The SEC has just cleared a path for what might become a distribution revolution in the mutual fund business. And though the change was probably spurred by the DoL rule, there's reason to believe that this shift will take hold even if the DoL rule falls under President Donald Trump's new administration.

Jay Baris Morrison & Foerster LLP Partner

On January 11, the SEC issued a no-action letter responding to a request made by Capital Group [profile] just five days earlier. In its response, the SEC gives its blessing to so-called "clean shares" that would have all loads and distribution fees stripped out and then have the broker selling the fund add on its own distribution fees. This could be a big deal for asset managers facing the passive fund onslaught, given that distribution fees (like all other fees) affect performance and passive funds are generally already clean of such fees; clean shares could make active-passive cost and performance comparisons, well, that much cleaner.

Michael Downer, Paul Roye, and Michael Triessl, all senior vice presidents and senior counsel for Capital Research and Management Company, penned the original letter to the SEC. Rachel Loko, senior counsel in the office of chief counsel for the SEC's division of investment management, wrote the regulatory agency's response.

The letters focus on section 22(d) of the Investment Company Act of 1940. That section requires mutual fund shares to only be sold at the public offering price, the single price (with whatever load and other fees are attached) listed in the fund's prospectus.

"The purpose here," Jay Baris, partner at Morrison & Foerster, explains to MFWire, "is a level playing field." (Baris also penned a client alert on the clean shares idea.)

B-Ds, says Baris, then wondered, "couldn't we just strip the sales charge on these mutual funds and we the broker-dealer will charge our customers whatever we want to charge them." Yet B-Ds "couldn't do that ... until now."

"It's basically decentralized sales charges," Baris adds.

Cap Group's Downer, speaking today at the FSI OneVoice conference in San Francisco, describes clean shares as giving active mutual fund shops the ability to show more outperformance over passive funds. He pitches clean shares as a way to revive active management.

Industry legal experts agree that Cap Group's request, and the SEC's response, were triggered at least in part by the pending DoL rule.

"What brought this on was the DoL rule that basically imposes a fiduciary obligation on brokers when they're putting clients into retirement accounts," Baris says.

"By allowing the clean share, the brokerage industry can figure out what the best cost structure is, and it'll assist them in meeting their obligations under the fiduciary rule," Bruce Leto, chair of the investment management group at Stradley Ronon, tells MFWire.

With the DoL rule's future uncertain under the new leadership in Washington, Leto predicts that the clean shares idea will still hold appeal for mutual fund shops. Baris agrees.

"I think clean shares are here to stay," Baris says. "It's a welcome, incremental advance in flexibility."

In a client alert, Drinker Biddle's Diana McCarthy looks ahead and wonders about "the extent to which other share classes may continue to co-exist with clean shares." For example, perhaps clean shares will trump another new type of share class, T shares. Leto has a prediction.

"I also don't think all share classes are going out of business and moving to clean shares," Leto says, arguing that there are "lots of different reasons" to have different share classes and that "many of those reasons remain" even in a clean shares world.

The SEC's no-action letter also left a key question unanswered, Leto says, via the letter's last footnote, number eight:

This letter does not address the effect under section 22(d) of a broker receiving revenue sharing payments from the fund's adviser.

"There's a lot of debate about that," Leto says. 

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