[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.
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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.
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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\
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\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.
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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.