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Vedder Thinking | Articles SEC Staff Bulletin Cautions Funds and Boards About the Risk of Cross-Subsidization from “Differential Advisory Fee Waivers”


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On February 2, 2023, the staff of the SEC’s Division of Investment Management issued a bulletin cautioning mutual funds, their boards of directors and their legal counsel 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 by the staff as “differential advisory fee waivers.” Specifically, the staff warned that a differential advisory fee waiver may constitute a “prohibited means of cross-subsidization between classes.”

Section 18(f)(1) of the 1940 Act generally prohibits a registered open-end investment company, or a series thereof, from issuing any “senior security,” which is defined, in relevant part, as “any stock of a class having priority over any other class as to distribution of assets or payment of dividends.” Section 18(i) generally requires that every share issued by a fund “be a voting stock and have equal voting rights with every other outstanding voting stock.” Rule 18f-3 under the 1940 Act provides a limited exemption from Sections 18(f)(1) and 18(i) that permits a fund, subject to certain conditions, to issue multiple classes of voting stock representing interests in the same portfolio that have different shareholder servicing or distribution arrangements, that provide their holders with certain different voting rights and that bear certain different expenses (generally other than advisory and custody fees and other expenses related to the management of the fund’s assets). Among other things, reliance on the rule is subject to a requirement that the fund’s board of directors adopt a written plan setting forth the separate arrangement and expense allocation of each class and any related conversion features or exchange privileges.

The staff’s bulletin emphasizes that although Rule 18f-3 expressly allows a fund’s fees and expenses to be waived or reimbursed by the adviser or another service provider, the SEC, in the 1995 adopting release for Rule 18f-3, warned that fee waivers and reimbursements were not intended to become “de facto modifications of the fees provided for in advisory or other contracts so as to provide a means for cross-subsidization between classes.” Moreover, the SEC’s adopting release directed boards to monitor the use of waivers or reimbursements to guard against cross-subsidization, a responsibility the SEC described as consistent with a board’s “oversight of the class system and its independent fiduciary obligations to each class.”

The SEC staff’s bulletin asserts that advisory fees charged to shareholders of all classes of a mutual fund should generally be the same percentage amount. In the staff’s view, “differential advisory fee waivers that are long-term or permanent, or effectively long-term or permanent, and are not substantiated with a clearly defined temporal purpose, could … present a means of cross-subsidization between classes in contravention of Rule 18f-3.”

The staff acknowledges that whether a differential advisory fee waiver constitutes prohibited cross-subsidization is a “facts-and-circumstances determination” that the fund’s board, in consultation with the adviser and counsel, should consider making and documenting after considering all relevant factors. The staff provided an example in which, in the fund-of-funds context, a board may be able to conclude that a long-term advisory fee waiver for one share class but not for other share classes does not constitute cross-subsidization; in the example, such a conclusion would be possible if the board were to find that (1) shareholders of the class subject to the waiver pay fees to the adviser at the investing fund level and (2) those fees, when added to the advisory fees paid by the waived class, after giving effect to the waiver, are at least equal to the amount of advisory fees paid by the other classes.

For funds that already have differential advisory fee waivers in place, the staff recommends that boards consider whether the arrangement allows for cross-subsidization, whether the steps the board takes to monitor against cross-subsidization are effective and whether alternative fee arrangements may be appropriate. The staff also advises funds to consider the extent to which the board’s consideration of these issues may require disclosure to shareholders.

The staff’s bulletin is available here.


John S. Marten


Nathaniel Segal


Jacob C. Tiedt