United States

Mutual funds consequences of the rapid migration to omnibus shareholder accounts


Mutual fund transfer agents have seen an unprecedented shift in their shareholder account mix, as the broker-dealer is now maintaining most intermediary-sold shares in omnibus accounts. What concerns does this cause for fund trustees?

Unlike traditional corporations, mutual funds have historically maintained the details of their shareholder relationships internally. Largely, corporate transfer agents did not have the systemic capability to deal with the reporting requirements unique to mutual funds. Also factoring into a mutual fund family's decision to in-source was the sponsor's belief that a proprietary transfer agent could provide a better level of shareholder service and thereby differentiate the fund complex from its competitors. Many fund sponsors were also able to negotiate transfer agency contractual arrangements with their funds' directors that provided a profit incentive. Some of these internal transfer agents used third-party technology developed specifically for mutual fund shareholder administration.

From Network Level 3 to omnibus

The rapid growth of third-party distribution of mutual funds in the 1990's required funds to shift to generic file structures and common industry service offerings for shareholders who purchased shares through broker-dealers, banks and other financial intermediaries. Those funds whose shares are settled through the NSCC maintain multiple levels of shareholder accounts. Network Level 1 accounts (most often associated with direct-sold mutual fund share classes) are fully maintained and serviced by the fund's transfer agent (purchases, sales, distributions, telephone support, tax reporting, etc.). In Network Level 3, the financial intermediary and the fund's transfer agent maintain duplicate accounts to facilitate the transfer of transactional information to and from the intermediary. The transfer agent has no information about or contact with the Network Level 3 shareholder as these account holders are considered to be the clients of the intermediary rather than of the fund.

Financial intermediaries have invested heavily in their back-office systems, and most now have the ability to aggregate and disaggregate their daily activity with mutual fund transfer agents thereby eliminating the need for Network Level 3 shareholder accounting. Instead, these accounts can now be pooled into single omnibus accounts on the mutual fund transfer agency records.

The mutual fund and intermediary relationship

As the relationship between the mutual funds and their distribution parties matured, the financial relationship between them has become more complex and financially intertwined.

Sub-TA fees
Financial intermediaries that have moved from Network Level 3 to omnibus generally seek remuneration from the mutual fund or its transfer agent to offset the additional costs associated with their maintenance of the shareholder account histories. These Sub-TA fees are often assessed as a fixed-dollar account fee, a basis point fee applied to average account balances, or a combination thereof.

Consideration: Should Sub-TA fees be considered an incremental fund expense?

Broker-dealers are not paid by underlying issuers to hold equity securities, municipal or corporate bonds, or exchange-traded funds (ETFs) in a proprietary brokerage account. These positions are tracked by broker-dealers in their accounting systems as a part of the services they are required to perform for customers, typically at no charge to the account holder. As a result, fund management is often asked by the board to provide evidence that the financial intermediary is providing incremental services for its customers holding mutual funds. Redemption fees, assessment of contingent deferred sales charges, fund exchanges and prospectus mailings are often suggested as justifying examples of responsibilities handled by the broker-dealers.

Consideration: Should the fee charged to the fund by its transfer agent be reduced to reflect a compensating shift in shareholder related activity from the transfer agent to the intermediary?

Many fund sponsors claim not to have experienced a reduction in their transfer agency activities in spite of the shift from Network Level 3 to omnibus accounts since much of that activity consisted of automated transactions. Instead, they have had to increase their transfer agency compliance staffs in order to oversee the incremental activity at the intermediary.

Revenue sharing arrangements
Revenue sharing arrangements are established when an investment adviser agrees to pay a fee for shelf space and marketing support. Revenue sharing can also be used to reimburse the broker-dealer for seminar sponsorships, advertisements and systems developments associated with the distribution of the funds. These arrangements are most often structured as a fixed number of basis points applied to average asset balances.

Are the incremental fees associated with omnibus accounts disguised marketing or distribution fees?

Consideration: Are some or all the fees associated with omnibus account activity more similar to revenue sharing than transfer agency, and therefore, not fund expenses?

Some factors the board might consider to determine the appropriateness of the charge of these fees to the fund include, but are not limited to:

  • Was there a revenue sharing arrangement in place before the move to omnibus?
  • How does the combined revenue sharing or Sub-TA fee charged by the intermediary compare with other revenue sharing fees paid to intermediaries which are utilizing Network Level 3 shareholder accounting?
  • Is the Sub-TA agreement solely a result of negotiations between the fund's transfer agent and intermediary's operations group? To what extent did the fund's distribution team participate in the deliberations?
  • Do the incremental services provided by the intermediary support the incremental fees charged to the fund?

12b-1 fees
Pursuant to rule 12b-1 of the Investment Company Act of 1040, a fund may adopt a plan providing for payment to financial advisers or to registered investment advisers who provide advice and recommendations on the selection and monitoring of investments, among other things.

Consideration: Similar to revenue sharing, the board should make efforts to determine whether any incremental payments to the intermediary are more in the nature of marketing and distribution related activities which otherwise would be permitted by rule 12b-1.

Differential cash compensation arrangements
These payments typically occur when a broker-dealer provides higher payouts or similar subsidies to its registered representatives for the sale of certain investment company products, such as investment companies that are proprietary funds of the broker-dealer.

Consideration: Is the intermediary passing some or the entire Sub-TA fee on to its registered representatives as sales incentives?

Methodology for determining the amount of omnibus expense charged to the funds and share classes

Although the methodology utilized to allocate transfer agency costs to each of the funds may be consistently applied within a fund complex from year to year, it is very unlikely that methodology is identical to one used by another fund sponsor. Mutual funds that are distributed through financial intermediaries often issue multiple classes of shares designed to accommodate the diverse needs of the distribution channels they employ. Allocations are often determined by each fund's proportionate share of accounts, average assets, transactions or a combination thereof. This top-down approach is then completed by similarly allocating each fund's transfer agency fee to its classes of shares. Other fund complexes first allocate transfer agency fees to each class of shares and then aggregate those fees to each fund, that is, a bottom-up methodology.

Some share classes are not impacted by the shift from Network Level 3 to omnibus and the shift within the affected classes is not necessarily applicable to all of the intermediaries distributing those shares. This introduces an additional and often material complexity to the allocation methodology.

Consideration: The rapid move to omnibus can result in a year-to-year material change in transfer agency fee expense, shifting the expense burden among funds or among share classes within a fund. These shifts may be mathematically appropriate but may not best reflect the underlying shareholder activity of the fund or class.


The rapid shift from Network Level 3 to omnibus requires fund sponsors and fiduciaries to examine not only the cost and allocation methodologies associated with transfer agency expenses, but also the intertwined financial arrangements among the funds, sponsors and distributors. The associated cost increase coupled with the shift among funds and among share classes of transfer agency fees increases the visibility of these relationships and the need for an enhanced level of fiduciary oversight.

By Joe Palombo, director, RSM US LLP, 617.241.1493.


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