Rule 12b-1 Supporting Statement (5-24-2012)

PAPERWORK REDUCTION ACT SUBMISSION
SUPPORTING STATEMENT
“RULE 12b-1”
A.

JUSTIFICATION
1.

Information Collection Necessity

Section 12(b) of the Investment Company Act of 1940 (the “Act”) (15 U.S.C. 80a-12(b))
prohibits a registered open-end investment company (“fund” or “mutual fund”) (other than a
fund complying with Section 10(d) of the Act (15 U.S.C. 80a-10(d)) from acting as a distributor
of securities that it has issued, except through an underwriter, in contravention of Commission
rules. Rule 12b-1 under the Act (17 CFR 270.12b-1) permits a mutual fund to bear expenses
associated with the distribution of its shares, provided that the fund complies with certain
requirements.
Rule 12b-1 requires, among other things, that the fund adopt a written plan describing all
material aspects of the proposed financing of distribution (“rule 12b-1 plan”). The rule 12b-1
plan must be approved by the fund’s board of directors, including the independent directors (as
described in the rule), and, if the rule 12b-1 plan is being adopted after public offering of the
fund’s voting securities, by a majority of the fund’s outstanding voting securities. Similarly, any
material amendments to the rule 12b-1 plan must be approved by the fund’s directors, including
the independent directors, and any material increase in the amount to be spent under the rule
12b-1 plan must be approved by the fund’s shareholders. In considering the implementation or
continuance of a rule 12b-1 plan, the fund’s board must request and evaluate information
reasonably necessary to make an informed decision. The board also must conclude, in the
exercise of reasonable business judgment and in light of the directors’ fiduciary duties, that there
is a reasonable likelihood that the rule 12b-1 plan will benefit the fund and its shareholders.

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Rule 12b-1 also requires that all agreements relating to a rule 12b-1 plan be in writing
and that they be approved by the board of directors, including the independent directors. The
rule 12b-1 plan and, in certain instances, any related agreements must incorporate certain
specified provisions, including that: (i) the plan or agreement will continue in effect for more
than one year only if the board, including the independent directors, approve the continuance at
least annually; (ii) the fund’s board reviews quarterly reports of the amounts spent under the
plan; and (iii) the plan may be terminated at any time by a majority vote of the independent
directors or outstanding voting securities. Rule 12b-1 also requires the fund to preserve for six
years copies of the rule 12b-1 plan and any related agreements and reports, as well as minutes of
board meetings that describe the factors considered and the basis for implementing or continuing
the rule 12b-1 plan.
Rule 12b-1 also prohibits funds from paying for distribution of fund shares with
brokerage commissions on their portfolio transactions. The rule requires funds that use brokerdealers that sell their shares to also execute their portfolio securities transactions, to implement
policies and procedures reasonably designed to prevent: (i) the persons responsible for selecting
broker-dealers to effect transactions in fund portfolio securities from taking into account brokerdealers’ promotional or sales efforts when making those decisions; and (ii) a fund, its adviser or
principal underwriter, from entering into any agreement under which the fund directs brokerage
transactions or revenue generated by those transactions to a broker-dealer to pay for distribution
of the fund’s (or any other fund’s) shares.

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2.

Information Collection Purpose

Rule 12b-1 enables funds to use their own assets to pay for distribution of their shares.
The board and shareholder approval requirements of the rule are designed to ensure that fund
shareholders and directors receive adequate information to evaluate and approve a rule 12b-1
plan and, thus, are necessary for investor protection. The provisions that require the board to be
provided with quarterly reports and termination authority are designed to ensure that the rule
12b-1 plan continues to benefit the fund and its shareholders. The recordkeeping requirements
of the rule are necessary to enable Commission staff to oversee compliance with the rule. The
requirement that funds or their advisers implement, and fund boards approve, policies and
procedures in order to prevent persons charged with allocating fund brokerage from taking
distribution efforts into account is designed to ensure that funds’ selection of brokers to effect
portfolio securities transactions is not influenced by considerations about the sale of fund shares.
3.

Information Technology Consideration

The Commission’s Electronic Data Gathering, Analysis and Retrieval System
(“EDGAR”) provides for the automated filing, processing and dissemination of full disclosure
filings. The automation provides for speed, accuracy and public availability of information,
generating benefits to investors and financial markets. Although rule 12b-1 does not require the
filing of any documents with the Commission, the Commission may use its EDGAR facility in
the future to improve the examination of records funds must keep under the rule. The Electronic
Signatures in Global and National Commerce Act and the conforming amendments to rules
under the Act permit funds to preserve records electronically.

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4.

Duplication

The Commission periodically evaluates rule-based reporting and recordkeeping
requirements for duplication, and reevaluates them whenever it proposes a rule or form, or a
change in either. Rule 12b-1 does not require duplicative reporting or recordkeeping. Although
rules 31a-1 and 31a-2 under the Act (17 CFR 270.31a-1 and 270.31a-2) generally require the
maintenance and preservation of records, including board minutes, rule 12b-1 specifies
documents to be retained under rule 12b-1 and substantive issues to be addressed in the board
minutes. Although rule 38a-1 under the Act (17 CFR 270.38a-1) requires funds to adopt and
implement compliance policies and procedures, the requirement in rule 12b-1 to adopt
procedures is intended to ensure the active monitoring of brokerage allocation decisions when
executing brokers also distribute a fund’s shares.
5.

Effect on Small Entities

The recordkeeping requirements of rule 12b-1 are the same for all funds that choose to
rely on the rule, including small entities. Rule 12b-1 is not mandatory, and funds may choose
other distribution arrangements. All funds that use their selling brokers to execute fund portfolio
securities transactions, however, are required to adopt policies and procedures under rule 12b1(h). The Commission does not believe that compliance with rule 12b-1 is unduly burdensome
for small entities.
6.

Consequences of Less Frequent Collection

Pursuant to rule 12b-1, fund directors receive information regarding a rule 12b-1 plan
and/or any related agreements (i) when the plan or any related agreements are implemented, or

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when a material amendment is made to the plan, (ii) quarterly in connection with reports
concerning amounts spent under the plan, and (iii) annually when the board decides whether to
continue the plan and any related agreements. The fund also must provide information to fund
shareholders when their vote is required to implement the plan and if any material increases in
amounts spent under the plan are proposed. These requirements are necessary to ensure proper
approval by fund boards and shareholders in connection with the adoption, continuance, or
amendment of a rule 12b-1 plan, and to ensure that fund boards can monitor payments made
under a rule 12b-1 plan. These requirements also are necessary for Commission staff to monitor
the duties and responsibilities of fund boards and to determine fund compliance with the
requirements of the rule. Rule 12b-1 also requires that, before a fund uses a broker-dealer that
sells fund shares to also execute portfolio transactions, the fund implement (and its board
approve) policies and procedures to prevent distribution efforts from being a factor in the
selection of executing broker-dealers. This requirement is necessary to ensure the active
monitoring of brokerage allocation decisions when executing brokers also distribute the fund’s
shares.
7.

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

Rule 12b-1 requires funds to retain certain written records for more than three years.
Funds relying on rule 12b-1 must preserve copies of the rule 12b-1 plan, related agreements and
reports, and board minutes related to the rule for at least six years, and maintain such records in
an easily accessible place for the first two years. The long-term retention of these records is
necessary for the Commission’s staff to determine compliance with rule 12b-1.

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8.

Consultation Outside the Agency

The Commission has sought and received public comment on rule 12b-1 and each rule
amendment before its adoption. 1 In addition, before submitting this request for an extension and
approval of the information collections under rule 12b-1, the Commission requested public
comment on those information collections. We received no comments in response to this
request. In addition, the Commission and the staff of the Division of Investment Management
continue to participate in an ongoing dialogue with representatives of the mutual fund industry
through public conferences, meetings and informal exchanges. These various forums assist the
Commission and its staff in ascertaining the magnitude of paperwork burdens confronting the
industry.
9.

Payment or Gift to Respondents

No payment or gift to respondents is provided.
10.

Confidentiality

No assurance of confidentiality is provided.
11.

Sensitive Questions

No questions of a sensitive nature are involved.
12.

Information Collection Annual Burden

Rule 12b-1 requires the board of each fund with a rule 12b-1 plan to (i) initially approve
the plan and thereafter consider the plan’s continuation on an annual basis, and to approve any
material amendments to the plan, (ii) review quarterly reports of amounts spent under the plan,
1

See, e.g., Prohibition on the Use of Brokerage Commissions to Finance Distribution, Investment
Company Act Release No. 26356 (Feb. 24, 2004) (69 FR 9726 (Mar. 1, 2004)).

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and (iii) approve policies and procedures to enable the fund to effect portfolio securities
transactions through an executing broker-dealer that also distributes the fund’s shares. The
number of hours required to comply with rule 12b-1 will vary considerably depending on several
factors, including the complexity of the rule 12b-1 plan and the number of classes of fund shares
covered by the plan.
Based on information filed with the Commission by funds, Commission staff estimates
that there are approximately 6,771 mutual fund portfolios that have at least one share class
subject to a rule 12b-1 plan. 2 However, many of these portfolios are part of an affiliated group of
funds, or mutual fund family, that is overseen by a common board of directors. Although the
board must review and approve the rule 12b-1 plan for each fund separately, we have allocated
the costs and hourly burden related to rule 12b-1 based on the number of fund families that have
at least one fund that charges rule 12b-1 fees, rather than on the total number of mutual fund
portfolios that individually have a rule 12b-1 plan. 3 Based on information filed with the
Commission, the staff estimates that there are approximately 375 fund families with common
boards of directors that have at least one fund with a rule 12b-1 plan.

2

This estimate is based on information from the Commission’s NSAR database.

3

This allocation is based on previous conversations with fund representatives on how fund boards
comply with the requirements of rule 12b-1. Despite this allocation of hourly burdens and costs,
the number of annual responses each year will continue to depend on the number of fund
portfolios with rule 12b-1 plans rather than the number of fund families with rule 12b-1 plans.
The staff estimates that the number of annual responses per fund portfolio will be four per year
(quarterly, with the annual reviews taking place at one of the quarterly intervals). Thus, we
estimate that funds will make 27,084 responses (6,771 fund portfolios x 4 responses per fund
portfolio = 27,084 responses) each year.

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Based on previous conversations with fund representatives, Commission staff estimates
that for each of the 375 mutual fund families with a portfolio that has a rule 12b-1 plan, the
average annual burden of complying with the rule is 425 hours. This estimate takes into account
the time needed to prepare quarterly reports to the board of directors, the board’s consideration
of those reports, and the board’s initial or annual consideration of whether to continue the plan. 4
We therefore estimate that the total hourly burden per year for all funds to comply with current
information collection requirements under rule 12b-1, is 159,375 hours (375 fund families x 425
hours per fund family = 159,375 hours).
We estimate the annual cost of the hourly burden per fund family under the rule to be
$107,040.00. 5 This figure reflects an estimate that each fund family with a rule 12b-1 plan
would spend the following hours each year complying with rule 12b-1:
•

380 hours annually by fund accountants at $134.00 per hour (preparing quarterly reports)
(380 hours x $134.00 per hour = $50,920.00);

•

10 hours annually by paralegals at $174.00 per hour (assisting with quarterly reports and
the preparation of initial or annual approval materials)
(10 hours x $174.00 per hour = $1740.00);

•

20 hours annually by compliance attorneys at $322.00 per hour (reviewing quarterly
reports and preparing initial or annual approval materials )
(20 hours x $322.00 per hour = $6,440.00);

4

We do not estimate any costs or time burden related to the recordkeeping requirements in rule
12b-1, as funds are either required to maintain these records pursuant to other rules or would keep
these records in any case as a matter of business practice.

5

Salary estimates for accountants, paralegals, compliance attorneys and fund counsel are from
SIFMA’s Management & Professional Earnings in the Securities Industry 2011, modified by
Commission staff to account for an 1800-hour work-year and multiplied by 5.35 to account for
bonuses, firm size, employee benefits and overhead.

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•

5 hours annually by a deputy general counsel at $588.00 per hour (reviewing quarterly
reports and the initial or annual approval materials)
(5 hours x $588.00 per hour = $2,940.00);

•

10 hours annually by the board of directors as a whole (reviewing quarterly reports and
the initial or annual approval materials, and making the necessary findings).
(10 hours x $4500.00 per hour 6 = $45,000.00).

•

($50,920.00 + $1,740.00 + $6,440.00 + $2,940.00 + $45,000.00 = $107,040.00)

Thus, we estimate that the total annual cost to all funds of the rule 12b-1 hour burden is
approximately $40 million (375 fund families with rule 12b-1 plans x $107,040.00 =
$40,140,000.00).
We estimate that there will be an industry total of 159,375 burden hours per year at a cost
of $40,140,000.00 per year over the three year period for which we are requesting approval of
the information collection burden. The estimate of average burden hours is made solely for the
purposes of the Paperwork Reduction Act, and is not derived from a comprehensive or even a
representative survey or study of the costs of Commission rules and forms.
13.

Cost Burden to Respondents

If a currently operating fund seeks to (i) adopt a new rule 12b-1 plan or (ii) materially
increase the amount it spends for distribution under its rule 12b-1 plan, rule 12b-1 requires that
the fund obtain shareholder approval. As a consequence, the fund will incur the cost of a proxy. 7

6

The estimate for the cost of board time as a whole is derived from estimates made by the staff
regarding typical board size and compensation that is based on information received from fund
representatives and publicly available sources.

7

In general, a fund adopts a rule 12b-1 plan before it begins operations. Therefore, the fund is not
required to obtain the approval of its public shareholders because the fund’s shares have not yet
been offered to the public.

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Based on previous conversations with fund representatives, Commission staff estimates that
approximately three funds per year prepare a proxy in connection with the adoption or material
amendment of a rule 12b-1 plan. Funds typically hire outside legal counsel and proxy
solicitation firms to prepare, print, and mail such proxies. The staff further estimates that the cost
of each fund’s proxy is $32,174. Thus the total annual cost burden of rule 12b-1 to the fund
industry is $96,522 (3 funds requiring a proxy x $32,174 per proxy).
14.

Cost to the Federal Government

Rule 12b-1 does not currently impose any costs on the federal government. The rule does
not require funds to file any documents with the Commission. Commission staff may review
records produced pursuant to the rule in order to assist the Commission in carrying out its
examination and oversight program.
15.

Changes in Burden

The estimated annual burden hours for funds with rule 12b-1 plans increased by 1,700
hours, from 157,675 hours to 159,375 hours. This is due to an increase in the number of mutual
fund families that have at least one fund that charges rule 12b-1 fees. The estimated total annual
cost burden increased $6,522, from $90,000 to $96,522. The increase in cost is due to inflation.
16.

Information Collection Planned for Statistical Purposes

The information collection is not used for statistical purposes.
17.

OMB Expiration Date Display Approval

The Commission is not seeking approval to not display the OMB approval expiration date.

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18.

Exceptions to Certification Statement

This collection complies with the requirements in 5 CFR 1320.9.
B.

COLLECTIONS OF INFORMATION EMPLOYING STATISTICAL METHODS
The collection of information will not employ statistical methods.