Fee Management Solutions Help Funds Monitor Waivers To Protect Against Regulatory Risk


Earlier this year, the staff of the SEC’s Division of Investment Management issued a bulletin cautioning mutual funds and their boards of directors about potential implications under the Investment Company Act of 1940 when fee waiver and expense reimbursement arrangements cause different advisory fees to be charged to different share classes of the same fund—referred to as “differential advisory fee waivers.”

The SEC’s bulletin directed boards to monitor the use of waivers or reimbursements to guard against one share class covering costs for another, referred to as cross-subsidization. The SEC described this responsibility as consistent with a board’s “oversight of the class system and its independent fiduciary obligations to each class.”

According to an Ignites analysis of data from Morningstar Direct, of the more than 2,000 mutual funds with fee waivers or expense reimbursements in place last year, 35 also had different management fees across their share classes. This is the precise practice that the bulletin warns funds to avoid. The analysis further found that those 35 funds were advised by four fund companies.

Long-Term Differential Fee Waivers

The bulletin acknowledges that Rule 18f-3 allows fee waivers and expense reimbursements, as long as those arrangements do not result in cross-subsidization of fees among classes. However, it emphasized that fee waivers and reimbursements were not intended to become “de facto modifications.” Differential fee arrangements should not be long-term or serve as permanent provisions without periodic checks to ensure they continue to be judicious.

One principle underlying Rule 18f-3, as expressed in the bulletin, is that advisory fees charged to all classes of a fund should “generally be the same percentage amount” since shareholders receive the same advisory services regardless of class. Based on that principle, the bulletin identifies long-term or permanent differential fee waivers as possibly creating a means of cross-subsidization among classes, which is in violation of Rule 18f-3.

Industrywide, 21 funds with inconsistent fee waivers or expense reimbursement arrangements had at least one share class where the waiver level didn’t change for five years or longer, according to Ignites’ data analysis. The bulletin warns that these such funds should be examined.

Review of Fee Waiver Arrangements

While the SEC’s bulletin is presented as a “reminder” to fund boards, it effectively serves as a warning to review waivers and address any issues that arise from their use in order to avoid future SEC action or enforcement.

For funds that already have differential fee waivers in place, the bulletin advises boards to consider whether the arrangement allows for cross-subsidization, whether effective steps are being taken to monitor such waivers to guard against cross-subsidization, and whether alternative fee arrangements may be appropriate.

It also encouraged mutual funds that already have differential fee waivers in place to assess whether such waivers create cross-subsidization, and to implement controls to prevent that possibility.

Effective Fee Waiver Monitoring Solutions

Determining whether a fee waiver or expense reimbursement operates as a cross-subsidization among share classes is a facts and circumstances determination and can prove challenging in practice.

Automated tools like Delta Data’s Fee Management solution can help funds monitor these waivers to guard against cross-subsidization with rapid production and accurate analysis of granular-level fee data. For mutual funds that already have differential fee waivers in place, these solutions serve as a tool and a control to identify and prevent cross-subsidization to ensure operational compliance.

Delta Data’s Fee Management solution performs independent fee calculations using distribution transparency data, the firm’s contract agreements, and automated technology to maintain compliance and ensure accuracy. These payment funding allocation calculations enable reporting on possible cross-subsidization.

Payment funding allocation and reporting capabilities of such automated tools facilitate operational efficiency and ensure absolute consistency in a fund’s fee management program, protecting against significant regulatory risk.

Contact Delta Data to learn how its Fee Management solution can shield mutual funds from the regulatory issues the SEC’s recent bulletin warns against.