[Federal Register Volume 61, Number 181 (Tuesday, September 17, 1996)]
[Proposed Rules]
[Pages 49022-49027]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23437]



  Federal Register / Vol. 61, No. 181 / Tuesday, September 17, 1996 / 
Proposed Rules  

[[Page 49022]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-22203; File No. S7-24-96]
RIN 3235-AG72


Rule Amendments Relating to Multiple Class and Series Investment 
Companies

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The Commission is proposing for public comment amendments to 
the rule under the Investment Company Act of 1940 that permits open-end 
management investment companies (``funds'') to issue multiple classes 
of shares representing interests in the same portfolio. The proposed 
amendments would expand and clarify the methods a fund may use to 
allocate among its classes income, gains and losses, and the expenses 
that are not attributable to a particular class. The proposed 
amendments also would clarify the shareholder voting provisions of the 
rule. The Commission also is proposing a technical amendment to the 
rule under the Investment Company Act that governs the use of fund 
assets to pay for the distribution of fund shares, as it applies to 
series funds.

DATES: Comments must be received on or before November 18, 1996.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, 
N.W., Stop 6-9, Washington, D.C. 20549. Comments also may be submitted 
electronically at the following E-mail address: [email protected]. 
All comment letters should refer to File No. S7-24-96; this file number 
should be included on the subject line if E-mail is used. Comment 
letters will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, N.W., Washington, 
D.C. 20549. Electronically submitted comment letters also will be 
posted on the Commission's Internet web site (http://www.sec.gov).

FOR FURTHER INFORMATION CONTACT: Marilyn Mann, Senior Counsel, Office 
of Regulatory Policy, (202) 942-0690, or, regarding accounting issues, 
Lawrence A. Friend, Chief Accountant, Office of the Chief Accountant, 
(202) 942-0590, both in the Division of Investment Management, Stop 10-
2, Securities and Exchange Commission, 450 Fifth Street, N.W., 
Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Commission today is requesting public 
comment on proposed amendments to rules 12b-1 [17 CFR 270.12b-1] and 
18f-3 [17 CFR 270.18f-3] under the Investment Company Act of 1940 [15 
U.S.C. 80a] (the ``Investment Company Act'').

Table of Contents

Executive Summary
    I. Discussion
    A. Rule 18f-3
    1. Background: Allocation Methods
    a. Settled Shares Method
    (1) Requirement For Same NAV Per Share Among Classes
    (2) Consistent Application Requirement
    b. Simultaneous Equations Method
    c. Request for Comments
    2. Purchase Class Voting Rights
    B. Rule 12b-1
II. Cost/Benefit Analysis
III. Initial Regulatory Flexibility Analysis
    A. Reasons for the Proposed Action
    B. Objectives
    C. Legal Basis
    D. Small Entities Subject to the Rule
    E. Reporting, Recordkeeping, and Other Compliance Requirements
     F. Duplicative, Overlapping or Conflicting Federal Rules
     G. Significant Alternatives
     1. The Establishment of Differing Compliance or Reporting 
Requirements or Timetables That Take Into Account the Resources 
Available to Small Entities
    2. The Clarification, Consolidation, or Simplification of 
Compliance and Reporting Requirements Under the Rule for Such Small 
Entities
    3. The Use of Performance Rather Than Design Standards
    4. An Exemption From Coverage of the Rule, or Any Part Thereof, 
for Such Small Entities
    H. Solicitation of Comments
IV. Statutory Authority
Text of Proposed Rule Amendments

Executive Summary

    The Commission is proposing amendments to rule 18f-3 under the 
Investment Company Act. Rule 18f-3 permits funds to issue multiple 
classes of shares representing interests in the same portfolio. Funds 
generally establish multiple classes of shares as a vehicle for 
offering investors a choice of methods for paying distribution costs or 
to allow funds to access alternative distribution channels more 
efficiently. The rule, among other things, prescribes how a fund must 
allocate to each class income, gains and losses, and the expenses that 
are not attributable to a particular class. The proposed amendments 
would provide greater flexibility in allocating these items. The 
proposed amendments would permit any fund that declares dividends daily 
to base allocations on settled shares (i.e., shares for which payment 
in federal funds has been received). Currently, only funds that declare 
daily dividends and maintain the same net asset value (``NAV'') per 
share in each class may use this method. The proposed amendments also 
would permit funds to base allocations on an additional method, the 
simultaneous equations method. Under this method, income, gains and 
losses, and expenses are allocated based on simultaneous equations that 
are designed to result in the annualized rate of return of each class 
generally differing from that of the other classes only by the expense 
differentials among the classes.
    The proposed amendments also would clarify shareholder voting 
rights under the rule when a fund offers one class of shares (the 
``purchase class'') that automatically converts into another class (the 
``target class''). Rule 18f-3 currently requires shareholders of the 
purchase class to approve increases in the expenses of the target class 
under certain circumstances. The proposed amendments would clarify that 
purchase class shareholders have voting rights only with respect to 
material increases in expenses that are submitted separately to target 
class shareholders for their approval.
    The Commission is also proposing to amend rule 12b-1 under the 
Investment Company Act, the rule that governs the use of fund assets to 
pay for the distribution of fund shares in accordance with a ``rule 
12b-1 plan.'' The proposed amendments would clarify how various 
provisions of the rule (e.g., those requiring shareholder voting) apply 
to a ``series'' fund. A series fund is a fund that offers investors an 
opportunity to invest in one or more portfolios, each of which has a 
specific investment objective. The amendments would clarify that a 
series fund's rule 12b-1 plan must be severable for each series and 
that whenever an action is required with respect to the plan (e.g., a 
shareholder vote on a proposal to increase the fee payable under the 
plan), that action must be taken separately for each series.

I. Discussion

A. Rule 18f-3

1. Background: Allocation Methods
    Rule 18f-3 permits funds to issue multiple classes of shares 
representing interests in the same portfolio of securities.1 Funds 
generally establish

[[Page 49023]]

multiple classes as a vehicle for offering investors a choice of 
methods for paying distribution costs or to allow funds to access 
alternative distribution channels more efficiently. Rule 18f-3 provides 
a framework for addressing certain corporate governance and accounting 
issues that may create conflicts among the classes. Among other things, 
the rule prescribes how a fund must allocate to each class income, 
gains and losses,2 and expenses that are not attributable to a 
particular class (``fundwide expenses'').
---------------------------------------------------------------------------

    \1\ Funds that issue multiple classes of shares must rely on 
rule 18f-3 or on an exemptive order because such issuances implicate 
section 18 of the Investment Company Act [15 U.S.C. 80a-18], which, 
among other things, generally makes it unlawful for a fund to issue 
any class of ``senior security'' or to issue classes of shares with 
different voting rights.
    \2\ In this release, ``gains and losses'' refers to both 
realized gains and losses and unrealized appreciation and 
depreciation.
---------------------------------------------------------------------------

    Rule 18f-3 generally requires a fund to allocate income, gains and 
losses, and fundwide expenses based on the net assets of each class in 
relation to the net assets of the fund (``relative net assets'').3 
The rule permits a fund that declares dividends daily, such as a money 
market fund or a fund that invests in fixed-income securities (a 
``daily dividend fund''), to use two alternative allocation methods, 
provided the fund maintains the same NAV per share in each class.4 
A daily dividend fund may allocate income, gains and losses, and 
fundwide expenses (i) to each share without regard to class,5 or 
(ii) to each class based on relative net assets, excluding the value of 
subscriptions for shares for which payment in federal funds has not 
been received (the ``Settled Shares Method'').6
---------------------------------------------------------------------------

    \3\ Rule 18f-3(c)(1) [17 CFR 270.18f-3(c)(1)].
    \4\ Rule 18f-3(c)(2) [17 CFR 270.18f-3(c)(2)].
    \5\ Because the fund must maintain the same NAV per share in 
each class, this method is equivalent to allocations based on 
relative net assets. Rule 18f-3 requires funds using this method to 
obtain the agreement of their service providers that, to the extent 
necessary to assure that all classes maintain the same NAV, the 
providers will waive or reimburse class expenses. Rule 18f-
3(c)(2)(i) [17 CFR 270.18f-3(c)(2)(i)]. The proposed amendments 
would clarify that payments waived or reimbursed under such an 
undertaking may not be carried forward or recouped at a later time. 
Proposed rule 18f-3(c)(1)(iv).
    \6\ The term ``net assets'' includes the value of any 
receivables, including subscriptions receivable. See AICPA, Audits 
of Investment Companies: Audit and Accounting Guide para. 5.13 (May 
1994). A fund that requires subscriptions to be accompanied by 
federal funds will record cash, rather than a receivable, as the 
asset that relates to the subscription.
---------------------------------------------------------------------------

a. Settled Shares Method
(1) Requirement For Same NAV Per Share Among Classes
    Many daily dividend funds pay dividends from net investment income 
only on settled shares (i.e., shares that are paid for in federal funds 
or for which payment has been converted into federal funds). Funds with 
this dividend policy have noted that the payment of daily dividends to 
a purchaser of fund shares that did not purchase its shares with 
immediately available funds would dilute the dividends of other 
shareholders, since the fund would not yet have invested the proceeds 
from such purchase.7 Using the Settled Shares Method to allocate 
income and fundwide expenses is consistent with this dividend policy.
---------------------------------------------------------------------------

    \7\ See Exemption for Open-End Management Investment Companies 
Issuing Multiple Classes of Shares; Disclosure by Multiple Class and 
Master-Feeder Funds; Class Voting on Distribution Plans, Investment 
Company Act Release No. 20915 (Feb. 23, 1995) [60 FR 11876, 11878-79 
& n.20 (Mar. 2, 1995)] (hereinafter ``Adopting Release''); T. Rowe 
Price Associates, Inc. (pub. avail. Dec. 22, 1986).
    A daily dividend fund may invest in securities that settle daily 
against federal funds (in contrast to other securities that have 
``regular way'' (i.e., ``T + 3'') settlement). A daily dividend fund 
that invests in income-producing securities that have a longer 
settlement period may choose to place orders for such securities 
when it receives orders for shares that are not accompanied by 
payment in federal funds, since it will not have to make payment for 
such securities before receiving payment for the shares. Id. The 
fund does not start earning interest on such securities until it has 
paid for them, however; therefore, these securities do not 
contribute to the fund's income immediately.
---------------------------------------------------------------------------

    Some daily dividend fixed-income funds currently use the Settled 
Shares Method pursuant to exemptive orders that predate the adoption of 
rule 18f-3. These funds are unable to rely on rule 18f-3 because they 
do not necessarily maintain the same NAV per share in each class, a 
requirement for funds that use the Settled Shares Method and rely on 
rule 18f-3. The proposed amendments would permit a daily dividend fund 
to use the Settled Shares Method without requiring the fund to maintain 
the same NAV per share in each class.8 This requirement may be 
unnecessary, since the Settled Shares Method will result in appropriate 
allocations even if NAV per share differs among the classes.
---------------------------------------------------------------------------

    \8\ Proposed rule 18f-3(c)(1)(iii). The amended rule would 
define a daily dividend fund as ``any company that has a policy of 
declaring distributions of net investment income daily, including 
any money market fund that determines its net asset value using the 
amortized cost method permitted by rule 2a-7.'' The reference to 
funds that use the amortized cost method under rule 2a-7 is designed 
to make it clear that valuing net assets based on amortized cost is 
permitted under rule 18f-3(c) [17 CFR 270.18f-3(c)]. See Adopting 
Release, supra note 7, at 11879.
---------------------------------------------------------------------------

(2) Consistent Application Requirement
    The release adopting rule 18f-3 stated that the allocation method 
selected by a fund ``must be applied consistently.'' 9 The 
Commission staff has indicated, however, that funds may allocate gains 
and losses based on relative net assets, while using the Settled Shares 
Method for allocating income and fundwide expenses.10 Allocating 
gains and losses based on relative net assets is consistent with the 
participation of all shares in any increase or decrease in NAV that 
results from appreciation or depreciation of the underlying securities, 
including shares that have not yet settled.11 The proposed 
amendments would explicitly permit this approach.12 The Commission 
believes that many funds take this approach and requests comment 
whether this approach should be mandatory for funds using the Settled 
Shares Method.
---------------------------------------------------------------------------

    \9\ Adopting Release, supra note 7, at 11879.
    \10\ Letter to Investment Company Chief Financial Officers from 
the Division of Investment Management 5 (Nov. 2, 1995).
    \11\ Using the Settled Shares Method to allocate gains and 
losses may cause a divergence of NAV per share among classes, 
creating a particular problem for those funds that seek to maintain 
the same or a similar NAV per share in each class. Id. This is 
because NAV per share is based on, among other things, the value of 
any receivables, including subscriptions to purchase shares for 
which the fund has not yet received payment. See supra note 6. 
Allocating gains and losses to classes based on the net assets of 
each class excluding subscriptions receivable causes the shares of 
each class to increase or decrease in value by a proportionately 
different amount per share than the shares of other classes.
    \12\ Proposed rule 18f-3(c)(1)(iii).
---------------------------------------------------------------------------

b. Simultaneous Equations Method
    The proposed amendments would permit funds to allocate income, 
gains and losses, and fundwide expenses based on an additional method, 
the ``Simultaneous Equations Method.'' 13 Under this method, 
allocation is based on simultaneous equations that are designed to 
result in the annualized rate of return of each class generally 
differing from that of the other classes only by the expense 
differentials among the classes. Using this method allows a fund to 
simultaneously allocate (or reallocate) various income and capital 
items based on the fund's operating results, changes in ownership 
interests of each class, and expense differentials among the 
classes.14 Industry representatives have suggested that the 
results derived from this method are consistent with the purpose of the 
rule's allocation provisions.
---------------------------------------------------------------------------

    \13\ Proposed rule 18f-3(c)(1)(ii); see also proposed rule 18f-
3(c)(2)(iv) (defining the Simultaneous Equations Method).
    \14\ The equations would allocate the day's income, realized 
gains (or losses), unrealized appreciation (or depreciation), and 
fundwide expenses and reallocate each class's undistributed net 
investment income, undistributed realized gains (or losses), and 
unrealized appreciation (or depreciation).
---------------------------------------------------------------------------

    The Commission understands that the equations used in connection 
with this method continue to be refined. The equations would therefore 
not be

[[Page 49024]]

specified in the amended rule. Comment is requested whether they should 
be specified. An example of the equations that have been used is 
attached to this Release as Appendix A.
c. Request for Comments
    The Commission requests comment on the Settled Shares and 
Simultaneous Equations Methods and whether there are any other 
allocation methods that should be included in the rule. The Commission 
also requests comment on the rule's overall approach of describing 
specific allocation methods and restrictions on the funds that may use 
them. In particular, the Commission requests comment whether the rule 
should permit a fund to use any method that results in shareholders of 
each class receiving their proportionate share of income, gains and 
losses, and fundwide expenses. Such an approach would provide funds 
with flexibility and avoid the possible need for further administrative 
relief. The Commission requests that, in connection with commenting on 
such approach, commenters address the need for the development of 
accounting standards applicable to allocation methods to be followed by 
multiple class funds. Commenters should address, for example, whether 
Generally Accepted Accounting Principles currently provide appropriate 
guidance on the allocation methods to be followed by multiple class 
funds and whether more specific guidance needs to be developed.
    Commenters favoring this approach should formulate a recommended 
standard. Should the rule, for example, permit allocations to be based 
on any method that is fair to the shareholders of each class? Should 
the rule permit funds to use any allocation method that produces 
substantially similar allocations to those that would have resulted if 
one of the allocation methods prescribed by the rule had been applied? 
Commenters should also consider whether the rule should require a 
particular party (e.g., the fund's investment adviser, independent 
accountants, or board of directors) to determine that the standard had 
been met. For example, would the accountant's report on internal 
controls required by sub-item 77B of Form N-SAR offer adequate 
safeguards for permitting additional flexibility? 15 If so, is it 
necessary to amend the instructions to sub-item 77B to have the 
accountant's report specifically address the allocation controls relied 
upon? Commenters favoring this approach should provide language for any 
recommended changes to the instructions.
---------------------------------------------------------------------------

    \15\ See 17 CFR 274.101. Prior to the adoption of rule 18f-3, 
Commission orders required an expert retained by each multiple class 
fund to file a report with the Commission on the adequacy of 
accounting procedures of the fund. This requirement was not included 
in the rule because the Commission and commenters agreed that rule 
18f-3 adequately defined the methodology that a fund should follow 
in allocating income, expenses and other items among the classes. 
See Adopting Release, supra note 7, at 11879 & nn.28-29.
---------------------------------------------------------------------------

2. Purchase Class Voting Rights
    Rule 18f-3 contains certain conditions that address arrangements 
that involve a class of shares with one type of distribution charge 
that automatically convert into another class after a specified period 
of time. The purchase class is generally a class with a higher 
distribution fee and a contingent deferred sales load 
(``CDSL'').16 A CDSL is a sales charge that is assessed when 
shares are redeemed. The CDSL generally declines to zero over time and 
is designed to recover any distribution costs that have not yet been 
recovered from the distribution fees. After a specified period, the 
purchase class shares convert automatically into the target class, 
which generally has a low (or no) distribution fee.
---------------------------------------------------------------------------

    \16\ A distribution fee is a charge to fund assets that may be 
used to pay certain distribution expenses in accordance with rule 
12b-1 [17 CFR 270.12b-1]. Such fees often are referred to as ``rule 
12b-1 fees.'' See infra part I.B. See generally Exemption for 
Certain Open-End Management Investment Companies to Impose Deferred 
Sales Loads, Investment Company Act Release No. 22202 (September 9, 
1996).
---------------------------------------------------------------------------

    One of rule 18f-3's conditions states that if expenses, including 
payments of distribution fees, are increased materially for the target 
class without approval of the shareholders of the purchase class, the 
fund will establish a new target class for the purchase class on the 
same terms as applied to the target class before the increase.17 
This condition, read literally, appears to require approval by the 
purchase class shareholders (or the creation of a new target class) for 
any material expense increase that applies to the target class. This 
could include increases in expenses that are not required to be 
submitted for shareholder approval (e.g., transfer agency fees) or that 
are required to be approved by shareholders on a fundwide basis rather 
than separately by class (e.g., advisory fees). This result was not 
intended. The condition was designed to give purchase class 
shareholders voting rights only when an expense increase is submitted 
for a separate vote of the target class shareholders.
---------------------------------------------------------------------------

    \17\ Rule 18f-3(e)(2)(iii) [17 CFR 270.18f-3(e)(2)(iii)]; see 
also rule 12b-1(b)(4) [17 CFR 270.12b-1(b)(4)] (requiring 
shareholder approval of any changes in a rule 12b-1 plan that would 
materially increase the fees payable under the plan).
---------------------------------------------------------------------------

    The amended rule would clarify that purchase class shareholders 
have voting rights (or rights to a new target class) with respect to 
increases in expenses that are submitted separately for approval by 
target class shareholders.18 These expenses would include a 
material increase in payments under the target class's rule 12b-1 plan 
and, if submitted for target class approval, an increase in payments 
under a shareholder services plan.19 The amendment will not affect 
whether a matter is required to be submitted to shareholders of the 
target class.
---------------------------------------------------------------------------

    \18\ See proposed rule 18f-3(e)(2)(iii); see also infra note 23 
regarding a technical amendment to rule 12b-1(g) [17 CFR 270.12b-
1(g)], which refers to the voting rights of purchase class 
shareholders in connection with a rule 12b-1 plan applicable to the 
target class.
    \19\ See rule 18f-3(a)(1)(i) [17 CFR 270.18f-3(a)(1)(i)] 
(regarding the allocation of expenses under a rule 12b-1 plan or 
shareholder services plan to a particular class). Purchase class 
shareholders also would have voting rights with respect to increases 
in any other expenses specifically assigned to the target class, 
such as transfer agency fees, but only if the increase is submitted 
for approval by the target class shareholders. See rule 18f-
3(a)(1)(ii) [17 CFR 270.18f-3(a)(1)(ii)] (regarding expenses other 
than fees under a rule 12b-1 or shareholder services plan that may 
be allocated to a particular class). Since the proposed amendment 
would refer to expenses allocated under rule 18f-3(a)(1) (i)-(ii), 
which includes payments authorized under a rule 12b-1 plan, the 
reference in the current rule to such payments would be deleted as 
unnecessary.
---------------------------------------------------------------------------

B. Rule 12b-1

    Rule 12b-1 governs the use of fund assets to pay for the 
distribution of fund shares. Among other things, rule 12b-1 requires 
that any payments made by the fund in connection with the distribution 
of its shares be made pursuant to a written rule 12b-1 plan that 
describes all material aspects of the proposed financing of 
distribution.20 Rule 12b-1 also requires certain shareholder votes 
to be taken with respect to the approval or amendment of the rule 12b-1 
plan.
---------------------------------------------------------------------------

    \20\ Rule 12b-1(b) [17 CFR 270.12b-1(b)].
---------------------------------------------------------------------------

    Rule 12b-1 specifies how its shareholder voting and other 
requirements apply when a fund offers separate classes of shares. The 
rule provides that if a rule 12b-1 plan covers more than one class, the 
provisions of the plan must be severable for each class, and that 
actions required to be taken under the rule must be taken separately 
for each class (the ``severability provision'').21 Although the 
severability provision does not specifically address a fund that offers 
more than one series of shares, the requirements of rule 12b-1 have 
been interpreted to apply separately to each

[[Page 49025]]

series offered by a fund.22 The Commission proposes to amend rule 
12b-1 to reflect this position. As amended, the severability provision 
also would apply to a rule 12b- plan that covers more than one series 
of shares.23
---------------------------------------------------------------------------

    \21\ Rule 12b-1(g) [17 CFR 270.12b-1(g)].
    \22\ See Distribution of Shares by Registered Open-End 
Management Investment Company, Investment Company Act Release No. 
22201 (September 9, 1996). The amendments adopted in Release No. 
22201 specified that a rule 12b-1 plan adopted before the shares of 
a fund are publicly offered or sold to persons who are not 
affiliated persons of the fund or affiliated persons of such persons 
does not have to be approved by shareholders. Commenters requested 
that the Commission clarify that the amendments also applied to a 
rule 12b-1 plan that related to a series that had not been publicly 
offered. The Commission adopted that interpretation; the amendments 
proposed today would codify it.
    \23\ See proposed rule 12b-1(g). A proviso to current rule 12b-
1(g) states that under rule 18f-3(e)(2), any vote by target class 
shareholders with respect to the target class's rule 12b-1 plan also 
requires a vote of the shareholders of the purchase class. Because 
the voting rights of purchase class shareholders are fully described 
in rule 18f-3, the Commission proposes to amend rule 12b-1(g) to 
delete this proviso. The amended rule would simply state that the 
provisions of rule 12b-1(g) do not affect the rights of purchase 
class shareholders under rule 18f-3(e)(2)(iii).
---------------------------------------------------------------------------

II. Cost/Benefit Analysis

    The amendments to rule 18f-3 would provide funds with greater 
flexibility in allocating income, gains and losses, and fundwide 
expenses among classes and would decrease costs for certain funds by 
allowing them to rely on the rule instead of on an exemptive order. The 
amendment to rule 12b-1 would not impose any burden since it merely 
clarifies an existing interpretation of the rule.

III. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis has been prepared in 
accordance with 5 U.S.C. 603. It relates to the proposed amendments to 
rules 12b-1 and 18f-3.

A. Reasons for the Proposed Action

    As discussed in part I.A.1, the proposed amendments to rule 18f-3 
would provide greater flexibility in allocating income, realized gains 
and losses, unrealized appreciation and depreciation, and fundwide 
expenses. The proposed amendments would also permit certain multiple 
class daily dividend funds that are currently relying on exemptive 
orders issued prior to the adoption of rule 18f-3 to rely on the rule. 
As discussed in part I.A.2, another proposed amendment to rule 18f-3 
would clarify that purchase class shareholders have voting rights (or 
rights to a new target class) only with respect to increases in 
expenses that are submitted separately for approval by target class 
shareholders.
    As discussed in part I.B, the proposed amendments to rule 12b-1 
would clarify how various provisions of the rule apply to a series 
investment company.

 B. Objectives

    The proposed amendments to the accounting provisions of rule 18f-3 
would give multiple class funds more flexibility and would permit 
certain daily dividend funds that are currently relying on exemptive 
orders to rely on the rule. The proposed amendment to the provision of 
rule 18f-3 relating to purchase class voting rights would provide 
greater certainty by correcting the language of the rule consistent 
with its original intent. The proposed amendment to rule 12b-1 relating 
to series funds would codify existing interpretations of the rule.

C. Legal Basis

    The Commission is proposing to amend rule 12b-1 under the authority 
set forth in sections 12(b) and 38(a) of the Investment Company Act, 
and rule 18f-3 under sections 6(c), 18(i), and 38(a) of the Investment 
Company Act.

D. Small Entities Subject to the Rule

    Rules 12b-1 and 18f-3 apply to registered open-end management 
investment companies. Any registered open-end management investment 
company with net assets of $50 million or less as of the end of its 
most recent fiscal year is considered a small entity under Commission 
rules.24 It is estimated that out of approximately 3000 active 
open-end management investment companies, approximately 500 are 
considered small entities. Of these 500 small entities, approximately 
42 offer multiple classes of shares.
---------------------------------------------------------------------------

    \24\ Rule 0-10 [17 CFR 270.0-10].
---------------------------------------------------------------------------

E. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed amendments would not impose any new reporting, 
recordkeeping, or other compliance requirements.

 F. Duplicative, Overlapping or Conflicting Federal Rules

    The Commission believes that there are no duplicative, overlapping, 
or conflicting federal rules.

G. Significant Alternatives

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant adverse impact on small issuers. In 
connection with the proposed amendments, the Commission considered the 
following alternatives.
1. The Establishment of Differing Compliance or Reporting Requirements 
or Timetables That Take Into Account the Resources Available to Small 
Entities
    If registered open-end management investment companies that are 
small entities wish to operate multiple class structures they must 
comply with either rule 18f-3 or an exemptive order. Rule 18f-3 eased 
the requirements the Commission imposed in exemptive orders. As 
discussed above, the amendment to the requirements for using the 
settled shares method of allocation will allow certain funds that are 
currently relying on exemptive orders to rely on the rule, which is 
expected to reduce costs and improve flexibility for these funds.
    The addition of the simultaneous equations method to the rule gives 
funds added flexibility and will not create any compliance burden since 
the use of that method is optional. The proposed amendment to rule 18f-
3 relating to purchase class voting rights and the proposed amendment 
to rule 12b-1 relating to series funds are merely clarifying changes 
and will have no adverse impact on small issuers.
    In light of the above, different compliance or reporting 
requirements or timetables are not necessary to accommodate small 
entities and would not be consistent with the objectives of investor 
protection.
2. The Clarification, Consolidation, or Simplification of Compliance 
and Reporting Requirements Under the Rule for Such Small Entities
    As noted above, certain of the proposed amendments are designed to 
clarify the requirements of rules 12b-1 and 18f-3. The proposed 
amendment to rule 18f-3 relating to the settled shares method will 
enable certain funds to rely on the rule, thereby easing disclosure and 
compliance requirements for those funds. Further simplification of the 
compliance requirements for small entities would not be consistent with 
the protection of investors.
3. The Use of Performance Rather Than Design Standards
    The Commission is requesting comment on rule 18f-3's approach of 
describing specific allocation methods and the funds that may use them. 
In particular, the Commission is requesting comment whether the rule 
should permit a fund to use any method that results in shareholders of 
each class

[[Page 49026]]

receiving their proportionate share of income, realized gains and 
losses, unrealized appreciation and depreciation, and fundwide 
expenses. Even if such a general standard were adopted, however, it 
would not decrease compliance costs for multiple class funds since such 
funds would still have to allocate the various accounting items on a 
daily basis using an appropriate method. At most, such a general 
standard would give funds flexibility in choosing the allocation method 
to be used.
    With respect to the other proposed amendments to rules 18f-3 and 
12b-1, the Commission believes that it is not possible to adopt 
performance standards that would achieve the objectives of the rules 
and be consistent with the Commission's mandate to protect investors.
4. An Exemption From Coverage of the Rule, or Any Part Thereof, for 
Such Small Entities
    Exempting small entities from the requirements in the proposed 
amendments would not be consistent with the Commission's statutory 
mandate of protecting investors.

H. Solicitation of Comments

    The Commission encourages the submission of comments with respect 
to any aspect of this Initial Regulatory Flexibility Analysis. As 
described at the beginning of this release, comments may be submitted 
to the Secretary of the Commission electronically or by letter. Such 
comments will be considered in the preparation of the Final Regulatory 
Flexibility Analysis, if the proposed amendments are adopted, and will 
be placed in the same public file as comments on the proposed 
amendments themselves.

IV. Statutory Authority

    The Commission is proposing to amend rule 12b-1 pursuant to the 
authority set forth in sections 12(b) and 38(a) [15 U.S.C. 80a-12(b), -
37(a)] of the Investment Company Act, and rule 18f-3 under sections 
6(c), 18(i), and 38(a) of the Investment Company Act [15 U.S.C. 80a-
6(c), -18(i), -37(a)].

List of Subjects in 17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rule Amendments

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

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. The authority citation for Part 270 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless 
otherwise noted;
* * * * *
    2. Section 270.12b-1 is amended by revising paragraph (g) to read 
as follows:


Sec. 270.12b-1  Distribution of shares by registered open-end 
management investment company.

* * * * *
    (g) If a plan covers more than one series or class of shares, the 
provisions of the plan must be severable for each series or class, and 
whenever this section provides for any action to be taken with respect 
to a plan, that action must be taken separately for each series or 
class affected by the matter. Nothing in this paragraph (g) shall 
affect the rights of any purchase class under Sec. 270.18f-
3(e)(2)(iii).
    3. Section 270.18f-3 is amended by revising paragraphs (c) and 
(e)(2)(iii) to read as follows:


Sec. 270.18f-3  Multiple class companies.

* * * * *
    (c)(1) Income, realized gains and losses, unrealized appreciation 
and depreciation, and Fundwide Expenses shall be allocated based on one 
of the following methods (which method shall be applied on a consistent 
basis):
    (i) To each class based on the net assets of that class in relation 
to the net assets of the company (``relative net assets'');
    (ii) To each class based on the Simultaneous Equations Method;
    (iii) To each class based on the Settled Shares Method, provided 
that the company is a Daily Dividend Fund (such a company may allocate 
income and Fundwide Expenses based on the Settled Shares Method and 
realized gains and losses and unrealized appreciation and depreciation 
based on relative net assets); or
    (iv) To each share without regard to class, provided that the 
company is a Daily Dividend Fund that maintains the same net asset 
value per share in each class and has received undertakings from its 
adviser, underwriter or any other provider of services to the company, 
agreeing to waive or reimburse the company for payments to such service 
provider by one or more classes, as allocated under paragraph (a)(1) of 
this section, to the extent necessary to assure that all classes of the 
company maintain the same net asset value per share. Payments waived or 
reimbursed under such an undertaking may not be carried forward or 
recouped at a future date.
    (2) For purposes of this section:
    (i) Daily Dividend Fund means any company that has a policy of 
declaring distributions of net investment income daily, including any 
money market fund that determines net asset value using the amortized 
cost method permitted by Sec. 270.2a-7;
    (ii) Fundwide Expenses means expenses of the company not allocated 
to a particular class under paragraph (a)(1) of this section;
    (iii) The Settled Shares Method means allocating to each class 
based on relative net assets, excluding the value of subscriptions 
receivable; and
    (iv) The Simultaneous Equations Method means the simultaneous 
allocation to each class of each day's income, realized gains and 
losses, unrealized appreciation and depreciation, and Fundwide Expenses 
and reallocation to each class of undistributed net investment income, 
undistributed realized gains or losses, and unrealized appreciation or 
depreciation, based on the operating results of the company, changes in 
ownership interests of each class, and expense differentials between 
the classes, so that the annualized rate of return of each class 
generally differs from that of the other classes only by the expense 
differentials among the classes.
* * * * *
    (e) * * *
    (2) * * *
    (iii) If the shareholders of the target class approve any increase 
in expenses allocated to the target class under paragraphs (a)(1)(i) 
and (a)(1)(ii) of this section, and the purchase class shareholders do 
not approve the increase, the company will establish a new target class 
for the purchase class on the same terms as applied to the target class 
before that increase.
* * * * *
    By the Commission.

    Dated: September 9, 1996.
Margaret H. McFarland,
Deputy Secretary.

    Note: Appendix A to the preamble will not appear in the Code of 
Federal Regulations.

Appendix A--Simultaneous Equations Method

    The equations set forth below are examples of a set of simultaneous 
equations that could be used as an allocation method in a multiple 
class fund with two classes at the end of day t.

Equation 1: At+Bt=Gt+Ct
Equation 2: At/Sat-Bt/Sbt=dx(NAV0)


[[Page 49027]]


where:

At: the total net assets to be allocated to class A at the end of 
day t
Bt: the total net assets to be allocated to class B at the end of 
day t
Gt: the cumulative undistributed net change in assets from 
operations for the fund at the end of day t
Ct: the cumulative capital for the fund at the end of day t
Sat: the number of shares in class A at the end of day t
Sbt: the number of shares in class B at the end of day t
d: the time adjustment factor, calculated as the number of days since 
the inception of class B or the ex-dividend date of the last income 
distribution (whichever is more recent), divided by 365
x: the differential in expense ratios between the two classes
NAV0: the NAV per share for class A and class B on day 0, where 
day 0 is either the day class B commences trading or the ex-dividend 
date of the last income distribution, whichever is more recent

[FR Doc. 96-23437 Filed 9-16-96; 8:45 am]
BILLING CODE 8010-01-P