Collective Investment Funds

Management Fees and Expenses – 9.18(b)(9) and 9.18(b)(10)

The CIF management fee regulation provides that a national bank may charge a CIF a reasonable management fee only if:

1. The fee is permitted under applicable law (and complies with fee disclosure requirements, if any) in the state in which the bank maintains the fund; and

2. The amount of the fee does not exceed an amount commensurate with the value of legitimate services of tangible benefit to the participating accounts that would not have been provided to the accounts were they not invested in the fund.

Essentially, a bank may charge a fee for managing a CIF provided that the participant’s share of that fee, together with the other fees charged to that participant, do not exceed the fees the participant would have paid for services if the bank had not invested the participant’s assets in the fund. A bank may charge different management fees to fund participants commensurate with the amount and types of services provided to fund participants. These variations in fees may be reflected in the number of units a participant receives. For example, if two participants are admitted with the same amount of money to invest, the bank is allowed to provide more units of the CIF to the one requiring fewer services.

A bank administering a CIF may charge reasonable expenses incurred in operating the fund to the extent not prohibited by applicable law in the state in which the bank maintains the fund. A bank must, however, absorb all expenses associated with the establishment or reorganization of a CIF. The regulation does not specifically define which expenses are “reasonable” and which are not.

The OCC has authorized banks to charge reasonable expenses directly associated with operating a CIF. Those expenses include, for instance, an audit of a fund; the cost of publishing the annual financial report; all costs, commissions, taxes, transfer taxes, legal fees, and other expenses associated with the purchase or sale of CIF assets; and all other reasonable costs incurred in the operation and administration of a fund.

A national bank is generally prohibited from passing brokerage and related fees associated with accounts being admitted to or withdrawn from a CIF to each participating account in the CIF. If this practice were allowed, long-term CIF participants could end up absorbing the costs associated with the admission and withdrawal of shorter term participants in the CIF.

However, an “index CIF” may charge brokerage fees and other costs to fund participants that are either admitted to or that withdraw from an index CIF. Index CIFs seek to replicate the performance of a specified index, such as the Standard and Poor’s 500 Index. Trading decisions are made according to a formula that tracks the rate of return of the index by replicating the entire portfolio of the index or by investing in a representative sample of that portfolio. The OCC has also authorized a bank that administers “model-driven” A2 funds to charge these costs to participants at the time they are admitted to or withdrawn from the fund. A “model-driven fund” is a fund that seeks to outperform a third-party index based upon certain pre-specified formulae or algorithms, and is quantitative in nature.

Generally, a bank may not charge participants with the cost of entering or exiting a CIF. However, the payment by an index or model-driven CIF of brokerage fees and expenses in order to accommodate a participant either entering or exiting the fund could negatively affect the fund’s return relative to the index or model for the remaining fund participants. To mitigate that impact, and in light of the limited discretion of the fund manager for an index or model-driven fund, the OCC has allowed funds with these investment strategies to allocate these costs to participants being admitted or withdrawn from either index or model-driven funds, provided that the CIF plan document discloses these charges.

While OCC regulations enable banks to develop flexible and competitive fee structures, a national bank fiduciary must ensure that it does not charge excessive fees or make decisions to invest in a particular product, such as a mutual fund, solely to maximize the revenues of the bank or an affiliate. See Banking Circular 233, “Acceptance of Financial Benefits by Bank Trust Departments” (February 3, 1988), and “Use of Mutual Funds as Fiduciary Investments” (appendix E) in the Comptroller’s Handbook “Conflicts of Interest.” The OCC has acknowledged that a bank may invest CIF assets in either bank-affiliated or third-party mutual funds and may receive both reasonable trust management fees from its customers and fees from the mutual fund for providing services to that fund, provided that these actions are consistent with applicable law.

Fees must be commensurate with the value of services provided. Unless authorized by applicable law, a bank should be careful not to double-charge a fund for fees already charged by a sub-adviser for the same services. In these situations, the bank must not only determine whether the investment is prudent and appropriate for each of the trust accounts, given the investment alternatives realistically available, but must also periodically review the prudence of retaining these investments.

The ’40 Act authorizes mutual funds to pay certain fees (“12b-1 fees”) to third parties to defray the cost of shareholder servicing and administrative services. These fees frequently are used to compensate banks for providing services such as placing orders, processing purchases, processing dividend and distribution payments, and responding to customer inquiries. When a bank receives 12b-1 fees from a mutual fund based upon investments in that fund by a bank-administered CIF, the bank should ensure that applicable law authorizes its receipt of the fee and that the bank discloses receipt of that fee to fund participants.

In addition to 12b-1 fees, some mutual fund complexes pay “finder fees” and other compensation to investors for placing their investments with a particular fund or for retaining their investments over time with a particular fund or fund complex. A bank administering a CIF must ensure that such fees are consistent with the OCC’s self-dealing and fee regulations and with SEC and other applicable guidance in this area.