2.3 Mutual Fund Pricing, Redemption, Exchanges, Sales Charges, and Share Classes

Forward Pricing (Section 22(c) and Rule 22c-1)

Rule 22c-1 requires that a fund's shares be sold and redeemed at a price based on the current net asset value next computed after receipt of the order. Most funds compute NAV once each business day at the close of the New York Stock Exchange, normally 4:00 p.m. Eastern time.

• An order received at 3:15 p.m. is priced at that day's NAV.
• An order received at 4:20 p.m. is priced at the next business day's NAV.
• Accepting an order after the cutoff and giving it the earlier price is late trading. It is illegal because it lets the investor trade on information released after the NAV was struck.

Short-term trading. Rule 22c-2 addresses market timing. A fund's board, including a majority of independent directors, must either approve a redemption fee of up to 2% of the amount redeemed on shares held for a period the board sets (no shorter than seven calendar days), or determine that such a fee is not necessary. Funds must also have agreements with intermediaries to obtain shareholder trading information. Supervisors should watch for repeated in-and-out fund trades that may violate fund prospectus limits.

Public Offering Price and Uniform Pricing (Section 22(d) and Rule 22d-1)

Section 22(d) prohibits a dealer from selling a fund's redeemable shares to the public except at the current public offering price described in the prospectus. Dealers cannot negotiate their own discounts. Rule 22d-1 permits scheduled variations in the sales load, such as breakpoints, rights of accumulation, letters of intent, NAV purchases for certain groups, and reinvestment privileges, if they are described in the prospectus and applied uniformly.

For a fund with a front-end load, the offering price and the load are related by:

$\text{POP} = \frac{\text{NAV}}{1 - \text{sales charge \%}}$

Example. With NAV of $19.00 and a 5% sales charge, POP = $19.00 / 0.95 = $20.00. The $1.00 load equals 5% of the offering price, which is about 5.26% of the net amount invested.

Redemption (Section 22(e))

An open-end fund must pay redemption proceeds within seven days of a proper tender. It may suspend redemptions or postpone payment only:

1. when the NYSE is closed other than for customary weekend and holiday closings, or trading on it is restricted;
2. during an emergency that makes disposal or valuation of portfolio securities not reasonably practicable; or
3. for other periods the SEC permits by order to protect shareholders.

Rule 22e-1 creates a narrow exemption for variable annuity separate accounts: once payments are being made based on life contingencies during the annuity payout period, the right of redemption may be suspended, because the owner has exchanged account value for lifetime income (Section 2.4).

Exchanges Within a Fund Family (Section 11 and Rule 11a-3)

Section 11 restricts exchange offers between investment companies to protect shareholders from switching abuses. It generally requires that exchanges be made on the basis of relative net asset values unless the SEC permits otherwise. Rule 11a-3 permits exchange offers within a fund group that impose certain administrative fees or sales loads if they are disclosed. Holders must receive at least 60 days' notice before an exchange offer is terminated or materially amended, except in narrow circumstances such as a suspension of redemptions.

An exchange within a fund family usually avoids a new front-end load, but it is still a sale and purchase for tax purposes. A switch between fund families generally incurs a new sales charge. Supervision of switching is covered in Section 5.3.

Sales Charge Limits (FINRA Rule 2341(d))

Rule 2341 makes a fund's sales charges excessive, and therefore off-limits for sale by members, unless they meet these ceilings:

Other Rule 2341 provisions:

• "No load" labels. A member may not describe a fund as "no load" or "no sales charge" if it has a front-end or deferred sales charge, or if its asset-based sales charges plus service fees exceed 0.25% per year.
• CDSC ordering. A declining contingent deferred sales charge must be calculated as if shares not subject to the charge are redeemed first, then the remaining shares in the order purchased, unless another order costs the shareholder less.
• Reinvested dividends. No sales charge may be imposed on shares bought through reinvested dividends, unless the fund's registration statement became effective before April 1, 2000.
• Selling dividends (Rule 2341(e)). It is prohibited to suggest that buying just before an ex-dividend date is advantageous without a specific, clearly described benefit, or to present capital gains distributions as part of the income yield.
• Withholding orders (Rule 2341(f)). A member may not withhold customer orders in order to profit from doing so.
• Refund of concession (Rule 2341(h)). If shares are redeemed within seven business days of the purchase, the dealer must refund its concession to the underwriter.
• CDSC confirmation legend (Rule 2341(n)). Confirmations for funds with a deferred sales charge must carry, on the front in at least 8-point type: "On selling your shares, you may pay a sales charge. For the charge and other fees, see the prospectus."

Share Classes

Because the same portfolio is offered with different costs, share-class selection is a recurring Reg BI and suitability issue. A customer investing $250,000 for 15 years in C shares will usually pay far more over the holding period than in A shares bought at a breakpoint. Section 5.3 covers the supervisory review.