Supporting Statement-22c-2 (2011)

Supporting Statement-22c-2 (2011).pdf

Investment Company Act rule 22c-2, 17 CFR 270.22c-2 Mutual Fund Redemption Fees

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SUPPORTING STATEMENT
for the Paperwork Reduction Act Information Collection Submission for
“Rule 22c-2”

A.

JUSTIFICATION
1.

Necessity for the Information Collection

Rule 22c-2 (17 CFR 270.22c-2 “Mutual Fund Redemption Fees”) under the Investment
Company Act of 1940 (15 U.S.C. 80a) (the “Investment Company Act” or “Act”) requires the
board of directors (including a majority of independent directors) of most registered investment
companies (“funds”) to either approve a redemption fee of up to two percent or determine that
imposition of a redemption fee is not necessary or appropriate for the fund. Rule 22c-2 also
requires a fund to enter into written agreements with their financial intermediaries (such as
broker-dealers and retirement plan administrators) under which the fund, upon request, can
obtain certain shareholder identity and trading information from the intermediaries. The written
agreement must also allow the fund to direct the intermediary to prohibit further purchases or
exchanges by specific shareholders that the fund has identified as being engaged in transactions
that violate the fund’s market timing policies. These requirements enable funds to obtain the
information that they need to monitor the frequency of short-term trading in omnibus accounts
and enforce their market timing policies.
The rule includes three “collections of information” within the meaning of the Paperwork
Reduction Act of 1995 (“PRA”).1 First, the rule requires boards to either approve a redemption
fee of up to two percent or determine that imposition of a redemption fee is not necessary or

1

44 U.S.C. 3501-3520.

2
appropriate for the fund. Second, funds must enter into information sharing agreements with all
of their “financial intermediaries”2 and maintain a copy of the written information sharing
agreement with each intermediary in an easily accessible place for six years. Third, pursuant to
the information sharing agreements, funds must have systems that enable them to request
frequent trading information upon demand from their intermediaries, and to enforce any
restrictions on trading required by funds under the rule.
2.

Purpose of the Information Collection

The collections of information created by rule 22c-2 are necessary for funds to effectively
assess redemption fees, enforce their policies in frequent trading, and monitor short-term trading,
including market timing, in omnibus accounts. These collections of information are mandatory
for funds that redeem shares within seven days of purchase. The collections of information also
are necessary to allow Commission staff to fulfill its examination and oversight responsibilities.
3.

Role of Improved Information Technology

Rule 22c-2 does not require the reporting of any information or the filing of any
documents with the Commission. The Electronic Signatures in Global and National Commerce

2

The rule defines a financial intermediary as: (i) Any broker, dealer, bank, or other person that
holds securities issued by the fund in nominee name; (ii) a unit investment trust or fund that
invests in the fund in reliance on section 12(d)(i)(E) of the Act; and (iii) in the case of a
participant directed employee benefit plan that owns the securities issued by the fund, a
retirement plan’s administrator under section 316(A) of the Employee Retirement Security Act of
1974 (29 U.S.C. 1002(16)(A) or any person that maintains the plans’ participant records.
Financial Intermediary does not include any person that the fund treats as an individual investor
with respect to the fund’s policies established for the purpose of eliminating or reducing any
dilution of the value of the outstanding securities issued by the fund. Rule 22c-2(c)(1).

3
Act3 and the conforming amendments to rules under the Investment Company Act of 1940 and
the Securities Exchange Act of 1934 permit funds and their financial intermediaries to maintain
records electronically.
4.

Efforts to Identify Duplication

The Commission is not aware of any duplicate reporting or recordkeeping requirements
concerning rule 22c-2.
5.

Effect on Small Entities

As discussed above, rule 22c-2 provides funds and their boards with the ability to impose
a redemption fee designed to reimburse the fund for the direct and indirect costs incurred as a
result of short-term trading strategies, such as market timing. The rule was designed to reduce
the cost burdens of small entities. Rule 22c-2 requires some funds to develop or upgrade
software or other technological systems to enforce certain market timing policies, or make
trading information available in omnibus accounts.
6.

Consequences of Less Frequent Collection

The rule’s requirement that funds enter into agreements with their financial
intermediaries is a single event that will provide the fund with the option to receive certain
identity and transaction information with which the fund can monitor implementation of its
redemption fee program and direct the intermediary to enforce the fund’s market timing policies
in certain circumstances. The rule’s requirement that the board of directors determine whether a
redemption fee is necessary or appropriate for the fund is also a single event designed to ensure

3

P.L. 106-229, 114 Stat. 464 (June 30, 2000).

4
that consideration is given to the interests of long-term investors. Further information collection
(i.e. requests for shareholder identification and trading information) is solely at the discretion of
the fund, and therefore is targeted to the individual needs of funds to protect shareholders.
7.

Inconsistencies With Guidelines in 5 CFR 1320.5(d)(2)

Rule 22c-2 requires funds to retain certain written records for more than three years. The
fund must maintain and preserve a written copy of any information sharing agreements then in
effect, or that has been in effect at any time in the previous six years, in an easily accessible
place. The long-term retention of these records is necessary for the Commission's inspections
program to determine compliance with rule 22c-2.
8.

Consultation Outside the Agency

In its releases proposing and adopting rule 22c-2 and its amendments, the Commission
requested public comment on the rule’s collection of information requirements and whether the
estimates contained in the proposal were reasonable. The Commission and the staff of the
Division of Investment Management participate in an ongoing dialogue with representatives of
the industry through public conferences, meetings, and informal exchanges. These various
forums provide the Commission and the staff with a means of ascertaining the magnitude of
paperwork burdens confronting the industry.
We received extensive comments on the projected costs of the rule both at the proposing
stage and after adoption. In many cases, funds and intermediaries, including a number of small
intermediaries, generally argued that the system functionality or start-up costs necessary to
assess and collect redemption fees on shares held through omnibus accounts, coupled with the
operational and maintenance costs, would be significant and in some cases greater than what we

5
originally estimated. The Commission adopted amendments to the rule intended to address these
concerns, and to alleviate any unnecessary burdens on funds and intermediaries.
The Commission requested public comment on the collection of information
requirements of rule 22c-2 before it submitted this request for extension and approval to the
Office of Management and Budget. The Commission received no comments in response to this
request.
9.

Payment or Gift to Respondents

Not applicable.
10.

Assurance of Confidentiality

Responses provided to the Commission will be accorded the same level of confidentiality
accorded to other responses provided to the Commission in the context of its examination and
oversight program. Responses provided in the context of the Commission’s examination and
oversight program are generally kept confidential.
11.

Sensitive Questions

Not applicable.
12.

Estimate of Hour Burden
A.

Board Determination

Rule 22c-2(a)(1) requires the board of directors of all registered investment companies
and series thereof (except for money market funds, ETFs, or funds that affirmatively permit
short-term trading of its securities) to approve a redemption fee for the fund, or instead make a

6
determination that a redemption fee is either not necessary or appropriate for the fund.
Commission staff understands that the boards of all funds currently in operation have undertaken
this process for the funds they currently oversee, and the rule does not require boards to review
this determination periodically once it has been made. Accordingly, we expect that only boards
of newly registered funds or newly created series thereof would undertake this determination.
Commission staff estimates that approximately 117 funds or series thereof (excluding money
market funds and ETFs) are newly formed each year and would need to make this determination.
Based on conversations with fund representatives,4 Commission staff estimates that it
takes approximately 2 hours of the board’s time, as a whole, (at a rate of $4000 per hour)5 to
approve a redemption fee or make the required determination. In addition, Commission staff
estimates that it takes compliance personnel of the fund (at a rate of $235 per hour)6
approximately 8 hours to prepare trading, compliance, and other information regarding the
fund’s operations to enable the board to make its determination, and takes internal counsel of the
fund (at a rate of $320 per hour) approximately 3 hours to review this information and present its
recommendations to the board. Therefore, for each fund board that undertakes this
determination process, Commission staff estimates it expends approximately 13 hours7 at a cost

4

Unless otherwise stated, estimates throughout this analysis are derived from a survey of funds and
conversations with fund representatives.

5

The estimate of $4000 per hour for the board’s time as a whole is based on conversations with
representatives of funds and their legal counsel.

6

Unless otherwise stated, all cost estimates for personnel time are derived from SIFMA’s
Management & Professional Earnings in the Securities Industry 2010, modified to account for an
1800-hour work-year and multiplied by 5.35 to account for bonuses, firm size, employee benefits,
and overhead.

7

This calculation is based on the following estimates: (2 hours of board time + 3 hours of internal

7
of $10,840.8 As a result, Commission staff estimates that the total time spent for all funds on this
process is 1521 hours at a cost of $1,268,280.9
B.

Information Sharing Agreements

Rule 22c-2(a)(2) requires a fund to enter into information-sharing agreements with each
of its financial intermediaries. Commission staff understands that all currently registered funds
have already entered into such agreements with their intermediaries. Funds enter into new
relationships with intermediaries from time to time, however, which requires them to enter into
new information sharing agreements. Commission staff understands that, in general, funds enter
into information-sharing agreement when they initially establish a relationship with an
intermediary, which is typically executed as an addendum to the distribution agreement.
Commission staff estimates that there are approximately 6911 open-end fund series currently in
operation (excluding money market funds and ETFs). However, the Commission staff
understands that most shareholder information agreements are entered into by the fund group (a
group of funds with a common investment adviser), and estimates that there are currently 669
currently active fund groups.10 Commission staff estimates that, on average, each active fund
group enters into relationships with approximately 3 new intermediaries each year. Commission

counsel time + 8 hours of compliance time = 13 hours).
8

This calculation is based on the following estimates: ($8000 ($4000 board time × 2 hours =
$8000) + $1880 ($235 compliance time × 8 hours = $1880) + $960 ($320 × 3 hours attorney time
= $960) = $10,840).

9

This calculation is based on the following estimates: (13 hours × 117 funds = 1521 hours);
($10,840 × 117 funds = $1,268,280).

10

ICI, 2011 INVESTMENT COMPANY FACT BOOK at Fig 1.7 (2011)
(http://www.ici.org/stats/latest/2011_factbook.pdf).

8
staff understands that funds generally use a standard information sharing agreement, drafted by
the fund or an outside entity, and modifies that agreement according to the requirements of each
intermediary. Commission staff estimates that negotiating the terms and entering into an
information sharing agreement takes a total of approximately 4 hours of attorney time (at a rate
of $320) per intermediary (representing 2.5 hours of fund attorney time and 1.5 hours of
intermediary attorney time). Accordingly, Commission staff estimates that it takes 12 hours at a
cost of $3840 each year11 to enter into new information sharing agreements, and all existing
market participants incur a total of 8028 hours at a cost of $2,568,960.12
In addition, newly created funds advised by new entrants (effectively new fund groups)
must enter into information sharing agreements with all of their financial intermediaries.
Commission staff estimates that there are approximately 40 new funds or fund groups that form
each year that will have to enter into information sharing agreements with each of their
intermediaries.13 Commission staff estimates that funds and fund groups formed by new advisers
typically have relationships with significantly fewer intermediaries than existing fund groups,
and estimates that new fund groups will typically enter into approximately 100 information
sharing agreements with their intermediaries when they begin operations.14 As discussed

11

This estimate is based on the following calculations: (4 hours × 3 new intermediaries = 12 hours);
(12 hours × $320 = $3840).

12

This estimate is based on the following calculations: (12 hours × 669 fund groups = 8028 hours);
(8028 hours × $320 = $2,568,960).

13

ICI, 2011 INVESTMENT COMPANY FACT BOOK at Fig 1.7 (2011)
(http://www.ici.org/stats/latest/2011_factbook.pdf).

14

Commission staff understands that funds generally use a standard information sharing agreement,
drafted by the fund or an outside entity, and then modifies that agreement according to the
requirements of each intermediary.

9
previously, Commission staff estimates that it takes approximately 4 hours of attorney time (at a
rate of $320) per intermediary to enter into information sharing agreements. Therefore,
Commission staff estimates that each newly formed fund group will incur 400 hours of attorney
time at a cost of $128,000,15 and all newly formed fund groups will incur a total of 16,000 hours
at a cost of $5,120,000 to enter into information sharing agreements with their intermediaries.16
Rule 22c-2(a)(3) requires funds to maintain records of all information-sharing agreements
for 6 years in an easily accessible place. Commission staff estimates that there are
approximately 6911 open-end fund series currently in operation (excluding money market funds
and ETFs). However, the Commission staff anticipates that most shareholder information
agreements will be stored at the fund group level and estimates that there are currently
approximately 669 fund groups. Commission staff understands that information-sharing
agreements are generally included as addendums to distribution agreements between funds and
their intermediaries, and that these agreements would be stored as required by the rule as a
matter of ordinary business practice. Therefore, Commission staff estimates that maintaining
records of information-sharing agreements requires approximately 10 minutes of time spent by a
general clerk (at a rate of $50)17 per fund, each year. Accordingly, Commission staff estimates

15

This estimate is based on the following calculations: (4 hours × 100 intermediaries = 400 hours);
(400 hours × $320 = $128,000).

16

This estimate is based on the following calculations: (40 fund groups × 400 hours = 16,000 hours)
($320 ×16,000 = $5,120,000).

17

$50 hour figure for a General Clerk is derived from SIFMA’s Office Salaries in the Securities
Industry 2010 modified to account for an 1800-hour work-year and multiplied by 2.93 to account
for bonuses, firm size, employee benefits, and overhead.

10
that all funds will incur approximately 112 hours at a cost of $560018 in complying with the
recordkeeping requirement of rule 22c-2(a)(3).
Therefore, Commission staff estimates that to comply with the information sharing
agreement requirements of rule 22c-2(a)(2) and (3), it requires a total of 24,140 hours at a cost of
$7,694,560.19
The Commission staff estimates that on average, each fund group requests shareholder
information once a week, and gives instructions regarding the restriction of shareholder trades
every day, for a total of 417 responses related to information sharing systems per fund group
each year, and a total 278,973 responses for all fund groups annually.20 In addition, the staff
estimates that funds make 117 responses related to board determinations, 2007 responses related
to new intermediaries of existing fund groups, 4000 responses related to new fund group
information sharing agreements, and 669 responses related to recordkeeping, for a total of 6793
responses related to the other requirements of rule 22c-2. Therefore, the Commission staff
estimates that the total number of responses is 285,766 (278,973 + 6793 = 285,766).
C.

Totals

The Commission staff estimates that the total hour burden for rule 22c-2 is 25,661 hours

18

This estimate is based on the following calculations: (10 minutes × 669 fund groups = 6690
minutes); (6690 minutes/ 60 = 112 hours); (112 hours × $50 = $5600).

19

This estimate is based on the following calculations: (8028 hours + 16,000 hours + 112 hours =
24,140 hours); ($2,568,960 + $5,120,000 + $5600 = $7,694,560).

20

This estimate is based on the following calculations: (52 + 365 =417); (417 × 669 fund groups =
278,973).

11
at an internal labor cost of $8,962,840.21
13.

Estimate of Total Annual Cost Burden

Rule 22c-2 requires funds to enter into information-sharing agreements with their
intermediaries that enable funds to, upon request (i) be provided certain information regarding
shareholders and their trades that are held through a financial intermediary or an indirect
intermediary, and (ii) require the intermediary to execute instructions from the fund restricting or
prohibiting further purchases or exchanges by shareholders that violate the fund’s frequent
trading policies. As a result of this requirement, some funds and intermediaries have had to
develop and maintain information sharing, monitoring, and order execution systems (collectively
“information sharing systems”). In general, costs related to these information-sharing systems
are borne at the fund group level.
The Commission understands that all currently operating funds and intermediaries have
either developed information systems themselves or purchased them from third parties.
However, these funds and intermediaries also incur certain ongoing costs related to these
systems’ maintenance and operation. The Commission staff understands that various
organizations have developed, enhancements to their systems that allow funds and intermediaries
to share the information required by the rule without developing or maintaining systems of their
own. Other organizations have developed “22c-2 solution” systems that funds may lease. The
Commission staff understands that most funds and intermediaries use these outside systems. In

21

This estimate is based on the following calculations: (1521 hours (board determination) + 24,140
hours (information sharing agreements) = 25,661 total hours); ($7,694,560 + $1,268,280 =
$8,962,840).

12
general, the staff estimates that the typical charges involved in operating and maintaining
information sharing systems average 25 cents for every 100 account transactions requested.
These systems generally also provide analytics, spreadsheets, and other tools designed to enable
funds to analyze the data presented, as well as communication tools to process fund instructions
regarding the restrictions and prohibitions they may request. Commission staff estimates that the
costs of developing, maintaining and operating information systems for funds and intermediaries
that do not use outside provider’s systems is comparable to the costs charged by outside
providers.22
The Commission staff estimates that, on average, each fund group requests information
for 100,000 transactions each week, incurring costs of $250 weekly, or $13,000 a year.23 In
addition, the Commission staff estimates that funds pay access fees to use these information
sharing systems (or comparable internal costs) of approximately $30,000 each year. The
Commission staff therefore estimates that a fund group would typically incur approximately
$43,000 in costs each year related to the operation and maintenance of information sharing
systems required by rule 22c-2. The Commission staff has previously estimated that there are
approximately 669 fund groups currently active, and therefore estimates that all fund groups

22

We include the burden for funds that develop and operate these information sharing systems
internally rather than purchasing them from third parties as a cost rather than as an hourly burden
because Commission staff understands that, even when developing these systems themselves,
funds generally either use independent contractors or hire new personnel, and thereby incur this
burden as a cost, not an hourly expenditure.

23

This estimate is based on the following calculations: (100,000 transaction requests × 0.0025¢ =
$250); ($250 × 52 weeks = $13,000).

13
incur a total of $28,767,000 in ongoing costs each year related to maintaining and operating
information sharing systems.24
In addition, newly formed funds and fund groups advised by advisers who are new
entrants would also need to incur certain additional costs related to the initial development or
purchase of these information-sharing systems. Commission staff estimates that it requires
approximately $100,000 to purchase or develop and implement such an information sharing
system for the first time. Commission staff has previously estimated that approximately 40
funds or fund groups are formed each year managed by new advisers, and therefore estimates
that all these funds would incur total costs of approximately $4,000,000.25 Therefore the staff
estimates that the total costs related to rule 22c-2 would be approximately $32,767,000
($28,767,000 + $4,000,000 = $32,767,000).
14.

Estimate of Cost to the Federal Government

The rule does not impose any additional costs on the federal government.
15.

Explanation of Changes in Burden

There has been a slight decrease in the estimates of burden hours for rule 22c-2. The
decrease primarily results from a reduction in the number of fund groups operating and minor
changes to the estimated number of intermediaries that existing fund groups enter into
agreements with each year. Accordingly, the estimated hour burden has decreased to 25,661
from a previously estimated 26,413 hours, a decrease of 752 hours. There has been a slight

24

This estimate is based on the following calculation: (669 fund groups × $43,000 = $28,767,000).

25

This estimate is based on the following estimate: ($100,000 × 40 new fund groups = $4,000,000).

14
increase in the cost burden associated with rule 22c-2. This increase is primarily due to the staff
increasing the estimated number of new fund groups that form each year and which therefore
must develop information sharing systems. As a result, the estimated cost burden has increased
to $32,767,000 from $31,440,000, an increase of $1,327,000.
16.

Information Collection Planned for Statistical Purposes

Not applicable.
17.

Approval to not Display Expiration Date

Not applicable.
18.

Exceptions to Certification Statement

Not applicable.
B.

COLLECTION OF INFORMATION EMPLOYING STATISTICAL METHODS
Not applicable.


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