[House Report 108-351]
[From the U.S. Government Publishing Office]



108th Congress                                                   Report
                        HOUSE OF REPRESENTATIVES
 1st Session                                                    108-351

======================================================================
 
        MUTUAL FUNDS INTEGRITY AND FEE TRANSPARENCY ACT OF 2003

                                _______
                                

November 4, 2003.--Committed to the Committee of the Whole House on the 
              State of the Union and ordered to be printed

                                _______
                                

  Mr. Oxley, from the Committee on Financial Services, submitted the 
                               following

                              R E P O R T

                        [To accompany H.R. 2420]

      [Including cost estimate of the Congressional Budget Office]

    The Committee on Financial Services, to whom was referred 
the bill (H.R. 2420) to improve transparency relating to the 
fees and costs that mutual fund investors incur and to improve 
corporate governance of mutual funds, having considered the 
same, report favorably thereon with an amendment and recommend 
that the bill as amended do pass.








                                CONTENTS

                                                                   Page
Amendment........................................................     1
Purpose and Summary..............................................     8
Background and Need for Legislation..............................     9
Hearings.........................................................    22
Committee Consideration..........................................    22
Committee Votes..................................................    23
Committee Oversight Findings.....................................    23
Performance Goals and Objectives.................................    23
New Budget Authority, Entitlement Authority, and Tax Expenditures    24
Committee Cost Estimate..........................................    24
Congressional Budget Office Cost Estimate........................    24
Federal Mandates Statement.......................................    25
Advisory Committee Statement.....................................    25
Constitutional Authority Statement...............................    25
Applicability to Legislative Branch..............................    26
Section-by-Section Analysis......................................    26
Changes in Existing Law Made by the Bill, as Reported............    32








                               Amendment

    The amendment is as follows:
    Strike all after the enacting clause and insert the 
following:

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Mutual Funds Integrity and Fee 
Transparency Act of 2003''.

SEC. 2. IMPROVED TRANSPARENCY OF MUTUAL FUND COSTS.

    (a) Regulation Revision Required.--Within 270 days after the date 
of enactment of this Act, the Securities and Exchange Commission shall 
revise regulations under the Securities Act of 1933, the Securities 
Exchange Act of 1934, or the Investment Company Act of 1940, or any 
combination thereof, to require, consistent with the protection of 
investors and the public interest, improved disclosure with respect to 
an open-end management investment company, in the quarterly statement 
or other periodic report to shareholders or other appropriate 
disclosure document, of the following:
          (1) The estimated amount, in dollars for each $1,000 of 
        investment in the company, of the operating expenses of the 
        company that are borne by shareholders.
          (2) The structure of, or method used to determine, the 
        compensation of individuals employed by the investment adviser 
        of the company to manage the portfolio of the company, and the 
        ownership interest of such individuals in the securities of the 
        company.
          (3) The portfolio turnover rate of the company, set forth in 
        a manner that facilitates comparison among investment 
        companies, and a description of the implications of a high 
        turnover rate for portfolio transaction costs and performance.
          (4) Information concerning the company's policies and 
        practices with respect to the payment of commissions for 
        effecting securities transactions to a member of an exchange, 
        broker, or dealer who--
                  (A) furnishes advice, either directly or through 
                publications or writings, as to the value of 
                securities, the advisability of investing in, 
                purchasing, or selling securities, and the availability 
                of securities or purchasers or sellers of securities;
                  (B) furnishes analyses and reports concerning 
                issuers, industries, securities, economic factors and 
                trends, portfolio strategy, and the performance of 
                accounts; or
                  (C) facilitates the sale and distribution of the 
                company's shares.
          (5) Information concerning payments by any person other than 
        the company that are intended to facilitate the sale and 
        distribution of the company's shares.
          (6) Information concerning discounts on front-end sales loads 
        for which investors may be eligible, including the minimum 
        purchase amounts required for such discounts.
  (b) Appropriate Disclosure Document.--
          (1) In general.--For purposes of subsection (a), a disclosure 
        shall not be considered to be made in an appropriate disclosure 
        document if the disclosure is made exclusively in a prospectus 
        or statement of additional information, or both such documents.
          (2) Exceptions.--Notwithstanding paragraph (1), the 
        disclosures required by paragraph (2) and (4) of subsection (a) 
        may be considered to be made in an appropriate disclosure 
        document if the disclosure is made exclusively in a prospectus 
        or statement of additional information, or both such documents.
  (c) Concept Release Required.--
          (1) In general.--The Commission shall issue a concept release 
        examining the issue of portfolio transaction costs incurred by 
        investment companies, including commission, spread, 
        opportunity, and market impact costs, with respect to trading 
        of portfolio securities and how such costs may be disclosed to 
        mutual fund investors in a manner that will enable investors to 
        compare such costs among funds.
          (2) Report and recommendations required.--The Commission 
        shall submit a report on the findings from the concept release 
        required by paragraph (1), as well as legislative and 
        regulatory recommendations, if any, to the Committee on 
        Financial Services of the House of Representatives and the 
        Committee on Banking, Housing, and Urban Affairs of the Senate, 
        no later than 270 days after the date of enactment of this Act.
  (d) Additional requirement for fee statement.--
          (1) In general.--Not later than 270 days after the date of 
        enactment of this Act, the Commission shall prescribe a rule to 
        require, with respect to an open-end management investment 
        company, in the quarterly statement or other periodic report, 
        or other appropriate disclosure document, a statement informing 
        shareholders that such shareholders have paid fees on their 
        investments, that such fees have been deducted from the amounts 
        shown on the statements, and where such shareholders may find 
        additional information regarding the amount of these fees.
          (2) Appropriate disclosure document.--The statement required 
        by paragraph (1) shall not be considered to be made in an 
        appropriate disclosure document unless such statement is--
                  (A) made in each periodic statement to a shareholder 
                that discloses the value of the holdings of the 
                shareholder in the securities of the company; and
                  (B) prominently displayed, in a location in close 
                proximity to the statement of the shares account value.
  (e) Reducing Burdens on Small Funds.--In prescribing rules under this 
section, the Commission shall give consideration to methods for 
reducing for small investment companies the burdens of making the 
disclosures required by such rules, consistent with the public interest 
and the protection of investors.

SEC. 3. OBLIGATIONS REGARDING CERTAIN DISTRIBUTION AND SOFT DOLLAR 
                    ARRANGEMENTS.

  (a) Reporting Requirement.--Section 15 of the Investment Company Act 
of 1940 (15 U.S.C. 80a-15) is amended by adding at the end the 
following new subsection:
  ``(g) Obligations Regarding Certain Distribution and Soft Dollar 
Arrangements.--
          ``(1) Reporting requirements.--Each investment adviser to a 
        registered investment company shall, no less frequently than 
        annually, submit to the board of directors of the company a 
        report on--
                  ``(A) payments during the reporting period by the 
                adviser (or an affiliated person of the adviser) that 
                were directly or indirectly made for the purpose of 
                promoting the sale of shares of the investment company 
                (referred to in paragraph (2) as a `revenue sharing 
                arrangement');
                  ``(B) services to the company provided or paid for by 
                a broker or dealer or an affiliated person of the 
                broker or dealer (other than brokerage and research 
                services) in exchange for the direction of brokerage to 
                the broker or dealer (referred to in paragraph (2) as a 
                `directed brokerage arrangement'); and
                  ``(C) research services obtained by the adviser (or 
                an affiliated person of the adviser) during the 
                reporting period from a broker or dealer the receipt of 
                which may reasonably be attributed to securities 
                transactions effected on behalf of the company or any 
                other company that is a member of the same group of 
                investment companies (referred to in paragraph (2) as a 
                `soft dollar arrangement').
          ``(2) Fiduciary duty of board of directors.--The board of 
        directors of a registered investment company shall have a 
        fiduciary duty--
                  ``(A) to review the investment adviser's direction of 
                the company's brokerage transactions, including 
                directed brokerage arrangements and soft dollar 
                arrangements, and to determine that the direction of 
                such brokerage is in the best interests of the 
                shareholders of the company; and
                  ``(B) to review any revenue sharing arrangements to 
                ensure compliance with this Act and the rules adopted 
                thereunder, and to determine that such revenue sharing 
                arrangements are in the best interests of the 
                shareholders of the company.
          ``(3) Summaries of reports in annual reports to 
        shareholders.--In accordance with regulations prescribed by the 
        Commission under paragraph (4), annual reports to shareholders 
        of a registered investment company shall include a summary of 
        the most recent report submitted to the board of directors 
        under paragraph (1).
          ``(4) Regulations.--The Commission shall adopt rules and 
        regulations implementing this section, which rules and 
        regulations shall, among other things, prescribe the content of 
        the required reports.
          ``(5) Definition.--For purposes of this subsection--
                  ``(A) the term `brokerage and research services' has 
                the same meaning as in section 28(e)(3) of the 
                Securities Exchange Act of 1934; and
                  ``(B) the term `research services' means the services 
                described in subparagraphs (A) and (B) of such 
                section.''.
  (b) Contractual Records.--Within 270 days after the date of enactment 
of this Act, the Securities and Exchange Commission shall, by rule 
prescribed pursuant to section 28(e) of the Securities Exchange Act of 
1934 (15 U.S.C. 78bb(e)), require that--
          (1) if any research services (as such term is defined in 
        section 15(g)(5)(B) of the Investment Company Act of 1940, as 
        amended by subsection (a) of this section)--
                  (A) are provided by a member of an exchange, broker, 
                or dealer who effects securities transactions in an 
                account, and
                  (B) are prepared or provided by a party that is 
                unaffiliated with such member, broker, or dealer,
        any person exercising investment discretion with respect to 
        such account shall maintain a copy of the written contract 
        between the person preparing such research and the member of an 
        exchange, broker, or dealer; and
          (2) such contract shall describe the nature and value of the 
        services provided.

SEC. 4. MUTUAL FUND GOVERNANCE.

  (a) Director Independence.--Section 10(a) of the Investment Company 
Act of 1940 (15 U.S.C. 80a-10) is amended by striking ``60 per centum'' 
and inserting ``one-third''.
  (b) Definition of Interested Person.--Section 2(a)(19) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19)) is amended--
          (1) in subparagraph (A)--
                  (A) by striking clause (vi) and redesignating clause 
                (vii) as clause (vi); and
                  (B) by amending clause (v) to read as follows:
                          ``(v) any natural person who is a member of a 
                        class of persons who the Commission, by rule or 
                        regulation, determines are unlikely to exercise 
                        an appropriate degree of independence as a 
                        result of--
                                  ``(I) a material business or 
                                professional relationship with the 
                                company or any affiliated person of the 
                                company, or
                                  ``(II) a close familial relationship 
                                with any natural person who is an 
                                affiliated person of the company,''; 
                                and
          (2) in subparagraph (B)--
                  (A) by striking clause (vi) and redesignating clause 
                (vii) as clause (vi); and
                  (B) by amending clause (v) to read as follows:
                          ``(v) any natural person who is a member of a 
                        class of persons who the Commission, by rule or 
                        regulation, determines are unlikely to exercise 
                        an appropriate degree of independence as a 
                        result of--
                                  ``(I) a material business or 
                                professional relationship with such 
                                investment adviser or principal 
                                underwriter (or affiliated person 
                                thereof), or
                                  ``(II) a close familial relationship 
                                with a natural person who is such 
                                investment adviser or principal 
                                underwriter (or affiliated person 
                                thereof),''.

SEC. 5. AUDIT COMMITTEE REQUIREMENTS FOR INVESTMENT COMPANIES.

  (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 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 new sentence: 
                ``The Commission, by rule, regulation, or order, may 
                exempt a registered management company or registered 
                face-amount certificate company 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 new subsection:
  ``(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 company, in 
        its capacity as a committee of the board of directors, shall be 
        directly responsible for the appointment, compensation, and 
        oversight of the work of any independent public accountant 
        employed by such registered 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 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 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 
                        company or the investment adviser or principal 
                        underwriter of the registered company; or
                          ``(ii) be an `interested person' of the 
                        registered company, as such term is defined in 
                        section 2(a)(19).
          ``(4) Complaints.--The audit committee of the registered 
        company shall establish procedures for--
                  ``(A) the receipt, retention, and treatment of 
                complaints received by the registered company regarding 
                accounting, internal accounting controls, or auditing 
                matters; and
                  ``(B) the confidential, anonymous submission by 
                employees of the registered 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 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 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 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 is amended by adding at the end the following new 
paragraph:
          ``(7) Exemption for investment companies.--Effective one year 
        after the date of enactment of the Mutual Funds Integrity and 
        Fee Transparency Act of 2003, 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.--Not later than 180 days after the date of 
enactment of this Act, the Securities and Exchange 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. 6. TRADING RESTRICTIONS.

  Subsection (e) of section 22 of the Investment Company Act of 1940 
(15 U.S.C. 80a-22(e)) is amended to read as follows:
  ``(e) Trading Restrictions.--
          ``(1) Prohibition and exceptions.--No registered investment 
        company shall suspend the right of redemption, or postpone the 
        date of payment or satisfaction upon redemption of any 
        redeemable security in accordance with its terms for more than 
        seven days after the tender of such security to the company or 
        its agents designated for that purpose for redemption, except--
                  ``(A) for any period (i) during which the principal 
                market for the securities in which the company invests 
                is closed, other than customary week-end and holiday 
                closings; or (ii) during which trading on such exchange 
                is restricted;
                  ``(B) for any period during which an emergency exists 
                as a result of which (i) disposal by the company of 
                securities owned by it is not reasonably practicable; 
                or (ii) it is not reasonably practicable for such 
                company fairly to determine the value of its net 
                assets; or
                  ``(C) for such other periods as the Commission may by 
                order permit for the protection of security holders of 
                the company.
          ``(2) Commission rules.--The Commission shall by rules and 
        regulations--
                  ``(A) determine the conditions under which trading 
                shall be deemed to be restricted;
                  ``(B) determine the conditions under which an 
                emergency shall be deemed to exist; and
                  ``(C) provide for the determination by each company, 
                subject to such limitations as the Commission shall 
                determine are necessary and appropriate for the 
                protection of investors, of the principal market for 
                the securities in which the company invests.''.

SEC. 7. DEFINITION OF NO-LOAD MUTUAL FUND.

  Within 270 days after the date of enactment of this Act, the 
Securities and Exchange Commission shall, by rule adopted by the 
Commission or a self-regulatory organization (or both)--
          (1) clarify the definition of ``no-load'' as such term is 
        used by investment companies that impose any fee under a plan 
        adopted pursuant to rule 12b-1 of the Commission's rules (17 
        CFR 270.12b-1); and
          (2) require disclosure to prevent investors from being misled 
        by the use of such terminology by the company or its adviser or 
        principal underwriter.

SEC. 8. INFORMING DIRECTORS OF SIGNIFICANT DEFICIENCIES.

  Section 42 of the Investment Company Act of 1940 (15 U.S.C. 80a-41) 
is amended by adding at the end the following new subsection:
  ``(f) Informing Directors of Significant Deficiencies.--If the report 
of an inspection by the Commission of a registered investment company 
identifies significant deficiencies in the operations of such company, 
or of its investment adviser or principal underwriter, the company 
shall provide such report to the directors of such company.''.

SEC. 9. EXEMPTION FROM IN PERSON MEETING REQUIREMENTS.

  Section 15(c) of the of the Investment Company Act of 1940 (15 U.S.C. 
80a-15(c)) is amended by adding at the end the following new sentence: 
``The Commission, by rule, regulation, or order, may exempt a 
registered investment company subject to this subsection from the 
requirement that the votes of its directors be cast at a meeting in 
person when such a requirement is impracticable, subject to such 
conditions as the Commission may require.''.

SEC. 10. PROXY VOTING DISCLOSURE.

  Section 30 of the Investment Company Act of 1940 (15 U.S.C. 80a-29) 
is amended by adding at the end the following new subsection:
  ``(k) Proxy Voting Disclosure.--Every registered management 
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 registrant's proxy voting record for the most recent 
twelve-month period ending on June 30. The financial statements of 
every such company shall state that information regarding how the 
company voted proxies relating to portfolio securities during the most 
recent 12-month period ending on June 30 is available--
          ``(1) 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
          ``(2) on the Commission's website.''.

SEC. 11. ETHICS COMPLIANCE BY MUTUAL FUNDS.

  Within 270 days after the date of enactment of this Act, the 
Commission shall, by rule pursuant to the Investment Company Act of 
1940 and the Investment Advisers Act of 1940, require each investment 
company and investment adviser registered with the Commission--
          (1) to adopt and implement policies and procedures reasonably 
        designed to prevent violation of 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.), the Trust Indenture Act of 1939 (15 U.S.C. 77aaa 
        et seq.), the Investment Company Act of 1940 (15 U.S.C. 80a-1 
        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);
          (2) review those policies and procedures annually for their 
        adequacy and the effectiveness of their implementation; and
          (3) appoint a chief compliance officer to be responsible for 
        administering the policies and procedures.

SEC. 12. INCENTIVE COMPENSATION AND MUTUAL FUND SALES.

  (a) Commission Rule Required.--Within 270 days after the date of 
enactment of this Act, the Commission shall by rule prohibit, as a 
means reasonably designed to prevent fraudulent, deceptive, or 
manipulative acts and practices, the sale of the securities of an 
investment company or of municipal fund securities by a broker or 
dealer or by a municipal securities broker or dealer without the 
disclosure of--
          (1) the amount and source of sales fees, payments by persons 
        other than the investment company that are intended to 
        facilitate the sale and distribution of the securities, and 
        commissions for effecting portfolio securities transactions, or 
        other payments, paid to such broker or dealer, or municipal 
        securities broker or dealer, or associated person thereof in 
        connection with such sale;
          (2) any commission or other fees or charges the investor has 
        paid or will or might be subject to, including as a result of 
        purchases or redemptions;
          (3) any conflicts of interest that any associated person of 
        the investor's broker or dealer or municipal securities broker 
        or dealer may face due to the receipt of differential 
        compensation in connection with such sale; and
          (4) information about the estimated amount of any asset-based 
        distribution expenses incurred, or to be incurred, by the 
        investment company in connection with the investor's purchase 
        of the securities.
  (b) Benchmarks.--In connection with the rule required by subsection 
(a), the Commission shall, to the extent practical, establish standards 
for such disclosures.
  (c) Definitions.--
          (1) Differential compensation.--For purposes of this section, 
        an associated person of a broker or dealer shall be considered 
        to receive differential compensation if such person receives 
        any increased or additional remuneration, in whatever form--
                  (A) for sales of the securities of an investment 
                company or municipal fund security that is affiliated 
                with, or otherwise specifically designated by, such 
                broker or dealer or municipal securities broker or 
                dealer, as compared with the remuneration for sales of 
                securities of an investment company or municipal fund 
                security offered by such broker or dealer or municipal 
                securities broker or dealer that are not so affiliated 
                or designated; or
                  (B) for the sale of any class of securities of an 
                investment company or municipal fund security as 
                compared with the remuneration for the sale of a class 
                of securities of such investment company or municipal 
                fund security (offered by such broker or dealer or 
                municipal securities broker or dealer) that charges a 
                sales load (as defined in section 2(a)(35) of the 
                Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(35)) 
                only at the time of such a sale.
          (2) Municipal fund security.--For purposes of this section, a 
        municipal fund security is any municipal security issued by an 
        issuer that, but for the application of section 2(b) of the 
        Investment Company Act of 1940 (15 U.S.C. 80a-2(b)), would 
        constitute an investment company within the meaning of section 
        3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3).

SEC. 13. COMMISSION STUDY AND REPORT REGULATING SOFT DOLLAR 
                    ARRANGEMENTS.

  (a) Study Required.--
          (1) In general.--The Commission shall conduct a study of the 
        use of soft dollar arrangements by investment advisers as 
        contemplated by section 28(e) of the Securities Exchange Act of 
        1934 (15 U.S.C. 78bb(e)).
          (2) Areas of consideration.--The study required by this 
        section shall examine--
                  (A) the trends in the average amounts of soft dollar 
                commissions paid by investment advisers and investment 
                companies in the past 3 years;
                  (B) the types of services provided through soft 
                dollar arrangements;
                  (C) the benefits and disadvantages of the use of soft 
                dollars for investors, including the extent to which 
                use of soft dollar arrangements affects the ability of 
                mutual fund investors to evaluate and compare the 
                expenses of different mutual funds;
                  (D) the potential or actual conflicts of interest (or 
                both potential and actual conflicts) created by soft 
                dollar arrangements, including whether certain 
                potential conflicts are being managed effectively by 
                other laws and regulations specifically addressing 
                those situations, the role of the board of directors in 
                managing these potential or actual (or both) conflicts, 
                and the effectiveness of the board in this capacity;
                  (E) the transparency of such soft dollar arrangements 
                to investment company shareholders and investment 
                advisory clients of investment advisers, the extent to 
                which enhanced disclosure is necessary or appropriate 
                to enable investors to better understand the impact of 
                these arrangements, and an assessment of whether the 
                cost of any enhanced disclosure or other regulatory 
                change would result in benefits to the investor; and
                  (F) whether such section 28(e) should be modified, 
                and whether other regulatory or legislative changes 
                should be considered and adopted to benefit investors.
  (b) Report Required.--The Commission shall submit a report on the 
study required by subsection (a) to the Committee on Financial Services 
of the House of Representatives and the Committee on Banking, Housing 
and Urban Affairs of the Senate, no later than one year after the date 
of enactment of this Act.

SEC. 14. STUDY OF ARBITRATION CLAIMS.

  (a) Study Required.--The Securities and Exchange Commission shall 
conduct a study of the increased rate of arbitration claims and 
decisions involving mutual funds since 1995 for the purposes of 
identifying trends in arbitration claim rates and, if applicable, the 
causes of such increased rates and the means to avert such causes.
  (b) Report.--The Securities and Exchange Commission shall submit a 
report on the study required by subsection (a) to the Committee on 
Financial Services of the House of Representatives and the Committee on 
Banking, Housing, and Urban Affairs of the Senate not later than one 
year after the date of enactment of this Act.

                          Purpose and Summary

    The purpose of H.R. 2420, the Mutual Funds Integrity and 
Fee Transparency Act of 2003, is to (1) improve transparency of 
mutual fund fees and costs and (2) improve corporate governance 
and management integrity of mutual funds. Better fee disclosure 
will promote robust industry competition and will help 
investors make more informed decisions about which mutual fund 
is most appropriate.
    Better corporate governance of mutual funds will enhance 
investor protection. The bill strengthens the influence of 
independent directors, who have a greater inclination to 
protect the interests of fund shareholders than those directors 
who are tied to the success of the mutual fund's management 
company. H.R. 2420 further promotes investor protection by 
directing the SEC to promulgate rules requiring enhanced 
disclosure and director scrutiny of directed brokerage, soft 
dollar and revenue sharing arrangements. The legislation also 
codifies the SEC rule requiring mutual funds to disclose both 
policies and procedures with respect to proxy voting and the 
actual votes cast, thus enabling shareholders to monitor their 
funds' involvement in the governance of portfolio companies. 
Finally, the legislation also codifies a pending Commission 
rule requiring mutual funds to implement internal audit 
procedures, including appointing a chief compliance officer to 
administer these procedures.

                  Background and Need for Legislation

    Mutual funds have brought the benefits of professional 
management, portfolio diversification, and securities ownership 
to millions of individuals. Today, 95 million individuals, 
comprising nearly half of all U.S. households, own mutual 
funds. The majority of these individuals represent households 
with moderate annual incomes between $25,000 and $75,000.
    The primary statute governing mutual funds is the 
Investment Company Act of 1940 (1940 Act). Its preamble calls 
for mutual funds to be ``organized, operated (and) managed'' in 
the interests of shareholders rather than in the interests of 
``directors, officers, investment advisers * * * underwriters 
or brokers.'' Some critics of mutual fund industry practices 
have charged that fund management companies and directors have 
not adequately served the interests of fund shareholders, as 
required by the 1940 Act.\1\ More recently, disturbing 
allegations have been made involving possible illegal activity 
harming long-term investors by a number of mutual funds, 
prompting a criminal investigation by State and Federal 
authorities.\2\
---------------------------------------------------------------------------
    \1\ See, e.g., John C. Bogle, The Emperor's New Mutual Funds, Wall 
Street Journal, July 8, 2003, at A16 (``I believe that the fund 
industry has not adequately measured up to its statutory 
responsibilities of stewardship to mutual fund investors. The express 
language of the preamble to the Investment Company Act of 1940 calls 
for mutual funds to be `organized, operated (and) managed' in the 
interests of shareholders rather than in the interest of `directors, 
officers, investment advisers * * * underwriters or brokers.' Yet since 
most new funds are organized to bring in assets and generate advisory 
fees, and operated at cost levels that virtually preclude market-
beating returns, it is simply impossible to believe the standards of 
that preamble are being honored * * *. The present situation, in which 
the fund adviser is typically the head of the fund's investment 
adviser, presents an unacceptable conflict of interest in the selection 
and compensation of fund management companies. Warren Buffett said it 
well: `Negotiating with oneself seldom produces a barroom brawl'.''); 
Neil Weinberg and Emily Lambert, The Great Fund Failure; why lousy 
managers, conflicts of interest and sky-high expenses are way too 
common in the fund business, Forbes, Sept. 15, 2003 (``* * * the fund 
business [is] shortsighted, poorly governed, weak on disclosure and 
riddled with conflicts of interest. This is an industry that pays lip 
service to helping investors achieve long-term goals while spending a 
bundle promoting the short-term payoff of hot-for-the-moment funds. It 
has tossed economies of scale out the window, charging more per dollar 
invested as fund assets have grown. Investors pay upwards of $100 
billion in annual fund costs and fees. What do they get for this? 
Almost by mathematical necessity, they get, on average, mediocrity.'').
    \2\ Shannon Buggs, Fund Scandal Threatens Very Foundation of 
Investing, Houston Chronicle, Sept. 8, 2003 (``Mutual funds are 
supposed to be the no-nonsense, safe and easy way to achieve your 
financial dreams * * *. That's why it's a gut punch to middle-income 
America's stomach to find out the companies that fashion themselves as 
the small investor's champions on Wall Street may be selling them 
out.'').
---------------------------------------------------------------------------
    It is widely recognized that one of the most important 
variables affecting fund performance is cost. Numerous studies 
and commentators have noted that equity mutual fund fees have 
continued to increase while fund returns have lagged those of 
relevant indexes. Yet, investors often are unaware of these 
fees. Mr. John C. Bogle, founder and former chief executive 
officer of The Vanguard Group, testified at a Capital Markets 
Subcommittee hearing that ``investors are largely unaware of 
the high level of mutual fund costs,'' and that ``since 
managers have an obvious vested interest sustaining this 
ignorance * * * we urgently need new SEC rules that require 
greater cost disclosure.'' \3\ The Securities and Exchange 
Commission (the SEC or the Commission), in a letter to 
Subcommittee Chairman Richard H. Baker, cited surveys 
demonstrating that investors do not understand the nature and 
effect of ongoing mutual fund fees.\4\
---------------------------------------------------------------------------
    \3\ Hearing on Mutual Fund Industry Practices and Their Effect on 
Individual Investors Before the House Committee on Financial Services, 
108th Cong. 11 (Mar. 12, 2003) (testimony of Mr. John C. Bogle, founder 
and former Chief Executive Officer, The Vanguard Group) [hereinafter 
Hearing on Mutual Fund Industry Practices].
    \4\ Letter from the Honorable William H. Donaldson, Chairman, 
Securities and Exchange Commission, to Congressman Richard H. Baker, 
Chairman, House Committee on Financial Services, Capital Markets 
Subcommittee, 11-12 (June 9, 2003) [hereinafter SEC Response].
---------------------------------------------------------------------------
    Mutual fund investors would be the direct beneficiaries of 
greater fee-based competition among mutual funds; more 
accessible and understandable information about mutual fund 
fees; stronger oversight by independent fund directors; and 
enhanced firewalls against a variety of conflicts of interest 
raised by the way mutual funds are operated and sold. H.R. 2420 
would provide all of these reforms for mutual fund investors.

Fee Disclosure

    There are several different types of costs associated with 
mutual funds. The costs that are disclosed in the fund's 
prospectus include account-based costs, such as sales loads, 
and ongoing costs, disclosed as the fund's ``expense ratio.'' 
Sales loads are a one-time fee, generally charged to an 
investor's account at the time of purchase or, in some cases, 
at the time of redemption. The expense ratio reflects the 
fund's annual operating expenses as a percentage of assets and 
is an ongoing charge. Unlike sales loads, the expenses included 
in the expense ratio are not charged directly to an investor's 
account, but are deducted from fund assets prior to earnings 
distributions to shareholders. The operating expenses include 
(1) the management or advisory fee, which is used to pay the 
adviser for managing the fund's investment portfolio, (2) 12b-1 
fees, which are used to pay for distribution and marketing of 
fund shares, and (3) the administrative costs for operating the 
fund.
    A mutual fund's board of directors is responsible for 
supervising fund fees. The board of directors, which must 
approve the contracts between the fund and its service 
providers, has a fiduciary obligation to the fund and must 
therefore ensure that the shareholders' interests are being 
served. As Mr. Bogle stated at a hearing before the 
Subcommittee, ``fund costs make the difference: As it turns 
out, the major reason that the return of the average equity 
fund lagged the stock market by 3.1 percent during the past 
twenty years is the costs that investors' funds incur--the 
management fees, the operating expenses, the out-of-pocket 
fees, the portfolio transaction costs, the sales charges, and 
the opportunity cost represented by the significant cash 
positions typically held by funds.'' \5\ In fact, a recent 
Standard & Poor's study found that mutual funds with lower fees 
(as measured by expense ratios) have outperformed their more 
expensive peers in nearly all fund categories.\6\ The study 
demonstrated that lower-cost funds beat more expensive ones in 
8 of the 9 domestic fund style categories over one, 3, 5, and 
ten years on an annualized basis.
---------------------------------------------------------------------------
    \5\ Hearing on Mutual Fund Industry Practices, 7-8 (testimony of 
Mr. Bogle, the Vanguard Group).
    \6\ Julie Earle-Levine, Low-fee funds outperform costlier rivals, 
Financial Times; June 12, 2003, at 21.
---------------------------------------------------------------------------
    In its 2000 report on mutual fund costs, the U.S. General 
Accounting Office (GAO) found that mutual funds do not 
generally compete for investors based on fees.\7\ In its 2003 
report, the GAO found that the average fees charged by 77 of 
the largest mutual funds had increased because of higher 
management fees to investment advisers.\8\ Mr. Bogle noted in 
testimony before the Subcommittee that the expense ratio of the 
average fund recently stood at 1.36 percent--49 percent higher 
than in the late 1970s.\9\ This data suggests that the fund 
companies have failed to deliver on their promise of lower fees 
through economies of scale. In addition, the SEC cited several 
surveys illustrating that mutual fund investors do not 
understand the fees they pay. For example, the SEC referred to 
a recent survey that found that 75 percent of respondents could 
not accurately define ``expense ratio'' and 64 percent did not 
understand the impact of expenses on fund returns.\10\ Another 
academic study in 2002 found that, despite clear evidence to 
the contrary, 84 percent of investors believe higher fees buy 
better performance.\11\ The 2000 GAO study stated, ``[s]tudies 
and data that others, and we, collected, indicate that mutual 
fund investors have focused more on fund performance and other 
factors than on fee levels. In contrast to the consideration 
they give fees, investors appear more concerned over the level 
of mutual fund sales charges (loads).'' \12\ As a result, fund 
advisers have lowered the loads charged on mutual funds since 
the 1980s.
---------------------------------------------------------------------------
    \7\ United States General Accounting Office, Report to the 
Chairman, Subcommittee on Finance and Hazardous Materials; and the 
Ranking Member, Committee on Commerce, House of Representatives, Mutual 
Fund Fees: Additional Disclosure Could Encourage Price Competition, at 
62 (June 2000) [hereinafter, 2000 GAO study].
    \8\ United States General Accounting Office, Report to 
Congressional Requesters, Mutual Funds: Information on Trends in Fees 
and their Related Disclosure, 6-9 (March 12, 2003).
    \9\ Hearing on Mutual Fund Industry Practices, 1, 3, Exhibit 1 
(testimony of Mr. Bogle, the Vanguard Group).
    \10\ SEC Response, at 12.
    \11\ Weinberg and Lambert, supra note 1.
    \12\ 2000 GAO study, at 66.
---------------------------------------------------------------------------
    H.R. 2420 carries the potential to similarly affect mutual 
fund fees. The bill makes substantial changes to fund 
disclosures with regard to fund operating expenses, portfolio 
turnover, directed brokerage, revenue sharing, soft dollar 
arrangements and breakpoint discounts, among other things, in 
an effort to enhance transparency of fees and costs associated 
with mutual funds.
    The SEC recently proposed a new rule that would require 
disclosure in a fund's semi-annual and annual report to include 
(1) a dollar example of the fees an investor would have paid on 
a hypothetical $10,000 investment, using the actual expenses 
incurred by the fund and the actual return achieved by the 
fund; and (2) the same dollar example, using the actual 
expenses incurred, but assuming a 5 percent return over the 
period so funds could be compared against each other. 
Currently, funds must provide similar disclosures (a dollar 
example of the fees an investor would pay on a hypothetical 
$10,000 investment in the fund based on expected, not actual 
fees, and assuming a 5 percent annual return) but this 
disclosure is only included in the fund's prospectus. H.R. 2420 
generally codifies the pending SEC proposal, but includes two 
important changes: first, the dollar example in the annual 
report must be based on a hypothetical $1,000 investment. The 
Committee believes that using $1,000 as the example will make 
it easier for investors to calculate the amount of fees paid. 
Second, the legislation includes a requirement that account 
statements include a legend prominently stating that (1) the 
investor has paid fees on the mutual fund investments, (2) 
those fees have been deducted from the amount shown on the 
statement, and (3) the investor can find more information by 
referring to documents disclosing the amounts of those fees.

Portfolio Transaction Expenses

    Portfolio transaction expenses are the costs funds incur 
when they buy and sell securities. These costs can be 
enormously significant, and in some cases, exceed the fund's 
operating expenses. According to some estimates, in 2002 the 
mutual fund industry paid brokers about $6 billion in 
commissions.\13\ It has been estimated that between $1 billion 
and $4 billion was paid for something other than simple trade 
execution.\14\ Trading costs can easily double the annual 
expense of a mutual fund. Mr. Gary Gensler, former Under 
Secretary of the Treasury and co-author of The Great Mutual 
Fund Trap, has stated that ``[r]ight now the average annual 
expense ratio for a mutual fund is about 1.3 percent, but when 
you add up trading costs and all the other fees, you can get up 
to 3 percent in annual costs.'' \15\
---------------------------------------------------------------------------
    \13\ Julie Creswell, Dirty Little Secrets; The mutual fund industry 
has been playing fast and loose with your dollars. Will the SEC finally 
take action?, Fortune, Sept. 1, 2003, at 133.
    \14\ Id.
    \15\ Id.
---------------------------------------------------------------------------
    Yet mutual fund transaction costs are not disclosed to 
investors in a useful way. Funds are required to include their 
commission costs, in dollars, in the Statement of Additional 
Information (the ``SAI''), a dense disclosure document that 
investors must request from the fund. Many believe this 
information is of limited utility to investors because (1) it 
is relatively inaccessible, (2) it does not include portfolio 
execution costs such as bid/ask spreads, which can be as high 
or higher than commission costs, and (3) the dollar format does 
not permit comparison against other funds as easily as 
percentages would.
    In testimony before the Subcommittee, Mr. John Montgomery, 
founder and President of Bridgeway Funds, cited a hypothetical 
example of a fund with an average trading cost of 1 percent 
(which he called ``probably conservative'') and a turnover rate 
of 100 percent, meaning the fund buys and sells the equivalent 
of the entire fund in one year's time. This fund, he noted, 
would have a total trading cost of 2 percent (purchases plus 
sales), which is significantly higher than the entire operating 
expense ratio of those funds. For small company funds, the 
trading costs are roughly twice as much. To ``beat the 
market,'' he concluded, the portfolio manager would have to add 
back value equal to the operating expense ratio of the fund 
(1.4 percent, on average), plus 2 percent in trading costs--``a 
huge performance hurdle to overcome and [one that] highlights 
the need for some way to provide shareholders with information 
on its magnitude.'' \16\
---------------------------------------------------------------------------
    \16\ Hearing on Mutual Fund Industry Practices, 5 (testimony of Mr. 
John Montgomery, founder and President, Bridgeway Funds).
---------------------------------------------------------------------------
    Similarly, Mr. Mercer Bullard, founder and chief executive 
officer of Fund Democracy, Inc., citing numerous studies, 
testified that ``portfolio transaction costs can be the single 
largest fund expense, exceeding all other fund expenses 
combined. These costs are not, however, included in fee 
information provided by the prospectus.'' \17\ He, and several 
other witnesses, stated that providing more meaningful 
disclosure for some types of transaction costs would be easier 
than for others. Commission costs, which are currently required 
to be included in a fund's SAI in dollar amounts, might be a 
more useful measure if disclosed ``per average net assets,'' 
and included in a document, such as the semi-annual report to 
shareholders, that is more accessible than the SAI.\18\ Other 
transaction costs, such as spread costs, market impact and 
opportunity costs, are more difficult to measure and there are 
no standardized methods for calculating these costs. There are, 
however, a number of private companies that do provide fund 
advisers with this information, for self-evaluative and board 
review purposes.
---------------------------------------------------------------------------
    \17\ Hearing on H.R. 2420 the Mutual Funds Integrity and Fee 
Transparency Act of 2003 Before the House Committee on Financial 
Services, 108th Cong. 6-7 (June 18, 2003; Serial No. 108-XX) (testimony 
of Mr. Mercer Bullard, founder and CEO, Fund Democracy, Inc.) 
[hereinafter Hearing on H.R. 2420].
    \18\ Hearing on Mutual Fund Industry Practices, 8 (testimony of Mr. 
Montgomery, Bridgeway Funds).
---------------------------------------------------------------------------
    Recognizing that developing an agreed-upon standard for 
valuing these costs will be a complicated, yet necessary, 
undertaking, the Committee directs the Commission in H.R. 2420 
to promulgate a ``concept release'' seeking input on this 
issue, for purposes of establishing rules that will provide 
more useful information to investors about these significant, 
but currently hidden, mutual fund costs.
    The legislation also directs the Commission to use a proxy 
for fund transaction costs, in the form of portfolio turnover, 
to provide investors more immediately with a useful tool with 
which to judge the potential transaction costs incurred by a 
fund. H.R. 2420 requires mutual fund companies to improve the 
portfolio turnover disclosure that funds currently provide, by 
including this disclosure in a document that is more widely 
read than the prospectus or SAI, and by requiring a textual 
explanation of the impact of high portfolio turnover rates on 
fund expenses and performance.

Portfolio Manager Compensation and Holdings

    Mutual funds are not required to disclose the compensation 
or structure of compensation of portfolio managers. Mr. 
Montgomery testified that ``When we invest in individual 
companies, we have the right to know the compensation of the 
company leaders. When we invest in mutual funds, we are in the 
dark * * * we believe that investors should know the actual 
compensation and structure of that compensation as it relates 
to the fund's management * * * compensation structure and level 
may strongly affect portfolio manager incentives and the 
decisions he or she makes on behalf of a fund.'' \19\ The SEC 
staff stated:
---------------------------------------------------------------------------
    \19\ Id. at 6.

          [D]isclosure regarding the structure of an individual 
        portfolio manager's compensation might * * * be useful 
        in supplementing existing disclosure of the advisory 
        fee. It could provide fund shareholders with 
        information that would be helpful in assessing the 
        incentives of the individuals who are managing the 
        fund. For example, disclosure that a manager is 
        compensated based on the fund's performance for a 
        particular period, e.g., 3 months, 1 year, or 5 years, 
        may shed light on the manager's incentives to maximize 
        short-term or long-term performance. Similarly, 
        disclosure of whether a portfolio manager's 
        compensation is based on a fund's pre-tax or after-tax 
        returns may be useful in assessing whether a fund is an 
        appropriate investment for a taxable or tax-deferred 
        account.\20\
---------------------------------------------------------------------------
    \20\ SEC Response, at 43.

    Accordingly, H.R. 2420 directs the Commission to issue 
rules requiring disclosure of the structure of fund manager 
compensation.
    Additionally, the legislation addresses the issue of fund 
manager investments in the fund he or she manages. Currently, 
funds are required to disclose fund ownership by officers and 
directors, but not individual portfolio managers. Mr. 
Montgomery and other commentators have argued for disclosure by 
portfolio managers as well, because it would help investors 
assess the confidence level of the portfolio manager. 
Similarly, the Commission staff noted that ``disclosure of a 
portfolio manager's holdings of fund shares could provide some 
indication of his or her alignment with the interests of fund 
shareholders * * * [and] could also provide investors with some 
insight into the level of confidence that a manager has in the 
investment strategy of the fund.'' \21\ Accordingly, the 
legislation directs the Commission to require that fund 
managers disclose their holdings in the funds they manage.
---------------------------------------------------------------------------
    \21\ Id. at 44-45.
---------------------------------------------------------------------------

Breakpoint Discounts

    Many mutual funds sell funds with front-end loads that may 
be reduced based on the amount of an investor's holdings 
(``breakpoint discounts''). Many investors, however, are 
unaware that they may be eligible for the discounts, and have 
overpaid front-end sales loads when they were actually entitled 
to a reduced rate pursuant to the fund's breakpoint policy. The 
staffs of the New York Stock Exchange and NASD recently 
conducted examinations of 43 broker-dealers that sell funds 
with front-end sales loads to determine whether investors were 
receiving the promised breakpoint discounts. These regulators 
found significant failures by the broker-dealers to deliver the 
discounts to eligible customers, and recently issued a report 
recommending improved disclosure.\22\ H.R. 2420 requires the 
Commission to mandate improved disclosure to help investors 
determine whether they are eligible for a discount. The 
Committee recognizes that it is the obligation of 
intermediaries such as brokers to ensure that their customers 
are given the breakpoint discounts that apply to a fund. The 
Committee also notes that it is the obligation of the fund's 
board of directors, which oversee the fund's operations 
generally, to ensure that appropriate mechanisms are in place 
so that fund shareholders receive the benefits of breakpoint 
discounts and other provisions that are disclosed in the fund's 
prospectus.
---------------------------------------------------------------------------
    \22\ Joint SEC/NASD/NYSE Report of Examinations of Broker/Dealers 
Regarding Discounts on Front-End Sales Charges on Mutual Funds, at 14-
16 (Mar. 11, 2003). The report found that most of the 43 broker/dealers 
examined failed to provide the appropriate breakpoint discount to 
customers in a significant number of cases. The group of firms examined 
did not provide breakpoints in about one-third of the breakpoint-
eligible transactions analyzed--the average dollar amount of the 
discount not provided was $364.
---------------------------------------------------------------------------

Revenue Sharing Arrangements

    Under a revenue sharing arrangement, the adviser of a fund 
uses its own profits to pay a broker or other party to sell 
shares of the fund. Revenue sharing is generally not disclosed 
to investors, thus leaving investors unaware of the incentives 
a broker may have for recommending one fund over another. SEC 
Chairman Donaldson at a Subcommittee hearing on May 22, 2003, 
testified that he believed that an investor should be informed 
of the incentives and the compensation that a broker or branch 
manager receives in promoting or selling a fund to an investor. 
Chairman Donaldson stated, ``A prospective buyer, in my view, 
has a right to know what incentives lie behind a 
recommendation.'' \23\ According to Donaldson, the SEC's 
``bottom line goal is to assure that a potential mutual fund 
investor through an investment banking firm is aware of all the 
compensation or inducements that are being paid to the broker 
that is selling them.'' \24\
---------------------------------------------------------------------------
    \23\ Hearing on The Long and Short of Hedge Funds: Effects of 
Strategies for Managing Market Risk Before the House Committee on 
Financial Services, 108th Cong. 35 (May 22, 2003) (statement of 
Chairman Donaldson, Securities and Exchange Commission).
    \24\ Id.
---------------------------------------------------------------------------
    Mr. Paul Roye, Director of the Commission's Division of 
Investment Management, echoed Chairman Donaldson's views on 
mutual fund revenue-sharing arrangements in his June 18, 2003, 
Subcommittee testimony. Mr. Roye declared that broker 
compensation is an area where disclosure can be improved. 
According to Mr. Roye, ``the investor ought to understand the 
incentives and the compensation that that broker has in 
promoting the fund or trying to sell the fund to you.'' \25\
---------------------------------------------------------------------------
    \25\ Hearing on H.R. 2420, 41 (testimony of Mr. Paul Roye, 
Director, Division of Investment Management, Securities and Exchange 
Commission).
---------------------------------------------------------------------------
    In addition, revenue sharing arrangements may be used in 
ways that constitute a violation of the 1940 Act, if an adviser 
is actually using fund assets, disguised as its own profits, to 
pay for distribution. As the Commission staff pointed out in 
its June 9, 2003, letter to Subcommittee Chairman Baker:

          Revenue-sharing payments may * * * affect funds and 
        their shareholders. Investment advisory fees may be 
        higher than they otherwise would be if no revenue-
        sharing payments were made * * *. In addition, an 
        investment adviser that makes revenue-sharing payments 
        for an existing fund may be less willing to agree to a 
        reduction of its investment advisory fee because its 
        profit already is reduced from making the payments. 
        Thus, in some instances, funds and their shareholders 
        may be effectively bearing the costs of the revenue-
        sharing payments made by the funds' investment 
        advisers.\26\
---------------------------------------------------------------------------
    \26\ SEC Response, at 81-82.

    Accordingly, the legislation requires fund directors to 
review these arrangements, consistent with their fiduciary duty 
to the fund. In seeking to enhance the mutual fund board's 
oversight of revenue sharing and other arrangements, the 
Committee recognizes the different roles of the board and the 
adviser. Directed brokerage and soft dollar activities 
potentially involve the assets of the fund and its 
shareholders, and therefore must be reviewed by the board under 
an exacting fiduciary duty standard. Revenue sharing 
arrangements, to the extent they involve 12b-1 plans, also 
involve fund assets and its shareholders and deserve comparable 
scrutiny by the board. The Committee recognizes that some 
revenue sharing arrangements involve the adviser's use of its 
legitimate profits, rather than fund assets. Because of the 
concerns highlighted by the Commission staff, the Committee 
believes it is important for the fund board to be aware of 
these revenue sharing arrangements when it assesses the fund's 
contract with the adviser, as part of its fiduciary obligation 
to the fund and its overall assessment of whether the adviser 
is charging fees to the fund that are reasonable in the 
aggregate in relation to the services provided by the adviser.

Directed Brokerage Arrangements

    Directed brokerage arrangements are also not clearly 
disclosed to investors. The Commission staff noted in its June 
9 response that funds have increasingly used a portion of the 
brokerage commissions that they pay on their portfolio 
transactions to compensate broker-dealers for distribution of 
fund shares. Certain of these arrangements, the staff observed, 
``result in the use of fund assets to facilitate distribution 
and should be reflected in rule 12b-1 distribution plans.''
    Accordingly, the bill directs the Commission to require 
enhanced disclosure of these arrangements, as well as enhanced 
oversight by the board of these arrangements, consistent with 
the board's fiduciary obligations to the fund.

Soft Dollar Arrangements

    A soft dollar transaction is one in which an investment 
adviser directs client brokerage transactions to a broker and, 
in exchange, receives research or other services from the 
broker or a third party. These transactions are permitted 
pursuant to a ``safe harbor'' provided by section 28(e) of the 
Securities Exchange Act of 1934. Soft dollar arrangements have 
been subject to criticism because of the potential for 
conflicts of interest between a fund and the investment 
adviser. Mr. Harold Bradley, Senior Vice President of American 
Century Investments, testified:

          Client[s] * * * pay [for] products and services as 
        part of the brokerage commissions charged to [an] 
        account * * * present[ing] an obvious temptation to the 
        manager to buy items that benefit [him]self rather than 
        the client, or items, such as general research reports, 
        quotations services and computer hardware and software, 
        that other managers consider their own responsibility 
        under their basic management fee. The money manager may 
        also pay too much in commissions or engage in 
        unnecessary trading so as to generate more commissions 
        and thus more soft dollars.\27\
---------------------------------------------------------------------------
    \27\ Hearing On Mutual Fund Industry Practices, 8-9 (testimony of 
Mr. Harold S. Bradley, Senior Vice President, American Century 
Investment Management).

    According to another witness, the problem with soft dollar 
arrangements is that there is an ``inadequate incentive for the 
adviser to keep trading costs low.'' \28\ He argues that 
shareholders should only pay for the benefits of soft dollar 
arrangements through management fees because the shareholder 
hires the adviser to manage the portfolio, which includes 
stock-picking tools.\29\
---------------------------------------------------------------------------
    \28\ Id. at 4 (testimony of Mr. Montgomery, Bridgeway Funds).
    \29\ Id.
---------------------------------------------------------------------------
    The Commission staff, discussing concerns about soft dollar 
arrangements, stated:

          We are * * * concerned about the growth of soft 
        dollar arrangements and the conflicts they may present 
        to money managers, including fund advisers * * *. The 
        effect of section 28(e) is to suspend the application 
        of otherwise applicable law, including fiduciary 
        principles, and to shift responsibility to advisory 
        clients (including fund boards) to supervise their 
        money manager's use of soft dollars and the resulting 
        conflicts of interest, based on disclosure that the 
        clients receive from the money manager.\30\
---------------------------------------------------------------------------
    \30\ SEC Response, at 37-38 (citing Section 28(e)(2) of the 
Securities and Exchange Act of 1934, which authorizes the Commission to 
require disclosure of an adviser's soft dollar policies and practices).

    H.R. 2420 addresses the inherent conflicts of interest with 
respect to soft dollar arrangements. First, the legislation 
requires the Commission to issue rules mandating disclosure of 
information about soft dollar arrangements.
    Second, the legislation requires fund advisers to submit to 
the fund's board of directors an annual report on these 
arrangements, and requires the fund to provide shareholders 
with a summary of that report in its annual report to 
shareholders.
    Third, the legislation imposes a fiduciary duty on the 
fund's board of directors to review soft dollar arrangements, 
consistent with their obligations to the fund.
    Fourth, the legislation directs the Commission to issue 
rules to require enhanced recordkeeping of soft dollar 
arrangements. When soft dollar research services are provided 
in connection with a fund's transactions, the person exercising 
investment discretion with respect to the fund must maintain a 
copy of the written contract relating to those arrangements. 
The contract must describe the nature and value of the services 
provided. The Committee notes that the Commission staff stated 
that ``we * * * expect to ask the Commission to propose changes 
to the record-keeping rule under the Advisers Act to require 
advisers to keep better records of the products and services 
they receive for soft dollars * * *'' \31\
---------------------------------------------------------------------------
    \31\ SEC Response, at 41.
---------------------------------------------------------------------------
    Finally, the legislation orders the Commission to conduct a 
study of soft-dollar arrangements, including: the trends in the 
average amounts of soft dollar commissions paid by investment 
advisers and funds; the types of services provided through 
these arrangements; the benefits and disadvantages of the use 
of soft dollar arrangements including the impact of soft dollar 
arrangements on investors' ability to evaluate and compare the 
expenses of different mutual funds; the potential or actual 
conflicts of interest created by these arrangements and the 
effectiveness of the board of directors in managing these 
conflicts; the transparency of soft dollar arrangements; and 
whether the ``safe harbor'' should be modified.
    The Committee is aware that securities regulators in other 
jurisdictions are also reviewing soft dollar arrangements.\32\ 
The Committee believes that regulations addressing soft dollar 
arrangements in other jurisdictions may not necessarily be 
appropriate for the United States, given the particular 
features of U.S. markets, including the importance of mutual 
funds as an investment vehicle and the diverse nature of U.S. 
providers of brokerage and research services.
---------------------------------------------------------------------------
    \32\ See, e.g., Bundled Brokerage and Soft Commission Arrangements, 
Consultation Paper 176, the United Kingdom Financial Services Authority 
(April 2003).
---------------------------------------------------------------------------

Independent Fund Directors

    Mutual fund management companies (i.e., fund advisers) are 
distinct from the funds themselves and have their own profits 
and, sometimes, shareholders to consider. Mutual funds 
themselves are, in fact, owned by their investors, not their 
advisers. While investors have the ability to ``vote with their 
feet'' by redeeming their shares of a fund if they are 
dissatisfied with the fund's performance (or for any other 
reason), and have occasional opportunities to vote in board 
elections, on changes in certain contractual fees, and other 
matters, in practice, mutual fund investors have very little 
power over the company they own. The Commission has noted that 
mutual funds are effectively dominated by their advisers.\33\ 
Mutual funds are set up by advisers, not by individual 
investors. Generally, all of the research, trading, money 
management and customer support staff actually work for the 
fund's adviser, distributor, or other service providers. While 
shareholders vote on the fund's directors, the adviser 
initially selects the directors, who rely on the adviser's 
staff for information. Furthermore, fund companies often set up 
a pooled structure, whereby fund directors serve on all of the 
fund boards in a fund complex.
---------------------------------------------------------------------------
    \33\ See, e.g., Role of Independent Directors of Investment 
Companies, Investment Company Act RE. No. 24082, at Part I (Oct. 15, 
1999) (``investment advisers typically dominate the funds they 
advise'').
---------------------------------------------------------------------------
    As Mr. Montgomery observed in his testimony:

          Over the years, I have examined the record of some of 
        the consistently worst-performing funds and wondered, 
        ``Where are the boards of directors?'' Unlike the 
        boards of privately held firms, non-profit 
        organizations, or even publicly traded companies with 
        multiple constituencies, a mutual fund's board really 
        exists only to protect the interest of its 
        shareholders. Nevertheless, 5 mutual funds declined by 
        more than 20 percent per year over the last 5 years; 3 
        of these had dismal returns for the 4 or 5 years before 
        this. The average expense ratio of these 5 funds is 
        11.5 percent, more than the entire average annual 
        return of the stock market. How can these funds hope to 
        make any return for shareholders? Why doesn't someone 
        put them out of their misery? \34\
---------------------------------------------------------------------------
    \34\ Hearing on Mutual Fund Industry Practices, 7 (testimony of Mr. 
Montgomery, Bridgeway Funds).

    Similarly, another witness testified that ``there is 
significant evidence suggesting that fund directors generally 
do not actively pursue fee reduction or changing money 
managers.'' \35\
---------------------------------------------------------------------------
    \35\ Id. at 11 (testimony of Mr. Gary Gensler, former Under 
Secretary for Domestic Finance, Department of the Treasury).
---------------------------------------------------------------------------
    In an effort to address the conflicts of interest inherent 
in the structure of mutual funds, the 1940 Act establishes 
specific roles and independence standards for mutual fund 
directors. As Mr. Bullard has observed, the effective 
domination of a fund by its adviser ``necessarily compromises 
the control normally exercised under State law by a board of 
directors. To compensate for this imbalance, it follows that 
additional requirements, beyond those provided under State law, 
may be necessary for the board to effectively police the 
adviser's conflicts of interest and protect shareholders.'' 
\36\
---------------------------------------------------------------------------
    \36\ Letter from Mr. Bullard to Chairman Baker and Ranking Member 
Paul E. Kanjorski (July 9, 2003), at 8 [hereinafter Bullard July 9 
Letter].
---------------------------------------------------------------------------
    The 1940 Act imposes those additional requirements, in the 
form of a requirement that ``interested persons''--i.e., non-
independent directors--comprise no more than 60 percent of a 
fund's board. In 2001, the SEC took various actions in an 
effort to make fund directors more independent of their adviser 
by raising the required percentage of independent directors 
from 40 to 50 percent. In practice, though, commentators have 
argued that fund directors have a difficult time striking a 
proper balance between working with the adviser and vigorously 
pursuing investors' interests. Mr. Gary Gensler, former Under 
Secretary of the Treasury for Domestic Finance, suggested that, 
``Too often the outcome is simply acquiescence to whatever the 
adviser proposes.'' \37\ He continued, ``many directors view 
their role as simply auditing the performance of the adviser 
and making sure there is no malfeasance or accounting problems, 
rather than acting as investors' vigorous advocates.'' \38\ 
Clearly, the greater the influence of independent directors on 
a board, the greater their ability to protect the interests of 
shareholders against those of the directors whose interests are 
tied to the success of the management company.
---------------------------------------------------------------------------
    \37\ Hearing on Mutual Fund Industry Practices, 6 (testimony of Mr. 
Gensler).
    \38\ Id.
---------------------------------------------------------------------------
    H.R. 2420 strengthens the influence of independent 
directors on fund boards by requiring that independent 
directors comprise at least two-thirds of the board. As Mr. 
Bullard noted:

          [T]he need for fund boards to be independent is much 
        greater than for operating company boards. The 
        conflicts between operating company directors and 
        management are mitigated by the fact that they report 
        to the same shareholders--the shareholders of the 
        company. In contrast, fund directors and management 
        report to different sets of shareholders. Fund 
        directors report to the shareholders of the funds. Fund 
        management reports to the shareholders of the manager.
          This unique structural conflict of interest lies at 
        the heart of fund regulation and is the most 
        distinguishing feature of mutual funds in comparison 
        with other types of companies. Congress has long 
        recognized that this conflict of interest necessitates 
        heightened standards of independence to ensure that 
        shareholders' interests are protected.\39\
---------------------------------------------------------------------------
    \39\ Bullard July 9 Letter, at 9.

    The Committee notes that the recent allegations, if true, 
involving criminal activity (permitting late-day trading for 
favored institutional clients) by numerous large mutual fund 
companies represent the most recent example of fund directors' 
failing to meet their fiduciary obligation to the funds they 
represent.

Audit Committee Requirements

    H.R. 2420 extends certain provisions to enhance the 
independence and authority of mutual funds' audit committees. 
The bill strengthens the audit committee of a fund by requiring 
that all of its members be independent. To further the 
objectivity of financial reporting, the bill charges the audit 
committee with direct responsibility for the appointment, 
compensation and oversight of the mutual fund's accountant. The 
bill also requires the audit committee to establish procedures 
for handling complaints regarding accounting matters and grants 
the audit committee the authority to engage and compensate 
outside advisers to assist it in carrying out its duties. In 
turn, the mutual fund is required to provide the appropriate 
funding for the audit committee to compensate the fund's 
accountant and any outside advisers it engages.

Use of the Term ``No-Load''

    Under current NASD rules, funds may not call themselves 
``no-load'' if they charge a 12b-1 fee of more than 25 basis 
points. However, they may use the term if they charge a 12b-1 
fee of 25 basis points or less. This may confuse investors, who 
might think that ``no-load'' means the fund is not charging any 
12b-1 fee at all. The bill directs the Commission to clarify 
rules relating to the use of the term ``no-load'' by mutual 
funds, so investors may better understand what they are 
actually paying when they choose such a fund. At a minimum, the 
Commission's rule should require disclosure designed to inform 
investors that the designation ``no-load,'' when used by a 
mutual fund, means that investors in the fund are not assessed 
certain transaction-based charges when purchasing or selling 
shares of the fund, but does not mean that the fund pays no 
operating fees or expenses.

Proxy Voting Disclosures

    Recent business scandals have created renewed investor 
interest in issues of corporate governance, underscoring the 
need for mutual funds to focus on this issue. Despite the fact 
that millions of American investors own the underlying 
securities of mutual funds, funds have been extremely reluctant 
to disclose how they exercise their proxy voting power with 
respect to portfolio securities. With the overwhelming support 
of investor advocacy groups, the Commission adopted a rule 
earlier this year that requires investment companies to 
disclose their policies and procedures with respect to proxy 
voting as well as the actual votes cast. By implementing the 
rule, the Commission sought to increase transparency of proxy 
voting by mutual funds, thereby enabling fund shareholders to 
monitor their funds' involvement in the governance of portfolio 
companies, which could have a dramatic impact on shareholder 
value in funds. The Committee strongly agrees with the 
Commission's position and supports this rule. H.R. 2420 
codifies the rule, to ensure that all mutual fund investors 
continue to get this important information.

Informing Directors of Significant Deficiencies

    The Commission staff regularly inspects mutual funds. In 
practice, the staff generally informs the fund's adviser of any 
significant deficiencies that are discovered. H.R. 2420 
includes a new requirement that the fund's board of directors 
be provided with a report of any deficiencies, to ensure that 
they will be able to take any necessary corrective action.

Ethics Compliance

    H.R. 2420 codifies aspects of a Commission proposal to 
strengthen the corporate governance practices of mutual funds. 
In February 2003, the Commission issued a proposed rule that 
would require investment companies to implement internal audit 
procedures to promote compliance and detect violations of 
Federal securities laws.\40\ The proposed rule would require 
investment companies to designate a chief compliance officer to 
administer the internal audit program. The internal audit 
program would have to be reviewed annually to evaluate its 
effectiveness. Imposing routine internal audits on investment 
companies helps foster early detection of practices harmful to 
investors and provides a deterrent to unlawful conduct. 
Moreover, strong internal auditing programs reduce the 
likelihood of securities law violations and allow companies to 
correct potential violations early. The Committee notes that 
the recent allegations, if true, of criminal activity by 
numerous large mutual fund companies further underscores the 
pressing need for adoption of these ethics-related provisions.
---------------------------------------------------------------------------
    \40\ Compliance Programs of Investment Companies and Investment 
Advisers, 68 Fed. Reg. 7037 (proposed Feb. 11, 2003).
---------------------------------------------------------------------------

Sales Practices and Broker Incentive Compensation

    H.R. 2420 includes a provision to address undisclosed 
conflicts of interest created by financial incentives for 
brokers to sell certain types of funds. The practice of 
providing financial incentives to brokers and branch managers 
to sell a particular fund, such as an in-house fund (i.e., a 
fund that is advised by the broker's employer) or a fund on a 
``preferred list'' (i.e., a fund that has paid the broker for 
``shelf space''), has been the subject of recent scrutiny by 
Federal and State regulators, including regulators in 
Massachusetts and New York as well as the SEC and NASD. 
Investors are not told that brokers may have a financial 
incentive to sell a particular fund, which is an obvious 
conflict of interest that should be disclosed to them. In 
testimony before the Committee, SEC Chairman Donaldson and Mr. 
Roye both agreed that disclosure of this information should be 
required.\41\
---------------------------------------------------------------------------
    \41\ See--supra notes 23-25 and accompanying text.
---------------------------------------------------------------------------
    Similar concerns have been raised regarding financial 
incentives, in the form of higher commissions, for brokers to 
promote a particular class of fund shares. When consumers buy 
mutual funds, they can choose from (1) Class A shares, which 
charge a commission upfront but have lower ongoing management 
fees, (2) Class B shares, which have higher ongoing fees and 
charge a commission if shares are redeemed before a certain 
period of time, or (3) Class C shares, which charge no 
commission but carry the highest ongoing fees. Concerns have 
been raised about brokers improperly recommending Class B 
shares, which are designed for long-term investors (because of 
the deferred sales charge), to short-term investors who would 
have paid a lower commission had they purchased Class A 
shares.\42\
---------------------------------------------------------------------------
    \42\ See Brooke A. Masters, The Cost of Buying In, Washington Post, 
July 6, 2003, at F1.
---------------------------------------------------------------------------
    H.R. 2420 addresses these concerns by directing the 
Commission to issue a rule requiring disclosure to mutual fund 
investors regarding any financial incentives provided to 
brokers for selling particular funds, as well as any conflicts 
of interest that the broker may face due to these financial 
incentives.

Study of Arbitration Claims Involving Mutual Funds

    This provision directs the SEC to study the dramatic 
increase in arbitration claims involving mutual funds since 
1995. Arbitration cases involving mutual funds have increased 
ten-fold in just the past few years, skyrocketing from 121 in 
1999 to 1,249 in 2002.\43\ The study will identify the reasons 
for this troubling trend, and will, therefore, help the 
Commission and the Committee enact measures to reverse it.
---------------------------------------------------------------------------
    \43\ http://www.nasdadr.com/statistics.asp.
---------------------------------------------------------------------------

                                Hearings

    On March 12, 2003, the Subcommittee on Capital Markets, 
Insurance, and Government Sponsored Enterprises held a hearing 
entitled ``Mutual Fund Industry Practices and Their Effect on 
Individual Investors.'' A number of issues were discussed, 
including mutual fund fees and the transparency of those fees, 
mutual fund governance, and other matters affecting fund 
investors. The Subcommittee heard testimony from Mr. John C. 
Bogle, founder and former chief executive officer, The Vanguard 
Group; Mr. Wayne H. Wagner, Chairman, Plexus Group, Inc.; Mr. 
John Montgomery, founder and President, Bridgeway Funds; Mr. 
Harold S. Bradley, Senior Vice President, American Century 
Investments; Mr. Paul Haaga, Jr., Executive Vice President, 
Capital Research and Management Company, and Chairman, 
Investment Company Institute; Mr. Gary Gensler, former Under 
Secretary for Domestic Finance, Department of the Treasury; and 
Mr. James S. Riepe, Chairman, T. Rowe Price Associates, Inc.
    On June 18, 2003, the Subcommittee on Capital Markets, 
Insurance, and Government Sponsored Enterprises held a 
legislative hearing on H.R. 2420, the Mutual Fund Integrity and 
Fee Transparency Act of 2003, a bill introduced by Subcommittee 
Chairman Baker which addresses concerns raised at the March 12 
hearing. The Subcommittee accepted written testimony by Mr. 
Paul Roye, Director of the Division of Investment Management, 
U.S. Securities and Exchange Commission; Mr. Richard Hillman, 
Director, Financial Markets and Community Investment, U.S. 
General Accounting Office; Mr. John C. Bogle, founder and 
former chief executive officer, The Vanguard Group; Mr. Mercer 
Bullard, President, Fund Democracy; Ms. Mellody Hobson, 
President, Ariel Mutual Funds; and Mr. Paul Haaga, Jr., 
Executive Vice President, Capital Research and Management 
Company, and Chairman, Investment Company Institute.

                        Committee Consideration

    The Subcommittee on Capital Markets, Insurance, and 
Government Sponsored Enterprises was discharged from the 
further consideration of H.R. 2420 on July 18, 2003.
    On July 23, 2003, the Committee on Financial Services met 
in open session and ordered H.R. 2420 reported to the House 
with a favorable recommendation, with an amendment, by a voice 
vote.

                            Committee Votes

    Clause 3(b) of rule XIII of the Rules of the House of 
Representatives requires the Committee to list the record votes 
on the motion to report legislation and amendments thereto. No 
record votes were taken in conjunction with the consideration 
of this legislation. A motion by Mr. Oxley to report the bill 
to the House with a favorable recommendation was agreed to by a 
voice vote.
    The following amendments were considered:

          An amendment in the nature of a substitute offered by 
        Mr. Oxley, no. 1, making a number of technical and 
        substantive changes to the bill, was agreed to by a 
        voice vote, as amended.
          An amendment to the amendment in the nature of a 
        substitute offered by Mr. Kanjorski, no. 1a, reducing 
        disclosure burdens on small funds, was agreed to by a 
        voice vote.
          An amendment to the amendment in the nature of a 
        substitute offered by Mr. Tiberi, no. 1b, striking the 
        independent chairman provision, was agreed to by a 
        voice vote.
          An amendment to the amendment in the nature of a 
        substitute offered by Mr. Baker, no. 1c, requiring 
        disclosure of proxy voting, an amendment to the 
        amendment in the nature of a substitute offered by Mr. 
        Baker, no. 1d, requiring each investment company and 
        investment adviser registered with the SEC to have a 
        code of ethics and a chief compliance officer, and an 
        amendment to the amendment in the nature of a 
        substitute offered by Mr. Baker, no. 1e, requiring the 
        portfolio manager disclose any holdings they have in 
        the funds they manage, were agreed to en bloc by a 
        voice vote.
          An amendment to the amendment in the nature of a 
        substitute offered by Mr. Baker, no. 1f, requiring 
        brokers disclose to investors whether or not they have 
        received an incentive to sell a particular fund or 
        class of shares, was agreed to by a voice vote.
          An amendment to the amendment in the nature of a 
        substitute offered by Mr. Shays, no. 1g, prohibiting 
        any registered investment company from using deceptive 
        or misleading names, was not agreed to by a voice vote.

                      Committee Oversight Findings

    Pursuant to clause 3(c)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee made findings that are 
reflected in this report.

                    Performance Goals and Objectives

    Pursuant to clause 3(c)(4) of rule XIII of the Rules of the 
House of Representatives, the Committee establishes the 
following performance related goals and objectives for this 
legislation:
    The SEC will utilize the authority granted by this 
legislation to improve the operation of the Nation's securities 
markets and protect investors by improving the governance of 
mutual funds and the disclosures made by those funds.

   New Budget Authority, Entitlement Authority, and Tax Expenditures

    In compliance with clause 3(c)(2) of rule XIII of the Rules 
of the House of Representatives, the Committee adopts as its 
own the estimate of budget authority, entitlement authority, or 
tax expenditures or revenues contained in the cost estimate 
prepared by the Director of the Congressional Budget Office 
pursuant to section 402 of the Congressional Budget Act of 
1974.

                        Committee Cost Estimate

    The Committee adopts as its own the cost estimate prepared 
by the Director of the Congressional Budget Office pursuant to 
section 402 of the Congressional Budget Act of 1974.

               Congressional Budget Office Cost Estimate

    Pursuant to clause 3(c)(3) of rule XIII of the Rules of the 
House of Representatives, the following is the cost estimate 
provided by the Congressional Budget Office pursuant to section 
402 of the Congressional Budget Act of 1974:

                                     U.S. Congress,
                               Congressional Budget Office,
                                 Washington, DC, September 2, 2003.
Hon. Michael G. Oxley,
Chairman, Committee on Financial Services,
House of Representatives, Washington, DC.
    Dear Mr. Chairman: The Congressional Budget Office has 
prepared the enclosed cost estimate for H.R. 2420, the Mutual 
Funds Integrity and Fee Transparency Act of 2003.
    If you wish further details on this estimate, we will be 
pleased to provide them. The CBO staff contact is Melissa E. 
Zimmerman.
            Sincerely,
                                       Douglas Holtz-Eakin,
                                                          Director.
    Enclosure.

H.R. 2420--Mutual Funds Integrity and Fee Transparency Act of 2003

    H.R. 2420 would establish new operating policies and 
federal reporting requirements for the mutual fund industry. 
The bill would require the Securities and Exchange Commission 
(SEC) to conduct studies and issue regulations regarding 
various aspects of a mutual fund's operations, including 
information about costs, fees, research services, audit 
committees, trading restrictions, compensation, and compliance 
with ethics requirements.
    Based on information from the SEC, CBO estimates that 
implementing this bill would cost about $1 million in 2004 and 
a total of about $2 million over the 2004-2008 period, assuming 
appropriation of the necessary amounts. Enacting H.R. 2420 
would not affect direct spending or revenues.
    H.R. 2420 contains no intergovernmental mandates, as 
defined in the Unfunded Mandates Reform Act (UMRA) and would 
impose no costs on state, local, or tribal governments.
    H.R. 2420 would impose private-sector mandates, as defined 
in UMRA, on mutual fund companies. Based on information 
provided by industry and government sources, CBO expects that 
the direct costs of complying with those mandates would fall 
below the annual threshold established by UMRA for private-
sector mandates ($117 million in 2003, adjusted annually for 
inflation).
    The bill would require the SEC to revise and implement 
regulations requiring mutual fund companies to disclose certain 
information to investors. The regulations would require:
           Disclosure of operating expenses for each 
        $1,000 of investment in the company that are borne by 
        shareholders;
           Notification of investors in their brokerage 
        account statements that fees have been deducted;
           Disclosure of portfolio turnover rates, 
        structure of the fund manager's compensation, and where 
        shareholders can find additional information;
           New reporting and record keeping of so-
        called soft dollar transactions;
           Directors to be informed of any significant 
        deficiencies in the operation of a mutual fund 
        discovered in a SEC inspection;
           Each fund to have a code of ethics and chief 
        compliance officer;
           Disclosure of any holdings managers have in 
        the funds they manage; and
           Disclosure to investors whether brokers 
        received extra financial incentives to sell a 
        particular fund or class of shares.
    The bill also would require such companies to make 
summaries of reports on fund distribution arrangements 
available to the public, revise audit committee 
responsibilities, and impose fiduciary duties on board of 
directors to review revenue-sharing arrangements.
    The CBO contacts for this estimate are Melissa E. Zimmerman 
(for federal costs) and Paige Piper/Bach (for the impact on the 
private sector). This estimate was approved by Peter H. 
Fontaine, Deputy Assistant Director for Budget Analysis.

                       Federal Mandates Statement

    The Committee adopts as its own the estimate of Federal 
mandates prepared by the Director of the Congressional Budget 
Office pursuant to section 423 of the Unfunded Mandates Reform 
Act.

                      Advisory Committee Statement

    No advisory committees within the meaning of section 5(b) 
of the Federal Advisory Committee Act were created by this 
legislation.

                   Constitutional Authority Statement

    Pursuant to clause 3(d)(1) of rule XIII of the Rules of the 
House of Representatives, the Committee finds that the 
Constitutional Authority of Congress to enact this legislation 
is provided by Article 1, section 8, clause 1 (relating to the 
defense and general welfare of the United States), and clause 3 
(relating to the power to regulate foreign and interstate 
commerce).

                  Applicability to Legislative Branch

    The Committee finds that the legislation does not relate to 
the terms and conditions of employment or access to public 
services or accommodations within the meaning of section 
102(b)(3) of the Congressional Accountability Act.

             Section-by-Section Analysis of the Legislation


Section 1. Short Title

    This section provides the short title of the bill, the 
``Mutual Funds Integrity and Fee Transparency Act of 2003''.

Section 2. Improved Transparency of Mutual Fund Costs

    Section 2(a) requires that the Securities and Exchange 
Commission, within 270 days after enactment of the bill, to 
revise regulations under the Securities Act of 1933, the 
Securities Exchange Act of 1934, or the Investment Company Act 
of 1940 Investment Company Act to require improved disclosure 
with respect to an open-end management investment company of: 
(1) The estimated amount, in dollars for each $1,000 of 
investment in the company, of operating expenses that are borne 
by shareholders; (2) the structure of, or method used to 
determine, the compensation of portfolio managers and the 
portfolio managers' ownership interest in securities; (3) 
portfolio turnover rate, set forth in a manner that facilitates 
comparison among investment companies, and a description of the 
implications of a high turnover rate for portfolio transaction 
costs and performance; (4) information concerning the company's 
policies and practices with respect to certain so-called ``soft 
dollar arrangements,'' specifically, the payment of brokerage 
commissions to a broker who provides research services; and 
information concerning the company's policies and practices 
with respect to the payment of brokerage commissions to a 
broker who facilitates the sale and distribution of the 
company's shares; (5) information concerning so-called 
``revenue sharing,'' i.e., payments by any person other than 
the company that are intended to facilitate the sale and 
distribution of the company's shares (e.g., payments by the 
company's investment adviser or an affiliate of the adviser to 
a broker that sells fund shares); and (6) information 
concerning so-called ``breakpoint'' discounts on front-end 
sales loads for which investors may be eligible, including the 
minimum purchase amounts required for those discounts.
    With respect to ``soft dollar arrangements,'' the research 
services covered are: (1) Furnishing advice, either directly or 
through publications or writings, as to the value of 
securities, the advisability of investing in, purchasing, or 
selling securities, and the availability of securities or 
purchasers or sellers of securities; or (2) furnishing analyses 
and reports concerning issuers, industries, securities, 
economic factors and trends, portfolio strategy, and the 
performance of accounts. These are the same research services 
included in the definition of ``brokerage and research 
services'' in sections 28(e)(3)(A) and (B) of the Exchange Act, 
for purposes of the safe harbor for certain ``soft dollar 
arrangements'' in section 28(e).
    This subsection also requires that the improved disclosure 
be made in the quarterly statement, a periodic report to 
shareholders, or other appropriate disclosure document. 
Subsection (b) permits the Commission to require that the 
disclosure be made in a prospectus or SAI, so long as that 
disclosure is also provided in another appropriate disclosure 
document. The Commission may consider whether a disclosure of 
information concerning portfolio managers' compensation and 
ownership interest in securities and disclosure of ``revenue 
sharing'' payments made exclusively in a prospectus, SAI, or 
both, is made in an appropriate disclosure document.
    Section 2(c) requires the Commission to issue a concept 
release on portfolio transaction costs with respect to trading 
portfolio securities and how costs can be disclosed to 
investors to allow cost comparison among mutual funds. Within 
270 days of enactment, the Commission must also submit a report 
on the findings from the concept release and make legislative 
and regulatory recommendations to the House Financial Services 
Committee and the Senate Banking Committee.
    Subsection (d) requires the Commission to issue a rule 
within 270 days of enactment of the legislation, requiring that 
investors be informed that they have paid fees to their mutual 
fund companies. Investment companies should provide a 
statement, in a quarterly statement or periodic report, 
prominently stating that the investor has paid fees on the 
mutual fund investments, and that those fees have been deducted 
from the amount shown on the statement, and further directing 
the investor to documents disclosing the amounts of the fees.
    Finally, subsection (e) requires that the Commission 
consider methods of reducing the burden of making the requisite 
fee disclosures on small investment companies.

Section 3. Obligations Regarding Certain Distribution and Soft Dollar 
        Arrangements

    Section 3 amends section 15 of the Investment Company Act 
to require each investment adviser to a registered investment 
company to annually provide the company's board of directors 
with a report on: (1) Payments made by the adviser (or its 
affiliated person) to promote the sale of shares of the company 
(revenue sharing); (2) services provided to the company or paid 
for by brokers executing securities transactions for the 
company (or its affiliated person) (directed brokerage); and 
(3) research services obtained by the adviser (or its 
affiliated person) from a broker as a result of securities 
transactions effected on behalf of the company (soft dollar 
arrangements).
    The Committee contemplates that, in exercising this 
authority, the Commission may adopt rules differentiating among 
different types of payments. The Committee believes, for 
example, that it would be consistent with the legislation for 
the Commission to require disclosure of information relating to 
payments made by mutual fund advisers to obtain preferential 
treatment, in offering or selling shares of the funds or in 
including the funds among those that are marketed more actively 
by financial intermediaries and their sales forces than other 
funds sold by the intermediaries (e.g., preferred lists). The 
Committee also believes it would be consistent with the 
underlying purpose of Section 2(a)(5) to mandate a different 
type of disclosure for payments made by fund advisers, 
distributors and their affiliates for shareholder services, 
administrative services or other non-distribution services.
    The section also establishes a fiduciary duty on the part 
of the board to review the adviser's direction of the company's 
brokerage transactions and to determine that the direction of 
fund brokerage is in the best interests of the shareholders of 
the investment company, and requires the board to review 
revenue sharing payments to ensure consistency with the 
provisions of the legislation, such as ensuring that they are 
not disguised payments from fund assets, and determining that 
those agreements are in the best interest of the shareholders 
of the investment company.
    This section also requires that an investment company's 
annual report include a summary of the most recent report 
submitted to the board of directors and gives the Commission 
rulemaking authority to implement the section.
    Finally, section 3 requires that within 270 days of 
enactment of this bill, the SEC must prescribe a rule (pursuant 
to the Securities Exchange Act) requiring that an investment 
manager maintain a copy of a written contract between a person 
providing research services if the person preparing or 
providing the research service is not affiliated with the 
investment manager.

Section 4. Mutual Fund Governance

    Section 4(a) amends section 10(a) of the Investment Company 
Act to decrease the maximum allowable percentage of directors 
on fund boards who are interested persons from 60 percent to 
\1/3\.
    Section 4(b) amends section 2(a)(19) of the Investment 
Company Act, which defines the term ``interested person,'' to 
give the Commission authority to expand the definition to 
include natural persons who are unlikely to exercise an 
appropriate degree of independence as a result of: (1) A 
material business relationship with the company, its investment 
adviser, or principal underwriter (or any of their affiliated 
persons), or (2) a close familial relationship with any natural 
person who is an adviser or principal underwriter to the 
company (or any of their affiliated persons).
    Section 4(b) also deletes from section 2(a)(19) references 
to broker-dealers and lenders as interested persons to permit 
the Commission to include persons with material business 
relationships as interested persons in a rule adopted pursuant 
to its new authority.

Section 5. Audit Committee Requirements for Investment Companies

    Section 5 extends to registered management companies and 
registered face-amount certificate companies certain audit 
committee requirements similar to those required by section 301 
of the Sarbanes-Oxley Act of 2002 and codified in section 
10A(m) of the Exchange Act for listed companies. Section 10A(m) 
required the Commission, by rule, to direct the national 
securities exchanges and national securities associations to 
prohibit the listing of any security of an issuer that is not 
in compliance with enumerated audit committee requirements.
    Section 5(a)(1) amends sections 32(a)(1) and (2) of the 
Investment Company Act to make the audit committee of a 
registered management company or registered face-amount 
certificate company, rather than the independent members of the 
full board of directors, responsible for selection of the 
auditor. This conforms the Investment Company Act to the 
approach of section 301 of the Sarbanes-Oxley Act, which 
currently applies to investment companies that are listed for 
trading on an exchange, and section 202 of the Sarbanes-Oxley 
Act, which requires an issuer's audit committee to preapprove 
all auditing services and which applies to most investment 
companies because they are ``issuers'' under the Sarbanes-Oxley 
Act. This section allows the SEC to exempt investment companies 
in certain situations from the requirement that votes by 
members of the audit committee be cast in person.
    Subsection (a)(2) adds new section 32(d) to the Investment 
Company Act. Section 32(d)(1) of the Investment Company Act 
makes it unlawful for any registered management company or 
registered face-amount certificate company to file with the 
Commission any financial statement signed or certified by an 
independent public accountant unless the company is in 
compliance with certain audit committee requirements and 
Commission rules and regulations. The audit committee 
requirements, which are similar to those enumerated in section 
301 of the Sarbanes-Oxley Act, are the following:
    Section 32(d)(2) of the Investment Company Act requires the 
audit committee to be directly responsible for the appointment, 
compensation, and oversight of auditors, and requires auditors 
to report directly to the audit committee.
    Section 32(d)(3) of the Investment Company Act requires 
each member of the audit committee to be an ``independent'' 
member of the board of directors. Section 32(d)(3)(B) of the 
Investment Company Act provides that, in order to be considered 
``independent,'' a member of an audit committee 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 
company or any affiliated person of the company; or (ii) be an 
``interested person'' of the company, as that term is defined 
in section 2(a)(19) of the Investment Company Act. This 
definition of ``independent'' differs from the definition in 
section 301 of the Sarbanes-Oxley Act in that (i) the 
prohibition on the acceptance of fees has been broadened to 
affiliated persons of the company in recognition of the fact 
that investment companies typically are externally managed, 
with most services rendered to the company by its investment 
adviser or another third party; and (ii) the long-standing 
``interested person'' standard of the Investment Company Act 
has been substituted for the ``affiliated person'' test of 
section 301, in recognition of the fact that the ``interested 
person'' standard is tailored to the particular circumstances 
of registered investment companies.
    Section 32(d)(4) of the Investment Company Act requires the 
audit committee to establish procedures for (i) the receipt, 
retention, and treatment of complaints regarding accounting, 
internal controls, or auditing matters; and (ii) the 
confidential, anonymous submission by employees of the company 
and its affiliated persons of concerns regarding accounting or 
auditing matters. Section 32(d)(4)(B) of the Investment Company 
Act requires that the audit committee establish procedures for 
the confidential, anonymous submission of concerns regarding 
questionable accounting or auditing matters not only by 
employees of the company, but also by employees of the 
company's affiliated persons. This is broader than section 301 
of the Sarbanes-Oxley Act, again to recognize the fact that 
investment companies typically are externally managed.
    Section 32(d)(5) of the Investment Company Act requires the 
audit committee to have the authority to engage independent 
counsel and other advisers, as it determines necessary to carry 
out its duties.
    Section 32(d)(6) of the Investment Company Act requires the 
company to provide appropriate funding, as determined by the 
audit committee, for payment of compensation to the auditors 
and any advisers employed by the audit committee.
    Section 32(d)(7) of the Investment Company Act defines 
``audit committee'' to mean (i) a committee of the board of 
directors that oversees the accounting and financial reporting 
processes of the company and audits of its financial 
statements; and (ii) if no such committee exists, the full 
board of directors.
    Section 5(b) of the bill adds new section 10A(m)(7) to the 
Exchange Act, which exempts registered investment companies 
from the requirements of section 10A(m) (the codification of 
section 301 of the Sarbanes-Oxley Act) effective one year after 
enactment of the legislation. Because all registered management 
companies and registered face-amount certificate companies are 
covered by new section 32(d) of the Investment Company Act, it 
is no longer necessary that registered investment companies 
that are listed on an exchange be covered by section 10A(m) of 
the Exchange Act. This exemption does not, however, preclude a 
national securities exchange or national securities association 
from imposing audit committee requirements on listed investment 
companies in appropriate circumstances. In the event that the 
rules promulgated pursuant to this Section become effective 
prior to one year after enactment, the Commission may use its 
exemptive authority under the Exchange Act to exempt listed 
investment companies that are subject to the provisions of 
10A(m) from those provisions so they will not be subject to two 
inconsistent regulatory requirements.
    Finally, section 5(c) requires the Commission to issue 
final regulations to carry out new section 32(d) of the 
Investment Company Act not later than 180 days after the date 
of enactment.

Section 6. Trading Restrictions

    Section 6 amends section 22(e) of the Investment Company 
Act to prohibit an investment company from suspending or 
postponing the right of redemption of a redeemable security for 
more than 7 days after the security has been tendered, except 
for periods when the securities market is closed or trading is 
restricted (aside from weekends and holidays), or when an 
emergency exists and disposal of securities is not reasonably 
practical. The Commission has the authority to determine when 
trading is restricted and when an emergency exists.

Section 7. Definition of No-Load Mutual Fund

    Section 7 requires that within 270 days of enactment of the 
bill, the Commission, or a self-regulatory organization, or 
both, must adopt a rule clarifying the definition of the term 
``no-load'' as used by mutual funds, so investors may better 
understand the use of the term. The Committee intends that 
nothing in this section impair, interfere, or prevent a bank 
from effecting transactions as part of a program for the 
investment or reinvestment of deposit funds into any investment 
company registered under the 1940 Act that holds itself out as 
a money market fund as permitted under Section 3(a)(4)(B)(v) of 
the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(4)).

Section 8. Informing Directors of Significant Deficiencies

    Section 8 amends section 42 of the Investment Company Act 
to require that if a report of a Commission inspection 
identifies significant deficiencies in a company's operations 
or in the operation of its investment adviser or principal 
underwriter, the company must provide the report to the 
company's board of directors.

Section 9. Exemption From In Person Meeting Requirements

    Section 9 amends section 15(c) of the Investment Company 
Act by allowing the Commission to issue a rule, regulation, or 
order to exempt an investment company from the requirement that 
votes cast by directors take place at an in person meeting when 
the requirement is impracticable. The Commission has the 
discretion to determine when those conditions exist.

Section 10. Proxy Voting Disclosure

    Section 10 amends section 30 of the Investment Company Act 
by requiring that every investment company (excluding small 
businesses) file an annual report with the Commission 
containing the company's proxy voting record for the 12 month 
period ending on June 30. The report must be filed on or before 
August 31 of each year. Company financial statements must state 
how the company voted proxies relating to portfolio securities. 
Companies must also make the information available free of 
charge upon request by a telephone number, through the 
company's website, and on the Commission's website.

Section 11. Ethics Compliance By Mutual Funds

    Section 11 requires that within 270 days of enactment of 
this bill, every investment company must adopt and implement 
policies and procedures designed to prevent violation of the 
federal securities laws. Investment companies are required to 
review the policies and procedures annually and appoint a chief 
compliance officer to administer the policies and procedures in 
place.

Section 12. Incentive Compensation and Mutual Fund Sales

    Section 12 requires that within 270 days of enactment, the 
Commission must issue a rule prohibiting the sale of mutual 
funds by a broker dealer who has not disclosed inducements that 
he or she receives to facilitate the sale and distribution of a 
particular mutual fund. In addition, a broker dealer must 
disclose his or her commission, fees an investor has or will 
pay as a result of a future purchase or redemption, and any 
conflicts of interest associated with the sale of a mutual 
fund.
     The Committee contemplates that this disclosure may be a 
``point of sale'' disclosure, or an after-the-fact disclosure, 
such as in a ``confirm'' that is provided to investors after 
execution of the transaction. Requiring brokers to disclose 
their commissions and incentives for selling particular funds 
will help inform investors about the costs involved in 
purchasing a particular fund or class of fund and permit them 
to better evaluate their broker's investment advice.

Section 13. Commission Study and Report Regulating Soft Dollar 
        Arrangements

    Section 13(a) directs the Commission to conduct a study of 
the use of soft dollars by investment advisers. The section 
requires the Commission, in preparing the report, to examine 
trends in soft dollar use during the preceding 3 years, the 
types of services provided, the benefits and disadvantages of 
the use of soft dollars, including the extent to which use of 
soft dollars impairs the ability of investors to evaluate and 
compare expenses of investment companies; the potential or 
actual conflicts of interest created by soft dollar 
arrangements, the transparency of those arrangements; and the 
extent to which enhanced disclosure is necessary to enable 
investors to understand the impact of theses arrangements. 
Finally, the study must address the Commission's view of 
whether section 28(e) of the Securities Exchange Act, which 
provides a ``safe harbor'' for soft dollar arrangements, should 
be modified, or whether other regulatory or legislative changes 
should be considered and adopted to benefit investors.
    Subsection (b) directs the Commission to submit a report on 
the soft dollar study to the Committee on Financial Services 
and the Senate Committee on Banking, Housing and Urban Affairs 
no later than 18 months after enactment of the bill.

Section 14. Study of Arbitration Claims

    Section 14(a) directs the Commission to study the increased 
rate of arbitration claims and decisions involving mutual funds 
since 1995.
    Section 14(b) requires the Commission to submit a report on 
the increased rate of arbitration claims and decisions 
involving mutual funds to the House Financial Services 
Committee and the Senate Banking Committee within one year of 
enactment of this legislation.

         Changes in Existing Law Made by the Bill, as Reported

    In compliance with clause 3(e) of rule XIII of the Rules of 
the House of Representatives, changes in existing law made by 
the bill, as reported, are shown as follows (existing law 
proposed to be omitted is enclosed in black brackets, new 
matter is printed in italic, existing law in which no change is 
proposed is shown in roman):

                     INVESTMENT COMPANY ACT OF 1940


TITLE I--INVESTMENT COMPANIES

           *       *       *       *       *       *       *



                          GENERAL DEFINITIONS

    Sec. 2. (a) When used in this title, unless the context 
otherwise requires--
          (1)  * * *

           *       *       *       *       *       *       *

          (19) ``Interested person'' of another person means--
                  (A) when used with respect to an investment 
                company--
                          (i)  * * *

           *       *       *       *       *       *       *

                          [(v) any person or any affiliated 
                        person of a person (other than a 
                        registered investment company) that, at 
                        any time during the 6-month period 
                        preceding the date of the determination 
                        of whether that person or affiliated 
                        person is an interested person, has 
                        executed any portfolio transactions 
                        for, engaged in any principal 
                        transactions with, or distributed 
                        shares for--
                                  [(I) the investment company;
                                  [(II) any other investment 
                                company having the same 
                                investment adviser as such 
                                investment company or holding 
                                itself out to investors as a 
                                related company for purposes of 
                                investment or investor 
                                services; or
                                  [(III) any account over which 
                                the investment company's 
                                investment adviser has 
                                brokerage placement discretion,
                          [(vi) any person or any affiliated 
                        person of a person (other than a 
                        registered investment company) that, at 
                        any time during the 6-month period 
                        preceding the date of the determination 
                        of whether that person or affiliated 
                        person is an interested person, has 
                        loaned money or other property to--
                                  [(I) the investment company;
                                  [(II) any other investment 
                                company having the same 
                                investment adviser as such 
                                investment company or holding 
                                itself out to investors as a 
                                related company for purposes of 
                                investment or investor 
                                services; or
                                  [(III) any account for which 
                                the investment company's 
                                investment adviser has 
                                borrowing authority,]
                          (v) any natural person who is a 
                        member of a class of persons who the 
                        Commission, by rule or regulation, 
                        determines are unlikely to exercise an 
                        appropriate degree of independence as a 
                        result of--
                                  (I) a material business or 
                                professional relationship with 
                                the company or any affiliated 
                                person of the company, or
                                  (II) a close familial 
                                relationship with any natural 
                                person who is an affiliated 
                                person of the company,
                          [(vii)] (vi) any natural person whom 
                        the Commission by order shall have 
                        determined to be an interested person 
                        by reason of having had, at any time 
                        since the beginning of the last two 
                        completed fiscal years of such company, 
                        a material business or professional 
                        relationship with such company or with 
                        the principal executive officer of such 
                        company or with any other investment 
                        company having the same investment 
                        adviser or principal underwriter or 
                        with the principal executive officer of 
                        such other investment company:
                Provided, That no person shall be deemed to be 
                an interested person of an investment company 
                solely by reason of (aa) his being a member of 
                its board of directors or advisory board or an 
                owner of its securities, or (bb) his membership 
                in the immediate family of any person specified 
                in clause (aa) of this proviso; and
                  (B) when used with respect to an investment 
                adviser of or principal underwriter for any 
                investment company--
                          (i)  * * *

           *       *       *       *       *       *       *

                          [(v) any person or any affiliated 
                        person of a person (other than a 
                        registered investment company) that, at 
                        any time during the 6-month period 
                        preceding the date of the determination 
                        of whether that person or affiliated 
                        person is an interested person, has 
                        executed any portfolio transactions 
                        for, engaged in any principal 
                        transactions with, or distributed 
                        shares for--
                                  [(I) any investment company 
                                for which the investment 
                                adviser or principal 
                                underwriter serves as such;
                                  [(II) any investment company 
                                holding itself out to 
                                investors, for purposes of 
                                investment or investor 
                                services, as a company related 
                                to any investment company for 
                                which the investment adviser or 
                                principal underwriter serves as 
                                such; or
                                  [(III) any account over which 
                                the investment adviser has 
                                brokerage placement discretion,
                          [(vi) any person or any affiliated 
                        person of a person (other than a 
                        registered investment company) that, at 
                        any time during the 6-month period 
                        preceding the date of the determination 
                        of whether that person or affiliated 
                        person is an interested person, has 
                        loaned money or other property to--
                                  [(I) any investment company 
                                for which the investment 
                                adviser or principal 
                                underwriter serves as such;
                                  [(II) any investment company 
                                holding itself out to 
                                investors, for purposes of 
                                investment or investor 
                                services, as a company related 
                                to any investment company for 
                                which the investment adviser or 
                                principal underwriter serves as 
                                such; or
                                  [(III) any account for which 
                                the investment adviser has 
                                borrowing authority,]
                          (v) any natural person who is a 
                        member of a class of persons who the 
                        Commission, by rule or regulation, 
                        determines are unlikely to exercise an 
                        appropriate degree of independence as a 
                        result of--
                                  (I) a material business or 
                                professional relationship with 
                                such investment adviser or 
                                principal underwriter (or 
                                affiliated person thereof), or
                                  (II) a close familial 
                                relationship with a natural 
                                person who is such investment 
                                adviser or principal 
                                underwriter (or affiliated 
                                person thereof),
                          [(vii)] (vi) any natural person whom 
                        the Commission by order shall have 
                        determined to be an interested person 
                        by reason of having had at any time 
                        since the beginning of the last two 
                        completed fiscal years of such 
                        investment company a material business 
                        or professional relationship with such 
                        investment adviser or principal 
                        underwriter or with the principal 
                        executive officer or any controlling 
                        person of such investment adviser or 
                        principal underwriter.
                For the purposes of this paragraph (19), 
                ``member of the immediate family'' means any 
                parent, spouse of a parent, child, spouse of a 
                child, spouse, brother, or sister, and includes 
                step and adoptive relationships. The Commission 
                may modify or revoke any order issued under 
                clause (vi) of subparagaph (A) or (B) of this 
                paragraph whenever it finds that such order is 
                no longer consistent with the facts. No order 
                issued pursuant to clause (vi) of subparagraph 
                (A) or (B) of this paragraph shall become 
                effective until at least sixty days after the 
                entry thereof, and no such order shall affect 
                the status of any person for the purposes of 
                this title or for any other purpose for any 
                period prior to the effective date of such 
                order.

           *       *       *       *       *       *       *


                       AFFILIATIONS OF DIRECTORS

    Sec. 10. (a) No registered investment company shall have a 
board of directors more than [60 per centum] one-third of the 
members of which are persons who are interested persons of such 
registered company.

           *       *       *       *       *       *       *


             INVESTMENT ADVISORY AND UNDERWRITING CONTRACTS

    Sec. 15. (a)  * * *

           *       *       *       *       *       *       *

    (c) In addition to the requirements of subsections (a) and 
(b) of this section, it shall be unlawful for any registered 
investment company having a board of directors to enter into, 
renew, or perform any contract or agreement, written or oral, 
whereby a person undertakes regularly to serve or act as 
investment adviser of or principal underwriter for such 
company, unless the terms of such contract or agreement and any 
renewal thereof have been approved by the vote of a majority of 
directors, who are not parties to such contract or agreement or 
interested persons of any such party, cast in person at a 
meeting called for the purpose of voting on such approval. It 
shall be the duty of the directors of a registered investment 
company to request and evaluate, and the duty of an investment 
adviser to such company to furnish, such information as may 
reasonably be necessary to evaluate the terms of any contract 
whereby a person undertakes regularly to serve or act as 
investment adviser of such company. It shall be unlawful for 
the directors of a registered investment company, in connection 
with their evaluation of the terms of any contract whereby a 
person undertakes regularly to serve or act as investment 
adviser of such company, to take into account the purchase 
price or other consideration any person may have paid in 
connection with a transaction of the type referred to in 
paragraph (1), (3), or (4) of subsection (f). The Commission, 
by rule, regulation, or order, may exempt a registered 
investment company subject to this subsection from the 
requirement that the votes of its directors be cast at a 
meeting in person when such a requirement is impracticable, 
subject to such conditions as the Commission may require.

           *       *       *       *       *       *       *

  (g) Obligations Regarding Certain Distribution and Soft 
Dollar Arrangements.--
          (1) Reporting requirements.--Each investment adviser 
        to a registered investment company shall, no less 
        frequently than annually, submit to the board of 
        directors of the company a report on--
                  (A) payments during the reporting period by 
                the adviser (or an affiliated person of the 
                adviser) that were directly or indirectly made 
                for the purpose of promoting the sale of shares 
                of the investment company (referred to in 
                paragraph (2) as a ``revenue sharing 
                arrangement'');
                  (B) services to the company provided or paid 
                for by a broker or dealer or an affiliated 
                person of the broker or dealer (other than 
                brokerage and research services) in exchange 
                for the direction of brokerage to the broker or 
                dealer (referred to in paragraph (2) as a 
                ``directed brokerage arrangement''); and
                  (C) research services obtained by the adviser 
                (or an affiliated person of the adviser) during 
                the reporting period from a broker or dealer 
                the receipt of which may reasonably be 
                attributed to securities transactions effected 
                on behalf of the company or any other company 
                that is a member of the same group of 
                investment companies (referred to in paragraph 
                (2) as a ``soft dollar arrangement'').
          (2) Fiduciary duty of board of directors.--The board 
        of directors of a registered investment company shall 
        have a fiduciary duty--
                  (A) to review the investment adviser's 
                direction of the company's brokerage 
                transactions, including directed brokerage 
                arrangements and soft dollar arrangements, and 
                to determine that the direction of such 
                brokerage is in the best interests of the 
                shareholders of the company; and
                  (B) to review any revenue sharing 
                arrangements to ensure compliance with this Act 
                and the rules adopted thereunder, and to 
                determine that such revenue sharing 
                arrangements are in the best interests of the 
                shareholders of the company.
          (3) Summaries of reports in annual reports to 
        shareholders.--In accordance with regulations 
        prescribed by the Commission under paragraph (4), 
        annual reports to shareholders of a registered 
        investment company shall include a summary of the most 
        recent report submitted to the board of directors under 
        paragraph (1).
          (4) Regulations.--The Commission shall adopt rules 
        and regulations implementing this section, which rules 
        and regulations shall, among other things, prescribe 
        the content of the required reports.
          (5) Definition.--For purposes of this subsection--
                  (A) the term ``brokerage and research 
                services'' has the same meaning as in section 
                28(e)(3) of the Securities Exchange Act of 
                1934; and
                  (B) the term ``research services'' means the 
                services described in subparagraphs (A) and (B) 
                of such section.

           *       *       *       *       *       *       *


   DISTRIBUTION, REDEMPTION, AND REPURCHASE OF REDEEMABLE SECURITIES

    Sec. 22. (a)  * * *

           *       *       *       *       *       *       *

    [(e) No registered investment company shall suspend the 
right of redemption, or postpone the date of payment or 
satisfaction upon redemption of any redeemable security in 
accordance with its terms for more than seven days after the 
tender of such security to the company or its agent designated 
for that purpose for redemption, except--
          [(1) for any period (A) during which the New York 
        Stock Exchange is closed other than customary week-end 
        and holiday closings or (B) during which trading on the 
        New York Stock Exchange is restricted;
          [(2) for any period during which an emergency exists 
        as a result of which (A) disposal by the company of 
        securities owned by it is not reasonably practicable or 
        (B) it is not reasonably practicable for such company 
        fairly to determine the value of its net assets; or
          [(3) for such other periods as the Commission may by 
        order permit for the protection of security holders of 
        the company.
The Commission shall by rules and regulations determine the 
conditions under which (i) trading shall be deemed to be 
restricted and (ii) an emergency shall be deemed to exist 
within the meaning of this subsection.]
    (e) Trading Restrictions.--
          (1) Prohibition and exceptions.--No registered 
        investment company shall suspend the right of 
        redemption, or postpone the date of payment or 
        satisfaction upon redemption of any redeemable security 
        in accordance with its terms for more than seven days 
        after the tender of such security to the company or its 
        agents designated for that purpose for redemption, 
        except--
                  (A) for any period (i) during which the 
                principal market for the securities in which 
                the company invests is closed, other than 
                customary week-end and holiday closings; or 
                (ii) during which trading on such exchange is 
                restricted;
                  (B) for any period during which an emergency 
                exists as a result of which (i) disposal by the 
                company of securities owned by it is not 
                reasonably practicable; or (ii) it is not 
                reasonably practicable for such company fairly 
                to determine the value of its net assets; or
                  (C) for such other periods as the Commission 
                may by order permit for the protection of 
                security holders of the company.
          (2) Commission rules.--The Commission shall by rules 
        and regulations--
                  (A) determine the conditions under which 
                trading shall be deemed to be restricted;
                  (B) determine the conditions under which an 
                emergency shall be deemed to exist; and
                  (C) provide for the determination by each 
                company, subject to such limitations as the 
                Commission shall determine are necessary and 
                appropriate for the protection of investors, of 
                the principal market for the securities in 
                which the company invests.

           *       *       *       *       *       *       *


       PERIODIC AND OTHER REPORTS; REPORTS OF AFFILIATED PERSONS

    Sec. 30. (a) * * *

           *       *       *       *       *       *       *

    (k) Proxy Voting Disclosure.--Every registered management 
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 registrant's proxy voting 
record for the most recent twelve-month period ending on June 
30. The financial statements of every such company shall state 
that information regarding how the company voted proxies 
relating to portfolio securities during the most recent 12-
month period ending on June 30 is available--
          (1) 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
          (2) on the Commission's website.

           *       *       *       *       *       *       *


                        ACCOUNTANTS AND AUDITORS

    Sec. 32. (a) It shall be unlawful for any registered 
management company or registered face-amount certificate 
company to file with the Commission any financial statement 
signed or certified by an independent public accountant, 
unless--
          [(1) such accountant shall have been selected at a 
        meeting held within thirty 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 those members of the board 
        of directors who are not interested persons of such 
        registered 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 those members of 
        the board of directors who are not interested persons 
        of such registered company, cast in person at a meeting 
        called for the purpose of voting on such action;]
          (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 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;

           *       *       *       *       *       *       *

If the selection of an accountant has been rejected pursuant to 
paragraph (2) or his employment terminated pursuant to 
paragraph (3), the vacancy so occurring may be filled by a vote 
of a majority of the outstanding voting securities, either at 
the meeting at which the rejection or termination occurred or, 
if not so filled, at a subsequent meeting which shall be called 
for the purpose. In the case of a common-law trust of the 
character described in section 16(c), no ratification of the 
employment of such accountant shall be required but such 
employment may be terminated and such accountant removed by 
action of the holders of record of a majority of the 
outstanding shares of beneficial interest in such trust in the 
same manner as is provided in section 16(c) in respect of the 
removal of a trustee, and all the provisions therein contained 
as to the calling of a meeting shall be applicable. In the 
event of such termination and removal, the vacancy so occurring 
may be filled by action of the holders of record of a majority 
of the shares of beneficial interest either at the meeting, if 
any, at which such termination and removal occurs, or by 
instruments in writing filed with the custodian, or if not so 
filed within a reasonable time then at a subsequent meeting 
which shall be called by the trustees for the purpose. The 
provisions of paragraph (42) of section 2(a) as to a majority 
shall be applicable to the vote cast at any meeting of the 
shareholders of such a trust held pursuant to this subsection. 
The Commission, by rule, regulation, or order, may exempt a 
registered management company or registered face-amount 
certificate company 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.

           *       *       *       *       *       *       *

    (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 
        company, in its capacity as a committee of the board of 
        directors, shall be directly responsible for the 
        appointment, compensation, and oversight of the work of 
        any independent public accountant employed by such 
        registered 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 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 
                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 company or the investment 
                        adviser or principal underwriter of the 
                        registered company; or
                          (ii) be an ``interested person'' of 
                        the registered company, as such term is 
                        defined in section 2(a)(19).
          (4) Complaints.--The audit committee of the 
        registered company shall establish procedures for--
                  (A) the receipt, retention, and treatment of 
                complaints received by the registered company 
                regarding accounting, internal accounting 
                controls, or auditing matters; and
                  (B) the confidential, anonymous submission by 
                employees of the registered 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 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 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 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.

           *       *       *       *       *       *       *


                          ENFORCEMENT OF TITLE

    Sec. 42. (a) * * *

           *       *       *       *       *       *       *

    (f) Informing Directors of Significant Deficiencies.--If 
the report of an inspection by the Commission of a registered 
investment company identifies significant deficiencies in the 
operations of such company, or of its investment adviser or 
principal underwriter, the company shall provide such report to 
the directors of such company.

           *       *       *       *       *       *       *

                              ----------                              


           SECTION 10A OF THE SECURITIES EXCHANGE ACT OF 1934


SEC. 10A. AUDIT REQUIREMENTS.

    (a) * * *

           *       *       *       *       *       *       *

    (m) Standards Relating to Audit Committees.--
          (1) * * *

           *       *       *       *       *       *       *

          (7) Exemption for investment companies.--Effective 
        one year after the date of enactment of the Mutual 
        Funds Integrity and Fee Transparency Act of 2003, 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.

                                
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