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94-41 NASD Clarifies Compensation Disclosure Requirements For Mutual Funds

SUGGESTED ROUTING

Senior Management
Legal & Compliance
Mutual Fund

Executive Summary

In Notice to Members 94-14, the NASD provided guidance on compliance with Article HI, Section 26 of the Rules of Fair Practice, which requires members to disclose in the fund prospectus any compensation received in the sale of mutual fund securities. This Notice clarifies that the guidance provided in Notice to Members 94-14 applies to current disclosure obligations of members in the sale of mutual fund securities.

Discussion

In March 1994, the NASD issued Notice to Members 94-14 to help members comply with the disclosure requirements of Article HI, Section 26 (1)(1)(C) of the Rules of Fair Practice, which prohibits members from accepting compensation from an underwriter when selling its mutual fund unless such compensation is disclosed in the fund prospectus. The NASD Investment Companies Regulation Department has received a number of inquiries as to whether the guidance provided in the Notice applies to members' current disclosure obligations under Section 26. This question has arisen because many members are aware that the NASD has had pending at the SEC since 1992 a rule filing that would amend the provisions of Section 26 (1). It appears that many members believe the guidance provided in Notice to Members 94-14 would apply only upon SEC approval of the rule filing.

The NASD is hereby clarifying that the guidance provided in Notice to Members 94-14 applies now to the current disclosure obligations of members in the sale of mutual fund securities. In publishing Notice to Members 94-14, the NASD was addressing its concern that the current level of disclosure in many cases does not meet the requirements of Section 26 (1)(1)(C). The NASD determined to remind members of their obligations under that provision and provide clear guidance to assist members in reviewing and, where necessary, modifying current disclosure in the fund prospectus.

Further, members have asked for clarification of their disclosure obligations under Section 26 when a mutual fund modifies its compensation arrangements to establish a "special" short-term compensation arrangement that is available to all participating members. The NASD agrees with members that this arrangement is not a "special compensation arrangement" that requires detailed disclosure because it is available to all participating members. However, because the special short-term compensation arrangement modifies the compensation provided to participating members, the fund prospectus is required to provide a clear statement of the new maximum cash compensation and/or a generic statement of the type of non-cash compensation to be provided under the short-term arrangement. Therefore, if the prospectus does not contain this disclosure, it should be amended or stickered to provide this information.

Any questions regarding this Notice should be directed to R. Clark Hooper, Vice President, Investment Companies Regulation Department (202) 728-8325.


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