Investment Management Industry News Summary - December 2003

On December 23, 2003, NASD posted on its website a sample written disclosure statement (the “Disclosure Statement”) on the availability of breakpoint discounts. NASD developed the Disclosure Statement to assist members in implementing the Joint NASD/Industry Task Force’s recommendation that broker-dealers provide to investors a Disclosure Statement explaining the availability of breakpoint discounts at the time of purchase and on a periodic basis.

The sample Disclosure Statement (i) includes descriptions of typical sales charges levied by mutual funds (e.g., Class A, B and C shares) with a brief explanation of the differences among typical share classes and (ii) provides a general description of breakpoint discounts, including information on mutual funds’ use of rights of accumulation and letters of intent.

The Disclosure Statement is available on NASD’s website, at www.nasdr.com/breakpoints_statement.asp. The Report of the Joint NASD/Industry Task Force on Breakpoints is also available on NASD’s website, at www.nasdr.com/breakpoints_report.asp. NASD – Breakpoint Written Disclosure Document, December 23, 2003.

On December 23, 2003, NASD issued a Notice to Members announcing the SEC’s approval on October 24, 2003 of new Rule 2790 (Restrictions on the Purchase and Sale of IPOs of Equity Securities), which replaces the Free-Riding and Withholding Interpretation (IM-2110-1).


Rule 2790 generally prohibits a member from selling a “new issue” to any account in which a “restricted person” has a beneficial interest. For more information on the new rule, see Industry News Summary for the week of 11/03/03 to 11/10/03 and “Special Notice to Hedge Fund Clients: SEC Staff Releases Hedge Fund Report,” attached.

The voluntary effective date of the new rule is December 23, 2003; the mandatory effective date is March 23, 2004. NASD Notice to Members 03-79, December 23, 2003.

On December 19, 2003, the SEC issued a Concept Release requesting public comment on a number of issues related to the disclosure of mutual fund transaction costs.

Proposals to Quantify Transaction Costs

The SEC requests comment on the following alternatives for improving the current disclosure requirements regarding transaction costs through quantitative disclosure:

• a requirement that mutual funds disclose the commissions they pay to effect securities transactions and include the result in their expense ratios and fee tables;
• a requirement that funds quantify and disclose all of the transaction costs that they incur;
• a requirement that funds use a “trade effect” measure of transaction costs, equal to the total mark-to-market profits or losses on the security purchases and sales made by a fund, and disclose the sum of these mark-to-market profits and losses across all trades on a given day; and
• sell-side alternatives under which markets or broker-dealers would disclose their execution quality for large, institutional orders.

Accounting Issues

The SEC requests comment on (1) the desire for and feasibility of including all transaction costs in fund expense ratios and fee tables contained in a fund’s prospectus and (2) whether the cost information obtained would be reliable and relevant for financial reporting purposes or whether, in the alternative, some subset of transactions costs can be reliably measured and expensed for financial reporting purposes.

Alternatives that Provide Additional Information About the Level of Transaction Costs

The SEC requests comment on the following alternatives that could improve transaction cost disclosure by requiring that funds:

• disclose transaction costs in terms of rated categories through which each fund would be compared to an industry standard;
• give greater prominence to the portfolio turnover ratio;
• provide additional information about the sale and redemption of fund shares;
• include a discussion of transaction costs and portfolio turnover in the prospectus, the report to shareholders, or in another disclosure document;
• move the information on brokerage costs that is currently included in the SAI to the fund prospectus and prominently display such information with the portfolio turnover information, or that funds provide disclosure on average commission rate per share; and
• provide a disclosure that captures indirectly the total cost of investing in funds, such as a disclosure on the return on their investments prior to all identifiable costs along with the investment return after such costs have been deducted.

Review of Transaction Costs by Fund Directors

The SEC requests comment on the following issues regarding fund directors’ review of transaction costs:

• the adequacy of, and potential improvements to, existing requirements for board review of transaction costs;
• whether boards should be required to receive reports with mandated information regarding soft dollars and directed brokerage payments, and whether investors should be provided periodically with a summary of these reports;
• whether the SEC or other independent body should collect execution performance statistics from similar funds and make available aggregate statistics for comparison purposes; and
• whether fund advisers should be required to provide fund boards with an internal allocation of their uses of brokerage commissions, indicating the amounts and percentage used by the adviser to obtain execution services and soft dollar benefits, specifically detailing the types and amounts of the various kinds of benefits, and whether there should be separate allocations among types of research.

Comments must be received by the SEC on or before February 23, 2004. SEC Release Nos. 33-8349, 34-48952, IC-26313; File No. S7-29-03.

On December 11, 2003, the SEC proposed form amendments to require enhanced disclosure by mutual funds and insurance companies concerning the frequent purchase and redemption of fund shares, and to clarify requirements regarding disclosure of fair value pricing and its effects. The SEC also proposed amendments to require mutual funds (other than money market funds) and insurance company managed separate accounts that offer variable annuities to disclose their policies and procedures with respect to disclosure of their portfolio securities, as well as any ongoing arrangements to make available portfolio holdings information.
The proposed amendments would make the following changes to FormsN-1A, N-3, N-4, and N-6 under the Securities Act of 1933 (the “Securities Act”) and the 1940 Act:

Disclosure Concerning Frequent Purchases and Redemptions of Fund Shares

• Form N-1A would be amended to require disclosure in a mutual fund’s prospectus of the risks to fund shareholders of the frequent purchase and redemption of fund shares. The disclosure would have to be specific to the fund, taking into account its investment objectives, policies, and strategies.
  
• Form N-1A would be amended to require a mutual fund’s prospectus to state whether the fund’s board of directors has adopted policies and procedures with respect to frequent purchases and redemptions of fund shares by shareholders. If the fund’s board has not adopted any such policies and procedures, the fund’s prospectus would be required to include a statement of the specific basis for the view of the board that it is appropriate for the fund not to have such policies and procedures.

If the board has adopted such policies and procedures, the fund’s prospectus would be required to include a description of those policies and procedures, including:

• whether or not the fund discourages or accommodates frequent purchases and redemptions of fund shares by fund shareholders;
• any policies and procedures of the fund for deterring frequent purchases and redemptions of fund shares by fund shareholders; and
• any policies and procedures of the fund for detecting frequent purchases and redemptions of fund shares, including frequent purchases and redemptions through intermediaries.

The description of such policies and procedures, if any, would be required to include any restrictions imposed by the fund to prevent or minimize such frequent purchases and redemptions, including:

• any restrictions on the volume or number of purchases, redemptions, or exchanges that a shareholder may make within a given time period;
• any exchange fee or redemption fee;
• any costs or administrative or other fees or charges that are imposed on shareholders deemed to be engaged in frequent purchases and redemptions of fund shares, together with a description of the circumstances under which such costs, fees, or charges will be imposed;
• any minimum holding period that is imposed before an investor may make exchanges into another fund;
• any restrictions imposed on exchange or purchase requests submitted by overnight delivery, electronically, or via facsimile or telephone; and
• any right of the fund to reject, limit, delay, or impose other conditions on exchanges or purchases or to close or otherwise limit accounts based on a history of frequent purchases and redemptions of fund shares, including the circumstances under which such right will be exercised.

A fund would also be required to indicate whether each restriction applies uniformly in all cases or whether the restriction will not be imposed under certain circumstances. If any restriction will not be imposed under certain circumstances, the fund would be required to describe with specificity the circumstances under which the restriction will not be imposed.

• Form N-1A would require a mutual fund to describe in its prospectus any arrangements with any person to permit frequent purchases and redemptions of fund shares. This description would include the identity of the persons permitted to engage in frequent purchases and redemptions and any compensation or other consideration received by the fund, its investment adviser, or any other party pursuant to such arrangements. A proposed instruction would clarify that the consideration required to be disclosed includes any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment adviser or by any affiliated person of the investment adviser.
• Form N-1A would be amended to clarify that the new disclosure that would be required regarding frequent purchases and redemptions of fund shares may not be omitted from the prospectus in reliance on current Item 7(f). Current Item 7(f) permits funds to omit from the prospectus certain information concerning purchase and redemption procedures if, among other things, the information is included in a separate document that is incorporated by reference into, and filed and delivered with, the prospectus.
• Forms N-3, N-4 and N-6 also would be amended to require similar disclosures by insurance company separate accounts that issue variable annuities and variable life insurance policies regarding both the risks of frequent transfers of contract value among sub-accounts, and the separate account’s policies and procedures with respect to such frequent transfers. The proposed amendments would include certain modifications due to the different structure of these issuers.

Disclosure of Circumstances under Which Funds Will Use Fair Value Pricing

Instructions to Item 7(a)(1) of Form N-1A would be amended to clarify that mutual funds, other than money market funds, are required to explain briefly in their prospectuses the circumstances under which they will use fair value pricing and the effects of using fair value pricing.

Selective Disclosure of Fund Portfolio Holdings

• Form N-1A would be amended to require a mutual fund’s statement of additional information (“SAI”) to describe the fund’s policies and procedures with respect to the disclosure of its portfolio securities. The fund would also be required to disclose any policies and procedures of its investment adviser or any other third party that the fund uses or that is used on its behalf. The SAI disclosure would be required to include:
• any conditions or restrictions placed on the use of information about portfolio securities that is disclosed, including any requirement that the information be kept confidential or prohibitions on trading based on the information, and any procedures to monitor the use of this information;
• the frequency with which information about portfolio securities is disclosed and the length of the lag, if any, between the date of the information and the date on which the information is disclosed;
• any policies and procedures with respect to the receipt of compensation or other consideration by the fund, its investment adviser, or any other party in connection with the disclosure of information about portfolio securities;
• the persons who may authorize disclosure of the fund’s portfolio securities;
• the procedures that the fund uses to ensure that disclosure of information about portfolio securities is in the best interests of fund shareholders, including procedures to address conflicts between the interests of fund shareholders and those of the fund’s investment adviser; principal underwriter; or any affiliated person of the fund, its investment adviser, or its principal underwriter; and
• the manner in which the board of directors exercises oversight of disclosure of the fund’s portfolio securities.
• Form N-1A would be amended to require a mutual fund to disclose in its SAI any ongoing arrangements to make available information about its portfolio securities, including the identity of the persons who receive information pursuant to such arrangements and any compensation or other consideration received by the fund, its investment adviser, or any other party in connection with such arrangements. Arrangements required to be disclosed would include any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment adviser or by any affiliated person of the investment adviser.

A fund would also be required to describe

• any conditions or restrictions placed on the use of information about portfolio securities that is disclosed, including any requirement that the information be kept confidential or prohibitions on trading based on the information, and any procedures to monitor the use of this information;
• the frequency with which information about portfolio securities is disclosed and the length of the lag, if any, between the date of the information and the date on which the information is disclosed; and
• the persons who may authorize disclosure of the fund’s portfolio securities.
• Form N-3 would be amended to impose similar requirements on insurance company managed separate accounts that issue variable annuities.

If the proposed disclosure requirements are adopted, the SEC expects to require all new registration statements and all post-effective amendments to effective registration statements filed on or after the effective date of the amendments to comply with the proposed amendments. Comments on the proposed amendments must be received by the SEC on or before February 6, 2004. SEC Release Nos. 33-8343; IC-26287; File No. S7-26-03.

On December 11, 2003, the SEC proposed amendments to rule 22c-1 under the Investment Company Act of 1940 (the “1940 Act”), which requires forward pricing of redeemable securities issued by funds. The amendments are intended to prevent unlawful late trading in fund shares.

Rule 22c-1 currently requires funds, their principal underwriters, and dealers to sell and redeem fund shares at a price based on the current net asset value (“NAV”) next computed after receipt of an order to buy or redeem. The rule also requires that funds calculate their NAV at least once a day.

The proposed amendments would add the following provisions to rule 22c-1:

Proposed Pricing Requirements

• An order would be deemed received only when it is received by (i) the fund itself, (ii) the fund’s designated transfer agent, or (iii) a clearing agency registered with the SEC.
  
  
• Fund-designated transfer agents would be required to record the date and time they receive order information. These transfer agents and the National Securities Clearing Corporation (“NSCC”) will operate as time-stamping organizations, ensuring that orders are assigned the correct day’s price.

Purchase and Sale Orders and Exchanges

• The term “order” would be defined to clarify when an order is complete, and thus received, for purposes of obtaining the appropriate day’s price. An “order” would mean the direction to purchase or sell either (i) a specific number of shares of a fund, or (ii) an indeterminate number of shares of a specific value. The definition also would state that each order would be deemed irrevocable as of the next pricing time after receipt by the fund, its designated transfer agent, or registered clearing agency.
  
  
• To preserve the ability of funds to offer “seamless” exchange transactions, the term “order” would include a direction to purchase redeemable securities of the fund using proceeds of a contemporaneous order to redeem a specific number of shares of another fund.

Exceptions

• Investor orders would be permitted to receive same-day treatment if, due to an emergency, a dealer was unable to transmit the orders, or NSCC or the fund’s designated transfer agent was unable to receive the orders.

This emergency exception would be available to dealers only if the chief executive officer (“CEO”) certifies to the fund (i) the nature, existence, and duration of the emergency, and (ii) that the intermediary received the orders before the applicable pricing time. A fund would be required to keep a record of each certification it received for six years. If an emergency prevented the designated transfer agent or the clearing agency from receiving order information, its CEO would have to provide notice of the emergency to the fund.



• Another exception would be added for “conduit” funds, which invest all their assets in another fund and thus must calculate their NAV on the basis of the other fund’s NAV. A conduit fund, such as a “master-feeder” fund or an insurance company separate account, would be permitted to submit its orders based on the NAV established by the other fund on the same day.

Comments on the proposed amendments must be received by the SEC on or before February 6, 2004. SEC Release No. IC-26288; File No. S7-27-03.

On December 17, 2003, the SEC adopted new rules under the Investment Company Act of 1940 (the “1940 Act”) and the Investment Advisers Act of 1940 that require each investment company and investment adviser registered with the SEC to adopt and implement written policies and procedures reasonably designed to prevent violation of the federal securities laws, review those policies and procedures annually for their adequacy and the effectiveness of their implementation, and designate a chief compliance officer to be responsible for administering the policies and procedures. The effective date of the new rules is February 5, 2004. We will provide more details on the final rules in the next issue of the News Summary.

On December 4, 2003, NASD requested comment on proposed changes to Interpretive Material 8310-2, which governs the release of disciplinary and other information to the public through NASD BrokerCheck. The proposed changes, which would enhance the existing approach for e-mail generated by BrokerCheck, are based on NASD’s review of the information that it makes public and comments on the review (See Notice to Members, 02-74).

The proposed changes to IM-8310-2 would broaden the scope of administrative and disclosure information NASD releases to the public. In addition, the proposed changes would replace the report attachment currently sent by e-mail with a unique access code and a link to a secure written report on the server. Individuals with the access code would be granted access to the specific written report requested and would then be able to view the written report electronically and print the report. Requesters also would be able to view investor education materials that would help them understand the written report.

Comments must be received by NASD by January 9, 2004. NASD Notice to Members 03-76, December 4, 2003.

On December 9, 2003, NASD proposed to amend Rules 2210 and 2211 to require all member communications with the public that contain fund performance information (“performance advertising”) to present specified information about the fund’s expenses and performance in a prominent text box. The amendments are intended to improve investor awareness of the costs of buying and owning a mutual fund, facilitate comparisons among funds, and make presentation of standardized performance more prominent.

The proposed amendments would require the following:

• All performance advertising would be required to contain a text box that sets forth the fund’s (i) standardized performance information, (ii) maximum sales charge, and (iii) annual expense ratio.
  
  
• The text box information would have to be presented in type size at least as large as any non-standardized performance information included.

Comments on the proposed amendments must be received by NASD by January 23, 2004. NASD Notice to Member 03-77, December 9, 2003.

On November 25, 2003, Senators Jon Corzine (D-NJ) and Christopher Dodd (D-CT) introduced the Restoration Act, which was referred to the Committee on Banking, Housing, and Urban Affairs. The Restoration Act seeks to improve transparency relating to the fees and costs that mutual fund investors incur as well as corporate governance of mutual funds.

The Restoration Act is similar to the Senate bill “Mutual Fund Transparency Act of 2003” (the “Transparency Act”) (see IMG Industry News Summary for the week of 11/10/03 to 11/17/03). The following provisions of the Restoration Act differ from the Transparency Act:

Enhanced disclosure. The Securities and Exchange Commission (the “SEC”) would be directed to revise regulations to require a mutual fund to disclose the following:

• the actual dollar amount, borne by each shareholder, of the expenses of the mutual fund;
• whether the chairman of the mutual fund’s board or any directors of the fund’s investment adviser employed to manage the fund’s portfolio do not own any securities of the fund;
• the estimated total annual dollar amount of fees, costs, expenses, taxes, and any other payments made by the fund for any purpose, excluding only pro rata distributions to shareholders, and set forth in a manner that facilitates comparison;
• information concerning the fund’s soft dollar and directed brokerage policies and practices;
• information concerning revenue sharing arrangements; and
• information concerning breakpoint discounts on front-end sales loads.

The bill would exclude from this requirement disclosures regarding: (1) portfolio manager compensation and ownership of the fund’s securities, (2) holdings of the fund’s shares by the chairman of the fund’s board and any directors of the fund’s investment adviser employed to manage the portfolio of the fund, and (3) soft dollar and directed brokerage policies and practices.

Revenue sharing arrangements. Each investment adviser to a fund would be required to submit annually to the fund’s board a report on revenue sharing arrangements, directed brokerage arrangements, and soft dollar arrangements. A fund’s board would have a fiduciary duty (1) to review the adviser’s direction of the fund’s brokerage transactions, including directed brokerage and soft dollar arrangements, and determine that the direction of such brokerage adheres to the fund’s stated policies and is in the best interests of fund shareholders, and (2) to review revenue sharing arrangements to ensure compliance with the Investment Company Act of 1940 (the “1940 Act”) and determine that such arrangements adhere to the fund’s stated policies and are in the best interests of fund shareholders. The SEC would be directed to adopt implementing rules and regulations that require a fund’s annual report to shareholders to include a summary of the most recent report submitted to fund directors under this provision.

Definition of “no-load” fund. The SEC would be directed to adopt self-regulatory rules to clarify the definition of “no-load” as used by funds that impose Rule 12b-1 fees, and to require disclosure to prevent investors from being misled by use of this term by the fund, its adviser, or its principal underwriter.

Broker compensation for sale of fund shares. Brokers would be required to provide written disclose to customers who purchase shares of a fund regarding the compensation the broker receives in connection with the transaction. This disclosure would have to be made no later than the date the transaction is completed, and could not be made exclusively in a fund’s registration statement or prospectus, or any other filing with the SEC. The SEC would be directed to establish standards for these disclosures.

Director elections. A fund’s directors would have to be elected by shareholders at least once every five years, and a majority of the independent directors would be required to determine annually, after reasonable inquiry, that each independent director does not have any material business or familial relationship with the fund, a significant service provider to the fund, or any entity controlling, controlled by, or under common control with such service provider, that is likely to impair the director’s independence. Each fund also would be required to have at least one “financial expert,” as defined by the SEC, on its board of directors.

Audit committees. Fund audit committees would be subject to standards similar to those imposed on listed companies by Section 301 of the Sarbanes-Oxley Act of 2002 and Rule 10A-3 under the Securities Exchange Act of 1934.

Reports to board of SEC inspections. A fund would be required to provide to its directors reports of SEC inspections that identify significant deficiencies in the operations of the fund, its investment adviser, or its principal underwriter. The SEC would be directed to review all inspection reports of registered funds and publicly disclose the ten most common deficiencies cited in those reports.

Amendments to Section 17(j). Section 17(j) of the 1940 Act, which authorizes the SEC to adopt rules to prevent fraud, deception, and manipulation, would be amended. SEC rules and regulations established under this provision would have to require the chairman of each fund’s board of directors to certify the following in the periodic report to shareholders or other appropriate document:

• procedures are in place for verifying that the determination of the mutual fund’s current net asset value complies with the requirements of the 1940 Act and the rules and regulations thereunder, and the fund is in compliance with such procedures;
• procedures are in place for the oversight of the flow of funds into and out of the securities of the mutual fund, and the fund is in compliance with such procedures;
• procedures are in place to ensure that investors are receiving any applicable breakpoint discounts;
• procedures are in place to ensure that, if the fund’s shares are offered as different classes of shares, such classes are designed in the interests of investors, and could reasonably be an appropriate investment option for an investor;
• procedures are in place to ensure that information about the fund’s portfolio securities is not disclosed in violation of the securities laws or the fund’s code of ethics;
• the independent directors have reviewed and approved the compensation of the fund’s portfolio manager in connection with their consideration of the investment advisory contract under Section 15(c) of the 1940 Act; and
• the fund implements and reviews compliance policies and procedures and appoints a chief compliance officer.

The SEC’s rules and regulations would also have to require the chief compliance officer of each fund to certify annually that (1) appropriate internal controls are in place for the review required by the chairman’s certification, and (2) the chief compliance officer has reviewed such internal controls and has determined reasonably that they achieve their stated purpose. In addition, the chairman and the chief compliance officer would be required to certify annually that any advisory contract entered into by the fund and associated management fees have been negotiated and are in the best interests of the fund.

Prohibition on management of both private and public funds. It would be unlawful for any individual to serve or act as portfolio manager or investment adviser to both a mutual fund and an unregistered fund or other category of company as prescribed by the SEC. The SEC could make exceptions to protect investors’ interest provided that any such rule, regulation, or order would require (1) enhanced disclosure by the fund to investors of any conflicts of interest raised by the joint management, and (2) fair and equitable policies and procedures for the allocation of securities to the jointly managed companies’ portfolios, and certification by the fund’s independent directors in the periodic report to shareholders or other appropriate disclosure document, that such policies and procedures are fair and equitable.

Prohibition on short-term trading. It would be unlawful for fund officers, directors, employees, and affiliates, to engage in “short-term transactions,” as defined by the SEC, in any securities of which the fund or its affiliate is the issuer. The provision would provide an exception for money market funds, other funds whose investment policies expressly permit short-term transactions, or other categories of funds specified by the SEC. The SEC would be directed to adopt rules requiring any fund that does not permit market timing to charge a redemption fee upon the short-term redemption of its shares.

Fair valuation. The SEC would be directed to prescribe standards concerning the obligation of funds to apply and use fair value determinations of net asset value when market quotations are unavailable or do not accurately reflect the fair market value of the fund’s securities. The SEC also would be directed to adopt rules that require (1) each fund and investment adviser to establish formal policies with respect to compliance with this provision, (2) public disclosure of such policies to shareholders, (3) the adoption of internal procedures to ensure compliance with such policies, (4) ongoing review of such policies by the fund or investment adviser, and (5) annual certification by the chief executive officer (“CEO”) of the fund or investment adviser that such policies are adhered to. A fund or investment adviser would not be permitted to alter such policies without the prior approval of a majority of shareholders.

Late trading. The SEC would be directed to issue rules to prevent transactions in the securities of any fund in violation of section 22 of the 1940 Act, including “after-hours trades” that are executed at a price based on a net asst value that was determined as of a time prior to the actual execution of the transaction. Such rules would have to permit execution of after-hours trades that are provided to the fund by a “permitted intermediary,” defined as an intermediary with late trading and detection policies and procedures subject to SEC inspection. The SEC also would be directed to require a permitted intermediary (1) to certify that it has policies and procedures in place to prevent and detect late-trades and has adhered to such policies, and (2) to submit an independent annual audit verifying that its policies and procedures do not permit the acceptance of late order trading.

The Reformation Act would direct the SEC to conduct studies of the allocation and adequacy of SEC supervision and enforcement resources, the use of soft dollar arrangements by investment advisers, the increased rate of arbitration claims and decisions involving mutual funds since 1995, and the financial literacy of mutual fund investors. The SEC would be directed to submit to Congress reports on these studies, as well as a report on market timing and late trading of mutual funds. The Reformation Act also would direct the General Accounting Office (“GAO”) to conduct studies and submit reports to Congress on the feasibility and benefits of establishing a “Mutual Fund Oversight Board,” and on the coordination of enforcement efforts between the SEC and state entities. (See s. 1971, “Mutual Fund Investor Confidence Restoration Act of 2003,” November 25, 2003 and s. 1822, “Mutual Fund Transparency Act of 2003,” November 4, 2003.)

1. Proposed amendments to the rule under the Investment Company Act of 1940 that requires forward pricing of redeemable securities issued by funds. The amendments would provide that an order to purchase or redeem fund shares would receive the current day’s price only if the fund, its designated transfer agent, or a registered securities clearing agency receives the order by the time that the fund establishes for calculating its net asset value.
   
   
2. Proposed amendments to Form N-1A to require funds to disclose in their prospectuses both the risks to shareholders of the frequent purchase and redemption of fund shares, and the fund’s policies and procedures with respect to such frequent purchases and redemptions. The SEC is also proposing to amend Forms N-1A and N-3 to clarify that open-end management investment companies and insurance company managed separate accounts that offer variable annuities, other than money market funds, are required to explain both the circumstances under which they will use fair value pricing and the effects of using fair value pricing. In addition, the SEC is proposing to require open-end management investment companies and insurance company managed separate accounts that offer variable annuities to disclose their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.

We will provide a more detailed analysis of these proposals in next week’s issue.

On November 25, 2003, the SEC published for comment a NYSE proposed rule change (SR-NYSE-2003-33) filed with the SEC that would make the following changes to NYSE’s continued annual listing fees for closed-end funds:

• A new continuing fee structure with increased fund family discounts would be established.
• The current five-tiered continued listing fee structure would be replaced with a new per million share base rate that would apply to all closed-end funds. Closed-end funds would pay at a rate of $930 per million shares, with a minimum annual fee of $25,000. The $1 million overall annual fund family fee cap would continue to apply.
• The availability of discounts applicable to fund families with multiple funds listed would be increased and expanded. Fund families with three to fourteen closed-end funds listed would receive a 5% discount off the calculated continuing annual fee for each listed fund, and families with more than fourteen listed closed-end funds would receive a 15% discount.
• The existing policy under which closed-end fund shares that are subject to continuing annual fees for a period of fifteen consecutive years become exempt from further fees would be eliminated.

SEC Release No. 34-48833, November 25, 2003; 68 FR 67717, December 3, 2003. 

The SEC recently adopted final rules designed to improve disclosure to investors regarding the nominating committee processes and the means by which shareholders may communicate with directors at funds in which they invest. According to the SEC release, these rules require new disclosures, but do not mandate any particular action by the fund or its board of directors.

The new disclosure standards require funds to disclose in their proxy statements the following additional information regarding a fund’s process of nominating directors:

• Whether a fund has a nominating committee. If the fund does not have one, the reasons why it does not have a nominating committee and an identification of those persons who determine nominees for directors;
• Whether a company has a nominating committee charter and if so, the fund’s website address if a current copy of the charter is available on the fund’s website. If the charter is not available on the website, the fund must provide the charter as an appendix to the fund’s proxy statement at least once every three fiscal years. If the fund does not have a nominating committee charter, a statement to that effect;
• Whether a fund has a policy regarding shareholder recommendations for director nominees and if so, a description of the material elements of that policy. If the nominating committee considers candidates recommended by shareholders, the fund should provide a description of the procedures to be followed by shareholders in submitting such recommendations. If the fund does not have a policy regarding shareholder recommendations for director nominees, a statement of that fact and the basis for the Board’s determination of the appropriateness of not having such a policy;
• The nominating committee’s process for identifying and evaluating nominees for directors, including nominees recommended by shareholders, and any differences in the manner in which the nominating committee evaluates nominees for director based on whether the nominee is recommended by a shareholder;
• Whether members of the nominating committee are “interested persons” of the fund, as defined in Section 2(a)(19) under the Investment Company Act of 1940 (the “1940 Act”);
• The minimum qualifications and standards that a fund seeks for director nominees;
• With regard to each nominee approved by the nominating committee for inclusion in the proxy card (other than nominees who are executive officers or directors standing for re-election), a statement describing the category of persons or entities who recommended that nominee (i.e., shareholder, director, chief executive officer, other executive officer, employee of the fund’s investment adviser, principal underwriter, or any affiliated person of the investment adviser or principal underwriter);
• If the fund pays any third party a fee to assist in identifying and evaluating candidates, disclosure of the functions performed by such third party; and
• Whether a fund has rejected candidates put forward by large, long-term security holders or groups of security holders (i.e., beneficial owners of greater than 5% of the fund’s voting stock who have held the security for at least one year as of the date of recommendation. The percentage of securities held by a recommending shareholder may be determined by reference to the fund’s most recent report on Form N-CSR.

The new disclosure standards also require funds to disclose information regarding shareholder communications with directors, including:

• Whether the fund has a process for communications by shareholders to directors and, if not, the basis for the board’s view that it is appropriate for the fund not to have such a process;
• If the fund has a such a process, a description of the procedures for communications by shareholders with directors, whether such communications are screened and, if so, by what process; and
• The fund’s policy regarding director attendance at annual meetings and the number of directors that attended the prior year’s annual meeting.

The new disclosure standards also require funds to report any material changes to the procedures for shareholder nominations. Registrants must comply with these disclosure requirements (i) in proxy or information statements that are first sent to shareholders on or after January 1, 2004, and (ii) in Form N-CSR for the first reporting period ending after January 1, 2004. Registrants may comply voluntarily with these disclosure requirements before the compliance date. (SEC Release Nos. 33-8340; 34-48825; IC-26262; File No. S7-14-03.)

At its open meeting on December 3, 2003, the SEC took the following actions:

1. The SEC voted to propose a rule requiring that fund orders be received by 4:00 p.m. Specifically, this proposal would require that an order to purchase or redeem mutual fund shares be received by the mutual fund, its primary transfer agent or a registered securities clearing agency by the time that the fund establishes for calculating its net asset value in order to receive that day’s price (usually, the close of the New York Stock Exchange). The SEC acknowledged that the proposed rule could have a significant impact on defined contribution plan administrators, who will have to decide to upgrade their systems or accept next day trading. The view seemed to be that the average 401(k) participant would not be concerned if s/he received next day’s NAV. The SEC indicated that many investors will not be impacted by these rules and the SEC staff proposed a long transition period to ease any burdens. A public comment period concerning this proposal will run for 45 days following its publication in the Federal Register.
2. The SEC also voted to adopt a rule that will require funds and advisers to (i) adopt and implement compliance policies and procedures, (ii) annually review them for adequacy and effectiveness and (iii) designate a chief compliance officer who, for funds, must report to the board of directors. The proposed chief compliance officer is envisioned by the SEC staff as being hired by the management company, but the fund board would approve the hire, set compensation, and have the sole ability to terminate the chief compliance officer. This officer’s role would be to oversee the written policies and procedures, ensure compliance is documented, and raise issues with fund management and ultimately with the fund board, where compliance failures arise. It is expected that compliance with this rule will be required no later than nine months after its publication in the Federal Register.
3. The SEC also voted to propose enhanced disclosure requirements. Under these requirements, funds would disclose (i) market timing policies and procedures, (ii) practices regarding “fair valuation” of their portfolio securities and (iii) policies and procedures with respect to the disclosure of their portfolio holdings.

These actions were the first of three planned SEC meetings over the next three months to bolster protections afforded to mutual find shareholders. The SEC plans to have Open Meetings on January 14 and February 11, 2004, at which it will consider:

• requirements for portfolio traders to disclose their personal trading;
• a requirement for board members to perform an annual self-evaluation;
• increasing the percentage of independent directors on fund boards to 75%;
• greater fund disclosure on fees, including revenue sharing;
• additional tools to combat market timing including mandatory redemption fees for market timing;
• break point disclosure and an interpretive release on Rule 12b-1;
• semi-annual disclosure of fees and expenses to shareholders;
• revised shareholder confirmation statements that would identify all transaction costs to shareholders; and
• requiring boards to maintain records detailing the approval of fees and increase disclosure as to the process.

We will provide further updates as more details become available.

NASD recently filed with the SEC proposed Rule 2712 to prohibit abuses in the allocation and distribution of shares in IPOs. The proposed amendments would require the following provisions in the underwriting agreement for an IPO between the issuer and lead managing underwriter:

• the lead managing underwriter would be required to report to the issuer’s pricing committee (or, if the issuer does not have a pricing committee, its board of directors) all indications of interest and the final allocations of the issuer’s shares;
• any lock-up or restriction on the transfer of the issuer’s shares would apply to issuer-directed shares held by officers and directors of the issuer; and
• the lead managing underwriter would be required to notify the issuer and make an announcement through a national news services at least two business days before the release or waiver of any lock-up or other restriction on the transfer of the issuer’s shares.

In addition, the proposed amendments would require the following provisions in any agreements between underwriters, with respect to any shares returned to a syndicate member by a purchaser after the commencement of secondary market trading:

• returned shares would be allotted to any existing short position of the syndicate;
• if no short position exists or is covered, the returned shares would be sold in the open market; and
• if the sales price exceeded the IPO price, the difference would be paid to the issuer; and if the market price were less than the IPO price, then the syndicate member would be able either to sell the shares or retain them for its own investment account.

Finally, the proposed amendment would prohibit any member from accepting a market order for the purchase of IPO shares during the first day that the IPO shares commence trading in the secondary market. In the proposed amendment, NASD also requests comment on potential regulatory initiatives on the issue of fair and reasonable pricing of IPOs. In a conversation with NASD staff about the application of the proposed rules to initial offerings of shares of closed-end funds, the NASD responded that the proposed rule does apply by its terms but that the NASD will consider more fully the implications, if any, to closed-end funds during the comment process. Comments are due by January 9, 2004. (NASD Notice to Members 03-72, November 2003.)

On November 26, 2003, NASD filed with the SEC proposed Rule 3013 to increase compliance with federal securities laws. The proposed rule would require (1) each NASD member company to designate a chief compliance officer (“CCO”), and (2) the company’s CEO and CCO to certify annually that the company has in place a process to establish, maintain, review, modify, and test policies and procedures reasonably designed to achieve compliance with NASD rules, rules of the Municipal Securities Rulemaking Board and federal securities laws. These processes would have to be set forth in a report reviewed by the company’s compliance officers, board of directors and audit committee.

The proposed rule is intended to enhance investor protection by ensuring that senior management focuses increased attention on their company’s compliance and supervisory systems and by fostering regular interaction between business and compliance officers. Details of the proposal are available on NASD’s website at http://www.nasdr.com/filings/rf03_176.asp and at http://www.nasdr.com/news/pr2003/release_03_055.html. (NASD press release, December 2, 2003, http://www.nasdr.com/news/pr2003/release_03_051.html.)

On November 21, 2003, the ICI submitted to the SEC proposed amendments to Form N-1A to require mutual funds that offer sales charge breakpoints to include in their prospectuses, in close proximity to the breakpoint schedule:

• a brief, plain English description of any arrangements under which a typical investor may qualify for breakpoint discounts, such as rights of accumulation or letters of intent;
• if the fund has a website, a statement that information about sales load breakpoints also is available on the fund’s website, as well as the website address; and
• if applicable, a statement that additional information concerning sales load breakpoints is available in the fund’s Statement of Additional Information or from a broker or financial intermediary through which shares of the fund may be purchased or sold.

The ICI urged mutual funds that offer breakpoint discounts to review their prospectuses and website disclosure and, if necessary, revise the disclosure to ensure that it conforms with the proposed amendments to Form N-1A. It also recommended that mutual funds with websites provide “quick and obvious” links from their website home pages to breakpoint information. (ICI Release No. 45-03, November 21, 2003).