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Oversight of Distribution

Most funds use intermediaries to distribute their shares. Intermediaries may include:

  • broker-dealers,
  • banks,
  • fund supermarkets,
  • insurance companies,
  • registered investment advisers, and
  •  retirement plan service providers.
key terms
Fund supermarket. A brokerage platform that provides access to funds from a wide range of fund families.

Among other things, intermediaries:

  • may provide financial advice and counseling to shareholders;
  • maintain the financial records and account information of shareholders;
  • disburse dividend and capital gains distributions;
  • mail trade confirmations, shareholder reports, and prospectus updates; and
  • complete year-end tax reporting.

Because intermediaries often are an important liaison between a fund and its shareholders, intermediaries can perform a range of vital compliance functions for funds, such as:

  • enforcing fund policies;
  • providing disclosures, confirmations, and account statements to fund shareholders;
  • collecting redemption fees;
  • calculating shareholder breakpoint discounts; and
  • monitoring for frequent trading.

Intermediary Compensation

Intermediaries are compensated for the distribution of fund shares and shareholder servicing through a variety of arrangements. Generally, fees for these activities are billed by intermediaries to the fund, the fund’s transfer agent, or an affiliate of the fund. Some forms of compensation are paid directly by investors. Each fund complex tailors the structure of intermediary arrangements and related compensation to its unique business model and the competitive forces within the industry. As a result, compensation structures may vary from one fund complex to another, and most fund complexes employ a combination of fee structures to compensate their intermediary business partners. Intermediaries are compensated for performing services that would otherwise need to be provided by the fund complex. For example, “subaccounting” fees are paid to intermediaries for maintaining the financial records of the individual investor, providing investor statements, and producing tax reporting to the investors. Often, these fees are evaluated in the context of the fund’s cost of providing the same services to an account directly held and serviced by the fund’s transfer agent.

Some fund investors pay a front-end sales charge to compensate intermediaries for activities conducted in connection with an investment. As an alternative, many funds use Rule 12b-1 under the 1940 Act. This rule permits funds to compensate brokers and other financial intermediaries out of fund assets, subject to specific conditions (including board approvals) for services they provide shareholders related to the distribution of fund shares.

did you know?
12b‑1 fees are an alternative to sales loads that pay for services provided by financial intermediaries to fund shareholders.

Director Responsibilities Under Rule 12b-1

Fund directors have several obligations in connection with payments made under Rule 12b-1. In general, the board is expected to determine that these payments are reasonably likely to produce benefits for the fund and its shareholders, set the level of 12b-1 fees, and monitor the arrangement once it is established.

Any payments that a fund makes for distribution must be in accordance with a written plan that must be approved by a majority of the independent directors. Both the full board and the independent directors must vote at least annually to renew the plan. Also, independent directors may terminate the 12b-1 plan at any time without penalty.

Other Intermediary Compensation

There are also other types of payments that may be made to intermediaries. Some fund distributors may have incentive programs for some of their distribution partners to compensate them for providing additional education to registered representatives and additional marketing to potential investors. These payments are made from the revenue of the distributor or adviser and are commonly known as “revenue sharing.”

to learn more
Read ICI/IDC’s paper Navigating Intermediary Relationships.

Another type of compensation that may be paid to intermediaries to incentivize them to include mutual funds as part of the array of offerings they carry for their customers are referred to as “shelf space” or “access” fees. The arrangements are generally established between fund affiliates and their more significant business partners.

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