[Federal Register Volume 64, Number 208 (Thursday, October 28, 1999)]
[Notices]
[Pages 58112-58117]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-28199]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42043; File No. SR-NASD-98-14]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval of and Notice of Filing and 
Order Granting Accelerated Approval of Amendment Nos. 4, 5, and 6 to 
the Proposed Rule Change Relating to Sales Charges and Prospectus 
Disclosure for Mutual Funds and Variable Contracts

October 20, 1999.

I. Introduction

    On March 12, 1998,\1\ the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation'') submitted to 
the Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act'') \2\ and Rule 19b-4 thereunder,\3\ a proposed rule 
change to amend Rule 2820 (the ``Variable contracts Rule'') and Rule 
2830 (the ``Investment Company Rule'') of the Conduct Rules of the 
NASD. The Investment Company Rule would be amended to: (1) provide 
maximum aggregate sales charge limits for fund-of-funds arrangements; 
(2) permit mutual funds to charge installment loads; (3) prohibit loads 
on reinvested dividends; (4) impose redemption order requirements for 
shares subject to contingent deferred sales loads

[[Page 58113]]

(``CDSLs''); and (5) eliminate duplicative prospectus disclosure. The 
Variable Contracts Rule would be amended to eliminate the specific 
sales charge limitations in the rule and a filing requirement relating 
to changes in sales charges.
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    \1\ NASD Regulation initially submitted the proposed rule change 
on February 17, 1998; however, the submission failed to provide a 
statutory basis section. Because proposed rule changes are not 
deemed filed until all necessary components, such as a statutory 
basis section, are provided, the proposed rule change was deemed 
filed when the Commission received NASD Regulation's amendment 
providing the statutory basis for the proposed rule change 
(``Amendment No. 1''). See Letter to Katherine A. England, Assistant 
Director, Commission, from Joan C. Conley, Secretary, NASD 
Regulation, dated March 12, 1998. NASD Regulation submitted another 
amendment on June 11, 1998, making certain technical corrections 
(``Amendment No. 2''). See Letter to Katherine A. England, Assistant 
Director, Commission, from Joan C. Conley, Secretary, NASD 
Regulation, dated June 10, 1998. Amendment No. 2, however, was 
insufficient in form. As a result, on July 13, 1998, NASD Regulation 
filed another amendment, superseding and replacing all previous 
versions of the filing (``Amendment No. 3''). See Letter to 
Katherine A. England, Assistant Director, Commission, from Joan C. 
Conley, Secretary, NASD Regulation, dated July 10, 1998. The 
substance of Amendment No. 3 was published in the Federal Register.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in the Federal 
Register on August 17, 1998.\4\ The NASD subsequently filed amendments 
to the proposed rule change on August 13, 1998, June 4, 1999, and 
September 13, 1999, respectively.\5\ The Commission received 8 comments 
on the proposal.\6\ This order approves the proposed rule change, as 
amended.
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    \4\ See Exchange Act Release No. 40310 (August 7, 1998), 63 FR 
43974 (August 17, 1998).
    \5\ See Letter from Joan C. Conley, Secretary, NASD Regulation, 
to Katherine A. England, Assistant Director, Division of Market 
Regulation, Commission, dated August 12, 1998 (``Amendment No. 4''). 
Amendment No. 4 made grammatical and technical changes to the 
proposed rule language. NASD Regulation asserted that the changes 
contained in Amendment No. 4 were non-substantial, and that 
Amendment No. 4 superseded and replaced the previous filing and 
amendments thereto. See Letter from Thomas M. Selman, Vice 
President, Investment Companies/Corporate financing, NASD 
Regulation, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated July 19, 1999 (``Amendment No. 
5''). Amendment No. 5 provided certain changes, discussed below, in 
response to commenters' concerns. See Letter from Thomas M. Selman, 
Vice President, Investment Companies/Corporate Financing, NASD 
Regulation, to Christine Richardson, Division of Market Regulation, 
Commission, dated September 13, 1999 (``Amendment No. 6''). As 
discussed below, Amendment No. 6 provides clarification with respect 
to certain issues.
    \6\ See Letters from Kathleen H. Moriarty, Carter, Ledyard & 
Milburn, to Jonathan G. Katz, Secretary, Commission, dated September 
4, 1998 (``Carter Letter''); Felice R. Foundos, Chapman & Cutler, to 
Jonathan G. Katz, Secretary, Commission, dated September 4, 1998 
(``Chapman & Cutler Letter''); Michael R. Rosella, Battle Fowler, to 
Jonathan G. Katz, Secretary, Commission, dated September 8, 1998 
(``Battle Fowler Letter''); Nora M. Jordan, Davis Polk & Wardwell, 
dated September 8, 1998 (``Davis Polk Letter''); Frances M. Stadler, 
Deputy Senior Counsel, Investment Company Institute, to Jonathan G. 
Katz, Secretary, Commission, dated September 8, 1998 (```ICI 
Letter''); Nathalie P. Maio, Senior Vice President, Deputy General 
Counsel, Prudential, to Jonathan G. Katz, Secretary, Commission, 
dated September 4, 1998 (``Prudential Letter''); Philip A. 
Heimowitz, Cahill Gordon & Reindel, to Jonathan G. Katz, Secretary, 
Commission, dated September 4, 1998 (``Cahill Letter''); and Mark J. 
Mackey, President and Chief Executive Officer, National Association 
for Variable Annuities, to Jonathan G. Katz, Secretary, Commission, 
dated September 8, 1998 (``NAVA Letter'').
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II. Description

A. Proposed Amendments to the Investment Company Rule

1. Fund-of-Funds
    The National Securities Market Improvement Act of 1996 (the ``1996 
Amendments'') amended the Investment Company Act of 1940 (``1940 Act'') 
to, among other things, broaden the ability of mutual fund sponsors to 
establish ``fund-of-funds'' arrangements.
    The Investment Company Rule currently does not take into account 
two-tier fund-of-funds structures in which asset-based sales charges 
are imposed at both the acquiring and underlying fund levels. The 
proposed amendments would amend the Investment Company Rule to ensure 
that, if a fund-of-funds charges distribution fees at both levels, the 
combined sales charges do not exceed the maximum percentage limits 
currently contained in the rule. The amended rule would permit an 
acquiring fund, an underlying fund, or both, to charge an asset-based 
sales fee that in the aggregate may not exceed .75 percent of average 
net assets and a service fee that in the aggregate does not exceed .25 
percent of average net assets. Consistent with the current rule, 
aggregate front-end and deferred sales charges would be limited in any 
transaction to 7.25 percent, or 6.25 percent if the contract includes a 
service fee.
2. Deferred Sales Loads
    In September 1996, the Commission amended Rule 6c-10 under the 1940 
Act to permit new types of deferred stocks, such as back-end and 
installment loads. The proposed amendments to the Investment Company 
Rule also would permit these types of deferred sales charges. The 
amendments would conform the definition of ``deferred sales charge'' in 
the Investment Company Rule to the definition of ``deferred sales 
load'' in Rule 6c-10 under the 1940 Act (i.e., ``any amount properly 
chargeable to sales or promotional expenses that is paid by a 
shareholder after purchase but before or upon redemption'').
3. Loads on Reinvested Dividends
    The proposed amendments would prohibit loads on reinvested 
dividends. When NASD Regulation proposed to prohibit loads on 
reinvested dividends in Notice to Members 97-48, commenters 
representing unit investment trust (``UIT'') sponsors objected to the 
proposed amendments. Although NASD Regulation does not believe that 
this practice is prevalent, it continues to believe that it is 
appropriate to prohibit loads on reinvested dividends for all 
investment companies, including UITs. It asserts that loads on 
reinvested dividends constitute excessive compensation, regardless of 
the type of investment company that imposes them. NASD Regulation 
proposes to defer implementation of this prohibition until April 1, 
2000, to address the commenters' Y2K concerns.\7\
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    \7\ See Amendment No. 5. NASD Regulation originally proposed to 
include a ``grandfather provision'' that would exempt from the 
operation of the prohibition all investment companies that currently 
impose such fees. The grandfather clause provision has since been 
eliminated. See Amemdment No. 6.
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4. CDSL Calculations
    The proposed amendments would prohibit members from selling fund 
shares that impose a CDSL unless the method used by the fund to 
calculate CDSLs in partial redemptions requires that investors be given 
full credit for the time they have invested in the fund. Because a CDSL 
declines over the period of a shareholder's investment, a first-in-
first-out (``FIFO'') redemption order requirement generally would 
ensure that transactions are subject to the lowest applicable CDSL. The 
proposed amendments, however, also would expressly provide that if a 
redemption order other than FIFO (e.g., last-in-first-out, or ``LIFO'') 
would result in a redeeming shareholder paying a lower CDSL, the other 
method could be used.
5. Prospectus Disclosure
    The Investment Company Rule currently prohibits a member from 
offering or selling shares of a fund with an asset-based sales charge 
unless its prospectus discloses that long-term shareholders may pay 
more than the economic equivalent of the maximum front-end sales 
charges permitted by the rule. In March 1998, the Commission adopted 
significant revisions to prospectus disclosure requirements for mutual 
funds. Included in the amendments is a requirement that the 
prospectuses of funds with asset-based sales charges include disclosure 
regarding Rule 12b-1 plans that is similar to the type of disclosure 
required by the Investment Company Rule. Accordingly, the proposed 
amendments would eliminate the prospectus disclosure requirement in the 
Investment Company Rule.

B. Proposed Amendment to the Variable Contracts Rule

    In Notice to Members 97-48, NASD Regulation proposed to amend the 
Variable Contracts Rule to eliminate the maximum sales charge 
limitations. The commenters to NTM 97-48 strongly supported the 
proposed amendment because they viewed specific sales charge limits in 
the Variable Contracts Rule as unnecessary and inconsistent

[[Page 58114]]

with the ``reasonableness'' standard enacted in the 1996 Amendments. 
Consistent with these comments, the proposed amendments would eliminate 
the maximum sales charge limitations in the Variable Contracts Rule. 
The proposed amendments also would make a conforming change to 
eliminate the requirement in the rule to file with the Advertising/
Investment Companies Regulation Department the details of any changes 
in a variable annuity's sales charges.

III. Summary of Comments

A. Proposed Amendments to the Investment Company Rule

1. Fund-of-Funds
    NASD Regulation proposed to amend the Investment Company Rule to 
ensure that the combined sales charges of a fund-of-funds that charges 
a distribution fee at both the acquiring and underlying fund levels, do 
not exceed the maximum percentage limits that are currently permitted 
by the rule. Under the proposed amendment, the aggregate asset-based 
sales charges of an acquiring fund and an underlying fund would not be 
subject to the cumulative sales limits that apply to other investment 
companies with asset-based sales charges. Instead, any asset-based fee 
charged by the acquiring fund and the underlying fund could not, in the 
aggregate, exceed .75% of average net assets. In addition, any service 
fee charged by the acquiring fund and the underlying fund could not, in 
the aggregate, exceed .25% of average net assets. The acquiring and 
underlying funds in a fund-of-funds structure, however, would remain 
individually subject to the cumulative limits in the Investment Company 
Rule.
    The Commission received comment on the proposed definition of 
``fund-of-funds.'' As proposed, ``fund-of-funds'' would have been 
defined as ``an investment company that invests any portion of its 
assets in the securities of registered open-end investment companies or 
registered unit investment trusts.'' Chapman & Cutler and the ICI 
believed this definition was too broad and might include funds that 
invest only a small portion of their assets in other funds. They 
suggested that the definition of ``fund-of-funds'' be modified to more 
closely reflect traditional fund of funds, such as those companies 
relying on Sections 12(d)(1)(F) and 12(d)(1)(G) of the 1940 Act.\8\ In 
the alternative, the ICI suggested that the definition include only 
funds whose investments in other funds exceed the limits permitted 
under Section 12(d)(1)(A) of the 1940 Act.\9\
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    \8\ See Chapman & Cutler Letter; and ICI Letter.
    \9\ See ICI Letter.
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    NASD Regulation has modified the definition of ``fund-of-funds'' by 
narrowing its scope to include only investment companies that acquire 
securities issued by other investment companies in excess of the 
amounts permitted under Section 12(d)(1)(A) of the 1940 Act.\10\
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    \10\ See Amendment No. 5.
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2. Deferred Sales Loads
    NASD Regulation proposed to conform the definition of ``deferred 
sales charge'' in the Investment Company Rule to the definition in Rule 
6c-10 under the 1940 Act (i.e., ``any amount properly chargeable to 
sales or promotional expenses that is paid by a shareholder after 
purchase but before or upon redemption''). The Commission did not 
receive comment on this aspect of the proposal.
3. Loads on Reinvested Dividends
    NASD Regulation proposed to prohibit NASD members from imposing 
front-end or deferred sales loads on the shares purchased through 
reinvested dividends. Several commenters objected to this 
prohibition.\11\ In particular, the commenters believed that the 
prohibition would be especially disadvantageous to UITs. Although the 
prohibition contained a ``grandfather clause'' for existing UITs so 
that it would only apply to investment companies, including UITs, 
registered after a certain date, commenters believed that it would 
disrupt the reinvestment options for those UITs that were not eligible 
for the ``grandfather clause.'' \12\ Some commenters asserted that such 
a prohibition was not justified because UIT investor does not pay a 
sales charge twice on the same assets when he or she purchases shares 
through reinvested dividends.\13\ Moreover, some commenters pointed out 
that unlike mutual fund underwriters, UIT sponsors are not permitted to 
receive fees pursuant to Rule 12b-1 under the 1940 Act. Commenters 
believe that UIT sponsors should be permitted to recoup their expenses 
through sales charges imposed on reinvested dividends.\14\
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    \11\ See Carter Letter; Chapman & Cutler Letter; Battle Fowler 
Letter; Davis Polk Letter; ICI Letter; Prudential Letter; and Cahill 
Letter. NASD Regulation has since eliminated the ``grandfather 
clause.'' See Amendment No. 6. Instead, NASD Regulation proposes to 
defer the prohibition until April 1, 2000. See Amendment No. 5.
    \12\ See Carter Letter; and Davis Polk Letter.
    \13\ See Carter Letter; Davis Polk Letter; Prudential Letter; 
and Cahill Letter.
    \14\ See Chapman & Cutler Letter; Prudential Letter; and Cahill 
Letter.
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    Several commenters asserted that prohibiting such sales charges 
would be inconsistent with Commission exemptive orders that permit 
certain UIT sponsors to impose sales charges on reinvested dividends, 
subject to certain conditions.\15\ Other commenters asserted that this 
prohibition would require certain UITs that offered deferred sales load 
structures to create multiple classes of shares, which could raise 
issues under the 1940 Act and the federal tax laws.\16\
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    \15\ See Carter Letter; ICI Letter; Prudential Letter; and 
Cahill Letter.
    \16\ See Battle Fowler Letter; and Chapman & Cutler Letter.
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    Commmenters also believed that the prohibition would require UITs 
to develop expensive new computer systems to separate reinvestment 
shares when deferred sales charges are deducted.\17\ Davis Polk 
questioned the Commission's authority to approve this portion of the 
rule change, given the Commission's moratorium on the implementation of 
new Commission rules that require major reprogramming of regulated 
entities' computer systems between June 1, 1999, and March 31, 
2000.\18\
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    \17\ See Carter Letter; and Davis Polk Letter.
    \18\ See Davis Polk Letter.
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    NASD Regulation responded to these comments by stating that it 
continues to believe that loads on reinvested dividends constitute 
excessive compensation, regardless of the type of investment company 
that imposes them. NASD Regulation believes that the proposed rule is 
not inconsistent with exemptive relief granted to UITs under the 1940 
act, as that relief does not refer to any dividend reinvestment 
program, and that the exemptive orders provide no relief from the 
application of NASD Conduct Rules.\19\
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    \19\ NASD Regulation asserts that although the exemptive relief 
``permitted UIT sponsors to charge installment loads, it does not 
appear to refer to any dividend reinvestment program. Indeed, we 
understand that at least two of these orders applied to fixed 
portfolio UITs that offered dividend reinvestment only into no-load 
mutual funds.'' See Amendment No. 5.
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    NASD Regulation asserted that the proposed rule would not require 
UITs to adopt a multiple class structure, but provided no rationale to 
support this belief. Instead, it deferred to the Commission's Division 
of Investment Management for its expertise on the matter. In contrast 
to commenters' interpretation of the potential effect of the rule 
change, NASD Regulation believes that, whether an investment

[[Page 58115]]

company's loads on reinvested dividends are excessive, is unrelated to 
whether the investment company charges Rule 12b-1 fees. NASD Regulation 
stated that the prohibition on charging front-end or deferred sales 
loads on shares purchased through reinvested dividends would apply to 
investment companies that have no Rule 12b-1 plan just as it would 
apply to investment companies that have such plans. It notes that, 
under the proposed rule change, UITs would not be prohibited from 
imposing sales charges on the initial purchase of UIT shares, which 
UITs may set at a level to adequately compensate them for their 
distribution costs.
    NASD Regulation responded to the commenters' Y2K concerns by 
amending the proposed rule change to delay implementation of the 
prohibition until April 1, 2000.\20\
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    \20\ See Amendment No. 5.
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4. CDSL Calculations
    NASD Regulation also proposed to reinstate requirements previously 
applicable under Rule 6c-10 under the 1940 Act concerning the order in 
which fund shares subject to a CDSL must be redeemed when an investor 
redeems some, but not all, of his fund shares. Chapman & Cutler 
commented that some investors, for business or tax reasons, may want to 
apply a different order of redemption than the one specified by the 
proposed rule (FIFO), and that the proposed rule therefore should be 
modified to allow investors to dictate a different order of 
redemption.\21\ The ICE commented that, while it does not object to the 
provision, it believes that the rule language should be modified to 
specify that it applies to partial redemptions. The ICI also 
recommended that the proposed rule language be modified to provide that 
an order of redemption other than FIFO may be used if such an order 
``could'' (rather than ``would'') result in the shareholder paying a 
lower CDSL.\22\
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    \21\ See Chapman & Cutler Letter.
    \22\ See ICI Letter.
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    NASD Regulation indicated that it does not intend to modify the 
proposed rule. NASD Regulation stated that it was not aware of any 
significant problems that had arisen as a result of identical 
requirements that were previously imposed on the investment company 
industry by Rule 6c-10 under the 1940 Act. NASD Regulation also is 
concerned that if investors were permitted to consent to a different 
order of redemption, investment company account agreements could 
include standard language that effectively would allow a fund sponsor 
to determine the order of redemption. Further, NASD Regulation does not 
believe it is necessary to modify its proposal to reflect that it 
applies only to partial redemptions because, if all shares are 
redeemed, the issue of redemption order becomes moot.\23\
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    \23\ See Amendment No. 5.
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5. Prospectus Disclosure
    NASD Regulation proposes to eliminate a prospectus disclosure 
requirement in the Investment Company Rule that is already required by 
Commission rules. The Commission did not receive comment on this aspect 
of the proposal.

B. Proposed Amendment to the Variable Contracts Rule

    NASD Regulation proposes to amend the Variable Contracts Rule to 
eliminate sales charge limits for variable annuity contracts, as well 
as to eliminate the requirement in the rule to file the details of any 
changes in a variable annuity's sales charges. NAVA strongly supported 
eliminating the sales charge limits on variable annuity sales loads. 
NAVA also believed that the imposition of sales charge restrictions on 
variable annuities would be inconsistent with the purpose and intent of 
the ``reasonableness'' standard adopted in the 1996 Amendments.\24\
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    \24\ See NAVA Letter.
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IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the Association, and, in particular, with the 
requirements of Section 15A(b)(6).\25\ Section 15A(b) requires that the 
rules of the Association, among other things, be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to remove impediments to and perfect the 
mechanism of a free and open market, and, in general, to protect 
investors and the public interest. The Commission finds that the 
proposed rule change will further these requirements by adapting the 
Investment Company Rule and the Variable Contracts Rule to take into 
account recent legislation, regulations promulgated by the Commission, 
and new distribution arrangements.\26\
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    \25\ 15 U.S.C. 78o-3(b)(6).
    \26\ In approving this rule change, the Commission notes that it 
has considered the proposal's impact on efficiency, competition, and 
capital formation, consistent with Section 3 of the Act. 15 U.S.C. 
78c(f).
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A. Amendments to the Investment Company Rule

1. Fund-of-Funds
    The Commission finds that the proposed application of aggregate 
sales charge limits on fund-of-funds that charge distribution fees at 
both levels to be consistent with the Act. Specifically, the Commission 
believes that the proposed amendment clarifies that the Investment 
Company Rule applies to two-tier fund-of-funds structures in which 
asset-based sales charges are imposed at both the acquiring and 
underlying fund levels. The application of these sales charge limits 
should help to ensure that charges remain reasonable and do not become 
excessive for investors.
    The Commission also believes that the definition of ``fund-of-
funds'' being adopted is consistent with the common understanding of 
the type of investment company that constitutes a fund-of-funds. As 
proposed, ``fund-of-funds'' would have been defined as ``an investment 
company that invests any portion of its assets in the securities of 
registered open-end investment companies or registered unit investment 
trusts.'' The commenters indicated that the proposed definition was 
broader than the traditional understanding of what constitutes a fund-
of-funds. In response to public comment, NASD Regulation revised this 
definition to include only those investment companies that acquire 
securities issues by another investment company in excess of the 
amounts permitted under Section 12(d)(1)(A) of the 1940 Act. Section 
12(d)(1)(A) of the 1940 Act permits an investment company to purchase a 
limited amount of the total outstanding voting stock of another 
investment company.\27\ Therefore, the definition of fund-of-funds will 
exclude investment companies that invest only a small portion of their 
assets in other funds' shares. The Commission believes that the 
definition being adopted

[[Page 58116]]

sufficiently addresses the concern that a fund-of-fund might assess 
unlimited sales loads (i.e., excessive layering of sales loads) by 
clarifying that the Investment Company Rule applies to those fund-of-
funds that invest more than a de minimis amount of their assets in the 
shares of other investment companies. The Commission further believes 
that NASD Regulation's modification to its proposed definition of fund-
of-funds will make it more manageable for investment companies in a 
fund-of-funds structure to monitor and enforce compliance with the 
requirements of the Investment Company Rule.
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    \27\ Section 12(d)(1)(A) generally prohibits any registered 
investment company and companies controlled by it (the ``acquiring 
company'') from acquiring securities of any other investment company 
(the ``acquired company''), and any investment company and companies 
controlled by it (the ``acquiring company'') from acquiring any 
security issued by a registered investment company (the ``acquired 
company'') if, after the acquisition, the acquiring company would 
own in the aggregate (i) more than 3% of the total outstanding 
voting stock of the acquired company; (ii) securities issued by the 
acquired company having an aggregate value in excess of 5% of the 
value of the total assets of the acquiring company; or (iii) 
securities issued by the acquired company and all other investment 
companies (other than treasury stock of the acquiring company) 
having an aggregate value in excess of 10% of the value of the total 
assets of the acquiring company.
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2. Deferred Sales Loads
    The Commission finds it appropriate to amend the definition of 
``deferred sales charge'' in the Investment Company Rule to conform to 
the definition in Rule 6c-10 under the 1940 Act (i.e., ``any amount 
properly chargeable to sales or promotional expenses that is paid by a 
shareholder after purchase but before or upon redemption''). The 
Commission believes that conforming the definition in this manner will 
allow for more flexibility in structuring deferred sales loads (e.g., 
by permitting installment loads), as taken into account by the 1996 
Amendments to Rule 6c-10. The Commission also notes that the conforming 
definition will prevent possible confusion and compliance burdens that 
could result from inconsistent definitions in Commission and NASD 
rules.
3. Loads on Reinvested Dividends
    NASD Regulation proposed to prohibit NASD members from imposing 
front-end or deferred sales loads on shares purchased with reinvested 
dividends. As noted above, the Commission received substantial comment 
on this aspect of the proposal, all of it critical. Specifically, 
commenters believed that the proposed prohibition included in NASD Rule 
2830(d)(6) would create a disadvantage for UITs by restricting only 
front-end and deferred sales loads, but not asset-based sales charges, 
e.g., Rule 12b-1 fees, which UIT's are not permitted to charge. 
Commenters believe that UITs would be disadvantaged because non-UIT 
funds would be permitted to charge Rule 12b-1 fees on reinvested 
dividends, and therefore recoup their distribution costs, while UITs 
would not. As noted by the NASD, UITs may set the sales charge on the 
initial purchase at a level to adequately compensate them for their 
distribution costs.
    Commenters further asserted that the proposed rule change would 
require UITs to create two classes of units with different 
characteristics, which would result in each class representing a 
different pool or specified securities, and would therefore raise 
issues under the 1940 Act and federal tax law. NASD Regulation asserted 
its view that ``complying with the proposed amendments should not 
require UITs to adopt a multiple class structure.'' NASD Regulation 
also consulted with staff in the Commission's Division of Investment 
Management on the matter, and the staff agrees that complying with the 
proposed amendments should not result in the creation of multiple 
classes.\28\ The Commission believes that the proposed rule change is 
consistent with the Act in that it should prevent sales charges from 
exceeding the appropriate limits, thereby benefiting investors and the 
public interest.
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    \28\ See Amendment No. 5.
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4. CDSL Calculations
    The Commission believes that it is consistent with the Act to 
reinstate requirements previously applicable under Rule 6c-10 under the 
1940 Act, concerning the order in which fund shares subject to a CDSL 
must be redeemed when an investor redeems some, but not all, of his 
fund shares. Although commenters asserted that investors should be able 
to choose the order of redemption used in calculating the CDSL applied 
to their shares, the Commission agrees with NASD Regulation that such 
discretion could result in investment companies incorporating standard 
language into account agreements, effectively allowing a fund sponsor 
to determine the order of redemption. The Commission believes that the 
provision provides sufficient flexibility as proposed. Specifically, 
the provision provides that if a redemption order other than FIFO 
(e.g., LIFO) would result in a redeeming shareholder paying a lower 
CDSL, the other method may be used. This approach should benefit 
investors by permitting them to pay the lowest CDSL when partially 
redeeming shares.
5. Prospectus Disclosure
    The Commission finds it appropriate to eliminate a prospectus 
disclosure requirement currently included in the Investment Company 
Rule in light of the Commission's 1998 revisions to the prospectus 
disclosure requirements for mutual funds. Specifically, the Commission 
requires that mutual funds with asset-based sales charges include 
disclosure in their prospectuses regarding Rule 12b-1 plans that is 
similar to the disclosure required in the Investment Company Rule. The 
adoption of this prospectus disclosure requirement made the prospectus 
disclosure requirement in the Investment Company Rule duplicative and 
unnecessary.

B. Proposed Amendment to the Variable Contracts Rule

    The Commission believes that the elimination of the maximum sales 
charge limitations from the Variable Contracts Rule is appropriate in 
light of the ``reasonable'' standard adopted in the 1996 Amendments. 
Specifically, in 1996, the 1940 Act was amended to exempt variable 
annuity (as well as variable life insurance) contracts from the 
specific charge restrictions contained in Sections 26 and 27. In place 
of the specific charge restrictions, the 1996 amendments added a 
section to the 1940 Act \29\ to regulate variable contract charges by 
requiring that the fees and charges under a variable contract, in the 
aggregate, be reasonable in relation to the services rendered, the 
expenses expected to be incurred, and the risks assumed by the 
insurance company.\30\ The Commission believes eliminating the maximum 
sales charge limitations from the Variable Contracts Rule is 
appropriate in light of the 1996 amendments.
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    \29\ See Section 26(e)(2) of the 1940 Act.
    \30\ Insurance companies issuing variable contracts are required 
to represent in the contract registration statements that fees and 
charges are reasonable.
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    Because Rule 2820 provisions regulating sales charges for variable 
annuities are being eliminated, NASD Regulation also proposed to 
eliminate the requirement to file with the Advertising/Investment 
Companies Regulation Department the details of any changes in a 
variable annuity's sales charges.\31\ The Commission believes the 
elimination of this filing requirement is appropriate in light of the 
concurrent elimination of the maximum sales charge limitations in the 
Variable Contracts Rule.
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    \31\ See Amendment No. 6.
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    The Commission finds good cause to approve Amendment No. 4 to the 
proposed rule change prior to the 30th days after the date of 
publication of notice filing thereof in the Federal Register. Amendment 
No. 4 makes grammatical and technical changes to the proposed rule 
language and supersedes and replaces the previous filing and amendments 
thereto. It does not substantive modify the proposal. Accordingly, the 
Commission believes that it is consistent with Sections

[[Page 58117]]

15A(b)(6) and 19(b)(2) of the Act to approve Amendment No. 4 to the 
proposed rule change on an accelerated basis.
    The Commission finds good cause to approve Amendment No. 5 to the 
proposed rule change prior to the 30th day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 5 does two things. First, in response to commenters, 
Amendment No. 5 modifies the definition of ``fund-of-funds'' so that it 
includes only those investment companies that acquire securities issued 
by any other investment company in excess of the amounts permitted 
under Section 12(d)(1)(A) of the 1940 Act. This definition is narrower 
than the one originally proposed and should make clear that the 
combined sales charge limits apply only to those structures 
traditionally understood to be funds-of-funds. Second, also in response 
to commenters, Amendment No. 5 delays the implementation of the 
prohibition of sales loads on reinvestment dividends until April 1, 
2000. This addresses commenters concerns regarding Y2K and the computer 
systems changes that the proposed rule change will necessitate. 
Accordingly, the Commission believes that is consistent with Sections 
15A(b)(6) and 19(b)(2) of the Act to approve Amendment No. 5 to the 
proposed rule change on an accelerated basis.
    The Commissions finds good cause to approve Amendment No. 6 to the 
proposed rule change prior to the 30th day after the date of 
publication of notice of filing thereof in the Federal Register. 
Amendment No. 6 clarifies that the prohibition of front-end or deferred 
sales charges on shares of investment companies purchased with 
reinvested dividends is not meant to apply to investment companies 
whose registration statements became effective under the Securities Act 
of 1933 prior to April 1, 2000. Amendment No. 6 also clarifies that the 
definition of ``fund-of-funds'' is intended only to cover an investment 
company that invests in the securities of another registered investment 
company. Accordingly, the Commission believes that it is consistent 
with Sections 15A(b)(6) and 19(b)(2) of the Act to approve Amendment 
No. 6 to the proposed rule change on an accelerated basis.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 4, 5, and 6 including whether the 
proposed rule changes are consistent with the Act. Persons making 
written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549-0609. Copies of the submission, all subsequent amendments, 
all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying at the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the Exchange. All submissions should refer to File 
No. SR-NASD-98-14 and should be submitted by November 18, 1999.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\32\ that the proposed rule change (SR-NASD-98-14) is approved, as 
amended.
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    \32\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
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    \33\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-28199 Filed 10-27-99; 8:45 am]
BILLING CODE 8010-01-M