[Federal Register Volume 67, Number 101 (Friday, May 24, 2002)]
[Proposed Rules]
[Pages 36712-36737]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12893]



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Part III





Securities and Exchange Commission





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17 CFR Part 230, et al.



Proposed Amendments to Investment Company Advertising Rules; Proposed 
Rule

  Federal Register / Vol. 67, No. 101 / Friday, May 24, 2002 / Proposed 
Rules  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 230, 239, 270, and 274

[Release Nos. 33-8101; 34-45953; IC-25575; File No. S7-17-02]
RIN 3235-AH19


Proposed Amendments to Investment Company Advertising Rules

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing rule and 
form amendments under the Securities Act of 1933 and the Investment 
Company Act of 1940 to provide registered investment companies and 
business development companies with the ability to disclose more timely 
information in advertisements and to reinforce the antifraud 
protections that apply to investment company advertisements. The 
proposed amendments would implement a provision of the National 
Securities Markets Improvement Act of 1996 by permitting the use of a 
prospectus under section 10(b) of the Securities Act with respect to 
securities issued by an investment company that includes information 
the substance of which is not included in the investment company's 
statutory prospectus. The proposed amendments also would require 
enhanced disclosure in investment company advertisements and are 
designed to encourage advertisements that convey balanced information 
to prospective investors, particularly with respect to past 
performance.

DATES: Comments must be received on or before July 31, 2002.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G. 
Katz, Secretary, Securities and Exchange Commission, 450 5th Street, 
NW., Washington, DC 20549-0609. Comments also may be submitted 
electronically at the following E-mail address: [email protected]. 
All comment letters should refer to File No. S7-17-02; this file number 
should be included on the subject line if E-mail is used. All comments 
received will be available for public inspection and copying in the 
Commission's Public Reference Room, 450 5th Street, NW., Washington, DC 
20549-0102. Electronically submitted comment letters will also be 
posted on the Commission's Internet site (http://www.sec.gov).\1\

FOR FURTHER INFORMATION CONTACT: Christopher P. Kaiser, Attorney, David 
S. Schwartz, Attorney, or Paul G. Cellupica, Assistant Director, at 
(202) 942-0721, Office of Disclosure Regulation, Division of Investment 
Management, Securities and Exchange Commission, 450 5th Street, NW., 
Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is proposing for comment amendments to rule 134 [17 
CFR 230.134], rule 156 [17 CFR 230.156], and rule 482 [17 CFR 230.482] 
under the Securities Act of 1933 [15 U.S.C. 77a et seq.] (``Securities 
Act'') and rule 34b-1 [17 CFR 270.34b-1] under the Investment Company 
Act of 1940 [15 U.S.C. 80a-1 et seq.] (``Investment Company Act''). The 
Commission also is proposing for comment technical amendments to Form 
N-1A [17 CFR 239.15A and 274.11A], Form N-3 [17 CFR 239.17a and 
274.11b], Form N-4 [17 CFR 239.17b and 274.11c], and Form N-6 [17 CFR 
239.17c and 274.11d], registration forms used by investment companies 
to register under the Investment Company Act and to offer their 
securities under the Securities Act.
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    \1\ We do not edit personal, identifying information, such as 
names or E-mail addresses, from electronic submissions. Submit only 
information that you wish to make publicly available.
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Table of Contents

I. Introduction and Background
    A. Fund Advertising Rules
    B. Performance Advertising Practices
II. Discussion
    A. Eliminating the ``Substance of Which'' Requirement from Rule 
482 and Rescinding Rule 134 for Funds
    B. Applicability of Antifraud Provisions to Fund Advertising
    C. Enhanced Disclosure under Rule 482
    D. Reorganization of Rule 482 and Technical Form Amendments
    E. Compliance Date
IV. Request for Comments
    A. Request for Comments on the Framework for Regulation of 
Investment Company Advertisements
    B. General Request for Comments
    C. Request for Comments on Rule 482(a)(5)(i) Relating to 
Variable Insurance Contracts
V. Cost/Benefit Analysis
VI. Consideration of Effects on Efficiency, Competition, and Capital 
Formation
VII. Paperwork Reduction Act
VIII. Initial Regulatory Flexibility Analysis
IX. Consideration of Impact on the Economy
X. Statutory Authority
Text of Proposed Rule and Form Amendments

I. Introduction and Background

    Like most issuers of securities, when an investment company 
(``fund'') offers its shares to the public, its promotional efforts 
become subject to the advertising restrictions of the Securities Act. 
Congress imposed these restrictions so that investors would base their 
investment decisions on the full disclosures contained in the 
``statutory prospectus,'' which Congress intended to be the primary 
selling document.\2\ The advertising restrictions of the Securities Act 
cause special problems for many investment companies, particularly for 
open-end management investment companies (``mutual funds'') and other 
investment companies that continuously offer and sell their shares.\3\ 
For these funds, the advertising restrictions apply continuously 
because the offering process, in effect, is continuous.
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    \2\ ``Statutory prospectus'' refers to the full prospectus 
required by Section 10(a) of the Securities Act. 15 U.S.C. 77j(a).
    \3\ An open-end management investment company (``mutual fund'') 
is an investment company, other than a unit investment trust or 
face-amount certificate company, that offers for sale or has 
outstanding any redeemable security of which it is the issuer. 
Sections 4 and 5(a)(1) of the Investment Company Act [15 U.S.C. 80a-
4 and 80a-5(a)(1)]. Mutual funds typically offer and sell their 
shares continuously to provide an ongoing flow of capital into their 
portfolios and to enable them to meet redemption requests from 
outgoing shareholders.
    A unit investment trust (``UIT'') is ``an investment company 
which (A) is organized under a trust indenture, contract of 
custodianship or agency, or similar instrument, (B) does not have a 
board of directors, and (C) issues only redeemable securities, each 
of which represents an undivided interest in a unit of specified 
securities; but does not include a voting trust.'' Section 4(2) of 
the Investment Company Act [15 U.S.C. 80a-4(2)]. UITs typically have 
active secondary markets in which the trusts' sponsors are 
continuously purchasing and selling the trusts' units.
    A face-amount certificate is a security that obligates the 
issuer to pay a stated (or determinable) amount on a fixed (or 
determinable) date or series of dates more than twenty-four months 
after the date of issuance. Section 2(a)(15) of the Investment 
Company Act [15 U.S.C. 80a-2(a)(15)]. A face-amount certificate 
company is an investment company that engages or proposes to engage 
in the business of issuing certain face-amount certificates. Section 
4(1) of the Investment Company Act [15 U.S.C. 80a-4(1)].
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    In recognition of these problems, the Commission has adopted 
special advertising rules for investment companies. The most important 
of these is rule 482 under the Securities Act, which permits investment 
companies to advertise investment performance data, as well as other 
information.\4\ Rule 482 advertisements are ``prospectuses'' under 
section 10(b) of the Securities Act (so-called ``omitting 
prospectuses''),\5\ which means that, historically, they

[[Page 36713]]

could only contain information the ``substance of which'' is included 
in the statutory prospectus.\6\ In the National Securities Markets 
Improvement Act of 1996 (``NSMIA''), Congress amended the Investment 
Company Act to permit, subject to rules adopted by the Commission, the 
use of prospectuses under section 10(b) of the Securities Act that 
include information the substance of which is not included in the 
statutory prospectus.\7\ Today, we are proposing to amend rule 482 and 
make other related rule and form changes to implement this legislation, 
which will provide funds with the ability to include more timely 
information in their advertisements, e.g., information about current 
economic conditions that normally would not be included in a fund's 
prospectus. The proposed amendment will also permit funds to eliminate 
from the statutory prospectus boilerplate disclosure that clutters the 
statutory prospectus and obscures other important information.
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    \4\ 17 CFR 230.482.
    \5\ 15 U.S.C. 77j(b).
    \6\ 17 CFR 230.482(a)(2).
    \7\ National Securities Markets Improvement Act of 1996, Pub. L. 
No. 104-290, 110 Stat. 3416, 3428, Section 204.
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    At the same time, we are proposing amendments to the fund 
advertising rules that are intended to reinforce antifraud protections 
and encourage the provision of information to investors that is more 
balanced and informative, particularly in the area of investment 
performance. Many funds experienced extraordinary performance during 
1999 and 2000, particularly funds investing in technology and Internet 
stocks.\8\ Eager to attract new investors, many of these funds engaged 
in advertising campaigns focusing on past performance.\9\ We became 
concerned that some funds, when advertising their performance, may 
resort to techniques that create unrealistic investor expectations or 
may mislead potential investors.
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    \8\ In 1999, for example, more than 200 funds had returns of 
more than 200 percent. Gavin Daly, SEC Reviewing Performance-Based 
Ads (Mar. 29, 2000) (visited June 13, 2000) http://www.ignites.com/. 
In particular, funds investing in technology and Internet stocks 
achieved unusually high returns. Humberto Cruz, Don't Let Numbers 
Mislead, Sun-Sentinel, Feb. 13, 2000, at 5F.
    \9\ See Cruz, supra note 8 (stating that ``[y]ou can't pick up a 
financial magazine these days or tune in to financial television 
without running into mutual fund ads like * * * `Heavenly,' `We're 
Still Celebrating,' `With Performance Like This,' [and] `Operators 
Are Standing By.' ''); Tony Lystra, Fund Advertising Spending Jumped 
in 2000, Mutual Fund Market News, Apr. 23, 2001 (``Mutual fund 
companies spent 22 percent more on advertising [in 2000] than in 
1999 as they touted their products' improved performance in a bull 
market.''); Simon London, The Managers Who Mislead Us: Controls Are 
Needed to Stop Absolute Performance Statistics Being Quoted Out Of 
Context, The Financial Times, Mar. 11, 2000, at 6 (``[T]he strength 
of world equity markets over the past decade has given managers some 
unusually eye-catching statistics to play with.'').
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    The Commission has undertaken a series of initiatives to address 
trends in the area of performance advertising. We have engaged in 
education efforts to caution investors against the dangers of chasing 
fund performance and focusing only on short-term asset growth.\10\ Our 
staff has conducted a special review of fund marketing materials, as 
well as examinations of funds that have employed aggressive marketing 
practices.\11\ And we have instituted enforcement actions based on 
misleading fund advertising.\12\ Today's proposed amendments are part 
of our continuing efforts to raise the bar for fund performance 
advertising so that investors are informed, and not misled, by that 
advertising.
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    \10\ See Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance (last 
modified Jan. 24, 2000) http://www.sec.gov/investor/pubs/mfperform.htm.
    \11\ Securities and Exchange Commission, Supplementary News 
Material: Special Review of Fund Advertising Fact Sheet (last 
modified Feb. 23, 2001) http://www.sec.gov/news/extra/funadfct.htm; 
Paul F. Roye, Director, Division of Investment Management, 
``Challenges for the Mutual Fund Industry in the Competitive 
Frontier,'' Remarks at the 2000 Mutual Funds and Investment 
Management Conference, Palm Desert, Ca. (Mar. 27, 2000) (transcript 
available at http://www.sec.gov/news/speech/speecharchive/200speech.shtml).
    \12\ For a discussion of these enforcement actions, see note 39 
infra and accompanying text.
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A. Fund Advertising Rules

    Section 5 of the Securities Act contains prohibitions regarding the 
dissemination of written selling material to investors during the 
offering period. Section 5(b)(1) makes it unlawful to use interstate 
commerce to transmit any prospectus relating to a security with respect 
to which a registration statement has been filed unless the prospectus 
meets the requirements of section 10 of the Securities Act.\13\ 
``Prospectus'' is broadly defined in section 2(a)(10) to include any 
advertisement or other communication, ``written or by radio or 
television, which offers any security for sale or confirms the sale of 
any security.'' \14\ Thus, advertisements are considered prospectuses 
under the Securities Act if they offer a security for sale. Because the 
term ``offer'' is defined and interpreted broadly to encompass any 
attempt to procure orders for a security, written and radio or 
television advertisements relating to a security, or aiding in the 
selling effort with respect to a security, generally must be in the 
form of a section 10 prospectus.\15\
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    \13\ 15 U.S.C. 77e(b)(1).
    \14\ 15 U.S.C. 77b(a)(10).
    \15\ Section 2(a)(3) of the Securities Act defines the term 
``offer'' to include ``every attempt or offer to dispose of, or 
solicitation of an offer to buy, a security or interest in a 
security, for value.'' 15 U.S.C. 77b(a)(3).
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    There is a limited exception to the general requirement that 
written and radio or television offers after the filing of a 
registration statement must be in the form of a section 10 prospectus. 
So-called ``supplemental sales literature'' may be used after the 
effective date of a registration statement if accompanied or preceded 
by the statutory prospectus.\16\ In addition, the use of ``tombstone'' 
advertisements is permitted under limited circumstances without prior 
delivery of the statutory prospectus.\17\
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    \16\ Under section 2(a)(10) of the Securities Act, supplemental 
sales literature is not considered to be a prospectus and, as a 
result, is not subject to section 5(b)(1) of the Securities Act.
    \17\ ``Tombstone'' advertisements are permitted by section 
2(a)(10)(b) of the Securities Act, which provides that an 
advertisement or other communication in respect of a security shall 
not be deemed a prospectus: If it states from whom a written 
prospectus meeting the requirements of section 10 may be obtained 
and, in addition, does no more than identify the security, state the 
price thereof, state by whom orders will be executed, and contain 
such other information as the Commission, by rules or regulations 
deemed necessary or appropriate in the public interest and for the 
protection of investors * * * may permit. 15 U.S.C. 77b(a)(10)(b).
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    The advertising restrictions of the Securities Act cause special 
problems for many investment companies. Unlike typical corporate 
issuers that generally offer their shares only periodically, mutual 
funds typically offer and sell their shares continuously to provide an 
ongoing flow of capital into their portfolios and to enable them to 
meet redemption requests from outgoing shareholders. Unit investment 
trusts (``UITs'') typically have active secondary markets in which the 
trusts' sponsors are continuously purchasing and selling the trusts' 
units. For mutual funds and UITs, the advertising restrictions apply 
continuously because the offering process, in effect, is continuous. In 
recognition of this issue, the Commission has adopted special 
advertising rules for investment companies.
Rule 482
    The Commission adopted rule 482 under the authority of section 
10(b) of the Securities Act, which permits the Commission to adopt 
rules that provide for a prospectus that ``omits in part'' or 
``summarizes'' information contained in the statutory prospectus.\18\ 
Rule 482

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permits registered investment companies and business development 
companies to advertise any information ``the substance of which'' is 
included in the statutory prospectus.\19\ The theory behind the 
``substance of which'' requirement is that an advertisement cannot be 
one that ``omits'' information from the statutory prospectus unless all 
of the information in the advertisement is derived from information in 
the statutory prospectus.\20\ Significantly, rule 482 provides a means 
for mutual funds to advertise performance information according to 
standardized formulas.\21\
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    \18\ 15 U.S.C. 77j(b). See also Investment Company Act Release 
No. 10852 (Aug. 31, 1979) [44 FR 52816 (Sept. 10, 1979)] (``1979 
Advertising Adopting Release'') (initially adopting rule 482 as rule 
434d).
    \19\ Rule 482(a)(2) under the Securities Act [17 CFR 
230.482(a)(2)]. Business development companies are a category of 
closed-end investment companies that are not required to register 
under the Investment Company Act. See Section 2(a)(48) of the 
Investment Company Act [15 U.S.C. 80a-2(a)(48)] (defining ``business 
development company'').
    \20\ Investment Company Act Release No. 9811 (June 8, 1977) [42 
FR 30379, 30380 (June 14, 1977)] (``1977 Advertising Proposing 
Release'') (proposing rule 434d, subsequently renumbered as rule 
482).
    \21\ Rule 482 provides mutual funds with an opportunity to 
advertise, according to standardized formulas, their current yield, 
tax-equivalent yield, total return, and after-tax return. Mutual 
funds also may advertise other historical measures of fund 
performance, subject to certain limitations, provided that the 
standardized total return is also included. Rule 482(e) under the 
Securities Act [17 CFR 230.482(e)]. The Commission adopted the use 
of standardized formulas in order to permit prospective investors to 
compare the performance claims of competing funds and to prevent 
misleading performance claims by funds. Investment Company Act 
Release No. 16245 (Feb. 2, 1988) [53 FR 3868 (Feb. 10, 1988)] 
(``1988 Advertising Adopting Release'').
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    Because a rule 482 advertisement is a prospectus under section 
10(b) of the Securities Act, a rule 482 advertisement is subject to 
section 12(a)(2) of the Securities Act, which imposes liability for 
materially false or misleading statements in a prospectus or oral 
communication, subject to a reasonable care defense.\22\ Rule 482 
advertisements are also subject to the antifraud provisions of the 
federal securities laws.\23\ Mere compliance with the terms of rule 482 
is not a safe harbor against antifraud liability.\24\
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    \22\ 15 U.S.C. 77l(a)(2). An action under section 12(a)(2) does 
not require proof of scienter (i.e., an intent to defraud 
investors), e.g., Wigand v. Flo-Tek, Inc., 609 F.2d 1028, 1034 (2d 
Cir. 1979), or investor reliance on a misleading statement or 
omission, e.g., MidAmerica Fed. S. & L. Assoc. v. Shearson/American 
Express, Inc., 886 F.2d 1249, 1256 (10th Cir. 1989); Sanders v. John 
Nuveen & Co., 619 F.2d 1222, 1225 (7th Cir. 1980), cert. denied, 450 
U.S. 1005 (1981). In contrast, claims under the antifraud provisions 
of section 10(b) of the Securities Exchange Act of 1934 (``Exchange 
Act'') [15 U.S.C. 78j(b)] reqire proof of scienter and investor 
reliance. Under either type of claim, however, the plaintiff must 
establish that the misrepresentation or omission is material.
    \23\ See, e.g., Section 17(a) of the Securities Act [15 U.S.C. 
77q]; section 10(b) of the Exchange Act [15 U.S.C. 78j(b)]; section 
34(b) of the Investment Company Act [15 U.S.C. 80a-33]; section 206 
of the Investment Advisers Act of 1940 [15 U.S.C. 80b-6] 
(``Investment Advisers Act'').
    Members of the National Association of Securities Dealers, Inc. 
(``NASD'') also must comply with rule 2210 of the NASD Conduct Rules 
when sponsoring fund advertisements. Rule 2210 provides NASD members 
with general standards outlining what may constitute misleading fund 
advertising and specific standards reflecting requirements for 
advertising communications. Rules 2210(d)(1) and (2) of the NASD 
Conduct Rules.
    \24\ 1988 Advertising Adopting Release, supra note 21, at 3878 
n. 51. See also Investment Company Act Release No. 24832 (Jan. 18, 
2001) [66 FR 9002, 9008 (Feb. 5, 2001)] (``After-Tax Adopting 
Release'') (compliance with rule 482 is not a safe harbor from 
antifraud liability); Investment Company Act Release No. 15315 
(Sept. 17, 1986) [51 FR 34384, 34391 (Sept. 26, 1986)] (``1986 
Advertising Proposing Release'') (in proposing amendments to rule 
482 to require the inclusion of a legend on advertisements, 
Commission stated that it was ``not suggesting that the legend 
information contains all the material information necessary to 
prevent an ad from being misleading * * * [and] that whoever 
sponsors the ad, be it the fund, the underwriter, or the dealer, 
bears the primary responsibility for assuring that the ad is not 
false or misleading''); 1977 Advertising Proposing Release, supra 
note 20, at 30380 (advertisements made pursuant to rule 434d 
(subsequently renumbered as rule 482) would be subject to the 
antifraud provisions of the securities laws); In the Matter of The 
Dreyfus Corporation and Michael L. Schonberg, Investment Advisers 
Act Release No. 1870 (May 10, 2000) (``Dreyfus Order'') 
(advertisements that comply with rule 482 are subject to the general 
antifraud provisions of the securities laws).
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Rule 134
    In contrast to rule 482, rule 134 is a content-based rule that 
specifies certain categories of information that a fund may advertise. 
The Commission adopted rule 134 under the authority of section 
2(a)(10)(b) of the Securities Act.\25\ Section 2(a)(10)(b) excepts a 
communication from the definition of ``prospectus'' if the 
communication states from whom an investor may obtain a written 
prospectus meeting the requirements of section 10 of the Securities Act 
and, in addition, does no more than identify the security, state its 
price and by whom orders will be executed, and contain any other 
information that the Commission permits by rule. Originally, rule 134 
communications, known as ``tombstone advertisements,'' were intended 
merely to announce the existence of a public offering and serve as a 
simple means for soliciting inquiries for the statutory prospectus.\26\ 
Over the years, however, the Commission has amended rule 134, 
broadening the permissible categories of information that a fund may 
include in its tombstone advertisements.\27\ Today, funds may advertise 
a broad range of information under rule 134, other than performance 
information.
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    \25\ 15 U.S.C. 77b(a)(10(b).
    \26\ See Division of Investment Management, Securities and 
Exchange Commission, Protecting Investors Study: A Half Century of 
Investment Company Regulation (1992) (``Protecting Investors 
Study'') at 358. See also T. Lemke, G. Lins, A. Smith III, 
Regulation of Investment Companies, Vol. 1, ch. 14, [sect] 14.02, at 
14-3 (2001).
    \27\ See Securities Act Release No. 5250 (May 9, 1972) [37 FR 
10071 (May 19, 1972)] (permitting tombstone advertisement to include 
general description of mutual fund); Investment Company Act Release 
No. 8568 (Nov. 4, 1974) [39 FR 39868 (Nov. 12, 1974)] (permitting 
tombstone advertisement to include description of certain special 
attributes of mutual fund, e.g., discussion of a fund's investment 
objectives); Investment Company Act Release No. 8824 (June 16, 1975) 
[40 FR 27442 (June 30, 1975)] (extending the expanded tombstone 
advertising contents to UITs and permitting certain kinds of 
pictorial illustrations, such as logos, to be used in investment 
company tombstone advertising).
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    Because the Commission adopted rule 134 under section 2(a)(10)(b) 
of the Securities Act, rule 134 advertisements are not considered 
prospectuses. As a result, rule 134 advertisements do not create 
liability under section 12(a)(2) of the Securities Act, which by its 
terms applies only to prospectuses and oral communications.\28\ Rule 
134 advertisements, however, are subject to the antifraud provisions of 
the federal securities laws.\29\
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    \28\ See supra note 22 and accompanying text (discussing 
liability under section 12(a)(2) of the Securities Act).
    \29\ See supra note 23 (noting various antifraud provisions 
under the federal securities laws).
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Rule 34b-1
    Rule 34b-1 under the Investment Company Act applies to supplemental 
sales literature, i.e., sales literature that is preceded or 
accompanied by the statutory prospectus.\30\ Under rule 34b-1, any 
performance data included in supplemental sales literature must be 
accompanied by performance data computed using the standardized 
formulas for advertising performance under rule 482.\31\ The Commission 
adopted rule 34b-1 to ensure that performance claims in supplemental 
sales literature would not be misleading and to promote comparability 
and uniformity among supplemental sales literature and rule 482 
advertisements.\32\ Supplemental sales literature is subject to the 
antifraud provisions of the federal

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securities laws. Mere compliance with the terms of rule 34b-1 is not a 
safe harbor against antifraud liability.\33\
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    \30\ 17 CFR 270.34b-1. Under section 2(a)(10)(a) of the 
Securities Act [15 U.S.C. 77b(a)(10)(a)], a communication sent or 
given after the effective date of the registration statement is not 
deemed a ``prospectus'' if it is proved that prior to or at the same 
time with such communication a written statutory prospectus was sent 
or given to the person to whom the communication was made.
    \31\ Rule 34b-1 applies to supplemental sales literature that is 
required to be filed with the Commission under section 24(b) of the 
Investment Company Act [15 U.S.C. 80a-24(b)], i.e., supplemental 
sales literature of registered open-end companies, unit investment 
trusts, and face-amount certificate companies.
    \32\ 1986 Advertising Proposing Release, supra note 24, at 
34393.
    \33\ After-Tax Adopting Release, supra note 24, at 9008.
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Rule 156
    Rule 156 under the Securities Act provides guidance on the types of 
information that could be misleading in fund sales literature.\34\ It 
applies to all advertisements and supplemental sales literature.\35\ 
Under rule 156, whether a statement involving a material fact is 
misleading depends on an evaluation of the context in which it is made. 
Rule 156 indicates that representations about past performance could be 
misleading in situations where portrayals of past performance convey an 
impression of net investment results that would not be justified under 
the circumstances.\36\
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    \34\ 17 CFR 230.156.
    \35\ 17 CFR 230.156(c).
    \36\ 17 CFR 230.156(b)(2)(i). See Investment Company Act Release 
No. 10915 (Oct. 26, 1979) [44 FR 64070 (Nov. 6, 1979)] (adopting 
rule 156).
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B. Performance Advertising Practices

    Although there are many factors other than performance that an 
investor should consider in deciding whether to invest in a particular 
fund, many investors consider performance to be one of the most 
significant factors when selecting or evaluating mutual funds.\37\ 
Eager to attract new investors, many funds have, from time to time, 
engaged in advertising campaigns focusing on past performance. As a 
result of advertising that focused on extraordinary fund performance 
during 1999-2000, there have been increasing concerns that some funds, 
when advertising their performance, may resort to techniques that 
create unrealistic investor expectations or may mislead potential 
investors.\38\ As discussed more fully below, we have particular 
concerns about the following practices:
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    \37\ See Investment Company Institute, Understanding 
Shareholders' Use of Information and Advisers (Spring 1997), at 21 
and 24 (Total return information was frequently considered by 
investors before a purchase, second only to the level of risk of the 
fund. Eighty-eight percent of fund investors surveyed said that they 
considered total return before their most recent purchase of a 
mutual fund. Eighty percent of fund owners surveyed reported that 
they followed a fund's rate of return at least four times per 
year.). See also Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance, supra note 
10 (cautioning investors to consider factors other than performance, 
such as fees, risks, volatility, and recent changes in the fund's 
operations, when evaluating mutual funds).
    \38\ Paul F. Roye, Director, Division of Investment Management, 
``Success and Survival of the Mutual Fund Industry in a Changing 
World,'' Remarks before the ICI General Membership Meeting, 
Washington, DC (May 19, 2000) (discussing Commission concerns with 
fund advertising). (transcript available at http://www.sec.gov/news/speech/spch373.htm).
    See also NASD Regulation, Inc. (``NASDR''), Inaccurate 
Performance Graphs Result In Formal Action (last modified Summer 
2000) http://www.nasdr.com/rca_summer00_adv.htm (warning against 
misleading performance graphs in fund advertising); NASD Notice to 
Membes No. 00-21 (Apr. 2000) (``NASD Notice 00-21'') (advising 
members to be careful when advertising extraordinary fund 
performance because prospective investors may believe that these 
unusually high returns will continue and warning that material 
disclosures, which may balance an advertisement's overall message, 
should not be relegated to footnotes).
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    [sbull] Advertising performance without providing adequate 
disclosure of unusual circumstances that have contributed to 
performance;
    [sbull] Advertising performance without providing adequate 
disclosure of the performance period, that more current performance 
information is available, or that more current performance may be lower 
than advertised performance; and
    [sbull] Advertising performance based on selective dates or time 
periods in order to showcase fund performance as of those specific 
dates or time periods without providing disclosure that would permit an 
investor to evaluate the significance of the performance.
Unusual Circumstances That Contribute to Fund Performance
    Mutual fund performance advertisements may be materially misleading 
when they fail to adequately disclose that unusual circumstances 
contributed to the fund's advertised performance. In each of two 
enforcement actions, an investment adviser had marketed a relatively 
small fund's unusually high return without disclosing that a 
significant percentage of the fund's return was attributable to its 
investments in securities issued in initial public offerings.\39\ Given 
the substantial growth in the funds' assets as a result of sales of the 
funds' shares to the public, to the point where the funds were no 
longer experiencing, by investing in additional initial public 
offerings, substantially similar performance as they previously 
experienced, the Commission found that the failure to disclose the 
contribution to the funds' performance of the initial public offering 
investments was materially misleading.
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    \39\ Dreyfus Order, supra note 24 (investment adviser violated 
antifraud prohibitions of section 206(2) of the Investment Advisers 
Act [15 U.S.C. 80b-6(2)] and section 17(a)(3) of the Securities Act 
[15 U.S.C. 77q(a)(3)]); In the Matter of Van Kampen Investment 
Advisory Corp. and Alan Sachtleben, Investment Advisers Act Release 
No. 1819 (Sept. 8, 1999) (investment adviser violated antifraud 
prohibitions of section 206(2) of the Investment Advisers Act [15 
U.S.C. 80b-6(2)] and section 34(b) of the Investment Company Act [15 
U.S.C. 80a-33(b)]).
---------------------------------------------------------------------------

    To address these concerns, some mutual fund advertisements 
supplement their presentations of performance information with 
narrative disclosure that is designed to inform investors that the 
funds' performance was achieved through the use of particular 
investment strategies under specified circumstances that are not likely 
to recur. For example, one fund advertisement disclosed that a 
significant portion of the fund's advertised performance was 
attributable to the allocation of initial public offering securities to 
the fund but indicated that such allocation would not likely continue 
in the future.
Currentness of Performance Information
    Rule 482 requires all performance data contained in any mutual fund 
advertisement to be as of the most recent practicable date, provided 
that any advertisement containing total return quotations is considered 
to have complied with this requirement if the total return quotations 
are current to the most recent calendar quarter ended prior to 
submission of the advertisement for publication.\40\ As a result, total 
return quotations may be up to three months old at the time that an 
advertisement is submitted for publication. We are concerned that, in 
some cases, an advertisement that complies with these requirements of 
rule 482 may nonetheless confuse, or even mislead, investors regarding 
the fund's current performance, particularly when the fund's 
performance has declined significantly after the period reflected in an 
advertisement.
---------------------------------------------------------------------------

    \40\ Rule 482(g) under the Securities Act [17 CFR 230.482(g)].
---------------------------------------------------------------------------

    We questioned this practice in an enforcement action where we found 
that the failure to disclose the large impact of initial public 
offerings on a fund's performance during the fund's first fiscal year 
made the fund's performance advertisements materially false and 
misleading.\41\ One of the significant facts in that case was that the 
fund's advertisements publicized extraordinary first-year returns at a 
time when the fund's more current returns had become negative.\42\ 
While the fund advertisements complied with rule 482, we noted that 
rule 482 advertisements remain ``subject to the general antifraud

[[Page 36716]]

provisions of the federal securities laws and must not be false and 
misleading.'' \43\
---------------------------------------------------------------------------

    \41\ See Dreyfus Order, supra note 24.
    \42\ Id. (81.92% total return for the one-year period ended 
September 30, 1996, publicized in October through December 1996 when 
total returns for the three-month periods ended August 30, September 
30, October 31, November 29, and December 31, 1996, were negative 
17.03%, 7.71%, 7.79%, 16.25%, and 13.37%, respectively).
    \43\ Id. at n. 16. Similarly, NASDR warned its members about 
performance advertising when a security's performance has been 
negatively affected by sudden changes in market conditions. NASDR 
advised its members ``that if a security experiences an abrupt 
negative change in performance, member firms should amend their 
historical performance communications to add either updated 
performance figures or clear disclosure that current performance is 
less than the figures shown.'' NASD Regulation, Inc., Sudden 
Performance Changes May Require More Information (last modified 
Summer 1999) http://www.nasdr.com/3085_9906. htm.
---------------------------------------------------------------------------

    To address this concern, some mutual fund advertisements supplement 
their presentations of performance information with narrative 
disclosure that is designed to inform investors that the advertised 
performance is not the fund's current performance. Some advertisements 
disclose that, due to market volatility or other factors, the fund's 
performance changes over time or that the fund's current performance 
may be lower than the advertised performance. Other advertisements 
direct investors to other sources where they may find more up-to-date 
performance information, such as the fund's toll-free telephone number 
or website or the mutual fund section of the newspaper in which the 
advertisements appear. In addition, some advertisements include 
performance information that is more current than the information 
required by rule 482.
Selective Use of Performance Figures
    A mutual fund advertisement may be materially misleading when it 
showcases a fund's performance for a certain time period without 
providing sufficient information to permit an investor to evaluate the 
significance of the performance data. Rule 482, by its terms, permits a 
mutual fund to advertise its performance for any period so long as it 
is accompanied by performance for 1-, 5-, and 10-year periods (or, if 
shorter, for the life of the fund) current to the most recent 
quarter.\44\ Nonetheless, if a fund selectively advertises performance 
that is unusually high and not representative of the fund's historical 
performance, investors potentially may be misled. Selectively 
advertising performance as of a particular date may be particularly 
problematic where performance has declined after the chosen date but 
before the advertisement is submitted for publication. To address these 
concerns, some mutual fund advertisements supplement their performance 
presentations with narrative disclosure to the effect that the fund's 
performance may be volatile, that the performance information shown is 
not current, or that the advertised performance is not representative 
of the fund's historical performance.
---------------------------------------------------------------------------

    \44\ Rule 482(e)(5)(ii) [17 CFR 230.482(e)(5)(ii)].
---------------------------------------------------------------------------

II. Discussion

    We are proposing to amend rule 482 to permit rule 482 
advertisements to include information that is not included in the 
statutory prospectus, in accordance with NSMIA. In light of the 
proposed amendments to rule 482, we are also proposing to rescind the 
provisions in rule 134 that apply to funds. At the same time, however, 
and in light of our concerns about fund advertising practices, we 
believe that it is appropriate to reinforce the antifraud protections 
in the fund advertising rules. Our proposals would require enhanced 
disclosure of information in fund advertisements and are designed to 
encourage advertisements that convey balanced information to 
prospective investors.

A. Eliminating the ``Substance of Which'' Requirement From Rule 482 and 
Rescinding Rule 134 for Funds

    In 1992, the Division of Investment Management recommended to the 
Commission that the Securities Act be amended to permit investment 
companies to advertise a wide range of information in the form of an 
``advertising prospectus,'' including information that is not included 
in the statutory prospectus required by section 10(a).\45\ Congress 
embraced this recommendation in NSMIA when it added new section 24(g) 
to the Investment Company Act. Section 24(g) directs the Commission to 
adopt rules or regulations that permit registered investment companies 
to use prospectuses that (i) include information the substance of which 
is not included in the statutory prospectus, and (ii) are deemed to be 
permitted by section 10(b) of the Securities Act.\46\
---------------------------------------------------------------------------

    \45\ Protecting Investors Study, supra note, at 370.
    \46\ 15 U.S.C. 80a-24(g). See also S. Rep. No. 293, 104th Cong., 
2d Sess. 8 (1996) (stating that the ``bill improves fund advertising 
by giving the Commission express authority to create a new 
investment company `advertising prospectus' '').
---------------------------------------------------------------------------

    Today we are proposing to implement this provision of NSMIA by 
amending rule 482 to remove the requirement that a rule 482 
advertisement contain only information the ``substance of which'' is 
included in the statutory prospectus.\47\ Eliminating this requirement 
will permit investment companies to include more information in rule 
482 advertisements on a real-time basis, e.g., information about 
current economic conditions that normally would not be included in a 
fund's prospectus. The proposed amendment will also permit funds to 
eliminate from the statutory prospectus information, such as 
boilerplate disclosure about the methods used to calculate performance 
in fund advertising, that clutters the statutory prospectus and 
obscures other important information. As a result, investors should 
receive better, more understandable, and more timely information in 
both the statutory prospectus and fund advertisements. In addition, the 
costs of regulatory compliance will be reduced for funds and, 
ultimately, for investors.
---------------------------------------------------------------------------

    \47\ The ``substance of which'' requirement is presently 
contained in rule 482(a)(2) [17 CFR 230.482(a)(2)]. We are also 
proposing to revise the language in the current note to paragraph 
(a)(3) of rule 482, which states that ``[t]he fact that the 
statements included in the advertisement are included in the section 
10(a) prospectus does not relieve the issuer, underwriter, or dealer 
of the obligation to ensure that the advertisement is not false or 
misleading.'' The proposed removal of the ``substance of which'' 
requirement makes the reference to the section 10(a) prospectus 
unnecessary. The revised language of this note is incorporated into 
the proposed note to proposed paragraph (a) of rule 482. See Section 
II.B., infra, ``Applicability of Antifraud Provisions to Fund 
Advertising.''
---------------------------------------------------------------------------

    Elimination of the ``substance of which'' requirement from rule 482 
should not diminish investor protection. The ``substance of which'' 
requirement is a technical requirement that does not, in itself, 
prevent misleading statements because it does not require an 
advertisement to use the same words as the statutory prospectus or 
prohibit the use of advertising techniques that are not included in the 
statutory prospectus.\48\ Importantly, rule 482 advertisements, as 
``prospectuses,'' will remain subject to section 12(a)(2) liability and 
the antifraud provisions of the federal securities laws. Also, rule 482 
advertisements, as section 10(b) prospectuses under the Securities Act, 
are subject to the summary suspension provisions of section 10(b), 
which permit the Commission to suspend the use of a materially false or 
misleading prospectus.\49\ In addition, fund advertising materials must 
continue to be filed with NASD Regulation, Inc. (``NASDR'') or the 
Commission, and NASDR rules relating to fund advertising will continue 
to apply.\50\

[[Page 36717]]

Finally, we are today proposing additional amendments to rule 482 to 
reinforce antifraud protections, particularly in the area of fund 
performance.\51\
---------------------------------------------------------------------------

    \48\ See 1977 Advertising Proposing Release, supra note 20, at 
30380.
    \49\ 15 U.S.C. 77j(b).
    \50\ Section 24(b) of the Investment Company Act [15 U.S.C. 80a-
24(b)] requires the filing with the Commission of ``any 
advertisement, pamphlet, circular, form letter, or other sales 
literature'' for any registered investment company other than a 
closed-end fund. Rule 24b-3 under the Investment Company Act [17 CFR 
270.24b-3] relieves funds of the obligation to file advertisements 
and other sales materials with the Commission if that material is 
filed with NASDR. See supra note 23 (discussion of NASD advertising 
rules).
    \51\ See discussion in Section II.B., ``Applicability of 
Antifraud Provisions to Fund Advertising,'' and Section II.C., 
``Enhanced Disclosure under Rule 482,'' infra.
---------------------------------------------------------------------------

    We are using our exemptive authority under the Securities Act to 
eliminate the ``substance of which'' requirement from rule 482 for the 
securities of business development companies (``BDCs'') as well as 
registered investment companies.\52\ Currently, BDCs and registered 
investment companies are treated similarly under rule 482. We believe 
that it is appropriate to extend the benefits that would result from 
elimination of the ``substance of which'' requirement to BDCs, given 
that elimination of this requirement should not diminish investor 
protection. We note, however, that BDCs, unlike mutual funds, do not 
continuously offer and sell their shares and do not make extensive use 
of advertisements.
---------------------------------------------------------------------------

    \52\ Section 28 of the Securities Act [15 U.S.C. 77z-3]. 
Business development companies are a category of closed-end 
investment companies that are not required to register under the 
Investment Company Act. See Section 2(a)(48) of the Investment 
Company Act [15 U.S.C. 80a-2(a)(48)] (defining ``business 
development company'').
---------------------------------------------------------------------------

    We request comment on the elimination of the ``substance of which'' 
requirement from rule 482.
    [sbull] Are the proposed amendments to rule 482 to eliminate the 
``substance of which'' requirement the appropriate means for 
implementing the authority provided to the Commission in NSMIA?
    [sbull] Are other restrictions or conditions necessary in rule 482 
for the protection of investors in the absence of the ``substance of 
which'' requirement?
    [sbull] What concerns should be addressed by any such restrictions 
or conditions?
    [sbull] Should the ``substance of which'' requirement be eliminated 
for BDCs?
    With the proposed elimination of the ``substance of which'' 
requirement, we believe that funds will no longer need to rely on rule 
134.\53\ We are therefore proposing to remove the provisions of rule 
134 that apply specifically to funds and to exclude both registered 
investment companies and business development companies from relying on 
rule 134. Rule 134 will remain available to other issuers. Rule 482, as 
we propose to amend it, will provide funds with sufficient flexibility 
to discuss topics, such as current economic conditions, that are 
currently discussed in rule 134 advertisements but generally not in the 
statutory prospectus. We believe that investor protection will be 
increased if fund advertisements including this information are subject 
to rule 482 and, as a result, to section 12(a)(2) liability.\54\
---------------------------------------------------------------------------

    \53\ The Protecting Investors Study recommended rescinding the 
provisions of rule 134 applicable solely to funds. Protecting 
Investors Study, supra note 26, at 363.
    \54\ Rule 134 advertisements are subject to the antifraud 
provisions under the federal securities laws but do not create 
liability under section 12(a)(2) of the Securities Act. See supra 
note 22 and accompanying text (discussing section 12(a)(2) 
liability) and note 28 and accompanying text (discussing rule 134 
advertisements and section 12(a)(2)).
---------------------------------------------------------------------------

    We request comment on the elimination of the rule 134 provisions 
that apply to funds.
    [sbull] Should funds be excluded from relying on rule 134?
    [sbull] If funds should continue to be permitted to rely on rule 
134, how, if at all, should rule 134 be amended?
    [sbull] In the alternative, should only certain types of funds 
(e.g., closed-end funds or business development companies) be able to 
use rule 134 advertisements? If so, why?

B. Applicability of Antifraud Provisions to Fund Advertising

    The Commission proposes to amend the fund advertising rules in 
order to reemphasize that fund advertisements are subject to the 
antifraud provisions of the federal securities laws. We understand that 
questions have been raised regarding whether compliance with the terms 
of rule 482 satisfies all of the obligations of a fund with respect to 
its advertisements.\55\ When we initially proposed rule 482 in 1977, we 
indicated that rule 482 advertisements would be subject to section 
12(a)(2) of the Securities Act and the antifraud provisions of the 
federal securities laws.\56\ Since then, we have reiterated that 
compliance with the ``four corners'' of rule 482 does not alter the 
fact that funds, underwriters, and dealers are subject to the antifraud 
provisions of the federal securities laws with respect to fund 
advertisements.\57\
---------------------------------------------------------------------------

    \55\ See, e.g., Bloomberg News, SEC Reviewing Funds Ads That May 
Mislead, Los Angeles Times, July 13, 1999, at C5 (stating that the 
Commission's position that advertisements complying with the four 
corners of rule 482 may still be misleading under the federal 
securities laws ``has drawn criticism from the fund sector'').
    \56\ 1977 Advertising Proposing Release, supra note 20, at 
30380.
    \57\ 1988 Advertising Adopting Release, supra note 21 at 3878 n. 
51. See also discussion in note 24, supra.
---------------------------------------------------------------------------

    To emphasize this principle, we propose adding a note to proposed 
paragraph (a) of rule 482 that would state that an advertisement that 
complies with rule 482 does not relieve the fund, underwriter, or 
dealer of the obligation to ensure that the advertisement is not false 
or misleading. We also propose adding a similar note to the 
introductory paragraph of rule 34b-1 under the Investment Company Act 
with respect to supplemental sales literature. We are proposing to add 
the note to rule 34b-1 to make clear that, as with rule 482, compliance 
with the rule does not relieve the fund, or its underwriter or dealer, 
from the obligation to ensure that an advertisement is not false or 
misleading, whether due to an affirmative misstatement or omission. 
These proposed notes also would cross-reference rule 156 under the 
Securities Act, which provides guidance about the factors to be weighed 
in determining whether statements, representations, illustrations, and 
descriptions contained in fund advertisements and sales literature are 
misleading.
    In addition, we are proposing to amend rule 156 to provide further 
guidance regarding the factors to be weighed in considering whether a 
statement involving a material fact in investment company sales 
materials is or might be misleading. As discussed above, we are 
concerned that the advertisement of past performance without an 
adequate explanation of other facts may create unrealistic investor 
expectations or even mislead potential investors. For that reason, we 
are modifying the language of rule 156 to state more explicitly that 
portrayals of past income, gain, or growth of assets may be misleading 
where the portrayals omit explanations, qualifications, limitations, or 
other statements necessary or appropriate to make these portrayals of 
past performance not misleading.\58\ This language is intended to 
address our concerns with fund performance advertisements that do not 
provide adequate disclosure (i) of unusual circumstances that have 
contributed to fund performance; \59\ (ii) that more current 
performance may be lower than advertised performance; \60\ or

[[Page 36718]]

(iii) that would permit an investor to evaluate the significance of 
performance that is based on selective dates.\61\ We remind funds and 
their underwriters and dealers, however, that this language would 
address other circumstances that we have not specifically enumerated 
and that each fund, and its underwriters and dealers, is responsible 
for analyzing the facts and circumstances concerning its advertisements 
and determining whether its advertisements may be fraudulent.
---------------------------------------------------------------------------

    \58\ Proposed rule 156(b)(2)(i). Currently, rule 156 states that 
portrayals of past performance may be deemed misleading if they 
convey an impression about the investment results that would not be 
justified under the circumstances. Rule 156(b)(2)(i) under the 
Securities Act [17 CFR 230.156(b)(2)(i)].
    \59\ See supra 39 note and accompanying text (discussing 
Commission enforcement cases sanctioning fund advisers for lack of 
disclosure regarding the impact of investments in initial public 
offerings on advertised performance).
    \60\ See supra notes 40-43 and accompanying text (discussing 
concerns that advertisements that comply with rule 482 may 
nonetheless mislead investors regarding the fund's current 
performance).
    \61\ See supra 44 note and accompanying text (discussing 
concerns about selective advertisement of performance that is 
unusually high and not representative of a fund's historical 
performance).
---------------------------------------------------------------------------

    We request comment on the proposed amendments reemphasizing the 
applicability of the antifraud provisions.
    [sbull] Are there additional amendments to rule 482, rule 34b-1, 
and rule 156 that would help to emphasize the obligations under the 
antifraud provisions of funds and their underwriters and dealers?

C. Enhanced Disclosure Under Rule 482

    We are also proposing additional amendments to rule 482 that would 
require enhanced disclosure of certain information designed to 
encourage advertisements that convey balanced information to 
prospective investors. Our proposed amendments would require that funds 
that advertise performance information make available to investors 
total returns that are current to the most recent month-end. They also 
would require that fund advertisements include improved narrative 
information and present explanatory information more prominently.
Availability of Month-End Performance Information
    As discussed above, Rule 482 requires all performance data 
contained in any mutual fund advertisement to be as of the most recent 
practicable date, provided that any advertisement containing total 
return quotations is considered to have complied with the requirement 
if the total return quotations are current to the most recent calendar 
quarter ended prior to submission of the advertisement for 
publication.\62\ As a result, total return quotations may be up to 
three months old at the time that an advertisement is submitted for 
publication. We are concerned that, in some cases, an advertisement 
that complies with these requirements of rule 482 may nonetheless 
confuse, or even mislead, investors, particularly when performance has 
declined significantly after the period reflected in an advertisement.
---------------------------------------------------------------------------

    \62\ Rule 482(g) under the Securities Act [17 CFR 230.482(g)].
---------------------------------------------------------------------------

    In order to address this concern, we are proposing to add a second 
condition for a fund advertisement to be considered to have complied 
with the requirement of rule 482 that performance be as of the most 
recent practicable date. Specifically, total return quotations current 
to the most recent month-end, and available to investors within three 
calendar days of the most recent month-end, must be provided at a toll-
free (or collect) telephone number.\63\
---------------------------------------------------------------------------

    \63\ Proposed paragraph (g)(2) of rule 482. Our understanding is 
that funds typically calculate performance daily so that making 
month-end performance numbers available within three calendar days 
of the most recent month-end should not be burdensome.
---------------------------------------------------------------------------

    This proposal would ensure that investors who are provided 
advertisements touting a fund's performance will have ready access to 
performance that is current to the most recent month-end and will not 
be forced to rely on performance data that may be more than three 
months old at the time of use by the investor. Outdated fund 
performance that is relied on by an investor when, for example, the 
markets have generally entered a period of lower performance, may cause 
the investor to have an overly optimistic view of the fund's ability to 
outperform the markets. We believe that today's proposal will help to 
address this problem by making more recent performance data available 
to investors in any fund that advertises its performance.
    We note that the proposed amendments would require the availability 
of month-end performance information even if the advertisement itself 
included performance current as of the most recent month-end at the 
time of submission for publication. The availability of month-end 
information would be useful to investors in these circumstances if, for 
example, the advertisement continued to be used subsequent to the end 
of the following month, or if the investor referred to the 
advertisement at a later date.
    Finally, we note that the availability of month-end information by 
telephone does not alter the application of the antifraud provisions to 
an advertisement. The month-end information obtained through a 
telephone call would not be considered part of the advertisement 
itself.
    We considered amending the requirements of rule 482 to provide that 
an advertisement would be considered to have complied with the ``most 
recent practicable date'' requirement if the total return quotations 
are current to the most recent calendar month ended prior to submission 
of the advertisement for publication. This approach would have the 
advantage of providing more current performance information to 
investors in advertisements rather than placing the burden on investors 
to seek out this information through a telephone call. We were not, 
however, persuaded that the benefits to investors from this approach 
would outweigh the costs it would impose.
    First, a month-end standard for rule 482 performance data could 
result in an increase in the number of instances in which performance 
information for different periods appeared concurrently as a result of 
different lead times for different publications. One advantage of the 
quarter-end approach is that it tends to result in the publication of 
comparable numbers by different funds. Second, requiring all funds to 
publish data as of the most recent month-end in all cases, without 
regard to the materiality of this information, would perhaps accord 
very recent performance greater status than it deserves and could 
contribute to investors' tendency to focus excessively on short-term 
performance.\64\
---------------------------------------------------------------------------

    \64\ See Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance, supra note 
(cautioning investors to look beyond short-term performance 
records).
---------------------------------------------------------------------------

    A month-end standard would also impose costs on funds and, 
indirectly, on investors. While a month-end standard might be fairly 
simple to comply with for advertisements in some publications (e.g., 
newspapers), it might be difficult for other forms of advertisement. 
For example, mutual fund distributors frequently supply sales material 
in bulk to third-party intermediaries, such as broker-dealers, and to 
retirement plan sponsors, who then distribute it to investors. If 
month-end numbers were required, the ``shelf life'' of this material 
would be abbreviated, which could result in significant additional 
printing and compliance costs associated with preparing updated 
material and providing it to all distribution channels.
    We also considered whether to provide funds greater flexibility in 
determining the medium through which to make month-end numbers 
available, so that a fund could, for example, meet this obligation 
through website access. We concluded that, at this time, requiring 
telephone availability would ensure the most widespread access to this 
information by all investors. While the percentage of households with 
Internet access has increased considerably in recent years, it remains

[[Page 36719]]

substantially lower than the percentage with access to telephones.\65\ 
We note, however, that we have taken steps to encourage issuers and 
market intermediaries to communicate with and deliver information to 
investors through the Internet.\66\ The increased availability of 
information through this medium has helped to promote transparency, 
liquidity, and efficiency by making information available to investors 
quickly and in a cost-effective manner. We encourage each fund to make 
its month-end performance information available to its investors on its 
website, if it has one. We applaud the efforts already being made by 
many funds to provide access to performance and other information, such 
as prospectuses, cost information, and portfolio holdings, through 
their websites. We encourage other funds to make similar efforts.
---------------------------------------------------------------------------

    \65\ Economics and Statistics Administration & National 
Telecommunications and Information Administration, A Nation Online: 
How Americans Are Expanding Their Use of the Internet, at 3 (Feb. 
2002) (50.5% of households had Internet access as of Sept. 2001); 
Federal Communications Commission, Telephone Subscribership In the 
United States, at 1 (Feb. 2002) (95.1% of households had telephone 
service as of July 2001).
    \66\ See, e.g., Securities Act Release No. 8089 (April 12, 2002) 
[67 FR 19896, 19902 (April 23, 2002)] (proposing to require 
companies to include disclosure in their annual reports on Form 10-K 
about the availability on company websites of reports on Forms 10-K, 
10-Q, and 8-K).
---------------------------------------------------------------------------

    We also note that nothing in rule 482 or our proposed amendments 
would preclude a fund from using (and disclosing in a rule 482 
advertisement) other methods for providing updated performance 
information, such as broker-dealers, investment advisers, and other 
financial intermediaries. We would encourage funds to use any means to 
make this information more accessible. Our proposals reflect our view, 
however, that updated performance information should be available from 
the fund itself through a telephone call to an identified number and 
that other forms of distribution of this updated information should 
supplement availability from the fund itself.
    We request comment on the proposed requirement that funds make 
available month-end performance numbers through a toll-free (or 
collect) telephone number in order to comply with the currentness 
requirements of rule 482.
    [sbull] Is our proposed requirement appropriate, or should we, 
instead, require funds to provide more current performance information 
in all advertisements? If so, how current should the information be, 
e.g., month-end, week-end, or some other period?
    [sbull] Should we require funds to provide more current performance 
information in certain types of publications, e.g., websites or 
newspapers and other publications where there is a short lead time 
between submission and publication and a short shelf life? If so, how 
current should the performance information be, e.g., month-end, week-
end, or some other period? To what types of publications should this 
requirement apply?
    [sbull] If we require funds to provide more current performance 
information through a toll-free telephone number or other means, is 
month-end data current enough or should this information be updated 
more frequently than monthly (e.g., weekly or daily)?
    [sbull] Should we require month-end performance data to be 
available at a toll-free (or collect) telephone number where the 
advertisement itself includes performance data current to the most 
recent month ended prior to submission of the advertisement for 
publication?
    [sbull] Should we require that updated performance information 
available through a telephone number be current as of the most recent 
practicable date (rather than specifying a particular date, such as 
month-end), and, if so, should we provide guidance regarding what would 
satisfy that requirement (e.g., month-end data)?
    [sbull] Is three calendar days an appropriate period of time after 
each month-end in which to require funds to make available month-end 
performance information on a telephone line? If not, should funds be 
allowed more or less time, and, if so, how much time is needed, e.g., 1 
day, 5 days, or some other amount of time? Should the time period be 
based on calendar days or business days?
    [sbull] Is telephone access to updated performance information the 
best alternative, or is another alternative, such as website access, 
better?
    [sbull] Should funds have flexibility to choose the medium for 
communicating updated performance information?
    [sbull] What would be the cost of requiring access to month-end 
performance information by toll-free telephone number for funds that do 
not currently provide this access?
    [sbull] A number of daily newspapers of national circulation, such 
as The Wall Street Journal and The New York Times, publish returns for 
a significant number of mutual funds on a daily basis.\67\ Should funds 
that advertise performance information, and for which daily performance 
information is available in the press, be required to refer to the 
availability of the daily information in their performance 
advertisements?
---------------------------------------------------------------------------

    \67\ See NASD Manual [sect] 6800 (CCH) at 6551 (March 2001) 
(describing Mutual Fund Quotation Service which disseminates prices 
for mutual funds). A mutual fund may choose to be included in the 
news media list released by The NASDAQ Stock Market through the 
Mutual Fund Quotation Service if it has at least 1,000 shareholders 
or $25 million in net assets. Id. at [sect] 6800(c)(1)(A).
---------------------------------------------------------------------------

Improved Narrative Disclosure
    As discussed above, there have been increasing concerns, arising 
from the period of extraordinary market performance in 1999 and 2000, 
that some funds, when advertising their performance, may resort to 
techniques that create unrealistic investor expectations or may mislead 
potential investors. As a result, we are proposing changes to the 
narrative disclosure that is required to accompany performance 
advertisements in order to help investors understand the limitations of 
past performance data and enhance the ability of investors to obtain 
updated performance information. At present, rule 482 requires 
advertisements to disclose (i) a source from which an investor may 
obtain a prospectus containing more complete information about the 
fund; (ii) that the performance data quoted represents past 
performance; and (iii) in the case of a non-money market fund, that the 
investment return and principal value of an investment will fluctuate 
so that an investor's shares, when redeemed, may be worth more or less 
than their original cost.\68\ Our proposed amendments would also 
require funds to include the following information in rule 482 
advertisements that contain performance figures: (i) A statement that 
past performance does not guarantee future results; (ii) a statement 
that current performance may be lower or higher than the performance 
data quoted; and (iii) a fund toll-free (or collect) telephone number 
and, if available, a Web site where an investor

[[Page 36720]]

may obtain performance data current to the most recent month-end.\69\
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    \68\ Rule 482(a)(3)(i) and (6) [17 CFR 230.482(a)(3)(i) and 
(6)]. Rule 482(a)(3)(ii) [17 CFR 230.482(a)(3)(ii)] requires that an 
advertisement used with a profile under rule 498 under the 
Securities Act [17 CFR 230.498] indicate that information is 
available in the profile about the fund, the procedures for 
investing in the fund, and the availability of the fund's 
prospectus. In addition, rule 482(a)(4) requires the ``subject to 
completion'' legend required by rule 481(b)(2) under the Securities 
Act if the advertisement is used prior to effectiveness of the 
fund's registration statement, or, in the case of a registration 
statement that becomes effective omitting certain information from 
the prospectus contained in the registration statement in reliance 
upon rule 430A, when the advertisement is used prior to 
determination of the public offering price. Rule 481(b)(2); rule 
430A [17 CFR 430.481(b)(2); 430.430A].
    \69\ Proposed paragraph (b)(3)(i) of rule 482. Cf. NASD Conduct 
Rule 2210(d)(2)(N) (investment performance illustrations may not 
imply that gain or income realized in the past will be repeated in 
the future); NASD Conduct Rule IM-2210-3(c)(4) (all advertisements 
and sales literature containing an investment company ranking must 
disclose that past performance is no guarantee of future results).
---------------------------------------------------------------------------

    These statements should help investors to understand the 
limitations of past performance presentations, namely, that they 
represent historical information that may not repeat in the future and 
may even be somewhat outdated at the time an investor is reviewing 
them. In addition, provision of a toll-free (or collect) telephone 
number and, if the fund has month-end performance information available 
on its Web site, the Web site where an investor may obtain performance 
data current to the most recent month-end will provide investors ready 
access to a fund's more current performance.
    We are also proposing an amendment to rule 482 that would direct 
prospective investors' attention to a fund's charges and expenses. The 
proposed amendment would require a fund to note in its rule 482 
advertisements that information about charges and expenses is contained 
in the statutory prospectus.\70\ The many fund advertisements 
highlighting fund performance have focused investor attention on fund 
returns.\71\ Investors, however, may be overlooking other important 
fund features, particularly charges and expenses, that may diminish a 
fund's return.\72\
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    \70\ Proposed paragraph (b)(1)(i) of rule 482. This disclosure 
would also be required in an advertisement used with a profile 
pursuant to rule 498 under the Securities Act. Proposed paragraph 
(b)(1)(ii) of rule 482. Rule 482 currently does not require funds to 
highlight the availability of information regarding the fund's 
charges and expenses. The rule does, however, require an 
advertisement to identify a source from which an investor may obtain 
a prospectus containing more complete information about the fund. 
Rule 482(a)(3)(i) [17 CFR 230.482(a)(3)(i)]. The rule also requires 
that a fund that advertises performance data include some 
information about sales loads and other nonrecurring fees. Rule 
482(a)(6) [17 CFR 230.482(a)(6)].
    \71\ See supra note 37 and accompanying text (discussing 
concerns about advertising campaigns focused on past performance).
    \72\ See Securities and Exchange Commission, Mutual Fund 
Investing: Look at More Than a Fund's Past Performance, supra note 
37 (cautioning investors to look beyond performance when evaluating 
funds and to consider the costs relating to a fund investment). See 
also NASD Notice to Members No. 98-107 (1998) (reminding members of 
their obligation to ensure that discussions concerning fees and 
expenses in fund advertising are fair, balanced, and not 
misleading).
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    Mutual fund fees and expenses are extremely important to 
shareholders. The United States General Accounting Office (``GAO''), in 
a recent report to Congress on mutual fund fees, stressed the 
importance of heightening ``investors'' awareness and understanding of 
the fees they pay.'' \73\ We believe that the amendment we are 
proposing today, which will ensure that fund advertisements remind fund 
shareholders about the availability of information about fund charges 
and expenses, will help to address the GAO's concerns. Although rule 
482 already requires that fund advertisements that contain performance 
data include standardized performance information net of fees and 
charges,\74\ we agree with the GAO that the level of charges and 
expenses of a mutual fund is an independent factor that should be given 
serious consideration by a mutual fund investor.
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    \73\ United States General Accounting Office, Mutual Fund Fees: 
Additional Disclosure Could Encourage Price Competition at 97 (June 
2000).
    \74\ Rule 482 requires that funds base standardized performance 
calculations on the methods prescribed in Forms N-1A, N-3, or N-4. 
Rule 482(d)(1), (e)(1)(i), (e)(2)(i), (e)(3)(i), and (e)(4)(i) [17 
CFR 230.482(d)(1), (e)(1)(i), (e)(2)(i), (e)(3)(i), and (e)(4)(i)]. 
These forms generally require the deduction of all recurring fees 
and maximum sales loads and charges deducted from payments in 
calculating standardized performance. Item 21(b) (1), (2), and (3) 
of Form N-1A; Item 25(b)(i) of Form N-3; Item 21(b)(i) of Form N-4.
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    We request comment on the proposed requirement for disclosure about 
charges and expenses.
    [sbull] Will the proposed disclosure about charges and expenses be 
helpful to investors?
    [sbull] Is there other disclosure with respect to charges and 
expenses that should be required in fund advertisements? Are there fund 
features, in addition to charges and expenses, that a rule 482 
advertisement should highlight?
Presentation of Explanatory Information
    We are also proposing that funds present certain information in 
their rule 482 advertisements more prominently. Funds often present 
required disclosure in small print and relegate it to a footnote at the 
bottom of a print advertisement or the end of a television 
advertisement.\75\ At present, rule 482 requires that the statement 
regarding the availability of the prospectus be ``conspicuous'' and 
that quotations of standardized performance be given no less prominence 
than other performance quotations.\76\ In addition, rule 482 print 
advertisements are required by rule 420(a) under the Securities Act to 
be in roman type at least as large and as legible as 8-point modern 
type.\77\ Under rule 420(b), rule 482 advertisements distributed 
through an electronic medium may satisfy legibility requirements 
applicable to printed documents by presenting all required information 
in a format readily communicated to investors, and, where indicated, in 
a manner reasonably calculated to draw investor attention to specific 
information.\78\
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    \75\ See Adam Shell, Investors' Business Daily, Feb. 3, 2000, at 
B1 (stating that the placement of serious warnings in ``mice type'' 
is a disservice to investors); Cruz, supra note 8 (stating that fund 
advertising often prints extraordinary fund return in bold-faced 
type but then discloses risk factor language in ``the fine print at 
the bottom of the ad''); Marcy Gordon, Securities Regulators Look at 
Mutual Fund Sales Pitches, The Austin American-Statesman, Feb. 18, 
2000, at D2 (citing how the Commission has decried the ``recent 
proliferation of ads by mutual fund companies boasting of triple-
digit returns * * * [when] only the fine print in the ads explains 
why the performance was so strong''). Cf. In the Matter of LBS 
Capital Management, Inc., Investment Advisers Act Release No. 1644 
(Jul. 18, 1997) (disclosure in footnote that advertised results of 
investment adviser were ``pro forma'' was inadequate to dispel 
misleading suggestion that advertised performance represented 
results of actual trading).
    \76\ Rule 482(a)(3), (e)(1)(iii), (e)(2)(iii), (e)(3)(iii), 
(e)(4)(v), and (e)(5)(iv) [17 CFR 230.482(a)(3), (e)(1)(iii), 
(e)(2)(iii), (e)(3)(iii), (e)(4)(v), and (e)(5)(iv)].
    \77\ Rule 420(a) [17 CFR 230.420(a)].
    \78\ Rule 420(b) [17 CFR 230.420(b)]. These legibility 
requirements include paper size, type size and font, bold-face type, 
italics, and red ink.
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    The proposed amendments would require print advertisements to 
present required narrative disclosures in a size type at least as large 
as and of a style different from, but at least as prominent as, that 
used in the major portion of the advertisement.\79\ This requirement 
would apply to the required narrative disclosures about the prospectus 
and the performance data.\80\ A radio or television advertisement would 
be required to give the required narrative disclosures emphasis equal 
to that used

[[Page 36721]]

in the major portion of the advertisement.\81\ These prominence 
requirements are intended to prevent advertisements from marginalizing 
or minimizing the presentation of the required disclosure.
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    \79\ Proposed paragraph (b)(5) of rule 482. The proposed 
presentation requirements for rule 482 are the same as those 
currently required under rule 134. Rule 134(a)(iii) [17 CFR 
230.134(a)(iii)]. The proposed presentation requirements would 
replace the current rule 482 requirement that certain required 
disclosures be ``conspicuous.'' Rule 482(a)(3) [17 CFR 
230.482(a)(3)].
    In addition to complying with the presentation requirements of 
proposed paragraph (b)(5) of rule 482, electronic versions of print 
rule 482 advertisements would also continue to be subject to the 
legibility requirements of rule 420(b). [17 CFR 230.420(b)].
    \80\ Proposed paragraphs (b)(1) and (b)(3) of rule 482. The 
narrative disclosure covered by the prominence requirement would 
also include, if applicable, the ``subject to completion'' legend 
that would be required by proposed rule 482(b)(2), and, if the 
advertisement is used with a profile under rule 498 under the 
Securities Act [17 CFR 230.498], disclosure explaining that the 
profile contains information about the fund, describing the 
procedures for investing in the fund, and indicating the 
availability of the prospectus. Proposed paragraphs (b)(1)(ii) and 
(b)(2) of rule 482. In addition, the prominence requirement would 
extend to disclosures specific to money market funds. Proposed 
paragraph (b)(4) of rule 482.
    \81\ Proposed paragraph (b)(5) of rule 482.
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    In addition, we are proposing that the narrative disclosures that 
specifically relate to fund performance be presented in close proximity 
to the performance data in both print and radio and television 
advertisements.\82\ In a print advertisement, this information also 
would be required to be in the body of the advertisement and not in a 
footnote. Rule 482 currently requires that performance advertisements 
identify the dates during which quoted performance occurred.\83\ We 
propose to require this information to be adjacent to, and have no less 
prominence than, the performance quotation itself.\84\ These proximity 
requirements are intended to help investors more readily find 
information and disclosure necessary to understand and evaluate the 
performance data shown, and to remind investors of the limitations of 
performance data.
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    \82\ Proposed paragraph (b)(5) of rule 482. The disclosure 
subject to the proximity requirement would include the disclosure 
required by proposed paragraph (b)(3) of rule 482 that the 
performance data quoted represents past performance; that past 
performance does not guarantee future results; in the case of a non-
money market fund, that the investment return and principal value of 
an investment will fluctuate; that current performance may be lower 
or higher than the performance data quoted; and the toll-free 
telephone number and, if available, website where an investor may 
obtain month-end performance data.
    \83\ Rule 482(e)(1)(iv), (e)(2)(v), (e)(3)(iv), (e)(4)(vi), and 
(e)(5)(v) [17 CFR 230.482(e)(1)(iv), (e)(2)(v), (e)(3)(iv), 
(e)(4)(vi), and (e)(5)(v)].
    \84\ Proposed paragraphs (d)(1)(iv), (d)(2)(v), (d)(3)(iv), 
(d)(4)(vi), (d)(5)(v), and (e)(1)(i) of rule 482.
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    We solicit comment on the proposed presentation requirements.
    [sbull] Are the proposed presentation requirements appropriate to 
encourage important explanatory information to be given sufficient 
prominence?
    [sbull] Are there alternative methods for encouraging important 
explanatory information to be given sufficient prominence in a rule 482 
advertisement?
    [sbull] Which required disclosures should be covered by any such 
presentation requirements?
    [sbull] Should we require a font size larger than the 8-point type 
required under rule 420 for these required disclosures?
    [sbull] Are the proposed presentation requirements feasible for 
radio and television advertisements, given the inherent time 
limitations associated with the use of these media?
    [sbull] Are there specific presentation requirements that should 
apply to the use of electronic media?
    [sbull] Are there any other requirements that should apply to fund 
performance advertisements in order to help ensure that performance is 
presented in a manner that is accurate, balanced, and not misleading?

D. Reorganization of Rule 482 and Technical Form Amendments

    We also propose to reorganize rule 482 to make it easier to use. To 
do this, we have added headings to the rule and have simplified certain 
provisions, without changing their content, to make the rule easier to 
understand. In addition, we have reordered provisions within the rule 
and grouped the provisions by topic.
    We request comment on the reorganization of rule 482.
    [sbull] Would these proposed changes make the rule more 
comprehensible?
    [sbull] Are there other changes that would be helpful?
    [sbull] Would these amendments inadvertently change the meaning of 
any provisions within the rule?
    We also propose to amend Item 21 of Form N-1A, Item 25 of Form N-3, 
and Item 21 of Form N-4, and to delete Item 4(c) of Form N-3, Item 4(b) 
of Form N-4, and Item 25 of Form N-6 to reflect the proposed removal of 
the ``substance of which'' requirement in rule 482.\85\ These items 
require funds that advertise performance data to provide in their 
prospectuses or statements of additional information (``SAI'') certain 
explanatory disclosure about the methods by which the performance data 
is calculated.\86\ This information is included in the prospectus or 
SAI to satisfy the ``substance of which'' requirement in connection 
with performance advertising.\87\ The proposed removal of the 
``substance of which'' requirement renders this disclosure unnecessary. 
As a result, we are revising these items in Forms N-1A, N-3, and N-4 to 
prescribe the methods of calculation to be used if performance data is 
included in the prospectus,\88\ and to eliminate the requirements for 
information intended to satisfy the ``substance of which'' requirement. 
Form N-6, the newly adopted registration form for variable life 
insurance, will not contain any item concerning performance data 
because we have not prescribed any particular method for calculating 
variable life insurance performance.\89\
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    \85\ Form N-1A [17 CFR 239.15A; 17 CFR 274.11A] is the 
registration form for open-end management investment companies. Form 
N-3 [17 CFR 239.17a; 17 CFR 274.11b] is the registration form for 
separate accounts organized as management investment companies that 
offer variable annuity contracts. Form N-4 [17 CFR 239.17b; 17 CFR 
274.11c] is the registration form for separate accounts organized as 
unit investment trusts that offer variable annuity contracts. Form 
N-6 [17 CFR 239.17c; 17 CFR 274.11d] is the registration form for 
separate accounts that are registered as unit investment trusts and 
that offer variable life insurance policies.
    \86\ The statement of additional information contains more 
extensive and detailed information about a fund than is contained in 
the prospectus, and is required to be delivered to investors upon 
request.
    \87\ Investment Company Act Release No. 23064 (Mar. 13, 1998) 
[63 FR 13916, 13936-37 (Mar. 23, 1998)]; 1986 Advertising Proposing 
Release, supra note 24, at 34392.
    \88\ Under proposed rule 482, these methods would continue to 
apply to performance data included in advertisements, as well. See, 
e.g., proposed paragraphs (d)(1)(i), (d)(2)(i), (d)(3)(i), 
(d)(4)(i), and (e)(1)(i) of rule 482.
    \89\ Investment Company Act Release No. 25522 (Apr. 12, 2002) 
[67 FR 19848, 19856 (Apr. 23, 2002)] (discussing variable life 
insurance performance).
---------------------------------------------------------------------------

    We also note that we are proposing to delete requirements in Forms 
N-1A, N-3, and N-4 that specifically require disclosure of the method 
of calculating performance, and the length of and the last day of the 
base period used in calculating a performance quotation, and 
requirements in Form N-1A that require disclosure of the income tax 
rate used in a performance calculation.\90\ We emphasize, however, that 
if a fund chooses to include any performance information in its 
prospectus or SAI that is not required to be included by the applicable 
registration form, the fund is responsible for ensuring that the 
information is not incomplete, inaccurate, or misleading.\91\ Thus, a 
fund should include any disclosure, including the method of calculating 
performance, and the dates of the performance and tax rates used, that 
is required to meet this responsibility.
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    \90\ Item 21(a)(5) and (b)(7) of Form N-1A; Item 25(a)(iii), 
(a)(iv), (b)(i)(B), (b)(i)(C), (b)(ii)(B), (b)(ii)(C), (b)(iii)(B), 
and (b)(iii)(C) of Form N-3; Item 21(a)(iii), (a)(iv), (b)(i)(B), 
(b)(i)(C), (b)(ii)(B), (b)(ii)(C), (b)(iii)(B), and (b)(iii)(C) of 
Form N-4.
    \91\ See General Instruction C.3.(b) of Form N-1A; General 
Instruction 2 for Parts A and B of Form N-3; General Instruction 2 
for Parts A and B of Form N-4; General Instruction C.3.(b) of Form 
N-6 (allowing information that is not otherwise required to be 
included in the prospectus or SAI so long as it is not incomplete, 
inaccurate, or misleading).
---------------------------------------------------------------------------

    We request comment on the proposed amendments to Forms N-1A, N-3, 
N-4, and N-6.
    [sbull] If we eliminate the ``substance of which'' requirement from 
rule 482, are there other reasons why a fund should continue to be 
required to include information about its methods of calculating 
performance in its prospectus or SAI?
    [sbull] For example, should a fund be required to include in the 
SAI a description of the methods by which

[[Page 36722]]

any non-standardized performance is calculated?

E. Compliance Date

    If we adopt the proposed amendments, we intend that the amendment 
eliminating the ``substance of which'' requirement from rule 482 will 
take effect immediately upon the effective date of the amendments. We 
also expect to require fund advertisements used 90 days or more after 
the effective date of the amendments to comply with the amendments. The 
Commission requests comment on these proposed dates. Is 90 days an 
appropriate transition period for compliance, or should this be shorter 
or longer? Should we base compliance on the date an advertisement is 
used, or should we require compliance based on the date an 
advertisement is submitted for publication, or should we adopt some 
other alternative?

III. Request for Comments

A. Request for Comments on the Framework for Regulation of Investment 
Company Advertisements

    The amendments we propose today would enhance the basic framework 
for fund performance advertising that we have had in place for many 
years. Since 1988, we have required mutual funds that advertise 
performance to include standardized performance numbers in their 
advertisements.\92\ In that same period, the assets of the industry 
have grown from approximately $800 billion to over $7 trillion, and the 
number of available mutual funds has exploded from nearly 3,000 to over 
8,000.\93\ Also, the range of mutual funds available to investors has 
changed dramatically. Today, investors choose from a broad range of 
fund options with very different risk profiles, including, among 
others, money market funds, government bond funds, high-yield bond 
funds, domestic equity funds, and international equity funds.
---------------------------------------------------------------------------

    \92\ 1988 Advertising Adopting Release, supra note 21.
    \93\ Investment Company Institute, 2001 Mutual Fund Fact Book at 
63 (41st ed.); Investment Company Institute, Trends in Mutual Fund 
Industry: March 2002, http://www.ici.org/facts_figures/trends_0302.html (Apr. 29, 2002).
---------------------------------------------------------------------------

    Investors today face a daunting task when they attempt to sort 
through the wealth of available mutual fund options to choose an 
appropriate investment. In making those choices, investors frequently 
rely on investment performance.\94\ Given the enormous growth and 
change in the fund industry in the past twenty-five years, the 
importance of fund sales materials to investor choices among funds, and 
the tendency of investors to emphasize performance in selecting mutual 
funds, we believe it is appropriate to reexamine the framework of 
regulation for investment company advertising and to consider whether 
it should be modified to better serve investors.
---------------------------------------------------------------------------

    \94\ See supra note 37 and accompanying text.
---------------------------------------------------------------------------

    The Commission is undertaking an effort to modernize our rules and 
forms in many areas. In light of this effort, we are searching for ways 
to provide more meaningful and useful information to investors about 
mutual funds.
    We request comment generally on whether the framework for the 
regulation of mutual fund advertising could be modified, and 
specifically on the following issues.
    [sbull] Are there alternatives to the framework of regulation for 
investment company advertising that is presently in place that would 
more effectively protect investors?
    [sbull] Has the role of advertisements changed over the past 
several years? Has the role of advertisements changed when compared to 
the role of the statutory prospectus? If so, how? Should we revise our 
approach to the regulation of fund advertisements in light of those 
changes?
    [sbull] For example, would it be better simply to require that 
mutual fund advertisements adhere to general standards that would 
result in providing information that would assist the average investor 
without prescribing any regulation of the contents of advertisements, 
including standards for performance advertising?
    [sbull] To what extent should standards for fund advertising be 
established by the Commission, and to what extent should they be 
established by other organizations, e.g., NASDR? For example, should we 
require NASDR to play a larger role in establishing standards for 
advertising? Would the limits on NASDR jurisdiction (that it regulates 
only its members) pose any issues if NASDR were to assume a larger role 
in establishing the standards for fund advertising?
    [sbull] Is the standardization of performance data necessary or 
helpful to enable investors to compare different funds or prevent 
fraudulent performance claims? Does the advertisement of standardized 
performance data obscure important factors, such as costs and risk, 
that vary from fund to fund and are important to an investment 
decision?
    [sbull] Does the standardization of performance advertising 
encourage too much reliance on performance? Should our rules be 
designed to produce more qualitative information in advertisements? If 
so, how?
    [sbull] Currently, our rules include standardized performance 
calculations for investment companies, but not for investment advisers. 
Does this difference make sense and, if not, what changes should we 
make?
    [sbull] Should fund advertisements be required to include 
information about a variety of factors that are important in making an 
investment decision? If so, should the Commission prescribe the factors 
that should be covered (e.g., investment objectives, fees, risk), or 
should the Commission simply establish a more general requirement that 
advertisements present a balanced discussion of qualitative and 
quantitative information that would assist the average investor?
    [sbull] Is it helpful or necessary to prescribe the manner in which 
information should be presented in advertisements, e.g., emphasis and 
location of information or font size?
    [sbull] Should radio and television fund advertisements, or other 
forms of advertisement where the investor may not refer back to the 
advertisement, be regulated differently than print advertisements?
    [sbull] What are the costs for funds, and indirectly for investors, 
as well as other parties, associated with various alternative means of 
regulating fund advertising?
    [sbull] What liability standards should apply to fund 
advertisements?

B. General Request for Comments

    The Commission requests comment on the amendments proposed in this 
release, suggestions for additional provisions or changes to existing 
rules or forms, and comments on other matters that might have an effect 
on the proposals contained in this release.

C. Request for Comments on Rule 482(a)(5)(i) Relating to Variable 
Insurance Contracts

    We also wish to solicit comment on a provision of rule 482 relating 
to variable insurance contracts. Rule 482 generally prohibits a rule 
482 advertisement from containing or being accompanied by an 
application to purchase fund shares.\95\ In order to preserve the 
statutory prospectus as the primary disclosure document by encouraging 
investors to read the statutory prospectus before investing, a rule 482 
advertisement is required to include a legend telling investors how to 
obtain a prospectus and directing

[[Page 36723]]

them to read it before investing.\96\ The prohibition against 
applications accompanying rule 482 advertisements was included in rule 
482 because the Commission believed that permitting purchase 
applications in a rule 482 advertisement would undermine the purpose of 
the legend requirement.\97\
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    \95\ Rule 482(a)(5) [17 CFR 230.482(a)(5)].
    \96\ Rule 482(a)(3)(i) [17 CFR 230.482(a)(3)(i)]; proposed 
paragraph (b)(1)(i) of rule 482.
    \97\ 1986 Advertising Proposing Release, supra note 24, at 34391 
nn. 57-60 and accompanying text.
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    Rule 482 contains an exception from the prohibition against 
applications for unit investment trusts that offer variable annuity or 
variable life insurance contracts.\98\ These contracts permit investors 
to allocate premiums among a variety of underlying mutual funds in 
which the unit investment trust invests. The contract prospectuses 
contain descriptions of the underlying mutual funds, which are 
considered rule 482 advertisements for the underlying funds.\99\ The 
underlying funds are separately registered as management investment 
companies on Form N-1A and offer their shares through separate 
prospectuses. The exception from the prohibition on applications for 
variable insurance contracts permits an application for the contract 
(which provides for investor allocation of purchase payments to 
specific underlying funds) to accompany the contract prospectus, even 
though the contract prospectus constitutes a rule 482 advertisement for 
the underlying mutual funds and even though prospectuses for the 
underlying funds do not accompany the contract prospectus.\100\
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    \98\ Rule 482(a)(5)(i) [17 CFR 230.482(a)(5)(i)]; proposed 
paragraph (c)(1) of rule 482. A rule 482 advertisement may also be 
accompanied by an application when the advertisement is used with a 
profile permitted by rule 498 under the Securities Act. Rule 
482(a)(5)(ii) [17 CFR 230.482(a)(5)(ii)]. See proposed paragraph 
(c)(2) of rule 482.
    \99\ See Item 5(c) of Form N-4 and Item 4(c) of Form N-6 
(requiring brief description of each underlying mutual fund offered 
through the contract). See also Investment Company Act Release No. 
14575 (June 14, 1985) [50 FR 26415, 26155 n. 48 and accompanying 
text (June 25, 1985)] (describing treatment of description of 
underlying mutual funds in contract prospectus as omitting 
prospectuses).
    \100\ See 1986 Advertising Proposing Release, supra note 87, at 
34391 n. 60.
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    In recent years, members of the variable insurance industry have 
requested that the Commission staff clarify the scope of the variable 
insurance exception from the application prohibition of rule 482. By 
its terms, the exception permits a contract application to accompany a 
rule 482 advertisement for the underlying funds only when the rule 482 
advertisement is a part of the contract prospectus itself. Members of 
the industry have argued that it should be permissible for a contract 
prospectus and application to be accompanied by other rule 482 
advertisements for the underlying funds that are not a part of the 
prospectus itself.
    Advocates of this position argue that rule 482 permits either of 
the following: (i) Delivery of a rule 482 advertisement for an 
underlying fund (without an application); and (ii) delivery of a 
contract prospectus with an application. They therefore argue that, 
under rule 482, delivery of a rule 482 advertisement for an underlying 
fund (without an application) could be either preceded or followed by 
delivery of a contract prospectus with an application. As a result, 
they conclude that it should be permissible for a contract prospectus 
and application to be accompanied by other rule 482 advertisements for 
the underlying funds because whether the delivery of the additional 
rule 482 advertisements is made together with the contract material or 
separately from it is a question of form, rather than substance.
    We believe that it would be useful to clarify the ambiguities in 
the scope of the insurance exception from the application prohibition 
of rule 482, so that issuers of variable insurance products may operate 
with greater certainty. Therefore, we request comment on this issue.
    We request comment on rule 482(a)(5)(i) relating to variable 
insurance products.
    [sbull] Should rule 482 advertisements for the underlying funds 
that are not contained in the contract prospectus itself be permitted 
to be delivered simultaneously with the contract prospectus and 
accompanying purchase application?
    [sbull] Should we amend rule 482 to explicitly permit this 
practice, or should we amend rule 482 to explicitly prohibit this 
practice?
    [sbull] Particularly in light of the fact that we are proposing to 
remove the ``substance of which'' requirement from rule 482, are there 
relevant differences between permitting a contract prospectus that is 
filed with the Commission and subject to strict liability under Section 
11 of the Securities Act to be accompanied by an application and 
permitting additional rule 482 advertisements for the underlying funds 
that are not subject to Section 11 liability to be accompanied by an 
application? \101\
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    \101\ Section 11 imposes strict liability on issuers, as well as 
other persons, including directors and underwriters, for material 
misstatements and omissions contained in the registration statement. 
15 U.S.C. 77k.
---------------------------------------------------------------------------

    [sbull] Variable insurance products are one among many channels 
through which mutual funds are distributed. How would explicitly 
broadening, or confining, the scope of the insurance exception from the 
application prohibition affect other sectors of the fund industry that 
are not permitted to include fund applications with rule 482 
advertisements? What would the competitive effects be within the 
variable insurance industry and as between the variable insurance 
industry and other sectors of the fund industry?
    [sbull] Should the Commission reconsider the insurance exception 
for competitive or other reasons? Is the insurance exception consistent 
with investor protection, given the limited amount of information about 
the underlying funds that is typically contained in the contract 
prospectus? We note, for example, that the fee table of recently 
adopted Form N-6 for variable life insurance policies requires 
disclosure of the range of expenses of all underlying funds offered 
through a policy rather than the expenses of each fund and that the 
Commission has proposed conforming amendments to the fee table of Form 
N-4 for variable annuities.\102\
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    \102\ Investment Company Act Release No. 25522, supra note 89 
(adopting Form N-6); Investment Company Act Release No. 25521 (Apr. 
12, 2002) [66 FR 19885 (Apr. 23, 2002)] (proposing changes to fee 
table of Form N-4).
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IV. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits associated 
with its rules. The Commission requests comment and empirical data 
regarding the costs and benefits of the proposed amendments to the 
advertising rules.

A. Introduction

    The Commission is proposing rule amendments under the Securities 
Act and the Investment Company Act. To provide funds with the ability 
to disclose more timely information in advertisements, the proposed 
amendments would remove the ``substance of which'' requirement 
contained in rule 482 under the Securities Act, and would rescind the 
provisions in rule 134 under the Securities Act that apply to funds. In 
addition, the proposed amendments would reinforce the antifraud 
protections in the fund advertising rules, and would require enhanced 
disclosure of certain information in fund advertisements designed to 
encourage advertisements that convey balanced information to 
prospective investors. Finally, the proposed amendments would make 
certain organizational changes to rule 482 and

[[Page 36724]]

technical amendments to the registration forms.
1. Present Fund Advertising Rules
    Like most issuers of securities, when an investment company 
(``fund'') offers its shares to the public, its promotional efforts 
become subject to the advertising restrictions of the Securities Act. 
Congress imposed these restrictions so that investors would base their 
investment decisions on the full disclosures contained in the 
``statutory prospectus,'' which Congress intended to be the primary 
selling document.\103\ The advertising restrictions of the Securities 
Act cause special problems for many investment companies, particularly 
for open-end management investment companies (``mutual funds'') and 
other investment companies that continuously offer and sell their 
shares. For these funds, the advertising restrictions apply 
continuously because the offering process, in effect, is continuous. To 
address these problems, the Commission has adopted a number of special 
advertising rules for investment companies, including rule 482 and rule 
134.
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    \103\ ``Statutory prospectus'' refers to the full prospectus 
required by Section 10(a) of the Securities Act. 15 U.S.C. 77j(a).
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Rule 482
    The Commission adopted rule 482 under the authority of section 
10(b) of the Securities Act, which permits the Commission to adopt 
rules that provide for a prospectus that omits ``in part'' or 
``summarizes'' information in the statutory prospectus.\104\ Rule 482 
permits investment companies to advertise any information ``the 
substance of which'' is included in the statutory prospectus.\105\ The 
theory behind the ``substance of which'' requirement is that an 
advertisement cannot be one that ``omits'' information from the 
statutory prospectus unless all of the information in the advertisement 
is derived from information in the statutory prospectus.\106\ 
Significantly, rule 482 provides a means for mutual funds to advertise 
performance information according to standardized formulas.\107\ Rule 
482 also requires advertisements to comply with certain disclosure 
requirements, particularly when presenting performance figures.\108\
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    \104\ 15 U.S.C. 77j(b). See also 1979 Advertising Adopting 
Release, supra note 18.
    \105\ Rule 482(a)(2) under the Securities Act [17 CFR 
230.482(a)(2)].
    \106\ 1977 Advertising Proposing Release, supra note 20, at 
30380.
    \107\ See supra note 21.
    \108\ Because a rule 482 advertisement is a prospectus under 
section 10(b) of the Securities Act [15 U.S.C. 77j(b)], a rule 482 
advertisement is subject to section 12(a)(2) of the Securities Act 
[15 U.S.C. 77l(a)(2)], which imposes liability for materially false 
or misleading statements in a prospectus or oral communication, 
subject to a reasonable care defense. Rule 482 advertisements are 
also subject to the antifraud provisions of the federal securities 
laws.
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Rule 134
    In contrast to rule 482, rule 134 is a content-based rule that 
specifies certain categories of information that a fund may advertise. 
Originally, rule 134 communications, known as ``tombstone 
advertisements,'' were intended merely to announce the existence of a 
public offering and serve as a simple means for soliciting inquiries 
for the statutory prospectus.\109\ Over the years, however, the 
Commission has amended rule 134, broadening the permissible categories 
of information that a fund may include in its tombstone 
advertisements.\110\ Today, funds may advertise a broad range of 
information under rule 134, other than performance information.\111\
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    \109\ See supra note 26.
    \110\ See supra note 27.
    \111\ Because the Commission adopted rule 134 under section 
2(a)(10)(b) of the Securities Act, rule 134 advertisements are not 
considered prospectuses. As a result, rule 134 advertisements do not 
create liability under section 12(a)(2) of the Securities Act, which 
by its terms applies only to prospectuses and oral communications. 
Rule 134 advertisements, however, are subject to liability under the 
antifraud provisions of the federal securities laws.
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2. Present Burden of Fund Advertising Rules
    Based on the Commission staff's discussions with certain fund 
complexes and its experience with the various types of investment 
companies registered with the Commission, we estimate that the current 
annual hour burden associated with rule 482 and rule 134 is 
approximately 40.275 hours per investment company.\112\ For the 
industry overall, this represents 225,015 (40.275 hours per investment 
company x 5,587 investment companies) burden hours, or $9,222,465 
(225,015 hours x $40.986 wage rate) in internal costs.\113\ Another 
89,143 hours, or $3,653,615 (89,143 hours x $40.986 wage rate) in 
internal costs, are imposed by the requirement that funds comply with 
rule 34b-1 under the Investment Company Act, which requires that any 
performance data included in supplemental sales literature be 
accompanied by performance data computed using the standardized 
formulas for advertising performance under rule 482.\114\ The 
Commission estimates that external costs presently associated solely 
with the regulatory burden of complying with the advertising rules are 
negligible.\115\ The benefits and costs associated with the proposed 
amendments affect these totals as indicated in the discussion that 
follows.
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    \112\ This figure was determined based on averages derived from 
information from nine fund complexes that offer mutual funds or 
variable insurance products. Because there was little data for 
closed-end funds, the burden hours for closed-end funds were based 
on estimates from one fund complex that offers closed-end funds and 
the Commission staff that these funds would incur approximately 8% 
of the burden of open-end funds.
    \113\ These figures are based on a Commission estimate of 5587 
investment companies and an estimated hourly wage rate of $40.986. 
The estimate of the number of investment companies is based on data 
derived from the Commission's EDGAR filing system. The estimated 
wage rate figure is based on published hourly wage rates for in-
house attorneys ($38.95), paralegals ($20.94), and compliance 
inspectors ($22.60) and the estimate, based on the Commission 
staff's discussions with certain fund complexes, that attorneys 
would account for 50% of hours spent on advertising regulation and 
that paralegal and compliance inspectors would account for the 
remaining 50% in equal ratio, yielding a weighted wage rate of 
$30.36 (($38.95 x .50) + ($20.94 x .25) + (22.60 x .25) = $30.36). 
Securities Industry Association, Report on Office Salaries in the 
Securities Industry 2000 (Oct. 2000); Securities Industry 
Association, Report on Management & Professional Earnings in the 
Securities Industry 2000 (Oct. 2000). This weighted wage rate was 
then adjusted upward by 35% for overhead, reflecting the costs of 
supervision, space, and administrative support, to obtain the total 
per hour internal cost of $40.986 ($30.36 x 1.35 = $40.986).
    \114\ 17 CFR 270.34b-1. These estimates are based on the number 
of pieces of sales literature filed annually with the Commission and 
the NASD, and the estimated wage rate described above in note 113.
    In addition, Rule 156 under the Securities Act [17 CFR 230.156] 
is an interpretive regulation giving guidance as to whether sales 
literature is materially misleading. There is no cost associated 
directly with this rule.
    \115\ External costs might include, for example, costs of hiring 
outside counsel or accountants, or purchasing new equipment.
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B. Benefits

    The proposed amendments would modify rule 482 of the Securities Act 
and related rules and forms, to provide more timely, informative, and 
balanced information in fund advertising for the benefit of investors. 
The amendments would also simplify and clarify the advertising rules, 
thus reducing regulatory compliance costs, and these cost savings may 
be passed on to investors.
1. Enhanced Disclosure of Information to Investors
    Currently, the regulations concerning advertising include 
significant disclosure requirements. The proposed amendments would 
enhance the disclosure provided to investors in fund advertising in 
several respects:
    [sbull] Availability of Monthly Performance Figures. Advertisements 
would have to disclose the availability of updated monthly performance 
figures by a toll-free telephone number, and, if

[[Page 36725]]

available, a website where an investor may obtain performance data 
current to the most recent month-end.\116\ Easy access to and awareness 
of this information would benefit investors not only by providing 
potentially more accurate and timely performance data and reducing the 
ability of funds to selectively use performance data, but also by 
highlighting for investors the limitations of relying too heavily on 
any one set of performance figures.
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    \116\ Proposed paragraph (g)(2) of rule 482.
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    [sbull] Warning Legend. If an advertisement provides performance 
figures, the proposed amendments would require the inclusion of an 
amended legend stating that past performance does not guarantee future 
results, and that current performance may be lower or higher than the 
data quoted.\117\ This legend would benefit investors by making them 
more aware of the limitations of relying on performance data for 
investment decisions, and thus may result in more informed investment 
decisions.
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    \117\ Proposed paragraph (b)(3)(i) of rule 482.
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    [sbull] Availability of Charge and Expense Information. 
Advertisements would have to highlight the availability of information 
concerning charges and expenses in the statutory prospectus.\118\ This 
provision would benefit investors by providing easy access to an 
important factor that would affect their returns, which in turn would 
allow investors to more easily compare the costs of competing funds.
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    \118\ Proposed paragraph (b)(1)(i) of rule 482. This disclosure 
would also be required in an advertisement used with a profile 
pursuant to rule 498 under the Securities Act. Proposed paragraph 
(b)(1)(ii) of rule 482.
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    [sbull] Prominence Requirements. Advertisements would be required 
to present certain disclosures, including those discussed above, (i) in 
a size and type style at least as prominent as that used in the major 
portion of the advertisement, or (ii) in the case of radio or 
television advertisements, with emphasis equal to that used in the 
major portion of the advertisement.\119\ This provision would ensure 
that advertisers do not marginalize or minimize the presentation of the 
required disclosure described above. The provision also helps to ensure 
some uniformity between different advertisements, facilitating 
investors' ability to compare the products of competing funds.
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    \119\ Proposed paragraph (b)(5) of rule 482.
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    [sbull] Proximity Requirement. In addition, the required 
disclosures regarding performance data would have to be identified in 
the body of the advertisement in close proximity to the performance 
data and not in a footnote, or, with regard to television or radio 
advertisements, presented in close proximity to the performance 
data.\120\ The length of and the date of the last day in the base 
period used in computing yield quotations, average annual total 
returns, after-tax returns, and other performance measures would have 
to be adjacent to the performance data.\121\ As with other disclosure 
requirements, this provision would help investors to more easily find 
information necessary to evaluate the performance figures shown and 
would help to remind investors of the limitations of performance data.
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    \120\ Id.
    \121\ Proposed paragraphs (d)(1)(iv), (d)(2)(v), (d)(3)(iv), 
(d)(4)(vi), and (d)(5)(v) of rule 482.
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    The benefits of these enhanced disclosure requirements to investors 
may be limited by the extent to which funds currently provide this 
disclosure voluntarily. Staff discussions with members of the fund 
industry indicate that most investment companies already comply with 
many of the requirements of the proposed amendments, by, for example, 
calculating performance data on at least a monthly basis, inserting 
warnings in advertisements that past performance is no guarantee of 
future performance, and operating websites and telephone call banks.
    Nevertheless, the enhanced disclosure requirements would provide 
two benefits to investors. To the extent investment decisions are made 
based on advertising, the improved disclosure would result in investors 
making better informed investment decisions, and therefore in a more 
efficient distribution of assets by investors among different funds. 
The transparency resulting from the enhanced disclosure in fund 
advertising may, in turn, also contribute to increased competition 
among funds and result in a more efficient allocation of resources 
among competing investment products. Although it is not possible to 
quantify the beneficial effects of more efficient allocation of 
investors' assets and increased competition, they may be significant, 
given the size of the mutual fund industry.\122\ We request comment on 
the nature and magnitude of the benefits to investors resulting from 
enhanced disclosure of information that would be required by the 
proposed amendments.
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    \122\ See Investment Company Institute, Trends in Mutual Fund 
Investing: March 2002, supra note 93 (assets of mutual funds total 
$7.1 trillion).
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2. Simplification and Clarification of Fund Advertising Rules
    The proposed amendments would add clarifying language to rule 482 
and rule 156 under the Securities Act and rule 34b-1 under the 
Investment Company Act to reemphasize the separate applicability of the 
antifraud provisions of the federal securities laws. In addition, the 
proposed amendments would reorganize and modify rule 482 to make it 
easier for funds to apply, by adding headings, reordering provisions, 
and clarifying certain language.
    The proposed amendments to rule 482 may aid funds and others in 
understanding and complying with the advertising rules, making it 
easier and cheaper for funds to advertise. This may, in turn, 
contribute to an increased flow of useful investment information to 
investors, which may lead to better-informed investment decisions and 
amplify the previously discussed benefits of efficient asset 
allocation.\123\ Although difficult to quantify, this easing of 
regulation may provide some reduction of burden to the funds that 
choose to advertise. We request comment on the nature and magnitude of 
the benefits resulting from this reduction of regulatory burden.
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    \123\ The trade-off between lower advertising burdens and 
increased advertising activity is complex and further complicated by 
business cycles and marketing strategy among other factors. We 
believe, however, that investors and funds would enjoy benefits in 
any event--either resources would be saved in reducing the costs and 
burdens of advertising or they would be spent to increase the amount 
and timeliness of information provided to investors in advertising.
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3. Elimination of the ``Substance of Which'' Requirement and the 
Rescission of Rule 134 Provisions That Apply to Funds
    To simplify the current structure of fund advertising rules and to 
provide funds the ability to disclose more timely information in 
advertisements, the proposed amendments would also remove the 
``substance of which'' limitation contained in rule 482, allowing funds 
to include in their 482 advertisements material that is not included in 
the statutory prospectus. These amendments would render the current 
distinction between rule 482 and rule 134 advertisements unnecessary. 
As such, the proposed amendments would also rescind the provisions of 
rule 134 that apply to funds.
    The elimination of the ``substance of which'' requirement would 
enable funds to avoid the need to include or update advertising related 
information in their prospectus or SAI, both in the initial 
registration statements and in post-effective amendments, before 
issuing an advertisement to the public. This would reduce filing costs 
for funds, including both internal costs and external costs such as 
outside legal fees.

[[Page 36726]]

The proposed amendments would also reduce the cost to the funds of 
printing and distributing prospectuses and SAIs. The elimination of 
unnecessary material from the prospectus or SAI may also help investors 
and others more easily understand the remaining information.
    Finally, the proposed rescission of the rule 134 provisions that 
apply to funds would consolidate the regulation of most fund 
advertising in one rule as rule 482, as amended, would then cover 
advertisements now covered by rule 134. This simplification would 
contribute to the benefits of easier and cheaper advertising as 
discussed in section IV.B.2 (``Simplification and Clarification of 
Advertising Rules'') above, principally by removing the unnecessary 
restrictions on the content of the advertisements and the unnecessary 
distinction with regard to their legal classification. The transfer of 
fund advertising regulation from rule 134 to rule 482 may also enhance 
investor protection by subjecting all fund advertisements to potential 
civil liability under section 12(a)(2) of the Securities Act.\124\ The 
Commission requests comment on the increase in potential liability 
under section 12(a)(2) for issuers that currently rely on rule 134 for 
their advertising.
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    \124\ The benefits of potential direct investor suits in both 
remedying fraudulent advertising by funds and deterring such 
advertising in the future are difficult to quantify, but may be 
significant. The benefits would be reduced to the extent that the 
potential liability would increase litigation and insurance costs 
for funds. However, because suits based on misleading advertising 
are relatively rare, we estimate that this cost would be minimal.
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    The Commission estimates that, on an annual basis, these benefits 
will save funds approximately 1.96 burden hours, or $80.33, per 
investment company in internal costs but only negligible amounts in 
external costs. We estimate that 5587 investment companies will be 
affected by the proposed amendments, and, thus, the Commission 
estimates that the annual internal burden associated with rule 482, for 
purposes of the Paperwork Reduction Act, will decrease by approximately 
10,950 (1.96 hours per investment company x 5,587 investment companies) 
burden hours.\125\ These burden hours represent a monetary savings of 
approximately $448,797 (10,950 hours x $40.986 wage rate) per 
year.\126\ We request comment on this estimate and on the nature and 
magnitude of any other benefits that would result from the proposed 
amendments.
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    \125\ The estimate of the number of investment companies is 
based on data derived from the Commission's EDGAR filing system. The 
estimate of the decrease in burden hours is based on information 
gathered from the fund industry by the Commission staff and from the 
staff's experience with the various advertising regulations.
    \126\ See discussion in note 113, supra, regarding wage rate.
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C. Costs

    The Commission estimates that the costs of the proposed amendments, 
in the aggregate, would be minimal and limited in duration. The 
Commission estimates that funds would incur one-time costs in modifying 
their current rule 482 advertising to meet the new disclosure and 
presentation requirements, although many funds already provide the 
disclosure that would be required and make available more current 
performance information voluntarily. For example, funds may have to 
modify their layouts and typesetting in order to convert existing 
advertisements to meet the requirements of the rule, or alternatively, 
replace existing advertisements more quickly than they otherwise would. 
However, the proposed amendments would allow a 90-day transition 
period, enabling funds to come into compliance with the new 
requirements in their next generation of quarterly advertisements with 
smaller conversion or replacement costs.
    In addition, the requirement for funds to provide access to 
performance figures that are current as of the last month end may also 
impose costs, some of which would be ongoing, both to generate such 
figures on a monthly basis and to provide the information by a toll-
free telephone number. This could include costs for computer time, 
accounting personnel, information technology staff, and additional 
computer and telephone equipment. However, many, if not most, funds 
already provide this or more current performance information through 
these means and, therefore, the marginal cost for most funds for making 
updated performance information available is expected to be negligible.
    The elimination of the ``substance of which'' requirement and the 
rescission of rule 134 as applicable to funds may require some funds to 
incur costs to convert many of their tombstone advertisements to rule 
482 advertisements. These costs, however, should be minimal and non-
recurring, since the rule 482 requirements would permit advertisements 
that are not significantly different from those currently permitted 
under current rule 134.
    The Commission estimates the one-time switchover costs for each 
investment company attributable to the proposed amendments would be 
approximately 2.18 hours, or $89.35 (2.18 hours x $40.986 wage rate), 
in internal costs, and $2,417 in external costs.\127\ In total this 
represents a one-time cost of approximately 12,180 internal burden 
hours (translating into approximately $499,209 (12,180 hours x $40.986 
wage rate) in internal costs) and $13,503,779 ($2,417 cost per 
investment company x 5,587 investment companies) in external 
costs.\128\ We request comment on this estimate, and on the nature and 
magnitude of any other costs to funds resulting from the proposed 
amendments.
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    \127\ These figures are based on averages derived from 
information gathered from several members of the fund industry by 
the Commission staff and from the staff's experience with the 
various advertising rules. Internal costs would include, for 
example, the cost of reviewing all fund advertisements for 
compliance with the revised rules. External costs would include, for 
example, the costs of typesetting and printing for new fund 
advertisements.
    \128\ See discussion in note 113, supra, regarding wage rate.
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D. Conclusion

    The Commission expects that the proposed advertising rule 
amendments will encourage more informed and efficient investing, while 
easing the regulatory burden on fund advertising, and that these likely 
benefits would justify the associated costs. To assist in the 
evaluation of the costs and benefits that may result from the proposed 
amendments, the Commission requests that commenters provide views and 
data relating to any anticipated costs and benefits associated with 
these proposals.

V. Consideration of Effects on Efficiency, Competition, and Capital 
Formation

    Section 2(c) of the Investment Company Act, section 2(b) of the 
Securities Act, and Section 3(f) of the Securities Exchange Act of 1934 
(``Exchange Act'') require the Commission, when engaging in rulemaking 
that requires it to consider or determine whether an action is 
necessary or appropriate in the public interest, to consider, in 
addition to the protection of investors, whether the action will 
promote efficiency, competition, and capital formation.\129\
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    \129\ 15 U.S.C. 77b(b), 78c(f), and 80a-2(c).
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    The proposed amendments seek to improve fund advertising by 
enhancing disclosure requirements and by simplifying and clarifying the 
rules, including elimination of the ``substance of which'' requirement. 
These changes may improve efficiency. The rule simplifications may 
lower the regulatory burden on funds engaged in advertising, freeing 
resources for more productive uses. For example, funds would no longer 
have to update their prospectuses or SAIs in order to change the types 
of performance information in

[[Page 36727]]

advertisements. The enhanced disclosure requirements may provide 
greater and timelier access by investors to updated performance 
figures, which would promote more efficient allocation of investments 
by investors and more efficient allocation of assets among competing 
funds. The proposed amendments may also improve competition, as 
enhanced disclosure may prompt funds to seek to provide better-informed 
investors with improved products and services. Finally, the effects of 
the proposed amendments on capital formation are unclear. Although, as 
noted above, we believe that the proposed amendments would benefit 
investors, the magnitude of the effect of the proposed amendments on 
efficiency, competition, and capital formation is difficult to 
quantify, particularly given that most funds may already comply with at 
least some of the new disclosure requirements.
    We request comment on whether the proposed amendments, if adopted, 
would promote efficiency, competition, and capital formation. 
Commenters are requested to provide empirical data and other factual 
support for their views if possible.

VI. Paperwork Reduction Act

A. Introduction

    Certain provisions of the proposed amendments contain ``collection 
of information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 [44 U.S.C. 3501, et seq.], and the Commission is 
submitting the proposed collections of information to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The titles for the existing collections of 
information are: (i) ``Form N-1A under the Investment Company Act of 
1940 and Securities Act of 1933, Registration Statement of Open-End 
Management Investment Companies''; (ii) ``Form N-2--Registration 
Statement of Separate Accounts Organized as Management Investment 
Companies'' \130\ (iii) ``Form N-3--Registration Statement of Separate 
Accounts Organized as Management Investment Companies''; (iv) ``Form N-
4--Registration Statement of Separate Accounts Organized as Unit 
Investment Trusts''; (v) ``Form N-6 Under the Investment Company Act 
and the Securities Act of 1933, Registration Statement of Insurance 
Company Separate Accounts Registered as Unit Investment Trusts that 
Offer Variable Life Insurance Policies''; and (vi) ``Rule 34b-1 of the 
Investment Company Act of 1940, Sales Literature Deemed to Be 
Misleading.'' A new collection of information is being created entitled 
``Rule 482 under the Securities Act of 1933, Advertising by an 
Investment Company.''\131\ An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid OMB control number.
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    \130\ Although the proposed amendments would not amend Form N-2, 
that form is included in this Paperwork Reduction Act summary 
because the PRA burden for rule 482 has previously been included in 
the various investment company registration statement forms affected 
by rule 482, including Form N-2. As discussed below, the Commission 
is transferring the PRA burden associated with rule 482 from all of 
these registration statement forms to a new rule 482 category.
    \131\ The proposed amendments would modify rule 482, which is 
part of Regulation C under the Securities Act of 1933. Regulation C 
describes the disclosure that must appear in registration statements 
under the Securities Act and Investment Company Act. The Paperwork 
Reduction Act (``PRA'') burden associated with rule 482 has 
previously been included in the various investment company 
registration statement forms, not in Regulation C. However, because 
the proposed amendments would eliminate the rationale for allocating 
the PRA burden for rule 482 to the registration forms, the 
Commission proposes to transfer the burden associated with rule 482 
to a new category. While this transfer and the fluctuation in the 
numbers of filings would affect the burden hours for the various 
forms, the proposed amendments to the forms would not have any 
effect on the burden hours for the forms.
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    Form N-1A (OMB Control No. 3235-0307), Form N-2 (OMB Control No. 
3235-0026), Form N-3 (OMB Control No. 3235-0316), Form N-4 (OMB Control 
No. 3235-0318), and Form N-6 (OMB Control No. 3235-0503) were adopted 
pursuant to section 5 of the Securities Act [15 U.S.C. 77e] and section 
8(a) of the Investment Company Act [15 U.S.C. 80a-8(a)]. Rule 482 of 
Regulation C was adopted pursuant to section 10(b) of the Securities 
Act [15 U.S.C. 77j(b)]. Rule 34b-1 (OMB Control No. 3235-0346) was 
adopted pursuant to section 34(b) of the Investment Company Act [15 
U.S.C. 80a-33(b)].
    The proposed amendments would modify rule 482 of the Securities Act 
and related rules and forms, to provide more timely, understandable, 
and balanced information in fund advertising for the benefit of 
investors, while simplifying and clarifying the advertising rules for 
the benefit of funds.\132\ First, the proposed amendments would enhance 
the disclosure that funds would be required to provide in 
advertisements, including by highlighting the availability of 
information concerning charges and expenses and requiring an amended 
legend warning that past performance does not guarantee future results. 
The proposed amendments would also set forth requirements ensuring that 
funds present these and other required disclosures at least as 
prominently as the material included in the body of the advertisement. 
Second, if a fund advertisement includes performance data, the fund 
would have to make available to investors month-end performance figures 
by a toll-free telephone number, and disclosed the availability of 
month-end performance data in the advertisement. Third, the proposed 
amendments would add clarifying language to rule 482 under the 
Securities Act and rule 34b-1 under the Investment Company Act to 
reemphasize the separate applicability of the antifraud provisions of 
the federal securities laws, and would amend rule 156 under the 
Securities Act to provide further guidance regarding the factors to be 
weighed in determining whether a statement involving a material fact in 
investment company sales literature is or might be misleading. Fourth, 
to allow funds the ability to disclose more timely information in 
advertisements, the proposed amendments would remove the ``substance of 
which'' limitation contained in rule 482 and would rescind the 
provisions in rule 134 under the Securities Act that apply to funds. 
Fifth, the proposed amendments would clarify portions of rule 482 
(without changing their content) by adding headings, reordering 
provisions, and simplifying certain provisions. Finally, the amendments 
would make technical and conforming changes to Forms N-1A, N-3, N-4, 
and N-6 to reflect all the rule changes listed above.
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    \132\ The Commission is proposing amendments to rules 134, 156, 
and 482 under the Securities Act, rule 34b-1 under the Investment 
Company Act, and Forms N-1A, N-3, N-4, and N-6 under the Investment 
Company Act and Securities Act.
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    The analysis in this PRA summary is divided in two sections. 
Section VI.B. (``The Registration Forms Burden'') discusses the current 
PRA burden attributable to the fund advertising rules, which is 
presently allocated to the collections of information for the various 
registration forms, and the transfer of this burden to a new collection 
of information category for rule 482. Section VI.C. (``Change in Burden 
Attributable to Proposed Amendments'') discusses the net change in 
burden hours attributable to the proposed amendments for both the new 
collection of information for rule 482 and the existing collection of 
information for rule 34b-1.

B. The Registration Forms Burden

    Presently, the PRA burdens imposed by rule 482 are accounted for 
under the various registration forms used by

[[Page 36728]]

investment companies affected by the rule: Form N-1A, Form N-2, Form N-
3, Form N-4, and Form N-6. We intend to remove these burden hours 
associated with rule 482 and place them in a separate rule 482 category 
in the following amounts:

------------------------------------------------------------------------
                                                               Hours
                          Form                              transferred
------------------------------------------------------------------------
Form N-1A...............................................         177,514
Form N-2................................................           1,014
Form N-3................................................             792
Form N-4................................................          36,630
Form N-6................................................           9,065
                                                         ---------------
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The information required to be filed with the Commission pursuant to 
the information collections contained in the registration forms permits 
the verification of compliance with securities law requirements and 
assures the public availability and dissemination of the information.
1. Form N-1A
    The purpose of Form N-1A is to meet the registration and disclosure 
requirements of the Securities Act and the Investment Company Act and 
to enable funds to provide investors with information necessary to 
evaluate an investment in the fund. The respondents to this information 
collection are open-end funds registering with the Commission. 
Compliance with the disclosure requirements on Form N-1A is mandatory. 
Responses to the disclosure requirements are not confidential.
    The current hour burden for preparing an initial Form N-1A filing 
is 824 burden hours per portfolio, and the Commission attributes 23 of 
these burden hours per portfolio to compliance with rule 482, reducing 
the remaining burden hours per portfolio to 801.\133\ The current 
annual hour burden for preparing post-effective amendments on Form N-1A 
is 122 hours per portfolio, and the Commission attributes 23 of these 
burden hours per portfolio to rule 482, reducing the remaining burden 
hours per portfolio to 99. The Commission estimates that, on an annual 
basis, 193 portfolios file initial registration statements on Form N-1A 
and 7,525 file post-effective amendments on Form N-1A. Thus, the burden 
hours attributable to rule 482 to be transferred from Form N-1A to the 
new rule 482 collection of information equal 177,514 ((23 hours x 193 
portfolios) + (23 hours x 7,525 portfolios)). After shifting the rule 
482 burden hours to a new collection of information, the total burden 
hours that remain allocated to Form N-1A for all purposes unassociated 
with rule 482 would be 899,568 ((801 hours x 193 portfolios) + (99 
hours x 7,525 portfolios)).
---------------------------------------------------------------------------

    \133\ The estimate of the burden hours attributable to 
compliance with rule 482 for filings on Forms N-1A and Form N-2 are 
based on information supplied to the Commission staff by members of 
the fund industry and the staff's experience with these registration 
forms.
---------------------------------------------------------------------------

    Except for the transfer of PRA burden from the Form N-1A to the new 
collection of information for rule 482, the Commission estimates no 
effect on the remaining PRA burden for Form N-1A from the proposed 
amendments. The change in PRA burden resulting from the purposed 
amendments is accounted for under the new rule 482 collection of 
information.
2. Form N-2
    The purpose of Form N-2 is to meet the registration and disclose 
requirements of the Securities Act and the Investment Company Act and 
to enable funds to provide investors with information necessary to 
evaluate an investment in the fund. The respondents to this information 
collection are closed-end funds registering with the Commission. 
Compliance with the disclosure requirements of Form N-2 is mandatory. 
Responses to the disclosure requirements are not confidential.
    The current hour burden for preparing an initial registration 
statement on Form N-2 is 542.4 burden hours per filing, and the current 
hour burden for preparing a post-effective amendment on Form N-2 is 
107.4 hours per filing. The Commission attributes 5.7 of these burden 
hours per filing to compliance with rule 482, reducing the burden hours 
per filing to 536.7 and 101.7, respectively. The Commission currently 
estimates that, on an annual basis, 140 respondents file an initial 
registration statement on Form N-2 and 38 file post-effective 
amendments on Form N-2. Thus, the burden hours attributable to rule 482 
to be transferred from N-2 to the new rule 482 collection of 
information equal 1,014 ((5.7 hours x 140 filings) + (5.7 hours x 38 
filings)). After shifting the rule 482 burden hours to a new collection 
of information, the total burden hours that remain allocated to Form N-
2 for all purposes unassociated with rule 482 would be 79,003 ((536.7 
hours x 140 filings) + (101.7 hours x 38 filings)).
    Except for the transfer of PRA burden from Form N-2 to the new 
collection of information for rule 482, the Commission estimates no 
effect on the remaining Form N-2 PRA burden from the proposed 
amendments. The change in PRA burden resulting from the proposed 
amendments is accounted for under the new rule 482 collection of 
information.
3. Form N-3
    The purpose of Form N-3 is to meet the registration and disclosure 
requirements of the Securities Act and the Investment Company Act and 
to enable funds to provide investors with information necessary to 
evaluate an investment in the fund. The respondents to this information 
collection are separate accounts, organized as management investment 
companies and offering variable annuities, registering with the 
Commission. Compliance with the disclosure requirements of Form N-3 is 
mandatory. Responses to the disclosure requirements are not 
confidential.
    The current annual hour burden for preparing an initial 
registration statement on Form N-3 is 910.5 hours per portfolio, and 
the Commission attributes 3.3 of these burden hours per portfolio to 
compliance with rule 482, reducing the remaining burden hours per 
portfolio to 907.2.\134\ The current annual hour burden for preparing 
post-effective amendments on Form N-3 is 151.7 hours per portfolio, and 
the Commission attributes 3.3 of these burden hours per portfolio to 
rule 482, reducing the remaining burden hours per portfolio to 148.4. 
The Commission estimates that, on an annual basis, no initial 
registration statements will be filed on Form N-3 and 60 post-effective 
amendments, including 240 portfolios, will be filed on Form N-3. Thus, 
the burden hours attributable to rule 482 to be transferred from Form 
N-3 to the new rule 482 collection of information equal 792 (3.3 hours 
x 240 portfolios). After shifting the rule 482 burden hours to a new 
collection of information, the total burden hours that remain allocated 
to Form N-3 for all purposes unassociated with rule 482 would be 35,616 
(148.4 x 240 portfolios).
---------------------------------------------------------------------------

    \134\ Estimates of the burden hours attributable to rule 482 for 
Forms N-3, N-4, and N-6 were derived by estimating the total burden 
hours for compliance with rule 482 for all variable insurance 
separate accounts, based on the staff's discussions with a member of 
the variable insurance products industry that issues both variable 
annuities and variable life insurance policies. This estimate of the 
total rule 482 burden hours for variable insurance products filings 
was allocated among Form N-3, Form N-4 and Form N-6 filings based on 
the ratio of burden hours previously allocated to each of these 
forms for PRA purposes. However, we excluded burden hours 
attributable to initial filings on Form N-3 because we currently 
anticipate no such filings.
---------------------------------------------------------------------------

    Except for the transfer of PRA burden from Form N-3 to the new 
collection of

[[Page 36729]]

information for rule 482, the Commission estimates no effect on the 
remaining PRA burden for Form N-3 resulting from the proposed 
amendments. The change in PRA burden resulting from the proposed 
amendments is accounted for under the new rule 482 PRA collection of 
information.
4. Form N-4
    The purpose of Form N-4 is to meet the registration and disclosure 
requirements of the Securities Act and the Investment Company Act and 
to enable separate accounts issuing variable annuity contracts to 
provide investors with information necessary to evaluate an investment 
in a contract. The respondents to this information collection are 
separate accounts, organized as unit investment trusts and offering 
variable annuities, registering with the Commission. Compliance with 
the disclosure requirements of Form N-4 is mandatory. Responses to the 
disclosure requirements are not confidential.
    The current hour burden for preparing an initial Form N-4 filing is 
298 burden hours per filing, and the Commission attributes 24.8 of 
these burden hours per filing to rule 482, reducing the remaining 
burden hours per filing to 273.2.\135\ The current annual hour burden 
for preparing post-effective amendments on Form N-4 is 219.8 hours per 
filing, and the Commission attributes 24.8 of these burden hours per 
filing to rule 482, reducing the remaining burden hours per filing to 
195. The Commission estimates that, on an annual basis, 157 respondents 
file initial registration statements on Form N-4 and 1320 respondents 
file post-effective amendments on Form N-4. Thus, the burden hours 
attributable to rule 482 to be transferred from Form N-4 to the new 
rule 482 collection of information equal 36,630 ((24.8 hours x 157 
filings) + (24.8 hours x 1320 filings)). After shifting the rule 482 
burden hours to a new collection of information, the total hour burden 
that remains allocated to Form N-4 for all purposes unassociated with 
rule 482 would be 300,292 ((273.2 hours x 157 filings) + (195 hours x 
1320 filings)).
---------------------------------------------------------------------------

    \135\ See discussion in note 134, supra.
---------------------------------------------------------------------------

    Except for the transfer of PRA burden from Form N-4 to the new 
collection of information for rule 482, the Commission estimates no 
effect on the remaining PRA burden for Form N-4 resulting from the 
proposed amendments. The change in PRA burden resulting from the 
proposed amendments is accounted for under the new rule 482 PRA 
collection of information.
5. Form N-6
    The purpose of Form N-6 is to meet the registration and disclosure 
requirements of the Securities Act and the Investment Company Act and 
to enable separate accounts issuing variable life insurance policies to 
provide investors with information necessary to evaluate an investment 
in a policy. The respondents to this information collection are 
separate accounts, organized as unit investment trusts and offering 
variable life insurance policies, registering with the Commission. 
Compliance with the disclosure requirements of Form N-6 is mandatory. 
Responses to the disclosure requirements are not confidential.
    The current hour burden for preparing an initial registration 
statement on Form N-6 is 800 burden hours per filing and the hour 
burden for a post-effective amendment on Form N-6 is 100 hours per 
post-effective amendment filed as an annual update, and 10 hours per 
post-effective amendment filed for other purposes. The Commission 
attributes 35 of these burden hours per filing to compliance with rule 
482 for both initial registration statements and post-effective 
amendments that are annual updates.\136\ The Commission estimates no 
burden hours associated with rule 482 for additional post-effective 
amendments that are not annual updates. The Commission estimates that, 
on an annual basis, 59 initial registration statements will be filed on 
Form N-6 and 500 post-effective amendments will be filed on Form N-6, 
200 as annual updates and 300 as additional post-effective 
amendments.\137\ Thus, the burden hours attributable to rule 482 to be 
transferred from Form N-6 to the new rule 482 collection of information 
equal 9,065 ((35 hours x 59 filings) + (35 hours x 200 filings)). The 
total hour burden that remains allocated to Form N-6 for all purposes 
unassociated with rule 482 would be 61,135 ((765 hours x 59 filings) + 
(65 hours x 200 filings) + (10 hours x 300 filings)).
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    \136\ See discussion in note 134, supra.
    \137\ Based on its analysis of data from the EDGAR filing system 
from 2000-2001, the Commission estimates that there are 
approximately 200 variable life insurace policies, with respect to 
which as least one post-effective amendment must be filed per year. 
In addition, the Commission estimates, also based on EDGAR filing 
data, that 300 additional post-effective amendments are filed for 
these variable life insurance policies each year, generally to make 
no-material changes to their registration statements.
---------------------------------------------------------------------------

    Except for the transfer of PRA burden from Form N-6 to the new 
collection of information for rule 482, the Commission estimates no 
effect on the remaining PRA burden for Form N-6 resulting from the 
proposed amendments. The change in PRA burden resulting from the 
proposed amendments is accounted for under the new rule 482 PRA 
collection of information.

C. Change in Burden Attributable to Proposed Amendments

    The information required by the proposed amendments to the 
advertising rules is primarily for the use and benefit of investors. 
The Commission is concerned that investors receive information in 
advertisements that is accurate, balanced, timely, not misleading, and 
otherwise appropriate and helpful in making investment decisions. The 
additional information that would be required to be disclosed to 
investors pursuant to the collection of information provisions of the 
rules affected by the proposed amendments, would address these concerns 
regarding investor protection.
1. Rule 34b-1
    Rule 34b-1, including the proposed amendments, contains collection 
of information requirements. The rule applies to supplemental sales 
literature, i.e., sales literature that is preceded or accompanied by 
the statutory prospectus and requires the inclusion of standardized 
performance data in sales literature that includes performance data. 
Compliance with rule 34b-1 is mandatory for every registered investment 
company that issues supplemental sales literature. Responses to the 
disclosure requirements will not be kept confidential.
    We estimate that approximately 37,000 responses are filed annually 
pursuant to rule 34b-1, and the burden per response is 2.9 hours. The 
proposed amendments would change rule 34b-1 only to add language to 
clarify the Commission's present interpretation of its rules, namely, 
that compliance with rule 34b-1 does not relieve the fund, underwriter, 
or dealer of the obligation to ensure that sales literature is not 
false or misleading. This added language merely confirms the present 
state of the law and imposes no additional burden hours.\138\
---------------------------------------------------------------------------

    \138\ The secondary effect on the burden attributable to rule 
34b-1 due to the proposed amendments to rule 482 is estimated to be 
negligible. Both before and after the proposed amendments, rule 34b-
1 would require any performance data included in supplemental sales 
literature to be accompanied by performance data computed using the 
standardized formulas for advertising performance under rule 482. We 
estimate that the changes in types of disclosure and presentation 
that would be required by the amendments to rule 482 would not 
affect the amount of review necessary for funds to ensure compliance 
with rule 34b-1. Therefore, all changes in burden associated with 
the proposed amendments are accounted for under the category 
associated with the principal rule generating the burden, i.e., the 
new rule 482 collection of information.

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[[Page 36730]]

2. Rule 482
    Rule 482, including the proposed amendments, contains collection of 
information requirements in that it permits a fund to advertise 
information subject to certain disclosure requirements. Compliance with 
rule 482 is mandatory for every fund that issues rule 482 
advertisements. Responses to the disclosure requirements will not be 
kept confidential.
    The Commission estimates that 41,484 responses are filed annually 
by 5,587 funds pursuant to rule 482. The burden associated with rule 
482 is presently included in the collections of information for the 
investment company registration statement forms, but the Commission is 
transferring this PRA burden to a new rule 482 collection of 
information, with an annual burden of 225,015 hours. The proposed 
amendments to rule 482 would affect this total. The Commission 
estimates an increase of 4,060 annual burden hours, or 0.727 hours per 
fund, would be required to comply with the proposed amendments to rule 
482, as a result of one-time switchover costs amortized over a three-
year period. The Commission also estimates a decrease of 10,950 annual 
burden hours, or 1.96 hours per fund, resulting from the proposed 
amendments due to the simplification and clarification of rule 482, 
including the removal of the ``substance of which'' requirement.\139\ 
The net result would be an annual decrease of approximately 6,890 
(4,060 hours increase--10,950 hours decrease) hours.
---------------------------------------------------------------------------

    \139\ The estimates of the changes in the hours attributable to 
rule 482 are based on information supplied to the Commission staff 
by members of the mutual fund and variable insurance products 
industry.
---------------------------------------------------------------------------

D. Request for Comments

    We request your comments on the accuracy of our estimates. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) 
Evaluate whether the proposed collection of information is necessary 
for the proper performance of the functions of the agency, including 
whether the information will have practical utility; (ii) evaluate the 
accuracy of the Commission's estimate of burden of the proposed 
collections of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) evaluate whether there are ways to minimize the 
burden of the collection of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Room 3208, 
New Executive Office Building, Washington, DC 20503, and should send a 
copy to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 5th Street, NW, Washington, DC 20549-0609, with 
reference to File No. S7-17-02. Request for materials submitted to OMB 
by the Commission with regard to this collection of information should 
be in writing, refer to File No. S7-17-02, and be submitted to the 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549, Attention: Records Management, Office of Filings and 
Information Services. OMB is required to make a decision concerning the 
collection of information between 30 and 60 days after publication of 
this release. Consequently, a comment to OMB is best assured of having 
its full effect if OMB receives it within 30 days after publication of 
this Release.

VII. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis (``Analysis'') has 
been prepared in accordance with 5 U.S.C. 603, and relates to the 
Commission's proposed rule and form amendments under the Securities Act 
of 1933 and the Investment Company Act of 1940 to provide investment 
companies with the ability to disclose more timely information in 
advertisements and to reinforce the antifraud protections that apply to 
investment company advertisements. The proposed amendments would 
implement a provision of NSMIA by eliminating the requirement in rule 
482 under the Securities Act that investment company advertisements 
contain only information the ``substance of which'' is included in the 
statutory prospectus. The proposed amendments also would require 
enhanced disclosure in investment company advertisements and are 
designed to encourage advertisements that convey balanced information 
to prospective investors, particularly with respect to past 
performance. In light of the proposed amendments to rule 482, the 
Commission is also proposing to rescind the provisions in rule 134 
under the Securities Act that apply to investment companies.

A. Reasons for, and Objectives of, Proposed Amendments

    The Commission has proposed the amendments to the advertising 
regulations described above to achieve two separate objectives. First, 
the Commission intends to simplify and clarify the rules governing fund 
advertising. Specifically, the proposed amendments would remove the 
``substance of which'' requirement of rule 482 and rescind the 
provisions of rule 134 that apply to investment companies, following 
Congress' directive in NSMIA to adopt rules or regulations allowing 
funds the use of a section 10(b) prospectus that may include 
information the substance of which is not included in the statutory 
prospectus.\140\ We are also proposing technical amendments to 
reorganize and clarify the language of rule 482. These simplifying and 
clarifying amendments are intended to aid funds and others in 
understanding and complying with the advertising rules, making it 
easier and cheaper for funds to advertise.
---------------------------------------------------------------------------

    \140\ National Securities Markets Improvement Act, supra note 7.
---------------------------------------------------------------------------

    Second, the Commission intends to enhance the disclosure required 
in rule 482 advertising. Specifically, we propose to require 
advertisements to (i) highlight the availability of certain additional 
information, such as charge and expense information and updated monthly 
performance figures; (ii) provide an amended warning legend; and (iii) 
present certain required disclosure with equal prominence as the major 
portion of the advertisement. We are proposing these amendments because 
of our concern about fund performance advertising that could create 
unrealistic investor expectations or mislead potential investors. The 
enhanced disclosure requirements are intended to encourage 
advertisements that are clear, easy to use, and balanced, and to make 
investors aware of important and timely information necessary to make 
informed investment decisions.

B. Legal Basis

    We are proposing amendments to rule 134 pursuant to authority set 
forth in sections 2(a)(10) and 19(a) of the Securities Act. We are 
proposing amendments to rule 156 pursuant to authority set forth in 
section 19(a) of the

[[Page 36731]]

Securities Act and sections 10(b) and 23(a) of the Exchange Act. We are 
proposing amendments to rule 482 pursuant to authority set forth in 
sections 5, 10(b), 19(a), and 28 of the Securities Act and sections 
24(g) and 38(a) of the Investment Company Act. We are proposing 
amendments to rule 34b-1 pursuant to authority set forth in sections 
34(b) and 38(a) of the Investment Company Act. We are proposing 
amendments to Form N-1A, Form N-3, Form N-4, and Form N-6 pursuant to 
authority set forth in sections 5, 6, 7, 10, and 19(a) of the 
Securities Act and sections 8, 24(a), 30, and 38 of the Investment 
Company Act.

C. Small Entities Subject to the Rule

    For purposes of the Regulatory Flexibility Act, an investment 
company is a small entity if it, together with other investment 
companies in the same group of related investment companies, has net 
assets of $50 million or less as of the end of its most recent fiscal 
year.\141\ Approximately 225 out of 5587 investment companies meet this 
definition.\142\
---------------------------------------------------------------------------

    \141\ 17 CFR 270.0-10.
    \142\ This estimate is based on figures compiled by the 
Commission staff regarding investment companies registered on Form 
N-1A, Form N-2, Form N-3, Form N-4, and Form S-6. Form S-6 is the 
form currently used by insurance company separate accounts 
registered as unit investment trusts and that offer variable life 
insurance policies to register their securities under the Securities 
Act. It will be replaced by new Form N-6. See Investment Company Act 
Release No. 25522, supra note 89. In determining whether an 
insurance company separate account is a small entity for purposes of 
the Regulatory Flexibility Act, the assets of insurance company 
separate accounts are aggregated with the assets of their sponsoring 
insurance companies. Investment Company Act rule 0-10(b) [17 CFR 
270.0-10(b)]. Currently, no insurance company separate account 
filing on Form N-3, Form N-4, or Form S-6 qualifies as a small 
entity.
---------------------------------------------------------------------------

    The Commission estimates, based on the staff's discussions with 
members of the fund industry, that approximately two-thirds of small 
entity funds do not advertise and, thus, do not incur any burdens or 
costs associated with rule 482. For small entity funds that do 
advertise, the Commission estimates an internal hour burden of 
approximately 80 hours per small entity fund. This represents 
approximately 6,000 (80 hours x 75 small entities) hours, or $246,915 
(6,000 hours x $40.986 wage rate) in internal costs, for all small 
entities. The Commission estimates that the external cost burden 
associated with rule 482 for small entities, as with other funds, is 
negligible. To the extent small entities currently advertise, the 
burden and costs may affect them to a greater extent because small 
entities are unable to take advantage of economies of scale available 
to larger fund complexes.\143\
---------------------------------------------------------------------------

    \143\ We note, however, that to the extent that the proposed 
amendments actually reduce the regulatory burden of advertising, 
small entities may be encouraged to increase their advertising 
activity.
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed amendments would modify the disclosure requirements 
applicable to rule 482 advertisements. Advertisements would have to 
contain an amended warning legend, an explanation about where charges 
and expense information could be found, and, if performance figures are 
used, information about where updated performance information could be 
found. In addition, the required disclosure would have to be given as 
much prominence in the advertisement as the major portion of the 
advertisement. The proposed amendments would also rescind the 
disclosure requirements of rule 134 as they apply to funds, but we 
expect that this would not result in any appreciable change in the 
disclosure that funds make in their advertisements because present rule 
134 advertisements would become rule 482 advertisements.
    After assessing the proposed amendments in light of the current 
reporting requirements and consulting with representatives in the 
industry, the Commission has considered the potential effect that the 
proposed amendments would have on the preparation of advertisements. 
Without regard to the size of the entity, we estimate that the proposed 
amendments would result in a net decrease of 1.23 hours, or $50.41 
(1.23 hours x $40.986 wage rate), per investment company per year in 
internal costs and a net increase of $805.67 per investment company per 
year in external costs.\144\
---------------------------------------------------------------------------

    \144\ These figures are based on the Commission staff's 
discussions with several fund complexes, and represent the net of 
the switchover internal hour burdens (12,180 hours (or 4,060 
amortized)) and external costs ($13,503,779 (or $4,501,259.67 
amortized)), amortized over 3 years, and the annual internal hour 
burden savings (10,950), which would be attributable to the proposed 
amendments.
    The net annual hour savings would be 6,890 hours (4,060 
amortized increase--10,950 annual decrease) or 1.23 hours per 
investment company (6,890 hours/5,587 investment companies). The 
annual external costs would be $805.67 per investment company 
($4,501,259.67/5,587 investment companies).
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    The Commission estimates some one-time switchover costs and burdens 
that would be imposed on all funds, but which may have a relatively 
greater impact on smaller firms. These costs include the costs of 
altering existing advertisements, including those now covered by rule 
134, to comply with the new provisions of rule 482; generating 
performance figures on a monthly basis; and making available the 
updated monthly performance data by a toll-free telephone number. The 
costs of making updated performance data available could include 
expenses for computer time, legal and accounting fees, information 
technology staff, and additional computer and telephone equipment. 
However, we believe, based on consultation with a number of fund 
complexes, that many investment companies that presently advertise 
already provide performance information on a basis at least as current 
as monthly through these means and, therefore, that the marginal cost 
increases for most funds are expected to be minimal.
    The Commission anticipates that the proposed amendments would also 
provide ongoing reductions in the compliance burden for all funds by 
clarifying the language of rule 482, eliminating the ``substance of 
which'' requirement, and consolidating fund advertising into one rule. 
These changes would effect savings primarily by reducing the time and 
money funds now spend on legal review and amending their SAIs to comply 
with the ``substance of which'' requirement in current rule 482.
    The Commission solicits comment on the effect the proposed 
amendments would have on small entities.

E. Duplicative, Overlapping or Conflicting Federal Rules

    There are no rules that duplicate, overlap, or conflict with the 
proposed amendments.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small issuers. In 
connection with the proposed amendments, the Commission considered the 
following alternatives: (i) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the proposed amendments for small entities; (iii) 
the use of performance rather than design standards; and (iv) an 
exemption from coverage of the proposed amendments, or any part 
thereof, for small entities.
    The Commission believes at the present time that special compliance 
or reporting requirements for small

[[Page 36732]]

entities, or an exemption from coverage for small entities, would not 
be appropriate or consistent with investor protection. The proposed 
disclosure amendments would provide shareholders and the public with 
more balanced information about a fund's performance. Different 
disclosure requirements for small entities, such as reducing the level 
of disclosure that small entities would have to provide shareholders in 
advertising, may create the risk that shareholders would not receive 
balanced information about a fund's performance or would receive 
confusing, false, or misleading information. In addition, applying 
different standards for advertising by small and large funds might 
impede investors' ability to adequately compare funds. We believe it is 
important for the enhanced advertising disclosure that would be 
required by the proposed amendments to be provided to investors by all 
funds, not just funds that are not considered small entities.
    The Commission also notes that current advertising requirements, 
and its disclosure rules in general, do not distinguish between small 
entities and other funds. In addition, we believe that it would be 
inappropriate to impose a different timetable on small entities for 
complying with the requirements.
    The proposed amendments would also reduce the internal regulatory 
burden on all funds, including small entities, by eliminating the 
``substance of which'' requirement from rule 482 and rescinding rule 
134 provisions that apply to funds, thereby consolidating and 
simplifying the advertising rules. Small entities should benefit from 
these amendments to the same degree as other investment companies. 
Further clarification, consolidation, or simplification of the 
proposals for funds that are small entities may be inconsistent with 
investor protection. Finally, we do not consider using performance 
rather than design standards to be consistent with our statutory 
mandate of investor protection in the present context.

G. Solicitation of Comments

    The Commission encourages the submission of written comments with 
respect to any aspect of this Analysis. Comment is specifically 
requested on the number of small entities that would be affected by the 
proposed amendments and the likely impact of the proposals on small 
entities. Commenters are asked to describe the nature of any impact and 
provide empirical data supporting the extent of the impact. These 
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. Comments should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW, Washington, DC 20549-0609. Comments also may be 
submitted electronically at the following E-mail address: [email protected]. All comment letters should refer to File No. S7-17-
02; 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, 
NW, Washington, DC 20549-0102. Electronically submitted comment letters 
also will be posted on the Commission's Internet web site (http://www.sec.gov).\145\
---------------------------------------------------------------------------

    \145\ We do not edit personal, identifying information, such as 
names or e-mail addresses, from electronic submissions. Submit only 
information that you wish to make publicly available.
---------------------------------------------------------------------------

VIII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996 (``SBREFA''),\146\ a rule is ``major'' if it results or is 
likely to result in:
---------------------------------------------------------------------------

    \146\ Pub. L. No. 104-21, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

    [sbull] An annual effect on the economy of $100 million or more;
    [sbull] Aa major increase in costs or prices for consumers or 
individual industries; or
    [sbull] Significant adverse effects on competition, investment, or 
innovation.

The Commission requests comment on the potential impact of the proposed 
amendments on the U.S. economy on an annual basis. Commenters are 
requested to provide empirical data to support their views.

IX. Statutory Authority

    The Commission is proposing amendments to rule 134 pursuant to 
authority set forth in sections 2(a)(10) and 19(a) of the Securities 
Act [15 U.S.C. 77b(a)(10) and 77s(a)]. The Commission is proposing 
amendments to rule 156 pursuant to authority set forth in section 19(a) 
of the Securities Act [15 U.S.C. 77s(a)] and sections 10(b) and 23(a) 
of the Exchange Act [15 U.S.C. 78j(b) and 78w(a)]. The Commission is 
proposing amendments to rule 482 pursuant to authority set forth in 
sections 5, 10(b), 19(a), and 28 of the Securities Act [15 U.S.C. 77e, 
77j(b), 77s(a), and 77z-3] and sections 24(g) and 38(a) of the 
Investment Company Act [15 U.S.C. 80a-24(g) and 80a-37(a)]. The 
Commission is proposing amendments to rule 34b-1 pursuant to authority 
set forth in sections 34(b) and 38(a) of the Investment Company Act [15 
U.S.C. 80a-33(b) and 80a-37(a)]. The Commission is proposing amendments 
to Form N-1A, Form N-3, Form N-4, and Form N-6 pursuant to authority 
set forth in sections 5, 6, 7, 10, and 19(a) of the Securities Act [15 
U.S.C. 77e, 77f, 77g, 77j, and 77s(a)] and sections 8, 24(a), 30, and 
38 of the Investment Company Act [15 U.S.C. 80a-8, 80a-24(a), 80a-29, 
and 80a-37].

List of Subjects

17 CFR Part 230

    Advertising, Investment companies, Reporting and recordkeeping 
requirements, Securities.

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rule and Form Amendments

    For the reasons set out in the preamble, the Commission proposes to 
amend Title 17, Chapter II, of the Code of Federal Regulations as 
follows.

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The general authority citation for Part 230 is revised to read 
as follows:

    Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 
78ll(d), 78mm, 79t, 80a-8, 80a-24, 80a-28, 80a-29, 80a-30, and 80a-
37, unless otherwise noted.
* * * * *
    2. Section 230.134 is amended by:
    a. Removing the authority citation following [sect] 230.134;
    b. Revising the introductory text of [sect] 230.134;
    c. Removing paragraphs (a)(3)(iii), (a)(13), and (e);
    d. Redesignating paragraphs (a)(3)(iv) and (a)(14) as paragraphs 
(a)(3)(iii) and (a)(13), respectively; and
    e. In newly redesignated paragraph (a)(13)(ii), revising the 
reference ``(a)(14)(i)'' to read ``(a)(13)(i)''.
    The revision reads as follows:


[sect] 230.134  Communications not deemed a prospectus.

    The term prospectus as defined in section 2(a)(10) of the Act (15 
U.S.C. 77b(a)(10)) does not include a notice,

[[Page 36733]]

circular, advertisement, letter, or other communication published or 
transmitted to any person after a registration statement has been filed 
if it contains only the statements required or permitted by this [sect] 
230.134. This [sect] 230.134 does not apply to a notice, circular, 
advertisement, letter, or other communication relating to an investment 
company registered under the Investment Company Act of 1940 (15 U.S.C. 
80a-1 et seq.) or a business development company as defined in section 
2(a)(48) of the Investment Company Act (15 U.S.C. 80a-2(a)(48)).
* * * * *
    3. Section 230.156 is amended by:
    a. Removing the authority citation following [sect] 230.156; and
    b. Revising paragraph (b)(2)(i) to read as follows:


[sect] 230.156  Investment company sales literature.

* * * * *
    (b) * * *
    (2) * * *
    (i) Portrayals of past income, gain, or growth of assets convey an 
impression of the net investment results achieved by an actual or 
hypothetical investment which would not be justified under the 
circumstances, including portrayals that omit explanations, 
qualifications, limitations, or other statements necessary or 
appropriate to make the portrayals not misleading; and
* * * * *
    4. Section 230.482 is revised to read as follows:


[sect] 230.482  Advertising by an investment company as satisfying 
requirements of section 10.

    (a) Scope of rule. This section applies to an advertisement or 
other sales material (advertisement) with respect to securities of an 
investment company registered under the Investment Company Act of 1940 
(15 U.S.C. 80a-1 et seq.) (1940 Act), or a business development 
company, that is selling or proposing to sell its securities pursuant 
to a registration statement that has been filed under the Act. This 
section does not apply to an advertisement that is excepted from the 
definition of prospectus by section 2(a)(10) of the Act (15 U.S.C. 
77b(a)(10)), or a Profile under [sect] 230.498. An advertisement that 
complies with this section, which may include information the substance 
of which is not included in the prospectus specified in section 10(a) 
of the Act (15 U.S.C 77j(a)), will be deemed to be a prospectus under 
section 10(b) of the Act (15 U.S.C. 77j(b)) for the purpose of section 
5(b)(1) of the Act (15 U.S.C. 77e(b)(1)).

    Note to paragraph (a): The fact that an advertisement complies 
with this section does not relieve the investment company, 
underwriter, or dealer of the obligation to ensure that the 
advertisement is not false or misleading. For guidance about factors 
to be weighed in determining whether statements, representations, 
illustrations, and descriptions contained in investment company 
advertisements are misleading, see [sect] 230.156. In addition, an 
advertisement that complies with this section is subject to the 
legibility requirements of [sect] 230.420.

    (b) Required disclosure. This paragraph describes information that 
is required to be included in an advertisement in order to comply with 
this section.
    (1) Availability of additional information. An advertisement must 
include a statement that:
    (i) Identifies a source from which an investor may obtain a 
prospectus; explains that the prospectus contains more complete 
information about the investment company, including charges and 
expenses; and states that the prospectus should be read carefully 
before investing; or
    (ii) If used with a Profile, explains that the accompanying Profile 
contains information about the investment company, including charges 
and expenses; describes the procedures for investing in the investment 
company; and indicates the availability of the investment company's 
prospectus.
    (2) Advertisements used prior to effectiveness of registration 
statement. An advertisement that is used prior to effectiveness of the 
investment company's registration statement or the determination of the 
public offering price (in the case of a registration statement that 
becomes effective omitting information from the prospectus contained in 
the registration statement in reliance upon [sect] 230.430A) must 
include the ``Subject to Completion'' legend required by [sect] 
230.481(b)(2).
    (3) Advertisements including performance data. An advertisement 
that includes performance data of an open-end management investment 
company or a separate account registered under the 1940 Act as a unit 
investment trust offering variable annuity contracts (trust account) 
must include the following:
    (i) A legend disclosing that the performance data quoted represents 
past performance; that past performance does not guarantee future 
results; that the investment return and principal value of an 
investment will fluctuate so that an investor's shares, when redeemed, 
may be worth more or less than their original cost; and that current 
performance may be lower or higher than the performance data quoted. 
The legend should also identify a toll-free (or collect) telephone 
number and, if available, a website where an investor may obtain 
performance data current to the most recent month-end. An advertisement 
for a money market fund may omit the disclosure about principal value 
fluctuation; and
    (ii) If a sales load or any other nonrecurring fee is charged, the 
maximum amount of the load or fee, and if the sales load or fee is not 
reflected, a statement that the performance data does not reflect the 
deduction of the sales load or fee, and that, if reflected, the load or 
fee would reduce the performance quoted.
    (4) Money market funds. An advertisement for an investment company 
that holds itself out to be a money market fund must include the 
following statement:
    An investment in the Fund is not insured or guaranteed by the 
Federal Deposit Insurance Corporation or any other government agency. 
Although the Fund seeks to preserve the value of your investment at 
$1.00 per share, it is possible to lose money by investing in the Fund.
    A money market fund that does not hold itself out as maintaining a 
stable net asset value may omit the second sentence of this statement.
    (5) Presentation. In a print advertisement, the statements required 
by paragraphs (b)(1) through (b)(4) of this section must be presented 
in a size type at least as large as and of a style different from, but 
at least as prominent as, that used in the major portion of the 
advertisement. In a radio or television advertisement, the statements 
required by paragraphs (b)(1) through (b)(4) of this section must be 
given emphasis equal to that used in the major portion of the 
advertisement. The statements required by paragraph (b)(3) of this 
section must be presented in close proximity to the performance data, 
and, in a print advertisement, must be presented in the body of the 
advertisement and not in a footnote.
    (6) Commission legend. An advertisement that complies with this 
section need not contain the Commission legend required by [sect] 
230.481(b)(1).
    (c) Use of applications. An advertisement that complies with this 
section may not contain or be accompanied by any application by which a 
prospective investor may invest in the investment company, except that:
    (1) Variable annuity and variable life insurance contracts. A 
prospectus meeting the requirements of section 10(a) of the Act (15 
U.S.C. 77j(a)) by

[[Page 36734]]

which a unit investment trust offers variable annuity or variable life 
insurance contracts may contain a contract application although the 
prospectus includes information about an investment company in which 
the unit investment trust invests that, pursuant to this section, is 
deemed a prospectus under section 10(b) of the Act (15 U.S.C. 77j(b)); 
and
    (2) Profile. An advertisement that complies with this section may 
be used with a Profile that includes, or is accompanied by, an 
application to purchase shares of the investment company as permitted 
under [sect] 230.498.
    (d) Performance data for non-money market funds. In the case of an 
open-end management investment company or a trust account (other than a 
money market fund referred to in paragraph (e) of this section), any 
quotation of the company's performance contained in an advertisement 
shall be limited to quotations of:
    (1) Current yield. A current yield that:
    (i) Is based on the methods of computation prescribed in Form N-1A 
([sect][sect] 239.15A and 274.11A of this chapter), N-3 ([sect][sect] 
239.17a and 274.11b of this chapter), or N-4 ([sect][sect] 239.17b and 
274.11c of this chapter);
    (ii) Is accompanied by quotations of total return as provided for 
in paragraph (d)(3) of this section;
    (iii) Is set out in no greater prominence than the required 
quotations of total return; and
    (iv) Adjacent to the quotation and with no less prominence than the 
quotation, identifies the length of and the date of the last day in the 
base period used in computing the quotation.
    (2) Tax-equivalent yield. A tax-equivalent yield that:
    (i) Is based on the methods of computation prescribed in Form N-1A 
([sect][sect] 239.15A and 274.11A of this chapter), N-3 ([sect][sect] 
239.17a and 274.11b of this chapter), or N-4 ([sect][sect] 239.17b and 
274.11c of this chapter);
    (ii) Is accompanied by quotations of yield as provided for in 
paragraph (d)(1) of this section and total return as provided for in 
paragraph (d)(3) of this section;
    (iii) Is set out in no greater prominence than the required 
quotations of yield and total return;
    (iv) Relates to the same base period as the required quotation of 
yield; and
    (v) Adjacent to the quotation and with no less prominence than the 
quotation, identifies the length of and the date of the last day in the 
base period used in computing the quotation.
    (3) Average annual total return. Average annual total return for 
one, five, and ten year periods, except that if the company's 
registration statement under the Act (15 U.S.C. 77a et seq.) has been 
in effect for less than one, five, or ten years, the time period during 
which the registration statement was in effect is substituted for the 
period(s) otherwise prescribed. The quotations must:
    (i) Be based on the methods of computation prescribed in Form N-1A 
([sect][sect] 239.15A and 274.11A of this chapter), N-3 ([sect][sect] 
239.17a and 274.11b of this chapter), or N-4 ([sect][sect] 239.17b and 
274.11c of this chapter);
    (ii) Be current to the most recent calendar quarter ended prior to 
the submission of the advertisement for publication;
    (iii) Be set out with equal prominence; and
    (iv) Adjacent to the quotation and with no less prominence than the 
quotation, identify the length of and the last day of the one, five, 
and ten year periods.
    (4) After-tax return. For an open-end management investment 
company, average annual total return (after taxes on distributions) and 
average annual total return (after taxes on distributions and 
redemption) for one, five, and ten year periods, except that if the 
company's registration statement under the Act (15 U.S.C. 77a et seq.) 
has been in effect for less than one, five, or ten years, the time 
period during which the registration statement was in effect is 
substituted for the period(s) otherwise prescribed. The quotations 
must:
    (i) Be based on the methods of computation prescribed in Form N-1A 
([sect][sect] 239.15A and 274.11A of this chapter);
    (ii) Be current to the most recent calendar quarter ended prior to 
the submission of the advertisement for publication;
    (iii) Be accompanied by quotations of total return as provided for 
in paragraph (d)(3) of this section;
    (iv) Include both average annual total return (after taxes on 
distributions) and average annual total return (after taxes on 
distributions and redemption);
    (v) Be set out with equal prominence and be set out in no greater 
prominence than the required quotations of total return; and
    (vi) Adjacent to the quotations and with no less prominence than 
the quotations, identify the length of and the last day of the one, 
five, and ten year periods.
    (5) Other performance measures. Any other historical measure of 
company performance (not subject to any prescribed method of 
computation) if such measurement:
    (i) Reflects all elements of return;
    (ii) Is accompanied by quotations of total return as provided for 
in paragraph (d)(3) of this section;
    (iii) In the case of any measure of performance adjusted to reflect 
the effect of taxes, is accompanied by quotations of total return as 
provided for in paragraph (d)(4) of this section;
    (iv) Is set out in no greater prominence than the required 
quotations of total return; and
    (v) Adjacent to the measurement and with no less prominence than 
the measurement, identifies the length of and the last day of the 
period for which performance is measured.
    (e) Performance data for money market funds. In the case of a money 
market fund:
    (1) Yield. Any quotation of the money market fund's yield in an 
advertisement shall be based on the methods of computation prescribed 
in Form N-1A ([sect][sect] 239.15A and 274.11A of this chapter), N-3 
([sect][sect] 239.17a and 274.11b of this chapter), or N-4 
([sect][sect] 239.17b and 274.11c of this chapter) and may include:
    (i) A quotation of current yield that, adjacent to the quotation 
and with no less prominence than the quotation, identifies the length 
of and the date of the last day in the base period used in computing 
that quotation;
    (ii) A quotation of effective yield if it appears in the same 
advertisement as a quotation of current yield and each quotation 
relates to an identical base period and is presented with equal 
prominence; or
    (iii) A quotation or quotations of tax-equivalent yield or tax-
equivalent effective yield if it appears in the same advertisement as a 
quotation of current yield and each quotation relates to the same base 
period as the quotation of current yield, is presented with equal 
prominence, and states the income tax rate used in the calculation.
    (2) Total return. Accompany any quotation of the money market 
fund's total return in an advertisement with a quotation of the money 
market fund's current yield under paragraph (e)(1)(i) of this section. 
Place the quotations of total return and current yield next to each 
other, in the same size print, and if there is a material difference 
between the quoted total return and the quoted current yield, include a 
statement that the yield quotation more closely reflects the current 
earnings of the money market fund than the total return quotation.
    (f) Advertisements that make tax representations. An advertisement 
for an open-end management investment company (other than a company 
that is permitted under [sect] 270.35d-1(a)(4) of

[[Page 36735]]

this chapter to use a name suggesting that the company's distributions 
are exempt from federal income tax or from both federal and state 
income tax) that represents or implies that the company is managed to 
limit or control the effect of taxes on company performance must 
accompany any quotation of the company's performance permitted by 
paragraph (d) of this section with quotations of total return as 
provided for in paragraph (d)(4) of this section.
    (g) Timeliness of performance data. All performance data contained 
in any advertisement must be as of the most recent practicable date 
considering the type of investment company and the media through which 
the data will be conveyed, except that any advertisement containing 
total return quotations will be considered to have complied with this 
paragraph provided that:
    (1) The total return quotations are current to the most recent 
calendar quarter ended prior to the submission of the advertisement for 
publication; and
    (2) Total return quotations current to the most recent month ended 
three calendar days prior to the date of use are provided at the toll-
free (or collect) telephone number identified pursuant to paragraph 
(b)(3)(i).
    (h) Filing. An advertisement that complies with this section need 
not be filed as part of the registration statement filed under the Act.

    Note to Paragraph (h): These advertisements, unless filed with 
NASD Regulation, Inc., are required to be filed in accordance with 
the requirements of [sect] 230.497.

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

    5. The authority citation for part 239 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77sss, 78c, 
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-24, 80a-26, 80a-29, 80a-30, and 
80a-37, unless otherwise noted.
* * * * *

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

    6. The authority citation for part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1, et seq., 80a-34(d), 80a-37, 80a-39, 
unless otherwise noted;
* * * * *
    7. Section 270.34b-1 is amended by:
    a. Revising the reference ``(a)(7) of [sect] 230.482'' in paragraph 
(a) to read ``(b)(4) of [sect] 230.482'';
    b. Revising the reference ``(a)(6) of [sect] 230.482'' in paragraph 
(b)(1)(i) to read ``(b)(3) of [sect] 230.482'';
    c. Revising the reference ``(d)(1)(i) of [sect] 230.482'' in 
paragraph (b)(1)(ii)(A) to read ``(e)(1)(i) of [sect] 230.482'';
    d. Revising the reference ``[sect] 230.482(d)(1)(iii)'' in 
paragraph (b)(1)(ii)(B) to read ``[sect] 230.482(e)(1)(iii)';
    e. Revising the reference ``(d)(1)(i) of [sect] 230.482'' in the 
first sentence of paragraph (b)(1)(ii)(C) to read ``(e)(1)(i) of [sect] 
230.482'';
    f. Revising the reference ``(e)(3) of [sect] 230.482'' in paragraph 
(b)(1)(iii)(A) to read ``(d)(3) of [sect] 230.482'';
    g. Revising the reference ``(e)(4) of [sect] 230.482'' in paragraph 
(b)(1)(iii)(B) to read ``(d)(4) of [sect] 230.482'';
    h. Revising the reference ``(e)(4) of [sect] 230.482'' in paragraph 
(b)(1)(iii)(C) to read ``(d)(4) of [sect] 230.482'';
    i. Revising the reference ``(e)(1) of [sect] 230.482'' in paragraph 
(b)(1)(iii)(D) to read ``(d)(1) of [sect] 230.482'';
    j. Revising the references ``(e)(2)'' and ``(e)(1) of [sect] 
230.482'' in paragraph (b)(1)(iii)(E) to read ``(d)(2)'' and ``(d)(1) 
of [sect] 230.482'', respectively;
    k. Revising the reference ``(e)(3)(ii), (e)(4)(ii)'' in paragraph 
(b)(3) to read ``(d)(3)(ii), (d)(4)(ii)''; and
    l. Adding a note following the introductory text of [sect] 270.34b-
1 to read as follows:


[sect] 270.34b-1  Sales literature deemed to be misleading.

* * * * *

    Note to Introductory Text of [sect] 270.34b-1: The fact that the 
sales literature includes the information specified in paragraphs 
(a) and (b) of this section does not relieve the investment company, 
underwriter, or dealer of the obligation to ensure that the sales 
literature is not false or misleading. For guidance about factors to 
be weighed in determining whether statements, representations, 
illustrations, and descriptions contained in investment company 
sales literature are misleading, see [sect] 230.156 of this chapter.

* * * * *

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

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

    8. 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, 80a-26, and 80a-29, unless otherwise 
noted.

    Note: The text of Forms N-1A, N-3, N-4, and N-6 does not, and 
these amendments will not, appear in the Code of Federal 
Regulations.

    9. Item 21 of Form N-1A (referenced in [sect][sect] 239.15A and 
274.11A) is amended by:
    a. Revising the introductory text of paragraphs (a) and (b); and
    b. Removing paragraphs (a)(5) and (b)(7), to read as follows:

Form N-1A

* * * * *

Item 21. Calculation of Performance Data

    (a) Money Market Funds. Yield quotation(s) for a Money Market Fund 
included in the prospectus should be calculated according to paragraphs 
(a)(1)-(4).
* * * * *
    (b) Other Funds. Performance information included in the prospectus 
should be calculated according to paragraphs (b)(1)-(6).
* * * * *
    10. Item 4 of Form N-3 (referenced in [sect][sect] 239.17a and 
274.11b) is amended by:
    a. Removing Item 4(c); and
    b. Redesignating Item 4(d) as Item 4(c).
    11. Item 25 of Form N-3 (referenced in [sect][sect] 239.17a and 
274.11b) is amended by:
    a. Removing Instruction 5 to paragraph (a); and
    b. Revising paragraphs (a) and (b), and Instruction 6 to paragraph 
(b)(i), to read as follows:

Form N-3

* * * * *

Item 25. Calculation of Performance Data

    (a) Money Market Accounts. Yield quotation(s) included in the 
prospectus for an account or sub-account that holds itself out as a 
``money market'' account or sub-account should be calculated according 
to paragraphs (a)(i)-(ii).
    (i) Yield Quotation. Based on the 7 days ended on the date of the 
most recent balance sheet of the Registrant included in the 
registration statement, calculate the yield by determining the net 
change, exclusive of capital changes and income other than investment 
income, in the value of a hypothetical pre-existing account having a 
balance of one accumulation unit of the account or sub-account at the 
beginning of the period, subtracting a hypothetical charge reflecting 
deductions from contractowner accounts, and dividing the difference by 
the value of the account at the beginning of the base period to obtain 
the base period return, and then multiplying the base period return by 
(365/7) with the resulting

[[Page 36736]]

yield figure carried to at least the nearest hundredth of one percent.
    (ii) Effective Yield Quotation. Based on the 7 days ended on the 
date of the most recent balance sheet of the Registrant included in the 
registration statement, calculate the effective yield, carried to at 
least the nearest hundredth of one percent, by determining the net 
change, exclusive of capital changes and income other than investment 
income, in the value of a hypothetical pre-existing account having a 
balance of one accumulation unit of the account or sub-account at the 
beginning of the period, subtracting a hypothetical charge reflecting 
deductions from contractowner accounts, and dividing the difference by 
the value of the account at the beginning of the base period to obtain 
the base period return, and then compounding the base period return by 
adding 1, raising the sum to a power equal to 365 divided by 7, and 
subtracting 1 from the result, according to the following formula:

Effective Yield = [(Base Period Return +1)365/7]-1.

    Instructions:
* * * * *
    (b) Other Accounts. Performance information included in the 
prospectus should be calculated according to paragraphs (b)(i)-(iii).
    (i) Average Annual Total Return Quotation. For the 1-, 5-, and 10-
year periods ended on the date of the most recent balance sheet of the 
Registrant included in the registration statement, calculate the 
average annual total return by finding the average annual compounded 
rates of return over the 1-, 5-, and 10-year periods that would equate 
the initial amount invested to the ending redeemable value, according 
to the following formula:

P(1+T)n = ERV

Where:

P = A hypothetical initial payment of $1,000
T = Average annual total return
n = Number of years
ERV = Ending redeemable value of a hypothetical $1,000 payment made at 
the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 
5-, or 10-year periods (or fractional portion).

    Instructions:
* * * * *
    6. Total return information in the prospectus need only be current 
to the end of the Registrant's most recent fiscal year.
    (ii) Yield Quotation. Based on a 30-day (or one month) period ended 
on the date of the most recent balance sheet of the Registrant included 
in the registration statement, calculate yield by dividing the net 
investment income per accumulation unit earned during the period by the 
maximum offering price per unit on the last day of the period, 
according to the following formula:


[GRAPHIC] [TIFF OMITTED] TP24MY02.001

Where:

a = Dividends and interest earned during the period.
b = Expenses accrued for the period (net of reimbursements).
c = The average daily number of accumulation units outstanding during 
the period.
d = The maximum offering price per accumulation unit on the last day of 
the period.

    Instructions:
* * * * *
    (iii) Non-Standardized Performance Quotation. A Registrant may 
calculate performance using any other historical measure of performance 
(not subject to any prescribed method of computation) if the 
measurement reflects all elements of return.
* * * * *
    12. Item 4 of Form N-4 (referenced in [sect][sect] 239.17b and 
274.11c) is amended by:
    a. Removing Item 4(b); and
    b. Redesignating Item 4(c) as Item 4(b).
    13. Item 21 of Form N-4 (referenced in [sect][sect] 239.17b and 
274.11c) is amended by:
    a. Removing Instruction 5 to paragraph (a); and
    b. Revising paragraphs (a) and (b), and Instruction 6 to paragraph 
(b)(i), to read as follows:

Form N-4

* * * * *

Item 21. Calculation of Performance Data

    (a) Money Market Funded Sub-Accounts. Yield quotation(s) included 
in the prospectus for an account or sub-account that holds itself out 
as a ``money market'' account or sub-account should be calculated 
according to paragraphs (a)(i)-(ii).
    (i) Yield Quotation. Based on the 7 days ended on the date of the 
most recent balance sheet of the Registrant included in the 
registration statement, calculate the yield by determining the net 
change, exclusive of capital changes and income other than investment 
income, in the value of a hypothetical pre-existing account having a 
balance of one accumulation unit of the account or sub-account at the 
beginning of the period, subtracting a hypothetical charge reflecting 
deductions from contractowner accounts, and dividing the difference by 
the value of the account at the beginning of the base period to obtain 
the base period return, and then multiplying the base period return by 
(365/7) with the resulting yield figure carried to at least the nearest 
hundredth of one percent.
    (ii) Effective Yield Quotation. Based on the 7 days ended on the 
date of the most recent balance sheet of the Registrant included in the 
registration statement, calculate the effective yield, carried to at 
least the nearest hundredth of one percent, by determining the net 
change, exclusive of capital changes and income other than investment 
income, in the value of a hypothetical pre-existing account having a 
balance of one accumulation unit of the account or sub-account at the 
beginning of the period, subtracting a hypothetical charge reflecting 
deductions from contractowner accounts, and dividing the difference by 
the value of the account at the beginning of the base period to obtain 
the base period return, and then compounding the base period return by 
adding 1, raising the sum to a power equal to 365 divided by 7, and 
subtracting 1 from the result, according to the following formula:

Effective Yield = [(Base Period Return+1)365/7]-1.

    Instructions:
* * * * *
    (b) Other Sub-Accounts. Performance information included in the 
prospectus should be calculated according to paragraphs (b)(i)-(iii).
    (i) Average Annual Total Return Quotation. For the 1-, 5-, and 10-
year periods ended on the date of the most recent balance sheet of the 
Registrant included in the registration statement, calculate the 
average annual total return by finding the average annual compounded 
rates of return over the 1-, 5-, and 10-year periods that would equate 
the initial amount invested to the ending redeemable value, according 
to the following formula:

P(1+T)n = ERV

Where:

P = A hypothetical initial payment of $1,000
T = Average annual total return
n = Number of years
ERV = Ending redeemable value of a hypothetical $1,000 payment made at 
the beginning of the 1-, 5-, or 10-year periods at the end of the 1-, 
5-, or 10-year periods (or fractional portion).


[[Page 36737]]


    Instructions:
* * * * *
    6. Total return information in the prospectus need only be current 
to the end of the Registrant's most recent fiscal year.
    (ii) Yield Quotation. Based on a 30-day (or one month) period ended 
on the date of the most recent balance sheet of the Registrant included 
in the registration statement, calculate yield by dividing the net 
investment income per accumulation unit earned during the period by the 
maximum offering price per unit on the last day of the period, 
according to the following formula:
[GRAPHIC] [TIFF OMITTED] TP24MY02.000


Where:

a = Net investment income earned during the period by the portfolio 
company attributable to shares owned by the sub-account.
b = Expenses accrued for the period (net of reimbursements).
c = The average daily number of accumulation units outstanding during 
the period.
d = The maximum offering price per accumulation unit on the last day of 
the period.

    Instructions:
* * * * *
    (iii) Non-Standardized Performance Quotation. A Registrant may 
calculate performance using any other historical measure of performance 
(not subject to any prescribed method of computation) if the 
measurement reflects all elements of return.
* * * * *
    14. General Instruction B.2.(b) of Form N-6 (referenced in 
[sect][sect] 239.17c and 274.11d) is amended by revising the reference 
``Items 27 (c), (k), (l), (n), and (o)'' to read ``Items 26 (c), (k), 
(l), (n), and (o)''.
    15. Item 25 of Form N-6 (referenced in [sect][sect] 239.17c and 
274.11d) is removed.
    16. Form N-6 (referenced in [sect][sect] 239.17c and 274.11d) is 
further amended by:
    a. Redesignating Items 26 through 34 as Items 25 though 33;
    b. Revising the reference ``Item 26'' in paragraph (j) of newly 
redesignated Item 25 to read ``Item 25'' and
    c. Revising the reference ``Item 26'' in paragraphs (l) and (m) of 
newly redesignated Item 26 to read ``Item 25''.

    By the Commission.

    Dated: May 17, 2002.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-12893 Filed 5-23-02; 8:45 am]
BILLING CODE 8010-01-P