What is the Issue?

It may not be “death by a thousand cuts” but it may feel like it, as yet another mutual fund fee issue is being raised by the regulators. FINRA issued a “targeted examination letter” focused on Rights of Reinstatement (“RoR”) due to customers in certain mutual fund sales and purchases. RoRs involve fee waivers or rebates due to customers who redeem or sell shares in a fund and subsequently reinvest some or all of the proceeds from the sale/redemption in the same share class of that fund or another fund within the same fund family subject to stated terms and conditions. Interestingly, the time period between the sale/redemption and subsequent purchase of qualifying shares is determined by the fund issuers and described in the prospectuses or statement of additional information (“SAI”) and can vary from 90 days to 120 days, but can be as long as 365 days.[1] The waivers or rebates may involve a front-end sales charge waiver (often, but not always, involving A shares) or a rebate of all or part of a contingent deferred sales charge fee (“CDSC”) (for example, with C share transactions).

FINRA and the SEC have been periodically, but not systematically, raising issues regarding mutual fund sales charges and waivers for almost two decades. Starting with FINRA’s and the SEC’s breakpoint sweeps in 2002 and follow-on enforcement cases in early 2004, through subsequent reviews involving mutual fund sales charge waivers and share class selection (fee-related) for charitable and retirement accounts, 529 accounts, and this most recent RoR sweep.[2]

The RoR sweep is yet another “cut” at the problem of ensuring that customers get waivers and rebates that they are supposed to receive. As we note below, it might be time for the industry, if not the regulators, to take a holistic view of what’s out there in terms of breaks on fees to get ahead of the issue and avoid the next fee area on which regulators choose to focus.

What is FINRA Asking for in its Sweep?

FINRA’s sweep letter, which covers Jan. 1, 2017 through June 30, 2020, requests information on five topics: (1) whether the firm has systems and procedures designed to provide eligible customers with RoR waivers or fee rebates; (2) detail regarding such systems and procedures; (3) explanation of any relevant changes to the firm’s systems or procedures during the review period; (4) any processes for standardizing the timeframe governing RoRs on its platform; and (5) whether the firm identified and missed waivers or rebates, including number of customers and the number and value of missed waivers or fee rebates.

Three Key Takeaways

  • Review your program to ensure that RoRs are addressed. Needless to say, even if a firm does not receive the FINRA sweep (or Targeted Examination) letter, every firm offering mutual fund products should review their systems, processes, and procedures to ensure that they reasonably address this area and have been providing waivers and/or rebates when customers’ sales of mutual fund shares and subsequent purchases entitled them to the waiver or rebate under the rights of reinstatement provisions. If a firm identifies gaps, the firm should put a systems and procedures remediation plan in place and document the plan’s implementation.
  • Remediate customers that should have received waivers or rebates. If customers’ sales and subsequent purchases met RoR conditions and the customers did not receive the waivers or rebates, the firm should consider a remediation process and, of course, document that process.
  • Conduct a holistic review of mutual fund fee/waivers/rebates offered by fund companies. A more widespread review is also recommended. As noted above, FINRA and the SEC have been bringing enforcement actions and issuing guidance for the past 18 years – mostly on an issue-by-issue basis – when they identify that a certain type of fee offered by fund issuers is not made available to customers. Sometimes, this can be remediated by disclosure. (An aside caution, however, is whether disclosure will cure not making certain waivers available in the post-Regulation Best Interest context, when more regulatory scrutiny is expected regarding the review for reasonably available alternatives.) Based on this approach by the regulators, it would be prudent for firms to do their own “sweep” of the prospectuses and SAIs of funds offered on their platforms to ensure that all available factors impacting fee waivers and rebates are accounted for in their offerings. It may also be helpful to periodically undertake a review of what changes mutual fund issuers may be offering regarding fees/waivers/rebates to assess whether clients are already entitled to them, or whether, given the prevalence of use by peer firms, your firm is an outlier. Staying ahead of the regulators in this area will avoid unnecessary concerns down the road.

If you would like assistance in reviewing or revising your firm’s policies and procedures in light of the questions raised by FINRA’s sweep letter, please contact anyone from the experienced McGuireWoods LLP Broker Dealer/Investment Adviser team.

1. This sweep letter follows a FINRA settlement, dated June 1, 2020, involving failure to supervise to ensure that customers eligible for waivers received them. (AWC 2017053494401).

2. See Report of the Joint NASD/Industry Task Force on Breakpoints (July 12, 2003). The Task Force was convened in Jan. 2003, at the request of the SEC, followed NASD’s examination findings and issuance of Special Notice to Members 02-85, dated Dec. 23, 2002, which reminded broker/dealers of their obligation to apply correctly breakpoint discounts to front-end sales load mutual fund transactions. https://www.finra.org/rules-guidance/guidance/reports/industry-task-force-breakpoints. Concurrent examinations by the SEC, NYSE, and NASD resulted in a Joint SEC/NASD/NYSE Report of Examinations of Broker/Dealers Regarding Discounts on Front-End Sales Charges on Mutual Funds, published on March 11, 2003. FINRA’s breakpoint self-assessment initiative began in March 2003. SEC announced: Fifteen Firms to Pay Over $21.5 Million in Penalties to Settle SEC and NASD Breakpoints Charges (Feb. 12, 2004) https://www.sec.gov/news/press/2004-17.htm. FINRA wrapped up its breakpoint self-assessment sweep in 2009, announcing: FINRA Fines 25 Firms More Than $2.1 Million for Failures in Mutual Fund Breakpoint Review, Other Violations; Case Concludes Series of Actions Arising From FINRA’s Mutual Fund Breakpoint Initiative (March 23, 2009) https://www.finra.org/media-center/news-releases/2009/finra-fines-25-firms-more-21-million-failures-mutual-fund-breakpoint.

In 2016, FINRA issued a Targeted Examination Letter, focusing its sweep on mutual fund waivers in retirement and charitable accounts. (Targeted Examination Letter on Mutual Fund Waivers, May 2016, https://www.finra.org/rules-guidance/guidance/targeted-exam-letter/mutual-fund-waiver). This sweep resulted in 56 enforcement cases. See, FINRA Announces Final Results of Mutual Fund Waiver Initiative; Total of 56 Settlements Reached with Member Firms Resulting in $89 Million in Restitution to Eligible Charitable and Retirement Accounts (July 17, 2019) https://www.finra.org/media-center/news-releases/2019/finra-announces-final-results-mutual-fund-waiver-initiative.