[Federal Register Volume 59, Number 158 (Wednesday, August 17, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-20114]


[[Page Unknown]]

[Federal Register: August 17, 1994]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 239, 274
[Release No. 33-7081; IC-20472; S7-22-94]
RIN 3235-AF94

 

Payment for Investment Company Services With Brokerage 
Commissions

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule and form amendments.

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SUMMARY: The Commission is proposing for comment rule and form 
amendments relating to the reporting of expenses by investment 
companies. The proposed amendments would require an investment company 
to reflect as expenses in its statement of operations certain 
liabilities of the company paid by broker-dealers in connection with 
the allocation of the company's brokerage transactions to the broker-
dealers. The amendments would also require an investment company to 
include expenses paid in this manner in the fee table and financial 
highlights table appearing in the company's prospectus, and in 
calculating the company's yield. The amendments are designed to enhance 
the information provided to investors so that they may be better able 
to assess and compare investment company expenses and performance.

DATES: Comments should be received on or before October 17, 1994.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Washington, D.C. 20549. All comment letters should refer to File 
No. S7-22-94. All comments received will be available for public 
inspection and copying in the Commission's Public Reference Room, 450 
Fifth Street, N.W., Washington, D.C. 20549.

FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Senior Counsel, Office 
of Disclosure and Investment Adviser Regulation, (202) 942-0726, or 
Anthony Evangelista, Assistant Chief Accountant, (202) 942-0636, 
Division of Investment Management, Securities and Exchange Commission, 
450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today 
is proposing for comment:
    (1) Amendments to rule 6-07 of Regulation S-X [17 CFR 210.6-07].
    (2) Amendments to Form N-1A [17 CFR 239.15A, 274.11A], Form N-2 [17 
CFR 239.14, 274.11a-1], Form N-3 [17 CFR 239.17a, 274.11b], and Form N-
4 [17 CFR 239.17b, 274.11c] under the Securities Act of 1933 [15 U.S.C. 
77a et seq.] (``1933 Act'') and the Investment Company Act of 1940 [15 
U.S.C. 80a-1 et seq.] (``1940 Act'').

Executive Summary

    The Commission is proposing to amend rule 6-07 of Regulation S-X, 
the regulation setting forth form and content requirements for 
financial statements included in registration statements, proxy 
statements, annual reports, and shareholder reports under the various 
securities laws. The amendments would require a registered investment 
company (``fund'') to adjust the amount of expenses reflected in the 
statement of operations in its financial statements to include amounts 
the fund would have paid to its service providers had a broker-dealer 
or any affiliate of the broker-dealer not paid or agreed to pay those 
service providers on behalf of the fund in connection with the 
allocation of fund transactions to the broker-dealer. The Commission is 
also proposing amendments to various fund registration forms to require 
that the adjusted expenses be reflected in the fee table and financial 
highlights table included in fund prospectuses, in the yield quotation 
required in fund Statements of Additional Information, and, as a 
result, in yield quotations in fund advertisements and sales 
literature. Finally, the Commission is proposing to require that the 
financial highlights table disclose the average commission rate paid by 
the fund.

I. Background

    Some investment companies recently have entered into arrangements 
under which a broker-dealer agrees to pay the cost of certain products 
or services provided to the investment company in exchange for fund 
brokerage (``brokerage/service arrangements''). Under a typical 
brokerage/service arrangement, a broker agrees to pay a fund's 
custodian fees or transfer agency fees and, in exchange, the fund 
agrees to direct a minimum amount of brokerage to the broker. The fund 
usually negotiates the terms of the contract with the service provider, 
who is paid directly by the broker.1
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    \1\Brokerage/service arrangements are structurally similar to 
the more common research soft-dollar arrangements by which an 
investment adviser uses client commission dollars to obtain research 
services. In a research soft-dollar arrangement, however, the 
receipt of a benefit by an adviser through the use of its clients' 
commission dollars raises conflict of interest concerns addressed by 
the safe harbor provisions of section 28(e) of the Securities 
Exchange Act of 1934 (``1934 Act''). These concerns generally are 
not raised by brokerage/service arrangements, which typically 
involve the use of a fund's commission dollars to obtain services 
that directly and exclusively benefit the fund. Nevertheless, a 
fund's investment adviser can benefit from these brokerage/service 
arrangements, particularly if a reduction in fund expenses affects 
the amount of any expense waiver or reimbursement by the adviser. 
The receipt by a fund's adviser of any direct or indirect economic 
benefit as the result of these arrangements would almost certainly 
violate section 17(e)(1) of the 1940 Act [15 U.S.C. 80a-17(e)(1)], 
unless the benefit received fell within the safe harbor provided by 
Section 28(e).
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    By entering into a brokerage/service arrangement, a fund can reduce 
expenses reported to shareholders in its statement of operations, fee 
table, and its expense ratio and can increase its reported yield.2 
This is because the costs paid on behalf of the fund by the broker are 
embedded in the brokerage commissions the fund pays.3 Under 
current accounting treatment, brokerage commissions are reflected in 
the cost basis of the purchased securities or as a reduction of the 
proceeds from the sale of securities.4 In substance, however, a 
brokerage/service arrangement involves a rebate on brokerage 
commissions which, if paid in cash to the fund, would not reduce fund 
expenses.5
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    \2\A fund is currently required to disclose in footnotes to its 
fee table, financial highlights table, and financial statements its 
participation in brokerage/service arrangements and the effect the 
arrangements may have on the level of brokerage commissions paid by 
the fund. To the extent practicable, a fund must also quantify in 
these footnotes the effect of brokerage/service arrangements on fund 
expenses. This footnote disclosure would no longer be necessary if 
the amendments are adopted.
    \3\The safe harbor provided by section 28(e) of the 1934 Act 
does not encompass soft dollar arrangements under which research 
services are acquired as a result of principal transactions, i.e., 
when a broker buys or sells securities for or from its own account. 
U.S. Department of Labor (pub. avail. July 25, 1990). Because, as 
discussed at note 1 supra and accompanying text, brokerage/service 
arrangements do not fall under the Section 28(e) safe harbor, a fund 
may use principal as well as agency transactions to accumulate 
credits with brokers for the payment of fund expenses. Therefore, 
references in this release to ``commissions'' or ``commission 
dollars'' rather than ``spreads'' or ``mark-ups'' are not intended 
to indicate otherwise.
    \4\See R. Kay & D. Searfoss, Handbook of Accounting and Auditing 
12-18 (2d ed. 1989).
    \5\Cash rebates would reduce the cost basis of securities 
purchased or increase the proceeds from securities sold.
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    As a result of the current accounting treatment of brokerage/
service arrangements, investors may not be able to evaluate fully the 
expenses of a fund that pays for services with commission dollars and 
accurately compare expenses and yields among funds. This lack of 
comparability is particularly significant considering the wide use of 
fund expense data by investors.
    Brokerage/service arrangements may benefit funds (and their 
shareholders) by reducing overall fund costs and increasing total 
return,6 particularly if lower commissions are not available to 
funds that do not enter into the arrangements.7 The receipt of a 
net benefit by a fund does not, however, alter the substance of the 
services provided under these arrangements. The services provided are 
generally wholly distinct from the execution of securities 
transactions, and their reflection as capital costs can distort fund 
financial information.8
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    \6\The characterization of costs as expenses or capital items 
will not affect a fund's total return calculated in accordance with 
Commission standards. The formula for total return is based upon 
``ending redeemable value''; expenses and capital costs are both 
inherent in this formula. See, e.g., Item 22(b)(i) of Form N-1A.
    \7\Entering into a brokerage/service arrangement when lower 
commissions are available raises questions whether the fund is 
receiving best execution for its transactions. See Securities 
Exchange Act Rel. No. 23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 30, 
1986)] (``Release 23170'') at Sec. V (discussing best execution 
obligations of money managers in the context of section 28(e)).
    \8\The Commission believes that a fund's board of directors or 
trustees, in connection with its review of brokerage allocation 
policies, should be informed of the fund's brokerage/service 
arrangements and the effects of the arrangements on fund expenses 
and commission rates.
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    The Commission, therefore, is proposing to amend its accounting 
rules to require that amounts the fund would have paid for services in 
the absence of brokerage/service arrangements be reflected as 
``expenses'' in fund financial information and in fund performance 
data.

II. Discussion

A. Accounting for Expenses Paid From Brokerage Commissions

1. The Proposed Accounting Method
    The Commission is proposing to amend rule 6-07 of Regulation S-
X9 to require that the amounts of the various expenses (such as 
custody fees, transfer agency fees, printing and legal fees, and other 
miscellaneous fees) listed in a fund's statement of operations be 
adjusted, or ``grossed-up,'' to include amounts paid with commission 
dollars.10 The required adjustments to the statement of operations 
would be made at the time financial statements are prepared, and no 
daily expense accruals for services paid for with commission dollars 
would be required. No amounts in the financial statements other than 
expenses and the expense ratio would be required to be adjusted.
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    \9\Article 6 of Regulation S-X specifies the contents of 
financial statements included in registration statements, proxy 
statements and shareholder reports of registered investment 
companies. Rule 6-07 of Regulation S-X sets forth the requirements 
for investment company statements of operations.
    \10\Rule 6-04(15) of Regulation S-X [17 CFR 210.6-04(15)] 
requires fund financial statements to disclose material contractual 
commitments. Contractual commitments covered by this rule include 
material commitments to allocate commission dollars for payment of 
fund expenses.
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    Under the proposed amendments, the total of the itemized expenses 
in the statement of operations, including the expenses paid with 
commission dollars, would be shown as the fund's ``total expenses.'' As 
discussed below, the total expense figure also would be used in 
determining the fund's expense ratio, its ``Other Expenses'' listed in 
the fee table, and its yield. The total expenses would be reduced by 
the total amount paid with commission dollars and the remainder shown 
on the statement of operations as ``net expenses.''\11\ The following 
example illustrates the adjustments to the statement of operations that 
would be required by the proposed amendments if custodian fees were 
paid with commission dollars:
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    \11\Because only expenses, and not realized gains/losses or 
unrealized appreciation/depreciation, would be adjusted in the 
statement of operations, the presentation of ``net expenses'' would 
be necessary so that net investment income remains the same.

Expenses:                                                               
  Management Fee...............................................       50
  [Other direct fund expenses].................................       48
  Custodian Fee [would include 8 paid by brokers]..............      10 
                                                                --------
      Total Expenses...........................................      108
      Fees Paid with Commission Dollars........................  (8)\12\
                                                                --------
      Net Expenses.............................................     100 
                                                                        

    The additional ``cost'' reflected on the statement of operations 
would be the amount that the fund would have paid for the services if 
commission dollars had not been used. If a fund negotiates the service 
provider's fees directly with the service provider, the cost of the 
services for purposes of making the required adjustments would be the 
amount negotiated, presumably the same amount the fund would have paid 
for the service in the absence of the arrangement. When the broker 
arranges for the services or provides them itself or through an 
affiliate, however, the actual cost of the services may not be readily 
determinable by the fund. In this case, the proposed amendments would 
require that the fund reflect in its financial statements an amount 
determined by making a good-faith estimate of the amount the fund would 
have paid had it contracted for the services directly in an arms-length 
transaction.\13\ Comment is requested whether there are alternative 
methods for valuing services provided or arranged by brokers.
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    \12\A footnote would be required to identify the specific 
services paid for with commission dollars. Any expense that, as a 
result of the proposed amendments, was increased by five percent or 
more over the amount paid directly by the fund, as well as the 
amount of the increase, would be required to be separately 
identified in the footnote. Amounts that were individually less than 
five percent of the unadjusted expense could be aggregated. The 
total of these amounts, which should equal the amount of the ``Fees 
Paid with Commission Dollars'' line item, also would be required to 
be stated in the footnote.
    \13\The good-faith estimate could be based upon price quotes for 
the services obtained by the fund or the amount funds of similar 
size and having similar investment objectives pay for the services.
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    The amendments would specifically except research services, as that 
term is used in section 28(e) of the 1934 Act, from the services the 
cost of which must be reflected as expenses.\14\ The cost of research 
``purchased'' by an adviser with fund commission dollars could also be 
considered an expense of the fund which is not reflected as an expense 
in the statement of operations and other financial information. The 
Commission is concerned that the adoption of these disclosure rules 
might lead some funds to discontinue brokerage/service arrangements and 
purchase more research through traditional soft dollar arrangements, 
which, under these proposals, would not be required to be treated as an 
expense. Comment is requested whether these proposals would have this 
effect.
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    \14\Because research services are typically provided to the 
adviser, not the fund, the specific exception may be unnecessary. 
However, in light of the widespread use of research soft-dollar 
arrangements, the Commission is proposing a specific exception.
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    The Commission is studying whether the cost of research services 
provided by brokers should be reflected as fund expenses and requests 
comment on this issue.\15\ Commenters favoring inclusion of research 
services in the amendments should address how such services should be 
valued and how the value of the services should be allocated among 
clients of the adviser that may benefit from them. If research services 
cannot be valued, should the Commission require that assumptions be 
made about their value by extrapolation from the brokerage commissions 
paid? For example, should the difference between a brokerage commission 
paid on a transaction and the lowest commission paid by the fund be 
considered a fund expense for research? Alternatively, should the 
Commission require only that the values of research services that have 
readily ascertainable values be quantified, such as subscriptions to 
newspapers, price quotation or valuation services, or research that is 
received in return for the direction of a determinable amount of 
brokerage?
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    \15\Funds are required to describe their soft-dollar practices 
in the Statement of Additional Information that must be provided to 
investors upon request. See, e.g., Item 17 of Form N-1A.
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2. An Alternative Accounting Method
    As an alternative to the accounting changes being proposed, funds 
could be required to allocate each commission paid between execution 
cost and payment for fund services and to present their financial 
statements based upon those allocations. This method would require 
separating commissions into brokerage and expense components, and 
reflecting the expense component as an expense in the financial 
statements.
    The allocation method would assess the actual economic character of 
a fund's brokerage commissions and adjust all fund financial 
information to reflect this assessment. Under the allocation method, 
the portion of a commission properly allocated to expenses would have 
to be estimated and may need to be adjusted as the total amount of 
commission dollars paid to the broker increases.\16\ This adjustment, 
in turn, would require that the cost bases and sales prices of 
particular securities be adjusted periodically based upon the 
transactions directed to a particular broker. Therefore, using the 
allocation method to account for expenses paid with commission dollars 
could prove to be costly and lead to undesirable uncertainties in 
accounting.
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    \16\If the benefits received by a fund from a given brokerage/
service arrangement remain constant (e.g., the payment of a 
specified fund expense), the portion of each commission used to pay 
for that benefit will decrease as the amount of commissions directed 
to the broker increases.
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    The Commission requests comment (i) on the ability of funds to 
account for amounts paid with commission dollars by the allocation 
method, (ii) whether the proposed gross-up method adequately reflects 
the economic nature of these arrangements, and (iii) on the costs of 
each of these accounting methods compared to their benefits to 
investors.

B. The Fee Table and Financial Highlights Table

    The Commission is proposing to amend instructions to the items of 
the fund registration forms that require funds to include in their 
prospectuses a table presenting the expenses paid by fund shareholders, 
either directly or out of the assets of the fund (the ``fee 
table'').\17\ The amended instructions would require that the expense 
percentages included in a fund's fee table be based upon total expenses 
(i.e., that the percentages include amounts paid with commission 
dollars).\18\ Similarly, the amendments would revise Form N-1A and Form 
N-2 to require that the ``ratio of expenses to average net assets'' in 
a fund's ``financial highlights'' table reflect expenses paid with 
commission dollars.\19\ The fee table and financial highlights table 
are required to be placed prominently in the prospectus, and are 
intended to be the primary means for the communication of fund expenses 
and performance to shareholders and prospective shareholders.\20\ The 
proposed amendments are intended to improve the ability of investors to 
use the fee table and financial highlights table to compare fund 
expenses.\21\
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    \17\Item 2(a)(i) of Form N-1A, Item 3.1 of Form N-2, Item 3(a) 
of Form N-3, and Item 3(a) of Form N-4.
    \18\The amended instructions to the fee table would clarify that 
the ``Other Expenses'' set forth in the fee table should be 
determined by reference to the expense amounts reported in the 
fund's statement of operations, including adjustments to reflect 
expenses paid with commission dollars. Accordingly, references in 
the instructions to the omission of brokerage commissions and other 
similar costs (which are not reported on the statement of 
operations) would be deleted. The amended instructions are not 
intended otherwise to revise the substance of the fee table 
requirements. See Instructions 10 to Item 2(a)(i) of Form N-1A; 
Instruction 9 to Item 3.1 of Form N-2; Instruction 15 to Item 3(a) 
of Form N-3; and Instruction 17 to Item 3(a) of Form N-4.
    \19\Item 3(a) of Form N-1A and Item 4.1 of Form N-2. Amendments 
to the per share tables in Forms N-3 and N-4 are not being proposed.
    \20\Unlike amounts paid with commission dollars, the amounts of 
any fee waivers or expense reimbursements would continue to be 
deducted from expenses for purposes of the fee table and financial 
highlights table. While, as discussed above, a fund bears the cost 
of expenses paid by a broker under a brokerage/service arrangement, 
it does not bear any cost to the extent an expense is waived or 
reimbursed.
    \21\The proposed instructions would not require the calculation 
of the ``net investment income'' and ``ratio of net income to 
average net assets'' entries in the financial highlights table based 
upon gross expenses. Net investment income in the financial 
highlights table would continue to correspond to the net investment 
income reported in the statement of operations.
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    The financial highlights table in fund prospectuses presents key 
financial data for each of the last ten fiscal years. Funds may not be 
able to readily determine amounts paid with commission dollars during 
past years. Therefore, the proposed amendments would not require that 
total expenses be reflected in the expense ratio in the financial 
highlights table for fiscal years ending before the adoption of the 
amendments.\22\ A footnote would be required disclosing the change in 
the manner in which expenses have been determined.
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    \22\If these proposals are adopted, the Commission may require 
funds to present the grossed-up expense information in statements of 
operations and financial highlights tables for the entire fiscal 
period ending on or after the date of adoption. Because funds 
ordinarily would maintain records related to these arrangements, 
this should not be burdensome. Comment is requested whether 
reflecting total expenses for the period beginning before adoption 
of the rule would be burdensome.
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C. Performance Information

    Commission rules require that any quotation of yield in a mutual 
fund advertisement be calculated in accordance with a formula that 
reflects fund expenses accrued for the period.\23\ Use of total 
expenses in the calculation of a fund's yield may be appropriate to 
reflect actual fund expenses and necessary to maintain the value of 
yield as an indicator of fund performance.\24\ Therefore, the 
Commission is proposing instructions to the yield formulas for funds 
(other than money market funds) to require that the costs of services 
paid for with brokerage commissions be reflected in quotations of yield 
in a fund's registration statement, and, as a result, in its 
advertisements.
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    \23\Paragraph (e)(1) of rule 482 under the 1933 Act [17 CFR 
230.482(e)(1)] requires that yield quotations included in fund 
advertisements be calculated in accordance with the formulas 
specified in fund registration forms. The yield formulas are set 
forth in Item 22(b)(ii) of Form N-1A, Item 25(b)(ii) of Form N-3, 
and Item 21(b)(ii) of Form N-4.
    \24\As discussed supra at note 4, the characterization of costs 
as expenses or capital items does not affect a fund's total return, 
and, therefore, no amendment to the total return formula is being 
proposed.
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    As discussed above, the proposed amendments to Regulation S-X would 
require that adjustments to fund expenses be made at the end of a 
financial statement period.\25\ Those amendments generally would not 
require funds to accrue or otherwise determine at the end of the 
thirty-day period for which yield is calculated the amount of expenses 
paid with brokerage commissions for that period. The proposed 
instructions to the yield formulas, therefore, would require funds to 
estimate amounts paid with commission dollars for the period of the 
yield quotation. Comment is requested on the feasibility of making such 
an estimate and whether there are alternative approaches.
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    \25\See Section II.A.1 supra.
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    The proposals would not revise the manner in which yield is 
calculated by money market funds. The money market fund yield formula 
is based upon the net change in the value of a hypothetical account, 
and any spread or mark-up paid by a fund would be amortized and 
reflected in that change in value.\26\ Therefore, requiring money 
market funds to include fees paid with commission dollars in the 
calculation of yield would result in those fees being counted 
twice.\27\ Comment is specifically requested whether the money market 
fund yield formula should be revised to reflect the cost of services 
paid for with commission dollars as expenses when they are incurred. 
Commenters should discuss the extent to which money market funds pay or 
can pay expenses through brokerage/service arrangements, and commenters 
suggesting revisions to the yield calculation should provide specific 
text or formulas.
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    \26\See Item 22(a) of Form N-1A, Item 25(a) of Form N-3, and 
Item 21(a) of Form N-4.
    \27\The same double-counting problem does not arise with respect 
to non-money market funds because the yield formula for those funds 
generally requires that the amortization of premium and accretion of 
discount on debt securities be based upon the market value of the 
security, rather than the initial purchase price. See, e.g., 
Instruction 1(a) to Item 22(b)(ii) of Form N-1A. The mark-up or 
spread paid by the fund upon the purchase of a security is not 
reflected in the security's market value and therefore would not be 
a part of any premium amortized or discount accreted for the 
purposes of calculating yield.
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D. Related Arrangements

    The Commission is aware that funds enter into certain other 
arrangements that, like brokerage/service arrangements, have the effect 
of reducing reported fund expenses. Some funds, for example, have 
``compensating balance'' arrangements with their custodians under which 
their custodian fees are reduced if they maintain cash on deposit with 
the custodians in non-interest bearing accounts. In these arrangements 
expenses are reduced by forgoing income rather than by recharacterizing 
them as capital items. The Commission requests comment whether an 
adjustment to fund expenses similar to that being proposed for 
brokerage/service arrangements should be required for these expense 
offset arrangements, or whether these arrangements should be addressed 
in footnotes to the financial statements. Because a fund that enters 
into these arrangements forgoes income, comment also is requested 
whether such income should be estimated and reflected in fund financial 
information, and how such estimates might be made.
    Some custodial arrangements may involve explicit oral or written 
understandings regarding the fee reductions that will occur when 
uninvested cash balances exceed predetermined levels. Often, however, a 
fund's custodian fee reflects an estimate of the income the custodian 
expects to derive from the fund's uninvested cash balances, and the 
resulting reduction in the fee is not explicitly disclosed in the 
custodial agreement. The Commission requests comment whether the amount 
of any increase in fund expenses to reflect these arrangements should 
include only amounts that are explicit in the agreements, or should 
also include amounts implicit in the basic custodian fee.\28\
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    \28\Footnote disclosure of compensating balance arrangements 
under which the withdrawal or use of cash or cash items is 
restricted, either legally or as a practical matter, is currently 
required by rule 6-04.5 of Regulation S-X [17 CFR 210.6-04.5].
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E. Average Commission Rates

    Brokerage commissions and other costs incurred in connection with 
the execution of a fund's portfolio transactions are not reflected in 
the fund's statement of operations, financial highlights table or fee 
table because these costs are treated as capital items which increase 
the cost of securities purchased or reduce the proceeds of securities 
sold. The Commission is concerned that adequate information about these 
costs currently may not be provided to investors.\29\ The Commission, 
therefore, is proposing to require that the average commission rate 
paid by a fund (in cents per share) be disclosed in the financial 
highlights table next to the portfolio turnover rate.\30\ Other fund 
transaction costs, such as mark-ups, mark-downs, and spreads, would not 
be included in this commission rate figure. Comment is requested 
whether these other costs should be reflected, and, if so, how they 
should be calculated or estimated.
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    \29\A fund is currently required to disclose in its Statement of 
Additional Information the aggregate amount of any brokerage 
commissions it paid during its three most recent fiscal years, as 
well as certain data about commissions paid to fund affiliates. Item 
17 of Form N-1A.
    \30\The new information would only be required for fiscal years 
beginning after adoption of the amendments.
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III. General Request for Comments

    Any interested persons wishing to submit written comments on the 
rule and form changes that are the subject of this Release, to suggest 
additional changes, or to submit comments on other matters that might 
have an effect on the proposals contained in this Release, are 
requested to do so. Comment is specifically requested regarding the 
prevalence and significant terms of brokerage/service arrangements, the 
expenses paid through the arrangements, and the effect of the 
arrangements on fund expenses and commissions.

IV. Cost/Benefit Analysis

    The rule and form changes proposed today are intended to improve 
the reporting of investment company expenses and improve the ability of 
investors to compare investment company expenses and performance. While 
the rule and form changes may increase the costs to funds of preparing 
financial statements and fund registration materials, the Commission 
believes that any such cost increases would, at most, be minimal. A 
fund that has brokerage/service arrangements would be required to add 
two captions and a footnote to its statement of operations and replace 
the net expense figures currently disclosed in its fee table and 
financial highlights table with total expense figures. These figures 
will normally be readily determinable by the fund. Funds should also be 
able to readily estimate expenses paid with brokerage commissions for 
purposes of yield calculations. In short, the Commission believes that 
the costs of the amendments proposed today would be substantially 
outweighed by the benefits to investors of receiving more accurate and 
useful financial information about funds.

V. Summary of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis in accordance with 5 U.S.C. 603 regarding the proposed 
amendments. The analysis notes that the rule and form proposals 
contained in this Release are intended to provide for the comparability 
of fund expenses reflected in fund disclosure documents and 
advertisements. Other aggregate cost-benefit information reflected in 
the ``Cost/Benefit Analysis'' section of this release also is reflected 
in the analysis. A copy of the Initial Regulatory Flexibility Analysis 
may be obtained by contacting Eric C. Freed, Securities and Exchange 
Commission, 450 Fifth Street, NW., Mail Stop 10-6, Washington, DC 
20549.

VI. Text of Proposed Rule and Form Amendments

List of Subjects

17 CFR Part 210

    Accounting, Reporting and recordkeeping requirements, Securities.

17 CFR Parts 239 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

    For the reasons set out in the preamble, Chapter II, Title 17 of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 210--FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL 
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 
1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT 
COMPANY ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF 1975

    1. The authority citation for part 210 continues to read as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77aa(25), 
77aa(26), 78l, 78m, 78n, 78o(d), 78w(a), 78ll(d), 79e(b), 79j(a), 
79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, and 80a-37, unless 
otherwise noted.

    2. By adding a new paragraph 2(g) to the statements of operations 
in Sec. 210.6-07 to read as follows:


Sec. 210.6-07  Statements of operations.

* * * * *
    2. Expenses. * * *
    (g) If a broker-dealer or an affiliate of the broker-dealer has, 
in connection with the direction of the person's brokerage 
transactions to the broker-dealer, provided, agreed to provide, paid 
for, or agreed to pay for, in whole or in part, services provided to 
the person (other than brokerage and research services as those 
terms are used in Section 28(e) of the Securities Exchange Act of 
1934 [15 U.S.C. 78bb(e)]), reflect as the cost of any such services 
in the expense items set forth under this caption the amount that 
would have been incurred by the person for the services had it paid 
for the services directly in an arms-length transaction. Show the 
total amount by which expenses are increased as a corresponding 
reduction in total expenses under this caption. In a note to the 
financial statements, list each expense that is increased and the 
amount of the increase in each expense, except that expenses 
increased by less than 5 percent of the unadjusted amount of the 
expense may be aggregated. The note should also include the total 
amount by which expenses are increased.
* * * * *

PART 239--FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933

PART 274--FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY ACT OF 1940

    3. The authority citation for Part 239 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77sss, 78c, 78l, 
78m, 78n, 78o(d), 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 79l, 79m, 
79n, 79q, 79t, 80a-8, 80a-29, 80a-30 and 80a-37, unless otherwise 
noted.
* * * * *
    4. The authority citation for Part 274 continues to read as 
follows:

    Authority: 15 U.S.C. 80a-1, et seq., unless otherwise noted.

    Note: The text of Form N-1A does not and the amendments will not 
appear in the Code of Federal Regulations.

    5. By revising the introductory text of Instruction 10 to Item 
2(a)(i) of Part A of Form N-1A (referenced in Secs. 239.15A and 
274.11A) to read as follows:

Form N-1A

* * * * *

Part A. Information Required in a Prospectus

* * * * *

Item 2. Synopsis

    (a)(i) * * *
    Instructions: * * *
    10. ``Other Expenses'' include all expenses (except nonrecurring 
account fees and expenses reported in other items of the table) that 
are deducted from fund assets or charged to all shareholder 
accounts. The amounts of expenses deducted from fund assets are the 
amounts shown as expenses in the Registrant's statement of 
operations (including increases resulting from complying with 
paragraph 2(g) of Rule 6-07 [17 CFR 210.6-07] of Regulation S-X 
regarding fees paid with Registrant's brokerage commissions).
* * * * *
    6. By amending Item 3(a) of Part A of Form N-1A (referenced in 
Secs. 239.15A and 274.11A) by adding the phrase ``Average Commission 
Rate Paid (in cents per share)'' below ``Portfolio Turnover Rate'' and 
adding a new Instruction 15 to read as follows:

Form N-1A

* * * * *

Part A. Information Required in a Prospectus

* * * * *

Item 3. Condensed Financial Information

    (a) * * *
    Instructions: * * *
    15. Compute the ``ratio of expenses to average net assets'' 
using the amount of expenses shown in the Registrant's statement of 
operations for the relevant fiscal year, including increases 
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR 
210.6-07] of Regulation S-X regarding fees paid with Registrant's 
brokerage commissions, and including reductions resulting from 
complying with paragraphs 2(a) and (f) of Rule 6-07 (17 CFR 210.6-
07) regarding fee waivers and reimbursements. If a change in the 
methodology of determining the ratio of expenses to average net 
assets results from applying paragraph 2(g) of Rule 6-07 (17 CFR 
210.6-07), explain in a note that the ratio reflects fees paid with 
brokerage commissions only for fiscal years ending after [the 
effective date of the final rule amendments].
* * * * *
    7. By redesignating Instructions 7 and 8 to Item 22(b)(ii) as 
Instructions 8 and 9, and adding a new Instruction 7 to Item 22(b)(ii) 
of Part B of Form N-1A (referenced in Secs. 239.15A and 274.11A) to 
read as follows:

Form N-1A

* * * * *

Part B. Information Required in a Statement of Additional Information

* * * * *

Item 22. Calculation of Performance Data

* * * * *
    (b) Other Registrants * * *
    (ii) Yield. * * *
    Instructions: * * *
    7. If a broker-dealer or an affiliate (as defined in paragraph 
(b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-X) of the 
broker-dealer has, in connection with the direction of the 
Registrant's brokerage transactions to the broker-dealer, provided, 
agreed to provide, paid for, or agreed to pay for, in whole or in 
part, services provided to the Registrant (other than brokerage and 
research services as those terms are used in Section 28(e) of the 
Securities Exchange Act of 1934 [15 U.S.C. 78bb(e)]), add to 
expenses accrued for the period an estimate of additional amounts 
that would have been accrued for the period if the Registrant had 
paid for the services directly in an arms-length transaction.
* * * * *
    Note: The text of Form N-2 does not and the amendments will not 
appear in the Code of Federal Regulations.

    8. By revising Instruction 9 to Item 3.1 of part A of Form N-2 
(referenced in Secs. 239.14 and 274.11a-1) to read as follows:

Form N-2

* * * * *

Part A--Information Required in A Prospectus

* * * * *

Item 3. Fee Table and Synopsis

    1. * * *
    Instructions * * *
    9. ``Other Expenses'' include all expenses (except fees and 
expenses reported in other items in the table) that are deducted 
from the Registrant's assets and will be reflected as expenses in 
the Registrant's statement of operations (including increases 
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR 
210.6-07] of Regulation S-X regarding fees paid with brokerage 
commissions).
* * * * *
    9. By amending Item 4.1 of part A of Form N-2 (referenced in 
Secs. 239.14 and 274.11a-1) by adding the phrase ``Average Commission 
Rate Paid (in cents per share)'' below ``Portfolio Turnover Rate'' and 
adding a new Instruction 17 to read as follows:

Form N-2

* * * * *

Part A.--Information Required in a Prospectus

* * * * *

Item 4. Financial Highlights

    1. General: * * *
    Instructions * * *
    17. Compute the ``ratio of expenses to average net assets'' 
using the amount of expenses shown in the Registrant's statement of 
operations for the relevant fiscal year, including increases 
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR 
210.6-07] of Regulation S-X regarding fees paid with Registrant's 
brokerage commissions, and including reductions resulting from 
complying with paragraphs 2(a) and (f) of Rule 6-07 (17 CFR 210.6-
07) regarding fee waivers and reimbursements. If a change in the 
methodology of determining the ratio of expenses to average net 
assets results from applying paragraph 2(g) of Rule 6-07 (17 CFR 
210.6-07), explain in a note that the ratio reflects fees paid with 
brokerage commissions only for fiscal years ending after [the 
effective date of the final rule amendments].
* * * * *
    Note: The text of Form N-3 does not and the amendments will not 
appear in the Code of Federal Regulations.

    10. By revising the introductory text of Instruction 15 to Item 
3(a) of Part A of Form N-3 (referenced in Secs. 239.17a and 274.11b) to 
read as follows:

Form N-3

* * * * *

Part A. Information Required in a Prospectus

* * * * *

Item 3. Synopsis

    (a) * * *
    Instructions: * * *
    15. ``Other Expenses'' include all expenses (except expenses 
reported in other items in the table) that are deducted from 
separate account assets. The amounts of expenses are the amounts 
shown as expenses in the Registrant's statement of operations 
(including increases resulting from complying with paragraph 2(g) of 
Rule 6-07 [17 CFR 210.6-07] of Regulation S-X regarding fees paid 
with Registrant's brokerage commissions).
* * * * *
    11. By redesignating Instruction 7 to Item 25(b)(ii) as Instruction 
8, and adding a new Instruction 7 to Item 25(b)(ii) of Part B of Form 
N-3 (referenced in Secs. 239.17a and 274.11b) to read as follows:

Form N-3

* * * * *

Part B. Information Required in a Statement of Additional Information

* * * * *

Item 25. Calculation of Performance Data

* * * * *
    (b) Other Accounts * * *
    (ii) Yield. * * *
    Instructions: * * *
    7. If a broker-dealer or an affiliate (as defined in paragraph 
(b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-X) of the 
broker-dealer has, in connection with the direction of the 
Registrant's brokerage transactions to the broker-dealer, provided, 
agreed to provide, paid for, or agreed to pay for, in whole or in 
part, services provided to the Registrant (other than brokerage and 
research services as those terms are used in Section 28(e) of the 
Securities Exchange Act of 1934 [15 U.S.C. 78bb(e)]), add to 
expenses accrued for the period an estimate of additional amounts 
that would have been accrued for the period if the Registrant had 
paid for the services directly in an arms-length transaction.
* * * * *
    Note: The text of Form N-4 does not and the amendments will not 
appear in the Code of Federal Regulations.

    12. By revising the introductory text of Instruction 17 to Item 
3(a) of Part A of Form N-4 (referenced in Secs. 239.17b and 274.11c) to 
read as follows:

Form N-4

* * * * *

Part A. Information Required in a Prospectus

* * * * *

Item 3. Synopsis

    (a) * * *
    Instructions: * * *
    17. ``Other Expenses'' include all expenses (except management 
fees) that are deducted from portfolio company assets. The amounts 
of expenses are the amounts shown as expenses in the portfolio 
company's statement of operations (including increases resulting 
from complying with paragraph 2(g) of Rule 6-07 [17 CFR 210.6-07] of 
Regulation S-X regarding fees paid with the portfolio company's 
brokerage commissions).
* * * * *
    13. By redesignating Instructions 2 and 3 to Item 21(b)(ii) as 
Instructions 3 and 4, and adding a new Instruction 2 to Item 21(b)(ii) 
of Part B of Form N-4 (referenced in Secs. 239.17b and 274.11c) to read 
as follows:

Form N-4

* * * * *

Part B. Information Required in a Statement of Additional Information

* * * * *

Item 21. Calculation of Performance Data

* * * * *
    (b) Other Sub-Accounts * * *
    (ii) Yield. * * *
    Instructions: * * *
    2. If a broker-dealer or an affiliate (as defined in paragraph 
(b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-X) of the 
broker-dealer has, in connection with the direction of the portfolio 
company's brokerage transactions to the broker-dealer, provided, 
agreed to provide, paid for, or agreed to pay for, in whole or in 
part, services provided to the portfolio company (other than 
brokerage and research services as those terms are used in Section 
28(e) of the Securities Exchange Act of 1934 [15 U.S.C. 78bb(e)]), 
add to expenses accrued for the period an estimate of additional 
amounts that would have been accrued for the period if the portfolio 
company had paid for the services directly in an arms-length 
transaction.
* * * * *
    Dated: August 11, 1994.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20114 Filed 8-16-94; 8:45 am]
BILLING CODE 8010-01-P