[Federal Register Volume 60, Number 145 (Friday, July 28, 1995)]
[Rules and Regulations]
[Pages 38918-38925]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-18472]




[[Page 38917]]

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Part III





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Parts 210, 239, and 274



Payment for Investment Company Services With Brokerage Commissions; 
Final Rule

  Federal Register / Vol. 60, No. 145 / Friday, July 28, 1995 / Rules 
and Regulations   

[[Page 38918]]


SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 239, and 274

[Release No. 33-7197; IC-21221; FR-46; S7-22-94]
RIN 3235-AF94


Payment for Investment Company Services With Brokerage 
Commissions

AGENCY: Securities and Exchange Commission.

ACTION: Final amendments to rules and forms.

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SUMMARY: The Securities and Exchange Commission is adopting rule and 
form amendments relating to the reporting of expenses by investment 
companies. The amendments require an investment company to reflect as 
expenses in its statement of operations and in other financial 
information certain liabilities of the company paid by broker-dealers 
in connection with allocation of the company's brokerage transactions 
to the broker-dealers and liabilities reduced by certain expense offset 
arrangements. In addition, the amendments require an investment company 
to disclose the average commission rate it paid in connection with the 
purchase and sale of portfolio securities, subject to a de minimis 
exception. The amendments are intended to enhance the information 
provided to investors so that they may be better able to assess and 
compare investment company expenses and yield information.

DATES: Effective Date: The amendments are effective September 1, 1995.
    Compliance Dates: Proxy statements and shareholder reports filed 
with the Commission and quotations of yield by investment companies in 
advertisements or sales literature published or distributed on or after 
December 1, 1995 must comply with the amendments. Required compliance 
for financial information appearing in registration statements is 
staggered to reflect the affected investment companies' annual updating 
schedules. A more detailed discussion of the compliance dates appears 
in section of this release.

FOR FURTHER INFORMATION CONTACT: Karen J. Garnett, Attorney, Office of 
Disclosure and Investment Adviser Regulation, (202) 942-0728, or 
Anthony Evangelista, Assistant Chief Accountant, (202) 942-0636, 
Division of Investment Management, Securities and Exchange Commission, 
450 Fifth Street, NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') today is adopting amendments to:
    (1) Rule 6-07 of Regulation S-X [17 CFR 210.6-07]; and
    (2) 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'').

Table of Contents

I. Background
II. Discussion
    A. Accounting for Expenses
    1. Brokerage/Service Arrangements
    2. Expense Offset Arrangements
    3. Accounting Method
    4. Financial Statement Note Disclosure
    B. Exception for Research Services
    C. Fee Table and Financial Highlights Table
    D. Yield
    E. Average Commission Rates
    F. Effective Date
    G. Compliance Dates
    1. Registration Statements
    2. Yield Information
    3. Proxy Statements and Shareholder Reports
    H. Filing Requirements for Post-Effective Amendments
III. Cost/Benefit Analysis
IV. Regulatory Flexibility Analysis
V. Statutory Authority
Text of Rule and Form Amendments

I. Background

    Some investment companies enter 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, which is paid directly 
by the broker.1

    \1\ Brokerage/service arrangements are structurally similar to 
the more common research soft dollar arrangements under 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'') [15 U.S.C. 78bb(e)]. These 
concerns generally are not raised by brokerage/service arrangements, 
which typically involve use of a fund's commission dollars to obtain 
services that directly and exclusively benefit the fund.
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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 expense ratio and can increase its reported yield. A fund is 
able to decrease expenses and increase yield under these arrangements 
because the costs paid on behalf of the fund by the broker are embedded 
in the brokerage commissions the fund pays.2 Brokerage commissions 
are reflected in the cost basis of the purchased securities or as a 
reduction of the proceeds from the sale of securities.

    \2\ The staff has stated that 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 brokerage/service arrangements 
do not rely on 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.
    On August 11, 1994, the Commission proposed for public comment 
amendments to its accounting rules that would require fund financial 
data to reflect amounts the fund would have paid to its service 
providers if a broker-dealer or any affiliate of the broker-dealer had 
not paid or agreed to pay those service providers on behalf of the fund 
in connection with a brokerage/service arrangement.3 As proposed, 
the amendments would require that the adjusted expenses be reflected in 
a fund's fee table and financial highlights table included in the 
fund's prospectus, and in the yield quotations in the fund's 
advertisements and sales literature. In addition, the proposed 
amendments would require that the financial highlights table disclose 
the average commission rate paid by the fund.

    \3\ Investment Company Act Release No. 20472 (Aug. 11, 1994) [59 
FR 42187 (Aug. 17, 1994)] (``Proposing Release'').
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    The Commission received comments on the Proposing Release from 104 
commenters.4 Commenters that addressed the substance of the 
Commission's proposals generally expressed support for the proposed 
amendments.5 These commenters expressed their belief that the 
proposals would enhance the information 

[[Page 38919]]
provided to investors so that they may be better able to assess and 
compare investment company expenses and performance. The Commission is 
adopting the proposed amendments with several modifications that 
reflect the comments received.6

    \4\ The Commission received a total of 108 comment letters, as 
four commenters provided two letters each. The comment letters and a 
summary of comments prepared by the Commission's staff are available 
for public inspection and copying in the Commission's public 
reference room in File No. S7-22-94.
    \5\ Seventy-one of the 104 commenters, however, limited their 
comments to the issue of whether the Commission should require funds 
to include as expenses the cost of research services provided by 
brokers. See infra section.
    \6\ As discussed in section II.A.2 below, one of these changes 
requires funds to reflect as expenses liabilities reduced in 
connection with certain expense offset arrangements.
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II. Discussion

A. Accounting for Expenses

1. Brokerage/Service Arrangements
    The Commission is adopting, substantially as proposed, amendments 
to rule 6-07 of Regulation S-X 7 to require that the amounts of 
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.8 The rule amendments require 
funds to make adjustments to their statements of operations at the time 
financial statements are prepared, but do not require daily expense 
accruals for services paid with commission dollars. The rule amendments 
do not require funds to adjust amounts in the financial statements 
other than expenses and the expense ratio.9

    \7\ 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.
    \8\ The staff previously has required funds to disclose in 
footnotes to the fee table, financial highlights table, and 
financial statements their participation in brokerage/service 
arrangements and the effect these arrangements may have on the level 
of brokerage commissions paid to the fund. See Proposing Release, 
supra note 3, at n.2. The amendments to rule 6-07 eliminate the need 
for this disclosure and therefore the staff will no longer require 
such footnotes.
    \9\ The Proposing Release explained that a fund's investment 
adviser can benefit from brokerage/service arrangements, 
particularly if a reduction in fund expenses affects the amount of 
any expense waiver or reimbursement by the adviser. Proposing 
Release, supra note 3, at n.1. Section 17(e)(1) of the 1940 Act [15 
U.S.C. 80a-17(e)(1)] makes it unlawful for an affiliated person of a 
fund (such as its adviser) to accept from any source compensation 
(other than regular wages) for the purchase or sale of fund shares. 
The receipt by a fund's adviser of any direct or indirect economic 
benefit as a result of brokerage/service arrangements would almost 
certainly violate section 17(e)(1), unless the benefit received fell 
within the safe harbor provided by section 28(e) of the 1934 Act. 
See supra note 1. However, the Commission believes that if a fund 
adviser voluntarily imposes a limitation on the fund's expenses or 
waives its fees, the fund's brokerage/service arrangements would not 
violate section 17(e)(1). Similarly, if compliance with expense 
limitations imposed by statute or by contract is measured by 
reference to the fund's total expenses (i.e., expenses adjusted to 
include the cost of services provided under brokerage/service 
arrangements), a fund's brokerage/service arrangements would not 
result in a violation of section 17(e)(1).
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    A majority of the commenters that addressed the substance of the 
proposal supported the proposed accounting changes. These commenters 
agreed that the gross-up adjustment to expenses would accurately 
reflect the economic effect of these arrangements, would assist 
investors in comparing expenses among funds, and would be consistent 
with current industry reporting standards for statements of operations. 
Fund industry commenters stated that the method proposed for reflecting 
broker-paid liabilities as fund expenses was appropriate and not 
burdensome.10 Some commenters, however, opposed the proposal, 
asserting that grossing-up fund expenses would not provide meaningful 
disclosure to investors and could mislead investors about the benefits 
to the fund of brokerage/service arrangements. Other commenters 
objected to the proposal arguing that it would cause funds to overstate 
expenses.

    \10\ In the Proposing Release, the Commission requested comment 
on an alternative accounting method that would require funds 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 have required funds to separate 
commissions into brokerage and expense components, and reflect the 
expense component as an expense in the financial statements. 
Commenters that addressed the alternative accounting method were 
uniformly opposed to it on grounds that it would be impractical, 
costly, and burdensome for funds to calculate, as well as difficult 
to audit.
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    Commenters opposing the proposed amendments asserted, in effect, 
that comparable commission rates might be paid by funds that choose not 
to enter into brokerage/service arrangements, and, therefore fund 
services provided under brokerage/service arrangements should be 
treated as ``free'' services and payments by brokers should be ignored. 
If brokers made these payments to funds in the form of cash, however, 
fund expenses would not be affected. Thus, it is merely the form these 
payments take, rather than their substance, that has permitted such 
payments to reduce fund expenses. To the extent that investors benefit 
from these arrangements (which the Proposing Release acknowledged they 
may), the benefit is reflected in overall fund return rather than as a 
reduction of fund expenses--a result that more accurately reflects 
these arrangements as a rebate on brokerage.
2. Expense Offset Arrangements
    a. Fee Reductions. Some funds enter into arrangements that, like 
brokerage/service arrangements, have the effect of reducing reported 
fund expenses. In these arrangements (``expense offset arrangements''), 
however, expenses are reduced by foregoing income rather than by 
recharacterizing them as capital items. For example, a fund may have a 
``compensating balance'' arrangement with its custodian under which the 
custodian reduces its fees if the fund maintains cash on deposit with 
the custodian in non-interest or below market interest bearing 
accounts. Similarly, a fund may enter into a securities lending 
agreement under which the fund permits the custodian to loan fund 
securities to third parties (typically unrelated broker-dealers) in 
exchange for a reduction in custody fees.11 Expense offset 
arrangements may involve explicit oral or written agreements regarding 
the amount of fee reductions. A fund's custody fee may, however, 
reflect an estimate of the income the custodian expects to derive from 
an expense offset arrangement, and the resulting fee reduction is not 
expressly stated in the custodial agreement.

    \11\ Securities lending arrangements may raise other issues 
under the federal securities laws. The Commission is not addressing 
in this release the merits of any particular securities lending 
arrangements.
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    The Commission requested comment whether an adjustment to fund 
expenses similar to that proposed for brokerage/service arrangements 
should be required for expense offset arrangements, or whether these 
arrangements should be addressed in footnotes to the financial 
statements.12 In addition, the Commission requested comment 
whether the amount of any increase in fund expenses to reflect these 
arrangements should include only amounts that are explicit in the 
agreement, or should also include amounts implicit in the basic 
custodian fee.

    \12\ 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]. In 
addition, Rule 6-04.11 of Regulation S-X [17 CFR 210.6-04.11] 
requires fund balance sheets to state the value of securities loaned 
and to indicate the nature of collateral received as security for 
the loan.
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    Most of the commenters addressing this issue supported an 
adjustment to fund expenses for expense offset arrangements. Commenters 
generally stated that requiring disclosure for expense offset 
arrangements would be consistent with requirements relating to 
brokerage/service arrangements. Commenters were divided, however, on 
whether the amount of any increase in fund expenses should include only 


[[Page 38920]]
amounts that are explicit in agreements between the fund and the 
service provider.
    The amendments to rule 6-07 of Regulation S-X, as adopted, require 
funds to include as expenses the amount of any reduction in fees or 
expenses arising from expense offset arrangements.13 A fund's 
statement of operations must reflect as the cost of services provided 
the amount that the fund would have paid in the absence of the expense 
offset arrangement.14 The requirement only applies to agreements 
that provide for specified or reasonably ascertainable fee reductions 
in exchange for use by another person of the fund's assets. It does not 
apply to fee reductions that are implicit in the service provider's 
basic fee.

    \13\ Rule 6-07.2(g)(2) of Regulation S-X [17 CFR 210.6-
07.2(g)(2)]. Under the amendments, expense offset arrangements 
include arrangements under which a service provider reduces its fees 
in return for the use of fund assets as well as arrangements under 
which another person, in return for the use of fund assets, makes 
payment to a fund service provider which in turn reduces its fees 
charged to the fund.
    \14\ Amendments to fund registration forms adopted today 
incorporate similar requirements for fund prospectuses by reference 
to rule 6-07.
    b. Foregone Income. The Commission also requested comment whether 
funds should be required to estimate income foregone under expense 
offset arrangements and reflect such amounts in fund financial 
information.15 The Commission asked commenters to suggest methods 
for estimating income foregone under these arrangements. Some 
commenters supported such a requirement, suggesting that funds should 
make a ``reasonable estimate'' of foregone income. Other commenters 
noted the difficulty of estimating lost income and expressed concern 
that such a requirement could result in misleading financial 
information. Moreover, one commenter argued that, in order to estimate 
lost income, a fund would have to assume income, which is inconsistent 
with generally accepted accounting principles (``GAAP'') and could 
prevent auditors from issuing an unqualified report that fund financial 
statements are prepared in accordance with GAAP.

    \15\ Proposing Release, supra note 3, at section II.D.
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    The Commission shares certain of these concerns and has therefore 
decided not to require funds to reflect in fund financial information 
income foregone as a result of expense offset arrangements. As amended, 
rule 6-07 requires a fund that enters into an expense offset 
arrangement to include in a footnote to financial statements a 
statement that the fund could have invested the assets used by the 
other person in an income-producing asset if it had not agreed to a 
reduction in fees or expenses under an expense offset arrangement.
3. Accounting Method
    Under rule 6-07, as amended, a fund's total expenses reported in 
the statement of operations must include expenses paid under brokerage/
service and expense offset arrangements.16 Total expenses are then 
reduced by the total amount paid under brokerage/service and expense 
offset arrangements. The remainder appears on the statement of 
operations as ``net expenses.'' 17 The following example 
illustrates adjustments to the statement of operations required by the 
amended rule:

    \16\ A fund must also use the total expense figure to calculate 
its expense ratio, its ``Other Expenses'' listed in the fee table, 
and its yield. See infra sections II.C and II.D.
    \17\ Because only expenses, and not realized gains/losses or 
unrealized appreciation/depreciation, are adjusted in the statement 
of operations, the presentation of ``net expenses'' is necessary to 
ensure that net investment income is not affected by the adjustment 
to expenses.

Expenses:                                                               
  Management Fee...............................................      $50
  [Other direct fund expenses].................................       48
  Custodian Fee [would include 8 paid by brokers]..............       10
                                                                --------
      Total Expenses...........................................      108
        Fees Paid Indirectly \18\..............................      (8)
                                                                --------
        Net Expenses...........................................      100
                                                                        

    The increase in ``Total Expenses,'' and the offsetting ``Fees Paid 
Indirectly,'' reflect the amount that the fund would have paid for 
services in the absence of brokerage/service and expense offset 
arrangements. If a fund directly negotiates the service provider's 
fees, the cost of the services for purposes of making the required 
adjustments is the amount negotiated, presumably the same amount the 
fund would have paid for the service in the absence of the arrangement. 
If the fund cannot readily determine the actual cost of such services, 
e.g., when a broker arranges for the services or provides them itself 
or through an affiliate, the fund must make a good-faith estimate of 
the amount it would have paid if it had contracted for the services 
directly in an arms-length transaction.19

    \18\ As amended, rule 6-07 requires funds to include a footnote 
to the financial statements that states separately the total amount 
of expenses paid through brokerage/service arrangements and the 
total amount of expenses paid through expense offset arrangements. 
See infra section II.A.4.
    \19\ The good-faith estimate may 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 same 
services.
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4. Financial Statement Note Disclosure
    As proposed, the amendments to rule 6-07 would have required a fund 
to identify separately in a note to the financial statements any 
expense that the amendments would require to be increased by five 
percent or more over the amount of the unadjusted expense.20 
Several commenters urged the Commission to require less detailed note 
disclosure, arguing that shareholders were not interested in individual 
expense amounts. In response to these concerns, the amended rule 
requires a fund to state separately in a note to the financial 
statements the total of expense increases resulting from brokerage/
service and expense offset arrangements (which together should be equal 
to the amount of the ``Fees Paid Indirectly'' line item in the 
statement of operations). The amended rule also requires a fund to 
state in the footnote each category of expense that is increased by an 
amount equal to at least five percent of total expenses.21

    \20\ Proposing Release, supra note 3, at n.12. The amendments, 
as proposed, would have permitted funds to aggregate amounts that 
individually were less than five percent of the unadjusted expense 
and required funds to state the total of these amounts.
    \21\ The five percent threshold is consistent with an existing 
provision of rule 6-07 that requires funds to state separately 
expense items that exceed five percent of the total expenses shown 
in the statement of operations. Rule 6-07.2(b) [17 CFR 210.6-
07.2(b)].
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B. Exception for Research Services

    As proposed, the requirement to adjust reported expenses to include 
amounts paid with commission dollars excepted the cost of research 
services (as that term is used in section 28(e) of the 1934 Act) 
provided by broker-dealers.22 Most commenters believed that the 
exception was appropriate. Many pointed out the difficulties of 
allocating research received by the adviser among accounts when the 
brokerage of those accounts is used to acquire the research.23 
Some also asserted that it would be difficult to value research 
services, particularly when combined with brokerage services, while 
others objected to 

[[Page 38921]]
making assumptions about the value of research services.

    \22\ See supra note 1. Because research services are typically 
provided to the adviser, not the fund, the specific exception may be 
unnecessary. In light of the widespread use of research soft dollar 
arrangements, however, the Commission is adopting a specific 
exception.
    \23\ Twenty commenters expressly opposed allocation of research 
on an account-specific basis, stating that such a requirement would 
be burdensome (with no corresponding benefit to investors), costly, 
arbitrary or impossible.
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    A minority of commenters supported the additional disclosure of 
research soft dollar practices. These commenters expressed concern that 
such practices pose the same hidden expense problems as brokerage/
service arrangements, and that such practices may be more likely to 
raise conflicts of interest than brokerage/service arrangements. None 
of the commenters, however, suggested a feasible approach for valuing 
24 or allocating 25 research services for purposes of 
disclosure. Because of the practical difficulties of valuing and 
allocating research services, the amendments except the cost of 
research services from the requirement to gross up fund 
expenses.26

    \24\ One commenter recommended that fund advisers be required to 
make a good faith estimate of what soft dollar research would have 
cost in an arms-length transaction. This approach, however, would 
require fund advisers to report positive values for unsolicited and 
unused research, which could distort fund expenses if receipt of the 
research was incidental to brokerage direction decisions made wholly 
on the basis of the broker's execution capabilities. In addition, 
good faith estimates may be difficult to make if the services 
provided are unlike those available for hard dollars.
    \25\ One commenter recommended that expenses incurred on behalf 
of more than one fund be allocated in accordance with written 
formulas approved by the board of directors of each fund. While it 
is possible that a board of directors may be in a position to 
provide guidance to an adviser in allocating the cost or value of 
research among series of a series fund or among funds having a 
common board of directors, it is unlikely that a board would be in 
such a position with respect to other clients of the adviser.
    \26\ The Commission recently proposed new disclosure 
requirements for soft-dollar practices. Investment Advisers Act Rel. 
No. 1469 (Feb. 14, 1995) [60 FR 9750 (Feb. 21, 1995)] (``Adviser 
Soft Dollar Release''). The Commission requested comment on the 
valuation issue in the Adviser Soft Dollar Release. If the comments 
received in response to the Adviser Soft Dollar Release suggest a 
feasible way to address these issues without imposing burdens that 
outweigh the benefits of disclosure, the Commission may reconsider 
the exception for research services provided in the amendments 
adopted today.
C. Fee Table and Financial Highlights Table

    The Commission also proposed amendments to the instructions to 
items of 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'').27 Most commenters supported these amendments and the 
Commission is adopting them as proposed.

    \27\ 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.
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    The amended instructions require that expense percentages included 
in a fund's fee table be based upon total expenses (i.e., expenses that 
include amounts paid in connection with brokerage/service arrangements 
and expense offset arrangements). Similarly, the ``ratio of expenses to 
average net assets'' (``expense ratio'') in a fund's financial 
highlights table must reflect total expenses.28 Funds must also 
include a footnote to the financial highlights table disclosing the 
change in the manner in which expenses have been determined.

    \28\ Item 3(a) of Form N-1A and Item 4.1 of Form N-2. The 
Commission did not propose amendments to the per share tables in 
Forms N-3 and N-4.
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D. Yield

    The Commission is adopting, substantially as proposed, amendments 
to the instructions to yield formulas for funds (other than money 
market funds) that require a fund to include the cost of services paid 
with brokerage commissions in yield quotations appearing in the fund's 
registration statement and, as a result, in its advertisements.29 
The amended instructions require funds to estimate amounts paid with 
commission dollars for the period of the yield quotation.30 A 
majority of commenters addressing this proposal expressed support for 
the requirement. These commenters stated that the proposed requirement 
would prevent funds from overstating yield and would be consistent with 
the Commission's objective of enhancing investors' ability to compare 
expenses and yields among funds.31

    \29\ 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.
    \30\ The amendments to Regulation S-X require funds to adjust 
expenses at the end of a financial statement period, but generally 
would not require funds to accrue or otherwise determine at the end 
of the 30-day period for which yield is calculated the amount of 
expenses paid with brokerage commissions for that period.
    \31\ The amendments do 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 is amortized and 
reflected in that change in value. See, e.g., Item 22(a) of Form N-
1A. 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. 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. Only two 
commenters addressed the question of revising the yield formula for 
money market funds. Both of these commenters agreed with the 
Commission's analysis of the effect of brokerage/service 
arrangements on money market fund yield, and both were opposed to 
such revisions.
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    The amendments do not require funds to adjust yield calculations to 
reflect expense offset arrangements. Because the formula for 
calculating yield requires funds to reduce income by expenses,32 
any increase in expenses to reflect expense offset arrangements would 
require a corresponding increase in income by an estimate of income 
foregone as a result of the arrangement. As discussed above, the 
amendments do not require estimates of foregone income in the statement 
of operations. Moreover, because expense offset arrangements generally 
reduce both income and expenses by similar amounts, reflection of (or 
failure to reflect) these arrangements in calculation of fund yield 
should have a minimal effect on the reported yield.

    \32\ See, e.g. Item 22(b)(ii) of Form N-1A.
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E. Average Commission Rates

    The Commission proposed to require funds to disclose the average 
commission rate paid by a fund in the financial highlights table next 
to the portfolio turnover rate. 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 that increase the cost of securities purchased 
or reduce the proceeds of securities sold. The Commission was concerned 
that funds may not provide adequate information about these costs to 
investors,33 particularly in light of the fact that these costs 
can reflect the cost of research and other benefits the fund adviser 
may receive in connection with its direction of fund brokerage.34

    \33\ A fund is required to disclose in its Statement of 
Additional Information the aggregate amount of brokerage commissions 
it paid to fund affiliates during its three most recent fiscal 
years. Item 17(b) of Form N-1A.
    \34\ See supra notes 1 and 2.
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    Most fund industry commenters opposed the proposal, asserting that 
disclosure of average commission rates either would not be meaningful 
or would be confusing for most investors because average commission 
rates do not reflect spreads and quality of execution. Furthermore, 
they argued, factors affecting commission rates, such as the size of 
the order, the market in which the security trades, and the 

[[Page 38922]]
nature of the brokerage firm capital commitment to the trade, would 
preclude any useful comparison between funds. Other commenters 
expressed concern that requiring funds to disclose average commission 
rates would induce funds to place undue emphasis on lower commission 
rates rather than quality of execution.
    The Commission believes that disclosure of average commission rates 
can improve investors' ability to evaluate and compare fund brokerage 
costs, and is adopting the requirement as proposed. While many factors 
may affect commission rates, many similar factors affect other fund 
costs. The Commission believes that a comparison of average commission 
rates among funds will be a useful bench-mark for investors and 
therefore is adopting the disclosure requirement substantially as 
proposed.35

    \35\ The Commission has added instructions to the various fund 
registration forms describing the method for calculating average 
commission rate. Instruction 17 to Item 3 of Form N-1A, and 
Instruction 19 to Item 4 of Form N-2. The instruction requires funds 
to compute the average commission rate paid by dividing the total 
dollar amount of commissions paid during the fiscal year by the 
total number of shares purchased and sold during the fiscal year for 
which commissions were charged. Funds must convert commissions paid 
in foreign currencies into US dollars and cents per share. Mark-ups, 
Mark-downs, and spreads on shares traded on a principal basis are 
not included in the average commission rate figure unless they are 
disclosed on confirmations prepared in accordance with rule 10b-10 
under the 1934 Act [17 CFR 240.10b-10].
---------------------------------------------------------------------------

    One commenter urged the Commission to exclude from the requirement 
to disclose average commission rates funds that have a de minimis 
amount of transactions on which brokerage commissions are paid. Because 
commission rate information may have limited value in such 
circumstances, the Commission has adopted an exclusion for funds that, 
during any fiscal year, invest on average less than ten percent of 
their net assets in equity securities on which commissions are charged 
on trades.36

    \36\ Instruction 16 to Item 3 of Form N-1A, and Instruction 18 
to Item 4 of Form N-2.
---------------------------------------------------------------------------

F. Effective Date

    The amendments are effective September 1, 1995. All funds may elect 
to comply with the amendments before the effective date or before the 
compliance dates described below.
G. Compliance Dates

1. Registration Statements
    a. Current Registrants. Registered investment companies must amend 
their registration statements to comply with the rule amendments no 
later than the next post-effective amendment updating financial 
statements pursuant to section 10(a)(3) of the 1933 Act to reflect 
information for fiscal years ending on or after the effective date.\37\ 
Information regarding average commission rates, however, must be 
provided only for fiscal years beginning on or after the effective 
date.\38\

    \37\ The financial highlights table in fund prospectuses 
presents financial data for each of the last ten fiscal years. The 
amendments do not require funds to reflect total expenses in the 
expense ratio of the financial highlights table for fiscal years 
ending before the effective date.
    \38\ This requirement is consistent with the Commission's 
proposal. See Proposing Release, supra note 3, at n.30.
---------------------------------------------------------------------------

    b. New Registrants. Funds with registration statements effective on 
or after the effective date of these rule amendments must first reflect 
these rule amendments in financial information contained in post-
effective amendments filed thereafter.
2. Yield Information
    Yield quotations appearing in fund advertisements or other sales 
literature published or distributed on or after December 1, 1995 must 
be calculated in accordance with the rule amendments.
3. Proxy Statements and Shareholder Reports
    Financial information covering fiscal years ending on or after the 
effective date contained in proxy statements and shareholder reports 
filed with the Commission must comply with the amendments.

H. Filing Requirements for Post-Effective Amendments

    Post-effective amendments to fund registration statements made for 
purpose of complying with these rule amendments may be made pursuant to 
the immediate effectiveness provisions of rule 485(b) under the 1940 
Act [17 CFR 230.485(b)], provided that the post-effective amendment 
otherwise meets the conditions for immediate effectiveness under that 
rule.

III. Cost/Benefit Analysis

    The rule and form changes adopted today are intended to improve the 
reporting of investment company expenses and the ability of investors 
to compare investment company expenses and yield. While these 
amendments may increase the cost to funds of preparing financial 
statements and registration materials, the Commission believes that any 
such cost increases would, at most, be minimal. A fund that has 
brokerage/service or expense offset arrangements is 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. Funds generally should be 
readily able to determine these figures. Commenters on the proposal 
stated that funds should also be readily able to estimate expenses paid 
with brokerage commissions for purposes of yield calculations. Thus, 
the Commission believes that the costs of the amendments will not be 
significant and will be substantially outweighed by the benefits to 
investors of receiving more accurate and useful financial information 
about funds.

IV. Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis, prepared 
in accordance with 5 U.S.C. 603, was published in the Proposing 
Release. No comments were received on this analysis. The Commission has 
prepared a final Regulatory Flexibility Analysis, a copy of which may 
be obtained by contacting Karen J. Garnett, Office of Disclosure and 
Investment Adviser Regulation, Securities and Exchange Commission, 450 
Fifth Street, N.W., Washington, DC 20549.

V. Statutory Authority

    The Commission is amending rule 6-07 of Regulation S-X and the 
various fund registration forms under the authority of section 7 of the 
1933 Act [15 U.S.C. 77g] and sections 8 and 38(a) of the 1940 Act [15 
U.S.C. 80a-8, 80a-37(a)]. The authority citations for the rule and form 
amendments precede the text of the amendments.

Text of 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 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:


[[Page 38923]]

    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, 80a-37a, unless 
otherwise noted.

    2. By adding paragraph 2.(g) to the Statements of Operations 
Sec. 210.6-07 to read as follows:


Sec. 210.6-07  Statements of operations.

* * * * *
    2. Expenses. * * *
    (g)(1) Brokerage/Service Arrangements. If a broker-dealer or an 
affiliate of the broker-dealer has, in connection with directing 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)]), include 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.
    (2) Expense Offset Arrangements. If the person has entered into an 
agreement with any other person pursuant to which such other person 
reduces, or pays a third party which reduces, by a specified or 
reasonably ascertainable amount, its fees for services provided to the 
person in exchange for use of the person's assets, include in the 
expense items set forth under this caption the amount of fees that 
would have been incurred by the person if the person had not entered 
into the agreement.
    (3) Financial Statement Presentation. Show the total amount by 
which expenses are increased pursuant to paragraphs (1) and (2) of this 
paragraph 2.(g) as a corresponding reduction in total expenses under 
this caption. In a note to the financial statements, state separately 
the total amounts by which expenses are increased pursuant to 
paragraphs (1) and (2) of this paragraph 2.(g), and list each category 
of expense that is increased by an amount equal to at least 5 percent 
of total expenses. If applicable, the note should state that the person 
could have employed the assets used by another person to produce income 
if it had not entered into an arrangement described in paragraph 
2.(g)(2) of this section.
* * * * *
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. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l, 78m, 
78n, 78o(d), 80a-8, 80a-24, and 80a-29, 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) in 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'' includes 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).
* * * * *
    6. By amending Item 3(a) in Part A of Form N-1A (referenced in 
Secs. 239.15A and 274.11A) by adding the phrase ``Average Commission 
Rate Paid'' below ``Portfolio Turnover Rate'', by redesignating 
Instructions 13 and 14 as Instructions 14 and 15, and adding 
Instructions 13, 16, and 17 to read as follows:

Form N-1A

* * * * *

Part A--Information Required in a Prospectus

* * * * *

Item 3. Condensed Financial Information

    (a) * * *
    Instructions:
* * * * *

Ratios/Supplemental Data

* * * * *
    13. 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, and including reductions resulting from complying with 
paragraphs 2(a) and (f) of Rule 6-07 regarding fee waivers and 
reimbursements. If a change in the methodology for determining the 
ratio of expenses to average net assets results from applying paragraph 
2(g) of Rule 6-07, explain in a note that the ratio reflects fees paid 
with brokerage commissions and fees reduced in connection with specific 
agreements only for fiscal years ending after September 1, 1995.
* * * * *

Average Commission Rate Paid

    16. A Registrant that invests not more than ten percent of the 
value of its average net assets in equity securities on which 
commissions are charged on trades may omit ``average commission rate 
paid.'' Compute average net assets based on amounts invested at the end 
of each fiscal quarter.
    17. Compute the ``average commission rate paid'' as follows: (A) 
divide the total dollar amount of commissions paid during the fiscal 
year by (B) the total number of shares purchased and sold during the 
fiscal year for which commissions were charged. Carry the amount of the 
average commission rate paid to no fewer than four decimal places. 
Convert commissions paid in foreign currency into U.S. dollars and 
cents per share using consistently either the prevailing exchange rate 
on the date of the transaction or average exchange rate over such 
period as related transactions took place. Do not include mark-ups, 
mark-downs, or spreads paid on shares traded on a principal basis 
unless such mark-ups, mark-downs, or spreads are disclosed on 
confirmations prepared in accordance with rule 10b-10 under the 1934 
Act [17 CFR 240.10b-10].
* * * * *
    7. By redesignating Instructions 7 and 8 to Item 22(b)(ii) as 
Instructions 8 and 9, and adding Instruction 7 to Item 22(b)(ii) in 
Part B of Form N-1A 

[[Page 38924]]
(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 directing 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 in 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'' includes 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).
* * * * *
    9. By amending Item 4.1 in Part A of Form N-2 (referenced in 
Secs. 239.14 and 274.11a-1) by adding ``l. Average Commission Rate 
Paid'' below ``k. Portfolio Turnover Rate'', by redesignating 
Instruction 16 as Instruction 17, and adding Instructions 16, 18 and 19 
to read as follows:

Form N-2

* * * * *

Part A--Information Required in a Prospectus

* * * * *

Item 4. Financial Highlights

    1. General * * *
    Instructions * * *
    Ratios and Supplemental Data * * *
    16. 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, and including reductions resulting from complying with 
paragraphs 2(a) and (f) of Rule 6-07 regarding fee waivers and 
reimbursements. If a change in the methodology for determining the 
ratio of expenses to average net assets results from applying paragraph 
2(g) of Rule 6-07, explain in a note that the ratio reflects fees paid 
with brokerage commissions and fees reduced in connection with specific 
agreements only for fiscal years ending after September 1, 1995.
* * * * *

Average Commission Rate Paid

    18. A Registrant that invests not more than ten percent of the 
value of its average net assets in equity securities on which 
commissions are charged on trades may omit ``average commission rate 
paid.'' Compute average net assets based on amounts invested at the end 
of each fiscal quarter.
    19. Compute the ``average commission rate paid'' as follows: (A) 
divide the total dollar amount of commissions paid during the fiscal 
year by (B) the total number of shares purchased and sold during the 
fiscal year for which commissions were charged. Carry the amount of the 
average commission rate paid to no fewer than four decimal places. 
Convert commissions paid in foreign currency into U.S. dollars and 
cents per share using consistently either the prevailing exchange rate 
on the date of the transaction or average exchange rate over such 
period as related transactions took place. Do not include mark-ups, 
mark-downs, or spreads paid on shares traded on a principal basis 
unless such mark-ups, mark-downs, or spreads are disclosed on 
confirmations prepared in accordance with rule 10b-10 under the 1934 
Act [17 CFR 240.10b-10].
* * * * *
    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) in 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'' includes all expenses (except fees and 
expenses reported in other items in the table) that are deducted from 
separate account 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).
* * * * *
    11. By redesignating Instruction 7 to Item 25(b)(ii) as Instruction 
8, and adding Instruction 7 to Item 25(b)(ii) in 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 directing 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 

[[Page 38925]]
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) in 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'' includes 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).
* * * * *
    13. By redesignating Instructions 2 and 3 to Item 21(b)(ii) as 
Instructions 3 and 4, and adding Instruction 2 to Item 21(b)(ii) in 
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 directing 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: July 21, 1995.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-18472 Filed 7-27-95; 8:45 am]
BILLING CODE 8010-01-P