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Meaning of No-Load Fund Could Get Muddled


New rules issued last week by the Securities and Exchange Commission outlining bank exemptions to the Gramm-Leach-Bliley Act may have important implications for the fund industry, particularly for no-load fund fees.

The new rules outline and clarify exemptions to the Gramm-Leach-Bliley Act, which allow banks to distribute security-based products without having to register as broker/dealers. The rule exemptions allow banks to operate much as they did under a blanket exemption included in the Glass-Steagall Act, portions of which Gramm-Leach-Bliley effectively repealed in November 1999.

However, in its attempt to clarify and define those exemptions, the SEC may have raised the question of whether no-load funds can have 12b-1 fees in excess of 25 basis points, according to Michael D. Mabry, a lawyer in the Philadelphia office of Ballard Spahr Andrews & Ingersoll, LLP.

The issue arises from the SEC's rule granting banks that offer no-load money market sweep accounts an exemption from having to register as broker/dealers, Mabry said. The rule appears to offer a new interpretation of the use of the term "no-load," allowing funds to charge in excess of 25 basis points for no-load money market funds, he said.

The SEC and the National Association of Securities Dealers "describe an investment company as being no-load' or as having no sales charge' if the investment company does not have a front-end or deferred-sales charge and if its total charges against net assets to provide for sales related expenses and/or service fees do not exceed 0.25% of 1 percent of average net assets per annum," according to the rule.

The new rule goes on to explain that the SEC's division of investment management has accepted this definition for no-load funds and the rules pertaining to banks' use of no-load money market funds.

However, the SEC included a footnote to the rule, which creates ambiguity as to whether or not banks can charge fees on no-load money market funds in excess of 25 basis points, Mabry said. The footnote states that a variety of services provided by banks in offering money market sweep accounts "will not be considered charges for personal service or the maintenance of shareholder accounts," and therefore, "will not count toward the 0.25 of 1 percent limit in Rule 3b-17(f)(2)."

Shareholder services performed by banks including transfer agent functions, purchase and redemption order fulfillment, dividend payment issuance, distributing shareholder communications and documents, sub-accounting services and receiving, distributing and tabulating proxy statements are all services that will not be counted toward the 25 basis point fee, according to the rule.

While the SEC clearly intended that the rule allow banks to continue using no-load money market funds as they did prior to the adoption of Gramm-Leach-Bliley, the new rule may have further implications, Mabry said.

"I think it's fair to say in the mutual fund world that everybody believed that in order to call yourself a no-load fund, you have to charge a 12 b-1 fee of 25 basis points or less," Mabry said. "This [rule] might provide some flexibility ... what will be interesting going forward is how far reaching will this be? Will it have broader repercussions for the no-load side of the fund world?"

While the exemption for banks offering no-load money market funds does create some ambiguity, it is not likely to result in other no-load funds raising their 12b-1 fees beyond 25 basis points, according to Catherine Hanks, a senior manager working in KPMG's Washington D.C. office. KPMG is based in Dallas. The rule has the potential to prompt no-load funds to raise 12b-1 fees beyond 25 basis points, but that is not likely to happen, she said. Raising 12b-1 fees would hurt a no-load fund's ability to compete and shareholders have become much more aware of fees and expense ratios, she said.

Another provision in the rule extending exemptions to Gramm-Leach-Bliley to thrifts may have positive implications for the fund industry, according to Sarah A. Miller, general counsel of the American Bankers Association Securities Association of Washington D.C.

Unlike banks, thrifts have traditionally had to register as broker/dealers in order to engage in any activity involving securities products or services, Miller said. However, by extending the exemptions to include thrifts, the SEC has made it easier for thrifts to distribute mutual funds, she said.

"It could encourage thrifts to offer more products and services with the assurance that they won't be acting as broker/dealers," Miller said.

The SEC issued the new rules as a result of questions raised by banks and securities firms about the exemptions to Gramm-Leach-Bliley, according to the SEC. Although the rules are considered final, the SEC is soliciting comments on the rules and will amend them in response to the comments it receives, it said.