[Congressional Record Volume 150, Number 16 (Tuesday, February 10, 2004)]
[Senate]
[Pages S793-S807]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. FITZGERALD (for himself, Mr. Levin, and Ms. Collins):
  S. 2059. A bill to improve the governance and regulation of mutual 
funds under the securities laws, and for other purposes; to the 
Committee on Banking, Housing, and Urban Affairs.
  Mr. FITZGERALD. Mr. President, today I rise to introduce the Mutual 
Fund Reform Act of 2004. This legislation would make fund governance 
truly accountable, require genuinely transparent total fund costs, 
enhance comprehension and comparison of fund fees, confront trading 
abuses, create a culture of compliance, eliminate hidden transactions 
that mislead investors and drive up costs, and save billions of dollars 
for the 95 million Americans who invest in mutual funds. Above all, the 
Mutual Fund Reform Act strives to preserve the attraction of mutual 
funds as a flexible and investor-friendly vehicle for long-term, 
diversified investment.
  I am pleased to be joined today by my distinguished colleagues on the 
Committee on Governmental Affairs, Senator Carl Levin and Senator Susan 
Collins, the committee's chairman, who are original cosponsors of this 
legislation. I am grateful for the extensive and important input both 
Senators provided in the drafting of this bill, and appreciate the 
invaluable perspective Senator Collins provided based on her first-hand 
experience as Maine's Commissioner of Professional and Financial 
Regulation.
  I would like to take this opportunity to recognize the work of a 
number of our colleagues in this area. Last year, I was pleased to 
cosponsor S. 1822, introduced by Senator Daniel Akaka, the Ranking 
Member of the Senate Governmental Affairs Subcommittee

[[Page S794]]

on Financial Management, the Budget, and International Security, which 
I chair, to address mutual fund trading abuses. Senators Corzine, Dodd, 
and Kerry also have sponsored mutual fund bills from which I drew, as 
well as legislation introduced by Congressman Richard Baker last summer 
and overwhelmingly passed by the House of Representatives at the end of 
the last session.
  I also would like to acknowledge the ongoing work of the Senate 
Committee on Banking, Housing and Urban Affairs, the authorizing 
committee which will ultimately decide questions of mutual fund 
industry reform. The committee is conducting a series of legislative 
hearings to examine the mutual fund scandal and the merits of various 
reform proposals. I commend the leadership of Chairman Richard Shelby 
and Ranking Member Paul Sarbanes, and look forward to continuing to 
work with them and the other members of the Banking Committee on this 
issue in the coming months.
  The bill I am introducing today reflects extensive testimony that was 
presented during oversight hearings of the Financial Management 
Subcommittee that I chaired on November 3, 2003, and January 27, 2004. 
The general consensus of the panelists at the November hearing was that 
illegal late trading and illicit market timing were indeed very serious 
threats to investors but that excessive fees and inadequate disclosure 
of those fees were an even more serious threat to American investors. 
Witnesses at our hearing last month testified regarding the propriety 
and the adequacy of the disclosure of mutual fund fees, specifically 
hidden fees such as revenue sharing, directed brokerage, soft money 
arrangements, and hidden loads such as 12b-1 fees. The subcommittee 
also heard from two whistleblowers who were responsible for the initial 
revelations regarding Putnam Investments and Canary Capital Partners, 
LLC.
  The bill also reflects the constructive input from a number of key 
organizations and leaders of mutual fund reform. I especially 
appreciate the extensive contributions of Mr. John Bogle, the founder 
and former CEO of the Vanguard Group, who has been a champion of 
reforms in the mutual fund industry for many years.
  I ask unanimous consent that letters from Mr. Bogle, Massachusetts 
Secretary of State William Galvin, and organizations representing 
investors and consumers endorsing this bill be printed in the Record.
  In 1980 only a small percentage of Americans invested in mutual funds 
and the assets of the industry were only $115 billion. Today, roughly 
95 million Americans own shares in mutual funds and the assets of all 
the funds combined are now more than $7 trillion. Mutual funds have 
grown in popularity in part because Congress has sanctioned or expanded 
a variety of tax-sheltered savings vehicles such as 401(k)s, Keoghs, 
traditional IRAs, Roth IRAs, Rollover IRAs, and college savings plans. 
Given that mutual funds are now the repository of such a large share of 
so many Americans' savings, few issues we confront are as important as 
protecting the money invested in mutual funds.
  I want to commend the many recent regulatory initiatives from the 
Securities and Exchange Commission (SEC). They are collectively a step 
in the right direction and a demonstration of our seriousness in 
Washington about putting the interests of America's mutual investors 
first. But the SEC does not have the statutory authority to take all of 
the needed steps to restore integrity and health to the mutual fund 
industry. The current scandals demand that Congress take a 
comprehensive look at an industry still governed by a 64-year old law.
  Therefore, the Mutual Fund Reform Act of 2004 puts the interests of 
investors first by: ensuring independent and empowered boards of 
directors, clarifying and making specific fund directors' foremost 
fiduciary duty to shareholders; strengthening the fund advisers' 
fiduciary duty regarding negotiating fees and providing fund 
information, and instituting Sarbanes-Oxley-style provisions for 
independent accounting and auditing, codes of ethics, chief compliance 
officers, compliance certifications, and whistleblower protections.
  The Mutual Reform Act of 2004 empowers both investors and free 
markets with clear, comprehensible fund transaction information by: 
standardizing computation and disclosure of (i) fund expenses and (ii) 
transaction costs, which yield a total investment cost ratio, and tell 
investors actual dollar costs; providing disclosure and definitions of 
all types of costs and requiring that the SEC approve imposition of any 
new types of costs; disclosing portfolio managers' compensation and 
stake in fund; disclosing broker compensation at the point of sale; 
disclosing and explaining portfolio turnover ratios to investors, and 
disclosing proxy voting policies and record.
  The Mutual Fund Reform Act of 2004 vastly simplifies the disclosure 
regime by: eliminating asset-based distribution fees (Rule 12b-1 fees), 
the original purpose of which has been lost and the current use of 
which is confusing and misleading--and amending the Investment Company 
Act of 1940 to permit the use of the adviser's fee for distribution 
expenses, which locates the incentive to keep distribution expenses 
reasonable exactly where it belongs--with the fund adviser; prohibiting 
shadow transactions--such as revenue sharing, directed brokerage, and 
soft-dollar arrangements--that are riddled with conflicts of interest, 
serve no reasonable business purpose, and drive up costs; 
``Unbundling'' commissions, such that research and other services, 
heretofore covered by hidden soft-dollar arrangements, will be the 
subject of separate negotiation and a freer and fairer market; 
requiring enforceable market timing policies and mandatory redemption 
fees--as well as provision by omnibus account intermediaries of basic 
customer information to funds to enable funds to enforce their market 
timing, redemption fee, and breakpoint discount policies; and requiring 
fair value pricing and strengthening late trading rules.
  The Mutual Fund Reform Act also would perpetuate the dialogue and 
preserve the wisdom gathered from hard experience. The Act directs the 
SEC and the General Accounting Office to conduct several studies, 
including a study of ways to minimize conflicts of interest and 
incentivize internal management of mutual funds; a study on 
coordination of enforcement efforts between SEC headquarters, SEC 
regional offices, and state regulatory and law enforcement entities; 
and a study to enhance the role of the internet in educating investors 
and providing timely information about laws, regulations, enforcement 
proceedings and individual funds, possibly by mandating disclosures on 
websites.
  Enactment of the Mutual Fund Reform Act would help restore the 
integrity of the mutual fund industry and would dramatically enhance 
the amount of retirement savings for many long term investors. 
Shareholders would be the big winners under this legislation, and the 
losers would be high cost mutual funds. I therefore urge my colleagues 
to support passage of this legislation.
  I ask unanimous consent that the text of the bill, as well as a one-
page summary and white paper describing the legislation, be printed in 
the Record.
  There being no objection, the materials were ordered to be printed in 
the Record, as follows:

                                           The Vanguard Group,

                               Valley Forge, PA, February 6, 2004.
       I salute Senator Fitzgerald for the bill he has drafted to 
     improve the governance and regulation of mutual funds. I've 
     spent the greater part of my career speaking out on nearly 
     all of the important legislative issues that Senator 
     Fitzgerald's Mutual Fund Reform Act of 2004 addresses. While 
     nothing can solve the industry's problems overnight, I view 
     of the bill as the gold standard in putting mutual fund 
     shareholders back in the driver's seat, and endorse it in its 
     entirety.
                                                    John C. Bogle,
     Founder.
                                  ____

                                     Secretary of the Commonwealth


                                             of Massachusetts,

                                     Boston, MA, January 23, 2004.
     Re Mutual Fund Reform act of 2004.

     Hon. Peter Fitzgerald,
     Chairman, Subcommittee of Financial Management, the Budget, 
         and International Security, Senate Committee of 
         Governmental Affairs, Hart Senate Building, Washington, 
         DC.
       Dear Senator Fitzgerald: As the chief securities regulator 
     in Massachusetts, I write in support of the Mutual Fund 
     Reform Act of 2004. The recently-exposed abuses relating to 
     mutual funds show the need for this legislation. Small 
     investors are particularly

[[Page S795]]

     vulnerable to these abusive practices, since nearly half of 
     U.S. households own mutual funds--often through their 
     retirement plans.
       The bill increases the independence of fund directors and 
     obliges them to act as fiduciaries on behalf of shareholders; 
     it makes the costs of mutual funds more transparent; and it 
     curtails many abusive mutual fund sales practices.
       We particularly support the provisions to prohibit directed 
     brokerage and soft dollar arrangements by mutual funds. These 
     practices, at best, mask the true costs of fund operations; 
     at worst, they are kick back-type payments in the securities 
     industry.
       I also encourage you to add a provision that will give 
     investors the ability to choose the forum where they may 
     arbitrate disputes with their brokers. Under the current 
     system, investors are forced to arbitrate their claims in a 
     forum chosen by the brokerage.
       Please contact me if I can assist you in working for the 
     adoption of this important legislation.
           Sincerely,
                                                William F. Galvin,
     Secretary of the Commonwealth.
                                  ____

                                                 February 5, 2004.
     Hon. Peter G. Fitzgerald,
     Dirksen Building, U.S. Senate,
     Washington, DC.
       Dear Senator Fitzgerald: We are writing to express our 
     enthusiastic support for your draft ``Mutual Fund Reform 
     Act.'' More than any other legislation that has yet to be 
     introduced since the mutual fund scandals erupted last year, 
     this bill recognizes the need to fundamentally transform the 
     way in which mutual funds are governed, operated, and sold to 
     ensure that they live up to their statutory obligation to 
     operate in their shareholders' best interests.
       This legislation offers a thoughtful and far-reaching 
     agenda for reform. It addresses significant gaps in the SEC's 
     proposals to improve fund governance, dramatically enhances 
     the quality of mutual fund cost disclosures, and prohibits 
     distribution practices that create unacceptable and poorly 
     understood conflicts of interest. It also takes the necessary 
     step of banning hidden ``soft dollar'' arrangements that 
     boost shareholder costs and create additional conflicts of 
     interest. We look forward to working with you to win passage 
     of these essential reforms.
       Our support for this bill is based on the firm belief that 
     mutual funds have been and will continue to be the best way 
     for average, middle-income investors to participate in our 
     nation's securities markets. Individuals with only modest 
     amounts to invest have benefited greatly from the opportunity 
     mutual funds offer to achieve broad diversification. While 
     wealthy investors have other options that provide similar 
     benefits, average, middle-class investors do not. The 
     resulting influx of money into mutual funds has in turn 
     produced generous profits for fund companies.
       This long record or mutual success had caused some in the 
     industry and among its regulators to become complacent, 
     taking for granted that all was well. By revealing the extent 
     to which some fund managers had abandoned their obligation to 
     operate in fund shareholders' best interests, the trading 
     scandals uncovered last fall provided sudden and compelling 
     evidence that such complacency was ill-founded. The closer 
     scrutiny of fund operations that resulted quickly uncovered 
     evidence of other similar failings: Management fees that had 
     failed to drop significantly, or in some cases at all, 
     despite a massive growth in assets; use of portfolio 
     transaction commissions, which are not incorporated in the 
     fund expense ratio, to pay for services whose costs would 
     otherwise have to be disclosed; use of portfolio transaction 
     commissions borne by shareholders to pay for services whose 
     benefits flowed in part or in whole to the fund manager; use 
     of poorly disclosed or misunderstood compensation methods, 
     including 12b-1 fees, directed brokerage, and payments for 
     shelf space to induce brokers to recommend particular funds; 
     and broker recommendation of mutual funds based on the 
     financial incentives received rather than on which funds 
     offer the best quality at the most reasonable price.
       By driving up costs to investors and undermining 
     competition based on cost and quality, these practices 
     inflict far greater financial harm on their victims than the 
     trading scandals appear to have done.
       Since it became clear that mutual fund sales and trading 
     abuses were widespread throughout the industry, the 
     Securities and Exchange Commission has responded with an 
     ambitious enforcement, investigation, and rule-making agenda. 
     In addition to developing reforms targeted specifically at 
     excessive and late trading, the Commission has issued 
     proposals to strengthen mutual fund governance, sought 
     suggestions on how to improve disclosure of portfolio 
     transaction costs, and proposed rules to improve disclosure 
     of distribution-related costs and conflicts of interest.
       Despite this important progress, there are serious gaps in 
     the SEC's regulatory agenda. Some result from the agency's 
     lack of authority to effect change. Others result from the 
     SEC's lack of a vision of how mutual fund regulation must be 
     transformed. This legislation fills those gaps. If it is 
     adopted, it will dramatically improve fund governance, 
     eliminate practices that create unacceptable conflicts of 
     interest, and save mutual fund investors potentially tens of 
     billions of dollars a year by wringing out excess costs.
       Our specific comments in support of some of the bill's most 
     important pro-investor provisions follow.
       1. The legislation's fund governance reforms address 
     significant gaps in the SEC's rule proposal.
       The Securities and Exchange Commission has made a promising 
     start on the issue of fund governance. In January, it issued 
     a rule proposal that would require that three-quarters of 
     mutual fund board members, including the chairman, be 
     independent. It would further require that independent 
     members meet at least quarterly without any interested 
     parties present. It authorizes the board to hire staff to 
     help it fulfill its responsibilities. And it requires boards 
     to retain copies of the written documents considered as part 
     of the board's annual review of the advisory contract.
       Although the Commission certainly deserves credit for this 
     important first step, there is more that must be done to 
     achieve the goal of improved fund governance. First and 
     foremost, the Commission lacks the authority to strengthen 
     the definition of independent director. So, even if it adopts 
     its independent governance requirements without weakening 
     amendments over the already announced objections of two 
     commissioners, non-immediate family members, individuals 
     associated with significant service providers of the fund, 
     and recently retired fund company employees would all be 
     eligible to serve as ``independent'' directors. Furthermore, 
     the SEC proposal does not require that independent directors 
     have sole authority to nominate new directors and set 
     director compensation, potentially leaving significant issues 
     in the hands of fund managers.
       This bill addresses all those concerns. It includes an 
     excellent definition of independence, which both specifically 
     addresses the issue of significant service providers and 
     authorizes the SEC to exclude from the definition of 
     independent director any set of individuals who for business, 
     family, or other reasons are unlikely to demonstrate the 
     appropriate degree of independence. It requires both that 
     independent directors determine director compensation and 
     that a committee of independent directors nominate new 
     directors. And it directs the SEC to study whether any limit 
     should be placed on the aggregate amount of director 
     compensation an individual could receive from a single fund 
     family and still be considered independent.
       The bill further recognizes that lack if independence is 
     not the only concern about mutual fund governance. Also 
     problematic is the failure of many mutual fund boards to act 
     as fiduciaries, with a broad responsibility to protect 
     shareholder interests. The bill attacks this problem by 
     broadening the scope of directors' fiduciary duty. As defined 
     in the legislation, that duty would include, among other 
     things, a responsibility to: take quality of management as 
     well as actual costs and economies of scale into account when 
     negotiating management contracts; evaluate the quality, 
     comprehensiveness, and clarity of disclosures to fund 
     shareholders regarding costs; assess any distribution and 
     marketing plan with regard to its costs and benefits; and 
     monitor enforcement of policies and procedures to ensure 
     compliance with applicable securities laws. The SEC would be 
     responsible for detailing how the board's fiduciary duty 
     applies in each instance.
       By shoring up the independence of fund boards and expanding 
     and clarifying their fiduciary duty to shareholders, this 
     bill would increase the likelihood that fund boards would 
     serve their intended function as the first line of defense 
     against a variety of abusive practices.
       One element missing from the bill, however, is any 
     consideration of creating an independent board to oversee 
     mutual funds. In testimony late last year, SEC Chairman 
     William Donaldson suggested that the Commission was exploring 
     ways in which funds could ``assume greater responsibilities 
     for compliance with the federal securities laws, including 
     whether funds and advisers should periodically undergo an 
     independent third-party compliance audit.'' ``These 
     compliance audits could be a useful supplement to our own 
     examination program and could ensure more frequent 
     examination of funds and advisers,'' he said.
       Recent accounting scandals should have taught us the risks 
     of relying on audits that are paid for by the entity being 
     audited. If the SEC needs a supplement to its own examination 
     program, a far better approach would be to create an 
     independent board, subject to SEC oversight, to conduct such 
     audits. The board could be modeled on the Public Company 
     Accounting Oversight Board, with similar authority to set 
     standards, conduct inspections, and bring enforcement actions 
     and similar (or, better yet, stronger) requirements for board 
     member independence. Your bill would require a GAO study of 
     the SEC's current organizational structure with respect to 
     mutual fund regulation. We urge you, at a minimum, to include 
     an assessment of the benefits of establishing an independent 
     oversight board as part of that study.
       2. The legislation would dramatically enhance the quality 
     of mutual fund cost disclosures.
       A major shortcoming in the SEC's regulation of mutual funds 
     have been its failure to take effective action to bring down 
     excessive costs. Not only has the agency not used its own 
     enforcement authority to bring cases against fund managers 
     who charge and fund boards who approve unreasonable fees, it 
     has criticized the New York Attorney General for negotiating 
     fee reduction agreements as

[[Page S796]]

     part of his settlement with fund companies that engaged in 
     abusive trading. In criticizing those fee reduction 
     agreements, Commission officials have suggested that they 
     prefer to rely on independent fund boards and the market to 
     discipline costs.
       While the Commission can show some progress on the issue of 
     fund governance, its proposals on cost disclosure are 
     extremely disappointing. They fall far short of the bare 
     minimum needed to introduce meaningful cost competition in 
     the mutual fund marketplace. This legislation attacks to 
     excessive costs both through strengthened governance 
     requirements that do beyond those in the SEC rule proposal 
     and through improved disclosures that will be more effective 
     in raising investor awareness of costs than those proposed so 
     far by the SEC.
       One important area where the bill improves on SEC proposals 
     is in disclosure of portfolio transaction costs. These costs 
     vary greatly from fund to fund, may be the highest cost for 
     an actively managed stock fund, and in some cases exceed all 
     others costs combined. A recent study found that, on average, 
     funds spend $0.43 on portfolio transactions for every $1.00 
     of expenses that are disclosed in the current expense ratio, 
     and that in some cases fund transaction costs can exceed 
     three or four times the current expense ratio. (Jason 
     Karceski, Miles Livingston, Edward O'Neal, Mutual Fund 
     Brokerage Commissions, Jan. 2004, available at http://
www.zeroalphagroup.com/headlines/
ZAG_mutual_fund_true_cost_study.pdf.)
       Yet, the SEC has long resisted incorporating these costs in 
     the expense ratio. In response to congressional pressure, the 
     agency has recently issued a concept release seeking 
     suggestions for improving transaction cost disclosure, but it 
     is not at all clear that the agency will come out in support 
     of an approach that goes much beyond its previously stated 
     preference for giving greater prominence to disclosure of the 
     portfolio turnover rate. Such an approach makes not 
     distinction between those funds that get good execution for 
     their trades and those that do not. Furthermore, it continues 
     to make it possible for funds to hide costs that would 
     otherwise have to be disclosed by paying for them through 
     soft dollar arrangements.
       The bill would bring these costs out into the open where 
     they belong. It would do so by requiring a separate 
     computation of portfolio transaction costs that includes, at 
     a minimum, brokerage commissions and bid-ask spread costs. 
     And it would require this transaction cost ratio to be 
     disclosed both separately and as part of a total investment 
     cost ratio in the prospectus fee table and wherever else the 
     expense ratio is disclosed. Because the bill would retain the 
     current expense ratio, while also creating a new total 
     expense ratio that includes portfolio transaction costs, it 
     would allow the markets to decide which measure of fund costs 
     is most appropriate and useful. Once this information is 
     brought out into the open, these costs are more likely to be 
     subject to competitive pressures, helping to drive down 
     expenses for shareholders.
       The bill would supplement this disclosure by requiring 
     individualized disclosure in annual reports of the projected 
     actual dollar amount of each investor's total annual costs 
     based upon the investor's assets at the time of the 
     disclosure. We strongly support individualized dollar cost 
     disclosures, but believe that, to be workable, this 
     information must be provided in the quarterly or annual 
     account statements that show the shareholder's account 
     balance and transaction activity. Putting cost information in 
     dollar amounts side-by-side with information on the fund's 
     gains or losses for the year is key to helping investors to 
     put those costs into perspective. We urge you to adopt this 
     clarification.
       In addition, the draft version of the legislation that we 
     have reviewed does not require pre-sale disclosure of mutual 
     fund costs, as opposed to distribution costs. If we are to 
     promote effective cost competition in the mutual fund 
     industry, investors must receive cost information in advance 
     of the sale. Post-sale disclosure, while useful in raising 
     investor awareness of costs, comes too late to influence the 
     purchase decision. We believe investors would be best served 
     by pre-sale cost disclosures that are comparative in nature, 
     showing how the fund's cost compare to category averages and 
     minimums, and how this is likely to affect performance over 
     the long-term. The provision in the bill that allows for 
     point-of-sale disclosure provides an easy mechanism for 
     offering this information. We urge you to add a provision to 
     this effect to your bill.
       With these changes, the cost disclosure provisions in this 
     bill will go a long way toward bringing meaningful cost 
     competition to an industry that has too long escaped its 
     disciplining effects.
       3. The bill would prohibit a variety of distribution 
     practices that create unacceptable conflicts of interest.
       Growing investor reluctance to pay the front loads that 
     were common in the 1980s has driven mutual fund distribution 
     costs underground. Funds substituted a variety of 
     distribution practices--e.g., 12b-1 fees, directed brokerage, 
     and payments for shelf space--that were less visible to 
     shareholders. These practices encouraged the impression that 
     the funds were load-free when in fact they imposed 
     significant distribution costs. The practices adopted also 
     posed significant new conflicts of interest.
       Although 12b-1 fees are disclosed as a separate line item 
     on prospectus fee tables, evidence suggests that investors 
     are less aware of the cost implications of annual expenses 
     than they are of front loads and do not necessarily 
     understand that 12b-1 fees are used to compensate brokers. 
     Because they are included in the expense ratio, 12b-1 fees 
     appear to be a cost the shareholder pays for the fund, not a 
     cost they pay for the services the broker provides. Problems 
     with 12b-1 fees abound, including the fact that investors in 
     funds that charge substantial 12b-1 fees may be stuck paying 
     distribution costs whose benefits flow partially, or even 
     primarily, to the fund company. Shareholders are forced to 
     pay the fees even when they do not use the services the fees 
     are designed to provide. With fund manager compensation based 
     on a percentage of assets under management, fund managers 
     reap significant benefits from the asset growth the fees 
     promote, without having to risk their own money in the 
     process.
       Because it also uses shareholder assets to promote 
     distribution, directed brokerage creates many of the same 
     conflicts as 12b-1 fees and more. Not only are shareholders 
     forced to pay higher costs for benefits that flow in part or 
     in full to the fund manager, in some cases costs paid by one 
     set of shareholders may be used in part to promote sale of 
     other funds in the same fund family. Furthermore, these 
     arrangements may encourage fund managers to decide where to 
     conduct their portfolio transactions based not on where they 
     can get the best execution, but on where they get the best 
     distribution. They may even encourage fund managers to trade 
     more than necessary simply to fulfill their directed 
     brokerage agreements. This, in turn, drives up costs to 
     shareholders. While 12b-1 fees are disclosed to investors, 
     distribution costs paid through directed brokerage are not. 
     Instead, they are hidden in undisclosed portfolio transaction 
     costs.
       Payments for shelf space are similar to directed brokerage 
     agreements. Instead of being paid indirectly through 
     portfolio transaction costs, however, these financial 
     incentives are made in the form of cash payments by the fund 
     manager to the broker. At best, by eating into the manager's 
     bottom line, the payments may reduce the likelihood that the 
     management fee will be reduced in response to economies of 
     scale. At worst, fund managers will pass along those costs to 
     shareholders in a form that is even less transparent than 
     directed brokerage payments.
       All these practices are designed to encourage brokers to 
     recommend funds based not on which offer the best quality at 
     the most reasonable price, but instead on which offer the 
     most generous compensation to the broker. As such, they stand 
     in sharp contrast to the image brokers promote of themselves 
     as objective advisers. To its great credit, the legislation 
     recognizes that simply disclosing these conflicts will not 
     solve the problem. The best disclosure in the world is 
     unlikely to counteract multi-million dollar advertising 
     campaigns intent on convincing investors to place their trust 
     in the objectivity and professionalism of their ``financial 
     consultant.''
       Instead, the legislation deals with these conflicts in the 
     cleanest, most sensible way possible. It eliminates them. In 
     doing so, it takes an enormous and much needed step toward 
     forcing brokers to act like the objective advisers they claim 
     to be. Furthermore, reforming the distribution system in this 
     way is one of the most important things Congress can do to 
     promote competition in the mutual fund industry based on cost 
     and quality. That is because these practices allow mediocre, 
     high-cost funds to survive and even thrive simply by offering 
     generous compensation to the brokers that sell them. And, by 
     making it harder for brokers to hide the compensation they 
     receive for selling particular funds, this legislation should 
     make it easier for shareholders to assess whether the 
     services they receive from their broker justify the costs.
       4. The bill would prohibit soft dollar arrangements that 
     boost shareholder costs and create unacceptable conflicts of 
     interest.
       Soft dollar arrangements allow fund managers to pay for 
     services through portfolio transaction costs that they would 
     otherwise have to bill for directly--primarily research, but 
     a variety of other services as well. And, because these costs 
     are hidden, they create a strong incentive for fund managers 
     to pay for services in this fashion. The conflicts they 
     create are substantial. As with directed brokerage 
     agreements, they encourage fund managers to direct their 
     portfolio transactions based on the services they receive and 
     not on who offers the best execution for those trades. Soft 
     dollar arrangements also may encourage excessive trading with 
     no purpose except to fulfill soft dollar agreements. This, in 
     turn, requires shareholders to pay those unnecessary trading 
     costs. Soft dollar arrangements may also encourage fund 
     managers to choose service providers based not on who offers 
     the best service at the best price, but on what services can 
     be paid for through soft dollars, where the costs will be 
     hidden.
       As with the distribution practices discussed above, the 
     legislation would deal with these conflicts by eliminating 
     them. We strongly support this approach, which would reduce 
     shareholder costs by requiring funds to seek best execution 
     on all their trades. Some in the independent research 
     community have raised concerns about this approach, 
     suggesting that it will harm independent research. Nothing 
     could be further

[[Page S797]]

     from the truth. As long as funds can pay for research through 
     soft dollars, they will have an incentive to choose the 
     research whose cost can be hidden in this fashion. If soft 
     dollar arrangements are banned, however, funds will have no 
     reason to choose research based on any consideration but 
     which is of the highest quality. If independent research can 
     compete on quality, its competitive position should be 
     improved under a soft dollar ban.


                               conclusion

       Mutual funds have been largely responsible for making it 
     possible for average, middle-income investors to participate 
     in our Nation's securities markets. As such, they have done 
     much to promote both the financial well-being of those 
     investors and the financial health of our capital markets. 
     Regulatory oversight, however, has not kept pace with mutual 
     funds' growing and changing role in our financial markets. 
     The recent trading and sales abuse scandals have offered a 
     painful reminder of just how far some fund companies have 
     strayed from their obligation to operate in shareholders' 
     best interests.
       Fundamental reform is needed to get the fund industry back 
     on track. The SEC has gotten us part of the way there with 
     its recent enforcement actions and rule proposals. But 
     partway there is simply not good enough. Important gaps exist 
     in the SEC's agenda that will keep it from delivering the 
     comprehensive reform that the current situation demands. This 
     legislation fills those gaps. It offers a far-reaching and 
     thoughtful approach that, if enacted, will go a long way 
     toward getting the mutual fund industry back to operating in 
     shareholders' best interests once again. Please let us know 
     what we can do to help win passage of these essential, pro-
     investor reforms.
           Respectfully submitted,
     Barbara Roper,
       Director of Investor Protection, Consumer Federation of 
     America.
     Travis Plunkett,
       Legislative Director, Consumer Federation of America.
     Mercer Bullard,
       Founder and President, Fund Democracy, Inc.
     Ed Mierzwinski,
       Consumer Program Director, U.S. Public Interest Research 
     Group.
     Sally Greenberg,
       Senior Counsel, Consumers Union.
     Kenneth McEldowney,
       Executive Director, Consumer Action.
                                  ____

                                               Coalition of Mutual


                                               Fund Investors,

                                 Washington, DC, January 26, 2004.
     Hon. Peter Fitzgerald,
     Chairman, Subcommittee on Financial Management, The Budget 
         and International Security, Committee on Governmental 
         Affairs, U.S. Senate, Hart Senate Office Building, 
         Washington, DC.
       Dear Senator Fitzgerald: The Coalition of Mutual Fund 
     Investors (``CMFI'' or ``Coalition'') has reviewed your 
     legislative proposals to reform the mutual fund industry. 
     Without a doubt, your legislative initiative is the most 
     comprehensive mutual fund bill yet to be introduced in either 
     the House or the Senate.
       The Coalition strongly supports your efforts to improve the 
     mutual fund regulatory framework in a manner which benefits 
     all individual investors. As the mutual fund reform debate 
     begins this year in the Senate, your bill is likely to serve 
     as the gold standard by which other legislative proposals are 
     evaluated for their effectiveness in protecting the interests 
     of individual investors.
       CMFI supports the provisions contained in the mutual fund 
     reform bill which recently passed the House of 
     Representatives (H.R. 2420), however, the Coalition has been 
     advocating additional regulatory measures to protect the 
     interests of individual investors. These additional measures 
     include: (1) better shareholder disclosure of mutual fund 
     operating and transaction costs, (2) improved oversight of 
     ``omnibus'' accounts operated by financial intermediaries, 
     and (3) enhanced disclosure of the Statement of Additional 
     Information.
       You have included many of these reform proposals in your 
     bill and so the Coalition is very pleased to offer its 
     support to your legislation. The Coalition is particularly 
     pleased that your legislation includes a CMFI proposal to 
     require financial intermediaries operating ``omnibus'' 
     accounts to disclose basic shareholder identity and 
     transaction information to mutual funds so that the funds can 
     ensure uniform application of their policies, procedures, 
     fees, and charges across all shareholder classes. The 
     interests of long-term shareholders are being harmed by a 
     lack of oversight regarding the trading activities occurring 
     in these ``omnibus accounts'' and your legislation addresses 
     this structural problem with an effective solution.
       The Coalition looks forward to working with you and your 
     staff to enact the many thoughtful provisions contained in 
     your bill.
           Sincerely,
                                                      Niels Holch,
     Executive Director.
                                  ____


                                S. 2059

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE; TABLE OF CONTENTS.

       (a) Short Title.--This Act may be cited as the ``Mutual 
     Fund Reform Act of 2004''.
       (b) Table of Contents.--The table of contents for this Act 
     is as follows:

Sec. 1. Short title; table of contents.
Sec. 2. Definitions.
Sec. 3. Rulemaking.

                        TITLE I--FUND GOVERNANCE

Sec. 110. Independent directors.
Sec. 111. Study of director compensation and independence.
Sec. 112. Fiduciary duties of directors.
Sec. 113. Fiduciary duty of investment adviser.
Sec. 114. Termination of fund advisers.
Sec. 115. Independent accounting and auditing.
Sec. 116. Prevention of fraud; internal compliance and control 
              procedures.

                      TITLE II--FUND TRANSPARENCY

Sec. 210. Cost consolidation and clarity.
Sec. 211. Advisor compensation and ownership of fund shares.
Sec. 212. Point of sale and additional disclosure of broker 
              compensation.
Sec. 213. Breakpoint discounts.
Sec. 214. Portfolio turnover ratio.
Sec. 215. Proxy voting policies and record.
Sec. 216. Customer information from account intermediaries.
Sec. 217. Advertising.

                TITLE III--FUND REGULATION AND OVERSIGHT

Sec. 310. Prohibition of asset-based distribution expenses.
Sec. 311. Prohibition on revenue sharing, directed brokerage, and soft 
              dollar arrangements.
Sec. 312. Market timing.
Sec. 313. Elimination of stale prices.
Sec. 314. Prohibition of short term trading; mandatory redemption fees.
Sec. 315. Prevention of after-hours trading.
Sec. 316. Ban on joint management of mutual funds and hedge funds.
Sec. 317. Selective disclosures.

                           TITLE IV--STUDIES

Sec. 410. Study of adviser conflict of interest.
Sec. 411. Study of coordination of enforcement efforts.
Sec. 412. Study of Commission organizational structure.
Sec. 413. Trends in arbitration clauses.
Sec. 414. Hedge fund regulation.
Sec. 415. Investor education and the Internet.

     SEC. 2. DEFINITIONS.

       In this Act, the following definitions shall apply:
       (1) Commission.--The term ``Commission'' means the 
     Securities and Exchange Commission.
       (2) Investment adviser.--The term ``investment adviser'' 
     has the same meaning as in section 2(a)(20) of the Investment 
     Company Act of 1940 (15 U.S.C. 80a-2(a)(20)).
       (3) Investment company--The term ``investment company'' has 
     the same meaning as in section 3 of the Investment Company 
     Act of 1940 (15 U.S.C. 80-3).
       (4) Registered investment company.--The term ``registered 
     investment company'' means an investment company that is 
     registered under section 8 of the Investment Company Act of 
     1940 (15 U.S.C. 80a-8).

     SEC. 3. RULEMAKING.

       (a) Timing.--Unless otherwise specified in this Act or the 
     amendments made by this Act, the Commission shall issue, in 
     final form, all rules and regulations required by this Act 
     and the amendments made by this Act not later than 180 days 
     after the date of enactment of this Act.
       (b) Authority To Define Terms.--The Commission may, in 
     issuing rules and regulations under this Act or the 
     amendments made by this Act, define any term used in this Act 
     or such amendments that is not otherwise defined for purposes 
     of this Act or such amendment, as the Commission determines 
     necessary and appropriate.
       (c) Exemption Authority.--The Commission may, in issuing 
     rules and regulations under this Act or the amendments made 
     by this Act, exempt any investment company or other person 
     from the application of such rules, as the Commission 
     determines is necessary and appropriate, in the public 
     interest or for the protection of investors.

                        TITLE I--FUND GOVERNANCE

     SEC. 110. INDEPENDENT DIRECTORS.

       (a) Independent Fund Boards.--Section 10(a) of the 
     Investment Company Act of 1940 (15 U.S.C. 80a-10(a)) is 
     amended--
       (1) by striking ``shall have'' and inserting the following: 
     ``shall--
       ``(1) have'';
       (2) by striking ``60 per centum'' and inserting ``25 
     percent'';
       (3) by striking the period at the end and inserting a 
     semicolon; and
       (4) by adding at the end the following:
       ``(2) have as chairman of its board of directors an 
     interested person of such registered company; or
       ``(3) have as a member of its board of directors any person 
     that is not an interested person of such registered 
     investment company--
       ``(A) who has served without being approved or elected by 
     the shareholders of such registered investment company at 
     least once every 5 years; and
       ``(B) unless such director has been found, on an annual 
     basis, by a majority of the directors who are not interested 
     persons, after

[[Page S798]]

     reasonable inquiry by such directors, not to have any 
     material business or familial relationship with the 
     registered investment company, a significant service provider 
     to the company, or any entity controlling, controlled by, or 
     under common control with such service provider, that is 
     likely to impair the independence of the director.''.
       (b) Action by Independent Directors.--Section 10 of the 
     Investment Company Act of 1940 (15 U.S.C. 80a-10) is amended 
     by adding at the end the following:
       ``(i) Independent Committee.--
       ``(1) In general.--The members of the board of directors of 
     a registered investment company who are not interested 
     persons of such registered investment company shall establish 
     a committee comprised solely of such members, which committee 
     shall be responsible for--
       ``(A) selecting persons to be nominated for election to the 
     board of directors;
       ``(B) adopting qualification standards for the nomination 
     of directors; and
       ``(C) determining the compensation to be paid to directors.
       ``(2) Disclosure.--The standards developed under paragraph 
     (1)(B) shall be disclosed in the registration statement of 
     the registered investment company.''.
       (c) Definition of Interested Person.--Section 2(a)(19) of 
     the Investment Company Act of 1940 (15 U.S.C. 80a-2) is 
     amended--
       (1) in subparagraph (A)--
       (A) in clause (iv), by striking ``two'' and inserting 
     ``5''; and
       (B) by striking clause (vii) and inserting the following:
       ``(vii) any natural person who has served as an officer or 
     director, or as an employee within the preceding 10 fiscal 
     years, of an investment adviser or principal underwriter to 
     such registered investment company, or of any entity 
     controlling, controlled by, or under common control with such 
     investment adviser or principal underwriter;
       ``(viii) any natural person who has served as an officer or 
     director, or as an employee within the preceding 10 fiscal 
     years, of any entity that has within the preceding 5 fiscal 
     years acted as a significant service provider to such 
     registered investment company, or of any entity controlling, 
     controlled by, or under the common control with such service 
     provider;
       ``(ix) any natural person who is a member of a class of 
     persons that the Commission, by rule or regulation, 
     determines is unlikely to exercise an appropriate degree of 
     independence as a result of--

       ``(I) a material business relationship with the investment 
     company or an affiliated person of such investment company;
       ``(II) a close familial relationship with any natural 
     person who is an affiliated person of such investment 
     company; or
       ``(III) any other reason determined by the Commission.'';

       (2) in subparagraph (B)--
       (A) in clause (iv), by striking ``two'' and inserting 
     ``5''; and
       (B) by striking clause (vii) and inserting the following:
       ``(vii) any natural person who is a member of a class of 
     persons that the Commission, by rule or regulation, 
     determines is unlikely to exercise an appropriate degree of 
     independence as a result of--

       ``(I) a material business relationship with such investment 
     adviser or principal underwriter or affiliated person of such 
     investment adviser or principal underwriter;
       ``(II) a close familial relationship with any natural 
     person who is an affiliated person of such investment adviser 
     or principal underwriter; or
       ``(III) any other reason as determined by the 
     Commission.''.

       (d) Definition of Significant Service Provider.--Section 
     2(a) of the Investment Company Act of 1940 is amended by 
     adding at the end the following:
       ``(53) Significant service provider.--
       ``(A) In general.--Not later than 270 days after the date 
     of enactment of the Mutual Fund Reform Act of 2004, the 
     Commission shall issue final rules defining the term 
     `significant service provider'.
       ``(B) Requirements.--The definition developed under 
     paragraph (1) shall include, at a minimum, the investment 
     adviser and principal underwriter of a registered investment 
     company for purposes of paragraph (19).''.

     SEC. 111. STUDY OF DIRECTOR COMPENSATION AND INDEPENDENCE.

       (a) In General.--The Commission shall conduct a study of--
       (1) whether any limits should be placed upon the amount of 
     compensation paid by a registered investment company or any 
     affiliate of such company to a director thereof; and
       (2) whether a director of a registered investment company 
     who is otherwise not an interested person of a registered 
     investment company, as defined in section 2(a)(19) of the 
     Investment Company Act of 1940, as amended by this Act, but 
     serves as a director of multiple registered investment 
     companies, or receives substantial compensation from the 
     investment adviser of any such company, should be considered 
     an ``interested person'' for purposes of section 2 of the 
     Investment Company Act of 1940.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     regarding the study conducted under subsection (a) to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 112. FIDUCIARY DUTIES OF DIRECTORS.

       Section 10 of the Investment Company Act of 1940 (15 U.S.C. 
     80a-10), as amended by this Act, is amended by adding at the 
     end the following:
       ``(j) Fiduciary Duty of Directors.--
       ``(1) In general.--The members of the board of directors of 
     a registered investment company shall have a fiduciary duty 
     to act with loyalty and care, in the best interests of the 
     shareholders.
       ``(2) Rulemaking.--The Commission shall promulgate rules to 
     clarify the scope of the fiduciary duty under paragraph (1), 
     which rules shall, at a minimum, require the directors of a 
     registered investment company to--
       ``(A) determine the extent to which independent and 
     reliable sources of information are sufficient to discharge 
     director responsibilities;
       ``(B) negotiate management and advisory fees with due 
     regard for the actual cost of such services, including 
     economies of scale;
       ``(C) evaluate the totality of fees with reference to the 
     interests of shareholders;
       ``(D) evaluate the quality of the management of the company 
     and potentially superior alternatives;
       ``(E) evaluate the quality, comprehensiveness, and clarity 
     of disclosures to shareholders regarding costs;
       ``(F) evaluate any distribution or marketing plan of the 
     company, including its costs and benefits;
       ``(G) evaluate the size of the portfolio of the company and 
     its suitability to the interests of shareholders;
       ``(H) implement and monitor policies to ensure compliance 
     with applicable securities laws; and
       ``(I) implement and monitor policies with respect to 
     predatory trading practices.''.

     SEC. 113. FIDUCIARY DUTY OF INVESTMENT ADVISER.

       Section 36 of the Investment Company Act of 1940 (15 U.S.C. 
     80a-35(b)) is amended--
       (1) by redesignating subsection (c) as subsection (d); and
       (2) by inserting after subsection (b) the following:
       ``(c) Duties With Respect To Compensation and Provision of 
     Information.--For purposes of subsections (a) and (b), the 
     fiduciary duty of an investment adviser--
       ``(1) with respect to any compensation received, may 
     require reasonable reference to the actual costs of the 
     adviser and economies of scale; and
       ``(2) shall include a duty to supply such material 
     information as is necessary for the independent directors of 
     a registered investment company with whom the adviser is 
     employed to review and govern such company.''.

     SEC. 114. TERMINATION OF FUND ADVISER.

       The Commission shall promulgate such rules as it determines 
     necessary in the public interest or for the protection of 
     investors to facilitate the process through which the 
     independent directors of a registered investment company may 
     terminate the services of the investment adviser of such 
     company in the good faith exercise of their fiduciary duties, 
     without undue exposure to financial or litigation risk.

     SEC. 115. INDEPENDENT ACCOUNTING AND AUDITING.

       (a) Amendments.--Section 32 of the Investment Company Act 
     of 1940 (15 U.S.C. 80a-31) is amended--
       (1) in subsection (a)--
       (A) by striking paragraphs (1) and (2) and inserting the 
     following:
       ``(1) such accountant shall have been selected at a meeting 
     held within 30 days before or after the beginning of the 
     fiscal year or before the annual meeting of stockholders in 
     that year by the vote, cast in person, of a majority of the 
     members of the audit committee of such registered investment 
     company;
       ``(2) such selection shall have been submitted for 
     ratification or rejection at the next succeeding annual 
     meeting of stockholders if such meeting be held, except that 
     any vacancy occurring between annual meetings, due to the 
     death or resignation of the accountant, may be filled by the 
     vote of a majority of the members of the audit committee of 
     such registered company, cast in person at a meeting called 
     for the purpose of voting on such action;''; and
       (B) by adding at the end the following: ``The Commission, 
     by rule, regulation, or order, may exempt a registered 
     management company or registered face-amount certificate 
     company otherwise subject to this subsection from the 
     requirement in paragraph (1) that the votes by the members of 
     the audit committee be cast at a meeting in person, when such 
     a requirement is impracticable, subject to such conditions as 
     the Commission may require.''; and
       (2) by adding at the end the following:
       ``(d) Audit Committee Requirements.--
       ``(1) Requirements as prerequisite to filing financial 
     statements.--Any registered management company or registered 
     face-amount certificate company that files with the 
     Commission any financial statement signed or certified by an 
     independent public accountant shall comply with the 
     requirements of paragraphs (2) through (6) of this subsection 
     and any rule or regulation of the Commission issued 
     thereunder.
       ``(2) Responsibility relating to independent public 
     accountants.--The audit committee of the registered 
     investment company, in its capacity as a committee of the 
     board of directors, shall be directly responsible for the 
     appointment, compensation, and

[[Page S799]]

     oversight of the work of any independent public accountant 
     employed by the registered investment company (including 
     resolution of disagreements between management and the 
     auditor regarding financial reporting) for the purpose of 
     preparing or issuing the audit report or related work, and 
     each such independent public accountant shall report directly 
     to the audit committee.
       ``(3) Independence.--
       ``(A) In general.--Each member of the audit committee of 
     the registered investment company shall be a member of the 
     board of directors of the company, and shall otherwise be 
     independent.
       ``(B) Criteria.--In order to be considered to be 
     independent for purposes of this paragraph, a member of an 
     audit committee of a registered investment company may not, 
     other than in his or her capacity as a member of the audit 
     committee, the board of directors, or any other board 
     committee--
       ``(i) accept any consulting, advisory, or other 
     compensatory fee from the registered investment company or 
     the investment adviser or principal underwriter of the 
     registered investment company; or
       ``(ii) be an interested person of the registered investment 
     company.
       ``(4) Complaints.--The audit committee of the registered 
     investment company shall establish procedures for--
       ``(A) the receipt, retention, and treatment of complaints 
     received by the registered investment company regarding 
     accounting, internal accounting controls, or auditing 
     matters; and
       ``(B) the confidential, anonymous submission by employees 
     of the registered investment company and its investment 
     adviser or principal underwriter of concerns regarding 
     questionable accounting or auditing matters.
       ``(5) Authority to engage advisers.--The audit committee of 
     the registered investment company shall have the authority to 
     engage independent counsel and other advisers, as it 
     determines necessary to carry out its duties.
       ``(6) Funding.--The registered investment company shall 
     provide appropriate funding, as determined by the audit 
     committee, in its capacity as a committee of the board of 
     directors, for payment of compensation--
       ``(A) to the independent public accountant employed by the 
     registered investment company for the purpose of rendering or 
     issuing the audit report; and
       ``(B) to any advisers employed by the audit committee under 
     paragraph (5).
       ``(7) Audit committee.--For purposes of this subsection, 
     the term `audit committee' means--
       ``(A) a committee (or equivalent body) established by and 
     amongst the board of directors of a registered investment 
     company for the purpose of overseeing the accounting and 
     financial reporting processes of the company and audits of 
     the financial statements of the company; and
       ``(B) if no such committee exists with respect to a 
     registered investment company, the entire board of directors 
     of the company.''.
       (b) Conforming Amendment.--Section 10A(m) of the Securities 
     Exchange Act of 1934 (15 U.S.C. 78j-1(m)) is amended by 
     adding at the end the following:
       ``(7) Exemption for investment companies.--Effective one 
     year after the date of enactment of the Mutual Fund Reform 
     Act of 2004, for purposes of this subsection, the term 
     `issuer' shall not include any investment company that is 
     registered under section 8 of the Investment Company Act of 
     1940.''.
       (c) Implementation.--The Commission shall issue final 
     regulations to carry out section 32(d) of the Investment 
     Company Act of 1940, as added by subsection (a) of this 
     section.

     SEC. 116. PREVENTION OF FRAUD; INTERNAL COMPLIANCE AND 
                   CONTROL PROCEDURES.

       (a) Detection and Prevention of Fraud.--Section 17(j) of 
     the Investment Company Act of 1940 (15 U.S.C. 80a-17(j)) is 
     amended to read as follows:
       ``(j) Detection and Prevention of Fraud.--
       ``(1) Commission rules to prohibit fraud, deception, and 
     manipulation.--It shall be unlawful for any affiliated person 
     of or principal underwriter for a registered investment 
     company or any affiliated person of an investment adviser of 
     or principal underwriter for a registered investment company, 
     to engage in any act, practice, or course of business in 
     connection with the purchase or sale, directly or indirectly, 
     by such person of any security held or to be acquired by such 
     registered investment company, or any security issued by such 
     registered investment company or by an affiliated registered 
     investment company, in contravention of such rules as the 
     Commission may adopt to define, and prescribe means 
     reasonably necessary to prevent, such acts, practices, or 
     courses of business as are fraudulent, deceptive or 
     manipulative.
       ``(2) Codes of ethics.--The rules adopted under paragraph 
     (1) shall include requirements for the adoption of codes of 
     ethics by a registered investment company and investment 
     advisers of, and principal underwriters for, such investment 
     companies establishing such standards as are reasonably 
     necessary to prevent such acts, practices, or courses of 
     business. Such rules and regulations shall require each such 
     registered investment company to disclose such codes of 
     ethics (and any changes therein) in the periodic report to 
     shareholders of such company, and to disclose such code of 
     ethics and any waivers and material violations thereof on a 
     readily accessible electronic public information facility of 
     such company and in such additional form and manner as the 
     Commission shall require by rule or regulation.
       ``(3) Additional compliance procedures.--The rules adopted 
     under paragraph (1) shall--
       ``(A) require each registered investment company and 
     investment adviser to adopt and implement general policies 
     and procedures reasonably designed to prevent violations of 
     this title, the Securities Act of 1933 (15 U.S.C. 78a et 
     seq.), the Securities Exchange Act of 1934 (15 U.S.C. 78a et 
     seq.), the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et 
     seq.) and amendments made by that Act, the Trust Indenture 
     Act of 1939 (15 U.S.C. 77aaa et seq.), the Investment 
     Advisers Act of 1940 (15 U.S.C. 80b et seq.), the Securities 
     Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.), 
     subchapter II of chapter 53 of title 31, United States Code, 
     chapter 2 of title I of Public Law 91-508 (12 U.S.C. 1951 et 
     seq.), or section 21 of the Federal Deposit Insurance Act (12 
     U.S.C. 1829b);
       ``(B) require each registered investment company and 
     registered investment adviser to review such policies and 
     procedures annually for their adequacy and the effectiveness 
     of their implementation; and
       ``(C) require each registered investment company to appoint 
     a chief compliance officer to be responsible for overseeing 
     such policies and procedures--
       ``(i) whose compensation shall be approved by the members 
     of the board of directors of the company who are not 
     interested persons of the company;
       ``(ii) who shall report directly to the members of the 
     board of directors of the company who are not interested 
     persons of such company, privately as such members request, 
     but not less frequently than annually; and
       ``(iii) whose report to such members shall include any 
     violations or waivers of, and any other significant issues 
     arising under, such policies and procedures.
       ``(4) Certifications.--The rules adopted under paragraph 
     (1) shall require each senior executive officer, or such 
     officers designated by the Commission, of an investment 
     adviser of a registered investment company to certify in each 
     periodic report to shareholders, or other appropriate 
     disclosure document, that--
       ``(A) procedures are in place for verifying that the 
     determination of current net asset value of any redeemable 
     security issued by the company used in computing periodically 
     the current price for the purpose of purchase, redemption, 
     and sale complies with the requirements of this title and the 
     rules and regulations issued under this title, and the 
     company is in compliance with such procedures;
       ``(B) procedures are in place to ensure that, if the shares 
     of the company are offered as different classes of shares, 
     such classes are designed in the interests of shareholders, 
     and could reasonably be an appropriate investment option for 
     a shareholder;
       ``(C) procedures are in place to ensure that information 
     about the portfolio securities of the company is not 
     disclosed in violation of the securities laws or the code of 
     ethics of the company;
       ``(D) the members of the board of directors who are not 
     interested persons of the company have reviewed and approved 
     the compensation of the portfolio manager of the company in 
     connection with their consideration of the investment 
     advisory contract under section 15(c); and
       ``(E) the company has established and enforces a code of 
     ethics, as required by paragraph (2).''.
       (b) Whistleblower Protection.--Section 1514A(a) of title 
     18, United States Code, is amended by striking the matter 
     preceding paragraph (1) and inserting the following:
       ``(a) Whistleblower Protection for Employees of Publicly 
     Traded Companies and Registered Investment Companies.--No 
     company with a class of securities registered under section 
     12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l), or 
     that is required to file reports under section 15(d) of the 
     Securities and Exchange Act of 1934 (15 U.S.C. 78o(d)), or 
     that is an investment adviser, principal underwriter, or 
     significant service provider (as such terms are defined under 
     section 2(a) of the Investment Company Act of 1940 (15 U.S.C. 
     80a-2(a)) of an investment company which is registered under 
     section 8 of the Investment Company Act of 1940, or any 
     officer, employee, contractor, subcontractor, or agent of 
     such company, may discharge, demote, suspend, threaten, 
     harass, or in any other manner discriminate against an 
     employee in the terms and conditions of employment because of 
     any lawful act done by the employee--''.

                      TITLE II--FUND TRANSPARENCY

     SEC. 210. COST CONSOLIDATION AND CLARITY.

       (a) Expense Ratio Computation.--
       (1) In general.--The Commission shall, by rule, develop a 
     standardized method of calculating the expense ratio of a 
     registered investment company that accounts for as many 
     operating costs to shareholders of such companies as is 
     practicable.
       (2) Separate disclosures.--In developing the method of 
     calculation required under paragraph (1), if the Commission 
     determines that the inclusion of certain costs in such 
     calculation will lead to a significant risk of confusing or 
     misleading shareholders, the Commission shall develop 
     separate standardized methods for the calculation and 
     disclosure of such costs.

[[Page S800]]

       (b) Transaction Cost Ratio.--The Commission shall, by rule, 
     develop a standardized method of computing the transaction 
     cost ratio of a registered investment company that 
     practicably and fairly accounts for actual transaction costs 
     to shareholders, including, at a minimum, brokerage 
     commissions and bid-ask spread costs. Such computation, if 
     necessary for ease of administration, may be based upon a 
     fair method of estimation or a standardized derivation from 
     easily ascertainable information.
       (c) Disclosure of Expense Ratio and Transaction Cost 
     Ratio.--The Commission shall, by rule, require the prominent 
     disclosure of the expense ratio and the transaction cost 
     ratio of a registered company, both separately and as a total 
     investment cost ratio, in--
       (1) each annual report of the registered investment 
     company;
       (2) any prospectus of the registered investment company, as 
     part of a fee table; and
       (3) such other filings with the Commission as the 
     Commission determines appropriate.
       (d) Actual Cost Disclosure.--The Commission shall, by rule, 
     require, on at least an annual basis, the prominent 
     disclosure in the shareholder account statement of a 
     registered investment company of the actual dollar amount of 
     the projected annual costs of each shareholder of the 
     company, based upon the asset value of the shareholder at the 
     time of the disclosure.
       (e) Definition of Fees and Expenses.--
       (1) In general.--The Commission shall, by rule, define all 
     specific allowable types or categories of fees and expenses 
     that may be borne by the shareholders of a registered 
     investment company.
       (2) New fees and expenses.--No new fee or expense, other 
     than any defined under paragraph (1), shall be borne by the 
     shareholders of a registered investment company, unless the 
     Commission finds that such new fee or expense fairly reflects 
     the services provided to, or is in the best interests of the 
     shareholders of--
       (A) a particular registered investment company;
       (B) specific types or categories of registered investment 
     companies; or
       (C) registered investment companies in general.
       (f) Cost Structures.--The Commission shall promulgate such 
     rules or regulations as are necessary--
       (1) to promote the standardization and simplification of 
     the disclosure of the cost structures of registered 
     investment companies; and
       (2) to ensure that the shareholders of such registered 
     investment companies receive all material information 
     regarding such costs--
       (A) in a nonmisleading manner; and
       (B) in such form and prominence as to facilitate, to the 
     extent practicable, ease of comprehension and comparison of 
     such costs.
       (g) Descriptions of Fees, Expenses, and Costs.--The 
     Commission shall, by rule, require--
       (1) the disclosure, in any annual or periodic report filed 
     with the Commission or any prospectus delivered to the 
     shareholders of a registered investment company, of all types 
     of fees, expenses, or costs borne by shareholders;
       (2) a clear definition of each such fee, expense, or cost; 
     and
       (3) information as to where shareholders may find out more 
     information concerning such fees, expenses, or costs.

     SEC. 211. ADVISOR COMPENSATION AND OWNERSHIP OF FUND SHARES.

       (a) Compensation of Investment Adviser.--The Commission 
     shall, by rule, require--
       (1) the disclosure to the shareholders of a registered 
     investment company of--
       (A) the amount and structure of, or the method used to 
     determine, the compensation paid by the registered investment 
     company to the portfolio manager or portfolio management team 
     of the investment adviser; and
       (B) the ownership interest in such company of the portfolio 
     manager or portfolio management team; and
       (2) the disclosure to the board of directors of the 
     registered investment company of all transactions in the 
     securities of the company by the portfolio manager or 
     management team of the investment adviser of such company.
       (b) Form of Disclosure.--The disclosures required under 
     subparagraphs (A) and (B) of subsection (a)(1) shall be made 
     by a registered investment company in--
       (1) the registration statement of the company; and
       (2) any other filings with the Commission that the 
     Commission determines appropriate.

     SEC. 212. POINT OF SALE AND ADDITIONAL DISCLOSURE OF BROKER 
                   COMPENSATION.

       Section 15(b) of the Securities Exchange Act of 1934 (15 
     U.S.C. 78o(b)) is amended by adding at the end the following:
       ``(11) Broker disclosures in mutual fund transactions.--
       ``(A) In general.--Each broker shall disclose in writing to 
     each person that purchases the shares of an investment 
     company registered under section 8 of the Investment Company 
     Act of 1940 (15 U.S.C. 80a-8)--
       ``(i) the source and amount of any compensation received or 
     to be received by the broker in connection with such 
     transaction; and
       ``(ii) such other information as the Commission determines 
     appropriate.
       ``(B) Timing of disclosure.--The disclosures required under 
     subparagraph (A) shall be made at or before the time of the 
     purchase transaction.
       ``(C) Limitation.--The disclosures required under 
     subparagraph (A) may not be made exclusively in--
       ``(i) a registration statement or prospectus of the 
     registered investment company; or
       ``(ii) any other filing of a registered investment company 
     with the Commission.''.

     SEC. 213. BREAKPOINT DISCOUNTS.

       The Commission, by rule, shall require the disclosure by 
     any registered investment company, in any quarterly or other 
     periodic report filed with the Commission, information 
     concerning discounts on front-end sales loads for which 
     shareholders may be eligible, including the minimum purchase 
     amounts required for such discounts.

     SEC. 214. PORTFOLIO TURNOVER RATIO.

       The Commission, by rule, shall require the disclosure, by 
     any registered investment company, in any quarterly or 
     periodic report filed with the Commission, and in any 
     prospectus delivered to the shareholders of such company, of 
     the portfolio turnover ratio of the company, and an 
     explanation of its meaning and implications for cost and 
     performance. Such rules shall require the disclosures to be 
     prominently displayed within the appropriate document.

     SEC. 215. PROXY VOTING POLICIES AND RECORD.

       Section 30 of the Investment Company Act of 1940 (15 U.S.C. 
     80a-29) is amended by adding at the end the following:
       ``(k) Proxy Voting Disclosure.--
       ``(1) In general.--Each registered investment company, 
     other than a small business investment company, shall file 
     with the Commission, not later than August 31 of each year, 
     an annual report, on a form prescribed by the Commission by 
     rule, containing the proxy voting record of the registrant 
     and policies of the company with respect to the voting of 
     such proxies for the most recent 12-month period ending on 
     June 30.
       ``(2) Notice in financial statements.--The financial 
     statements of each registered investment company shall state 
     that information regarding how the company voted proxies and 
     proxy voting policies relating to portfolio securities during 
     the most recent 12-month period ending on June 30 is 
     available--
       ``(A) without charge, upon request, by calling a specified 
     toll-free (or collect) telephone number; or on or through the 
     company's website at a specified Internet address, or both; 
     and
       ``(B) on the website of the Commission.''.

     SEC. 216. CUSTOMER INFORMATION FROM ACCOUNT INTERMEDIARIES.

       (a) In General.--The Commission shall, by rule, require 
     that each account intermediary of a registered investment 
     company provide to such company, with respect to each account 
     serviced by the intermediary, such information as is 
     necessary for the company to enforce its investment, trading, 
     and fee policies.
       (b) Requirements.--The information provided by a registered 
     investment company under subsection (a) shall include, at a 
     minimum--
       (1) the name under which the account is opened with the 
     intermediary;
       (2) the taxpayer identification number of such person;
       (3) the mailing address of such person; and
       (4) individual transaction data for all purchases, 
     redemptions, transfers, and exchanges by or on behalf of such 
     person.
       (c) Privacy of Information.--The information provided under 
     subsection (a), and the use thereof, shall be subject to all 
     Federal and State laws with regard to privacy and proprietary 
     information.

     SEC. 217. ADVERTISING.

       (a) Performance Advertising.--The Commission shall 
     promulgate such rules as the Commission determines necessary 
     with respect to the advertising of a registered investment 
     company regarding--
       (1) unrepresentative short-term performance;
       (2) performance based upon an undisclosed or improbable 
     event; and
       (3) performance based upon incomplete or misleading data.
       (b) Dollar and Time-Weighted Returns.--
       (1) In general.--Subject to paragraph (2), the Commission 
     shall, by rule, require each registered investment company to 
     disclose, in its annual report and any prospectus delivered 
     to shareholders, dollar-weighted returns and time-weighted 
     returns for each of--
       (A) the preceding fiscal year;
       (B) the preceding 5 fiscal years;
       (C) the preceding 10 fiscal years; and
       (D) the life of the company.
       (2) Exception.--The Commission may omit or require 
     additional disclosures required under paragraph (1) for such 
     time periods as the Commission determines necessary.
       (3) Commission use of benchmarks.--The Commission may 
     require, in the interest of facilitating non-misleading 
     disclosures, that any performance-related advertising by a 
     registered investment company be accompanied by such 
     benchmarks as the Commission may deem appropriate.
       (c) Subsidized Yields.--The Commission shall, by rule, 
     require that any registered investment company that discloses 
     in any publication a subsidized yield to disclose in the same 
     publication the amount and duration of such subsidy.

[[Page S801]]

                TITLE III--FUND REGULATION AND OVERSIGHT

     SEC. 310. PROHIBITION OF ASSET-BASED DISTRIBUTION EXPENSES.

       (a) Repeal of Rule 12b-1.--
       (1) In general.--Beginning 180 days after the date of 
     enactment of this Act (or such earlier time as the Commission 
     may elect), as in effect on the date of enactment of this 
     Act, section 270.12b-1 of chapter II of title 17 of the Code 
     of Federal Regulations, promulgated under section 12 of the 
     Investment Company Act of 1940 (15 U.S.C. 80a-12), is 
     repealed, and shall have no force or effect.
       (2) Preservation of actions.--Paragraph (1) shall have no 
     effect on any case pending or penalty imposed under section 
     270.12b-1 of the Code of Federal Regulations prior to the 
     date of repeal under paragraph (1).
       (b) Payment of Distribution Expenses from Management Fee.--
     Section 12 of the Investment Company Act of 1940 (15 U.S.C. 
     80a-12) is amended by adding at the end the following:
       ``(h) Payment of Distribution Expenses.--Notwithstanding 
     any provision of subsection (b), or any rule or regulation 
     promulgated thereunder, distribution expenses incurred by an 
     investment adviser may be paid out of the management fee 
     received by the investment adviser.''.
       (c) Sums Expended Promoting Sale of Securities.--The 
     Commission shall, by rule--
       (1) require that any sums expended by the investment 
     adviser of a registered investment company to promote or 
     facilitate the sale of the securities of such company be 
     disclosed to the board of directors of the company;
       (2) require that such sums be accounted for and identified 
     in the expense ratio of any such company; and
       (3) authorize the board of directors of any such company to 
     prohibit its investment adviser from using any compensation 
     received from the company for distribution expenses that the 
     board determines not to be in the best interest of the 
     shareholders of the company.
       (d) Prohibition of Asset-Based Fees.--Section 12 of the 
     Investment Company Act of 1940 (15 U.S.C. 80a-12), as amended 
     by subsection (a), is amended by adding at the end the 
     following:
       ``(i) Asset-Based Fees.--
       ``(1) In general.--It shall be unlawful for any registered 
     investment company to pay asset-based fees to any broker or 
     dealer in connection with the offer or sale of the securities 
     of such investment company.
       ``(2) Definition of asset-based fees.--The Commission 
     shall, by rule, define the term `asset-based fees' for 
     purposes of this subsection.''.

     SEC. 311. PROHIBITION ON REVENUE SHARING, DIRECTED BROKERAGE, 
                   AND SOFT DOLLAR ARRANGEMENTS.

       (a) In General.--The Investment Company Act of 1940 (15 
     U.S.C. 80a-1 et seq.) is amended by inserting after section 
     12 the following:

     ``SEC. 12A. PROHIBITION ON REVENUE SHARING, DIRECTED 
                   BROKERAGE, AND SOFT DOLLAR ARRANGEMENTS.

       ``(a) Revenue Sharing Arrangements.--It shall be unlawful 
     for any investment adviser to enter into a revenue sharing 
     arrangement with any broker or dealer with respect to the 
     securities of a registered investment company.
       ``(b) Directed Brokerage Arrangements.--It shall be 
     unlawful for any registered investment company, or any 
     affiliate of such company, to enter into a directed brokerage 
     arrangement with a broker or dealer.
       ``(c) Soft-Dollar Arrangements.--It shall be unlawful for 
     any registered investment company or registered investment 
     adviser to enter into a soft-dollar arrangement with any 
     broker or dealer.
       ``(d) Regulations Respecting Section 28(e) of the 
     Securities Exchange Act of 1934.--The Commission shall, by 
     rule, narrow the soft-dollar safe harbor under section 28(e) 
     of the Securities Exchange Act of 1934 (15 U.S.C. 78bb(e)(1)) 
     to promote such parity as the Commission determines 
     appropriate, and in the best interests of shareholders of a 
     registered investment company, between registered investment 
     companies governed by section 12A, and companies not covered 
     by section 12A.
       ``(e) Definitions.--
       ``(1) In general.--In this section--
       ``(A) the term `directed brokerage arrangement' means the 
     direction of discretionary brokerage by an investment company 
     or an affiliate of that company, to a broker or dealer in 
     exchange for services other than trade executions;
       ``(B) the term `revenue sharing arrangement' means any 
     direct or indirect payment made by an investment adviser (or 
     any affiliate of an investment adviser) to a broker or dealer 
     for the purpose of promoting the sales of securities of a 
     registered investment company, other than any payment made 
     directly by a shareholder as a commission for the purchase of 
     such securities;
       ``(C) the term `soft-dollar arrangement' means payments to 
     a broker or dealer for best trade executions in exchange for, 
     or which generate credits for, services or products other 
     than trade executions; and
       ``(D) the term `trade executions' has the meaning given 
     that term by the Commission, by rule;
       ``(2) Regulations.--The Commission may, by rule, refine the 
     definitions under paragraph (1), define such other terms as 
     the Commission determines necessary, and otherwise tailor the 
     proscriptions set forth under this section to achieve the 
     purposes of--
       ``(A) protecting the best interests of shareholders of a 
     registered investment company;
       ``(B) minimizing or eliminating conflicts with the best 
     interests of shareholders of a registered investment company;
       ``(C) enhancing market negotiation for and price 
     competition in trade execution services, and products and 
     services previously obtained under arrangements prohibited by 
     this section;
       ``(D) ensuring the transparency of transactions for trade 
     executions, and products and services previously obtained 
     under arrangements prohibited by this section, and disclosure 
     to shareholders of costs associated with trade executions, 
     and products and services previously obtained under 
     arrangements prohibited by this section, that is simplified, 
     clear, and comprehensible; and
       ``(E) providing reasonable safe harbors for conduct 
     otherwise consistent with such purposes.''.
       (b) Technical and Conforming Amendment.--Section 28(e)(1) 
     of the Securities Exchange Act of 1934 (15 U.S.C. 78bb(e)(1)) 
     is amended by striking ``This section is exclusive'' and 
     inserting ``Except as provided under section 12A of the 
     Investment Company Act of 1940, this section is exclusive''.

     SEC. 312. MARKET TIMING.

       (a) In General.--The Commission shall, by rule, require--
       (1) the disclosure in any registration statement filed with 
     the Commission by a registered investment company of the 
     market timing policies of that company and the procedures 
     adopted to enforce such policies; and
       (2) that any registered investment company that declines to 
     adopt restrictions on market timing disclose such fact in the 
     registration statement of the company, and in any advertising 
     or other publicly available documents, as the Commission 
     determines necessary.
       (b) Fundamental Investment Policy.--The policies required 
     to be disclosed under paragraph (1) shall be deemed 
     ``fundamental investment policies'' for purposes of sections 
     8(b)(3) and 13(a)(3) of the Investment Company Act of 1940 
     (15 U.S.C. 80a-8(b)(3) and 80a-13(a)(3)).

     SEC. 313. ELIMINATION OF STALE PRICES.

       (a) In General.--Not later than 90 days after the date of 
     enactment of this Act, the Commission shall prescribe, by 
     rule or regulation, standards concerning the obligation of 
     registered investment companies under the Investment Company 
     Act of 1940, to apply and use fair value methods of 
     determination of net asset value when market quotations are 
     unavailable or do not accurately reflect the fair market 
     value of the portfolio securities of such a company, in order 
     to prevent dilution of the interests of long-term 
     shareholders or as necessary in the public interest or for 
     the protection of shareholders.
       (b) Content.--The rule or regulation prescribed under 
     subsection (a) shall identify, in addition to significant 
     events, the conditions or circumstances from which such an 
     obligation will arise, such as the need to value securities 
     traded on foreign exchanges, and the methods by which fair 
     value methods shall be applied in such events, conditions, 
     and circumstances.

     SEC. 314. PROHIBITION OF SHORT TERM TRADING; MANDATORY 
                   REDEMPTION FEES.

       (a) Short-Term Trading Prohibited.--Section 17 of the 
     Investment Company Act of 1940 (15 U.S.C. 80a-17) is amended 
     by adding at the end the following:
       ``(k) Short-Term Trading Prohibited.--
       ``(1) Prohibition.--It shall be unlawful for any officer, 
     director, partner, or employee of a registered investment 
     company, any affiliated person, investment adviser, or 
     principal underwriter of such company, or any officer, 
     director, partner, or employee of such an affiliated person, 
     investment adviser, or principal underwriter, to engage in 
     any short-term transaction, in any securities issued by such 
     company, or any affiliate of such company.
       ``(2) Limitation.--This subsection does not prohibit any 
     transaction in a money market fund, or in funds, the 
     investment policy of which expressly permits short-term 
     transactions, or such other category of registered investment 
     company as the Commission shall specify, by rule.
       ``(3) Definition.--For purposes of this subsection, the 
     term `short-term transaction' has the meaning given that term 
     by the Commission, by rule.''.
       (b) Mandatory Redemption Fees.--The Commission shall, by 
     rule, require any registered investment company that does not 
     allow for market timing practices to charge a redemption fee 
     upon the short-term redemption of any securities of such 
     company. In determining the application of mandatory 
     redemption fees, shares shall be considered in the reverse 
     order of their purchase.
       (c) Increased Redemption Fees Permitted for Short-Term 
     Trading.--Not later than 90 days after the date of enactment 
     of this Act, the Commission shall permit a registered 
     investment company to charge redemption fees in excess of 2 
     percent upon the redemption of any securities of such company 
     that are redeemed within such period after their purchase as 
     the Commission specifies in such rule to deter short term 
     trading that is unfair to the shareholders of such company.

[[Page S802]]

       (d) Deadline for Rules.--The Commission shall prescribe 
     rules to implement section 17(k) of the Investment Company 
     Act of 1940, as added by subsection (a) of this section, not 
     later than 90 days after the date of enactment of this Act.

     SEC. 315. PREVENTION OF AFTER-HOURS TRADING.

       (a) Additional Rules Required.--The Commission shall issue 
     rules to prevent transactions in the securities of any 
     registered investment company in violation of section 22 of 
     the Investment Company Act of 1940 (15 U.S.C. 80a-22), 
     including after-hours trades that are executed at a price 
     based on a net asset value that was determined as of a time 
     prior to the actual execution of the transaction.
       (b) Trades Collected by Intermediaries.--The Commission 
     shall determine the circumstances under which to permit, 
     subject to rules of the Commission and an annual independent 
     audit of such trades, the execution of after-hours trades 
     that are provided to a registered investment company by a 
     broker, dealer, retirement plan administrator, insurance 
     company, or other intermediary, after the time as of which 
     the net asset value was determined.

     SEC. 316. BAN ON JOINT MANAGEMENT OF MUTUAL FUNDS AND HEDGE 
                   FUNDS.

       (a) Amendment.--Section 15 of the Investment Company Act of 
     1940 (15 U.S.C. 80a-15) is amended by adding at the end the 
     following:
       ``(h)  Ban on Joint Management of Mutual Funds and Hedge 
     Funds.--
       ``(1) Prohibition of joint management.--It shall be 
     unlawful for any individual to serve or act as the portfolio 
     manager or investment adviser of a registered open-end 
     investment company if such individual also serves or acts as 
     the portfolio manager or investment adviser of an investment 
     company that is not registered or of such other categories of 
     companies as the Commission shall prescribe by rule in order 
     to prohibit conflicts of interest, such as conflicts in the 
     selection of the portfolio securities.
       ``(2) Exceptions.--Notwithstanding paragraph (1), the 
     Commission may, by rule, regulation, or order, permit joint 
     management by a portfolio manager in exceptional 
     circumstances when necessary to protect the interest of 
     shareholders, provided that such rule, regulation, or order 
     requires--
       ``(A) enhanced disclosure by the registered open-end 
     investment company to shareholders of any conflicts of 
     interest raised by such joint management; and
       ``(B) fair and equitable policies and procedures for the 
     allocation of securities to the portfolios of the jointly 
     managed companies, and certification by the members of the 
     board of directors who are not interested persons of such 
     registered open-end investment company, in the periodic 
     report to shareholders, or other appropriate disclosure 
     document, that such policies and procedures of such company 
     are fair and equitable.
       ``(3) Definition.--For purposes of this subsection, the 
     term `portfolio manager' means the individual or individuals 
     who are designated as responsible for decision-making in 
     connection with the securities purchased and sold on behalf 
     of a registered open-end investment company, but shall not 
     include individuals who participate only in making research 
     recommendations or executing transactions on behalf of such 
     company.''.
       (b) Deadline for Rules.--The Commission shall prescribe 
     rules to implement section 15(h) of the Investment Company 
     Act of 1940, as added by subsection (a) of this section, not 
     later than 90 days after the date of enactment of this Act.

     SEC. 317. SELECTIVE DISCLOSURES.

       (a) In General.--The Commission shall promulgate such rules 
     as the Commission determines necessary to prevent the 
     selective disclosure by a registered investment company of 
     material information relating to the portfolio of securities 
     held by such company.
       (b) Requirements.--The rules promulgated under subsection 
     (a) shall treat selective disclosures of material information 
     by a registered investment company in substantially the same 
     manner as selective disclosures by issuers of securities 
     registered under section 12 of the Securities Exchange Act of 
     1934 under the rules of the Commission.

                           TITLE IV--STUDIES

     SEC. 410. STUDY OF ADVISER CONFLICT OF INTEREST.

       (a) In General.--The Commission shall conduct a study of--
       (1) the consequences of the inherent conflicts of interest 
     confronting investment advisers employed by registered 
     investment companies;
       (2) the extent to which legislative or regulatory measures 
     could minimize such conflicts of interest; and
       (3) the extent to which legislative or regulatory measures 
     could incentivize internal management of a registered 
     investment company.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     on the results of the study required under subsection (a) 
     to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 411. STUDY OF COORDINATION OF ENFORCEMENT EFFORTS.

       (a) In General.--The Comptroller General of the United 
     States, with the cooperation of the Commission, shall conduct 
     a study of the coordination of enforcement efforts between--
       (1) the headquarters of the Commission;
       (2) the regional offices of the Commission; and
       (3) State regulatory and law enforcement agencies.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     on the results of the study required under subsection (a) 
     to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 412. STUDY OF COMMISSION ORGANIZATIONAL STRUCTURE.

       (a) In General.--The Comptroller General of the United 
     States, with the cooperation of the Commission, shall conduct 
     a study of--
       (1) the current organizational structure of the Commission 
     with respect to the regulation of investment companies;
       (2) whether the organizational structure and resources of 
     the Commission sufficiently credit the importance of 
     oversight of investment companies to the 95 million investors 
     in such companies within the United States;
       (3) whether certain organizational features of that 
     structure, such as the separation of regulatory and 
     enforcement functions, are sufficient to promote the optimal 
     understanding of the current practices of investment 
     companies; and
       (4) whether a separate regulatory entity would improve or 
     impair effective oversight.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Comptroller General shall submit a 
     report on the results of the study required under subsection 
     (a) to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 413. TRENDS IN ARBITRATION CLAUSES.

       (a) In General.--The Commission shall conduct a study on 
     the trends in arbitration clauses between brokers, dealers, 
     and investors since December 31, 1995, and alternative means 
     to avert the filing of claims in Federal or State courts.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     on the results of the study required under subsection (a) 
     to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 414. HEDGE FUND REGULATION.

       (a) In General.--The Commission shall conduct a study of 
     whether additional regulation of alternative investment 
     vehicles, such as hedge funds, is appropriate to deter the 
     recurrence of trading abuses, manipulation of registered 
     investment companies by unregistered investment companies, or 
     other distortions that may harm investors in registered 
     investment companies.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     on the results of the study required under subsection (a) 
     to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.

     SEC. 415. INVESTOR EDUCATION AND THE INTERNET.

       (a) In General.--The Commission shall conduct a study of--
       (1) the means of enhancing the role of the Internet in 
     educating investors and providing timely information 
     regarding laws, regulations, enforcement proceedings, and 
     individual registered investment companies;
       (2) the feasibility of mandating that each registered 
     investment company maintain a website on which shall be 
     posted filings of the registered investment company with the 
     Commission and any other material information related to the 
     registered investment company; and
       (3) the means of ensuring that the EDGAR database 
     maintained by the Commission is user-friendly and contains a 
     search engine that facilitates the expeditious location of 
     material information.
       (b) Report.--Not later than 1 year after the date of 
     enactment of this Act, the Commission shall submit a report 
     on the results of the study required under subsection (a) 
     to--
       (1) the Committee on Banking, Housing, and Urban Affairs of 
     the Senate; and
       (2) the Committee on Financial Services of the House of 
     Representatives.
                                  ____


                                S. 2059

    Summary of Key Provisions of the Mutual Fund Reform Act of 2004

       The Mutual Fund Reform Act of 2004 makes fund governance 
     truly accountable, requires genuinely transparent total fund 
     costs, enhances comprehension and comparison of fund fees, 
     confronts trading abuses, creates a culture of compliance, 
     eliminates hidden transactions that mislead investors and 
     drive up costs--and saves billions of dollars for the 95 
     million Americans who invest in mutual funds. MFRA strives 
     above all to preserve the attractiveness of mutual funds as a 
     flexible and investor-friendly vehicle for long-term, 
     diversified investment.


                Title 1: Truly Fiduciary Fund Governance

       The Mutual Fund Reform Act of 2004 puts the interests of 
     investors first by:
       Ensuring independent and empowered boards of directors;

[[Page S803]]

       Clarifying and making specific fund directors' foremost 
     fiduciary duty to shareholders;
       Strengthening the fund advisers' fiduciary duty regarding 
     negotiating fees and providing fund information; and
       Instituting Sarbanes-Oxley-style provisions for independent 
     accounting and auditing, codes of ethics, chief compliance 
     officers, compliance certifications, and whistleblower 
     protections.


                 Title 2: Meaningful Fund Transparency

       The Mutual Reform Act of 2004 empowers both investors and 
     free markets with clear, comprehensible fund transaction 
     information by:
       Standardizing computation and disclosure of (i) fund 
     expenses and (ii) transaction costs, which yield a total 
     investment cost ratio, and tell investors actual dollar 
     costs;
       Providing disclosure and definitions of all types of costs 
     and requiring that the SEC approve imposition of any new 
     types of costs;
       Disclosing portfolio managers' compensation and stake in 
     fund;
       Disclosing broker compensation at the point of sale;
       Disclosing and explaining portfolio turnover ratios to 
     investors; and
       Disclosing proxy voting policies and record.


               Title 3: Straightforward Fund Transactions

       The Mutual Fund Reform Act of 2004 vastly simplifies 
     disclosure regime by:
       Eliminating asset-based distribution fees (Rule 12b-1 
     fees), the original purpose of which has been lost and the 
     current use of which is confusing and misleading--and 
     amending the Investment Company Act of 1940 to permit the use 
     of the adviser's fee for distribution expenses, which locates 
     the incentive to keep distribution expenses reasonable 
     exactly where it belongs--with the fund adviser;
       Prohibiting shadow transactions--such as revenue sharing, 
     directed brokerage, and soft-dollar arrangements--that are 
     riddled with conflicts of interest, serve no reasonable 
     business purpose, and drive up costs;
       ``Unbundling'' commissions, such that research and other 
     services, heretofore covered by hidden soft-dollar 
     arrangements, will be the subject of separate negotiation and 
     a freer and fairer market;
       Requiring enforceable market timing policies and mandatory 
     redemption fees--as well as provision by omnibus account 
     intermediaries of basic customer information to funds to 
     enable funds to enforce their market timing, redemption fee, 
     and breakpoint discount policies; and
       Requiring fair value pricing and strengthening late trading 
     rules.
                                  ____


                     Mutual Fund Reform Act of 2004

       The Mutual Fund Reform Act of 2004 (MFRA) restores truly 
     fiduciary fund governance, simplifies fund fees, confronts 
     trading abuses, creates a culture of compliance, and 
     eliminates the conflict-riddled shadow transactions that 
     drive up costs. The essence of the legislation is not any 
     regulatory regime it creates, but the market forces it 
     liberates. Obscurity is the enemy of a free market. Too 
     little information--and too much incomprehensible 
     information--equally undermine informed investor decision-
     making. The Mutual Fund Reform Act lifts the veil off 
     mislabeled and misleading transactions, ensures genuine 
     transparency, and promotes true price competition.
       With 95 million American stakeholders, mutual funds are 
     truly America's investment vehicle of choice. MFRA strives 
     above all to preserve the attractiveness of mutual funds as a 
     flexible and investor-friendly vehicle for long-term, 
     diversified investment. That goal requires a careful 
     balancing of accountability and incentive--or carrot and 
     stick. Federal and state governments cannot police, much less 
     micromanage, over 8,000 funds. The overriding duty to 
     shareholders rests primarily with the funds themselves, and 
     secondarily with the funds' service providers--each guided by 
     a clearer statement of purpose and priority, incentivized by 
     a more robust and transparent market that rewards low cost 
     and good performance--because it can truly identify them--and 
     accountable for failures that privilege fund managers' or 
     brokers' interests over shareholders.
       Vanguard Founder and industry savant John Bogle calls the 
     Mutual Fund Reform Act of 2004 ``the gold standard in putting 
     mutual fund shareholders back in the driver's seat.''The 
     Consumer Federation of America says the Mutual Fund Reform 
     Act of 2004 ``will save mutual fund investors potentially 
     tens of billions of dollars a year by wringing out excess 
     costs.'' The Securities and Exchange Commission's (SEC) 
     recent spate of regulatory initiatives is a testament to 
     Washington's will in redressing the scandals and excessive 
     fees that erode America's retirement and college savings. But 
     the SEC cannot take the range of initiatives that are 
     necessary to rationalize an industry governed by 64-year-old 
     legislation. It is time for Congress to take the step that 
     truly empowers America's investors and invigorates market 
     forces. It is time for reforms that finally put investors 
     first.
       MFRA is divided into four titles: Title 1 (Fund 
     Governance); Title 2 (Fund Transparency); Title 3 (Fund 
     Regulation and Oversight); and Title 4 (Studies). The 
     provisions under each title are analyzed below.


                        title 1: Fund Governance

                         Independent directors

       The Mutual Fund Reform Act empowers a truly independent 
     board of directors to exercise its essential ``watchdog'' 
     role as the original Investment company Act of 1940 
     envisioned. An inherent tendency to defer to authority--or to 
     parties with more information--must be countered with both 
     numbers and authority for the board to reliably flex its 
     independent muscle in the best interests of shareholders. 
     Thus, at least 75% of the board must be independent--
     including the chair.
       That independence must be self-perpetuating. Thus, 
     independent directors will nominate new directors and adopt 
     qualification standards for such nomination.
       Close relationships with fund advisers, or other 
     significant service providers, can easily compromise 
     independence. Thus, the legislation tightens the definition 
     of independence to exclude individuals with material business 
     or close family relationships with such service providers. 
     Further, the legislation directs the SEC to study whether 
     substantial aggregate compensation from a fund adviser, 
     especially when directors serve on multiple boards, 
     compromises independence.

                       Directors' fiduciary duty

       Building on the ringing declaration in the Investment 
     Company Act's Preamble, section 36(a) refers specifically to 
     the fiduciary duty of directors--but it has been a relatively 
     empty reference. Merely to recite ``fiduciary duty,'' it 
     appears, will not ensure fidelity to it. Directors need 
     direction--and content--in discharging their fiduciary 
     duties. MFRA supplies both. MFRA amends the Investment 
     Company Act to make expressly clear that the directors' 
     fiduciary duty obliges them to act in the best interests 
     of shareholders.
       A ``fiduciary'' duty is supposed to be a rigorous one--yet 
     its content has been unenforced guesswork. Mindful of the 
     industry's complexity, NFRA thus directs the SEC to provide 
     directors with specific guidance on the content of their 
     fiduciary duty. Such content will include, at a minimum, 
     determining the extent to which independent and reliable 
     sources of information are sufficient to discharge director 
     responsibilities, negotiating management and advisory fees 
     with due regard for the actual cost of services, including 
     economies of scale, evaluating management quality and 
     considering potentially superior alternatives, evaluating the 
     quality, comprehensiveness, and clarity of disclosures to 
     shareholders regarding costs, evaluating any distribution or 
     marketing plan of the company, including its costs and 
     benefits, evaluating the size of the fund's portfolio and its 
     suitability to the interests of shareholders, implementing 
     and monitoring policies and procedures to ensure compliance 
     with applicable securities laws, and implementing and 
     monitoring policies with respect to predatory trading 
     practices, such as market timing.

                  Investment advisers' fiduciary duty

       After Wharton School and SEC studies in the 1960s found 
     that mutual fund shareholders pay excessive fees because they 
     lack bargaining power, the SEC recommended to Congress that 
     it require that fees be ``reasonable.'' That did not happen. 
     Instead, in 1970, Congress imposed a ``fiduciary'' duty on 
     fund advisers with respect to fees. As with the directors' 
     ``fiduciary'' duty, however, the term lost any meaningful 
     moorning in client-first professional stewardship. Indeed, in 
     a watershed judicial interpretation of the adviser's 
     ``fiduciary'' duty under section 36(b), the Second Circuit 
     deemed the duty satisfied unless the adviser charged ``a fee 
     that is so disproportionately large that it bears no 
     reasonable relationship to the services rendered and could 
     not have been the product of arm's-length bargaining.'' 
     Gartenberg v. Merrill Lynch Asset Mgt., Inc., 694 F.2d 923 
     (2d Cir. 1982). Against such a startling hurdle, no plaintiff 
     ever wins an excessive fee case--and the SEC has declined to 
     hold fund directors accountable for failing adequately to 
     review adviser fee agreements (under section 36(a)).
       Once again, merely invoking the phrase ``fiduciary'' will 
     not ensure fair stewardship. MFRA makes clear that the fund 
     adviser's fiduciary duty with respect to fees ``may require 
     reasonable reference to actual costs of the adviser and 
     economies of scale.'' Advisers are entitled to a fair 
     profit--and nothing in MFRA ``caps'' or ``legislates'' fees, 
     or otherwise imposes a ``price control.'' But MFRA does 
     ensure that accountability is fairly allocated in the 
     interests of shareholders.
       MFRA also addresses another fiduciary deficit in the 
     relationship between fund adviser and fund director. 
     Conscientious independent directors may experience reckless 
     intimidation and misdirection trying to penetrate the 
     adviser's monopoly on critical fund information. Indeed, as 
     Fund Democracy founder Mercer Bullard noted three years ago, 
     under the current regime, ``fund directors who try to do 
     their jobs may do so at their own risk. In 1997, the 
     directors of the Navellier Aggressive Small-Cap fund 
     complained to the SEC that the fund's adviser, Louis 
     Navellier, had refused to provide information they needed to 
     evaluate his services. . . . Intent on proving that no good 
     deed goes unpunished, Navellier dragged the fund's directors 
     through years of litigation,'' which was finally resolved in 
     the directors' favor.
       Subjecting directors to the sufferance of fund advisers 
     turns the fiduciary duties of

[[Page S804]]

     both on their heads. MFRA cures this damaging imbalance by 
     specifying that fund advisers owe a specific fiduciary duty 
     to provide information that is material to fund governance. 
     In other words, directors will no longer be obliged to think 
     of every possible question necessary to obtain essential 
     information--much less be bullied by resistant advisers.

                      Termination of fund adviser

       When fund managers cease to perform as effective stewards 
     of the investments entrusted to them, they should be subject 
     to the market discipline facing most Americans on the job--
     termination. Independent directors, exercising their 
     fiduciary duties in the best interests of shareholders, 
     should have the latitude to replace fund managers without 
     undue fear of reprisal, spurious litigation, and other 
     tactics by recalcitrant advisers. MFRA accordingly directs 
     the SEC to issue regulations that facilitate the process by 
     which independent directors, upon critical evaluation of fund 
     management, terminate the service of fund management in the 
     exercise of their fiduciary duties without undue exposure to 
     financial or litigation risk.

                  Independent accounting and auditing

       Last December, Business Week magazine called for Congress 
     to ``reverse the embarrassing exemption it gave to the 
     mutual-fund industry from the Sarbanes-Oxley corporate reform 
     law's requirement that outside auditors evaluate internal 
     controls.'' MFRA requires an audit committee, with 
     requirements that track Sarbanes-Oxley provisions, and 
     selection by that committee of an independent accountant.

                          Compliance provisions

        MFRA, like S.1971 introduced by Senators Corzine and Dodd, 
     draws significant inspiration from the lessons of the 
     corporate scandals that gave rise to the Sarbanes-Oxley Act 
     of 2002. While those corporate scandals triggered a massive 
     public outcry, it is noteworthy that the total cost to the 
     American public was far less than the trading abuses and 
     excessive fees in the $7 trillion mutual fund industry. Thus, 
     MFRA engenders a culture of compliance--employing tools from 
     the landmark Sarbanes-Oxley Act.
        MFRA requires adoption--by funds, investment advisers, and 
     principal underwriters--of a code of ethics, which is 
     reasonably designed to prevent violation of securities laws. 
     This code must be disclosed to the public and reviewed 
     annually. MFRA further requires appointment of a chief 
     compliance officer, whose compensation is set by independent 
     directors, who reports directly to independent directors, who 
     may be an employee of the fund adviser, but who may be 
     terminated only with the consent of the independent 
     directors.
        MFRA requires certain certifications to ensure careful 
     monitoring and accountability. And finally, mindful of the 
     singular contribution of whistleblowers to illumination of 
     the current scandals, MFRA installs rigorous protections 
     against retaliation for disclosing violations of securities 
     laws or codes of ethics.


                       Title 2: Fund Transparency

                     Cost consolidation and clarity

        For the market to discipline excessively high-cost funds, 
     investors must know total costs in comprehensive and 
     accessible disclosures. Current regulations require 
     disclosure of a fund's ``expense ratio''--but that figure 
     excludes significant costs borne directly by investors. These 
     largely hidden ``transaction costs'' occur when the fund buys 
     and sells securities in its portfolio. As the SEC recently 
     noted in its Concept Release on transaction costs, ``for many 
     funds, the amount of transaction costs incurred during a 
     typical year is substantial. One study estimates that 
     commissions and spreads alone cost the average equity fund as 
     much as 75 basis points.'' In other words, transaction costs 
     may sometimes double the cost of investment. Additional 
     transaction costs, such as market impact and opportunity 
     costs, may cost even more.
        MFRA enhances cost disclosure in several ways. First, MFRA 
     requires standardized computation and disclosure of two cost 
     ratios: the first is the expense ratio, designed to capture 
     fund operating expenses, and the second is the transaction 
     cost ratio, designed to capture the true costs of portfolio 
     management. These two ratios must then be combined and 
     disclosed as a single ``investment cost ratio.'' MFRA 
     recognizes that certain transaction costs, such as 
     commissions and bid-ask spreads, are indisputable candidates 
     for disclosure in the ``transaction cost ratio''--while 
     others, such as market impact and opportunity costs, may more 
     precisely reflect simply the principal price a manager is 
     willing to pay (or accept) for securities, and thus may not, 
     in the ultimate judgment of the SEC, warrant computation and 
     disclosure as part of the transaction cost ratio.
        Additionally, MFRA assists investors confronting 
     voluminous fund information with clear, simple, and at-least 
     annual actual dollar cost disclosure. Including actual cost 
     disclosure in the one document that investors do routinely 
     review--their own statement--simplifies cost analysis for all 
     investors and promotes genuine cost competition.
        Some say that mutual fund reform invites the proverbial 
     ``rock on jello''--and that a wily industry will react to 
     reasonable restraints of one type of cost by simply shifting 
     the cost to a new label. MFRA stabilizes the mutual fund fee 
     structure. The SEC is directed to standardize all allowable 
     types or categories of fees, expenses, loads, or charges 
     borne by fund shareholders. New costs cannot be created 
     without an SEC determination that the new cost is in the best 
     interests of shareholders of (i) a particular fund, (ii) 
     certain types of funds, or (iii) funds generally. Everyone, 
     including (or perhaps especially) the mutual fund industry, 
     acknowledges the critical importance of restoring investor 
     trust. By stabilizing the fee structure--and building in 
     safeguards against cynical manipulation of complex fee 
     structures--MFRA takes the long stride toward ensuring 
     sustained investor confidence.
       Finally, MFRA addresses financial literacy by requiring 
     clear explanation and definition of all types of fees, 
     charges, expenses, loads, commissions, and payments--as well 
     as where investors may find additional information about 
     them.

           Advisor compensation and ownership of fund shares

       The Sarbanes-Oxley Act turned the spotlight on executive 
     compensation--not merely to satisfy casual investor curiosity 
     but to deter conflicts of interest and distorted incentives. 
     MFRA does the same--albeit only with respect to portfolio 
     management. If, as a consequence of disclosure, fund managers 
     feel more motivated to earn their compensation, so much the 
     better for investors. It may likewise be relevant whether 
     fund managers are invested in the very funds they manage--and 
     investors are entitled to know. Finally, insider transactions 
     in the fund must be disclosed to the board of directors. 
     Insider transactions are not per se problematic--quite the 
     contrary, it may be a strong positive to have fund managers 
     invested in the funds they manage. But to help deter 
     potential abuses, the board should be informed of insider 
     transactions. (In Title 3, MFRA prohibits short-term insider 
     transactions to prevent abusive rapid trading by insiders.)

                          Broker confirmations

       MFRA requires point-of-sale disclosure of the source and 
     compensation to be received by the broker in connection with 
     the transaction. Such disclosure is standard with other 
     financial instruments--and broker/dealers can do the same for 
     mutual fund investors. Significantly, however, as discussed 
     below, MFRA vastly simplifies broker disclosures by 
     prohibiting certain conflict-riddled broker-compensation 
     practices--such as revenue sharing, directed brokerage and 
     soft-dollar arrangements--that artificially inflate broker 
     commissions and introduce distorted sales incentives.

                          Breakpoint discounts

       Breakpoint discounts are essentially ``volume discounts''--
     reductions in sales charges for purchases beyond certain 
     thresholds. The policies for applying breakpoint discounts, 
     however, can be complicated. For example, an investor may be 
     entitled to a breakpoint discount based on total shares 
     purchased over a period of time, or from different accounts 
     or together with other family members.
       The National Association of Securities Dealers (the self-
     regulatory organization of brokers and dealers) estimated 
     that more than $86 million in breakpoint discounts were not 
     correctly applied by broker/dealers in 2001 and 2002, which 
     indicates investor overcharges in one out of every five 
     eligible transactions.
       MFRA requires more prominent disclosure of information and 
     policies about breakpoint discounts, so that investors are 
     better equipped to help themselves. Perhaps more importantly 
     as discussed below under Customer Information from Account 
     Intermediaries, MFRA bridges one critical gap in the uniform 
     application of breakpoint discount policies.

                        Portfolio turnover ratio

       Many investors do not understand that the benign, or even 
     enticing, term--``actively managed''--may conceal 
     inordinately high transaction costs. When fund managers buy 
     and sell securities in the fund portfolio, they incur 
     transaction costs, such as commissions, bid-ask spread costs, 
     market impact costs and opportunity costs. All of these costs 
     diminish performance. To be sure, some actively managed funds 
     do very well. But investors have a right to know, in 
     straightforward terms, just how ``actively'' the portfolio is 
     managed. The portfolio turnover ratio is a good indicator. 
     MFRA requires prominent disclosure of the portfolio turnover 
     ratio, as well as explanation of its meaning and implications 
     for cost and performance. Thus, MFRA takes no legislative 
     position on the propriety of active or passive management--
     but merely equips investors with clearer and more 
     comprehensible information so that they can make decisions 
     based upon their own investment objectives.

                    Proxy voting policies and record

       Mutual funds are a seven-trillion-dollar industry--and 
     control nearly one-third of U.S. equity voting power. See 
     Alan R. Palmiter, Mutual Fund Voting of Portfolio Shares: Why 
     Not Disclose? 23 Cardozo L. Rev. 1419, 1421 (March 2002). 
     That is an impressive stake in U.S. corporate governance. 
     Such enormous power is ill-suited to the shadows. MFRA 
     requires disclosure of the fund's proxy voting record, as 
     well as any proxy voting policies that may better equip 
     investors to align their mutual fund purchasing with their 
     corporate governance preferences.

[[Page S805]]

            Customer information from account intermediaries

       Rules against market timing, application of breakpoint 
     discounts, imposition of redemption fees on short-term 
     trading--all of these salutary practices work only if the 
     fund knows the identify and trading activity of its 
     investors. But many financial intermediaries, including 
     broker/dealers, convey aggregate trading information to funds 
     through ``omnibus accounts,'' consisting of multiple 
     anonymous fund customers. Failure of a fund to know its own 
     investors seriously impairs fair and uniform enforcement of 
     its trading policies.
       As Niels Holch, Executive Director of the Coalition of 
     Mutual Fund Investors, stated in a December 12, 2003 letter 
     to the SEC, ``individual, long-term shareholders will not 
     be guaranteed equal and fair application of fund policies, 
     procedures, fees and charges, unless and until each mutual 
     fund is provided information from its intermediaries about 
     the identity of all shareholders in omnibus accounts and 
     the individual transactions engaged in by those 
     shareholders.''
       MFRA requires that intermediaries convey to funds the basic 
     customer identification and trading activity information 
     needed to enforce fund policies fairly and uniformly. 
     However, such information may only be used to enforce fund 
     policies, and all proprietary rights to such customer 
     information under state and federal law are preserved.

                              Advertising

       Mutual funds fairly compete for investor attention and 
     purchase. Indeed, because a certain percentage of investors 
     can be expected to sell their shares every year, mutual funds 
     want to meet these redemptions with new purchases so that 
     ``net redemptions'' do not force funds to sell off too many 
     portfolio assets. Advertising is one way to stimulate demand. 
     However, some funds engage in questionable claims. 
     Performance advertising, in particular, is fertile territory 
     for misleading investors. Former SEC Chief Economist Susan 
     Woodward put the matter bluntly in a recent Wall street 
     Journal op-ed: ``A fund's past performance provides zero 
     guidance about its future performance.''
       MFRA directs the SEC to address several aspects of 
     performance advertising, including unrepresentative short-
     term performance, performance based upon undisclosed non-
     recurring or improbable events, and performance based upon 
     technically accurate but incomplete or misleading data.
       Truthful and non-misleading advertising is a right 
     guaranteed by the United States Constitution. MFRA respects 
     that right--with requisite emphasis on ``non-misleading.''


                 Title 3: Fund Regulation and Oversight

       MFRA is truly structural reform. It does not merely mandate 
     yet more ``disclosure'' in an industry already saturated with 
     voluminous disclosure rules. MFRA's essence is not the 
     regulatory regime that it creates, but the free market forces 
     that it liberates. MFRA fuels a competitive mutual fund 
     market by making its transactions honest and comprehensible. 
     Market distortions occur when market players can obscure 
     their activities and mislead consumers. Examples addressed in 
     MFRA include 12b-1 fees, revenue sharing, soft-dollar 
     arrangements, and directed brokerage. MFRA lifts the veil of 
     mislabeled and misleading transactions, creates true 
     transparency and promotes meaningful competition. Merely 
     demanding more disclosure--while salutary up to a point--
     risks encyclopedic and incomprehensible data dumps on 
     investors.
       A more honest and straightforward, and thus more vibrantly 
     competitive, mutual fund market well serves the 95 million 
     Americans who entrust their savings to mutual funds--and not 
     incidentally, well serves the robustness of the mutual fund 
     industry itself. Mercer Bullar, founder of Fund Democracy and 
     sponsor of the recent Fund Summit in Oxford, Mississippi--
     where 11 lawmakers, regulators, and industry leaders convened 
     to debate the direction of the industry--said of his 
     panelists that they all share the aspiration for ``America's 
     favorite retirement vehicle, a great institution, a great 
     industry, to provide the best service it can for America's 
     investors.'' That aspiration permeates the Mutual Fund Reform 
     Act of 2004. And central to that aspiration is the 
     recognition that scandal, cynicism, and revolt are inevitable 
     consequences of confusing and opaque cost schemes.
       Time magazine notes, for example, that investors have been 
     flocking to ``separately managed accounts''--customized 
     investment vehicles with minimum investment requirements. One 
     noteworthy virtue, writes Time, of separately managed 
     accounts: ``fee transparency. Typically, separate-account 
     mangers charge a flat annual fee of 1.5% to 2.5% of assets. 
     In most cases there are none of the loads, redemption fees, 
     12b-1 marketing fees, trading commissions, or soft-dollar 
     costs that proliferate in the mutual-fund world and drive 
     annual expenses far higher than disclosed levels.'' The 
     vexation here is not merely with the ``hiddenness'' of many 
     of these costs--but with the very existence of such a 
     confusing and cynical welter of ways to siphon investors' 
     money. MFRA is a decisive answer to that vexation--and an 
     answer that well serves all Americans, not only the ones who 
     can afford the minimum investment requirements of separately 
     managed accounts and hedge funds.

             Asset-based distribution expenses (Rule 12b-1)

       A sales load was once an honest sales load. Then came Rule 
     12b-1. Designed in 1980 by the SEC, Rule 12b-1 permitted 
     funds to use fund assets, temporarily, for distribution and 
     market--to (1) stimulate purchases and thus redress temporary 
     net redemptions, and (2) increase the size of the fund so 
     that cost savings from economies of scale could be passed 
     along to investors. The theory was sound. But Rule 12b-1 has 
     wandered far from its original moorings. It has become a 
     permanent fixture of most fee schedules, and can cost 
     investors up to 1% of their investment every year. Over the 
     life of a retirement plan, that 1% can cost an investor 35% 
     to 40% of his or her retirement income. And it does not 
     appear that investors have benefited from economies of scale.
       Nearly two-thirds of 12b-1 fees end up in the hands of 
     brokers. In other words, 12b-1 fees have become disguised 
     loads.
       Fund management properly includes fund distribution. MFRA 
     accordingly places the distribution duty where it belongs. 
     MFRA gets funds out of the distribution business by 
     prohibiting asset-based distribution fees (such as 12b-1 
     fees)--but, importantly, amends the Investment Company Act of 
     1940 to make clear that fund advisers may use their adviser 
     fees for distribution expenses. What happens when fund 
     advisers use their own profits--instead of tapping directly 
     into investors' money--for distribution expenses? 
     Distribution expenses become very reasonable.
       In negotiating their fees with an empowered and independent 
     board, advisers will now have to make the case that their 
     costs necessarily include specified distribution expenses. 
     And once advisers receive their fee, distribution expenses 
     will, dollar for dollar, reduce adviser profits. That dynamic 
     locates the incentive to keep distribution expenses 
     reasonable precisely where it belongs. And MFRA incorporates 
     one additional structural check on unreasonable distribution 
     expenses--one that goes to the heart of the inherent conflict 
     between fund managers and fund shareholders. If the board of 
     directors determines that certain distribution expenses are 
     not in the best interests of existing shareholders, then the 
     board may stipulate that no part of the adviser's fee may be 
     used for that expense. A distribution expense designed solely 
     to pump up the asset base of an already large fund, for 
     example, and not otherwise necessary to meet net redemptions, 
     would obviously well-serve the adviser, who collects a 
     percentage of net assets, but not necessarily existing 
     shareholders.
       Importantly, MFRA does not prohibit distribution expenses 
     or sales charges. Charging a load (subject to NASD rules) is 
     fully justified--but call it a load, make it account-based 
     and don't disguise it in a permanent asset-based distribution 
     fee.

                    Indefensible brokerage practices

       There is a reflexive preference in approaching our markets 
     for demanding ``disclosure'' as a total solution--and 
     sometimes as a total substitute for clear ethical and 
     practical judgments. But some practices cannot be rationally 
     defended. And some clear rules enrich and enliven our 
     markets. We do not tell football players that they can clip, 
     hold, or jump offside as long as they do so openly. We should 
     not tell fund advisers and broker-dealers that they may 
     misuse investor money with soft-dollar arrangements, revenue 
     sharing and directed brokerage as long as they file reports. 
     ``Disclosure'' of these practices merely precipitates an even 
     more confusing blizzard of incomprehensible information--and 
     even further alienates average investors from meaningful 
     participation in the mutual fund market. As former SEC 
     Chairman Arthur Levitt aptly remarked, ``[t]he law of 
     unintended results has come into play: Our passion for full 
     disclosure has created fact-bloated reports, and prospectuses 
     that are more redundant than revealing.'' Three practices--
     soft dollar arrangements, revenue sharing, and directed 
     brokerage--ought not clutter any mutual fund prospectus. And 
     neither funds nor fund advisers should be spending time and 
     money crafting elaborate disclosures and justifications of 
     ultimately indefensible practices. By simply prohibiting 
     these practices, MFRA vastly simplifies the disclosure 
     regime, and benefits all stakeholders.

                            Revenue sharing

       Kiplinger.com commentator Steven Goldberg calls revenue 
     sharing ``the fund industry's most insidious practice . . . 
     It sounds benign, but it boils down to mutual fund payola, 
     giving brokers, financial planners or other financial 
     advisers a little extra compensation if they sell a load fund 
     to you. That is, a little something extra over and above the 
     load you're already paying.'' A ``little something''? Annual 
     revenue sharing payments to brokerage firms total an 
     estimated $2 billion. And investors listening to a broker's 
     ``advice'' may not realize that the broker's ``Preferred 
     List'' of mutual funds is a function of this payola.
       Moreover, revenue-sharing, like nearly two-thirds of 12b-1 
     money, goes to brokers, as a presumptive ``distribution'' 
     expense--yet revenue sharing effectively circumvents the 
     elaborate rules capping 12b-1 fees at no more than 1% of 
     assets. The only difference is that revenue sharing payments 
     are made by the fund adviser, out of the adviser's fee--which 
     of course comes from the fund assets. Consumer Federation of 
     America, along with several consumer groups that have 
     endorsed MFRA, note the negative impact of revenue sharing, 
     despite the fact that such payments come from the adviser 
     rather than directly

[[Page S806]]

     from fund assets: ``At best, by eating into the manager's 
     bottom line, the payments may reduce the likelihood that the 
     management fee will be reduced in response to economies of 
     scale. At worst, fund managers will pass along those costs to 
     shareholders in a form that is even less transparent than 
     directed brokerage payments.''
       Revenue sharing aggravates the conflicted interests of both 
     brokers and fund advisers at the expense of fund 
     shareholders. On the one hand, brokers get payola out of the 
     fund adviser's management fee--and peddle funds they're paid 
     to peddle without the requisite regard for the investor's 
     best interests. On the other hand, fund advisers collectively 
     give away $2 billion of their evidently abundant fees to 
     promote yet further sales of fund shares, which increases 
     fund assets, which increases the adviser's fee, which makes 
     more money available for payola. MFRA breaks this investor-
     hostile circular enrichment, and restores rational solicitude 
     for investors' money.

                        Soft dollar arrangements

        Under soft dollar arrangements, brokers inflate their 
     commissions on portfolio trades and give credits to fund 
     managers in return. These credits are then used for research 
     services, software, hardware, and other manager 
     ``overhead''--which directly and immediately benefit fund 
     managers, but only indirectly, if at all, benefit the 
     shareholders who pay for them. Moreover, these direct costs 
     to shareholders are not even reflected in the expense ratio, 
     because commissions--as with all transaction costs--are 
     excluded from the expense ratio. Thus, by using surreptitious 
     soft dollars, instead of honest hard dollars, the industry 
     effectively hides yet another significant cost of mutual fund 
     investment.
        Soft dollars also effectively suppress entire markets. 
     Soft dollar arrangements distort the markets in both trade 
     executions and products and services ``purchased'' with soft 
     dollars--because there is little or no meaningful price 
     negotiation or competition in these markets. Why would there 
     be? Fund advisers use investors' money, through artificially 
     inflated brokerage commissions, and competition inevitably 
     and severely suffers when demand is driven by someone else's 
     money.
        Managers should pay for their overhead out of their 
     management fee instead of forcing shareholders to pick up the 
     tab through artificially inflated brokerage commissions. MFRA 
     effectively ``unbundles'' the commission dollar. All 
     stakeholders can then more readily assess the true cost of 
     trade execution. And industry research and other unbundled 
     services, now purchased with hard dollars through traditional 
     negotiation, will acquire more authentic market values. Some 
     services will thrive; others will crater. That happens when 
     the market is healthy and transparent, and the demand side 
     cannot spend someone else's money.
        MFRA's treatment of soft dollar arrangements, like its 
     treatment of 12b-1 fees, is inspired not by intent to 
     regulate private transactions--but to label such transactions 
     honestly. Just as a load is a load, and should be charged as 
     such, so research expense should be the fruit of competitive 
     negotiation for research--not the backdoor largesse of 
     forcing investors to pay inflated brokerage commissions.
        John Montgomery of Bridgeway Funds perfectly summarized 
     the justification for banning soft dollars (as opposed to 
     mandating yet more elaborate ``disclosures'') when he 
     testified before the House Capital Markets Subcommittee in 
     March 2003: ``The bottom lines: Congress should not work to 
     improve disclosure of soft dollars; it should simply stop the 
     practice altogether. Ultimately, this will improve the 
     quality of decisions made on things soft dollars buy, save 
     shareholders some money, and greatly reduce the time that 
     advisers, auditors, regulators, and lawyers spend trying to 
     document the fairness of a firm's practice.''

                           Directed brokerage

        Directed brokerage is the practice by a customer (such as 
     a mutual fund or affiliated person) of directing brokerage 
     business to a particular broker or dealer in exchange for 
     services other than trade executions. Examples of such 
     services include sales support (as with revenue sharing), or 
     administrative services. Directed brokerage seems benign--but 
     the effect is yet a further hidden cost to investors, in the 
     form of higher brokerage costs. Once brokerage is 
     ``directed'' by a customer, the manager's ability to obtain 
     better or less expensive execution from a different broker is 
     disabled.
        Last December, Louis Harvey, president of Dalbar Inc., a 
     Boston-based research company, told Investment News that the 
     practice of directed commissions obscures what best execution 
     actually costs. Thus, funds pay more than retail investors to 
     buy and sell stock. ``If the practice is done away with, it 
     will be replaced by competitive forces.''
        In recognition of the indefensibility of the practice, 
     several funds announced recently that they are ceasing 
     directed brokerage arrangements. The industry's leading trade 
     association, the Investment Company Institute, likewise 
     recently advocated prohibiting directed brokerage.

                              Late trading

        Late trading is already illegal. The policy problem with 
     late trading is not with the law, but with the practice of 
     processing some orders after the calculation of ``net asset 
     value'' (NAV), and thus share price, for that day. Typically, 
     mutual funds calculate their NAVs as of 4:00 p.m. EST, the 
     closing time of the major U.S. stock exchanges. The SEC's 
     Rule 22c-1 requires funds to calculate NAV at least once a 
     day. All orders to buy or sell mutual fund shares received 
     on a particular day are executed at the same price. Under 
     Rule 22c-1, orders to buy or sell mutual fund shares must 
     be executed at a price based on the NAV next calculated 
     after receipt of the order. The Rule therefore requires 
     that orders for most funds received after 4:00 p.m. be 
     executed using the next day's price.
       ``Late trading'' refers to the practice of submitting an 
     order to buy or redeem fund shares after the 4:00 p.m. 
     pricing time yet receiving that day's price rather than the 
     price set at 4:00 p.m. the following day, or placing a 
     conditional order prior to 4:00 p.m. that is either confirmed 
     or canceled after 4:00 p.m. A late trader typically seeks to 
     trade profitably on developments after 4:00 p.m., such as 
     earnings announcements or events in overseas markets. As 
     noted, late trading is already illegal.
       But when is an order to buy or sell ``received'' under Rule 
     22c-1--when the fund receives the order, or when an 
     intermediary (such as a retail broker or a 401k 
     administrator) receives the order? To date, the SEC has 
     interpreted ``receipt'' as used in Rule 22c-1 to include 
     receipt of an order to buy or sell mutual fund shares by 
     retail brokers and other intermediaries. Investors may thus 
     place orders to buy or sell fund shares through broker-
     dealers, through retirement accounts and through variable 
     insurance carriers, confident that they will receive that 
     day's price for the shares. According to some estimates, 
     mutual funds receive over half of their orders in the form of 
     aggregated orders provided by intermediaries after 4:00 p.m. 
     The SEC is currently reexamining its rules.
       MFRA directs the SEC to enforce the current strict terms of 
     Rule 22c-1--but gives the SEC the authority to fashion rules 
     that accommodate investors transacting through their 
     preferred intermediaries. For example, if it can be verified 
     that intermediaries received their orders from their 
     customers before 4:00 p.m.--and the intermediaries have 
     systems in place that ensure compliance and permit 
     independent verification--then the rules developed by the SEC 
     may permit processing of such orders by the mutual fund after 
     the 4:00 p.m. close. MFRA's ultimate purpose is two-fold: (1) 
     preserve the appeal of mutual funds as a flexible and 
     investor-friendly vehicle for long-term investment; and (2) 
     prevent the unfair dilution of mutual fund value by short-
     term predators.

                             Market timing

       ``I have no interest in building a business around market 
     timers, but at the same time I do not want to turn away $10-
     20m,'' wrote Richard Garland, then head of Janus Capital 
     Groups international business to a colleague. Thus did Mr. 
     Garland succinctly describe the sirenic tug that triggered 
     the current industry scandals.
       ``Market timing'' refers to a form of trading mutual fund 
     shares in which short-term investors seek to exploit a 
     perceived difference between the fund's calculated NAV and 
     the actual underlying value of the fund's portfolio holdings. 
     As earlier noted, funds must calculate their NAV and set 
     their share price at least once a day--typically at 4 p.m. 
     EST. Sometimes, the closing price of a portfolio security at 
     4:00 p.m. EST may not reflect its current market value. For 
     example, an event may occur or news may be released after 
     4:00 p.m. that can reasonably be expected to have an impact 
     on a security's price when trading resumes. Securities that 
     trade overseas are especially fertile ground for market 
     timers, because many hours may elapse between the close of 
     trading in an overseas market and the calculation of the 
     fund's NAV.
       Market timers seek to reap quick profits in mutual fund 
     shares from these arbitrage opportunities. A market timer 
     seeks to purchase a fund's shares based on events occurring 
     before the fund's NAV calculation. For example, a market 
     timer might guess that rising prices in the U.S. securities 
     markets indicate likely higher prices in overseas markets the 
     next day. The market timer would purchase mutual fund shares 
     that reflect stale closing prices in overseas markets. The 
     market timer would then redeem the fund's shares the next 
     day, when the fund's next NAV calculation would reflect the 
     presumably higher prices in overseas markets. The market 
     timer seeks to make a quick and relatively risk-free profit.
       Market timing is not specifically illegal--hence the 
     conundrum facing many fund advisers and other industry 
     players. But many mutual funds discourage market timing, 
     often resolutely, because timers take their profits directly 
     out of the value of shares held by long-term investors--i.e., 
     the very category of the 95 million American mutual fund 
     investors most likely to have entrusted retirement and 
     college savings to mutual funds. Sale of fund shares at an 
     artificially low price based on stale information dilutes the 
     ownership interest of existing shareholders. Similarly, 
     redemption of fund shares at an artificially high price 
     dilutes the interest of remaining shareholders.
       Some question whether market timing strategies really work. 
     Importantly, however, merely the perception that market 
     timing works, and is available, encourages rapid trading, 
     which burdens funds regardless of whether the underlying 
     timing strategy works. A fund forced to meet multiple 
     redemptions from rapid trading activity may be obliged to 
     keep more fund assets in cash

[[Page S807]]

     or sell more portfolio securities to meet such redemptions--
     which increases the fund's transactions costs at the expense 
     of existing shareholders.
       As noted earlier, MFRA's overriding purpose with respect to 
     trading abuses is two-fold: (1) preserve the appeal of mutual 
     funds as a flexible and investor-friendly vehicle for long-
     term investment; and (2) prevent the unfair dilution of 
     mutual fund value by short-term predators. MFRA thus 
     addresses the problem of market timing with solicitude for 
     the long-term investor, and steers market timing away from 
     the mutual funds. MFRA provisions include:
       Requiring explicit disclosure in fund offering documents of 
     market timing policies and specific procedures to enforce 
     policies--and requiring that such a policy be deemed a 
     ``fundamental investment policy'' (which cannot, under the 
     Investment Company Act of 1940, be changed without a 
     shareholder vote).
       Requiring that any fund that declines to adopt enforceable 
     restrictions on market timing must so advise prospective 
     investors in its prospectus, advertising, and otherwise as 
     determined by the SEC.
       Requiring regular fair value pricing--so that NAV more 
     fairly reflects actual portfolio value, and opportunities for 
     predatory arbitrage are diminished.
       Requiring mandatory redemption fees for short-term trading 
     (which fees are deposited back into fund assets, thus 
     benefiting all shareholders, while discouraging arbitrage by 
     increasing its cost).
       Permitting (but not requiring) redemption fees exceeding 
     two percent for short-term transactions that are unfair to 
     shareholders.


                            title 4: studies

                Learning from experiences: Further study

       MFRA seeks to perpetuate the dialogue and to preserve the 
     wisdom gathered from hard experience. Several studies are 
     directed:
       A study and report by the SEC on the consequences of the 
     inherent conflict of interest confronting fund advisers, the 
     extent to which legislative or regulatory measures could 
     minimize this conflict of interest, and the extent to which 
     legislative or regulatory measures could incentivize internal 
     management of mutual funds.
       A study and report by the General Accounting Office (GAO) 
     on coordination of enforcement efforts between SEC 
     headquarters, SEC regional offices, and state regulatory and 
     law enforcement entities.
       A study and report by GAO on the SEC's current 
     organizational structure with respect to investment company 
     regulation, and whether that organizational structure 
     sufficiently credits the importance of mutual fund oversight 
     to the 95 million mutual fund investors in America, and 
     whether certain features of that organizational structure, 
     such as the separation of regulatory and enforcement 
     functions, conduce to optimal regulatory understanding of 
     current practices.
       A study and report by the SEC on trends and causes in 
     arbitration claims since 1995, and means to avert claims.
       A study and report by the SEC on whether additional 
     regulation of alternative investment vehicles, such as hedge 
     funds, is appropriate to deter recurrence of trading abuses, 
     manipulation of regulated investment companies by unregulated 
     investment companies, or other distortion that may harm 
     investors in shares of registered investment companies.
       A study by the SEC, coupled with regulatory and acquisition 
     initiatives as appropriate, designed to enhance the role of 
     the internet in educating investors and providing timely 
     information about laws, regulations, enforcement proceedings 
     and individual funds. Further, the SEC should study the 
     feasibility of mandating that funds have websites, and 
     disclosure thereupon of material filings and fund 
     information. Further, the SEC should take necessary steps to 
     ensure that its EDGAR system is user-friendly and contains a 
     search-engine that facilitates expeditious location of 
     material information in the SEC's database.
                                 ______