hundreds of funds.
    \448\ The 207 advisers that advise at least one fund with a 12b-
1 fee in excess of 25 bps advise a total of 7660 funds, for an 
average of 37 funds per family.
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    The staff estimates that, as of the end of 2009, there were 
approximately 26,788 fund share classes. On average, the staff 
estimates that each mutual fund has approximately 3 share classes.\449\ 
However, some funds only have one share class (including many no-load 
funds), while others may have ten or more classes to support a variety 
of distribution arrangements.\450\ Generally, funds that charge 12b-1 
fees tend to have more share classes, because they offer multiple 
methods of paying for distribution (e.g., at the time of purchase, at 
the time of redemption, or over time through the 12b-1 fee charged on 
fund assets) for investors with different needs and goals.\451\ Thus, 
for purposes of estimating costs per fund in this analysis, the staff 
will assume that a typical fund that charges 12b-1 fees would have 4 
classes: An A, B, and C share class, as well as an institutional or 
retirement share class.\452\
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    \449\ This is based on the following calculation: (26,788 
classes / 8611 funds = 3 classes per fund). The staff excludes ETFs 
from this calculation because most ETFs offer only one class of 
shares, and therefore have reduced both the total fund and class 
number by the number of ETFs in this calculation. An ETF that is 
offered as a share class in a fund would be included in this 
estimate of average share classes per fund.
    \450\ See, e.g., Prospectus for The Growth Fund of America (Nov 
1, 2009) (http://www.americanfunds.com/pdf/mfgepr-905_gfap.pdf).
    \451\ Not all funds that charge 12b-1 fees offer multiple retail 
classes. For example, the Legg Mason Funds only offer a single 
retail class of shares for their funds, a C share equivalent that 
charges 12b-1 fees without a front-end load. See, e.g., Prospectus 
for Legg Mason American Leading Companies Value Trust (Aug 1, 2009), 
(http://prospectus-express.newriver.com/get_
template.asp?clientid=legg&fundid=52465Q101&level=4&doctype=pros).
    \452\ See supra note 84. We do not expect that institutional 
classes would be affected by our proposal because funds do not 
typically charges 12b-1 fees on these classes.
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    Of the 26,788 existing fund share classes, 12,646 (or 47% of all 
classes) do not charge a 12b-1 fee. These classes hold approximately 
$7.3 trillion in assets.\453\ The remaining 14,142 classes (or 53% of 
all classes) that do charge a 12b-1 fee hold approximately $4.9 
trillion in assets. The staff believes that 47% of fund classes (those 
that do not charge 12b-1 fees) are unlikely to incur any costs as a 
result of our rule proposal.\454\ Thus, the staff believes that funds 
managing approximately $7.3 trillion in assets, representing 60% of all 
assets under management, would not have to change their operations or 
disclosures as a result of our proposal.\455\
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    \453\ This figure is based on a staff examination of industry 
data and includes mutual funds, funds of funds, ETFs, and funds 
underlying insurance company separate accounts.
    \454\ If our proposal is adopted, we do not expect that fund 
classes that do not currently charge 12b-1 fees would begin charging 
asset-based distribution fees, because the fund would have already 
established a distribution structure and in light of the necessity 
of obtaining shareholder approval to institute such a fee.
    \455\ This figure is based on the following calculation: ($7.3 
trillion (assets not subject to a 12b-1 fee) / $12.2 trillion (total 
assets under management) = 60% of assets under management not 
subject to a 12b-1 fee).
---------------------------------------------------------------------------

    A total of 6,482 share classes (or 46% of classes that charge 12b-1 
fees) charge a 12b-1 fee of 25 basis points or less. As discussed 
further below, although our proposal would affect these classes, we 
anticipate that the funds with these classes are likely to incur 
minimal costs associated with complying with our proposal. As a result, 
the staff anticipates that of all 26,788 fund share classes, 19,128 
(which hold $11.3 trillion in assets, representing approximately 93% of 
all assets under management) would incur only minor, if any, costs if 
our rule proposals are adopted.\456\
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    \456\ As discussed further below, we recognize that the cost 
impact of our proposal would not be distributed evenly across all 
funds, but rather that certain funds and fund families are likely to 
bear a greater share of the expenses that may result due to the 
nature of their distribution and operational models.
---------------------------------------------------------------------------

    Approximately 7,660 (or 54%) of the share classes that have 12b-1 
fees charge 12b-1 fees of greater than 25 basis points. All of these 
classes would be affected in some way by our rule proposals. These 
share classes hold approximately $855 billion in assets, or 17% of the 
assets managed by classes that charge 12b-1 fees, and 7% of all assets 
under management.
     We request comment on these estimates.

[[Page 47111]]

[GRAPHIC] [TIFF OMITTED] TP04AU10.000

C. Marketing and Service Fee

    Proposed rule 12b-2 would allow funds to deduct from fund assets a 
marketing and service fee of up to the maximum rate of the service fee 
permitted under NASD Conduct Rule 2830 (currently 0.25% or 25 basis 
points of net fund assets annually).\457\ The proposed 25 basis point 
marketing and service fee could be used for any legitimate distribution 
related activity including, but not limited to, the continuing 
shareholder account services encompassed by the NASD service fee.
---------------------------------------------------------------------------

    \457\ Proposed rule 12b-2(b); NASD Conduct Rule 2830(d)(5).
---------------------------------------------------------------------------

1. Benefits
    We anticipate that proposed rule 12b-2 would benefit investors by 
permitting funds to continue to pay for: (i) Follow-up services 
provided to investors by brokers and other intermediaries after the 
sale has been made; and (ii) a fund's participation in distribution 
channels that offer investors a convenient way of buying shares, such 
as fund supermarkets \458\ and retirement plans.\459\
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    \458\ See supra Section III.C.
    \459\ Because these payments represent an integral part of many 
funds' distribution strategies, we believe that significantly 
restricting the ability of funds to continue to pay for these 
ongoing services through fund assets would likely disrupt existing 
distribution systems, impose significant costs on funds and 
intermediaries, and may have other unintended consequences that 
could adversely affect funds and fund shareholders.
---------------------------------------------------------------------------

    We anticipate that our proposal would also benefit funds and their 
directors, and ultimately fund shareholders, by eliminating the 
procedural requirements of rule 12b-1. Under proposed rule 12b-2, 
boards of directors of funds that deduct a marketing and service fee 
would not be required to adopt a 12b-1 plan or annually approve it. As 
a result, funds and their advisers would no longer incur many of the 
costs of creating a 12b-1 plan, preparing quarterly and fiscal year 
reports of plan expenditures, or preparing materials that support the 
specific findings that fund boards are required to make annually in 
order to approve a 12b-1 plan, as discussed in more detail in Section I 
of this analysis.
    As discussed above, fund boards would have discretion to use fund 
assets to finance distribution activities within the limits of the rule 
and their fiduciary obligations to the fund and fund shareholders. 
Therefore, we anticipate that funds would still incur some costs 
stemming from director review of arrangements paid for through the 
marketing and service fee. Our understanding is that, in general, funds 
pay their directors on an annual or per meeting basis, and we do not 
expect that the directors will reduce the frequency of their meetings 
as a result of the proposed marketing and service fee. Based on this 
assumption, we estimate that funds that currently charge a 12b-1 fee of 
25 basis points or less will likely not realize significant cost 
savings as a benefit deriving from our proposal. However, the directors 
of funds that impose a marketing and service fee

[[Page 47112]]

under proposed rule 12b-2 might spend less time on reviews and plan 
approvals, and instead be able to focus more of their time on other 
pressing concerns related to the fund's operations.\460\
---------------------------------------------------------------------------

    \460\ We discuss the cost savings that might result from the 
proposed rescission of rule 12b-1 and its attendant director duties 
in Section V.I of this Release, infra.
---------------------------------------------------------------------------

2. Costs
    We anticipate that funds that currently charge a 12b-1 fee of 25 
basis points or less would not change the amount that they currently 
charge under proposed rule 12b-2. The proposed maximum amount of the 
marketing and service fee would be the same as the current NASD limit 
on service fees, and would also be the same as the current NASD limit 
on the amount of asset-based distribution fees that may be charged by 
funds describing themselves as ``no-load.'' Thus, we expect that funds 
that currently use 12b-1 fees for these purposes would continue to 
charge the same level of fees. Because under the proposal, funds that 
currently charge 12b-1 fees of 25 basis points or less could charge 
marketing and service fees of the same or smaller amount without 
holding a shareholder vote, we expect that funds that currently charge 
12b-1 fees of 25 basis points or less would incur only the costs of 
updating their disclosure documents as a result of our proposed 
rulemaking.\461\
---------------------------------------------------------------------------

    \461\ We estimate the costs of such disclosure changes in 
Section V.G of this Release, infra.
---------------------------------------------------------------------------

    As discussed above, we do not anticipate that funds that currently 
charge 25 basis points or less in 12b-1 fees would have to implement 
any significant systems changes or incur other additional operational 
costs in order to impose a marketing and service fee under proposed 
rule 12b-2 because there should be no significant impact on operational 
expenses due to a transition from a 12b-1 fee of that level to a 
marketing and service fee. Nevertheless, directors and legal counsel to 
these funds and their advisers may require some time and training to 
review and understand the permissible uses and limits of marketing and 
service fees, compared to current practices. Commission staff estimates 
that for each fund family with one or more funds that charge a 12b-1 
fee of 25 basis points or less, inside fund counsel would spend \462\ 
approximately 20 hours \463\ to review and understand the proposal and 
the board of directors would spend approximately 3 hours \464\ to 
review and understand their responsibilities under the proposal. 
Because inside counsel and directors are typically not paid on an 
hourly basis, and the staff does not expect that funds would hire 
additional personnel or increase the frequency of meetings as a result 
of this proposal, the staff does not anticipate that this process would 
have any specific dollar costs for funds or advisers. However, we 
recognize that this represents time that directors and counsel would 
otherwise have spent on other fund business.
---------------------------------------------------------------------------

    \462\ Throughout this analysis we will estimate the cost of the 
time spent by internal personnel in complying with the proposal, 
because the time spent represents time that would otherwise be 
available for other activities of the fund (or relevant entity). 
Although these costs may be an economic cost of the proposal, it 
would not result in new monetary costs for funds, and would not 
result in the hiring of more staff by advisers or funds.
    \463\ The staff estimates that the internal time cost equivalent 
for time spent by internal counsel is $316 per hour, for a total 
cost per fund family of $6320 (20 hours x 316 per hour = $6230). 
This estimate of $316 per hour, as well as all other internal time 
cost estimates made in this analysis (unless otherwise noted) is 
derived from SIFMA's Management & Professional Earnings in the 
Securities Industry 2009, modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits and overhead or from SIFMA's 
Office Salaries in the Securities Industry 2009, modified by 
Commission staff to account for an 1800-hour work-year and 
multiplied by 2.93 to account for bonuses, firm size, employee 
benefits and overhead.
    \464\ The staff estimates that the internal time cost equivalent 
for time spent by the boards of directors as a whole is $4500 per 
hour, for a total cost per fund family of $13,500 (3 hours x $4500 
per hour = $13,500). The staff has estimated the average cost of 
board of director time as $4500 per hour for the board as a whole, 
based on information received from funds, intermediaries, and their 
counsel.
---------------------------------------------------------------------------

    Based on these estimates, other than the costs of revising their 
disclosure documents which we analyze later in the section on the 
disclosure amendments, the staff expects that the 6482 fund classes 
that currently charge 12b-1 fees of 25 basis points or less would incur 
no new costs in complying with proposed rule 12b-2. The assets under 
management of these classes represent approximately 82% of the total 
assets under management that are currently subject to 12b-1 fees.
    We request comment on these estimates and assumptions regarding the 
costs of compliance with our proposal for funds that currently charge 
12b-1 fees of 25 basis points or less.
     Is the staff correct in estimating that, other than costs 
to amend disclosure documents, these funds would incur no new dollar 
costs in complying with this part of our proposal? Is the estimate 
regarding time spent by inside counsel and directors reasonable? Would 
funds hire additional personnel, or otherwise incur additional or 
different costs or benefits than what we have estimated here?

D. Ongoing Sales Charge: Funds

    The proposed amendments to rule 6c-10 would permit funds to deduct 
asset-based distribution fees in excess of the marketing and service 
fee in the form of an ongoing sales charge.\465\ Proposed rule 6c-10(b) 
would limit ongoing sales charges to an amount that does not exceed the 
amount of the highest front-end load that the investor would have paid 
if he or she had invested in another class of shares in the same fund. 
Funds could also comply with the proposed rule amendments by deducting 
the ongoing sales charge only until the cumulative rates imposed on 
each share purchase matches the maximum front-end load, or in some 
circumstances, the maximum sales charge limit set forth in NASD Conduct 
Rule 2830(d)(2)(A) (currently 6.25% of the amount invested). In effect, 
the proposal would treat asset-based distribution fees in excess of the 
marketing and service fee as a type of deferred sales load.
---------------------------------------------------------------------------

    \465\ For a complete discussion of the proposed ongoing sales 
charge, see Section III.D, supra. All funds that charge an ongoing 
sales charge would also incur the costs of implementing a marketing 
and service fee pursuant to proposed rule 12b-2 as well, as 
discussed in Section C above.
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1. Benefits
    We believe that the ongoing sales charge proposal would create a 
number of benefits, many of which are discussed above.\466\ The 
proposed amendment would limit the cumulative ongoing sales charges 
that may be imposed on a purchase of fund shares to a set ``reference 
load'' (generally the highest front-end load charged on the fund's 
class A shares). As a result, investors would have the benefit of 
knowing, at the time of their purchase, either the maximum amount that 
they would pay for distribution, or the maximum length of time ongoing 
sales charges would be deducted. As a result, long-term shareholders 
would be protected from paying disproportionate amounts of sales 
charges in certain share classes, as is currently possible under rule 
12b-1.\467\ Finally, the ongoing sales charge would also be clearly 
identified and described in the fund prospectus and fee table, which 
should increase

[[Page 47113]]

transparency and improve investor understanding of fees.
---------------------------------------------------------------------------

    \466\ See supra Section III.M.
    \467\ See, e.g., Comment Letter of Bridgeway Funds, Inc. and 
Bridgeway Capital Management, Inc. (July 19, 2007).
---------------------------------------------------------------------------

    We believe that the ongoing sales charge proposal would also result 
in benefits for funds and fund directors. Under our proposal, funds 
would not have to adopt a ``plan'' in order to impose an ongoing sales 
charge, and fund directors would not be required to undertake time-
consuming formal reviews and approvals of 12b-1 plans. Instead, funds 
and their boards would consider ongoing sales charges as integral parts 
of a fund's sales load structure and would review them under the same 
procedures under which boards currently review and approve the fund's 
underwriting contract. Boards could benefit from this to the extent it 
permits them to focus more on the fund's distribution system as a 
whole.
    As a result of our proposal, funds may eventually incur lower 
compliance costs in tracking the sales charge limits established by 
NASD Conduct Rule 2830. As discussed previously, NASD Conduct Rule 
2830(d)(2) imposes a complex, fund-level cap on the aggregate amount of 
sales charges, including asset-based sales charges, that may be imposed 
by funds sold by broker-dealer members. The investor-level cap on 
ongoing sales charges created by our proposal would provide an 
alternative means of ensuring that the NASD sales charge rule's maximum 
sales charge limits are not circumvented through the use of asset-based 
sales charges. If our proposal is adopted, FINRA may consider amending 
(or interpreting), this provision to eliminate the need for funds to 
track aggregate sales charges at the fund level.\468\
---------------------------------------------------------------------------

    \468\ See note 74 supra (discussing how rule 2830 provides a 
``minimum standard,'' and does not prevent a fund from developing a 
better method of tracking the loads paid by shareholders and 
ensuring that they do not overpay).
---------------------------------------------------------------------------

    If FINRA were to amend (or interpret) this provision of Rule 2830, 
it could reduce compliance costs for these funds.\469\ The staff 
estimates that funds currently spend $2000 in costs and 5 hours of 
internal staff time tracking these caps annually for each class that 
charges a 12b-1 fee in excess of 25 basis points. The costs are for 
computer and software resources, outside accountants, and other 
compliance costs. The 5 hours of internal time spent by these funds 
include 4 hours of time spent by accountants (at a cost of $153 per 
hour) and 1 hour spent by an assistant compliance director (at a cost 
of $326 per hour), for a total internal time cost equivalent of $938 
per fund class.\470\ As discussed above, approximately 7660 classes 
charge a 12b-1 fee in excess of 25 basis points, and we estimate that 
approximately 50% of these (or 3830 classes) may no longer need to 
incur these expenses. Therefore, the staff estimates a potential total 
annual cost savings of $7,660,000 and a time savings of 19,150 hours 
(representing an internal time cost equivalent of $3,592,540) \471\ for 
this portion of the proposal for all funds.
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    \469\ Funds that continue to have shares in classes with 
grandfathered 12b-1 fees pursuant to proposed rule 12b-2(d) would 
continue to incur these costs, however, during the grandfathering 
period.
    \470\ This estimate is based on the following calculations: 
($153 x 4 hours = $612; $612 + $326 = $938).
    \471\ This is based on the following calculation: ($938 x 3830 
classes = $3,592,540 time savings value; 5 hours x 3830 classes = 
19,150; $2,000 x 3830 classes = $7,660,000 cost savings).
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     We request comment on these estimates and assumptions.
    We considered several alternative methods of achieving the goals of 
this rulemaking, including potentially requiring individual shareholder 
level accounting of asset-based distribution fees, and prohibiting the 
deduction of asset-based distribution fees entirely. Although these 
alternatives might result in some of the benefits of the ongoing sales 
charge proposal, we expect they would come at a significant cost. Our 
proposal for an ongoing sales charge instead is designed to provide 
many of these benefits to investors, without significantly disrupting 
current distribution models or requiring most funds and intermediaries 
to develop costly new operating systems.
2. Costs
    If adopted, the limitations on ongoing sales charges contained in 
proposed rule 6c-10(b) would require funds that currently charge 12b-1 
fees in excess of 25 basis points to amend their share classes and/or 
alter their operations in one of several ways. First, some funds may 
choose to amend their share classes so that they conform to the new 
requirements (e.g., by reducing their fees to a level that would not 
implicate the ongoing sales charge limitations). Second, other funds 
might restructure their expenses and separate non-distribution related 
expenses from their asset-based distribution fees in order to keep 
total fees from exceeding 25 basis points. Third, some funds might keep 
their present share classes, but issue new shares that comply with the 
proposed rule amendments after a certain date (i.e., ``old'' and 
``new'' shares would be mixed in the same class). Fourth, other funds 
might create new share classes on or before the compliance date that 
meet the proposal's requirements. The chosen method of complying with 
the new requirements would likely be driven by the fund's business 
model and the cost-effectiveness of each option given the fund's 
particular circumstances. In general, the staff assumes that either 
funds or their advisers or other service providers would bear the costs 
of implementing these changes.\472\ The costs of each of these 
potential compliance options are discussed below.
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    \472\ Fund families are organized in many ways, with some having 
affiliated transfer agents, underwriters and other service 
providers, and others contracting these services out to unaffiliated 
third parties. The staff understands that some contracts obligate 
the fund to reimburse the transfer agent for system costs related to 
regulatory changes, while other contracts require the transfer agent 
to bear these expenses. Because of the variability in these contract 
terms, throughout this analysis, when the staff estimates costs, the 
staff generally assumes that the estimated costs would be borne 
directly by the affiliated service providers and the fund family, or 
indirectly through increased expenses charged by unaffiliated 
service providers. Except in the case of retirement plan record 
keepers, who may face unique issues in responding to this proposal, 
the staff does not break these costs out separately.
---------------------------------------------------------------------------

a. Fee Reductions
    Funds with classes that currently charge 12b-1 fees of more than 25 
basis points might determine that it would be cost effective to reduce 
their asset-based distribution fees to the 25 basis point cap of the 
marketing and service fee. Funds could accomplish this by either 
reducing their distribution expenses or shifting a portion of the costs 
to their adviser or another party. These funds could continue offering 
their existing share classes without having to provide for a conversion 
period under proposed rule 6c-10(b).
    We anticipate that, out of the funds that charge a 12b-1 fee of 
more than 25 basis points, only those funds that charge up to 30 basis 
points would likely reduce their asset-based distribution fee to 25 
basis points or less. We expect that funds that charge more than 30 
basis points would be unlikely to find the reduction to 25 basis points 
or less to be the most cost effective means of complying with our 
proposal, and therefore would be unlikely to pursue this alternative. 
Commission staff estimates that there are approximately 471 fund 
classes that charge 12b-1 fees of more than 25 up to and including 30 
basis points (representing $143 billion in assets), and that 40% of 
these classes (188) may reduce their fees to 25 basis points or less in 
response to our proposal. The average class that charges 12b-1 fees in 
this range has approximately $304 million in assets. If a class with 
$304 million in assets that charged 30 basis

[[Page 47114]]

points reduced its 12b-1 fees to 25 basis points, investors in that 
class would see their 12b-1 fees reduced by approximately $152,000 
annually. If all of the classes that chose to reduce their fees charged 
the full 30 basis points, the maximum fee reduction would be 
approximately $28,576,000 a year.\473\
---------------------------------------------------------------------------

    \473\ This estimate is based on the following calculation: 
($152,000 x 188 classes = $28,576,000).
---------------------------------------------------------------------------

    These reductions in fees could be viewed as a cost to these funds 
or their advisers. Nonetheless, investors in the funds would experience 
a corresponding and offsetting dollar-for-dollar benefit due to lower 
expenses. In any event, a fund likely would only elect this alternative 
if it determined that the reduction would be cost effective. We request 
comment as to the likelihood that funds would respond to our proposal 
with fee reductions.
     Are we correct in assuming that only funds that charge 
between 25 and 30 basis points are likely to reduce their fees? How 
many funds would choose this option? What kind of costs would they or 
their affiliates bear to reduce their current 12b-1 fee, if any?
b. Fee Restructuring
    Many funds currently pay for expenses that are not distribution 
related with 12b-1 fees (such as administrative, sub-transfer agency, 
or other fees). As a result, we expect that some funds with classes 
that impose 12b-1 fees of more than 25 basis points, up to and 
including 50 basis points (e.g., some A and R share classes), might 
instead be able to treat the amount greater than 25 basis points as a 
fund operating expense. These funds would have to carefully examine 
their 12b-1 fees and identify which, if any, expenses could be properly 
classified as non-distribution expenses. If non-distribution expenses 
paid through 12b-1 plans are significant enough, these funds might be 
able to reduce their asset-based distribution fees to the 25 basis 
point cap and avoid being subject to the ongoing sales charge limits 
and conversion periods in proposed rule 6c-10(b).
    The staff estimates that there are approximately 2168 fund classes 
that charge 12b-1 fees of more than 25 up to and including 50 basis 
points. The staff previously estimated that approximately 188 of these 
classes may respond by reducing their fees, leaving a total of 1980 
classes that fall into this category. Of those classes, the staff 
estimates that approximately 50% (or 990 classes) may be able, and find 
it cost effective, to re-characterize a portion of their current 12b-1 
fee.
    We expect that funds that choose this course of action would incur 
the costs of: (i) Conducting an internal review of the fees and 
expenses charged by the affected share classes; (ii) amending fund 
prospectuses and disclosure documents to reflect the fee re-structuring 
(as discussed in greater detail below); and (iii) modifying operational 
and accounting systems to reflect the restructured fees. The staff 
estimates that it would take approximately 20 hours of inside counsel 
time (at an internal time cost equivalent of $316 per hour), and 1 hour 
of time for each board as a whole (at an internal time cost equivalent 
of $4500 per hour), for a total internal time cost equivalent of 
$10,820 to complete these tasks for each class.\474\ The staff 
estimates that funds may incur an additional $5,000 in outside counsel 
expenses associated with the internal review and disclosure 
changes.\475\
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    \474\ This is based on the following calculations: ($316 x 20 = 
$6320); ($6320 + $4500 = $10,820).
    \475\ Any operational and accounting system costs would be 
likely made at the fund family level, and are included in the 
staff's estimated costs for fund families complying with the ongoing 
sales charge proposal, as discussed below.
---------------------------------------------------------------------------

    Therefore, we estimate that it would cost the 990 fund classes that 
might perform this internal review and re-assessment of expenses 
approximately $4,950,000 in outside expenses and $10,711,800 in 
internal time cost equivalent to comply with our proposal.\476\ We 
assume that the other 990 fund classes that charge between 25 and 50 
basis points in 12b-1 fees, but do not re-assess these fees or 
otherwise reduce their fees to 25 basis points or less, would impose an 
ongoing sales charge in compliance with proposed rule 6c-10(b). Their 
costs are discussed below.
---------------------------------------------------------------------------

    \476\ This estimate is based on the following calculations: 
($5000 per class x 990 classes = $4,950,000 total expenses); 
($10,820 per class x 990 classes = $10,711,800 total internal time 
cost equivalent).
---------------------------------------------------------------------------

    We request comment on these estimates and assumptions.
     Is the staff's estimate of $5,000 per fund class for 
outside counsel expenses, 20 hours of inside counsel time, and 1 hour 
of board time reasonable for the internal review and disclosure 
amendment process? If not, what would be a better estimate? Are there 
other costs that might be associated with such a review?
c. Ongoing Sales Charge: Conversion and Modified Share Classes
    Under our proposed amendments to rule 6c-10, funds with asset-based 
distribution fees in excess of 25 basis points (i.e. with ongoing sales 
charges) that issue new shares after the compliance date, must have, or 
create, a share class that does not impose an ongoing sales charge 
(such as a typical class A) into which shares with the ongoing sales 
charge would convert after a set period of time (a ``target 
class'').\477\ We anticipate that there would be two primary sets of 
costs that these fund families may incur related to our proposed 
amendments to rule 6c-10: (i) Updating or creating a conversion system, 
and (ii) amending or creating new share classes. Both sets of costs 
would include expenses related to building or enhancing systems and 
back office technology and operations.
---------------------------------------------------------------------------

    \477\ See supra Section III.D for a further discussion of the 
operation of the proposed rule.
---------------------------------------------------------------------------

(i) Conversion System
    As a preliminary matter, the staff estimates that approximately 90% 
(or 186) of the 207 fund families \478\ that may be affected by our 
proposed amendments to rule 6c-10 have at least one fund with a class 
of B shares and, as a result, have a conversion system in place that 
they could use to convert shares with ongoing sales charges. The staff 
estimates that it may cost a fund family $100,000 in one time initial 
costs, and $50,000 annually, to modify an existing B share conversion 
system to manage the conversions of funds with ongoing sales charges. 
These costs would include: (i) Computer hardware needed to store an 
increased volume of transaction activity; (ii) computer software to 
expand and update the systems' ability to track share lots and convert 
the shares based on the new aging schedules; and (iii) expanding back 
office and accounting operations and hiring and training additional 
back office personnel.
---------------------------------------------------------------------------

    \478\ As we have discussed previously, a number of funds may 
avoid these costs by reducing their asset-based distribution fees or 
by re-characterizing expenses. Although some funds in a family may 
be able to avoid such costs, it may be that only a few funds in the 
family could do so, and therefore the fund family as a whole would 
still incur these costs of complying with this part of our proposal. 
The staff has therefore chosen to be conservative and include all 
fund families that might be affected by the ongoing sales charge 
proposal in the cost estimates below.
---------------------------------------------------------------------------

    The other 10% or 21 fund families that do not have conversion 
systems may incur additional costs to create a conversion system, or 
contract for one through an external service provider. The staff 
estimates that it would cost a fund family (or its affiliated transfer 
agent) approximately $250,000 in initial costs and $100,000 in annual 
costs to purchase or create a conversion system, integrate existing 
computers, software, and networks, train personnel, and

[[Page 47115]]

update records. The staff estimates it would cost approximately the 
same amount to outsource this type of system to an outside vendor. 
Because a fund family's class structure generally is intimately tied to 
its conversion system, as discussed below, we expect that the decision 
to amend or create new share classes would be made in coordination with 
any changes to the conversion system.
(ii) Operational Changes and Modified Share Classes
    Next, we describe four potential routes that we believe fund 
families could use to come into compliance with our proposed amendments 
to rule 6c-10. In addition, we describe the staff's estimates of the 
number of fund families that may use each route and the potential 
costs. These routes include: (1) Retaining existing share class 
structures and conversion systems; (2) updating the fund family's 
existing conversion system and amending the class structure; (3) 
updating the fund family's existing conversion system, amending the 
class structure, and creating new share classes; and (4) creating/
purchasing a new conversion system, amending the class structure, and 
creating new share classes. Because these routes are general paths to 
compliance with our proposed amendments to rule 6c-10, we expect that 
the experience of each fund family would likely vary significantly from 
the average costs outlined below. In addition, some fund families may 
need to ``mix and match'' parts of these outlined routes to meet the 
particular needs of each fund within the fund family. However, we would 
expect that affected fund families would generally comply with the 
proposed amendments in one of the ways described above.
    Funds would also have a variety of choices in managing shares with 
12b-1 fees that have been grandfathered pursuant to proposed rule 12b-
2(d). Some fund families may choose to retain grandfathered 12b-1 share 
classes for the period allowed, and amend those classes so that future 
share purchases comply with the proposed amendment to rule 6c-10 
(essentially mixing shares with differing conversion dates in the same 
class), and then converting or exchanging the grandfathered shares into 
the amended classes after five years. Other fund families may decide 
not to grandfather 12b-1 shares and instead amend their existing 
classes to fully comply with the proposed amendments to rule 6c-10 for 
both new and existing shareholders (effectively applying the 
requirements of the proposal to existing shares and not taking 
advantage of the grandfathering provisions of proposed rule 12b-2(d)). 
Finally, some funds may choose to manage grandfathered shares by 
leaving those assets in existing classes for the period allowed, and 
creating new share classes for all future share purchases, and then 
converting or exchanging the grandfathered shares into the new classes 
after five years. In any event, we anticipate that fund families would 
choose the method that is most cost-effective and is in the best 
interest of the fund family and its shareholders. The method of 
managing share classes with grandfathered 12b-1 fees selected by the 
fund family is likely to influence the route that the fund family would 
select in complying with our proposed amendments to rule 6c-10(b), and 
we have included the costs of managing share classes with grandfathered 
fees in the staff's estimates below.\479\
---------------------------------------------------------------------------

    \479\ Funds that amend or update existing share classes as a 
result of our proposal would provide notification to their existing 
shareholders. If the proposal is adopted, we anticipate providing a 
transition period of at least 18 months, which should allow most 
funds to provide this notification in their next regularly scheduled 
prospectus update, or in an annual or semi-annual report. In some 
cases, due to timing constraints, a fund may determine that it needs 
to ``sticker'' its registration statement and inform its 
shareholders of the share class changes in a separate and 
unscheduled communication. These funds would incur additional costs.
---------------------------------------------------------------------------

Route 1: Retain Existing Share Class Structure and Conversion Systems
    A fund family that sells funds with an existing class structure 
that already generally complies with our proposed amendments to rule 
6c-10 might only need to make minor changes to its operations in 
response to our proposal. A fund family that does not sell C shares, 
sells B shares that convert at a time that is consistent with proposed 
rule 6c-10(b), and has a target class for converted shares (i.e., a 
class that deducts 25 basis points or less in asset-based distribution 
fees), would be included in this category.\480\ The costs and time 
expended by such a fund family to comply with the proposed amendments 
to rule 6c-10 would include: Reviewing the requirements of the rule (if 
adopted); updating fund prospectuses, SAIs, and shareholder reports to 
reflect the changed terminology and function of the two new types of 
asset-based distribution fees; reviewing and making any necessary 
updates to compliance policies and procedures; hiring outside counsel 
to perform these reviews and updates; and providing training to 
relevant internal personnel (i.e., staff from the fund, adviser, or 
underwriter).
---------------------------------------------------------------------------

    \480\ Such a fund would be unlikely to incur any costs relating 
to managing shares with grandfathered 12b-1 fees because its 
existing class structure would already be in compliance with our 
proposed amendments and, thus, it would not need to maintain 
separate classes for shares with grandfathered 12b-1 fees.
---------------------------------------------------------------------------

    The staff estimates that approximately 15% (or 28) of the 186 fund 
families that may be affected would be able to comply with the proposal 
by making these minor changes to their operations. The staff estimates 
that fund families that would make these operational changes would 
incur approximately $20,000 in one-time costs, and 100 hours of time 
expended by internal personnel to implement these changes for the 
entire fund family. The staff estimates that the 100 hours spent by 
internal personnel would break down as follows: 50 hours spent by 
accountants and other back office personnel at $153 per hour; 30 hours 
spent by programmers and other IT personnel at $190 per hour; 18 hours 
spent by internal counsel at $316 per hour; and 2 hours spent by the 
board of directors at $4500 per hour, for a total internal time cost 
equivalent of $28,038.\481\ The staff therefore estimates that the 
total costs for all affected fund families that use this route would be 
$560,000 in one-time costs and 2800 hours of internal personnel time 
expended at a total internal time cost equivalent of $785,064.\482\
---------------------------------------------------------------------------

    \481\ These figures are based on the following calculations: (50 
hours x $153 = $7650); (30 hours x $190 = $5700); (18 hours x $316 = 
$5688); (2 hours x $4500 = $9000); ($7650 + $5700 + $5688 + $9000 = 
$28,038 total internal time cost equivalent).
    \482\ These figures are based on the following calculations: 
($20,000 costs x 28 fund families = $560,000); (100 hours x 28 fund 
families = 2800); ($28,038 x 28 fund families = $785,064).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.
Route 2: Update Conversion System and Make Amendments to Class 
Structure
    Alternatively, funds might need to make amendments to their 
existing share classes to comply with our proposal.\483\ These funds 
may need to change the conversion period of their class B shares, 
institute a conversion period for class C shares, or make other changes 
to their class structure. However, the staff assumes that fund families 
that choose this route would not need to create new share classes, 
because they would already have a target class for conversions that 
meets the requirements of proposed rule 6c-10(b) (e.g., an existing 
share class with

[[Page 47116]]

12b-1 fees of 25 basis points or less). The staff expects that these 
fund families would not choose to create new share classes for 
purchases made after the compliance date of the proposal (if adopted), 
but would instead amend their existing classes.\484\ These fund 
families would also have to update their conversion systems, at a 
previously estimated one-time cost of $100,000 and $50,000 annually. 
The staff estimates that approximately 50% (or 93) of the 186 fund 
families that may be affected would need to amend their existing share 
classes as a result of our proposal. The staff estimates that, on 
average, each fund that amends its share classes would need to amend an 
average of two share classes. The staff estimates that it would 
typically cost approximately $10,000 and 25 hours of internal personnel 
time to amend a share class to meet the requirements of our proposed 
amendments to rule 6c-10.
---------------------------------------------------------------------------

    \483\ Pursuant to rule 18f-3, fund share classes are required to 
be organized according to a written plan that is approved by the 
fund's directors, and thus this plan must be amended when changes 
are made to a share class.
    \484\ Instead, they would either amend existing classes to mix 
grandfathered 12b-1 fee shares with new purchases with differing 
conversion dates, or would not grandfather existing 12b-1 fees. In 
either case, these funds would amend existing share classes, but 
would not create new ones. The costs for funds that choose to create 
new share classes as a means of managing share classes with 
grandfathered 12b-1 fees or in response to our proposed amendments 
to rule 6c-10 are described in our discussion of route 3, below.
---------------------------------------------------------------------------

    However, the staff expects that most fund families would amend all 
of the relevant share classes at the same time as part of a coordinated 
plan for compliance with the proposed rules, and therefore should be 
able to achieve significant economies of scale. Much of the work 
involved in amending one share class is similar to that involved in 
amending other classes, and if all amendments are undertaken at the 
same time, significant efficiencies and elimination of duplicative 
effort should result. The staff therefore estimates that a fund family 
with 35 funds (the average for fund families that have at least one 
fund with 12b-1 fees in excess of 25 basis points) would incur a total 
of $100,000 in outside expenses and 250 hours of internal personnel 
time expended. The time would represent approximately 140 hours spent 
by accountants and other back office personnel at a rate of $153 per 
hour, 100 hours spent by inside counsel at a rate of $316 per hour, and 
10 hours spent by the board of directors as a whole, at a rate of $4500 
per hour, for a total internal time cost equivalent of $98,020.\485\
---------------------------------------------------------------------------

    \485\ These figures are based on the following calculations: 
($153 x 140 hours = $21,420); ($316 x 100 hours = $31,600); ($4500 x 
10 hours = $45,000); ($21,420 + $31,600 + $45,000 = $98,020).
---------------------------------------------------------------------------

    These costs and time expenditures would include internal staffing 
and outside counsel review to establish the amended terms of the class, 
creating and/or amending relevant disclosure documents, amending the 
written plan setting forth the terms of the funds' class structure, 
holding a director vote on the class plan if necessary, any training 
expenses, costs related to amending distribution or underwriting 
agreements, and any costs related to altering the terms of the class on 
the fund or its transfer agent's systems, the costs of exchanging or 
converting remaining grandfathered shares into appropriate share 
classes after the expiration of the grandfathering period, as well as 
the costs of updating the fund family's operations discussed 
above.\486\ The staff assumes that the costs of maintaining these 
amended share classes would be the same as the cost of maintaining 
current share classes, and therefore the staff estimates that funds 
that choose this option would incur no additional ongoing annual cost 
burden.
---------------------------------------------------------------------------

    \486\ The costs of amending the fund family's operations, as 
discussed above under route 1, is included in this estimate.
---------------------------------------------------------------------------

    Therefore, the staff estimates that each fund family would incur 
$100,000 in costs and 250 hours in internal personnel time (at an 
internal time cost equivalent of $98,020) to amend their share classes, 
and an additional $100,000 in one-time costs and $50,000 in annual 
costs to update their conversion systems, for a total one-time cost of 
$200,000, annual costs of $50,000, and 250 hours of time expended for 
each of these fund families to comply with the ongoing sales charge 
portion of our proposal. Based on these estimates, the staff further 
estimates that all 93 potentially affected fund families that may 
choose this option would incur a total of $18,600,000 in one-time 
costs, $4,650,000 annually, and 23,250 hours in one-time internal 
personnel time expended at an internal time cost equivalent of 
$9,115,860.\487\
---------------------------------------------------------------------------

    \487\ These figures are based on the following calculations: 
($200,000 one-time costs x 93 fund families = $18,600,000); ($50,000 
annually x 93 fund families = $4,650,000); (250 hours x 93 fund 
families = 23,250 hours); ($98,020 x 93 fund families = $9,115,860).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.
Route 3: Update Conversion System, Make Significant Changes to Class 
Structure, and Create New Share Classes
    Other fund families may need to create new share classes to comply 
with our proposed amendments to rule 6c-10. These fund families might 
need to create new share classes either because they do not have an 
appropriate target class for conversions (for example, if their class A 
shares deduct more than 25 basis points in asset-based distribution 
fees), or if they chose to maintain grandfathered 12b-1 assets in 
existing share classes and create new share classes for all future 
share purchases after the compliance date of the rule (if 
adopted).\488\ In addition to creating new share classes, these fund 
families would also likely need to amend their existing share classes. 
These fund families would also need to update their conversion systems, 
at a previously estimated one-time cost of $100,000, and $50,000 
annually.\489\
---------------------------------------------------------------------------

    \488\ For example, a fund might have a class A that deducts 35 
basis points in asset-based distribution fees, class B shares that 
convert at a date later than the proposal would require, and class C 
shares that do not convert. This fund might need to create a new 
class A that deducts 25 basis points or less as a target class for 
conversions, and if the fund chose to maintain grandfathered assets 
in the existing A and C shares classes, might also create a new 
class A and C that meets the terms of the proposal. In addition, the 
fund may choose to amend the conversion requirements of the class B 
shares to comply with the requirements of the proposal for both new 
and existing shareholders (``mixing'' conversion dates in the same 
class). This fund would be creating three new share classes and 
amending one other class.
    \489\ See supra Section V.D.2.c.(i).
---------------------------------------------------------------------------

    The staff estimates that the remaining 35% (or 65) of 186 
potentially affected fund families with conversion systems would create 
new share classes in response to our proposed amendments to rule 6c-10. 
The staff estimates that it would cost each fund approximately $100,000 
and 100 hours of internal personnel time to create a new share 
class.\490\ These expenses would include internal staffing and outside 
counsel involvement to establish the terms of the new class, create 
and/or amend relevant disclosure documents, amend the written plan 
setting forth the terms of the funds' class structure, hold a director 
vote if necessary, any training expenses, the costs of amending 
distribution and underwriting agreements, the costs of exchanging or 
converting remaining grandfathered shares into appropriate share 
classes after the expiration of the grandfathering period, any costs 
related to implementing the new class on the fund's or transfer agent's 
systems, and any costs related to updating the fund's operations 
discussed above. The staff's estimate assumes that the costs of 
maintaining these new share classes would be the same as the costs of 
maintaining current share classes, and the staff estimates that funds 
that choose

[[Page 47117]]

this option would incur no additional ongoing annual cost burden 
related to the class structure changes. The staff estimates that, on 
average, each fund that creates new share classes would need to create 
two new share classes and amend one additional share class (at the same 
cost as amending share classes discussed above).
---------------------------------------------------------------------------

    \490\ As discussed below, funds that choose this option would 
likely achieve significant cost savings and economies of scale by 
creating all new classes simultaneously. To be conservative, 
however, Commission staff has also estimated the costs of creating 
each class individually.
---------------------------------------------------------------------------

    However, as discussed previously, the staff expects that most fund 
families would make all necessary changes to their distribution 
structure as part of a coordinated plan for compliance with the 
proposed rules, and therefore should be able to achieve significant 
economies of scale and costs savings over the costs of amending or 
creating a single share class. For example, often, a number of funds in 
a family share a single prospectus, which could be amended at a single 
time, and the class structure could be amended with a single director 
vote. In light of these expected economies of scale, the staff 
estimates that a typical fund family would incur $800,000 in costs and 
500 hours in internal personnel time to create new share classes, and 
$50,000 in costs and 100 hours in internal personnel time expended to 
amend existing share classes, for a total of $850,000 in outside costs 
and 600 hours of internal personnel time expended. The internal 
personnel time expended would include approximately 200 hours spent by 
programmers and other back office IT staff at a rate of $190 per hour, 
200 hours spent by accountants at a rate of $153 per hour, 190 hours 
spent by inside counsel at a rate of $316 per hour, and 10 hours spent 
by the board of directors as a whole at $4500 per hour, for a total 
internal time cost equivalent of $173,640.\491\ Including $100,000 in 
one-time costs and $50,000 in annual costs to update their conversion 
systems, the total cost for each fund family would be $950,000 in one-
time costs, $50,000 in annual costs and 600 hours expended.
---------------------------------------------------------------------------

    \491\ These figures are based on the following calculations: 
($190 x 200 hours = $38,000); ($153 x 200 hours = $30,600); ($316 x 
190 hours = $60,040); ($4500 x 10 hours = $45,000); ($38,000 + 
$30,600 + $60,040 + $45,000 = $173,640).
---------------------------------------------------------------------------

    Based on these staff estimates, the 65 potentially affected fund 
families would incur a total of $61,750,000 in one-time costs, 
$3,250,000 in annual costs, and 39,000 hours in one-time internal 
personnel time expended (at an internal time cost equivalent of 
$11,286,600) to comply with our proposal.\492\
---------------------------------------------------------------------------

    \492\ These figures are based on the following calculations: 
($950,000 one-time costs x 65 fund families = $61,750,000); ($50,000 
annually x 65 fund families = $3,250,000); (600 hours x 65 fund 
families = 39,000 hours); ($173,640 x 65 fund families = 
$11,286,600).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.
Route 4: Purchase New Conversion System, Make Significant Changes to 
Class Structure, and Create New Share Classes
    Finally, if our proposed amendments to rule 6c-10 are adopted, some 
funds would have to purchase or create a conversion system. As 
previously discussed, the staff estimates that 10% or 21 fund families 
that may be affected by our proposed amendments to rule 6c-10 currently 
do not have a conversion system, either because they only sell a single 
class of shares, or if they sell multiple classes of shares, none of 
their share classes has a conversion feature. The staff has previously 
estimated that it would cost approximately $250,000 in initial costs 
and $100,000 in annual costs to purchase or create a conversion system.
    In addition to purchasing a new conversion system, these fund 
families would also need to create a new target class for converted 
shares and amend existing share classes to meet the requirements of our 
proposed amendments to rule 6c-10. For example, if a fund sold only 
class C shares that deducted asset-based distribution fees in excess of 
25 basis points, the fund would need to create a new target class for 
converted shares. In addition, if the fund chose to maintain 
grandfathered 12b-1 assets in the existing class, the fund may need to 
create a second class of shares for future purchases. On the other 
hand, if the fund chose to dispense with grandfathering 12b-1 fees, it 
might amend the existing C class so that it complied with our proposed 
amendments to rule 6c-10 for both existing and new shareholders.
    The staff has previously estimated that it may cost each fund 
approximately $100,000 and 100 hours of internal personnel time to 
create a new share class and $10,000 and 25 hours to amend a share 
class. The staff assumes that each affected fund that does not 
currently convert shares would have to create two new share classes and 
amend one additional share class to meet the requirements of the 
proposed amendments to rule 6c-10.
    However, as discussed previously, the staff expects that most fund 
families would make all necessary changes to their distribution 
structure as part of a coordinated plan for compliance with the 
proposed rules, and therefore should be able to achieve significant 
economies of scale and costs savings over the costs of amending or 
creating a single share class. In light of these expected economies of 
scale, the staff estimates that each fund family would incur $800,000 
in costs and 500 hours in internal personnel time to create new share 
classes, and $50,000 in costs and 100 hours in internal personnel time 
expended to amend existing share classes, for a total of $850,000 in 
outside costs and 600 hours of internal personnel time expended. The 
internal personnel time expended would include approximately 200 hours 
spent by programmers and other back office IT staff at a rate of $190 
per hour, 200 hours spent by accountants at a rate of $153 per hour, 
190 hours spent by inside counsel at a rate of $316 per hour, and 10 
hours spent by the board of directors as a whole at $4500 per hour, for 
a total internal time cost equivalent of $173,640.\493\ Including 
$250,000 in one-time costs and $100,000 in annual costs to purchase or 
build a conversion system, the total cost for each fund family would be 
$1,100,000 in one-time costs, $100,000 in annual costs and 600 hours 
expended.
---------------------------------------------------------------------------

    \493\ These figures are based on the following calculations: 
($190 x 200 hours = $38,000); ($153 x 200 hours = $30,600); ($316 x 
190 hours = $60,040); ($4500 x 10 hours = $45,000); ($38,000 + 
$30,600 + $60,040 + $45,000 = $173,640).
---------------------------------------------------------------------------

    Based on these staff estimates, the 21 potentially affected fund 
families would incur a total of $23,100,000 in one-time costs, 
$2,100,000 in annual costs, and 12,600 hours in one-time internal 
personnel time expended (at an internal time cost equivalent of 
$3,646,440) to comply with our proposal.\494\
---------------------------------------------------------------------------

    \494\ These figures are based on the following calculations: 
($1,100,000 one-time costs x 21 fund families = $23,100,000); 
($100,000 annually x 21 fund families = $2,100,000); (600 hours x 21 
fund families = 12,600 hours); ($173,640 x 21 fund families = 
$3,646,440).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.

E. Ongoing Sales Charge: Investors

    Investors currently appear to have difficulty understanding 12b-1 
fees and the activities and services for which they are used.\495\ Our 
proposal would differentiate between the two constituent parts of 
current 12b-1 fees (asset-based sales charges and service fees). It 
would allow funds to use a limited amount of assets as a marketing and 
service fee, and deduct any excess amounts over the marketing and 
service fee as an ongoing sales charge. The renamed fees would appear 
separately in an amended fee table in the prospectus under the headings 
``marketing and service fees'' and ``ongoing sales charge.''
---------------------------------------------------------------------------

    \495\ See supra Section II.E.

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[[Page 47118]]

    By more clearly identifying the two types of asset-based 
distribution fees, we expect that the proposal would make it easier for 
investors to understand when they are paying a sales charge. In 
addition, these proposed changes to the fee table and the revised 
narrative disclosure in the prospectus should also help investors 
better understand the services they are paying for through the 
marketing and service fee and the ongoing sales charge. This improved 
understanding should help investors more easily compare sales charges 
in alternative share classes and competing funds and, therefore, choose 
the sales charge option that best meets their investment needs. We 
anticipate that this would lead investors to choose lower priced 
offerings of funds or share classes that offer comparable services, 
which should lead to greater price competition among funds and lower 
sales charges.
    Investors empowered with this information may invest differently. 
Although we cannot predict investor behavior, we assume that if offered 
lower prices for the same services, or provided with better information 
regarding the distribution services received, many investors would 
choose to move their investments to, or make new investments in, a fund 
or share class with lower asset-based distribution fees or loads. 
Conversely, investors may decide to avoid funds that charge high asset-
based distribution fees if they believe that they would not get, or 
want, commensurate levels of service. We expect that investors who 
choose to shift invested assets would only move assets that are not 
subject to a CDSL, or on which they had not already paid a front-end 
load. Thus, we do not anticipate that investors would shift assets 
invested in class A or B shares if our proposal were adopted. In 
addition, our proposal would require that assets held for long periods 
of time in level load classes (for example, class C shares) eventually 
convert to classes that do not deduct an ongoing sales charge, which 
would result in a net movement of assets out of these level load 
classes into lower cost classes.
    Commission staff estimates that approximately $686 billion in total 
net assets currently are invested in level load share classes, and that 
approximately $3.4 billion in 12b-1 fees are deducted from these assets 
fees annually, for an average 12b-1 fee as a percentage of total net 
assets in these classes of 50 basis points.\496\ The staff further 
estimates that if our proposed rule and disclosure amendments are 
adopted, improved investor understanding of distribution related 
charges would result in an aggregate total of between five and ten 
percent of assets currently invested in level load classes (for 
example, C shares) moving to share classes (within the same fund or in 
a different fund) that do not deduct an asset-based distribution fee. 
If five percent of the $686 billion in assets in these classes (or $34 
billion) were moved to share classes without asset-based distribution 
fees, at an annual 12b-1 fee rate of 50 basis points, investors would 
save approximately $170 million annually.\497\ If ten percent of the 
$686 billion in assets in these classes (or $68 billion) were moved to 
share classes without asset-based distribution fees, investors would 
save approximately $340 million annually.\498\ Over a ten-year period, 
this would represent a potential savings of between $1.7 billion and 
$3.4 billion to investors in asset-based distribution fees that they 
would otherwise have paid, but would avoid because of better informed 
decision making.
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    \496\ We recognize that some portion of the 50 basis points may 
represent service fees and that an investor who shifts their assets 
from a level load fund class may still select a fund class that 
charges a service fee or a reduced ongoing sales charge. However, 
for purposes of this analysis, the result of the staff's estimates 
represent the total cumulative effect of all asset movement from 
level load funds to no-load or lower load funds.
    \497\ This estimate is based on the following calculation: 
($34,000,000,000 x 0.005 = $170,000,000).
    \498\ This estimate is based on the following calculation: 
($68,000,000,000 x 0.005 = $340,000,000).
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    If our proposal is adopted, we would provide a grandfathering 
provision for current 12b-1 share classes for a five-year period. 
However, at the end of that five-year period, all shares that are 
currently subject to a 12b-1 plan would need to be converted or 
exchanged into a class that does not deduct an ongoing sales charge and 
with a marketing and service fee that is no higher than the 12b-1 fee 
in effect in the previous fiscal year. This expiration of the 
grandfathering period would effectively time limit level load share 
classes as they exist today. All assets that remain in level load share 
classes after the expiration of the grandfathering period would need to 
be converted to a class that does not deduct an ongoing sales charge; 
effectively a class that charges 25 basis points or less in asset-based 
distribution fees. This conversion or exchange would benefit investors 
who remained in these level load classes at the end of the 
grandfathering period to the extent that the asset-based distribution 
fees on the share class they are converted into is lower than the 
current 12b-1 fee.
    The staff estimated above that the average 12b-1 fee on level load 
share classes is 50 basis points. Because no ongoing sales charge could 
be charged on the converted or exchanged shares and the highest 
marketing and service fee allowed under the proposal is 25 basis 
points, the staff estimates that investors who remain in the 
grandfathered 12b-1 share class would save 25 basis points a year after 
the expiration of the grandfathering period. However, as discussed 
above, the staff estimates that some investors may move their existing 
level load assets to lower load classes as a result of this proposal, 
and further reductions in the assets of existing level load share 
classes may occur through redemptions or reduced investment. The staff 
estimates that at the expiration of the grandfathering period in five 
years, approximately 50% of the $686 billion (or $343 billion) in 
existing level load share class assets will remain. Upon the conversion 
or exchange of these assets into share classes that do not deduct an 
ongoing sales charge, the staff estimates that investors in these 
classes will save 25 basis points a year (the asset-based distribution 
fees charged in excess of the amount permitted as a marketing and 
service fee), or a total of $857,500,000 annually.\499\
---------------------------------------------------------------------------

    \499\ This estimate is based on the following calculation: 
($343,000,000,000 x 0.0025 = $857,500,000).
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    In addition, if our proposal is adopted, we estimate that net new 
investments in level load fund classes would decline as investors 
choose share classes with no or lower sales charges, whether in the 
form of an asset-based distribution fee, front-end load or CDSL, and as 
a result of requirements in the proposal to eventually convert shares 
that charge an ongoing sales charge into a class that does not deduct 
such a fee at a set time. The staff estimates net new investments in 
level load fund classes may decline between ten and twenty percent as a 
result of our proposal (with a commensurate increase in net new 
investments in no or low load funds). Based on a review of Lipper's 
LANA Database and data filed with the Commission, the staff estimates 
that approximately $52 billion in net new cash flowed to level load 
classes in 2009, with those level load classes charging an average 
asset-based distribution fee of approximately 50 basis points. Assuming 
that there would be similar net cash flow to these classes in future 
years, if ten percent of the net new cash flow to level load classes 
(or

[[Page 47119]]

$5.2 billion) is invested in classes that do not charge asset-based 
distribution fees, Commission staff estimates that investors would save 
approximately $26 million annually.\500\ If twenty percent of the net 
new cash flow to these classes (or $10.4 billion) is instead invested 
in classes that do not charge asset-based distribution fees, Commission 
staff estimates that investors would save approximately $52 million 
annually.\501\ Over a ten-year period, this represents potential 
savings of between $260 million and $520 million for investors who 
might be better served in other classes with a more appropriate level 
of service for their needs or wants.
---------------------------------------------------------------------------

    \500\ This estimate is based on the following calculation: 
($5,200,000,000 x .005 = $26,000,000).
    \501\ This estimate is based on the following calculation: 
($10,400,000,000 x .005 = $52,000,000).
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    As discussed above, we expect that one result of our proposal would 
be a net shift by investors to lower load share classes. As part of 
this net shift, we would expect that some investors might determine 
that they need or want continuing high levels of service, and may 
choose to move their assets out of level load share classes and into 
fee-based or wrap fee accounts, which may have higher expenses than the 
level load share classes the investor had previously owned.\502\ These 
investors may pay higher expenses as a result of this choice, but would 
presumably also receive higher levels of service, and the ability to 
trade between funds in different fund families without paying 
additional loads. The proposal would provide investors with better 
information regarding the asset-based distribution fees they pay, which 
should enhance the ability of investors to select the type of account 
or method of paying distribution fees that is best for them, even if 
some investors choose to invest through more costly methods as a 
result.
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    \502\ Other investors, however, would move their assets into 
lower cost funds, as discussed previously. Level-load share classes 
typically deduct 100 basis points or less in asset-based 
distribution fees annually. Fee-based or wrap accounts often charge 
higher fees (between 100 and 200 basis points annually) but the 
broker-dealers that offer wrap accounts also provide additional 
services and transaction options for their clients.
---------------------------------------------------------------------------

    There is some question as to whether a reduction in asset-based 
distribution fees paid by investors would be purely a benefit of the 
proposal resulting from markets that are more efficient and investors 
making better-informed investment choices, or whether it would 
represent a transfer of assets from investment managers or broker-
dealers to investors. The goals of this rulemaking include providing 
better and more transparent information to investors regarding the 
asset-based distribution fees they pay, enabling investors to more 
efficiently allocate their investments and meet their investment goals, 
and promoting competitive markets. In light of these goals, we believe 
that any reduction in asset-based distribution fees paid by investors 
that is due to better-informed investment decisions made as a result of 
this proposal should be counted as a benefit.
     Do commenters agree that the estimated reductions in sales 
charges investors would pay are a benefit of this proposal? We further 
request comment on the estimates and assumptions we have made in this 
section regarding the benefits of our proposal to investors and the 
likelihood that a certain portion would invest in funds with lower 
sales charges. In particular, we request comment on the quantitative 
estimates the staff has made and request that commenters provide any 
quantitative data they may have on the likely behavior of investors in 
response to our proposals.
    Currently, funds with class C shares typically do not charge a CDSL 
after the first year, which allows the potential for some short-term 
shareholders in C share classes to redeem soon after purchase and pay 
less asset-based distribution fees compared to longer-term shareholders 
in the same share class. Essentially, the longer-term C class 
shareholders subsidize some of the distribution expenses of the 
shorter-term shareholders. Funds typically structure their C shares in 
this manner to attract investors who may not want to be committed to a 
long-term investment in a fund, and who may pay significantly more or 
less in distribution costs depending on how long they remain invested 
in the fund. Funds also take the risk that the distribution expenses 
associated with short-term investments in C shares will not be balanced 
out by long-term C class shareholders who may pay significantly more in 
asset-based distribution fees than if they had instead invested in some 
other class.
    Proposed new rule 12b-2 and amended rule 6c-10 would have the 
effect of limiting the total asset-based distribution fees that long-
term shareholders would pay, and may thereby alter the economic 
incentives involved in structuring a C share class without a CDSL. If 
the proposal is adopted, some funds may reconsider the economics of C 
share classes, and could restructure those classes, perhaps imposing a 
CDSL similar to B share classes. If this occurs, this could effectively 
eliminate the opportunity for some short-term C class shareholders to 
avoid paying a portion of the distribution expenses associated with 
their investment. However, it would also effectively eliminate the 
potential for some longer-term shareholders in C classes to subsidize 
those costs by paying significantly more in asset-based distribution 
fees over time. One of the goals of this rulemaking is to help ensure 
more equity between shareholders in the payment of fund distribution 
expenses. However, we acknowledge that achieving this more equitable 
treatment between shareholders may come at a cost to certain short-term 
shareholders whose distribution expenses would no longer be subsidized 
by long-term C class shareholders.
    We request comment on the likelihood of funds restructuring their C 
share classes as discussed above, and any potential impact such a 
restructuring might have on both long- and short-term investors in 
those classes.
     In particular, we request comment on any quantitative 
estimates of the amount of additional asset-based distribution fees 
that short-term investors may pay and the amount of such fees that 
long-term shareholders may save as a result of this proposal.

F. Ongoing Sales Charge: Intermediaries

    Broker-dealers and other intermediaries may also be affected by the 
proposed limitations on ongoing sales charges. Currently, FINRA rules 
do not limit the total amount of asset-based sales charges that an 
individual fund investor may pay. NASD Conduct Rule 2830 limits the 
aggregate amount of these fees and other sales loads that a fund may 
pay to its distributor, to a percentage of the amount of gross new 
sales of fund shares. Because most funds continually sell new shares 
(and thus have new sales), we understand that most funds do not reach 
this limit. As a result, broker-dealers generally may receive asset-
based sales charges on an investment in fund shares for as long as the 
investor holds the shares (or, in the case of B shares, until the 
shares convert). The conversion requirements of our ongoing sales 
charge proposal would limit the amount of asset-based distribution fees 
that an individual investor would pay to an amount that is tied to the 
front-end load of the fund, or the NASD sales charge limits.
    Our proposed amendments to rule 6c-10 may have the effect of 
reducing the total compensation that intermediaries receive from the 
sale of certain types of shares (such as B, C, or R shares). However, 
as discussed previously, any reduction in compensation would be

[[Page 47120]]

experienced as reduced costs for investors because distribution charges 
that are not deducted from fund assets would be retained by 
shareholders.
    The amount of any reduction in intermediary compensation that might 
result is speculative.\503\ For example, many class B shares currently 
convert on a schedule that generally meets, or come close to meeting, 
the requirements we propose today. Therefore, we anticipate that 
complying with the proposal's requirements with respect to class B 
shares would result in, at most, a minor reduction in compensation to 
broker-dealers. Class C shares (which are generally described in fund 
prospectuses as being suitable for short-term investments) do not 
convert, but if they are sold as short-term investments, we believe 
they generally would not be held long-term. Based on average holding 
periods for funds generally, we expect that only a limited portion of 
outstanding class C shares would be held long enough for any asset-
based distribution fees on class C shares to exceed the proposed 
ongoing sales charge limit.\504\
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    \503\ The staff has estimated some potential effects of our 
rulemaking on investor behavior (and consequent reduction in 
intermediary compensation) in Section V.E of this Release, supra.
    \504\ Comprehensive data on the typical retention period for C 
shares is not available, but the typical fund shareholder only holds 
fund shares for approximately 3-4 years. Based on a front-end load 
equal to 6%, a C share investor could pay an ongoing sales charge of 
75 basis points for approximately 8 years before reaching the 
ongoing sales charge limits we propose today. This holding period 
would be more than double the typical holding period for all fund 
shares, and particularly long for C shares, which funds disclose as 
appropriate for short-term holding periods.
---------------------------------------------------------------------------

    Funds with class R shares or similar classes (which typically are 
sold in tax-advantaged accounts and are intended as long-term 
investments) may charge 12b-1 fees in amounts exceeding 25 basis points 
that would become subject to the limitations on ongoing sales charges. 
These share classes often use 12b-1 fees to pay for associated 
recordkeeping and shareholder services, as well as for distribution 
expenses. As we have discussed above, some funds may be in a position 
to identify those non-distribution expenses and re-characterize them as 
administrative fees, thereby avoiding the need to impose an ongoing 
sales charge without reducing distribution payments to intermediaries. 
To the extent that any portion of 12b-1 fees currently charged on class 
R shares must be considered to be an ongoing sales charge, any estimate 
reduction in compensation resulting from our proposal would be 
speculative, because as discussed above, we anticipate that the lost 
revenue may be recovered through other sources.\505\
---------------------------------------------------------------------------

    \505\ As discussed above, broker-dealers often receive payments 
from fund advisers known as ``revenue sharing,'' which supplements 
the compensation they receive for distributing fund shares. See 
supra note 65.
---------------------------------------------------------------------------

    If intermediaries experience a significant reduction in 
distribution compensation, would they be likely to renegotiate revenue 
sharing agreements and recover some or all of the lost compensation 
through these sources? Would intermediaries be likely to receive less 
compensation based on the ongoing sales charge limits of our proposal? 
How much less? Would they make up any or all of any such loss through 
revenue sharing agreements? Do commenters believe that this reduction 
in compensation should be treated as a cost of the proposal, 
considering that any reduction would come with a corresponding increase 
in the assets held by investors?
    Intermediaries such as broker-dealers, banks, and insurance 
companies may also incur costs in connection with our proposals.\506\ 
For example, these intermediaries may need to enter into new or amended 
distribution agreements with the funds that they sell, enhance their 
recordkeeping systems, update sales literature, and provide additional 
training to their sales representatives regarding the new regulatory 
framework for mutual fund asset-based distribution fees and the 
suitability of different share classes for their clients. The staff 
estimates that there are approximately 4,770 of these types of 
intermediaries, and that approximately 40% of these intermediaries (or 
1,908) receive 12b-1 fees, and therefore would be affected by our 
proposal.\507\ The staff estimates that, on average, each affected 
intermediary would expend $50,000 in costs and 100 hours of internal 
personnel time in response to our proposals.\508\ This internal time 
would include approximately 75 hours spent by professionals such as 
compliance personnel at a rate of $210 \509\ per hour and 25 hours 
spent by inside counsel at a rate of $316 per hour, at a total internal 
time cost equivalent of $23,650.\510\ Therefore, the staff estimates 
that all intermediaries may incur approximately $95,400,000 in one-time 
costs and 190,800 hours (at an internal time cost equivalent of 
$45,124,200 as a result of the proposed new rule and rule 
amendments).\511\
---------------------------------------------------------------------------

    \506\ The costs for retirement plan record keepers are discussed 
below, and the costs for transfer agents are included in the 
previously discussed costs for mutual funds above.
    \507\ This number consists of the following: 2,203 broker-
dealers classified as specialists in fund shares, 167 insurance 
companies sponsoring registered separate accounts organized as unit 
investment trusts, approximately 2,400 banks that sell funds or 
variable annuities (the number of banks is likely over inclusive 
because it may include a number of banks that do not sell registered 
variable annuities or funds, or banks that do their business through 
a registered broker-dealer on the same premises). This number may be 
over or under inclusive, because the actual number of intermediaries 
that would be affected would vary based on the intermediary's 
business model and whether the intermediary sells funds that deduct 
12b-1 fees.
    \508\ We recognize that this average will likely vary 
significantly, with large intermediaries incurring many times this 
cost estimate and small intermediaries likely incurring far less.
    \509\ The staff has based the hourly cost estimates for time 
spent by intermediaries in this section on SIFMA's Management & 
Professional Earnings in the Securities Industry 2009, supra note 
407, because the staff believes the hourly costs are comparable.
    \510\ These figures are based on the following calculations: 
($210 x 75 hours = $15,750); ($316 x 25 hours = $7,900); ($15,750 + 
$7,900 = $23,650).
    \511\ These estimates are based on the following calculations: 
(1,908 intermediaries x $50,000 = $95,400,000 in costs); (1,908 
intermediaries x 100 hours = 190,800 hours expended); (1,908 
intermediaries x $23,650 = $45,124,200).
---------------------------------------------------------------------------

    In addition, our proposal may require intermediaries such as 
retirement plan administrators or other omnibus account record-keepers 
to begin tracking share lots and managing share conversions. This 
change may require these intermediaries to invest in new systems or 
enhance their current recordkeeping and back office systems. If a 
retirement plan offers fund classes that deduct an ongoing sales 
charge, the proposal would require such shares purchased by plan 
participants to eventually be converted to a class that does not deduct 
an ongoing sales charge. This conversion requirement would create costs 
for retirement plan record-keepers because we understand that 
currently, most record-keepers do not maintain individual participant 
share histories. Record-keepers for plans that offer shares classes 
with an ongoing sales charge would need to begin tracking the date of 
purchase of each share lot for each participant, and tie that share 
history to the appropriate conversion date. In addition, plans 
currently usually only have a single class of shares for each fund 
offered within the plan. If our proposal is adopted, however, if the 
single class that is offered within the plan deducts an ongoing sales 
charge, a second class of shares for each fund (i.e. a target class for 
converted shares) would have to be added to the record-keeper's 
systems, effectively adding more complexity and costs to their 
operations. For example, as a result of this increase in the number of 
shares classes, record-keepers might

[[Page 47121]]

need to increase the size of their participant statements, spend more 
time answering participant questions, process more trades, and manage 
operational complexities related to multiple share classes (such as 
allocating withdrawals between share classes for participant loans and 
rebalancings, identifying the correct conversion date for reinvested 
dividends, and other issues).
    Only record-keepers that provide services to retirement plans that 
offer fund share classes with 12b-1 fees in excess of 25 basis points 
would be affected by our proposal.\512\ The staff estimates that there 
are approximately 2,025 intermediaries that provide recordkeeping for 
retirement plans, and that approximately 25% (or 506) of those record-
keepers provide services to plans that offer fund share classes with 
12b-1 fees in excess of 25 basis points.\513\ The staff estimates that 
approximately 35% (or 177) of the 506 affected record-keepers would 
choose to upgrade their systems to manage ongoing sales charges, while 
the other 65% (or 329) would choose to do business only with plans that 
offer funds without an ongoing sales charge, and thus avoid the costs 
discussed below.\514\ The staff estimates that it would cost a record-
keeper approximately $1,000,000 in one-time costs and $1,500,000 
annually to manage ongoing sales charges for the plans they 
service.\515\ These expenses would include, but not be limited to, 
expenses related to enhancing computer software to begin tracking and 
aging share histories and multiple share classes, additional computer 
hardware and storage costs for the increased volume of information 
related to participant positions, larger participant statements (and 
higher mailing costs), increased time spent providing service to 
participants, and costs related to managing the operational 
complexities discussed above. Therefore, the staff estimates that 
intermediaries that provide recordkeeping services to retirement plans 
may incur a total one-time cost of $177,000,000 and an annual cost of 
$265,500,000 in complying with our proposal.\516\
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    \512\ Record-keepers for plans that only offer funds with 12b-1 
fees of 25 basis points or less would be generally unaffected by our 
proposal, because they would not need to change their systems to 
manage the ongoing sales charge and its related multiple share 
classes and conversions.
    \513\ This includes 225 bank, mutual fund, and insurance record-
keepers, and an additional 1,800 third party administrators that 
provide some recordkeeping for the plans they administer. The number 
of participant accounts serviced by these record-keepers varies 
widely, with some servicing more than ten million accounts, and 
others only providing service to a few hundred or thousand accounts. 
The costs we provide here are estimates for the average record-
keeper, and we acknowledge that the larger firms will likely incur 
significantly higher costs, while the smaller firms may incur far 
less.
    \514\ These funds might include funds that have re-assessed the 
asset-based distribution fees they charge and restructured their 
fees to identify non-distribution services that could be paid 
separately from the asset-based distribution fee limits of our 
proposal, in the manner discussed in Section V.D.2.b of this 
Release, supra.
    \515\ The staff assumes that record-keepers would continue to 
receive approximately the same amount of compensation for the 
services they provide. Record-keepers currently often receive some 
or all of their compensation from 12b-1 fees deducted from 
participant funds. The staff expects that much of the compensation 
that is currently paid to record-keepers through a 12b-1 fee in 
excess of the marketing and service fee (which would be an ongoing 
sales charge that would eventually end and no longer be able to pay 
for recordkeeping services) may be re-assessed and paid as an 
ordinary fund expense, and not be subject to the limits on asset-
based distribution fees contained within our proposal.
    \516\ These estimates are based on the following calculations: 
(177 record-keepers x $1,000,000 one-time costs = $177,000,000 in 
one-time costs); (177 record-keepers x $1,500,000 in annual costs = 
$265,500,000 in annual costs).
---------------------------------------------------------------------------

    As discussed previously, under our proposed rulemaking, ongoing 
sales charges would qualify as transaction based compensation, and 
intermediaries who receive the ongoing sales charge may need to 
register as broker-dealers under section 15 of the Exchange Act unless 
they can avail themselves of an exception or exemption from 
registration.\517\ The proposed rulemaking could potentially lead to 
some intermediaries who are currently receiving 12b-1 fees but that are 
not registered as broker-dealers under section 15 of the Exchange Act 
to either no longer receive asset-based distribution fees or to 
register as broker-dealers. However, we understand that virtually all 
advisers and other intermediaries that currently receive 12b-1 fees in 
excess of 25 basis points (thus qualifying as an ongoing sales charge) 
already associate themselves with registered broker-dealers, either by 
registering themselves, or by becoming an independent contractor 
registered representative of a registered broker-dealer. Therefore, we 
do not anticipate that, if our proposal is adopted, any intermediaries 
who are currently receiving 12b-1 fees would newly register as broker-
dealers, and thus incur the costs associated with registration.
---------------------------------------------------------------------------

    \517\ See supra note 168.
---------------------------------------------------------------------------

    We request comment on all of the estimates and assumptions made in 
this section.
     Is our understanding correct? Would the proposed 
rulemaking in fact require any intermediaries who are currently 
receiving 12b-1 fees to register as a broker-dealer? In particular, we 
request comment on what types of intermediaries, if any would be 
affected, and if they are affected, how many would be required to 
register or no longer receive ongoing sales charges. If intermediaries 
are required to register, what kind of costs would they incur? We 
currently estimate that any new entities registering as broker-dealers 
would incur a time burden of 2.75 hours to complete Form BD.\518\ Are 
there other costs that would be implicated by broker-dealer 
registration? Would other burdens be incurred and, if so, what are 
those burdens? What one-time and on-going costs, if any, would be 
incurred? We request comment on the estimates and assumptions we have 
made in this section.
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    \518\ Form BD is the application form used by entities to apply 
to the Commission for registration as a broker-dealer. See Proposed 
Collection; Comment Request (Apr. 20, 2010) [75 FR 22638 (Apr. 29, 
2010)] (providing estimates of and seeking comments on compliance 
burden of Form BD).
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G. Disclosure

    The proposal would make the following changes to the disclosure 
requirements:
     Amend Form N-1A to replace the current line item for 12b-1 
fees in the fee table and statement of operations with two new line 
items (``Marketing and Service Fee'' and ``Ongoing Sales Charge'') and 
revise most of the current disclosure in the prospectus and SAI related 
to the discussion of 12b-1 plans (which would no longer exist) and the 
dollar amounts spent under the plans for different distribution 
activities;
     Eliminate the periodic reporting requirement related to 
12b-1 plans in Form N-SAR, the annual and semi-annual reporting form 
used by mutual funds;
     Amend the statement of operations for fund income and 
expenses in Regulation S-X to conform to our proposal;
     Amend Forms N-3, N-4, and N-6 to conform to our proposed 
changes; and
     Provide better proxy disclosures for shareholder votes on 
asset-based distribution fees.
    These proposed disclosure changes would provide a number of 
benefits, including providing more descriptive disclosure of the use 
and amount of asset-based distribution fees deducted by funds in 
prospectuses and SAIs, providing greater transparency of these fees to 
investors, removing requirements that would become outdated, and 
conforming disclosure requirements to our proposal. We have discussed 
these

[[Page 47122]]

benefits in detail previously in this Release in Sections III.I and 
III.M above. These benefits include providing clearer disclosure of the 
amount and use of asset-based distribution fees, eliminating 
potentially confusing or unnecessary disclosure, and providing better 
descriptions of the fees. The amendments would provide investors access 
to more relevant and transparent information that could help guide 
their investment making decision when considering whether to invest in 
a fund that deducts asset-based distribution fees. As discussed below, 
the staff estimates that there would be no additional ongoing costs as 
a result of these disclosure changes, and in fact, those ongoing costs 
may decrease.
1. Revised Fee Table, Prospectus, and SAI Disclosure
    The proposal would require funds to eliminate the current line item 
titled ``Distribution and/or Service (12b-1) Fees'' and add, as 
necessary, two items for the fees permitted under the proposal--
``Marketing and Service Fee'' and ``Ongoing Sales Charge.'' Funds that 
do not currently charge asset-based distribution fees would not be 
affected by these proposed amendments. The staff estimates that funds 
that charge asset-based distribution fees would be able to complete the 
revised fee table in the same amount of time, and for the same cost 
because the revised fee table only includes data that is readily 
available when the fund regularly updates the fee table, and does not 
include any new information. The revised fee table would not be 
significantly longer, and would instead simply include a new line item, 
which is a breakdown of an existing line item, that was already known 
when the fee was instituted.\519\ Therefore, the staff estimates that 
the proposed new line items in the fee table would not increase costs 
or the amount of time required to complete Form N-1A, either initially 
or when submitting a post-effective amendment.
---------------------------------------------------------------------------

    \519\ There are two types of Form N-1A filings; (i) Initial 
filings, and (ii) annual post-effective amendments. Funds usually 
incur significantly more time and incur greater costs when first 
registering a fund under their initial N-1A filings than when filing 
their annual post-effective updates. Therefore, the staff separately 
estimates the burden for each type of filing.
---------------------------------------------------------------------------

    The proposal would also significantly revise the disclosure 
required for funds with 12b-1 fees in the prospectus narrative and in 
the SAI. These proposed amendments would eliminate many disclosures 
that would become outdated or irrelevant based on our proposed rule 
changes, including some of the most detailed disclosures of the dollar 
amount the fund spends on each distribution activity. However, some of 
the other disclosure requirements regarding asset-based distribution 
fees currently in Form N-1A would be retained in the same or similar 
form.\520\ Thus, we anticipate that the proposed amendments would 
reduce the amount of time needed to provide disclosure on asset-based 
distribution fees on an ongoing basis, although some one-time costs may 
be incurred to initially revise and update the prospectus to conform 
its description regarding asset-based distribution fees to the proposed 
new framework.
---------------------------------------------------------------------------

    \520\ See Section III.J, supra.
---------------------------------------------------------------------------

    In our most recent Paperwork Reduction Act submission for Form N-
1A, the staff estimated that for each fund portfolio or series, the 
initial filing burden is approximately 830.47 hours at a cost of 
$20,300, and the post-effective amendment burden is approximately 111 
hours at a cost of $8894. This includes time spent by inside counsel, 
back office personnel, compliance professionals, and others in filling 
out the form. The costs include that of outside counsel to prepare and 
review these filings. We assume that only funds that charge asset-based 
distribution fees would be affected by our proposed amendments to Form 
N-1A. The staff estimates that, each year, there are approximately 7367 
funds with 12b-1 plans that file post-effective amendments.
    The staff estimates that our proposed amendments would result in 
time savings of approximately 10 hours for each portfolio's initial 
filing (for a new total estimate of 820.47 hours) and of 1 hour for 
each post-effective amendment (for a new total estimate of 110 hours). 
The staff further estimates that the amendments would reduce costs 
spent on outside counsel, and other costs associated with completing 
Form N-1A, by $500 for each initial filing (for a new total estimate of 
$19,800) and $150 for each post-effective amendment (for a new total 
estimate of $8744). In addition, the staff estimates that each fund 
would incur a total one-time cost of $2000 and a one-time time 
expenditure of 10 hours of attorney time at a rate of $316 per hour to 
initially revise their post effective amendments to Form N-1A to meet 
the requirements of the proposed amendments for the first time.
    The staff estimates that, in each year following the effective date 
of the proposed amendments, 300 additional funds with asset-based 
distribution fees would file an initial Form N-1A. Based on these 
estimates, the staff estimates that funds would save a total of 3000 
hours (at an internal time cost equivalent of $948,000) \521\ and 
$150,000 when submitting initial Form N-1A filings each year.\522\ In 
addition, the staff anticipates that funds would save approximately 
7367 hours (at an internal time cost equivalent of $2,327,972)\523\, 
and $1,050,050 annually when preparing post-effective updates to Form 
N-1A.\524\ Finally, the staff estimates that all funds with asset-based 
distribution fees would incur a total one-time expenditure of 73,670 
hours (at an internal time cost equivalent of $23,279,720) and a cost 
of $14,734,000 when preparing post-effective amendments to comply with 
the proposed amendments for the first time.\525\
---------------------------------------------------------------------------

    \521\ This estimate is based on the following calculation: (300 
new filers x 10 hours savings = 3,000 hours in total savings); 
(3,000 hours x $316 per hour = $948,000).
    \522\ This estimate is based on the following calculations: (300 
new filers x $500 savings = $150,000 total savings).
    \523\ This estimate is based on the following calculation: 
(7,367 amendments x 1 hour savings = 7,367 hours in total savings); 
(7,367 hours x $316 per hour = $2,327,972).
    \524\ This estimate is based on the following calculations: 
(7,367 amendments x $150 savings = $1,105,050 total savings).
    \525\ This estimate is based on the following calculations: 
(7,367 amendments x 10 hours expended = 73,670 hours); (73,670 hours 
x 316 per hour = $23,279,720); (7,367 amendments x $2,000 costs = 
$14,734,000 total one-time costs).
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     We request comment on these estimates and assumptions.
2. N-SAR Periodic Reporting
    Our proposal would amend the instructions to Form N-SAR, which 
currently requires funds to respond to a series of questions regarding 
their 12b-1 plans. Form N-SAR is the form that registered investment 
companies use to make periodic reports to the Commission. Our proposed 
amendments would add an instruction to Form N-SAR to disregard, for 
funds that no longer have 12b-1 plans, four questions (Items 41-44) 
that relate to the operation of rule 12b-1 plans (because they would be 
irrelevant in light of our proposed new framework for asset-based 
distribution fees). However, funds that maintain grandfathered fund 
classes would continue to respond to these items.
    The staff estimates that there are approximately 1292 management 
investment companies that respond to Items 41-44 of Form N-SAR. The 
staff estimates that our proposed amendments would reduce the time it 
takes funds that do not have grandfathered share classes to complete

[[Page 47123]]

Form N-SAR by 0.25 hours, and that there would be no change for funds 
that maintain grandfathered share classes. The staff estimates that, if 
these amendments are adopted, in the first three years after adoption, 
approximately 20% of these 1292 management investment companies (or 
258) would no longer maintain grandfathered share classes and would 
then experience the estimated savings, while the remaining 80% (or 
1034) would continue to have grandfathered share classes and respond to 
these items. Because Form N-SAR is completed twice a year, the staff 
estimates that each respondent would save approximately 0.5 hour 
annually (at an internal time cost equivalent rate of $316 per hour). 
The staff therefore estimates that our proposed amendments to Form N-
SAR would result in total incremental time savings of approximately 129 
hours (with a total internal time equivalent cost savings of $40,764) 
\526\ annually.
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    \526\ This estimate is based on the following calculation: (258 
x 0.5 hours = 129 hours); (129 hours x $316 per hour = $40,764).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.
3. Regulation S-X
    As discussed in Section III.L of this Release, we are proposing 
changes to rule 6-07 of Regulation S-X, which requires funds to file a 
statement of operations listing income and expenses, and state 
separately all amounts paid in accordance with a 12b-1 plan. Our 
proposal would conform the disclosure requirement to the terms of our 
proposed new rule and rule amendments regarding asset-based 
distribution fees, by requiring that funds state separately amounts 
charged for marketing and service fees and ongoing sales charges.
    Our understanding is that funds already have information on asset-
based distribution fees available in order to prepare the statement of 
operations as we have proposed. Funds analyze this information as a 
matter of course for ordinary business and tax reasons, and therefore 
our proposed changes to Regulation S-X would not require the 
preparation of new information. Accordingly, the staff estimates that 
our proposed changes to Regulation S-X would not change the amount of 
time or the costs required for funds to prepare their statements of 
operations under the regulation.
     We request comment on these estimates and assumptions.
4. Form N-3, N-4, and N-6
    The proposal would revise the currently required disclosure for 
12b-1 plans in the prospectus narrative and in the SAI of Form N-3. 
These proposed amendments would eliminate disclosures that would become 
outdated or irrelevant based on our proposed rule changes, including 
some of the most detailed disclosures of the exact dollar amount the 
registrant spends on each distribution activity. However, much of the 
general disclosures regarding asset-based distribution fees currently 
in Form N-3 would be retained in the same or similar form.\527\
---------------------------------------------------------------------------

    \527\ See supra Section III.L.
---------------------------------------------------------------------------

    In our most recent Paperwork Reduction Act submission for Form N-3, 
the staff estimated that for each portfolio, the initial filing burden 
is approximately 922.7 hours at a cost of $20,300, and the post-
effective amendment burden is approximately 154.7 hours at a cost of 
$7650. This hourly burden includes time spent by in-house counsel, back 
office personnel, compliance professionals, and others in preparing the 
form. The costs include that of outside counsel to prepare and review 
these filings.
    The staff assumes that only registrants that charge asset-based 
distribution fees would be affected by our proposed amendments to Form 
N-3. Based upon a review of filings with the Commission, the staff 
estimates that 1 registrant that currently files on Form N-3 charges 
asset-based distribution fees, and would file a post effective 
amendment. The staff estimates that it would cost this registrant 
approximately $2000 in one-time costs (for outside legal counsel 
drafting and review) and require an expenditure of 10 hours in internal 
personnel time (at an internal time cost equivalent rate of $316 per 
hour) to revise its prospectus to comply with the proposed amendments. 
The staff further estimates that the proposed amendments to Item 21 and 
instruction 5 of Item 26 would result in time savings when completing a 
post-effective amendment of Form N-3. The staff estimates that this 
registrant would save approximately 1 hour (at an internal time cost 
equivalent of $316 per hour) annually as a result of the proposed 
amendments.
    The staff further estimates that no new registrants that file on 
Form N-3 are likely to charge asset-based distribution fees under 
proposed rule 12b-2 and the proposed amendments to rule 6c-10. 
Accordingly, the staff estimates that there will be no other changes in 
burden hours or costs as a result of the proposed rule and rule 
amendments.
     We request comment on any of these estimates or 
assumptions.
    Our proposal would also amend Forms N-4 and N-6 to conform them to 
the new rule and rule amendments that we are proposing today.\528\ The 
proposed form amendments would replace references to rule 12b-1 with 
references to proposed rules 6c-10(b), 12b-2(b) or 12b-12(d), as 
appropriate. We expect this would benefit investors because it would 
more accurately describe these fees.
---------------------------------------------------------------------------

    \528\ Form N-3 is used by separate accounts offering variable 
annuity contracts that are registered as management investment 
companies. Form N-4 is used by separate accounts offering variable 
annuity contracts and are registered as unit investment trusts. Form 
N-6 is used by separate accounts offering variable life insurance 
contracts and are registered as unit investment trusts.
---------------------------------------------------------------------------

    The staff estimates that the proposed amendments to these forms 
would not change current estimates of the amount of time or costs 
associated with completing the forms because they are primarily 
technical and only conform the disclosure to the proposal. Therefore, 
we estimate no costs will result from these proposed Form N-4 and N-6 
changes.
     We request comment on these estimates and assumptions.
5. Streamlined Proxy Procedure
    Our proposal would eliminate a number of disclosures in Schedule 
14A (the form for proxy statements) that would become irrelevant in 
light of the proposed rule and rule amendments.\529\ We anticipate that 
the proposed amendments would result in cost savings to funds that 
prepare such proxies when obtaining shareholder consent to increase or 
implement marketing and service fees.
---------------------------------------------------------------------------

    \529\ See proposed Item 22 of Schedule 14A.
---------------------------------------------------------------------------

    Funds that rely on proposed rule 12b-2(d) would not be permitted to 
institute new 12b-1 plans or increase the rate of a 12b-1 fee under an 
existing plan after the rule's compliance date, and therefore they 
would no longer solicit proxies in relation to their 12b-1 plans. 
Proposed rule 12b-2(b) would require a shareholder vote and attendant 
proxy solicitation when a fund institutes or increases a marketing and 
service fee in existing share classes.\530\
---------------------------------------------------------------------------

    \530\ As discussed in Section III.N.4 of this Release, supra, we 
would not require a shareholder vote if a 12b-1 fee is relabeled a 
marketing and service fee, provided the fee is 25 basis points or 
less and is not increased.
---------------------------------------------------------------------------

    Commission staff estimates that approximately 3 funds would solicit 
proxies each year for the purposes of implementing or increasing a fee 
under

[[Page 47124]]

proposed rule 12b-2(b) (the same number that we have previously 
estimated would solicit proxies under rule 12b-1). Funds typically hire 
outside legal counsel and proxy solicitation firms to prepare, print, 
and mail these proxies. For each of these 3 funds, the staff estimates 
that our proposed amendments to Schedule 14A would result in an 
incremental burden reduction of 3 hours of internal personnel time (at 
an internal time cost equivalent rate of $316 per hour) and reduced 
costs of $400 for the services of outside professionals. The staff 
therefore estimates that these amendments will reduce the total annual 
costs of soliciting proxies and completing Schedule 14A by 
approximately 9 hours of internal personnel time (3 funds x 3 hours) at 
a internal time cost equivalent of $2,844 \531\ and approximately $1200 
(3 funds x $400) for the services of outside professionals.
---------------------------------------------------------------------------

    \531\ This estimate is based on the following calculation: (9 
hours x $316 per hour = $2844).
---------------------------------------------------------------------------

H. Account-Level Sales Charge Alternative

    Proposed rule 6c-10(c) would provide funds the option of offering a 
class of fund shares that could be sold by dealers with sales charges 
set at negotiated rates. The sales charge could vary in amount, or time 
of payment, and could better reflect services provided by the broker. 
We assume that a limited number of funds would choose to rely on this 
exemption immediately, and that reliance on the exemption may increase 
over time as funds and dealers better understand the costs and benefits 
associated with a different business model.
1. Benefits
    Some of the benefits that may derive from this exemption include 
enhanced competition in fund distribution, greater transparency of 
distribution charges for fund investors, and reduced conflicts for 
broker-dealers selling funds with different compensation 
structures.\532\ Other benefits include less complicated distribution 
structures and reduced training required for registered representatives 
of broker-dealers. This part of the proposal could also prompt new 
innovative fund distribution systems and allow the development of new 
business models. We discuss the many other potential benefits of this 
proposal in detail in Sections III.I and III.M above.
---------------------------------------------------------------------------

    \532\ We have not received any applications for an exemption 
from section 22(d) that are similar to our proposal, so we assume 
the proposal would not result in cost savings related to reduced 
preparation and processing of exemptive applications.
---------------------------------------------------------------------------

2. Costs
    Proposed rule 6c-10(c) is elective, and thus only funds or dealers 
that choose to rely on it would incur the costs of complying with its 
conditions. Proposed rule 6c-10(c) requires a fund that chooses to rely 
on the exemption to meet the following two conditions: (i) The fund 
must not deduct an ongoing sales charge pursuant to proposed rule 6c-
10(b); and (ii) the fund must disclose that it has elected to rely on 
the exemption in its registration statement. The first condition 
(prohibiting funds from deducting an ongoing sales charge) should not 
impose any costs on funds. We expect that any fund that relies on 
proposed rule 6c-10(c) would do so as part of the creation of a new 
fund or fund class, and that therefore no funds with ongoing sales 
charges would incur costs in eliminating these charges.
    We estimate that funds may incur some minor costs in complying with 
the second condition, the requirement to disclose the election to rely 
on proposed rule 6c-10(c) in their registration statement. The staff 
estimates that to make the required disclosure on the registration 
statement it would require one hour of time spent by outside counsel, 
charged at the rate of $400 per hour. Once the disclosure has been 
initially made on the registration statement, the staff estimates that 
there would be no further costs or time to update or revise the 
election, and therefore there would be no annual costs. Thus, the staff 
estimates that the cost of complying with the conditions in relying on 
rule 6c-10(c) would be a one-time initial cost of $400 per fund. The 
staff estimates that between 10 and 100 new funds might rely on 
proposed 6c-10(c) for the first time each year, and therefore estimate 
that the total costs for all funds to comply with the proposed 
exemption would be between $4000 and $40,000 \533\ in one-time costs 
(to newly formed funds) each year.
---------------------------------------------------------------------------

    \533\ This estimate is based on the following calculations: (10 
funds x $400 = $4000; 100 funds x $400 = $40,000).
---------------------------------------------------------------------------

    We anticipate that funds that rely on proposed rule 6c-10(c) would 
do so as part of a decision to provide competitive alternatives to 
other distribution models, and that any other costs not imposed by the 
conditions of the rule to establish the structure would be justified by 
the anticipated benefits accruing to the fund. Other such costs to 
establish the new distribution structure might include setting up new 
classes of the fund, negotiating new distribution agreements with 
broker-dealers, and educating investors and financial representatives 
about the new fee structure.\534\ The decision to rely on the proposed 
rule would be driven by business factors, and the potential for new 
markets and customers. Funds and broker-dealers that do not choose to 
rely on this exemption would not bear any costs related to the proposed 
rule.\535\
---------------------------------------------------------------------------

    \534\ Based on discussions with one fund, that fund suggested 
that these and similar efforts could include one-time costs of 
$550,000 and ongoing costs of $250,000 annually per fund family.
    \535\ Broker-dealers could face certain difficulties related to 
``investor portability'' or account transfers for investors in 
classes that rely on the proposed rule. Broker-dealers may encounter 
recordkeeping or other issues when an investor account that holds 
fund shares in such a class is transferred to a broker-dealer that 
only sells shares of the fund with asset-based distribution fees. 
Broker-dealers currently face this issue when transferring investor 
accounts today (if, for example, the transferred account includes 
shares of a fund that the new broker-dealer does not sell), although 
it may be exacerbated by the different fee structure the exemption 
offers.
---------------------------------------------------------------------------

    We request comment on the discussion of the costs and benefits of 
our proposed rule 6c-10(c).
     Are there any costs that this exemption would impose on 
funds or others? What other benefits might it provide? What should we 
assume about the compensation structure that brokers would design? How 
many funds are likely to take advantage of this exemption, and what 
kind of factors would drive this choice? What kind of costs would these 
funds incur? Are our estimates of the cost of complying with the 
conditions of the exemptions reasonable?
    As discussed previously, our experience with unfixing commission 
rates leads us to expect that when sales loads are subject to market 
pressure, sales loads will go down for all investors. However, we 
acknowledge the potential that some investors (perhaps due to a lack of 
bargaining power) may pay higher sales loads under proposed rule 6c-
10(c) than they might have under the fixed sales load regime of section 
22(d). We request comment as to whether investors are likely to pay 
lower (or higher) sales loads if they purchase fund shares from a fund 
taking advantage of the proposed exemption.
     Are investors likely to experience any other costs or 
benefits as a consequence of the proposed exemption? If the exemption 
is widely relied upon, what might be the effect on distribution 
arrangements, and on distributors that do not rely on the rule?

[[Page 47125]]

I. Director Responsibilities

    Board of directors' responsibilities would change under the 
proposal because we would not require directors to adopt and annually 
renew a 12b-1 plan or make any special findings.\536\ The proposal 
would not impose other procedural requirements currently in rule 12b-1, 
including the requirements for quarterly review. Although the proposal 
would eliminate director specific oversight requirements, directors 
would still have a fiduciary obligation to consider whether the asset-
based distribution fees are in the best interest of the fund and fund 
shareholders.
---------------------------------------------------------------------------

    \536\ Our proposed rescission of rule 12b-1 would also eliminate 
the recordkeeping requirements in rule 12b-1(f) to maintain copies 
of the plan, reports or any other agreements related to the plan. 
Although our proposal would not impose recordkeeping requirements, 
we do not anticipate that funds would realize any cost savings as a 
result of this amendment, because they would continue to maintain 
records regarding their asset-based distribution fees to prepare 
their financial statements.
---------------------------------------------------------------------------

1. Benefits
    We expect that the proposed reduction in formal requirements 
regarding the approval of asset-based distribution fees would result in 
significant cost and time savings for funds and their investors. The 
staff has estimated in our most recent Paperwork Reduction Act analysis 
for rule 12b-1 that, for each fund family that has at least one fund 
with a 12b-1 plan, it takes approximately 425 hours for the fund's 
directors, counsel, accountants, and other staff to maintain the plan, 
prepare and evaluate quarterly reports, make the necessary findings, 
and hold director votes, at an internal time cost of $99,811 per fund 
family. The staff estimates that there are approximately 379 fund 
families with at least one fund that charges 12b-1 fees. Therefore, the 
staff estimates that for all fund families with a 12b-1 plan, funds 
expend a total of 161,075 hours at an internal time cost of 
$37,828,369.\537\
---------------------------------------------------------------------------

    \537\ These estimates are based on the following calculations: 
(425 hours x 379 fund families = 161,075 hours; $99,811 x 379 fund 
families = $37,828,369).
---------------------------------------------------------------------------

    The staff estimates that our proposal would reduce this burden by 
approximately 75% (proportionately for all fund employees) for an 
annual hour reduction for each fund family of 319 hours, and a $74,858 
reduction in internal costs.\538\ If our proposal is adopted, we 
estimate that funds, their employees (or the employees of the adviser), 
and directors would only need to spend 106 hours instead of 425 hours 
annually on asset-based distribution fee matters pursuant to rules 12b-
2 and 6c-10, at an internal cost of $24,953 instead of $99,811.\539\ 
Therefore, the staff estimates that our proposed amendments to director 
responsibilities and the proposed removal of rule 12b-1 would reduce 
this total time from a total of 161,075 hours per year at an internal 
cost of $37,828,369, to 40,269 hours at an annual cost of $9,457,092 
\540\ resulting in an annual savings of 120,806 hours and $28,371,277 
dollars.\541\
---------------------------------------------------------------------------

    \538\ This estimate applies to both funds that deduct asset-
based distribution fees under proposed rules 12b-2(b) and 6c-10, and 
to funds that deduct grandfathered 12b-1 fees pursuant to proposed 
rule 12b-2(d).
    \539\ These estimates are based on the following calculations: 
(425 hours x 25% = 106 hours; $99,811 x 25% = $24,953).
    \540\ These estimates are based on the following calculations: 
(161,075 hours x 25% = 40,269 hours; $37,828,369 x 25% = 
$9,457,092).
    \541\ These estimates are based on the following calculations: 
(161,075 hours x 75% = 120,806 hours; $37,828,369 x 25% = 
$28,371,277).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.
2. Costs
    Other than the time expenditures we have outlined previously in 
this analysis, we do not expect that there will be any costs associated 
with our proposed removal of rule 12b-1 and clarification of director 
responsibilities in our proposal. As discussed above, we anticipate 
that the proposed changes would simplify the requirements for imposing 
asset-based distribution fees compared to the current requirements of 
rule 12b-1. Costs that a fund might incur in connection with revising 
disclosures regarding asset-based distribution fees are discussed 
above.\542\
---------------------------------------------------------------------------

    \542\ See supra Section V.G of this Release.
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.

J. 11a-3 Amendments

    We are also proposing to amend rule 11a-3 (which governs sales 
loads on offers of exchange within a fund family) to bring it into 
conformity with the proposed treatment of ongoing sales charges we 
describe in this Release. The proposed amendments would require funds 
to give shareholders ``credit'' against the rate of any sales load owed 
for ongoing sales charges paid by investors who exchange fund shares 
within a fund group.\543\
---------------------------------------------------------------------------

    \543\ A more detailed description of these amendments is 
included in Section III.K of this Release, supra.
---------------------------------------------------------------------------

1. Benefits
    We anticipate that the proposed amendments to rule 11a-3 would 
provide a number of benefits. Some of the principal benefits include 
more equitable treatment of investors who pay sales charges, whether 
with the initial investment, or over time, and greater transparency in 
sales charges paid.
2. Costs
    Based on conversations with industry representatives, the staff 
understands that most funds that currently rely on the exemptive relief 
provided by rule 11a-3 have systems that can credit ongoing sales 
charges in the way the proposed amendments would require. In order to 
process credits for CDSLs (and other purposes), funds (or their 
transfer agents) use a bucketing system that allows them to track the 
history of fund shares. The staff understands that these existing 
systems can track the length of time shares subject to an ongoing sales 
charges have been held, determine the charges that have been paid, and 
credit those charges against any load imposed on the new shares 
acquired in an exchange. The staff understands that most funds 
generally limit exchanges to shares of the same class in other funds 
within the fund group. As a result, when transferred, the ongoing sales 
charge and conversion date of both the exchanged and acquired shares 
would generally be the same, if the maximum sales load remains the 
same. In those circumstances, no action would be required on the part 
of the fund or its transfer agent. Alternatively, the conversion date 
may need to be changed (if, for example, the maximum sales loads of the 
two funds are different). We expect that most funds should be able to 
comply with our proposed 11a-3 amendments with little difficulty.
    Funds may still need to update their systems for share exchanges 
and enhance their capacity to include shares with ongoing sales 
charges. The staff therefore estimates that a typical fund family with 
funds that deduct ongoing sales charges (or the fund's transfer agent) 
would incur $25,000 in one-time costs to update its systems to comply 
with our proposed amendments. For purposes of this analysis, the staff 
assumes that all 196 fund families that may be affected by our ongoing 
sales charge proposal would incur this cost, for a total cost of 
$4,900,000.\544\
---------------------------------------------------------------------------

    \544\ This estimate is based on the following calculation: (196 
fund families x $25,000 = $4,900,000).
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.

[[Page 47126]]

K. Other Technical Amendments

    Our proposal would make a number of technical amendments to 
Investment Company Act rules and forms, removing current references to 
rule 12b-1 and adding references to the appropriate proposed rule.\545\ 
We do not expect these changes to materially affect funds, 
intermediaries, or others, because they are technical changes that 
should not affect fund operations. Therefore, we do not believe that 
there would be any costs associated with these amendments. We request 
comment on this assumption.
---------------------------------------------------------------------------

    \545\ These proposed technical amendments would affect rules 
17a-8, 17d-3, 18f-3, and Regulation S-X under the Act. For a 
complete discussion of the changes, see Section III.L of this 
Release, supra.
---------------------------------------------------------------------------

     Would there be any costs associated with making the 
technical changes described in Section III.L above?

L. Rule 10b-10

    The proposed amendments to Exchange Act rule 10b-10 would provide 
broker-dealer customers with additional information related to mutual 
fund costs and callable securities.
1. Benefits
    The improved disclosure related to mutual fund costs could be 
expected to help make the confirmation a more complete record of the 
transaction and help mutual fund investors more fully understand the 
sales charges they incur. Those improved disclosures could be expected 
to promote decision making by investors that more appropriately takes 
those costs into account. Those improved disclosures also could be 
expected to assist investors in verifying whether they paid the correct 
sales charge set forth in the prospectus. The improved disclosure 
related to callable debt securities could be expected to help alert 
investors to misunderstandings, avoid confusion, promote the timely 
resolution of problems, and better enable investors to evaluate 
potential future transactions.
2. Costs
    These proposed amendments to rule 10b-10 would require brokers-
dealers to include additional information in confirmations that are 
currently sent to investors. The costs of adding this new information 
into confirmation disclosures would largely be expected to be one-time 
programming-related costs, borne primarily by clearing firms and third-
party service providers, which are included in the estimates of the 
Paperwork Reduction Act burden. For purposes of the Paperwork Reduction 
Act, the Commission staff has estimated that the one-time burden to 
clearing firms with proprietary systems to reprogram software and 
otherwise update their systems to enable them to generate confirmations 
meeting the requirements of the proposed amendments would be 
approximately 720,000 hours.\546\ The staff estimates that this one-
time burden would equal total internal costs of approximately $180.7 
million dollars,\547\ or $1.1 million per vendor.\548\ The staff also 
estimates that vendor licensors of platforms would incur costs 
equivalent to those incurred by clearing firms with proprietary 
systems, resulting in one-time burden of 13,500 hours and costs of 
approximately $3.4 million dollars,\549\ or $1.1 million per 
vendor.\550\ In addition, the staff understands that clearing firm 
licensees would incur an additional 800 burden hours each, or 296,000 
total, for a total cost of approximately $74.3 million,\551\ or 
$200,800 per clearing firm licensee.\552\
---------------------------------------------------------------------------

    \546\ 4,500 burden hours x 160 clearing firms with proprietary 
systems = 720,000 burden hours. See note 437 supra and accompanying 
text.
    \547\ 720,000 hours x $251 dollars per hour = $180,720,000. 
These figures are based on an estimated hourly wage rate of $251. 
The estimated wage figure is based on published compensation for 
compliance attorneys ($291) and the average costs of a senior 
computer programmer ($285) and a computer programmer analyst ($190) 
(($190 + $285) / 2 = $238). See Securities Industry and Financial 
Markets Association, Management and Professional Earnings in the 
Securities Industry (Sept. 2009). The staff estimates that 
programmers would utilize 75% of the burden hours to implement 
system changes while attorneys would utilize 25% of the burden hours 
to review the output, yielding a weighted wage rate of $251 dollars 
per hour (($291 x .25) + ($238 x .75)) = $251).
    \548\ 4,500 burden hours x $251 dollars per hour = $1,129,500.
    \549\ 3 vendors x 4,500 burden hours x $251 dollars per hour = 
$3,388,500. For purposes of this analysis, the staff assumes that 
vendors would incur the same per hour costs and burden hours 
incurred by clearing firms with proprietary systems. See note 438 
supra.
    \550\ 4500 burden hours per vendor x $251 dollars per hour = 
$1,129,500.
    \551\ 370 clearing firm licensees x 800 burden hours x $251 
dollars per hour = $74,296,000. For purposes of this analysis, the 
staff also assumes that vendors or other third-parties would perform 
the work needed to adapt each of these clearing firms' systems to 
the changes made to its vendor's platform. The staff further assumes 
the hourly costs to clearing firms to outsource these additional 
burdens to third-parties would be equivalent to the hourly costs 
incurred by vendors and by clearing firms with proprietary systems. 
This hourly cost is estimated at approximately $251 per hour. See 
note 438 supra.
    \552\ 800 burden hours per clearing firm licensee x $251 per 
hour = $200,800.
---------------------------------------------------------------------------

    When we include the costs borne by vendors and clearing firm 
licensees, we estimate that total one-time burden as a whole would be 
approximately $258.4 million dollars.\553\
---------------------------------------------------------------------------

    \553\ ((3 vendors x 4,500 burden hours) + (370 clearing firm 
licensees x 800 burden hours) + (160 clearing firms with proprietary 
systems x 4,500 burden hours)) x $251 per hour = $258,404,500. As 
discussed above, the staff believes that all parties would incur 
costs of $251 per hour.
---------------------------------------------------------------------------

     We request comment on these estimates and assumptions.

M. Total Costs and Benefits

    As discussed above, we have designed our proposal to minimize the 
cost impact on funds, intermediaries, and service providers while 
maximizing the investor protection and other benefits. The staff 
anticipates that funds representing approximately 93% of all assets 
under management will incur minor or no expenses in complying with our 
proposal.\554\
---------------------------------------------------------------------------

    \554\ See supra Section V.B of this Release.
---------------------------------------------------------------------------

    The staff estimates that the total one-time costs of compliance 
with our proposed amendments would be $400,994,000 in outside expenses 
and $362,348,000 in internal time cost equivalents. The staff further 
estimates the total annual costs of compliance would be $304,076,000. 
The staff also estimates that the total annual benefits of compliance 
with our proposed amendments would be between $1,062,361,000 to 
$1,258,361,000 in cost savings and $31,963,000 in internal time cost 
equivalents. This does not reflect our full expectation of the costs 
and benefits of the proposed amendments because many of the expected 
costs and benefits are qualitative in nature.
     We request comment on these estimates.

N. Request for Comment

    We request comments on all aspects of this cost-benefit analysis, 
including identification of any additional costs or benefits of, or 
suggested alternatives to, the proposed amendments. Commenters are 
requested to provide empirical data and other factual support for their 
views to the extent possible. In particular, we request comment on the 
quantitative estimates made within this section and any other costs or 
benefits that were not discussed here that might result from the 
amendments. We encourage commenters to identify, discuss, analyze, and 
supply relevant data regarding any additional costs and benefits.

VI. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis (``IRFA'') has been 
prepared in accordance with 5 U.S.C. 603. It relates to the 
Commission's proposed removal

[[Page 47127]]

of rule 12b-1, new rule 12b-2, and amendments to rules 6c-10, 10b-10, 
11a-3, 17a-8, 17d-3, and 18f-3, and amendments to Forms N-1A, N-3, N-4, 
N-6, N-SAR and Regulation S-X and Schedule 14A, under the Securities 
Act, the Securities Exchange Act, and the Investment Company Act.

A. Reasons for, and Objectives of, the Proposed Actions

    As more fully described in Sections I, II, and III of this Release, 
we are proposing a new rule and rule and form amendments designed to 
address funds' use of asset-based distribution fees, to amend our 
current regulations to reflect current economic realities and the role 
of directors regarding these charges, and to enhance transparency and 
equity of these fees for investors. Rule 12b-1, the current rule that 
governs the use of asset-based distribution fees, relies on fund 
directors to oversee the level and use of these fees. Asset-based 
distribution fees have evolved into a substitute for front-end loads, 
and have also enabled the development of new models of fund 
distribution that could not have been anticipated when the rule was 
adopted. Small funds, in particular, often rely on asset-based 
distribution fees as a means of gaining access to distribution channels 
that would not otherwise be available to them.\555\
---------------------------------------------------------------------------

    \555\ See, e.g., Roundtable Transcript, supra note 109, at 67-68 
(statement of Mellody Hobson, Ariel Capital Management, LLC), and 
discussion of the impact of the proposal on small funds, Section 
III.M, supra.
---------------------------------------------------------------------------

    The proposal is also designed to improve investor understanding of 
these fees and their purposes, as well as to enhance equity in the 
amount of distribution costs all fund shareholders pay, regardless of 
the method of payment. Currently, investors may not understand that 
asset-based distribution fees are the equivalent of sales loads, and 
some investors may believe that they have avoided a sales load entirely 
by purchasing a share class that charges an asset-based distribution 
fee. In addition, under current distribution practices, certain long-
term shareholders that pay asset-based distribution fees may subsidize 
the distribution expenses of other shareholders in the fund. As a 
result, some fund shareholders may pay a disproportionate amount of the 
fund's distribution expenses.
    Our proposed new rule, and rule and form amendments, would 
significantly revise our current regulations regarding asset-based 
distribution fees by eliminating the specific requirements for the 
board of directors. The proposal would recognize that funds bear 
ongoing expenses that, although they are distribution related, may 
benefit the fund and fund shareholders, and would replace the specific 
formal requirements for the board with other regulatory protections. In 
particular, the proposal would recognize that asset-based distribution 
fees may be used as a substitute for a sales load, and would regulate 
them in a similar manner. We expect that this would give directors more 
time to focus on other important fund matters. In order to provide 
greater equity among shareholders who bear distribution fees, the 
proposal would limit the amount of asset-based distribution fees that 
may be charged to each investor. Funds would be required to convert 
shares that have an ongoing sales charge to a class that does not 
impose an ongoing sales charge no later than when the cumulative 
charges equal the amount of the highest front-end load that the 
investor would have paid had the investor invested in another class of 
shares in the same fund, or after a set conversion period based on the 
rate of the front-end load and the rate of the ongoing sales charge 
imposed.
    In addition, the proposal would allow funds that deduct a marketing 
and service fee pursuant to rule 12b-2 to sell their shares at other 
than the public offering price as disclosed in their prospectus. This 
would enable funds to offer new choices to investors in paying for the 
costs of distribution; enhance competition in pricing between broker-
dealers in the sale of fund shares; and present new business 
opportunities to funds that choose to use this exemption. We believe 
small funds may be the funds that are more likely to so experiment and 
use this exemption to expand their market opportunities.
    Finally, the proposal would also make a number of changes to 
current disclosure requirements designed to enhance investor 
understanding of these fees. In particular, the proposal would require 
the prospectus fee table to state separately (i) the amount of asset-
based distribution fees that pays for services received by shareholders 
in the fund and for other general distribution purposes (the marketing 
and service fee), and (ii) the amount of asset-based distribution fees 
that are a substitute for a sales load (the ongoing sales charge). This 
disclosure is designed to allow fund shareholders to understand better 
the purpose of these fees, and the amounts they are paying. The 
proposal would also make a number of conforming changes to other rules 
and forms that are intended to update current references to rule 12b-1 
to reflect the regulations we are proposing today, as well as 
eliminating or updating requirements that would become irrelevant if 
our proposal were adopted. The proposal further would make changes to 
rule 10b-10 to improve disclosure on broker-dealer confirmations of 
costs related to mutual funds and to make other improvements.

B. Legal Basis

    The Commission is proposing amendments to Schedule 14A under the 
authority set forth in sections 3(b), 10, 13, 14, 15, 23(a), and 36 of 
the Exchange Act [15 U.S.C. 78c(b), 78j, 78m, 78n, 78o, 78w(a), and 
78mm], and sections 20(a), 30(a), and 38(a) of the Investment Company 
Act [15 U.S.C. 80a-20(a), 80a-29(a), and 80a-37(a)]. The Commission is 
proposing amendments to rule 6-07 of Regulation S-X under the authority 
set forth in section 7 of the Securities Act [15 U.S.C. 77g] and 
sections 8 and 38(a) of the Investment Company Act [15 U.S.C. 80a-8, 
80a-37(a)].
    The Commission is proposing to remove rule 12b-1 under the 
authority set forth in sections 12(b) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-12(b) and 80a-37(a)]. The Commission is 
proposing new rule 12b-2 under the authority set forth in sections 
12(b) and 38(a) of the Investment Company Act [15 U.S.C. 80a-12(b) and 
80a-37(a)]. The Commission is proposing amendments to rule 6c-10 under 
the authority set forth in sections 6(c), 12(b), 22(d)(iii), and 38(a) 
of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-12(b), 80a-
22(d)(iii) and 80a-37(a)]. The Commission is proposing amendments to 
rules 11a-3, 17a-8, 17d-3, and 18f-3 under the authority set forth in 
sections 6(c), 11(a), 17(d), 18(i), and 38(a) of the Investment Company 
Act [15 U.S.C. 80a-6(c), 80a-11(a), 80a-17(d), 80a-18(i) and 80a-
37(a)].
    The Commission is proposing amendments to Form N-SAR under the 
authority set forth in sections 10(b), 13, 15(d), 23(a), and 36 of the 
Securities Exchange Act [15 U.S.C. 78j(b), 78m, 78o(d), 78w(a), and 
78mm], and sections 8, 13(c), 24(a), 30, and 38 of the Investment 
Company Act [15 U.S.C. 80a-8, 80a-13(c), 80a-24(a), 80a-29, and 80a-
37]. The Commission is proposing amendments to registration Forms N-1A, 
N-3, N-4, and N-6, under the authority set forth in sections 6, 7(a), 
10, and 19(a) of the Securities Act [15 U.S.C. 77f, 77g(a), 77j, 
77s(a)], and sections 8(b), 24(a), and 30 of the Investment Company Act 
[15 U.S.C. 80a-8(b), 80a-24(a), and 80a-29]. The Commission is 
proposing amendments to Exchange Act rule 10b-10 pursuant to the 
authority conferred by the Exchange Act, including sections 10, 17,

[[Page 47128]]

23(a), and 36(a)(1) [15 U.S.C. 78j, 78q, 78w(a), and 78mm(a)(1)].

C. Small Entities Subject to the Rule

    For purposes of the Regulatory Flexibility Act, an investment 
company is a small entity if it, together with other investment 
companies in the same group of related investment companies, has net 
assets of $50 million or less as of the end of its most recent fiscal 
year. Based on a review of filings submitted to the Commission, 
approximately 108 investment companies registered on Form N-1A meet 
this definition. These funds have approximately 189 classes. Commission 
staff estimates that 40 of these investment companies have at least one 
class that charges 12b-1 fees, with approximately 78 classes that 
deduct 12b-1 fees. Of those 78 classes, 23 charge 12b-1 fees in excess 
of 25 basis points, while the remaining 55 classes charge 12b-1 fees of 
less than 25 basis points.
    For purposes of the Regulatory Flexibility Act, a broker-dealer is 
a small business if it had total capital (net worth plus subordinated 
liabilities) of less than $500,000 on the date in the prior fiscal year 
as of which its audited financial statements were prepared pursuant to 
rule 17a-5(d) of the Exchange Act or, if not required to file such 
statements, a broker-dealer that had total capital (net worth plus 
subordinated liabilities) of less than $500,000 on the last business 
day of the preceding fiscal year (or in the time that it has been in 
business, if shorter) and if it is not an affiliate of an entity that 
is not a small business.\556\ The Commission staff estimates that 
approximately 862 broker-dealers meet this definition.\557\ Of these, 
however, only 17 clearing firms can be classified as small entities 
that would likely incur the costs of adopting the proposed amendments 
to rule 10b-10.\558\
---------------------------------------------------------------------------

    \556\ 17 CFR 240.0-10.
    \557\ This estimate is based on information provided in FOCUS 
Reports filed with the Commission in 2009.
    \558\ As discussed above, although there are approximately 5035 
broker-dealers registered with the Commission to whom the rule would 
apply, the staff believes that the costs of implementing the 
proposed changes to rule 10b-10 would be primarily borne by clearing 
firms. Also as discussed above, the staff estimates that there are 
approximately 530 clearing firms. Based on FOCUS Reports filed with 
the Commission in 2009, the staff believes that of these 530 
clearing firms, approximately 17 come within the definition of a 
small entity.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    Our proposal would amend the reporting, recordkeeping, and other 
compliance requirements for all funds (including small entities) that 
comply with rule 12b-1, or would comply with proposed rule 12b-2, 
proposed amendments to rules 6c-10, 11a-3, 17a-8, 17d-3, and 18f-3, or 
that would respond to amended Forms N-1A, N-3, N-4, N-6, N-SAR, 
Schedule 14A and Regulation S-X.\559\ We have estimated the costs of 
these amendments for all marketplace participants previously in the 
cost-benefit analysis in Section V. above. No new classes of skills 
would be required to comply with our proposed new rule, or rule and 
form amendments.
---------------------------------------------------------------------------

    \559\ For a complete discussion of the specifics of the new rule 
and rule and form amendments, see Section III, supra.
---------------------------------------------------------------------------

1. Rule 6c-10
    The proposed amendments to rule 6c-10(b) would allow a fund to 
deduct asset-based distribution fees from fund assets in excess of 
asset-based fees permitted under proposed rule 12b-2 (an ``ongoing 
sales charge''), provided shares sold subject to such an ongoing sales 
charge convert to another class of shares without an ongoing sales 
charge when the shareholder has paid cumulative charges or rates of 
fees that are equivalent to what he or she would have paid for shares 
subject to a front-end sales load. Rule 6c-10(c) would allow funds to 
sell shares at a price other than described in the prospectus. This 
provision is an exemption, and thus would not create any new 
recordkeeping, reporting, or compliance requirements for small entities 
unless they chose to rely on the exemption.
    The proposed amendments would not impose any new reporting 
obligations on small entities. However, small entities that charge an 
ongoing sales charge would be required to keep certain new records 
regarding the length of time that a shareholder holds shares and would 
be required to comply with the new requirement for conversion of those 
shares. Commission staff has estimated the costs of these requirements 
for all funds (including small entities) in the cost-benefit analysis 
in Section V above. We do not anticipate that small funds would face 
unique or special burdens when complying with the proposed amendments 
to rule 6c-10.
2. Removal of Rule 12b-1
    We are proposing to remove rule 12b-1. As discussed above, 
Commission staff has estimated that the proposed removal would reduce 
costs significantly for affected funds, including the 40 small funds 
that the Commission staff estimates have at least one class that 
currently charges 12b-1 fees. The proposal would eliminate existing 
recordkeeping, reporting, and compliance requirements, and would not 
create any new ones.
3. Rule 12b-2
    The proposal would include new rule 12b-2, which would permit funds 
to deduct a ``marketing and service fee'' from fund assets, limited to 
the amount established in the NASD sales charge rule for ``service 
fees.'' Any assets a fund deducts in excess of the marketing and 
service fee would be regulated under rule 6c-10 as an ongoing sales 
charge. The proposal would also permit funds to continue to charge 12b-
1 fees on shares sold prior to the compliance date of the rule and rule 
amendments, if they are adopted, and would continue to regulate the use 
of fund assets to pay for brokerage as under rule 12b-1(h) (by 
including a similar provision in proposed rule 12b-2). We have 
previously estimated that almost all funds (including small funds) that 
currently charge 25 basis points or less in asset-based distribution 
fees under rule 12b-1 would incur no additional reporting, 
recordkeeping, or compliance requirements under proposed rule 12b-2.
4. Rule 11a-3
    As previously discussed, our proposal would amend rule 11a-3 to 
ensure that funds give credit for ongoing sales charges when an 
investor exchanges fund shares within a fund family. The proposed 
amendments would expand current recordkeeping responsibilities for 
funds that charge an ongoing sales charge, including small funds. 
Commission staff has estimated the costs of these changes for all funds 
in the cost-benefit analysis in Section V above. The staff estimates 
that 40 funds qualify as small entities for purposes of the Regulatory 
Flexibility Act, and that they would incur the same costs of compliance 
($25,000, as estimated in section V.K above) to comply with the 
proposed amendments to rule 11a-3 as larger funds, because these funds 
use similar computer systems and/or transfer agents to track share 
exchanges. Although the volume of rule 11a-3 share exchanges may be 
less for small funds, with comparably lower costs of expanding the 
systems to handle exchanges as compared to larger funds, the staff 
estimates that any expenses incurred in upgrading these systems to meet 
the compliance requirements of our proposal would be comparable, due to 
a lack of bargaining power and economies of scale for the smaller 
funds. Therefore, the Commission staff estimates that each small fund 
family

[[Page 47129]]

that charges 12b-1 fees high enough to qualify as ongoing sales 
charges, would incur $25,000 in expenses related to the proposed 
amendments to the reporting, recordkeeping, and compliance requirements 
of rule 11a-3.
5. Rules 17a-8, 17d-3, and 18f-3
    Our proposal would make technical conforming changes to these rules 
as discussed in Section III.L above. Commission staff estimates that 
the proposed changes would create no change in the reporting, 
recordkeeping, or compliance requirements for funds (including small 
funds).
6. Form N-1A
    Form N-1A is the form that open-end mutual funds use to register 
with the Commission. The proposed amendments would require funds that 
file Form N-1A to: (i) Eliminate the line item currently titled 
``Distribution and/or service (12b-1) fee'' and include two line items, 
(if relevant) titled ``Marketing and Service Fee'' and ``Ongoing Sales 
Charge''; (ii) revise and streamline prospectus narrative disclosure on 
asset-based distribution fees; and (iii) revise and streamline SAI 
disclosure regarding asset-based distribution fees. The staff estimates 
that the proposed changes would reduce costs for all funds, including 
small entities, by reducing the amount of time and costs funds incur in 
preparing the forms, and would not impose new reporting or 
recordkeeping requirements.
7. Form N-3, Form N-4, and Form N-6
    The proposed amendments to Forms N-3, N-4, and N-6 would conform 
disclosures in these forms to our proposals.\560\ The proposed 
amendments would replace references to rule 12b-1 with references to 
proposed rules 6c-10(b) or 12b-2(b) and (d). Form N-3 is the 
registration form used by insurance company separate accounts 
registered as management investment companies that offer variable 
annuity contracts. The proposed amendments to Form N-3 would: (i) 
Revise and streamline prospectus narrative disclosure on asset-based 
distribution fees; and (ii) revise and streamline Statement of 
Additional Information disclosure regarding asset-based distribution 
fees. The proposed changes would not impose new reporting or 
recordkeeping requirements for Form N-3.
---------------------------------------------------------------------------

    \560\ Form N-3 is used by separate accounts offering variable 
annuity contracts and registered as management investment companies. 
Form N-4 is used by separate accounts offering variable annuity 
contracts and registered as unit investment trusts. Form N-6 is used 
by separate accounts offering variable life insurance contracts and 
registered as unit investment trusts.
---------------------------------------------------------------------------

    The proposed changes to Forms N-4 and N-6 are technical and 
designed to update references to 12b-1 plans to the new terminology 
used in our proposal. These proposed changes would not change the 
reporting or recordkeeping requirements of these forms. In the cost-
benefit analysis above, we explained that we do not anticipate that 
these amendments would result in new costs or burdens associated with 
preparing the forms. We do not believe that these amendments will 
impose any new recordkeeping, reporting, or compliance requirements.
8. Form N-SAR
    Our proposal would amend the instructions to Form N-SAR, which 
currently requires funds to respond to a series of questions regarding 
their 12b-1 plans. Form N-SAR is the form that registered investment 
companies use to make periodic reports to the Commission. Our proposed 
amendments would add an instruction to Form N-SAR to disregard, for 
funds that no longer have 12b-1 plans, four questions (Items 41-44) 
that relate to the operation of rule 12b-1 plans (because they would be 
irrelevant in light of our proposed new framework for asset-based 
distribution fees). However, funds that maintain grandfathered fund 
classes would continue to respond to these items. The proposal would 
impose no new recordkeeping, reporting, or compliance requirements, and 
would instead reduce these burdens for respondents that do not have 
grandfathered 12b-1 plans.
9. Schedule 14A
    Funds comply with the requirements of Schedule 14A when they 
solicit proxies from their shareholders. Our proposal would amend the 
required disclosures under section 14A when a fund institutes or 
materially increases a marketing and service fee after shares have been 
offered to the public. The proposed amendments would streamline proxy 
disclosures, removing items that would be superfluous if our proposed 
new rules and rule amendments on marketing and service fees were 
adopted. As discussed above, we have previously estimated that our 
changes to Schedule 14A would not create any new reporting, 
recordkeeping, or compliance burdens for funds that solicit proxies, 
and would instead reduce the existing burden.
10. Regulation S-X
    Regulation S-X requires funds to file a statement of operations 
listing their income and expenses, and to state separately all amounts 
paid in accordance with a plan adopted under rule 12b-1. Our proposal 
would conform this requirement to the terms of our proposed new rules 
and rule amendments regarding asset-based distribution fees. The 
proposed amendments to regulation S-X would require that funds state 
asset-based distribution fees paid, and state separately amounts paid 
pursuant to our proposed rules on marketing and service fees and 
ongoing sales charges. Our understanding is that funds, as a matter of 
good business practice, already keep the information on asset-based 
distribution fees in the proper form, because that information is used 
to prepare information on 12b-1 fees, and is a component of the overall 
statement of expenses. The staff estimates that our proposed changes to 
regulation S-X would not change the amount of time or the costs 
required for funds (including small funds) to prepare their statements 
of operations. Therefore, we do not expect that these amendments will 
impose any new recordkeeping, reporting, or compliance requirements.
11. Rule 10b-10
    Exchange Act rule 10b-10 requires broker-dealers to provide 
transaction confirmations to customers. The proposed amendments to this 
rule would require disclosure of additional information related to 
sales charges in connection with transactions involving mutual funds, 
and certain additional information in connection with callable debt 
securities. The proposed amendments would expand current recordkeeping 
responsibilities for broker-dealers, including small broker-dealers. As 
discussed above, the Commission staff estimates that the one-time 
burden for clearing firms with proprietary systems associated with 
these proposed amendments would equal total internal costs of 
approximately $180.7 million dollars \561\ or approximately $1.1 
million per clearing firm with a proprietary system.\562\ Also as 
discussed above, as a general matter, medium-sized and smaller clearing 
firms, and also some larger ones, use platforms licensed from vendors 
to generate the data necessary to send confirmations. As discussed

[[Page 47130]]

above, the staff understands that there are three primary vendors that 
license the majority of platforms to clearing firms that do not have 
proprietary systems. In addition, clearing firms may also use vendors 
to send physical confirmations to investors. Therefore, these vendors 
would have to reprogram their software and update these platforms to 
generate the data that would allow their clients to comply with these 
proposed amendments to rule 10b-10. Based on discussions with industry 
representatives, the staff is of the view that the cost and burdens to 
vendors to update the platforms that they license to clearing firms 
would be equivalent to the costs and burdens that would be incurred by 
clearing firms who would have to reprogram and update their proprietary 
systems, resulting in a cost to these vendors of approximately $3.4 
million dollars \563\ or $1.1 million per vendor.\564\ In addition, the 
staff understands that clearing firm licensees of these platforms would 
still incur a one-time cost of approximately $74.3 million dollars 
\565\ or $200,800 \566\ per clearing firm licensee, to adopt the 
changes made to vendor platforms and to determine whether the output 
satisfies the requirements of the proposed amendments.
---------------------------------------------------------------------------

    \561\ (4,500 burden hours x 160 clearing firms with proprietary 
systems) x $251 dollars per hour = $180,720,000.
    \562\ 4,500 hours x $251 dollars per hour = $1,129,500. See note 
548 supra.
    \563\ (3 vendors x 4500 burden hours) x $251 dollars per hour = 
$3,388,500. See note 549 supra.
    \564\ 4500 hours x $251 dollars per hour = $1,129,500. See note 
550 supra.
    \565\ (800 burden hours x 370 clearing firms that use vendor 
licensed platforms) x $251 per hour = $74,296,000. See note 551 
supra.
    \566\ 800 hours x $251 dollars per hour = $200,800. See note 552 
supra.
---------------------------------------------------------------------------

    As discussed above, of the approximately 530 clearing firms that 
would incur upgrade costs, 17 of those are small entities. The staff 
believes that these small entity clearing firms would likely license 
their platforms from vendors. Accordingly, the staff estimates that 
these firms would incur costs of approximately $200,800 each to adapt 
to the changes in vendor platforms, or approximately $3.4 million 
total.\567\ These figures are already included in the total burden 
costs that clearing firms, and in particular, clearing firm licensees, 
would incur to implement the proposed amendments to rule 10b-10.
---------------------------------------------------------------------------

    \567\ (800 burden hours x 17 small entity clearing firms) x $251 
per hour = $3,413,600.
---------------------------------------------------------------------------

    In addition, as discussed above,\568\ the staff believes that 
clearing firms will bear most of the costs associated with updating 
back-office operations to accommodate the proposed changes to rule 10b-
10. Accordingly, the staff does not believe that small introducing 
firms will incur these costs.
---------------------------------------------------------------------------

    \568\ See Section IV.H supra.
---------------------------------------------------------------------------

12. Request for Comment
     The Commission solicits comment on these estimates and the 
anticipated effect the proposed amendments would have on small entities 
subject to the proposed rule and rule and form amendments.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    We have not identified any federal rules that duplicate, overlap, 
or conflict with the proposed rule or rule or form amendments.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small issuers. In 
connection with the proposed amendments, the Commission considered the 
following alternatives: (i) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the proposed amendments for small entities; (iii) 
the use of performance rather than design standards; and (iv) an 
exemption from coverage of the proposed amendments, or any part 
thereof, for small entities.
    Investors in small funds face the same issues as investors in 
larger funds when paying asset-based distribution fees. Small funds use 
asset-based distribution fees as a means of growing their funds and 
accessing alternate distribution channels, and our rule proposal is 
designed to allow funds to continue to use asset-based distribution 
fees for these purposes. We have endeavored through the proposed 
amendments to minimize the regulatory burden on all funds, including 
small entities, while meeting our regulatory objectives. We have tried 
to design our proposal so that small entities would not be 
disadvantaged, and we anticipate that the potential impact of the 
proposed rule and amendments on small entities would not be 
significant. Small entities should experience the same benefits from 
the proposal as other funds. We have endeavored to clarify, 
consolidate, and simplify disclosure for all funds, which should be 
beneficial for all funds, including those that are small entities. 
Moreover, with respect to the proposed revisions to the broker-dealer 
confirmation requirements of rule 10b-10, we also believe that special 
compliance or reporting requirements for small broker-dealers would not 
be appropriate or consistent with investor protection, because 
distinguishing such requirements based on the size of the broker-dealer 
may be accompanied by disparate treatment of investors and could lead 
to investor confusion.
    For these reasons, we have not proposed alternatives to the 
proposed rule and rule and form amendments.

G. Request for Comments

    We encourage the submission of comments with respect to any aspect 
of the IRFA.
     We particularly request comments on the number of, and the 
likely impact on, small entities that would be subject to the proposed 
rule, and rule and form amendments. Commenters are asked to describe 
the nature of any impact and provide empirical data supporting its 
extent. These comments will be considered in connection with any 
adoption of the proposed rule and amendments, and reflected in a Final 
Regulatory Flexibility Analysis.
    Comments should be submitted in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090. Comments also may be submitted 
electronically to the following e-mail address: rule-comments@sec.gov. 
All comment letters should refer to File No. S7-15-10, and this file 
number should be included on the subject line if e-mail is used.\569\ 
Comment letters will be available for Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street, NE., Washington, 
DC 20549-1520, on official business days between the hours of 10 a.m. 
and 3 p.m. Electronically submitted comment letters also will be posted 
on the Commission's Internet Web site (http://www.sec.gov).
---------------------------------------------------------------------------

    \569\ Comments on the IRFA will be placed in the same public 
file that contains comments on the proposed rule and amendments.
---------------------------------------------------------------------------

VII. Consideration of Burden on Competition and Promotion of 
Efficiency, Competition and Capital Formation

    Section 23(a)(2) of the Exchange Act requires the Commission, in 
adopting rules under the Exchange Act, to consider the impact that any 
new rule would have on competition, and prohibits the Commission from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\570\ Section 2(b) of the Securities Act and

[[Page 47131]]

section 3(f) of the Exchange Act require the Commission, when engaging 
in rulemaking that requires it to consider or determine whether an 
action is necessary or appropriate in the public interest to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.\571\ Further, 
section 2(c) of the Investment Company Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is consistent with the public interest, to consider, 
in addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.\572\ As 
discussed below, we expect that the proposed rule, and rule and form 
amendments, may promote efficiency, competition, and capital formation.
---------------------------------------------------------------------------

    \570\ 15 U.S.C. 78w(a)(2).
    \571\ 15 U.S.C. 77b(b); 15 U.S.C. 78c(f).
    \572\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------

A. Removal of Rule 12b-1

    Our proposal would remove rule 12b-1, and in so doing, would 
eliminate the explicit requirements in the rule for board approval and 
annual review of asset-based distribution fees and written 12b-1 plans. 
By eliminating these formal requirements in rule 12b-1, our proposal is 
designed to modify the regulations governing these fees to reflect 
current economic realities. As discussed in Section V above, funds may 
realize significant time and expense savings when managing asset-based 
distribution fees under our proposal, compared to the current 
requirements of rule 12b-1. Thus, we expect that the proposed removal 
of rule 12b-1 would enhance the efficiency of funds in managing and 
overseeing the operation and use of asset-based distribution fees.
    Many funds use asset-based distribution fees to pay for 
distribution costs in a cost-effective manner that allows them to 
compete with other investment products. We expect that, in combination 
with the rest of our proposal, our proposed removal of rule 12b-1, if 
adopted, would not prevent funds from continuing to access the 
competitive benefits of paying for distribution through asset-based 
fees. Small funds often use asset-based distribution fees as a means of 
building their funds and participating in distribution channels that 
they might not otherwise be able to access. We have designed our 
proposals to allow funds to continue to grow through these means. In 
addition, our proposal would allow funds that currently charge 12b-1 
fees to continue to deduct these fees on outstanding shares without 
significant disruption. Therefore, we do not anticipate that our 
proposal to remove rule 12b-1 would affect capital formation or 
competition.

B. Rule 12b-2

    We are proposing to adopt rule 12b-2 (in combination with the rest 
of our proposal) to replace rule 12b-1. Proposed rule 12b-2 would allow 
funds to deduct a ``marketing and service fee'' from fund assets, up to 
the amount permitted for service fees under NASD Conduct Rule 2830. The 
proposed amendments would consider any asset-based distribution fee 
that exceeds this amount to be an ``ongoing sales charge'' that would 
be separately regulated under our proposed amendments to rule 6c-10, as 
discussed below. Proposed rule 12b-2 would not require a ``plan'' or 
impose other special board requirements to deduct a marketing and 
service fee. As discussed above, we expect that the marketing and 
service fee under proposed rule 12b-2 would allow funds to continue to 
experience the competitive and capital formation benefits resulting 
from a 25 basis point asset-based distribution fee. The limited 
conditions associated with the proposed rule should allow funds to 
impose these fees in a more efficient way. Because all funds would be 
able to rely on the proposed rule, and because we do not expect that 
the rule would affect the ability of funds to create distribution 
structures that fit their competitive model, we do not believe that the 
proposed rulemaking would impact competition significantly. We also do 
not anticipate that the proposed rule would significantly encourage or 
discourage assets being invested in the capital markets, or in 
particular funds, and thus do not expect that there would be a 
significant impact on capital formation.

C. Amended Rule 6c-10

    Proposed rule 6c-10(b) would treat asset-based distribution fees 
deducted in excess of the marketing and service fee as ``ongoing sales 
charges.'' The proposal would require that funds convert shares subject 
to an ongoing sales charge to a share class without the fee after the 
investor has paid cumulative amounts or rates of ongoing sales charges 
that equal the fund's front-end load.
    We expect that the ongoing sales charge may allow investors to 
better understand the costs of distribution they pay, and would reduce 
the potential for some long-time investors to subsidize the 
distribution costs of other investors in the same fund. Our proposal 
therefore may allow investors who are better informed to allocate their 
investments more efficiently. The proposed amendments should also 
reduce fund intermediary conflicts of interest when advising investors 
regarding fund classes that provide different levels of intermediary 
compensation based on the period or method for payment of distribution 
fees. This might allow fund intermediaries to spend less time managing 
these conflicts and instead allocate their resources more efficiently 
towards providing better services to investors and increasing 
competition among intermediaries. Because all funds would be able to 
rely on the proposed rule, and because we do not expect that the rule 
would affect the ability of funds to create distribution structures 
that fit their competitive model, we do not believe that the proposed 
rulemaking would impact competition significantly. We also do not 
anticipate that the proposed rule would significantly encourage or 
discourage assets being invested in the capital markets, or in 
particular funds, and thus do not expect that there would be a 
significant impact on capital formation.
    In addition, the proposed amendments to rule 6c-10(c) would permit 
funds to sell their shares at a price other than a current public 
offering price as described in the prospectus, which is otherwise 
required by section 22(d). Section 22(d) imposes a significant 
restriction on competition and the efficient setting of sales loads for 
mutual fund distribution, because it effectively requires dealers to 
sell fund shares at the same sales load, regardless of the services 
provided or the actual cost of distribution. Currently, all investors 
in a particular fund class pay the same costs for distribution when 
purchasing shares through a fund intermediary, regardless of the 
quality or type of services provided by the intermediary. Our proposal 
would allow funds to make available a class of shares that 
``unbundles'' the costs of distribution from the fund's operating 
expenses. This is designed to give funds and intermediaries new avenues 
for competition, by permitting funds and intermediaries to break out 
the costs of distribution from other services they provide, and letting 
investors choose different levels of service based on their needs, 
considering among other things, cost and quality of the services 
offered.
    Under our proposal, investors would be able to seek out 
intermediaries that provide a high level of service, provide simple 
execution of fund trades, or provide services that fall somewhere in 
the middle. Sales charges would be

[[Page 47132]]

transparent and could be imposed or deducted in a manner and at any 
time selected by the investor. We expect that this would enhance 
efficiency of capital allocation as well as competition among fund 
intermediaries by allowing investors to shop for the pricing structure 
that best suits the investor's needs and the marketing choices of the 
fund or intermediary.\573\
---------------------------------------------------------------------------

    \573\ Some roundtable commenters agreed that the externalization 
of asset-based distribution fees could improve competition among 
mutual funds. See Comment Letter of Bridgeway Funds, Inc. and 
Bridgeway Capital Management, Inc. (July 19, 2007) (``Mutualization 
of [12b-1] fees * * * distorts fundamental, free-market economics 
and restricts valuable competition in the intermediary channel.'').
---------------------------------------------------------------------------

    Funds that take advantage of the exemption would be able to 
effectively externalize the distribution of their shares, an approach 
that may encourage small funds and new entrants to the market that are 
eager to attract dealers that wish to sell shares based on their own 
fee schedules. It may also permit these funds to compete better by 
reducing their expense ratios (because it would eliminate, at least 
with respect to the particular class, ongoing sales charges), while 
still charging low or no front-end sales loads. In addition, innovative 
distribution models may encourage additional investors to invest in the 
capital markets, enhancing capital formation.
    An externalized approach could simplify the operations of 
intermediaries, allowing them to process transactions more efficiently 
based on a single, uniform fee structure. In some cases, it could also 
simplify fund operations and fund prospectuses by eliminating the need 
to offer multiple classes of shares, further reducing fund expenses, 
enhancing the efficiency of distribution, and reducing investor 
confusion. This type of structure may also help traditional mutual 
funds better compete with other investments, such as exchange-traded 
funds (ETFs), which have externalized distribution costs and have been 
growing in popularity.\574\
---------------------------------------------------------------------------

    \574\ In 2009, ETF assets grew 46 percent (from $531 billion to 
$777 billion) while traditional equity and bond mutual fund assets 
grew 16 percent (from $9.6 trillion to $11.1 trillion). See 2010 ICI 
Fact Book, supra note 6, at 9 and 41.
---------------------------------------------------------------------------

    The proposed exemption is designed to foster price competition 
among fund intermediaries that charge for the sale of mutual funds, and 
enhance the efficiency of fund operations and investor choice. 
Therefore, as discussed above, we expect that the proposed rule 
amendments are likely to enhance efficiency, competition, and capital 
formation in the fund marketplace.

D. Disclosure Amendments

    Our proposal would amend Forms N-1A, N-SAR, N-3, N-4, and N-6 and 
Regulation S-X, to conform them to our proposed treatment of asset-
based distribution fees.\575\ The proposed amendments would improve 
disclosure by separately identifying the ``marketing and service fee'' 
and ``ongoing sales charge'' as individual line items in the fee table 
and income statement. The proposed amendments would also streamline 
current disclosure regarding asset-based distribution fees by replacing 
disclosure made irrelevant by our proposal with more narrowly focused 
and precise information regarding asset-based distribution fees. The 
proposed disclosure amendments would also replace references to 12b-1 
fees in these forms with references to the appropriate rule in our 
proposal.
---------------------------------------------------------------------------

    \575\ See supra Section III.
---------------------------------------------------------------------------

    These proposed changes may allow investors to more efficiently 
obtain and manage information about their investments, as well as 
reduce the time and cost burdens funds bear in preparing this 
information. These proposed amendments may lead to increased efficiency 
by enhancing the ability of investors to more specifically identify the 
costs of distribution they pay when investing in funds. This 
information should promote more efficient allocation of investments by 
investors among funds because they may compare and choose funds based 
on their costs of distribution and the services provided for these fees 
more easily. To the extent that these create efficiencies, this may 
result in new investors investing in funds (or existing investors 
adding additional capital), and could enhance capital formation, and 
the efficiency of investors selecting among funds. Because these 
disclosure amendments would apply to all funds, we do not expect that 
they would have an impact on competition in the fund marketplace.

E. Rule 11a-3 and Technical Amendments

    Our proposal would also make amendments to rule 11a-3 (which 
governs the payment of sales loads when making share exchanges within a 
fund family) to conform to our proposed treatment of asset-based 
distribution fees as sales loads. The proposed amendments would require 
funds to credit ongoing sales charges an investor has paid against any 
other load owed when the investor exchanges shares within a fund 
family. We do not anticipate that these amendments would affect capital 
formation or competition, nor would they reduce the efficiency of these 
exchanges because they apply to all funds and should not encourage or 
discourage investors to invest in the capital markets. We expect that 
the proposed amendments may reassure investors that they would not pay 
excessive distribution costs when making exchanges within a fund 
family, regardless of whether they chose to pay the costs of 
distribution front-end, over time, or upon redemption.
    Our proposal would also make technical conforming amendments to 
rules 17a-8, 17d-3, and 18f-3, to replace references to rule 12b-1 with 
references to the appropriate rule regulating asset-based distribution 
fees in our proposal. We do not expect that these changes would affect 
the operation of funds, or the behavior of investors, fund 
intermediaries, or service providers. Therefore, we do not anticipate 
that these proposed amendments would impact competition, efficiency, or 
capital formation.

F. Rule 10b-10 Amendments

    Our proposal further would amend rule 10b-10 to provide broker-
dealer customers with improved information in transaction confirmations 
about mutual fund sales charges and about information regarding 
callable securities. These proposed amendments may lead to increased 
efficiency and competitiveness by enhancing the ability of investors to 
more specifically understand information related to their transactions 
in these securities, which not only would allow them to correct any 
associated errors, but also would help inform their future purchases of 
securities of this type and promote investment into securities that 
bear lower distribution-related costs.

G. Request for Comment

     We request comment on whether the proposed rule and rule 
and form amendments, if adopted, would promote efficiency, competition, 
and capital formation. We also request comment on any anti-competitive 
effects of the proposed amendments. Commenters are requested to provide 
empirical data and other factual support for their views, if possible.

VIII. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996 (``SBREFA''), a rule is ``major'' if it results or is 
likely to result in:
     An annual effect on the economy of $100 million or more;

[[Page 47133]]

     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effects on competition, investment, or 
innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review.
     We request comment on the potential impact of the proposed 
rules and rule amendments on the economy on an annual basis. Commenters 
are requested to provide empirical data and other factual support for 
their views to the extent possible.

IX. Statutory Authority

    The Commission is proposing amendments to rule 6-07 of Regulation 
S-X under the authority set forth in section 7 of the Securities Act 
[15 U.S.C. 77g] and sections 8 and 38(a) of the Investment Company Act 
[15 U.S.C. 80a-8 and 80a-37(a)]. The Commission is proposing amendments 
to Schedule 14A under the authority set forth in sections 3(b), 10, 13, 
14, 15, 23(a), and 36 of the Securities Exchange Act [15 U.S.C. 78c(b), 
78j, 78m, 78n, 78o, 78w(a), and 78mm], and sections 20(a), 30(a), and 
38(a) of the Investment Company Act [15 U.S.C. 80a-20(a), 80a-29(a), 
and 80a-37(a)].
    The Commission is proposing to rescind rule 12b-1 under the 
authority set forth in sections 12(b) and 38(a) of the Investment 
Company Act [15 U.S.C. 80a-12(b) and 80a-37(a)]. The Commission is 
proposing new rule 12b-2 under the authority set forth in sections 
12(b) and 38(a) of the Investment Company Act [15 U.S.C. 80a-12(b) and 
80a-37(a)]. The Commission is proposing amendments to rule 6c-10 under 
the authority set forth in sections 6(c), 12(b), 22(d)(iii), and 38(a) 
of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-12(b), 80a-
22(d)(iii), and 80a-37(a)]. The Commission is proposing amendments to 
rules 11a-3, 17a-8, 17d-3, and 18f-3 under the authority set forth in 
sections 6(c), 11(a), 17(d), 18(i), and 38(a) of the Investment Company 
Act [15 U.S.C. 80a-6(c), 80a-11(a), 80a-17(d), 80a-18(i), and 80a-
37(a)]. The Commission is proposing amendments to Exchange Act rule 
10b-10 pursuant to the authority conferred by the Exchange Act, 
including Sections 10, 17, 23(a), and 36(a)(1) [15 U.S.C. 78j, 78q, 
78w(a), and 78mm(a)(1)].
    The Commission is proposing amendments to registration Forms N-1A, 
N-3, N-4, and N-6 under the authority set forth in sections 6, 7(a), 
10, and 19(a) of the Securities Act [15 U.S.C. 77f, 77g(a), 77j, and 
77s(a)], and sections 8(b), 24(a), and 30 of the Investment Company Act 
[15 U.S.C. 80a-8(b), 80a-24(a), and 80a-29]. The Commission is 
proposing amendments to Form N-SAR pursuant to authority set forth in 
sections 10(b), 13, 15(d), 23(a), and 36 of the Securities Exchange Act 
[15 U.S.C. 78j(b), 78m, 78o(d), 78w(a), and 78mm], and sections 8, 
13(c), 24(a), 30, and 38 of the Investment Company Act [15 U.S.C. 80a-
8, 80a-13(c), 80a-24(a), 80a-29, and 80a-37].

List of Subjects

17 CFR Part 210

    Accounting, Reporting, and recordkeeping requirements, Securities.

17 CFR Parts 239, 240, and 249

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rules and Form Amendments

    For reasons set forth in the preamble, Title 17, Chapter II of the 
Code of Federal Regulations is proposed to be amended as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL 
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 
1934, INVESTMENT COMPANY ACT OF 1940, INVESTMENT ADVISERS ACT OF 
1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

    1. The authority citation for Part 210 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77aa(25), 77aa(26), 77nn(25), 77nn(26), 78(c), 78j-1, 78l, 78m, 78n, 
78o(d), 78q, 78u-5, 78w, 78ll, 78mm, 80a-8, 80a-20, 80a-29, 80a-30, 
80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, unless otherwise 
noted.

    2. The Part 210 heading is revised as set forth above.
    3. Section 210.6-07 is amended by revising paragraph 2(f) to read 
as follows:

Sec.  210.6-07  Statements of operations.

* * * * *
    2. Expenses. * * *
    (f) State separately all fees deducted from fund assets to finance 
distribution activities pursuant to Sec. Sec.  270.12b-2(b), (d) or 
270.6c-10(b) of this chapter. Reimbursement to the fund of expenses 
deducted from fund assets pursuant to Sec. Sec.  270.12b-2(b), (d) and 
270.6c-10(b) shall be shown as a negative amount and deducted from 
current Sec. Sec.  270.12b-2(b), (d) and 270.6c-10(b) expenses. If 
Sec. Sec.  270.12b-2(b) and 270.6c-10(b) expense reimbursements exceed 
current Sec. Sec.  270.12b-2(b) and 270.6c-10(b) expenses, such excess 
shall be used in the calculation of total expenses under this caption.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

    4. The authority citation for Part 239 continues to read, in part, 
as follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77sss, 78c, 78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll, 78mm, 80a-
2(a), 80a-3, 80a-8, 80a-9, 80a-10, 80a-13, 80a-24, 80a-26, 80a-29, 
80a-30, and 80a-37, unless otherwise noted.
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    5. The general authority citation for Part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 
80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise 
noted.

    6. Section 240.10b-10 is amended by:
    a. Revising paragraph (a)(6)(i);
    b. Removing from paragraph (a)(9)(ii) the period at the end of the 
paragraph and adding in its place ``; and''
    c. Adding paragraphs (a)(10) and (a)(11);
    d. Revising paragraph (b)(2);
    e. Adding paragraph (d)(10);
    f. Removing from paragraph (e) introductory text ``, Provided 
that:'' at the end and adding in its place ``; provided that the broker 
or dealer that effects any transaction for a customer in security 
futures products in a futures account gives or sends to the customer no 
later than the next business day after execution of any futures 
securities product transaction, written notification disclosing:''
    g. Removing paragraph (e)(1) introductory text and redesignating 
paragraphs (e)(1)(i), (ii), (iii) and (iv) as paragraphs (e)(1), (2), 
(3), and (4), respectively; and
    h. Removing paragraph (e)(2).
    The revisions and additions read as follows.

Sec.  240.10b-10  Confirmation of transactions.

* * * * *
    (a) * * *
    (6) * * *
    (i) The yield at which the transaction was effected, including the 
percentage

[[Page 47134]]

amount and its characterization (e.g., current yield, yield to 
maturity, or yield to call) and if effected at yield to call, the type 
of call, the call date and, if different, the first date upon which the 
security may be called, and call price; and
* * * * *
    (10) In the case of a purchase of a mutual fund security:
    (i) The amount of any sales charge that the customer incurred at 
the time of purchase, expressed in dollars and as a percentage of the 
public offering price, the net dollar amount invested in the security, 
and the amount of any applicable breakpoint or similar threshold used 
to calculate the sales charge;
    (ii) The maximum amount of any deferred sales charge that the 
customer may incur in connection with the subsequent redemption or sale 
of the securities purchased, expressed as a percentage of the net asset 
value at the time of purchase or at the time of redemption or sale, as 
applicable;
    (iii) If the customer will incur any ongoing sales charge (as 
defined in Sec.  270.6c-10) or any marketing and service fee (as 
defined in Sec.  270.12b-2) after the time of purchase:
    (A) The annual amount of the charge or fee, expressed as a 
percentage of net asset value; the aggregate amount of the ongoing 
sales charge that may be incurred over time, expressed as a percentage 
of net asset value; and the maximum number of months or years that the 
customer will incur ongoing sales charge; and
    (B) The following statement (which may be revised to reflect the 
particular charge or fee at issue): ``In addition to ongoing sales 
charges and marketing and service fees, you will also incur additional 
fees and expenses in connection with owning this mutual fund, as set 
forth in the fee table in the mutual fund prospectus; these typically 
will include management fees and other expenses. Such fees and expenses 
are generally paid from the assets of the mutual fund in which you are 
investing. Therefore, these costs are indirectly paid by you.''; and
    (11) In the case of a redemption or sale of a mutual fund security, 
the amount of any deferred sales charge that the customer has paid in 
connection with the redemption or sale, expressed in dollars and as a 
percentage of the net asset value at the time of purchase or at the 
time of redemption or sale, as applicable.
    (b) * * *
    (2) Such broker or dealer gives or sends to such customer within 
five business days after the end of each quarterly period, for 
transactions involving investment company and periodic plans, and after 
the end of each monthly period, for other transactions described in 
paragraph (b)(1) of this section, a written statement disclosing each 
purchase or redemption, effected for or with, and each dividend or 
distribution credited to or reinvested for, the account of such 
customer during the month; the date of such transaction; the identity, 
number, and price of any securities purchased or redeemed by such 
customer in each such transaction; the total number of shares of such 
securities in such customer's account; any remuneration received or to 
be received by the broker or dealer in connection therewith; any 
ongoing sales charges or marketing and service fees incurred in 
connection with the purchase or redemption of a mutual fund security; 
and that any other information required by paragraph (a) of this 
section will be furnished upon written request: Provided, however, that 
the written statement may be delivered to some other person designated 
by the customer for distribution to the customer; and
* * * * *
    (d) * * *
    (10) Mutual fund security means any security issued by an open-end 
company, as defined by section 5(a)(1) of the Investment Company Act of 
1940 (15 U.S.C. 80a-5(a)(1)), that is registered or required to 
register under section 8 of that Act, including any series of such 
company.
* * * * *
    7. Schedule 14A (referenced in Sec.  240.14a-101) is amended by 
revising paragraphs (a)(1)(iii) and (d) in Item 22 to read as follows:

Sec.  240.14a-101  Schedule 14A Information required in a proxy 
statement.

* * * * *

Item 22. Information Required in Investment Company Proxy Statement

    (a) * * *
    (1) * * *
    (iii) Marketing and Service Fee. The term ``Marketing and Service 
Fee'' shall mean a fee deducted from Fund assets to finance 
distribution activities pursuant to rule 12b-2(b) (Sec.  270.12b-2(b)).
* * * * *
    (d) Marketing and Service Fees. If action is to be taken to 
institute a Marketing and Service Fee or increase the rate of an 
existing Marketing and Service Fee, include the following information 
in the proxy statement:
    (1) A description of the nature of the action to be taken and the 
reasons therefore, the rate of the Marketing and Service Fee as it is 
proposed to be deducted and the purposes for which such fee may be 
used, and, if the action to be taken is an increase in the rate of an 
existing Marketing and Service Fee, the reasons for the increase.
    (2) If the Fund currently deducts a Marketing and Service Fee:
    (i) Provide the date that the Marketing and Service Fee was first 
instituted and the date of the last increase, if any;
    (ii) Disclose the rate of the Marketing and Service Fee and the 
purposes for which such fee may be used; and
    (iii) Disclose the name of, and the amount of any Marketing and 
Service Fee paid by the Fund during its most recent fiscal year to, any 
person who is an affiliated person of the Fund, its investment adviser, 
principal underwriter, or Administrator, an affiliated person of such 
person, or a person that during the most recent fiscal year received 
10% or more of the aggregate amount of Marketing and Service Fees paid 
by the Fund.
* * * * *

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    8. The authority citation for Part 249 continues to read, in part, 
as follows:

    Authority:  15 U.S.C. 78a et seq. and 7201 et seq.; and 18 
U.S.C. 1350, unless otherwise noted.
* * * * *

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    9. The general authority citation for Part 270 continues to read in 
part as follows:

    Authority:  15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.

    10. The authority citation for Sec.  270.6c-10 is revised to read 
as follows:

    Authority: * * *

    Section 270.6c-10 is also issued under 15 U.S.C. 80a-6(c), 15 
U.S.C. 80a-12(b), 15 U.S.C. 80a-22(d) and 80a-37(a).
* * * * *
    11. The authority citation for Sec.  270.12b-2 is added to read as 
follows:

    Authority: * * *
* * * * *
    Section 270.12b-2 is also issued under 15 U.S.C. 80a-6(c), 15 
U.S.C. 80a-12(b), and 80a-37(a).
* * * * *
    12. The authority citation for Sec.  270.17a-8 continues to read as 
follows:

[[Page 47135]]

    Authority: * * *
* * * * *
    Section 270.17a-8 is also issued under 15 U.S.C. 80a-6(c) and 
80a-37(a).
* * * * *
    13. Section 270.6c-10 is revised to read as follows:

Sec.  270.6c-10  Exemptions for certain open-end management investment 
companies to impose deferred sales loads and other sales charges.

    (a) Deferred Sales Load. (1) Exemption. Notwithstanding sections 
2(a)(32), 2(a)(35), and 22(d) of the Act [15 U.S.C. 80a-2(a)(32), 80a-
2(a)(35), and 80a-22(d), respectively] and Sec.  270.22c-1, a fund, 
other than a registered separate account, and any exempted person may 
impose a deferred sales load on fund shares, if:
    (i) The amount of the deferred sales load does not exceed a 
specified percentage of the net asset value or the offering price at 
the time of purchase; and
    (ii) The terms of the deferred sales load are covered by the 
provisions of Rule 2830 of the Conduct Rules of the NASD; and
    (iii) The same deferred sales load is imposed on all shareholders, 
except that a fund may offer scheduled variations in or elimination of 
a deferred sales load to a particular class of shareholders or 
transactions if the fund has satisfied the conditions in Sec.  270.22d-
1.
    (2) Load Reductions. Nothing in this paragraph (a) prevents a fund 
from offering to existing shareholders a new scheduled variation that 
would waive or reduce the amount of a deferred sales load not yet paid.
    (b) Fund-Level Sales Charge. (1) Exemption. Notwithstanding Sec.  
270.12b-2(b)(1), a fund may deduct an ongoing sales charge from fund 
assets if the cumulative ongoing sales charges imposed on a purchase of 
fund shares do not exceed the shareholder's maximum sales load, 
provided that:
    (i) A fund may satisfy the requirements of this paragraph (b) if 
shares subject to an ongoing sales charge convert (without any 
shareholder action and in accordance with Sec.  270.18f-3(f)(2)) to a 
fund share class without an ongoing sales charge, on or before the end 
of the conversion period;
    (ii) Shares acquired by reinvestment of dividends or other 
distributions may be invested in a fund share class with an ongoing 
sales charge only if the reinvested shares convert to a share class 
without an ongoing sales charge no later than when the shares on which 
the dividend or distribution was declared convert;
    (iii) A fund may offer scheduled variations in the conversion 
period to a particular class of shareholders or transactions if the 
fund has satisfied the conditions in Sec.  270.22d-1; and
    (iv) The fund does not acquire shares of another fund that, with 
respect to the class of shares acquired, deducts an ongoing sales 
charge.
    (2) Sales Charge Reductions. Nothing in this paragraph (b) prevents 
a fund from offering to existing shareholders a new scheduled variation 
that would reduce the conversion period.
    (3) Changes to Ongoing Sales Charge. No fund may:
    (i) Institute or increase the rate of an ongoing sales charge 
applied to a fund share class or series after any public offering of 
the fund's voting shares or the sale of such shares to persons who are 
not organizers of the fund; or
    (ii) Increase the amount of time after which a share class will 
automatically convert to a class of shares that does not have an 
ongoing sales charge, if it would increase the cumulative amount of 
ongoing sales charges imposed.
    (c) Account-Level Sales Charge. Notwithstanding section 22(d) of 
the Act [15 U.S.C. 80a-22(d)], any fund class and any exempted person 
may offer or sell fund shares at a price other than the current public 
offering price described in the prospectus, if:
    (1) The class does not impose an ongoing sales charge pursuant to 
Sec.  270.6c-10(b), although it may impose a marketing and service fee 
pursuant to Sec.  270.12b-2(b); and
    (2) The fund discloses in its registration statement that it has 
elected to rely on this paragraph (c) for an exemption from section 
22(d) of the Act [15 U.S.C. 80a-22(d)].
    (d) Definitions. For purposes of this section:
    (1) Acquired security has the same meaning as in Sec.  270.11a-
3(a)(1).
    (2) Conversion period is the period beginning on the day that 
shares are purchased and ending on the last day of the calendar month 
during which the cumulative ongoing sales charge rates exceed the 
shareholder's maximum sales load rate. The maximum number of months in 
a conversion period is determined by dividing the shareholder's maximum 
sales load rate by the ongoing sales charge rate and multiplying the 
result by 12.
    (3) Deferred sales load means any amount properly chargeable to 
sales or promotional expenses that is paid directly by a shareholder to 
a fund after purchase but before or upon redemption.
    (4) Distribution activity means any ``Distribution activity,'' as 
defined in Sec.  270.12b-2(e)(2).
    (5) Exchanged security has the same meaning as in Sec.  270.11a-
3(a)(4).
    (6) Exempted person means any principal underwriter of, dealer in, 
and any other person authorized to effect transactions in, shares of a 
fund.
    (7) Fund means a registered open-end management investment company, 
and includes a separate series of a fund.
    (8) Group of investment companies has the same meaning as in Sec.  
270.11a-3(a)(5).
    (9) Maximum sales load means the maximum sales load rate multiplied 
by the total dollar amount paid.
    (10) Maximum sales load rate means the reference load minus the sum 
of the rates of:
    (i) Any sales load (including a deferred sales load) incurred in 
connection with the purchase of fund shares; and
    (ii) Any sales loads or ongoing sales charges previously paid with 
respect to an exchanged security within the same group of investment 
companies.
    (11) Ongoing sales charge means any charges or fees deducted from 
fund assets to finance distribution activity in excess of the maximum 
rate permitted under Sec.  270.12b-2(b). In the case of a fund (``the 
acquiring fund'') that acquires shares of another fund (the ``acquired 
fund''), ongoing sales charge means any charges or fees deducted from 
fund assets to finance distribution activity in excess of the acquiring 
fund's marketing and service fee (as defined in Sec.  270.12b-2(e)(3)), 
without regard to any acquired fund's marketing and service fee.
    (12) Ongoing sales charge rate is the annual ongoing sales charge, 
expressed as a percentage of net asset value.
    (13) Organizers of a fund means any affiliated person of the fund, 
any affiliated person of such person, any promoter of the fund, and any 
affiliated person of such promoter.
    (14) Reference load means:
    (i) The highest sales load rate that the shareholder would have 
paid if, at the time of the purchase of fund shares, the shareholder 
had purchased a class offered by the fund that does not have an ongoing 
sales charge and for which the shareholder qualifies according to the 
fund's registration statement;
    (ii) In the case of shares exchanged within the same group of 
investment companies, the highest applicable sales load rate of the 
acquired security or the exchanged security; or
    (iii) If no reference load can be determined under paragraphs 
(d)(14)(i) or (d)(14)(ii) of this section, the reference load is the 
maximum sales charge rate permitted a fund that deducts an asset-based 
sales charge and

[[Page 47136]]

a service fee under Rule 2830(d)(2)(A) of the Conduct Rules of the 
NASD.
    (15) Sales load rate is the sales load expressed as a percentage of 
the fund share offering price.
    14. Section 270.11a-3 is amended by revising paragraphs (b)(4) and 
(b)(5)(i)(A) and (b)(5)(ii)(A) to read as follows:

Sec.  270.11a-3  Offers of exchange by open-end investment companies 
other than separate accounts.

* * * * *
    (b) * * *
    (4) Any sales load charged with respect to the acquired security is 
a percentage that is no greater than the excess, if any, of the rate of 
the sales load applicable to that security in the absence of an 
exchange over the sum of the rates of all sales loads and ongoing sales 
charges (as permitted under Sec.  270.6c-10(b)), previously paid on the 
exchanged security, Provided that:
    (i) The percentage rate of any sales load charged when the acquired 
security is redeemed, that is solely the result of a deferred sales 
load imposed on the exchanged security, may be no greater than the 
excess, if any, of the applicable rate of such sales load, calculated 
in accordance with paragraph (b)(5) of this section, over the sum of 
the rates of all ongoing sales charges and sales loads previously paid 
on the acquired security, and
    (ii) In no event may the sum of the rates of all ongoing sales 
charges and sales loads imposed prior to and at the time the acquired 
security is redeemed, including any ongoing sales charges and sales 
load paid or to be paid with respect to the exchanged security, exceed 
the maximum sales load rate, calculated in accordance with paragraph 
(b)(5) of this section, that would be applicable in the absence of an 
exchange to the security (exchanged or acquired) with the highest such 
rate;
    (5) * * *
    (i) * * *
    (A) Reduced by the sum of the rates of all ongoing sales charges 
collected on the acquired security pursuant to Sec.  270.6c-10(b), and
* * * * *
    (ii) * * *
    (A) The deferred sales load is reduced by the sum of the rates of 
all ongoing sales charges previously collected on the exchanged 
security pursuant to Sec.  270.6c-10(b), and
* * * * *

Sec.  270.12b-1  [Removed]

    15. Section 270.12b-1 is removed.
    16. Section 270.12b-2 is added to read as follows:

Sec.  270.12b-2  Investment company distribution fees.

    (a) Preliminary Matters. (1) Except as provided in this section, it 
is unlawful for any fund (other than a fund complying with the 
provisions of section 10(d) of the Act [15 U.S.C. 80a-10(d)]) to act as 
a distributor of securities of which it is the issuer, except through 
an underwriter.
    (2) For purposes of this section, a fund will be deemed to be 
acting as a distributor of securities of which it is the issuer, other 
than through an underwriter, if it directly or indirectly uses fund 
assets to finance any distribution activity.
    (b) Marketing and Service Fee. A fund may use fund assets to 
finance distribution activity, provided that, with regard to any class 
of the fund:
    (1) All charges and fees deducted from fund assets to finance 
distribution activity do not exceed the maximum rate of the service fee 
allowed under Rule 2830 of the NASD Conduct Rules, except as permitted 
by Sec.  270.6c-10(b);
    (2) If a fund (the ``acquiring fund'') acquires shares of another 
fund (the ``acquired fund''), the combined rate of the marketing and 
service fees of the acquiring fund and any acquired fund to finance 
distribution activities does not exceed the maximum rate permitted in 
paragraph (b)(1) of this section.
    (3) The marketing and service fee (or any increase in the rate of 
such a fee) has been approved by a vote of at least a majority of the 
fund's outstanding voting securities if the fee is instituted or 
increased after any public offering of the fund's voting securities or 
the sale of such securities to persons who are not affiliated persons 
of the company, affiliated persons of such persons, promoters of the 
fund, or affiliated persons of such promoters.
    (c) Directed Brokerage. Notwithstanding any other provision of this 
section, a fund may not:
    (1) Compensate a broker or dealer for any promotion or sale of 
shares issued by that fund by directing to the broker or dealer:
    (i) The fund's portfolio securities transactions; or
    (ii) Any remuneration, including but not limited to any commission, 
mark-up, mark-down, or other fee (or portion thereof) received or to be 
received from the fund's portfolio transactions effected through any 
other broker (including a government securities broker) or dealer 
(including a municipal securities dealer or a government securities 
dealer); and
    (2) Direct its portfolio securities transactions to a broker or 
dealer that promotes or sells shares issued by the fund, unless the 
fund (or its investment adviser):
    (i) Is in compliance with the provisions of paragraph (c)(1) of 
this section with respect to that broker or dealer; and
    (ii) Has implemented, and the fund's board of directors (including 
a majority of directors who are not interested persons of the fund) has 
approved, policies and procedures reasonably designed to prevent:
    (A) The persons responsible for selecting brokers and dealers to 
effect the fund's portfolio securities transactions from taking into 
account the brokers' and dealers' promotion or sale of shares issued by 
the fund or any other registered investment company; and
    (B) The fund, and any investment adviser and principal underwriter 
of the fund, from entering into any agreement (whether oral or written) 
or other understanding under which the fund directs, or is expected to 
direct, portfolio securities transactions, or any remuneration 
described in paragraph (c)(1)(ii) of this section, to a broker 
(including a government securities broker) or dealer (including a 
municipal securities dealer or a government securities dealer) in 
consideration for the promotion or sale of shares issued by the fund or 
any other registered investment company.
    (d) Grandfathered Rule 12b-1 Fees. Until [date 5 years after 
compliance date of the rule], notwithstanding any other provision in 
this section, a fund may act as a distributor of securities sold prior 
to [the compliance date of rule 12b-2] subject to a rule 12b-1 plan 
approved under Sec.  270.12b-1 (2010 version) as in effect prior to 
[the compliance date of rule 12b-2], provided that:
    (1) The fund's board of directors may vote to eliminate the 
provisions in the fund's rule 12b-1 plan that were required by 
paragraphs (b)(3)(i) (annual approval), (b)(3)(ii) (quarterly reports) 
and (b)(3)(iii) (termination) of Sec.  270.12b-1 (2010 version);
    (2) With regard to any class of the fund, the fund does not 
increase the annual rate of the fee paid under its rule 12b-1 plan in 
the most recent fiscal year, and
    (3) As of [date 5 years after compliance date of the final rule] 
all securities subject to paragraph (d) of this section must be 
exchanged or converted into securities of a class that does not deduct 
an ongoing sales charge as defined in Sec.  270.6c-10(d)(11) and that 
does not charge a marketing and service fee in excess of the annual 
rate of the fee paid under its rule 12b-1 plan in the most recent 
fiscal year.

[[Page 47137]]

    (e) Definitions. For purposes of this section:
    (1) Fund means a registered open-end management investment company, 
and includes a separate series of the fund.
    (2) Distribution activity means any activity which is primarily 
intended to result in the sale of shares issued by a fund, including, 
but not necessarily limited to, advertising, compensation of 
underwriters, dealers, and sales personnel, the printing and mailing of 
prospectuses to other than current shareholders, and the printing and 
mailing of sales literature.
    (3) Marketing and Service Fee means any charges or fees deducted 
from fund assets under paragraph (b)(1) of this section.
    17. Section 270.17a-8 is amended by revising paragraph (a)(3)(iv) 
to read as follows:

Sec.  270.17a-8  Mergers of affiliated companies.

    (a) * * *
    (3) * * *
    (iv) Any distribution fees (as a percentage of the fund's average 
net assets) authorized to be paid by the surviving company pursuant to 
provisions of Sec.  270.12b-2(b) or (d) or Sec.  270.6c-10(b), are no 
greater than the distribution fees (as a percentage of the fund's 
average net assets) authorized to be paid by the merging company.
* * * * *
    18. Section 270.17d-3 is amended by revising paragraph (a) to read 
as follows:

Sec.  270.17d-3  Exemption relating to certain joint enterprises or 
arrangements concerning payment for distribution of shares of a 
registered open-end management investment company.

* * * * *
    (a) Such agreement is made in compliance with the provisions of 
Sec.  270.12b-2(b) or (d) or Sec.  270.6c-10(b); and
* * * * *
    19. Section 270.18f-3 is amended by revising paragraph (f)(2)(ii) 
to read as follows:

Sec.  270.18f-3  Multiple class companies.

* * * * *
    (f) * * *
    (2) * * *
    (ii) The expenses, including distribution payments authorized under 
Sec.  270.12b-2(b) or (d) or Sec.  270.6c-10(b), for the target class 
are not higher than the expenses, including distribution payments 
authorized under Sec.  270.12b-2(b) or (d) or Sec.  270.6c-10(b), for 
the purchase class; and
* * * * *

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    20. The authority citation for Part 274 continues to read in part 
as follows:

    Authority:  15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, 80a-26, and 80a-29, unless otherwise 
noted.
* * * * *
    21. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is 
amended by:
    a. Adding the definition ``asset-based distribution fee'' in 
alphabetical order to General Instructions A;
    b. Revising the ``Annual Fund Operating Expenses'' fee table and 
Instruction 3(b) to Item 3;
    c. Revising paragraph b and removing the Instruction to paragraph b 
of Item 12;
    d. Revising paragraph g and adding an Instruction to paragraph g of 
Item 19;
    e. Adding paragraph d to item 25;
    f. Revising Instruction 5 to paragraph (b)(4) of Item 26;
    g. In the expense example in paragraph (d)(1) of Item 27, removing 
the reference to ``distribution [and/or service](12b-1) fees'' and 
adding in its place ``asset-based distribution fees'';
    h. In Instruction 2(a)(i) following paragraph (d)(1) to Item 27, 
removing the reference to ``Distribution [and/or service](12b-1) fees'' 
and adding in its place ``asset-based distribution fees''; and
    i. Removing and reserving paragraph (m) of Item 28.
    The revisions read as follows:

    Note:  The text of Form N-1A does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-1A

* * * * *

General Instructions

A. Definitions

* * * * *
------``Asset-Based Distribution Fee'' means a fee deducted from Fund 
assets to finance distribution activities pursuant to rule 12b-2(b) (17 
CFR 270.12b-2(b)) (``Marketing and Service Fee''), rule 12b-2(d) (17 
CFR 270.12b-2(d)), and/or rule 6c-10(b) (17 CFR 270.6c-10(b)) 
(``Ongoing Sales Charge'').
* * * * *

Item 3. Risk/Return Summary: Fee Table

* * * * *
    Annual Fund Operating Expenses (expenses that you pay each year as 
a percentage of the value of your investment).

Management Fees...........................................         ----%
Ongoing Sales Charge......................................         ----%
Other Expenses............................................         ----%
  Marketing and Service Fee...............................         ----%
                                                                   ----%
                                                                   ----%
Total Annual Fund Operating Expenses......................         ----%

* * * * *
    Instructions.
* * * * *

3. Annual Fund Operating Expenses

* * * * *
    (b) ``Ongoing Sales Charge'' includes all expenses incurred during 
the most recent fiscal year pursuant to rule 6c-10(b) (17 CFR 270.6c-
10(b)). ``Marketing and Service Fee'' includes all expenses incurred 
during the most recent fiscal year pursuant to rule 12b-2(b) (17 CFR 
270.12b-2(b)).
* * * * *

Item 12. Distribution Arrangements

* * * * *
    (b) Asset-Based Distribution Fees. If the Fund deducts an Asset-
Based Distribution Fee, state separately the rate of Ongoing Sales 
Charges, Marketing and Service Fees, or fees charged pursuant to rule 
12b-2(d) (17 CFR 270.12b-2(d)), as applicable, and state each one's 
purpose and general terms, and provide disclosure to the following 
effect:
    (1) The Fund deducts a fee for the sale and distribution of its 
shares and, if applicable, for services provided to fund investors. If 
the Fund deducts a fee for such services, describe the nature and 
extent of services provided to fund investors.
    (2) For Multiple Class Funds that offer more than one Class in the 
prospectus, discuss the general circumstances under which an investment 
in a Class that deducts an Asset-Based Distribution Fee may be more or 
less advantageous than an investment in a Class that either does not 
deduct an Asset-Based Distribution Fee or a Class that deducts a 
different Asset-Based Distribution Fee. Include the effect of different 
holding periods and investment amounts in this description.
    (3) For Funds that deduct an Ongoing Sales Charge, the number of 
months/years that an investor's shares would be subject to the charge 
before automatically converting to a Class without such a deduction.
* * * * *

Item 19. Investment Advisory and Other Services

* * * * *
    (g) Asset-Based Distribution Fees. If the Fund deducts an Asset-
Based

[[Page 47138]]

Distribution Fee, provide a description of the fee(s) and how they are 
used, including a list of the principal types of activities for which 
payments are or will be made (e.g., advertising; printing and mailing 
of prospectuses to other than current shareholders; compensation to 
underwriters, compensation to broker-dealers, shareholder servicing 
fees, etc.).
    Instruction. If a Fund offers a Class that deducts both an Ongoing 
Sales Charge and a Marketing and Service Fee, separate the list of 
activities according to type of fee.
* * * * *

Item 25. Underwriters

* * * * *
    (d) If the fund has elected to rely on rule 6c-10(c) (17 CFR Sec.  
270.6c-10(c)) to permit the fund or its underwriter to distribute 
shares at a price other than a current public offering price described 
in the prospectus, state that the fund has made this election.
* * * * *

Item 26. Calculation of Performance Data

* * * * *
    (b) * * *
    (4) * * *
    Instructions.
* * * * *
    5. Include expenses accrued due to any Asset-Based Distribution 
Fees owed in the expenses accrued for the period. Reimbursement accrued 
may reduce the accrued expenses, but only to the extent the 
reimbursement does not exceed expenses accrued for the period.
* * * * *

Item 28. Exhibits

* * * * *
    (m) Reserved.
* * * * *
    22. Form N-3 (referenced in Sec. Sec.  239.17a and 274.11b) is 
amended by:
    a. Revising Instruction 2 to Item 7(a);
    b. Revising paragraph (f) and the Instruction to paragraph (f) of 
Item 21;
    c. Revising Instruction 5 to Item 26(b)(ii).
    The revisions read as follows:

    Note: The text of Form N-3 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

Form N-3

* * * * *

Item 7. Deductions and Expenses

    (a) * * *
    Instructions.
* * * * *
    2. If proceeds from explicit sales loads will not cover the 
expected costs of distributing the contracts, identify from what source 
the shortfall, if any, will be paid. If any shortfall is to be made up 
from assets from the Insurance Company's general account, disclose, if 
applicable, that any amounts paid by the Insurance Company may consist, 
among other things, of proceeds derived from mortality and expense risk 
charges deducted from the account. If Registrant directly or indirectly 
pays any asset-based distribution expenses under rule 12b-2(b) (17 CFR 
270.12b-2(b)), rule 12b-2(d) (17 CFR 270.12b-2(d)), or rule 6c-10(b) 
(17 CFR 270.6c-10(b)), provide a description of the expenses and list 
the principal types of activities for which payments are made.
* * * * *

Item 21. Investment Advisory and Other Services

* * * * *
    (f) If the Registrant deducts any asset-based distribution fees 
under rule 12b-2(b) (Sec.  270.12b-2(b)), rule 12b-2(d) (17 CFR 
270.12b-2(d)), or rule 6c-10(b) (17 CFR 270.6c-10(b)), provide a 
description of the fee(s) and how they are used, including a list of 
the principal types of activities for which payments are or will be 
made (e.g., advertising; printing and mailing of prospectuses to other 
than current shareholders; compensation to underwriters, compensation 
to broker-dealers, shareholder servicing fees, etc.).
    Instruction. If a Registrant deducts both an ongoing sales charge 
and a marketing and service fee, separate the list of activities 
according to type of fee.
* * * * *

Item 26. Calculation of Performance Data

* * * * *
    (b) * * *
    (ii) * * *
* * * * *
    Instructions.
* * * * *
    5. Include all asset-based distribution expenses accrued under rule 
12b-2(b) (17 CFR 270.12b-2(b)), rule 12b-2(d) (17 CFR 270.12b-2(d)), 
and rule 6c-10(b) (17 CFR 270.6c-10(b)) among the expenses accrued for 
the period. Reimbursement of expenses deducted from fund assets 
pursuant to rule12b-2(b) (17 CFR 270.12b-2(b)), rule 12b-2(d) (17 CFR 
270.12b-2(d)), and rule 6c-10(b) (17 CFR 270.6c-10(b)) may reduce the 
accrued expenses, but only to the extent the reimbursement does not 
exceed expenses accrued for the period.
* * * * *
    23. Form N-4 (referenced in Sec. Sec.  239.17b and 274.11c) is 
amended by:
    a. In the ``Total Annual [Portfolio Company] Operating Expenses'' 
table in Item 3(a), removing the reference to ``distribution [and/or 
service](12b-1) fees'' and adding in its place ``asset-based 
distribution fees.''
    b. In Instruction 16 to Item 3 adding a definition of ``asset-based 
distribution fees.''
    The addition reads as follows:

    Note:  the text of Form N-4 does not, and these amendments will 
not, appear in the Code of Federal Regulations.

Form N-4

* * * * *

Item 3. Synopsis

* * * * *
    16. ``Management Fees'' include investment advisory fees (including 
any component thereof based on the performance of the portfolio 
company), any other management fees payable by the portfolio company to 
the investment adviser or its affiliates, and administrative fees 
payable to the investment adviser or its affiliates not included as 
``Other Expenses.'' ``Asset-based distribution fee'' includes all 
asset-based distribution expenses paid under rule 12b-2(b) (17 CFR 
270.12b-2(b)), rule 12b-2(d) (17 CFR 270.12b-2(d)), and rule 6c-10(b) 
(17 CFR 270.6c-10(b)).
* * * * *
    24. Form N-6 (referenced in Sec. Sec.  239.17c and 274.11d) is 
amended by:
    a. In the ``Total Annual [Portfolio Company] Operating Expenses'' 
table in Item 3, removing the reference to ``distribution [and/or 
service](12b-1) fees'' and adding in its place ``asset-based 
distribution fees.''
    b. Adding paragraph (g) to Instruction 4 of Item 3.
    The addition reads as follows:

    Note:  The text of Form N-6 does not, and these amendments will 
not, appear in the Code of Federal Regulations.

.Form N-6

* * * * *

Item 3. Risk/Benefit Summary: Fee Table

* * * * *
    Instructions.
* * * * *
    (4) * * *
    (g) ``Asset-based distribution fee'' includes all asset-based 
distribution expenses paid under rule 12b-2(b) (17 CFR 270.12b-2(b)), 
rule 12b-2(d) (17 CFR 270.12b-2(d)), and rule 6c-10(b) (17 CFR 270.6c-
10(b)).
* * * * *

[[Page 47139]]

    25. Form N-SAR (referenced in Sec. Sec.  249.330 and 274.101) is 
amended by:
    a. Revising Item 40 in Instructions to Specific Items;
    b. Removing Items 41-44 in Instructions to Specific Items; and
    c. Removing the last sentence in the Instruction to Sub-Item 72DD2 
in Instructions to Specific Items.
    The revision reads as follows:

    Note: The text of Form N-6 does not, and these amendments will 
not, appear in the Code of Federal Regulations.

Form N-SAR

* * * * *

Instructions to Specific Items

* * * * *

Item 40: Plans Adopted Pursuant to Former Rule 12b-1

    Rule 12b-1 under the Act (17 CFR 270.12b-1), has been rescinded. 
Registrants that have grandfathered 12b-1 share classes pursuant to 
rule 12b-2(d) (17 CFR 270.12b-2(d)), should answer this question 
``Yes.'' Registrants that do not have grandfathered 12b-1 share classes 
pursuant to rule 12b-2(d) under the Act should answer this question 
``No.''

     Dated: July 21, 2010.

    By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2010-18305 Filed 8-3-10; 8:45 am]
BILLING CODE 8010-01-P