[Federal Register Volume 68, Number 209 (Wednesday, October 29, 2003)]
[Proposed Rules]
[Pages 61720-61731]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-27198]



[[Page 61719]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 210, et al.



Exemption From Shareholder Approval for Certain Subadvisory Contracts; 
Proposed Rule

  Federal Register / Vol. 68, No. 209 / Wednesday, October 29, 2003 / 
Proposed Rules  

[[Page 61720]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 239, 240, 270 and 274

[Release Nos. 33-8312, 34-48683, IC-26230; File No. S7-20-03]
RIN 3235-AH80


Exemption From Shareholder Approval for Certain Subadvisory 
Contracts

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing a new rule under the Investment Company Act of 1940 that 
would, under certain conditions, permit an adviser to serve as a 
subadviser to an investment company (``fund'') without approval by the 
shareholders of the fund. The rule is designed to reduce burdens on 
investment companies by eliminating the need to obtain from the 
Commission exemptive orders that facilitate so-called ``manager of 
managers'' arrangements, under which one or more subadvisers manage a 
fund's assets subject to the supervision of an investment adviser whose 
advisory contract has been approved by fund shareholders.

DATES: Comments must be received on or before January 8, 2004.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by one method only.
    Comments in paper format should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549-0609. Comments in electronic 
format may be submitted at the following e-mail address: [email protected]. All comment letters should refer to File No. S7-20-
03; if e-mail is used, this file number should be included on the 
subject line. Comment letters will be available for public inspection 
and copying in the Commission's Public Reference Room, 450 Fifth 
Street, NW., Washington, DC 20549. Electronically submitted comment 
letters will be posted on the Commission's Internet web site (http://www.sec.gov).\1\
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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 you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Adam B. Glazer, Attorney, or C. Hunter 
Jones, Assistant Director, Office of Regulatory Policy, (202) 942-0690, 
Division of Investment Management, Securities and Exchange Commission, 
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450 Fifth Street, NW., Washington DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Commission today is proposing for public 
comment new rule 15a-5 [17 CFR 270.15a-5] under the Investment Company 
Act of 1940 [15 U.S.C. 80a] (the ``Investment Company Act'' or 
``Act''); amendments to rule 6-07 [17 CFR 210.6-07] of Regulation S-X 
[17 CFR part 210] under the Investment Company Act and the Securities 
Act of 1933 [15 U.S.C. 77a-aa] (the ``Securities Act''); amendments to 
Form N-1A [17 CFR 274.11A] under the Investment Company Act and the 
Securities Act; and amendments to Schedule 14A [17 CFR 240.14a-101] 
under the Securities Exchange Act of 1934 [15 U.S.C. 78a-mm] (the 
``Exchange Act'').

Table of Contents

Executive Summary

I. Background
II. Discussion
    A. Conditions of the Proposed Rule
    1. Terms of the Subadvisory Contacts; Subadvisory Fees
    2. Obligation to Supervise
    3. Arm's Length Relationship Between Principal Adviser and 
Subadvisers
    4. Board Oversight
    5. Expectation of Investors
    6. Number of Subadvisers
    B. Rescission of Previously Issued Exemptive Orders
III. General Request for Comment
IV. Cost-Benefit Analysis
V. Consideration of Promotion of Efficiency, Competition, and 
Capital Formation
VI. Paperwork Reduction Act
VII. Summary of Initial Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Proposed Rules and Form Amendments

Executive Summary

    The Commission is proposing new rule 15a-5 under the Investment 
Company Act. The rule would permit manager of managers funds to operate 
without obtaining shareholder approval when the fund's principal 
investment adviser hires a new subadviser or replaces an existing 
subadviser. The rule would eliminate the need for a fund to obtain an 
exemptive order permitting these arrangements. A fund that relied on 
the proposed rule would be required to inform investors of the identity 
of the current subadviser(s) managing their portfolio and the ability 
of the fund to add or replace the subadviser(s) without shareholder 
approval. The rule also would require that the fund's investment 
adviser supervise and oversee the fund's subadvisers, and that the 
hiring of a new or different subadviser not increase the fees charged 
to the fund.

I. Background

    A growing number of investment companies (``funds'') \2\ are now 
offered whose investment advisers do not directly manage a portfolio of 
securities. Instead, the advisers supervise one or more subadvisers,\3\ 
which are themselves responsible for the day-to-day management of the 
funds' portfolios. In these ``manager of managers'' funds, the 
investment adviser seeks to achieve the funds' investment objectives by 
hiring, supervising and, when appropriate, discharging subadvisers, 
each of which is responsible for the management of a portion of a 
fund's portfolio.\4\ In many cases, these funds also authorize the 
adviser to allocate and reallocate fund assets among subadvisers.
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    \2\ In this Release and proposed rule 15a-5, we use the term 
``fund'' to mean a registered open-end management investment company 
or a separate series of such a company. A series company (or series 
fund) is a registered open-end investment company which, in 
accordance with the provisions of section 18(f)(2) of the Act [15 
U.S.C. 80a-18(f)(2)], issues two or more classes or series of 
preferred or special stock each of which is preferred over all other 
classes or series in respect of assets specifically allocated to 
that class or series. See 17 CFR 270.18f-2(a).
    \3\ In this Release and proposed rule 15a-5, we use the term 
``subadviser'' to mean a party that contracts with a fund's 
principal adviser to provide investment advisory services to the 
fund, and the term ``principal adviser'' to mean a party that 
contracts directly with a fund to provide investment advisory 
services to the fund. See proposed rule 15a-5(b)(2)-(3) (defining 
``principal adviser'' and ``subadviser'' by reference to sections 
2(a)(20)(A)-(B) of the Act [15 U.S.C. 80a-2(a)(20)(A) `` (B)]).
    \4\ In the case of a series fund, the adviser seeks to achieve 
the fund's investment objectives by hiring, supervising and, when 
appropriate, discharging subadvisers for the management of all or a 
portion of the portfolio of a series.
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    Since they were first introduced in the early 1990s, manager of 
managers funds have grown in popularity. Today more than 100 fund 
complexes offer these types of funds, which hold more than 400 billion 
dollars in assets.\5\ Many of these funds are sponsored by insurance 
companies and operate as funding vehicles for separate accounts 
offering variable annuity and variable

[[Page 61721]]

life insurance contracts.\6\ They represent one of the more recent 
innovations in managed asset arrangements.
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    \5\ Since 1995 we have issued over 100 orders allowing manager 
of managers funds to retain subadvisers (and materially amend 
subadvisory contracts) without shareholder approval. See, e.g., 
Hillview Investment Trust II and Hillview Capital Advisors, LLC, 
Investment Company Act Release Nos. 24853 (Feb. 6, 2001) [66 FR 
10037 (Feb. 13, 2001)] (notice) and 25055 (June 29, 2001) [66 FR 
35676 (July 6, 2001)] (order); Sun Capital Advisers Trust and Sun 
Capital Advisers, Inc., Investment Company Act Release Nos. 24368 
(Mar. 27, 2000) [65 FR 17546 (Apr. 3, 2000)] (notice) and 24401 
(Apr. 24, 2000) [72 SEC Docket 864 (May 23, 2000)] (order).
    \6\ See Gary O. Cohen, Fitting Variable Annuity Contracts and 
Variable Life Insurance into the Regulatory Framework of the 
Investment Company Act of 1940 and Securities Act of 1933, 813 PLI/
Comm 129, 212-13 (2001).
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    Many sponsors of manager of managers funds have sought and obtained 
from us orders exempting them from section 15(a) of the Act,\7\ which 
prohibits any person from serving as an investment adviser (or a 
subadviser) to a fund except under a written contract that the fund's 
shareholders have approved.\8\ The orders permit funds and advisers to 
enter into and materially amend subadvisory contracts without 
shareholder approval. Many sponsors of these funds have asserted that 
without relief from the shareholder voting requirement, the costs and 
delays associated with obtaining a shareholder vote would prevent 
advisers from hiring and firing subadvisers and from achieving the 
funds' investment objectives. They also have asserted that the 
underlying purpose of section 15(a)--to give shareholders a voice in 
the fund's investment advisory arrangements \9\--would be satisfied 
without a shareholder vote on the subadvisory contracts because the 
principal adviser's contract must still be approved by fund 
shareholders. Moreover, the principal adviser would act in the 
shareholders' interests by supervising and overseeing the fund's 
subadvisers. Sponsors have analogized subadvisers in a manager of 
managers arrangement to portfolio managers employed by a fund adviser 
who may be hired and fired without the consent of shareholders.\10\
    The Commission is today proposing a new rule, 15a-5, and amendments 
to Form N-1A, which together would codify the orders we have issued for 
manager of managers funds, including many of their conditions.\11\ The 
Commission believes that the proposed rule would benefit shareholders 
by allowing funds to terminate poorly performing subadvisers and hire 
new subadvisers without the need for a shareholder vote.\12\ These 
amendments are designed to limit the scope of the relief to subadvisers 
of manager of managers funds, and to assure that investors in manager 
of managers funds are fully informed of the identity of the current 
subadviser(s) managing their portfolio, and of the fact that 
subadvisers could be added or replaced without shareholder approval.
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    \7\ 15 U.S.C. 80a-15(a).
    \8\ See supra note 5.
    \9\ See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before a Subcomm. of the Senate Comm. on Banking and 
Currency, 76th Cong., 3d Sess. 253 (1940) (statement of David 
Schenker).
    \10\ See, e.g., TIFF Investment Program, Inc. and Foundation 
Advisers, Inc., Investment Company Act Release Nos. 21268 (Aug. 3, 
1995) [60 FR 40875 (Aug. 10, 1995)] (notice) and 21328 (Aug. 30, 
1995) [60 SEC Docket 316 (Sept. 26, 1995)] (order), in which the 
applicant had represented that the employment of a new subadviser 
was ``closely analogous to the decision by a money management firm 
to hire another portfolio manager or analyst.'' See id., Investment 
Company Act Release No. 21268, at text following n.1. Our disclosure 
rules require that a change in portfolio managers be disclosed to 
investors through a prospectus ``sticker.'' See Disclosure of Mutual 
Fund Performance and Portfolio Managers, Investment Company Act 
Release No. 19382 (Apr. 6, 1993) [58 FR 19050 (Apr. 12, 1993)], at 
text accompanying nn.9-11. A fund also must disclose in its 
prospectus the identity of the fund's subadvisers. See Item 6(a)(1) 
of Form N-1A.
    \11\ As discussed below, we also are proposing related 
amendments to Regulation S-X under the Act and the Securities Act 
and to Schedule 14A under the Securities Exchange Act. We are not, 
however, proposing amendments to rule 18f-2 [17 CFR 270.18f-2] even 
though we have provided relief, in response to requests, from rule 
18f-2 in a number of our manager of managers exemptive orders. Rule 
18f-2, among other things, describes how the shareholder voting 
requirement of section 15(a) applies in the case of a fund with 
multiple series or multiple classes. Because the relief we are 
proposing today would provide exemptive relief from the requirements 
of section 15(a), we believe that relief from rule 18f-2 is 
unnecessary.
    \12\ The inability of a fund adviser to hire a subadviser 
without obtaining shareholder approval can inhibit a fund manager 
from terminating a poorly performing subadviser and thus managing 
the fund in the best interests of shareholders. An investment 
adviser has a fiduciary duty to act in the best interests of a fund 
it advises. See Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971); 
Brown v. Bullock, 194 F.Supp. 207, 229, 234 (S.D.N.Y.), aff'd, 294 
F.2d 415 (2d Cir. 1961). See also In the Matter of Provident 
Management Corp., Securities Act Release No. 5115 (Dec. 1, 1970) at 
n.12 and accompanying text.
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II. Discussion

    Section 15(a) of the Investment Company Act was designed to protect 
the interests and expectations of fund shareholders by requiring that 
they approve advisory contracts,\13\ including subadvisory 
contracts.\14\ The Congress that enacted section 15(a) anticipated 
subadvisory arrangements, and concluded that shareholders should have a 
role in the selection of subadvisers. In crafting this rule proposal 
(and the exemptive orders that have preceded it), we have sought to 
distinguish subadvisory arrangements in which the subadvisers have 
resembled portfolio managers from the more traditional subadvisory 
arrangements that Congress explicitly covered in the shareholder voting 
requirement of section 15(a). Our proposed rule, therefore, contains 
several conditions, which we discuss below, that limit the scope of 
relief to subadvisers of manager of managers funds and that provide 
other means of protecting fund investor expectations and interests.\15\
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    \13\ See Investment Trusts and Investment Companies: Hearings on 
S. 3580 Before a Subcomm. of the Senate Comm. on Banking and 
Currency, 76th Cong., 3d Sess. 253 (1940) (statement of David 
Schenker) (section 15 recognizes that a ``management contract is 
personal, that it cannot be assigned, and that you cannot turn over 
the management of other people's money to someone else'').
    \14\ Section 15(a) of the Investment Company Act prohibits a 
person from serving as an investment adviser to a fund except under 
a written contract, whether with the fund or with an investment 
adviser of the fund, that has been approved by the vote of a 
majority of the fund's outstanding voting securities. Thus, the 
shareholder voting requirement applies not only to an advisory 
contract between a fund and an adviser, but also to a subadvisory 
contract between a fund's adviser and a subadviser. See 15 U.S.C. 
80a-2(a)(20) (defining investment adviser). See also Role of 
Independent Directors of Investment Companies, Investment Company 
Act Release No. 24816 (Jan 2, 2001) [66 FR 3734 (Jan. 16, 2001)] at 
n.53 (``The Act does not distinguish an adviser from a sub-
adviser.'') (citing section 2(a)(20)). Section 15(c) also requires 
that a majority of the fund's independent directors approve 
contracts with all investment adisers, including subadvisers. 15 
U.S.C. 80a-15(c).
    \15\ Section 6(c) of the Act [15 U.S.C. 80a-6(c)] permits the 
Commission, conditionally or unconditionally, to exempt any person, 
security, or transaction (or classes of persons, securities, or 
transactions) from any provision of the Act ``if and to the extent 
that such exemption is necessary or appropriate in the public 
interest and consistent with the protection of investors and the 
purposes fairly intended by the policy and provisions'' of the Act.
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    Today we are proposing a rule that would eliminate the need for 
funds to obtain exemptive orders to hire subadvisers that they 
supervise. We have drafted the rule to preserve, to the extent 
possible, the important role the Investment Company Act gives 
shareholders in the governance of their funds while accommodating the 
special needs of manager of managers funds. The other provisions of 
section 15 would remain applicable. Under those provisions, the manager 
of managers fund's principal adviser \16\ still must have its contract 
approved by the fund's board and shareholders,\17\ and the board must 
approve the terms of each subadvisory contract.\18\ Thus, the rule 
would afford shareholders of a manager of managers fund the 
opportunity, both directly through their consideration of the principal 
advisory contract and indirectly through their representatives

[[Page 61722]]

on the board of directors, to influence the terms of the advisory 
contracts under which their fund is managed.
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    \16\ We use the term ``principal adviser'' to mean a party that 
contracts directly with a fund to provide investment advisory 
services to the fund. See supra note 3.
    \17\ See 15 U.S.C. 80a-15(a). Although the proposed rule does 
not exempt a fund's advisory contract with a principal adviser from 
the shareholder approval requirement of section 15(a), rule 15a-4 
under the Act [17 CFR 270.15a-4] allows for the possibility that a 
principal adviser to the fund is temporarily serving the fund 
without shareholder approval of its advisory contract.
    \18\ See 15 U.S.C. 80a-15(c).
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A. Conditions of the Proposed Rule

1. Terms of the Subadvisory Contracts; Subadvisory Fees
    The proposed amendments would largely rely on the principal 
adviser, negotiating with each subadviser on an arm's length basis and 
subject to the approval of the fund's board, to determine the terms of 
the subadvisory contract, including the amount of the subadviser's fee. 
As a condition to the rule, however, we would preclude a new or 
modified subadvisory contract from directly or indirectly increasing 
the management fees charged to the fund or its shareholders.\19\ As a 
result, the rule would preserve the statutory requirement that 
increases in the rate of advisory fees paid by the fund be approved by 
shareholders.\20\
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    \19\ Proposed rule 15a-5(a)(1). It's a new subadvisory contract 
were to increase those fees, the subadviser entering into the 
contract would not qualify for relief under the rule, and the 
contract would need to be submitted to shareholders for their 
approval. A subadvisory fee could be increased under the rule, 
however, as long as the total amount of the advisory fees paid by 
the fund does not exceed the total amount provided by advisory 
contracts that shareholders have approved. For instance, a 
subadvisory contract would still be eligible for relief under the 
proposed rule even though it increases a fund's subadvisory fees, if 
the increase is deducted from the principal adviser's fee. See 
Republic Funds, Investment Company Act Release Nos. 24292 (Feb. 16, 
2000) [65 FR 10132 (Feb. 25, 2000)] (notice) and 24338 (Mar. 14, 
2000) [71 SEC Docket 2701 (Apr. 11, 2000)] (order) (granting 
exemption from sharehold approval for subadvisory contracts where 
the fund directly pays subadvisory fees and deducts the subadvisory 
fees from the fee paid to the principal adviser).
    \20\ See 15 U.S.C. 80a-15(a)(1) (requesting any investment 
advisory contract to precisely describe all compensation to be paid 
thereunder).
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    In most cases, subadvisers are compensated by the fund's principal 
adviser, which negotiates the amount of the subadvisers' compensation. 
Consequently, a principal adviser is free to bargain for lower 
subadvisory fees, which will benefit the fund to the extent that lower 
subadvisory fees are passed on through lower advisory fees. Sponsors of 
manager of managers funds have represented that they are able to 
negotiate lower fees with subadvisers if they do not have to disclose 
those fees separately, and in our orders we have provided them relief 
from our disclosure requirements.\21\ We are proposing to codify this 
relief, which permits a manager of managers fund to disclose only the 
aggregate amount of advisory fees that it pays to subadvisers as a 
group.\22\
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    \21\ See, e.g., Endeavor Series Trust, Investment Company Act 
Release Nos. 24054 (Sept. 27, 1999) [64 FR 53428 (Oct. 1, 1999)] 
(notice) and 24108 (Oct. 22, 1999) [70 SEC Docket 3081 (Nov. 23, 
1999)] (order); Frank Russell Investment Company, Investment Company 
Act Release Nos. 21108 (June 2, 1995) [60 FR 30321 (June 8, 1995)] 
(notice) and 21169 (June 28, 1995) [59 SEC Docket 2105 (June 25, 
1995)] (order).
    \22\ The individual fee paid to an unaffiliated subadviser of 
the principal adviser would not have to be disclosed, but the 
individual fee paid to each wholly-owned subadviser (defined below 
in Section II.A.3) would have to be disclosed. Under our proposal, a 
fund would disclose in its statement of Additional Information on 
Form N-1A, in lieu of the individual fee paid to each subadviser, 
(i) the individual fees paid to the principal adviser and to each 
subadviser that is an affiliated person of the principal adviser 
(including a wholly-owned subadviser whose contract has not been 
approved by shareholders on reliance on the proposed rule), (ii) the 
net advisory fee retained by the principal adviser after payment of 
fees to all subadvisers, and (iii) the aggregate fees paid to all of 
the fund's subadvisers that are not affiliated persons of the 
principal adviser. Proposed Instruction 5 to Item 15(a)(3) of Form 
N-1A. We also are proposing conforming amendments to rule 6-07 of 
Regulation S-X and the Instructions to Item 22(c) of Schedule 14A.
    Under the conditions of the manager of managers orders allowing 
a fund to disclose the aggregate fees paid to all of the fund's 
unaffiliated subadvisers, the principal adviser is required to 
provide the board, no less frequently than quarterly, with 
information about its profitability for each fund that is relying on 
the order. In addition, the principal adviser is required to provide 
the board with information showing the expected impact on the 
principal adviser's profitablity whenever a subadviser is hired or 
terminated. We have not included these conditions in the proposed 
rule. However, information must still be provided to the board 
pursuant to section 15(c) of the Act, which requires fund directors 
to request and evaluate, and an investment adviser to the fund to 
furnish, any information that may be necessary to evaluate the terms 
of any investment advisory contract with the fund.
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    We recognize that permitting aggregate disclosure of subadvisory 
fees will not permit investors to understand the benefits obtained by a 
principal adviser that negotiates lower subadvisory fees. We note, 
however, that the Act compels a fund board to take into consideration 
subadvisory fees when establishing the amount of the principal 
adviser's compensation,\23\ and imposes significant liabilities on the 
principal adviser itself with respect to that compensation.\24\ The 
board is in the best position to assess the overall compensation of the 
principal adviser when, for example, some subadvisory fees have 
increased and some have decreased. Moreover, the reduction of an 
individual subadvisory fee would be reflected in lower aggregate fees 
that would be disclosed under the proposed amendments.
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    \23\ Section 15(c) of the Act requires fund directors to request 
and evaluate, and an investment adviser to the fund to furnish, any 
information that may be necessary to evaluate the terms of any 
investment advisory contract with the fund. Therefore, the board 
must request, and the principal adviser must provide, information 
regarding the fees paid to the principal adviser's subadvisers in 
order for the board to evaluate properly the terms of the principal 
adviser's contract with the fund.
    \24\ Section 36(b) of the Act [15 U.S.C. 80a-35(b)] imposes a 
fiduciary duty on an investment adviser with respect to its receipt 
of compensation from the fund for services, and allows an action to 
be brought by the Commission or a shareholder for a breach of this 
duty. See Daily Income Fund, Inc. v. Fox, 464 U.S. 523, 541-42 
(1984) (discussing fund shareholders' right to initiate legal 
proceedings against the fund's adviser for breach of the adviser's 
fiduciary duty with regard to its receipt of compensation under 
section 36(b) of the Act, without first making a demand on the board 
to initiate such action).
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    We request comment on the proposal.
    [sbull] Should the Commission permit fund directors to enter into 
subadvisory contracts that increase advisory fees without the consent 
of shareholders?
    [sbull] Should the Commission limit relief to subadvisory contracts 
that do not increase the portion of the advisory fee retained by the 
principal adviser in order to assure that subadvisers are selected 
based on ability and performance?
    [sbull] Do shareholders need information about the amount of 
compensation paid to each subadviser?
    [sbull] We also request comment on whether any amendments are 
required to the fee table items of Forms N-4 and N-6, the registration 
forms used by insurance company separate accounts registered under the 
Act as unit investment trusts.\25\
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    \25\ 17 CFR 239.17b-c, 274.11c-d.
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2. Obligation To Supervise
    An important aspect of any manager of managers arrangement is the 
responsibility assumed by the principal adviser to supervise, i.e., 
monitor and oversee, the subadvisers in the performance of their duties 
for the fund.\26\ We propose to require that any principal advisory 
contract under the rule obligate the principal adviser to supervise the 
subadviser.\27\ In addition,

[[Page 61723]]

because the principal adviser must be able to discharge a subadviser in 
order to effectively supervise the subadviser, our proposed rule 
includes a condition requiring that the subadvisory contracts be 
terminable at any time by the principal adviser, on no more than 60 
days written notice, without payment of penalty.\28\
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    \26\ See, e.g., Pitcairn Funds and Pitcairn Trust Company, 
Investment Company Act Release Nos. 25106 (Aug. 9, 2001) [66 FR 
42901 (Aug. 15, 2001)] (notice) and 25150 (Sept. 5, 2001) [75 SEC 
Docket 2214 (Oct. 2, 2001)] (order); Frank Russell Investment 
Company, Investment Company Act Release Nos. 21108 (June 2, 1995) 
[60 FR 30321 (June 8, 1995)] (notice) and 21169 (June 28, 1995) [59 
SEC Docket 2105 (July 25, 1995)] (order). A typical subadvisory 
agreement stipulates that the subadviser, in carrying out its 
investment management duties under the agreement, is subject to the 
supervision and/or oversight of the board of directors and the 
principal adviser.
    \27\ Proposed rule 15a-5(a)(4). See Western Asset Management Co. 
and Legg Mason Fund Adviser, Inc., Investment Advisers Act Release 
No. 1980 (Sept. 28, 2001) (the Commission found that the principal 
adviser failed to adequately supervise an employee of its affiliated 
subadviser). Although the manager of managers orders do not require 
the principal advisory contract to contain a provision requiring the 
principal adviser to supervise all of the subadvisers it retains to 
provide services to the fund, the orders do require the principal 
adviser to supervise its subadvisers. See, e.g., Hillview Investment 
Trust II and Hillview Capital Advisors, LLC, Investment Company Act 
Release Nos. 24853 (Feb. 6, 2001) [66 FR 10037 (Feb. 13, 2001)] 
(notice) and 25055 (June 29, 2001) [66 FR 35676 (July 6, 2001)] 
(order); Frank Russell Investment Company, Investment Company Act 
Release Nos. 21108 (June 2, 1995) [60 FR 30321 (June 8, 1995)] 
(notice) and 21169 (June 28, 1995) [59 SEC Docket 2105 (July 25, 
1995)] (order).
    \28\ Proposed rule 15a-5(b)(4). The manager of managers 
exemptive orders typically do not require that the principal adviser 
be able to terminate a subadvisory contract. Most subadvisory 
contracts for manager of managers funds operating under an exemptive 
order, however, are terminable by the principal adviser. This 
termination provision often is found in the same section of the 
contract that provides, as required by section 15(a)(3) of the Act 
[15 U.S.C. 80a-15(a)(3)], that the advisory contract is terminable 
by the fund's board or shareholders.
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3. Arm's Length Relationship Between Principal Adviser and Subadvisers
    We are proposing two related conditions designed to limit the rule 
to arrangements in which the principal adviser is in a position to hire 
and supervise (and, if necessary, discharge) subadvisers on the basis 
of the subadviser's performance, rather than on the basis of other 
business relationships the principal adviser may have with the 
subadviser. First, we would preclude subadvisers relying on the rule 
from being affiliated persons of the principal adviser with which they 
contract or of the fund (other than by reason of serving as investment 
advisers to the fund) (``affiliated subadviser'').\29\ Second, we would 
preclude any director or officer of the fund and the principal adviser 
or any director or officer of the principal adviser with which the 
subadviser has contracted from owning, directly or indirectly, any 
material interest in the subadviser other than through a pooled 
investment vehicle that is not controlled by such person or entity.\30\ 
A principal adviser may not be in a position to discharge, for example, 
a parent corporation or a sister corporation, or a person that controls 
the principal adviser. It may have substantial economic incentives to 
hire and refrain from discharging a subsidiary or other types of 
affiliated persons. These conditions have been a key element of our 
exemptive orders in order to protect against the conflict of interest 
and potential for self-dealing that are inherent when a principal 
adviser hires an affiliated subadviser.\31\
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    \29\ Proposed rule 15a-5(a)(2)(i).
    \30\ Proposed rule 15a-5(a)(2)(i).
    \31\ See, e.g., Pitcairn Funds and Pitcairn Trust Company, 
Investment Company Act Release Nos. 25106 (Aug. 9, 2001) [66 FR 
42901 (Aug. 15, 2001)] (notice) and 25150 (Sept. 5, 2001) [75 SEC 
Docket 2214 (Oct. 2, 2001)] (order); Frank Russell Investment 
Company, Investment Company Act Release Nos. 21108 (June 2, 1995) 
[60 FR 30321 (June 8, 1995)] (notice) and 21169 (June 28, 1995) [59 
SEC Docket 2105 (July 25, 1995)] (order).
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    The Commission, however, has issued an order expanding the 
traditional relief to allow wholly-owned subsidiaries of the principal 
adviser to replace other wholly-owned subsidiaries of the principal 
adviser as subadvisers (``wholly-owned subadvisers'') to the manager of 
managers fund and to allow the principal adviser to materially amend a 
wholly-owned subsidiary's subadvisory contract without shareholder 
approval.\32\ The applicants asserted that no impermissible conflict of 
interest would be present when replacing one wholly-owned subadviser 
with another wholly-owned subadviser.\33\
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    \32\ See PIMCO Funds: Multi-Manager Series and PIMCO Advisors 
L.P., Investment Company Act Release Nos. 24558 (July 17, 2000) [65 
FR 45632 (July 24, 2000)] (notice) and 24597 (Aug. 14, 2000) [73 SEC 
Docket 176 (Sept. 12, 2000)] (order) (``PIMCO''). A ``wholly-owned 
subsidiary'' is defined in section 2(a)(43) of the Act [15 U.S.C. 
80a-2(a)(43)].
    \33\ See PIMCO, supra note. That order contains all of the other 
conditions contained in a typical manager of managers order, 
including the condition that prohibits a new subadvisory contract 
from increasing the management fees. The principal adviser would be 
unlikely to have a direct economic incentive to replace one wholly-
owned subadviser with another, because its overall compensation 
would not increase by virtue of its ownership interest in both 
entities.
---------------------------------------------------------------------------

    In light of the absence of an economic incentive for the principal 
adviser to replace one wholly-owned subadviser with another (other than 
to increase the fund's return on its investments),\34\ we are including 
wholly-owned subadvisers within the scope of the proposed rule.\35\ We 
are, however, limiting relief to allow the principal adviser to replace 
only a wholly-owned subadviser with another wholly-owned subadviser and 
to allow the principal adviser to materially amend a wholly-owned 
subsidiary's subadvisory contract without shareholder approval.\36\ The 
rule would not permit a principal adviser to replace any other type of 
subadviser with a wholly-owned subadviser, because the principal 
adviser would have an economic incentive in such a situation by virtue 
of its total (or near total) ownership interest in the wholly-owned 
subadviser, as compared to no ownership or a smaller ownership interest 
in the subadviser being replaced.

    \34\ Replacing one wholly-owned subadviser with another is no 
different than the principal adviser terminating a wholly-owned 
subadviser and directly managing the assets of the fund formerly 
managed by the wholly-owned subadviser. In either situation, the 
principal adviser's advisory fee (and the portion of the fee that it 
retains after paying all unaffiliated subadvisers) remains the same.
    \35\ Proposed rule 15a-5(a)(2)(ii).
    \36\ Proposed rule 15a-5(a)(2)(ii). The first wholly-owned 
subadviser hired by the fund would not qualify for relief under the 
proposed rule, and its subadvisory contract would have to be 
approved by shareholders. A wholly-owned subadviser that replaces 
the original wholly-owned subadviser (and any wholly-owned 
subadvisers thereafter that replace other wholly-owned subadvisers) 
would then be eligible for exemptive relief under the proposed rule.
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    [sbull] We request comment on whether the scope of the proposed 
rule should be expanded to include wholly-owned subadvisers replacing 
other affiliated subadvisers.
    [sbull] Should the scope of the rule be expanded to include other 
affiliated subadvisers? Should all subadvisory contracts be exempt from 
the Act's shareholder voting requirement? If so, should the Commission 
expand the proposed rule to include all subadvisers?
4. Board Oversight
    Under the Investment Company Act, a fund's board plays an important 
role in the selection and oversight of the fund's subadvisers.\37\ 
Because the rule would permit a fund board to approve subadvisory 
contracts without the shareholder vote that the statute otherwise 
requires, we propose to require that the fund adopt certain governance 
practices that strengthen the role of the independent directors. As 
part of our initiative to improve fund governance practices, in 2001 we 
made similar amendments to a number of our exemptive rules, including 
rule 15a-4, which permits boards of directors to approve interim 
advisory contracts

[[Page 61724]]

without a shareholder vote.\38\ Thus, manager of managers funds relying 
on the rule would be required to have a board of directors whose 
independent directors (i) constitute a majority of directors, (ii) are 
selected and nominated by independent directors, and (iii) if 
represented by legal counsel, are represented by ``independent legal 
counsel.'' \39\
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    \37\ Section 15 of the Act requires that a majority of the 
board's independent directors approve the fund's advisory contracts 
(including subadvisory contracts), and that the board (or 
shareholders) annually approve any advisory contract that continues 
more than two years. 15 U.S.C. 80-15(a), 15(c). The directors also 
must request and evaluate information reasonably necessary for them 
to evaluate the terms of an advisory contract. 15 U.S.C. 80a-15(c). 
The board in carrying out its obligations under the Act should 
consider any material business arrangements between the adviser or 
principal underwriter and the subadviser, including the involvement 
of the subadviser in the distribution of the fund's shares. The 
board when approving a wholly-owned subadviser's contract also 
should consider the effect that the affiliation between the 
principal adviser and wholly-owned subadviser had on the decision of 
the principal adviser to replace a wholly-owned subadviser with 
another wholly-owned subadviser (as opposed to replacing with an 
unaffiliated subadviser).
    \38\ See Role of Independent Directors of Investment Companies, 
Investment Company Act Release No. 24816 (Jan. 2, 2001) [66 FR 3734 
(Jan. 16, 2001)].
    \39\ Proposed rule 15a-5(a)(7). See 17 CFR 270.0-1(a)(6)(i) 
(defining ``independent legal counsel''). The manager of managers 
exemptive orders have typically included these board composition and 
nomination requirements. The manager of managers orders that also 
include relief from our disclosure rules require independent 
directors to retain independent counsel. Consistent with the 
amendments to exemptive rules in 2001, the proposed rule would 
require that the independent directors have independent counsel only 
if they choose to retain counsel. See Role of Independent Directors 
of Investment Companies, Investment Company Act Release No. 24816 
(Jan. 2, 2001) [66 FR 3734 (Jan. 16, 2001)].
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5. Expectation of Investors
    We also are proposing four requirements designed to assure that 
investors understand that they are investing in a manager of managers 
fund, and to require that they receive information about who the 
subadvisers are and that the subadvisers could be changed at any time 
without shareholder approval. First, the rule would require that, 
except in the case of a newly offered fund, shareholders approve the 
fund's operation as a manager of managers fund, by authorizing the 
adviser (with the approval of the fund's board of directors) to enter 
into subadvisory contracts without shareholder approval.\40\ Second, we 
would amend Form N-1A to require that the fund disclose in its 
prospectus the principal adviser's ability, subject to the approval of 
the fund's board of directors, to retain and discharge subadvisers 
without shareholder approval.\41\
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    \40\ Proposed rule 15a-5(a)(3). If the fund has not publicly 
offered securities or sold securities to non-affiliates or promoters 
(or their affiliates), the rule would require that the board of 
directors approve the fund's operation as a manager of managers fund 
by authorizing the adviser to enter into subadvisory contracts 
without shareholder approval. Id. This condition also has been 
included as a condition to our orders.
    \41\ Proposed Instruction 3 to Item 4(b)(1) and proposed 
amendments to Item 6(a)(1)(i) of Form N-1A. The amendments to Form 
N-1A also would require the fund to disclose in its prospectus, in 
the discussion of principal investment strategies, the fund's use of 
(or reservation of its right to use) subadvisers that may be changed 
at any time. Proposed Instruction 3 to Item 4(b)(1). A fund also 
would have to disclose in its summary of principal investment 
strategies, required by Item 2(b) of Form N-1A, that the fund uses 
(or reserves the right to use) the services of one or more 
subadvisers without shareholder approval. See Item 2(b) of Form N-1A 
(Item 2(b) of the prospectus must identify, based on the information 
given in response to Item 4(b), the fund's principal investment 
strategies).
---------------------------------------------------------------------------

    Third, proposed rule 15a-5 would prohibit a fund from having a name 
that contains the subadviser's name unless the name of the principal 
adviser precedes the subadviser's name. This limitation is designed to 
prevent confusion about the relative roles of the adviser and 
subadviser. A fund name that includes the name of a subadviser might 
serve to invite investors to invest in the fund to obtain the advisory 
services of the subadviser rather than the adviser, which is arguably 
inconsistent with the basis upon which we have granted relief from the 
shareholder voting requirement for manager of managers funds. Use of 
such a name also suggests that the principal adviser is unlikely to be 
in a position to terminate the advisory contract without upsetting the 
investors who have invested for the purpose of seeking the advisory 
services of the subadviser. On the other hand, use of a subadviser's 
name may merely identify one investment option among many in a series 
fund.
    Fourth, we are proposing to require that when the principal adviser 
enters into a subadvisory contract or makes a material change to a 
wholly-owned subadviser's contract, the fund furnish shareholders with 
(and file with the Commission) an information statement that describes 
the subadvisory agreement, and contains other information that would 
have been provided in a proxy statement had a vote been held.\42\ This 
condition has been included in our exemptive orders.
---------------------------------------------------------------------------

    \42\ Proposed rule 15a-5(a)(5). The information would have to be 
provided to shareholders within 90 days of entering into a 
subadvisory contract or materially amending a wholly-owned 
subadviser's contract.
---------------------------------------------------------------------------

    [sbull] We request comment on whether the proposed requirements are 
adequate to assure that investors understand they are investing in a 
manager of managers fund. If they are not adequate, what additional 
requirements should be included? Should the rule simply prohibit the 
use of the subadviser's name in a manager of managers fund to assure 
that investors are investing in a fund based on the principal adviser's 
reputation for selecting and supervising subadvisers?
    [sbull] We are considering whether to adopt substantially similar 
amendments to Form N-3, the registration form for insurance company 
``managed separate accounts.'' \43\ Should we amend Form N-3, and if so 
should the amendments differ from the proposed Form N-1A amendments?
---------------------------------------------------------------------------

    \43\ 17 CFR 239.17a, 274.11b.
---------------------------------------------------------------------------

6. Number of Subadvisers
    Many manager of managers funds employ multiple subadvisers. Our 
exemptive orders, however, do not require the retention of a minimum 
number of subadvisers,\44\ and some funds operating under our orders 
use only one subadviser for the fund, or for each series of the 
fund.\45\
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    \44\ See, e.g., Frank Russell Investment Company, Investment 
Company Act Release Nos. 21108 (June 2, 1995) [60 FR 30321 (June 8, 
1995)] (notice) and 21169 (June 28, 1995) [59 SEC Docket 2105 (July 
25, 1995)] (order).
    \45\ See, e.g., Managed Accounts Services Portfolio Trust and 
Mitchell Hutchins Asset Management, Inc., Investment Company Act 
Release Nos. 21590 (Dec. 11, 1995) [60 FR 64461 (Dec. 15, 1995)] 
(notice) and 21666 (Jan. 11, 1996) [61 SEC Docket 142 (Feb. 6, 
1996)] (order) (order granted to fund in which each series of the 
fund was advised initially by a single subadviser).
---------------------------------------------------------------------------

    The conditions contained in our exemptive orders provide the same 
protections for funds with single subadvisers and those with multiple 
subadvisers.\46\ In each case, the conditions limit relief to funds in 
which the subadviser is analogous to a portfolio manager and in which 
shareholders were informed of the principal adviser's ability to retain 
new subadvisers without shareholder approval. Moreover, the principal 
adviser's ability to hire and fire subadvisers without shareholder 
approval benefits shareholders by allowing funds to terminate poorly 
performing subadvisers, while avoiding having to operate for a 
significant period of time without a subadviser providing investment 
management services.\47\ Also, subadviser changes are not infrequent 
for funds advised by single subadvisers.\48\ Therefore, the Commission 
has issued orders to funds with a single subadviser, and our proposed 
rule would not require that each fund or portfolio engage a certain 
minimum number of subadvisers.\49\

    \46\ For example, the compensation received by subadvisers to 
single subadviser funds is fully disclosed to investors. See supra 
Section II.A.1.
    \47\ Absent the impediment of operating without a subadviser, it 
is more likely that poorly performing subadvisers would be 
terminated.
    \48\ For example, between August 1999 and October 2000, 6 of 27 
American Skandia portfolios that employed only one subadviser 
replaced the subadviser. Between October 1999 and September 2000, 3 
of 11 Paine Webber PACE Select Advisors Trust portfolios that 
employed only one subadviser (as of October 1999) replaced the 
subadviser.
    \49\ Some have argued that the conditions of the Commission's 
exemptive orders were designed for funds in which a principal 
adviser selects and supervises multiple subadvisers, and that the 
costs and delays associated with a shareholder vote for a fund with 
one subadviser do not warrant exemptive relief. See Hillview 
Investment Trust II and Hillview Capital Advisors, LLC, Investment 
Company Act Release No. 25055 (June 29, 2001) [66 FR 35676 (July 6, 
2001)].

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

[[Page 61725]]

[sbull] We request comment on whether the circumstances involving 
single subadvisers are sufficiently similar to those involving multiple 
subadvisers, to justify similar treatment under the proposed 
amendments.
[sbull] Should the proposed rule include as a condition that the 
principal adviser engage multiple subadvisers for each fund, or each 
series of the fund? Should any of the conditions in the rule be 
modified in the case of single subadviser funds?

B. Rescission of Previously Issued Exemptive Orders

    As discussed above, we have issued over 100 orders permitting 
manager of managers funds to operate without the need for shareholder 
approval of new subadvisory contracts. Our rule proposal today is 
designed largely to codify the relief we have provided by order. 
However, the conditions in some of the orders vary slightly from 
others.\50\ We are concerned that, if we permit the continued operation 
of funds under the orders we have issued in the past, funds will be 
operating under different sets of conditions, which might have an 
adverse effect on competition.\51\ We therefore anticipate rescinding 
those orders upon adoption of the proposed rule.
---------------------------------------------------------------------------

    \50\ It is not unusual for the conditions in our orders to 
evolve as we and our staff gain experience with the operation of a 
type of a fund under an exemptive order.
    \51\ The rescission of the orders would not affect existing 
subadvisory contracts entered into under an order prior to the 
adoption of the proposed rule. However, new or renewed subadvisory 
contracts entered into after adoption of the proposed rule would 
have to comply with the proposed rule's requirements.

[sbull] We request comment on the possible effects caused by the 
rescission of the orders. If the Commission does not rescind the 
orders, how would competition be affected?

III. General Request for Comment

    The Commission requests comment on the proposed rule, rule 
amendments, and form amendments proposed in this Release. The 
Commission also requests suggestions for additional changes to existing 
rules or forms, and comments on other matters that might have an effect 
on the proposals contained in this Release. Commenters are requested to 
provide empirical data to support their views.

IV. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. As discussed above, proposed rule 15a-5 and the proposed 
amendments to Form N-1A would essentially codify existing exemptive 
orders that allow manager of managers funds and their principal 
advisers to enter into subadvisory contracts without shareholder 
approval. Therefore this analysis examines the costs and benefits to 
funds, advisers, and investors that would result from reliance on the 
exemptive relief under the proposed amendments, in comparison to the 
costs and benefits associated with obtaining an exemptive order from 
the Commission.

A. Benefits

    We anticipate that funds, their advisers, and their shareholders 
would benefit from the proposed rule and amendments.\52\ Funds and 
advisers that rely on the rule would be able to enter into subadvisory 
contracts without obtaining exemptive relief from the Act's shareholder 
approval requirement, which relief can be costly to funds and their 
shareholders.\53\ Obtaining an exemptive order also can entail delays 
for the fund that applies for relief, although these applications for 
relief are typically processed expeditiously.\54\
---------------------------------------------------------------------------

    \52\ Our staff estimates that approximately 2,798 portfolios 
(comprising portions of 631 open-end funds) have at least one 
subadviser and as such could benefit from the proposed rule and 
amendments. The staff's estimates are based on an examination of the 
information reported on Form N-SAR from July through December 2002.
    \53\ Based on discussions with fund representatives, the 
Commission estimates that obtaining an exemptive order for a manager 
of managers fund costs approximately $35,000.
    \54\ Our staff estimates, based upon orders issued in the past, 
that the exemptive application process (from initial filing to 
issuance of order) takes about eight months. During that time, 
Commission staff review and comment on applications, applicants 
submit responses to comments, the completed application is 
summarized in a notice to the public, and public comments are 
received and evaluated.
---------------------------------------------------------------------------

    Some of the conditions included in the proposed rule and amendments 
differ from the conditions or representations typically included in a 
manager of managers exemptive order. We anticipate that these 
differences will not yield significant costs or benefits. For example, 
an exemptive order for a fund that intends to provide only aggregate 
fee disclosure concerning subadvisers typically requires that the 
fund's independent directors retain independent legal counsel.\55\ The 
proposed rule would not require independent directors to retain legal 
counsel.
---------------------------------------------------------------------------

    \55\ See, e.g., Pitcairn Funds and Pitcairn Trust Company, 
Investment Company Act Release Nos. 25106 (Aug. 9, 2001) [66 FR 
42901 (Aug. 15, 2001)] (notice) and 25150 (Sept. 5, 2001) [75 SEC 
Docket 2214 (Oct. 2, 2001)] (order).
---------------------------------------------------------------------------

B. Costs

    Funds that choose to rely on the proposed amendments, as well as 
their advisers, would incur certain costs in complying with the 
rules.\56\ As discussed above, proposed rule 15a-5 includes a condition 
requiring the contract between a manager of managers fund and its 
principal adviser to provide that the adviser will supervise and 
monitor the performance of its subadvisers.\57\ If the Commission 
rescinds the previous exemptive orders granted for manager of managers 
funds, a fund that already has an exemptive order would need to modify 
its advisory contract to include that provision. Similarly, if an 
existing fund were to choose to operate as a manager of managers fund 
under the proposed amendments, it would need to modify its advisory 
contract.\58\
---------------------------------------------------------------------------

    \56\ Because the proposed rule is an exemptive rule, funds can 
choose whether or not to rely on it. Only those funds that choose to 
rely on the proposed rule would incur costs in complying with the 
rule.
    \57\ See supra Section II.A.2.
    \58\ Under our proposal, contracts between the principal adviser 
and subadvisers also would be required to authorize the principal 
adviser to terminate the subadvisory contract at any time without 
penalty. However, most if not all subadvisory contracts already 
contain such a provision, and therefore this condition would not 
impose a new cost on funds.
---------------------------------------------------------------------------

    The modification of advisory contracts in response to the proposed 
rule would impose one-time costs. The Commission anticipates providing 
a sufficiently long compliance period for the proposed amendments, so 
that the contract modifications could be made when the fund's board 
next approves a new advisory contract. Therefore we believe the costs 
involved in making the modifications would be minor.\59\
---------------------------------------------------------------------------

    \59\ For purposes of the Paperwork Reduction Act, the Commission 
staff has estimated that it would take a total of 5 hours and 
$1,287.77 per fund to comply with the condition of proposed rule 
15a-5 related to the supervision of subadvisers. During the first 
year after adoption of the rule, it is estimated that all funds that 
currently rely on exemptive orders (plus existing funds that would 
choose to rely on the proposed rule during the first year) would 
spend a total of 600 hours and $154,719 to comply with the 
supervision requirement. After the first year, the staff estimates 
that ten funds per year, whose securities have already been publicly 
offered, would seek to rely on the proposed rule and therefore would 
need to modify their advisory contracts with principal advisers. The 
Commission staff estimates that, after the first year, those ten 
funds together would annually spend 50 hours and $12,877 to comply 
with the supervision requirement.
---------------------------------------------------------------------------

    There are no new costs associated with any of the remaining 
conditions of the proposed rule and amendments. First, the proposed 
rule would require that the fund provide shareholders,

[[Page 61726]]

within 90 days of the entry into a subadvisory contract or a material 
change to a wholly-owned subadviser's contract, with an information 
statement that contains the information that would have been provided 
to shareholders in a proxy statement if a shareholder vote had been 
held.\60\ Second, the proposed rule would require funds to obtain 
shareholder authorization for a principal adviser to enter into 
subadvisory contracts without shareholder approval.\61\ Third, the 
proposed rule would require that disinterested directors comprise a 
majority of the fund board, and that the disinterested directors select 
and nominate any other disinterested directors.\62\ Fourth, the 
proposed rule would require independent directors, if they hire legal 
counsel, to hire an independent legal counsel.\63\ All of these 
conditions (or their substantial equivalent) are typically included in 
manager of managers exemptive orders, and therefore would not result in 
any new costs to funds, their advisers, or investors.\64\
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    \60\ Proposed rule 15a-5(a)(5).
    \61\ Proposed rule 15a-5(a)(3).
    \62\ Proposed rule 15a-5(a)(7)(i).
    \63\ Proposed rule 15a-5(a)(7)(ii).
    \64\ The manager of managers orders that also include relief 
from our disclosure rules require independent directors to retain 
independent counsel. The proposed rule would require that the 
independent directors have independent counsel only if they choose 
to retain counsel. Moreover, the amendments we made to a number of 
exemptive rules in January 2001, see supra notes 38-39 and 
accompanying text, make it likely that most funds that would use the 
exemptive relief provided by the proposed rule would already have 
independent counsel or would not retain legal counsel.
---------------------------------------------------------------------------

    Although the proposed rule would alter the relationship between the 
principal adviser and shareholders (by allowing the principal adviser 
to hire and terminate subadvisers without shareholder approval) and the 
principal adviser and its subadvisers, the effects of such alterations 
would be minimal because shareholders have the right to terminate 
subadvisers \65\ and principal advisers have a contractual duty to 
supervise their subadvisers.\66\
---------------------------------------------------------------------------

    \65\ Section 15(a)(3) of the Act [15 U.S.C. 80a-15(a)(3)] 
provides that any advisory contract must be terminable at any time 
by vote of a majority of the outstanding voting securities of the 
fund.
    \66\ The proposed rule would require the principal adviser's 
contract with the fund to include a provision requiring the 
principal adviser to supervise its subadvisers. See proposed rule 
15a-5(a)(4).
---------------------------------------------------------------------------

C. Request for Comment

    The Commission requests comment on the potential costs and benefits 
of the proposed rule and amendments and any suggested alternatives to 
the proposals. We encourage commenters to identify, discuss, analyze, 
and supply relevant data regarding any additional costs and benefits. 
For purposes of the Small Business Regulatory Enforcement Act of 
1996,\67\ the Commission also requests information regarding the 
potential impact of the proposals on the U.S. economy on an annual 
basis. Commenters are requested to provide data to support their views.
---------------------------------------------------------------------------

    \67\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

V. Consideration of Promotion of 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 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 whether the action will promote efficiency, 
competition, and capital formation.\68\ The Commission anticipates that 
the proposed amendments would not adversely affect efficiency, 
competition, or capital formation.
---------------------------------------------------------------------------

    \68\ 15 U.S.C. 80a-2(c), 15 U.S.C. 77b(b), and 15 U.S.C. 78c(f). 
Section 23(a)(2) of the Exchange Act also requires the Commission, 
in adopting rules under the Exchange Act, to consider the 
anticompetitive effects of any rule it adopts. 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The proposed amendments are intended to allow funds to enter into 
subadvisory contracts without shareholder approval, which would 
eliminate the need for funds to hold a shareholder meeting or obtain 
specific exemptive relief, either of which can be costly and time 
consuming. We anticipate that the proposed amendments would enhance 
efficiency by significantly reducing the time period needed for 
selecting subadvisers, while also reducing the fund's costs associated 
with the hiring of a new subadviser.\69\ Adoption of the proposed rule 
and rescission of the exemptive orders would subject all funds and 
advisers to the same conditions, and enable them to compete under more 
uniform conditions. The Commission does not expect the proposed 
amendments to have a material effect on competition or capital 
formation.\70\
---------------------------------------------------------------------------

    \69\ The proposed amendments permitting a fund to disclose only 
the aggregate fees paid to all of the fund's unaffiliated 
subadvisers also could enhance efficiency by allowing funds to 
negotiate fees lower than the subadviser's usual fee. See supra 
Section II.A.1.
    \70\ Similarly, the Commission does not expect the adoption of 
the proposed rule and amendments to have any anticompetitive 
effects. See supra note 68.
---------------------------------------------------------------------------

    The Commission requests comments on whether the proposed rule and 
proposed form and rule amendments, if adopted, would promote 
efficiency, competition, and capital formation. Comments will be 
considered by the Commission in satisfying its responsibilities under 
section 2(c) of the Investment Company Act, section 2(b) of the 
Securities Act, and sections 3(f) and 23(a)(2) of the Exchange Act.

VI. Paperwork Reduction Act

    Certain provisions of proposed rule 15a-5 and certain provisions of 
the proposed amendments to Form N-1A would result in new ``collection 
of information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995.\71\ The Commission is submitting these proposals 
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 title for the 
collection of information associated with the proposed rule is ``Rule 
15a-5 under the Investment Company Act of 1940, `Exemption from 
shareholder approval for certain subadvisory contracts.' '' The title 
for the collection of information associated with the proposed 
amendments is ``Form N-1A under the Investment Company Act of 1940 and 
Securities Act of 1933, `Registration Statement of Open-End Management 
Investment Companies.' '' 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 control number. The approved 
collection of information associated with Form N-1A, which would be 
revised by the proposed amendments, displays control number 3235-0307.
---------------------------------------------------------------------------

    \71\ 44 U.S.C. 3501.
---------------------------------------------------------------------------

    Proposed rule 15a-5 and the proposed amendments to Form N-1A would 
permit manager of managers funds to operate without obtaining 
shareholder approval when the fund's principal adviser hires a new 
subadviser or replaces an existing subadviser subject to certain 
conditions. The rule and amendments would largely codify numerous 
exemptive orders issued by the Commission. We believe that the 
information collection requirements of the proposed rule and amendments 
ensure that only manager of managers funds are eligible for relief, 
that shareholders are provided with information on the identity of the 
fund's subadvisers, and that shareholders are aware of a fund's and a 
principal adviser's ability to hire and fire subadvisers without 
shareholder approval. The provision of information in accordance with 
the proposed rule and amendments would be voluntary,

[[Page 61727]]

because rule 15a-5 is an exemptive rule and, therefore, funds may 
choose whether to rely on it. Because the information provided to the 
Commission on Form N-1A is available to the public, this analysis does 
not address the confidentiality of responses under the proposed rule.
    The proposed rule would require that a fund's contract with each 
principal adviser that retains the services of one or more subadvisers 
contain a provision obligating the principal adviser to supervise and 
oversee the activities of its subadvisers.\72\ The proposed rule also 
would require all contracts with subadvisers that are retained without 
shareholder approval to provide that the principal adviser may 
terminate the subadviser at any time without penalty.\73\
---------------------------------------------------------------------------

    \72\ Proposed rule 15a-5(a)(4).
    \73\ Proposed rule 15a-5(b)(4). Most subadvisory contracts 
already contain terms that allow the principal adviser to terminate 
the contract at any time. We therefore estimate that there would be 
no costs imposed on funds by this requirement.
---------------------------------------------------------------------------

    During the first year after adoption of the rule, the Commission 
staff estimates that requiring funds to modify their existing contracts 
with principal advisers so that each principal adviser is required to 
supervise and oversee the activities of its subadvisers would create an 
initial one-time burden of 5 hours per fund (4 hours by in-house 
counsel, .5 hours by fund directors, .5 hours by support staff) \74\ or 
about 600 burden hours.\75\ The Commission staff estimates that after 
the first year, approximately 10 registered open-end investment 
companies \76\ would spend, on average, 5 hours annually (4 hours by 
in-house counsel, .5 hours by fund directors, .5 hours by support 
staff) to modify their contracts regarding supervision, for a total of 
50 burden hours.
---------------------------------------------------------------------------

    \74\ These estimates are based on discussions with fund 
representatives.
    \75\ The Commission staff estimates that 120 funds would have to 
modify their advisory contracts with their principal advisers to 
comply with the proposed rule. These 120 funds include 101 funds 
that currently rely on exemptive orders, 9 funds that have filed an 
application for an exemptive order and, as explained infra note 76, 
10 additional funds that would choose to rely on the proposed rule 
during the first year. The total number of burden hours for the 
first year is 120 funds x 5 hours = 600 hours.
    \76\ Based on the number of manager of managers applications 
submitted since 1995, the staff estimates that 20 additional funds 
per year would seek to rely on the proposed rule. Approximately 10 
of those funds would be funds whose securities have already been 
publicly offered, and therefore would need to modify their advisory 
contracts with principal advisers.
---------------------------------------------------------------------------

    Rule 15a-5 also would require funds to provide shareholders (and 
file with the Commission), within 90 days of entering into a 
subadvisory contract or materially amending a wholly-owned subsidiary's 
subadvisory contract, with an information statement describing the 
agreement and containing all of the information shareholders would have 
received in a proxy statement had a shareholder vote been held.\77\ 
During the first 3 years after adoption of the proposed rule, the 
Commission staff estimates that 150 registered open-end investment 
companies \78\ would each spend 20 hours \79\ annually in preparing and 
distributing information statements. The total annual burden estimate 
for complying with the reporting requirement of rule 15a-5 would be 
3,000 hours annually.
---------------------------------------------------------------------------

    \77\ Proposed rule 15a-5(a)(5).
    \78\ Commission staff estimates that 130 funds (including 101 
funds that currently rely on exemptive orders, 9 funds that have 
filed an application for an exemptive order, and 20 additional funds 
that would have filed for exemptive relief during the first year 
after the rule's adoption) would rely on the proposed rule during 
the first year after its adoption. After the first year, the staff 
estimates that each year 20 additional funds would rely on the 
proposed rule.
    \79\ Based on discussions with fund representatives, the 
Commission estimates that on average each fund would hire two new 
subadvisers per year. Therefore, funds would be required to send to 
shareholders two information statements per year. Based on 
discussions with fund representatives, the Commission estimates that 
each fund would spend 10 hours to prepare and mail each information 
statement.
---------------------------------------------------------------------------

    The proposed amendments also would result in new information 
collection requirements. The proposed amendments to Form N-1A would 
require any fund that is authorized to hire one or more subadvisers 
without shareholder approval pursuant to proposed rule 15a-5, to 
disclose this information in its prospectus.\80\ The Commission 
believes that the added information collection burdens would be 
negligible and would be mostly offset by other disclosure amendments 
that would permit funds that comply with the requirements of proposed 
rule 15a-5 to disclose the aggregate fees paid to all unaffiliated 
subadvisers of the principal adviser, in lieu of the individual fee 
paid to each subadviser.\81\
---------------------------------------------------------------------------

    \80\ Proposed Instruction 3 to Item 4(b)(1) of Form N-1A would 
require a fund to disclose if it is authorized to use the services 
of subadvisers without shareholder approval. Proposed Item 
6(a)(1)(i) of Form N-1A would require a fund in its identification 
and description of its investment advisers to explain for each 
subadviser that serves the fund without shareholder approval that 
such adviser may be replaced, and additional subadvisers may be 
retained, without shareholder approval.
    \81\ Proposed Instruction 5 to Item 15(a)(3) of Form N-1A would 
allow funds to disclose the aggregate fees paid to all unaffiliated 
subadvisers of the principal adviser in lieu of the individual fee 
paid to each such subadviser.
---------------------------------------------------------------------------

    To arrive at the total information collection burden, a weighted 
average of the first year burden and the annual burden after the first 
year was calculated. Using a three-year period, the weighted average 
information collection burden is 3,232 hours.\82\ Pursuant to 44 U.S.C. 
3506(c)(2)(B), the Commission solicits comments in order to: (i) 
Evaluate whether the proposed collections of information are necessary 
for the proper performance of the functions of the Commission, 
including whether the information will have practical utility; (ii) 
evaluate the accuracy of the Commission's estimate of the 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) minimize the burden of the collections of 
information on those who are to respond, including through the use of 
automated collection techniques or other forms of information 
technology.
---------------------------------------------------------------------------

    \82\ The first year burden of 3,600 hours (600 hours to modify 
existing contracts + 3,000 hours to comply with the reporting 
requirement) is weighted (1 year / 3 years = 33 percent) as 1,188 
hours. The burden after the first year of 3,050 hours (50 hours to 
modify contracts + 3,000 hours to comply with the reporting 
requirement) is weighted (2 years / 3 years = 67 percent) as 2,044 
hours. The total weighted information collection burden hours for 
the proposed amendments are 1,188 + 2,044 = 3,232 hours.
---------------------------------------------------------------------------

    Persons wishing to submit comments on the collection of information 
requirements of the proposed rule and amendments should direct them to 
the Office of Management and Budget, Attention Desk Officer for the 
Securities and Exchange Commission, Office of Information and 
Regulatory Affairs, Room 10102, New Executive Office Building, 
Washington, DC 20503, and should send a copy to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-20-03. OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication of this Release; therefore a 
comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release. Requests 
for materials submitted to OMB by the Commission with regard to these 
collections of information should be in writing, refer to File No. S7-
20-03, and be submitted to the Securities and Exchange Commission, 
Records Management, Office of Filings and Information Services.

VII. Summary of Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis

[[Page 61728]]

(``IRFA'') in accordance with 5 U.S.C. 603 regarding proposed rule 15a-
5 under the Investment Company Act and proposed amendments to rule 6-07 
of Regulation S-X under the Investment Company Act and the Securities 
Act, Form N-1A under the Investment Company Act and the Securities Act, 
and Schedule 14A under the Exchange Act. The following summarizes the 
IRFA.
    The IRFA summarizes the background of the proposed rule and 
amendments. The IRFA also discusses the reasons for the proposed rule 
and amendments and the objectives of, and legal basis for, the rule and 
amendments. Those items are discussed above in this Release.
    The IRFA discusses the effect of the proposed rule and amendments 
on small entities. A small business or small organization 
(collectively, ``small entity'') for purposes of the Regulatory 
Flexibility Act is a fund that, together with other funds 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.\83\ Of approximately 
2,200 registered open-end investment companies (consisting of about 
9,000 portfolios), approximately 157 are small entities.\84\ 
Approximately 2,798 portfolios (comprising portions of 631 registered 
open-end investment companies) currently retain one or more 
subadvisers. Approximately 13 of the 631 registered open-end companies 
(containing 35 of the 2,798 portfolios) are small entities.\85\ Funds 
that are small entities, like other funds, may rely on the rule if they 
satisfy its conditions. The rule is an exemptive rule and therefore 
funds may choose not to rely on it.
---------------------------------------------------------------------------

    \83\ 17 CFR 270.0-10.
    \84\ Some or all of these entities may contain multiple series 
or portfolios. If a registered investment company is a small entity, 
the portfolios or series it contains are also small entities.
    \85\ These estimates are based on data reported on Form N-SAR 
filed with the Commission between July and December 2002.
---------------------------------------------------------------------------

    The Commission staff estimates that only two of the approximately 
one hundred exemptive orders issued by the Commission involved small 
entities. The staff anticipates that the number of funds seeking 
exemptive relief will continue to rise, but that the proportion of 
small funds to total funds will remain relatively stable in the 
future.\86\
---------------------------------------------------------------------------

    \86\ The Commission believes that small funds are unlikely to 
retain multiple subadvisers to manage fund assets because it would 
not be practical for subadvisers to manage a portion of a small 
fund's assets. A subadviser receives as a fee a percentage of the 
value of the assets under its management. Therefore, providing 
management services to a portion of a small fund's assets would not 
provide a large enough fee to justify the subadviser's time or 
effort. Because it is unlikely that a small fund would retain more 
than one subadviser, small funds rarely have reason to seek 
exemptive relief.
---------------------------------------------------------------------------

    The Commission staff expects the proposed rule and amendments to 
have little impact on small entities. Like other funds, small entities 
will be affected by the proposed rule and amendments only if they enter 
into a subadvisory contract with an unaffiliated or wholly-owned 
subadviser. Because the proposed rule is voluntary in nature, only 
small entities that choose to rely on the rule will be subject to its 
conditions.\87\ Moreover, the burdens imposed by the proposed rule and 
amendments should be more than offset by the fact that the proposed 
rule and amendments would enable funds, including small entities, to 
enter into subadvisory contracts without incurring the expenses 
associated with a shareholder vote or the filing of an application for 
exemption under section 6(c) of the Act.
---------------------------------------------------------------------------

    \87\ As noted above, to date only two small funds have obtained 
an exemptive order allowing them to enter into subadvisory contracts 
without shareholder approval. The Commission does not believe that 
the number of small funds seeking such relief will increase in the 
future. See supra note 86 and accompanying text.
---------------------------------------------------------------------------

    The IRFA discusses the reporting, recordkeeping, and compliance 
requirements associated with the proposed rule and amendments. It notes 
that the proposed rule would require funds to provide an information 
statement to its shareholders (and file it with the Commission) within 
90 days of the entry into a subadvisory contract or a material change 
to a wholly-owned subadviser's contract as a substitute for the proxy 
statement that the fund would have had to provide to each shareholder 
if a shareholder vote had been held.\88\
---------------------------------------------------------------------------

    \88\ Proposed rule 15a-5(a)(5). The exemptive orders that have 
been issued by the Commission require that shareholders be provided 
with an information statement in place of the proxy statement.
---------------------------------------------------------------------------

    The IRFA also explains that the proposed rule would impose 
compliance requirements. For funds relying on the proposed rule, the 
rule would require that: (i) the subadvisory contract: (a) does not 
directly or indirectly increase the management and advisory fees 
charged to the fund or its shareholders,\89\ and (b) provides that it 
may be terminated at any time, on no more than 60 days written notice, 
without penalty, by the principal adviser; \90\ (ii) the subadviser is 
not an affiliated person of the fund or the principal adviser with 
which it has contracted (other than by reason of serving as an 
investment adviser to the fund); \91\ (iii) no director or officer of 
the fund, and no principal adviser or director or officer of the 
principal adviser with which the subadviser has contracted, directly or 
indirectly owns any material interest in the subadviser other than an 
interest through ownership of shares of a pooled investment vehicle 
that is not controlled by such person or entity; \92\ (iv) shareholders 
of the fund have authorized a principal adviser, subject to approval by 
the board of directors, to enter into subadvisory contracts without 
shareholder approval or, if the fund's securities have not been 
publicly offered or sold to persons who are not promoters or affiliated 
persons of the fund, the directors have authorized the principal 
adviser to enter into such contracts; \93\ (v) the contract between the 
fund and a principal adviser provides that the principal adviser must 
supervise and oversee the activities of its subadvisers on behalf of 
the fund; \94\ (vi) if the fund identifies the subadviser as part of 
the fund's name or title, it also clearly identifies the principal 
adviser with which the subadviser has contracted, before the name of 
the subadviser; \95\ (vii) a majority of the directors of the fund are 
not interested persons of the fund, and those directors select and 
nominate any other disinterested directors; \96\ and (viii) any person 
who acts as legal counsel for the disinterested directors is an 
independent legal counsel.\97\
---------------------------------------------------------------------------

    \89\ Proposed rule 15a-5(a)(1).
    \90\ Proposed rule 15a-5(b)(4).
    \91\ Proposed rule 15a-5(a)(2)(i).
    \92\ Proposed rule 15a-5(a)(2)(i). The proposed rule would allow 
a wholly-owned subadviser to qualify for relief from section 15(a) 
of the Act even though it is an affiliate of the principal adviser 
and the principal adviser has an ownership interest in the 
subadviser, if the wholly-owned subadviser meets all of the other 
conditions of the proposed rule and the wholly-owned subadviser is 
replacing another wholly-owned subadviser or its contract has been 
materially amended. Proposed rule 15a-5(a)(2)(ii).
    \93\ Proposed rule 15a-5(a)(3).
    \94\ Proposed rule 15a-5(a)(4).
    \95\ Proposed rule 15a-5(a)(6).
    \96\ Proposed rule 15a-5(a)(7)(i).
    \97\ Proposed rule 15a-5(a)(7)(ii).
---------------------------------------------------------------------------

    The IRFA explains that the proposed rule would benefit funds by 
allowing them to enter into subadvisory contracts without shareholder 
approval, and thereby avoid incurring the costs and delay associated 
with the exemptive application process or with obtaining shareholder 
approval. The IRFA also notes that while the proposed rule would 
require funds to comply with numerous conditions, many of the 
compliance requirements do not involve any new costs on funds and those 
that

[[Page 61729]]

do would not result in a significant burden being placed on the 
funds.\98\
---------------------------------------------------------------------------

    \98\ The requirements regarding prohibited relationships between 
the subadviser and the fund or principal adviser (or their 
affiliates) do not involve any costs or burdens. The requirements 
regarding board composition and the selection and nomination of 
independent directors would not impose any new costs or burdens. 
Under our current manager of managers orders, funds are required to 
comply with the same board composition and selection and nomination 
requirements. The independent legal counsel requirement does not 
require independent directors to retain legal counsel, but those who 
are represented by counsel that does not meet the definition of 
``independent legal counsel'' would be required to retain different 
counsel if their fund chooses to rely on the proposed rule. The 
manager of managers orders that also include relief from our 
disclosure rules require independent directors to retain independent 
counsel. Moreover, the amendments we made to a number of exemptive 
rules in January 2001, see supra notes 38 and 39 and accompanying 
text, make it likely that most funds that would use the exemptive 
relief provided by the proposed rule would already have independent 
counsel or would not retain legal counsel.
    Requiring funds to furnish shareholders with an information 
statement (and file such statement with the Commission) following 
the retention of a new subadviser or a change in the fee paid to a 
wholly-owned subadviser would not impose any new costs on funds. 
Currently, funds either have to provide shareholders with a proxy 
statement in connection with seeking shareholder approval of the 
subadvisory contract or, if operating under a manager of managers 
exemptive order, have to provide shareholders with an information 
statement (and file such statement with the Commission). In the 
absence of the proposed rule, therefore, the fund still would be 
required to provide shareholders with the same information. 
Similarly, requiring the shareholders or the board of the fund to 
authorize the principal advisers to enter into subadvisory contracts 
without shareholder approval would not impose any new costs on the 
fund. Currently, a fund either has to receive shareholder approval 
of all subadvisory contracts or, if operating under a manager of 
managers exemptive order, obtain shareholder authorization for 
entering into subadvisory contracts without shareholder approval. In 
the absence of the proposed rule, therefore, the fund would still 
incur the same or greater costs in obtaining shareholder approval or 
operating under an order.
---------------------------------------------------------------------------

    The IRFA explains that the proposed amendments would impose 
reporting requirements on funds, but would not impose recordkeeping or 
compliance requirements. The proposed amendments would require any fund 
that is authorized to hire one or more subadvisers without shareholder 
approval pursuant to proposed rule 15a-5, to disclose this ability in 
its prospectus.\99\ Compliance with these amendments would require 
little time, involve no extra costs to funds, and should not impose a 
significant burden, if any, on funds, including small entities. 
Shareholders of funds would benefit by being fully informed of the 
fund's ability to replace subadvisers without shareholder approval.
---------------------------------------------------------------------------

    \99\ Proposed Instruction 3 to Item 4(b)(1) of Form N-1A would 
require a fund to disclose if it is authorized to use the services 
of subadvisers without shareholder approval. Proposed Item 
6(a)(1)(i) of Form N-1A would require a fund in its identification 
and description of its investment advisers to explain for each 
subadviser that serves the fund without shareholder approval that 
such subadviser may be replaced, and additional subadvisers may be 
retained, without shareholder approval.
---------------------------------------------------------------------------

    The proposed amendments also would allow a fund that complies with 
the requirements of proposed rule 15a-5 to decide not to disclose the 
individual fee paid to each unaffiliated subadviser of the principal 
adviser.\100\ For purposes of fee disclosure in the fund's Statement of 
Additional Information, the fund would be required to disclose in place 
of the individual fee paid to each subadviser (both as a dollar amount 
and as a percentage of its net assets) (i) the individual fees paid to 
the principal adviser and to each of its affiliated subadvisers 
(including its wholly-owned subadvisers), (ii) the net advisory fee 
retained by the principal adviser after payment of fees to all 
subadvisers, and (iii) the aggregate fees paid to all subadvisers that 
are not affiliated persons of the principal adviser.\101\ These 
amendments would benefit funds, including small entities, by reducing 
the disclosure burden on funds that qualify for relief under the 
proposed rule and by allowing the principal adviser to negotiate a 
lower advisory fee with each unaffiliated subadviser than the fee 
normally charged by each such subadviser.\102\
---------------------------------------------------------------------------

    \100\ Proposed rule 6-07(2)(d) of Regulation S-X, proposed 
Instruction 2 to Item 22(c) of Schedule 14A, and proposed 
Instruction 5 to Item 15(a)(3) of Form N-1A. In the absence of these 
amendments, funds would be required to disclose the individual fee 
paid to each subadviser.
    \101\ Proposed Instruction 5 to Item 15(a)(3) of Form N-1A.
    \102\ By allowing funds to disclose only the aggregate fee paid 
to all unaffiliated subadvisers, each unaffiliated subadviser would 
be more likely to accept a lower fee than the fee it charges to its 
other clients, because a subadviser's other clients would not be 
aware of the exact fee paid to each subadviser.
---------------------------------------------------------------------------

    The IRFA explains that the Commission has considered significant 
alternatives to the proposed rule and amendments that would accomplish 
the stated objective, while minimizing any significant adverse impact 
on small entities. The Commission believes that no alternative could 
carry out these objectives as effectively as the proposed rule and 
amendments.
    The Commission encourages the submission of comments on matters 
discussed in the IRFA. Specifically, comment is requested on the 
effects the proposed rule and amendments would have on small entities, 
and the number of small entities that would be affected. Commenters are 
asked to describe the nature of any effect and provide empirical data 
supporting the extent of the effect. These comments will be placed in 
the same public file as comments on the proposed rule and amendments 
themselves. A copy of the IRFA may be obtained by contacting Adam B. 
Glazer, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0506.

VIII. Statutory Authority

    The Commission is proposing to adopt new rule 15a-5 pursuant to the 
authority set forth in sections 6(c) and 38(a) [15 U.S.C. 80a-6(c) and 
80a-37(a)] of the Investment Company Act. The Commission is proposing 
amendments to rule 6-07 of Regulation S-X pursuant to authority set 
forth in section 7 of the Securities Act [15 U.S.C. 77g] and sections 8 
and 38(a) of the Investment Company Act [15 U.S.C. 80a-8, 80a-37(a)]. 
We are proposing amendments to Schedule 14A pursuant to authority set 
forth in sections 14 and 23(a)(1) of the Exchange Act [15 U.S.C. 78n, 
78w(a)(1)] and sections 20(a) and 38 of the Investment Company Act [15 
U.S.C. 80a-20(a), 80a-37]. We are proposing amendments to Form N-1A 
pursuant to authority set forth in sections 6, 7, 10, and 19(a) of the 
Securities Act [15 U.S.C. 77f, 77g, 77j, 77s(a)] and sections 8, 24(a), 
and 30 of the Investment Company Act [15 U.S.C. 80a-8, 80a-24(a), and 
80a-29].

List of Subjects

17 CFR Part 210

    Accounting, Reporting and recordkeeping requirements, Securities.

17 CFR Parts 239 and 240

    Reporting and recordkeeping requirements, Securities.

17 CFR Parts 270 and 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rules and Form Amendments

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

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

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


[[Page 61730]]


    Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77z-2, 77z-3, 
77aa(25), 77aa(26), 78c, 78j-1, 78l, 78m, 78n, 78o(d), 78q, 78u-5, 
78w(a), 78ll, 78mm, 79e(b), 79j(a), 79n, 79t(a), 80a-8, 80a-20, 80a-
29, 80a-30, 80a-31, 80a-37(a), 80b-3, 80b-11, 7202 and 7262, unless 
otherwise noted.

    2. Section 210.6-07 is amended by:
    a. Redesignating paragraphs 2.(d), (e), (f), and (g) as paragraphs 
2.(e), (f), (g), and (h); and
    b. Adding new paragraph 2.(d) to read as follows:


Sec.  210.6-07  Statements of operations.

* * * * *
    2. Expenses. * * *
    (d) If a registered investment company or separate series of a 
registered investment company (``Fund'') or a principal adviser (as 
defined in Sec.  270.15a-5(b)(2) of this chapter) of the Fund, in 
reliance on Sec.  270.15a-5 of this chapter, has entered into a 
contract or contracts with a subadviser (as that term is defined in 
Sec.  270.15a-5(b)(3) of this chapter) of the Fund without approval by 
a vote of the securities of the Fund, the investment advisory fee paid 
to any subadviser that is not an affiliated person (as defined in 15 
U.S.C. 80a-2(a)(3)) of the principal adviser with which it has 
contracted or of the Fund (other than by reason of serving as an 
investment adviser to the Fund) need not be disclosed as a separate 
expense item in response to paragraphs 2.(a), (b), or (c) of this 
section.
* * * * *

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

    3. 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 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    4. The authority citation for part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, 7202, 7241, 7262, and 7263; and 18 U.S.C. 1350, 
unless otherwise noted.

* * * * *
    5. Section 240.14a-101, Item 22, is amended by:
    a. Designating the Instruction before paragraph (c)(1) as 
Instruction 1 and adding Instruction 2; and
    b. Designating the Instruction after paragraph (c)(10) as 
Instruction 1 and adding Instruction 2.
    These additions and revisions read as follows:


Sec.  240.14a-101  Schedule 14A. Information required in proxy 
statement.

* * * * *
Item 22. Information required in investment company proxy statement.
* * * * *
    (c) * * *
    Instructions to paragraph (c). 1.* * *
    2. Where information is furnished in response to this item in order 
to comply with the requirements of Sec.  270.15a-5(a)(5) of this 
chapter, the rate of compensation and the aggregate amount of the fee 
paid to the subadviser (as that term is defined in Sec.  270.15a-
5(b)(3) of this chapter) need not be disclosed in response to any 
paragraph of this item, and the information required by paragraph 
(c)(9) of this item need not be disclosed, unless such subadviser is a 
wholly-owned subsidiary (as defined in 15 U.S.C. 80a-2(a)(43)) of the 
principal adviser (as that term is defined in Sec.  270.15a-5(b)(2) of 
this chapter) with which it has contracted.
* * * * *
    (10) * * *
    Instructions to paragraph (c)(10). 1. * * *
    2. Where information is furnished in response to this item in order 
to comply with the requirements of Sec.  270.15a-5(a)(5) of this 
chapter, the compensation information required by this paragraph 
(c)(10) need not be disclosed, unless the information pertains to a 
subadviser (as that term is defined in Sec.  270.15a-5(b)(3) of this 
chapter) that is a wholly-owned subsidiary (as defined in 15 U.S.C. 
80a-2(a)(43)) of the principal adviser (as that term is defined in 
Sec.  270.15a-5(b)(2) of this chapter) with which it has contracted.

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, and 80a-
39, unless otherwise noted.

* * * * *
    7. Section 270.15a-5 is added to read as follows:


Sec.  270.15a-5  Exemption from shareholder approval for certain 
subadvisory contracts.

    (a) Exemption from shareholder approval. Notwithstanding section 
15(a) of the Act (15 U.S.C. 80a-15(a)), a subadvisory contract need not 
be approved by a vote of a majority of the outstanding voting 
securities of a fund, if the following conditions are met:
    (1) No increase in fees. The subadvisory contract does not directly 
or indirectly increase the management and advisory fees charged to the 
fund or its shareholders.
    (2) Conflicting relationships prohibited.
    (i) The subadviser is not an affiliated person of the principal 
adviser with which it has contracted or of the fund (other than by 
reason of serving as an investment adviser to the fund), and no 
director or officer of the fund, and no principal adviser or director 
or officer of the principal adviser with which the subadviser has 
contracted, directly or indirectly owns any material interest in the 
subadviser other than an interest through ownership of shares of a 
pooled investment vehicle that is not controlled by such person (or 
entity); or
    (ii) The subadviser is a wholly-owned subsidiary (as defined in 
section 2(a)(43) of the Act (15 U.S.C. 80a-2(a)(43)) of the principal 
adviser, and the wholly-owned subsidiary has been hired as a subadviser 
to replace another wholly-owned subsidiary that has been terminated as 
a subadviser to the fund, or the subadvisory contract of a wholly-owned 
subsidiary has been materially amended.
    (3) Shareholder authorization. Shareholders of the fund have 
authorized a principal adviser, subject to approval by the board of 
directors, to enter into contracts with subadvisers without approval by 
a vote of the outstanding voting securities of the fund or, if the 
fund's securities have not been publicly offered or sold to persons who 
are not promoters or affiliated persons of the fund, the directors of 
the fund have authorized the principal adviser to enter into such 
contracts.
    (4) Supervision of subadvisers. A contract between the fund and a 
principal adviser provides that the principal adviser must supervise 
and oversee the activities of the subadviser under the subadvisory 
contract on behalf of the fund.
    (5) Disclosure to shareholders. Within 90 days after entry into a 
new subadvisory contract or after making a material change to a wholly-
owned subsidiary's existing subadvisory contract, the fund furnishes 
its shareholders with an information statement, which must be filed 
with the

[[Page 61731]]

Commission in accordance with the requirements of Sec.  240.14c-5(b) of 
this chapter, that describes the new agreement, and contains the 
information specified in Regulation 14C (17 CFR 240.14c-1 through 
240.14c-7), Schedule 14C (17 CFR 240.14c-101), and Item 22 of Schedule 
14A (17 CFR 240.14a-101) under the Securities Exchange Act of 1934 (15 
U.S.C. 78a-mm).
    (6) Fund name. If the fund identifies the subadviser as a part of 
the fund's name or title, it also clearly identifies in its name or 
title the principal adviser with which the subadviser has contracted, 
before the name of the subadviser.
    (7) Board of directors composition, selection, and representation.
    (i) A majority of the directors of the fund are not interested 
persons of the fund, and those directors select and nominate any other 
disinterested directors; and
    (ii) Any person who acts as legal counsel for the disinterested 
directors is an independent legal counsel.
    (b) Definitions.
    (1) Fund means a registered open-end management investment company, 
or separate series of a registered open-end management investment 
company.
    (2) Principal adviser means an investment adviser as defined in 
section 2(a)(20)(A) of the Act (15 U.S.C. 80a-2(a)(20)(A)).
    (3) Subadviser means an investment adviser as defined in section 
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
    (4) Subadvisory contract means a contract between a principal 
adviser and subadviser to a fund, under which contract the subadviser 
agrees to perform investment advisory services on behalf of the fund, 
and which is terminable at any time by the principal adviser, on no 
more than 60 days written notice, without payment of penalty.

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 in part 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.

    9. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is 
amended by:
    a. In Item 4(b)(1) by redesignating Instructions 3, 4, 5, 6, and 7 
as Instructions 4, 5, 6, 7, and 8 and adding new Instruction 3;
    b. In Item 6 adding a sentence to the end of paragraph (a)(1)(i) 
and a Note; and
    c. In Item 15 adding Instruction 5 before paragraph (b).
    These additions and revisions read as follows:

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

Form N-1A

* * * * *

Item 4. Investment Objectives, Principal Investment Strategies, and 
Related Risks

* * * * *
    (b) * * *
    (1) * * *
    Instructions. * * *
    3. A Fund that uses (or reserves the right to use) the services of 
any other investment adviser to implement the investment objectives, 
strategies, and policies of the Fund, without shareholder approval of 
those advisers' contracts in reliance on Sec.  270.15a-5, should regard 
such use (or reservation to use) as a principal investment strategy.
* * * * *

Item 6. Management, Organization, and Capital Structure

    (a) * * *
    (1) Investment Adviser.
    (i) * * * If the investment adviser is a subadviser whose contract 
has not been approved by shareholders in reliance on Sec.  270.15a-5, 
explain that the subadviser may be replaced, and that additional 
subadvisers may be retained, without shareholder approval.

    Note: If the Fund uses the services of more than one subadviser 
whose contracts have not been approved by shareholders in reliance 
on Sec.  270.15a-5, then the Fund may include a general statement, 
appropriately located, explaining that any of the subadvisers may be 
replaced, and that additional subadvisers may be retained, without 
shareholder approval.

* * * * *

Item 15. Investment Advisory and Other Services

    (a) * * *
    (3) * * *
    Instructions. * * *
    5. If the Fund and an investment adviser comply with the conditions 
of Sec.  270.15a-5(a)(1)-(7) and (b)(4) (which permits a subadviser to 
advise the Fund without shareholder approval), the Fund may elect not 
to disclose separately the fees paid to each subadviser that is not an 
affiliated person of the principal adviser with which it has 
contracted, if the Fund instead discloses, both as a dollar amount and 
as a percentage of its net assets:
    (a) The individual fees paid to the principal adviser of the Fund 
and to each subadviser that is an affiliated person of the principal 
adviser with which it has contracted;
    (b) The net advisory fee retained by the principal adviser after 
payment of fees to all subadvisers; and
    (c) The aggregate fees paid to all subadvisers of the Fund that are 
not affiliated persons of the principal adviser with which they have 
contracted.
* * * * *
    By the Commission.

    Dated: October 23, 2003.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-27198 Filed 10-28-03; 8:45 am]
BILLING CODE 8010-01-P