[Federal Register Volume 68, Number 242 (Wednesday, December 17, 2003)]
[Proposed Rules]
[Pages 70402-70419]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-31070]



[[Page 70401]]

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Part IV





Securities and Exchange Commission





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17 CFR Parts 239 and 274



Disclosure Regarding Market Timing and Selective Disclosure of 
Portfolio Holdings, Proposed Rule

  Federal Register / Vol. 68, No. 242 / Wednesday, December 17, 2003 / 
Proposed Rules  

[[Page 70402]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239 and 274

[Release Nos. 33-8343; IC-26287; File No. S7-26-03]
RIN 3235-AI99


Disclosure Regarding Market Timing and Selective Disclosure of 
Portfolio Holdings

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing amendments 
to Form N-1A under the Securities Act of 1933 and the Investment 
Company Act of 1940 to require open-end management investment companies 
to disclose in their prospectuses both the risks to shareholders of the 
frequent purchase and redemption of investment company shares, and the 
investment company's policies and procedures with respect to such 
frequent purchases and redemptions. The proposals would also amend 
Forms N-3, N-4, and N-6 to require similar prospectus disclosure for 
insurance company separate accounts issuing variable annuity and 
variable life insurance contracts. The Commission is also proposing to 
amend Forms N-1A and N-3 to clarify that open-end management investment 
companies and insurance company managed separate accounts that offer 
variable annuities, other than money market funds, are required to 
explain both the circumstances under which they will use fair value 
pricing and the effects of using fair value pricing. In addition, the 
Commission is proposing to require open-end management investment 
companies and insurance company managed separate accounts that offer 
variable annuities to disclose their policies and procedures with 
respect to the disclosure of their portfolio securities, and any 
ongoing arrangements to make available information about their 
portfolio securities.

DATES: Comments must be received on or before February 6, 2004.

ADDRESSES: To help us process and review your comments more 
efficiently, comments should be sent by one method only. Comments 
should be submitted in triplicate to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609. Comments also may be submitted electronically at the 
following e-mail address: [email protected]. All comment letters 
should refer to File No. S7-26-03; this file number should be included 
in the subject line if electronic mail is used. Comment letters will be 
available for public inspection and copying in the Commission's Public 
Reference Room, 450 Fifth Street, NW., Washington, DC 20549. 
Electronically submitted comment letters also 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 electronic mail addresses, from electronic submissions. You 
should submit only information that you wish to make available 
publicly.

FOR FURTHER INFORMATION CONTACT: Kieran G. Brown, Attorney, or Sanjay 
Lamba, Attorney, Office of Disclosure Regulation, Division of 
Investment Management, (202) 942-0721, at the Securities and Exchange 
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Commission, 450 Fifth Street, NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is proposing for comment amendments to Form N-1A [17 
CFR 239.15A and 274.11A], Form N-3 [17 CFR 239.17a and 274.11b], Form 
N-4 [17 CFR 239.17b and 274.11c], and Form N-6 [17 CFR 239.17c and 
274.11d], registration forms used by investment companies to register 
under the Investment Company Act of 1940 (``Investment Company Act'') 
and to offer their securities under the Securities Act of 1933 
(``Securities Act'').

Table of Contents

I. Introduction and Background
    A. Forward Pricing and Market Timing
    B. Selective Disclosure of Fund Portfolio Holdings
    C. Disclosure Proposals
II. Discussion
    A. Disclosure Concerning Frequent Purchases and Redemptions of 
Fund Shares
    B. Disclosure of Circumstances Under Which Funds Will Use Fair 
Value Pricing
    C. Selective Disclosure of Fund Portfolio Holdings
    D. Compliance Date
III. General Request for Comments
IV. Paperwork Reduction Act
V. Cost Benefit Analysis
    A. Benefits
    B. Costs
    C. Request for Comments
VI. Consideration of Effects on Efficiency, Competition, and Capital 
Formation
VII. Initial Regulatory Flexibility Analysis
VIII. Consideration of Impact on the Economy
IX. Statutory Authority
Text of Proposed Rule and Form Amendments

I. Introduction and Background

    Millions of individual American investors hold shares of open-end 
management investment companies (``mutual funds''), relying on these 
funds for their retirements, their children's educations, and their 
other basic financial needs.\2\ The tremendous growth of mutual funds 
reflects the trust that investors have placed in funds and the 
regulatory protections provided by the federal securities laws.
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    \2\ A management investment company is an investment company 
other than a unit investment trust or face-amount certificate 
company. See section 4 of the Investment Company Act [15 U.S.C. 80a-
4]. Management investment companies typically issue shares 
representing an undivided proportionate interest in a changing pool 
of securities, and include open-end and closed-end companies. See T. 
Lemke, G. Lins, A. Smith III, Regulation of Investment Companies, 
Vol. I, ch. 4, Sec.  4.04, at 4-5 (2002). An open-end company is a 
management company that is offering for sale or has outstanding any 
redeemable securities of which it is the issuer.
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    Recent allegations regarding late trading and abusive market 
timing, however, point to instances where it appears that some in the 
mutual fund industry, and some intermediaries that sell fund shares, 
have lost sight of their obligations to investors.\3\ These allegations 
relate to abuses in at least three areas:
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    \3\ See, e.g., Riva D. Atlas, Another Fund Faces Inquiry Over 
Trading, NEW YORK TIMES, October 22, 2003, at C4; Tom Lauricella, 
Two-Tier System: For Staid Mutual Fund Industry, Growing Probe 
Signals Shake Up--Investigators Find Indications of Widespread 
Abuses Hurting Small Investors--Unfair Pricing for Big Players, WALL 
STREET JOURNAL, October 20, 2003, at A1; Brooke A. Masters, Spitzer 
Alleges Mutual Fund Improprieties, WASHINGTON POST, September 4, 
2003, at E1.
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    [sbull] ``Late trading,'' the practice of placing orders to buy or 
redeem mutual fund shares after 4 p.m., Eastern time, as of which most 
funds calculate their net asset value (``NAV''), but receiving the 
price based on the 4 p.m. NAV;
    [sbull] Abuses related to ``market timing,'' including the alleged 
overriding of stated market timing policies by fund executives to 
benefit large investors at the expense of small investors, or to 
benefit the fund's investment adviser; and
    [sbull] The selective disclosure by some fund managers of their 
funds' portfolio holdings in order to curry favor with large investors.
    The Commission is extremely concerned by the abuses that have 
surfaced in the mutual fund industry, and we have taken vigorous 
enforcement action where abuses have been uncovered.\4\ We also 
believe,

[[Page 70403]]

however, that regulatory reforms are necessary to help prevent such 
abuses from recurring in the future. The Commission is proposing a 
package of rule amendments intended to address abuses that have 
surfaced in the areas of late trading, market timing, and selective 
disclosure. In this release, we are proposing disclosure reforms 
intended to shed more light on market timing and selective disclosure 
of portfolio holdings. In a second release, we are proposing amendments 
that would require that an order to purchase or redeem redeemable 
securities of a registered investment company be received by the 
company, its designated transfer agent, or a registered securities 
clearing agency by the time that the fund establishes for calculating 
its NAV in order to receive that day's price. In addition, we are 
publishing a release adopting rules requiring registered investment 
companies and investment advisers to adopt and implement written 
compliance policies and procedures, review those policies and 
procedures annually, and designate a chief compliance officer 
responsible for their administration.
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    \4\ See, e.g., In the Matter of Putnam Investment Management, 
LLC, Release No. IC-26255 (Nov. 13, 2003) (investment adviser 
violated antifraud provisions of the federal securities laws by 
failing to disclose potentially self-dealing short-term trading of 
mutual fund shares by several of its employees, and by failing to 
take adequate steps to detect and deter such trading activity 
through its own internal controls and its supervision of investment 
management professionals); In the Matter of James Patrick Connelly, 
Jr., Release No. IC-26209 (Oct. 16, 2003) (vice chairman of 
investment advisory firm violated antifraud provisions of the 
federal securities laws by allowing select investors to time mutual 
funds managed by the firm); In the Matter of Steven B. Markovitz, 
Release No. IC-26201 (Oct. 2, 2003) (hedge fund trader who engaged 
in late trading of mutual fund shares violated antifraud provisions 
of the federal securities laws and rule 22c-1(a) under the 
Investment Company Act).
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A. Forward Pricing and Market Timing

    Section 22 of the Investment Company Act of 1940 (the ``Investment 
Company Act'') regulates the pricing, distribution, and redemption of 
redeemable securities, including mutual fund shares.\5\ Paragraph (c) 
of section 22 gives the Commission broad power to regulate the pricing 
of redeemable securities, including the power to prescribe by rule 
methods for computing the price that a shareholder will receive upon 
redemption. Rule 22c-1(a) under the Investment Company Act requires 
mutual funds to sell and redeem their shares at a price based on the 
NAV next computed after receipt of an order. This requirement is 
referred to as ``forward pricing.'' The purpose of this requirement is 
to prevent dilution and assure that prices bear an appropriate relation 
to the current NAV of a mutual fund's shares.\6\ Rule 22c-1 generally 
requires mutual funds to compute their NAVs at least once daily, Monday 
through Friday, at a specific time or times as determined by their 
boards.\7\ Typically, mutual funds calculate their NAVs once each day 
at or near the close of the major U.S. securities exchanges and markets 
(usually 4 p.m., Eastern time).
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    \5\ Both mutual funds and unit investment trusts issue 
redeemable securities. See section 4(2) and 5(a)(1) of the 
Investment Company Act [15 U.S.C. 80a-4(2) and 80a-5(a)(1)]. For 
purposes of simplicity, this section of the release only refers to 
mutual funds.
    \6\ Investment Company Act Release No. 5519 (Oct. 16, 1968) [33 
FR 16331 (October 8, 1968) (adopting rule 22c-1) (``Rule 22c-1 
Adopting Release'').
    \7\ Rule 22c-1(b) under the Investment Company Act [17 CFR 
270.22c-1(b)].
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    Mutual funds generally calculate their NAVs by using the closing 
prices of portfolio securities on the exchange or market on which the 
securities principally trade. In some cases, however, the closing price 
of a security held in a mutual fund's portfolio may not reflect its 
current market value at the time of the fund's NAV calculation, for 
example, if an event that will affect the value of those securities has 
occurred since the closing price was established, but before the fund's 
NAV calculation.\8\
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    \8\ Investment Company Act Release No. 14244 (Nov. 21, 1984) [49 
FR46558, 46559-46660 n.7 (Nov. 27, 1984)].
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    When market quotations for a portfolio security are not readily 
available (including when market quotations are unreliable), a mutual 
fund is required to calculate its NAV by using the fair value of that 
security, as determined in good faith by the fund's board.\9\ In a 
separate release adopting rule 38a-1 under the Investment Company Act, 
we are reemphasizing the obligation of mutual funds to fair value their 
securities under certain circumstances. If a mutual fund misprices its 
shares by failing to use fair value pricing when market quotations for 
its portfolio securities are unreliable, an investor may take advantage 
of the disparity between the portfolio securities' last quoted prices 
and their fair value. When mutual fund shares are mispriced, short-term 
traders have an arbitrage opportunity that they can use to exploit the 
fund and disadvantage the fund's long-term investors by extracting 
value from the fund without assuming any significant investment risk, 
through market timing.\10\ Mutual funds that fair value their portfolio 
securities consistent with their obligations can effectively reduce or 
eliminate the profit that market timers seek to exploit.\11\
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    \9\ See Accounting Series Release No. 118 (Dec. 23, 1970) [35 FR 
19986 (Dec. 31, 1970)]; Investment Company Act Release No. 14244 
(Nov. 21, 1984) [49 FR46558, 46559-46660 n.7 (Nov. 27, 1984)]. 
Subsequent to the issuance of these releases, our staff has reminded 
funds of their fair valuation obligations. In 1999 and 2001, the 
Division of Investment Management issued interpretive letters 
elaborating on funds' obligations under sections 2(a)(41) of the 
Investment Company Act and rule 22c-1 [17 CFR 270.22c-1] thereunder. 
Letter from Douglas Scheidt, Associate Director and Chief Counsel, 
SEC Division of Investment Management, to Craig S. Tyle, General 
Counsel, Investment Company Institute (Dec. 8, 1999) (http://www.sec.gov/divisions/investment/guidance/tyle120899.htm); Letter 
from Douglas Scheidt, Associate Director and Chief Counsel, SEC 
Division of Investment Management, to Craig S. Tyle, General 
Counsel, Investment Company Institute (Apr. 30, 2001) (http://www.sec.gov/divisions/investment/guidance/tyle043001.htm).
    \10\ See Rule 22c-1 Adopting Release, supra note 6 (describing 
market timing). Market timing may take many forms. In this release, 
we use the term to refer to arbitrage activity involving the 
frequent buying and selling of mutual fund shares in order to take 
advantage of the fact that there may be a lag between a change in 
the value of a mutual fund's portfolio securities and the reflection 
of that change in the fund's share price.
    \11\ ``Fair valuation'' refers to the process of determining the 
current market value of a security when market quotations are not 
readily available (such as when there are no market quotations for 
the security or if the market quotations for the security are 
unreliable). When market quotations for a security are not readily 
available, a fund is required to calculate its NAV by using the fair 
value of that security, as determined in good faith by the fund's 
board.
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    Mutual funds that invest in overseas securities markets are 
particularly vulnerable to market timers who may take advantage of time 
zone differences between the foreign markets on which international 
funds' portfolio securities trade and the U.S. markets which generally 
determine the time as of which NAV is calculated (``time-zone 
arbitrage''). For example, a market timer may purchase shares of a 
mutual fund that invests in overseas markets based on events occurring 
after foreign market closing prices are established, but before the 
fund's NAV calculation, that are likely to result in higher prices in 
foreign markets the following day. The market timer would redeem the 
fund's shares the next day when the fund's share price would reflect 
the increased prices in foreign markets, for a quick profit at the 
expense of long-term fund shareholders. Market timing opportunities are 
not limited to international funds. Mutual funds that invest in small-
cap securities and other types of investments which are not frequently 
traded, including high-yield bonds, also can be the targets of market 
timers.\12\
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    \12\ See Eric Zitzewitz, Who Cares About Shareholders? 
Arbitrage-Proofing Mutual Funds, Research Paper No. 1749, Stanford 
Graduate School of Business Research Paper Series (Oct. 2002), 
available at http://faculty-gsb.stanford.edu/zitzewitz/Research/arbitrage1002.pdf (``Zitzewitz''), at 2 (estimating arbitrage 
returns available in domestic small-cap equity funds at 20-25 
percent and estimating arbitrage returns available in convertible 
and high-yield and convertible bond funds at 10-25 percent). See 
also William Goetzmann, Zoran Ivkovich, and K. Geert Rouwenhorst, 
Day Trading International Mutual Funds: Evidence and Policy 
Solutions, Working Paper No. ICF-00-03, Yale School of Management, 
Yale University (Oct. 2000), available at: http://papers.ssrn.com/paper.taf?abstract_id=217168, at 7-8 (describing opportunities for 
arbitrage in stale pricing of Russell 2000 index).

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[[Page 70404]]

    Market timing itself is not illegal. However, market timing may 
dilute the value of long-term shareholders' interests in a mutual fund 
if the fund calculates NAV using closing prices that are no longer 
accurate. Dilution may occur, for example, if fund shares are 
overpriced because redeeming shareholders will receive a windfall at 
the expense of the shareholders that remain in the fund. Similarly, 
dilution may occur when a fund sells its shares at a price lower than 
its NAV.\13\
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    \13\ By one estimate, dilution resulting from market timing can 
cost investors in international stock funds that are focused on a 
particular geographic region as much as 2.3% of their assets each 
year, and may cost fund shareholders as a whole up to $4.9 billion 
per year. See Zitzewitz, supra note 12, at 2 and 16; Jason Greene 
and Charles Hodges, The Dilution Impact of Daily Fund Flows on Open-
End Mutual Funds: Evidence and Policy Solutions, 36 Journal of 
Financial Economics, 131-158 (2002) (estimating annualized dilution 
from market timing of 0.48% in international funds and nearly 1% for 
a subsample of funds whose daily flows are particularly large).
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    Market timing also may harm shareholders because it may cause 
mutual funds to manage their portfolios in a disadvantageous manner. 
For example, a mutual fund's investment adviser may maintain a larger 
percentage of its assets in cash or may be forced to liquidate certain 
portfolio securities prematurely to meet higher levels of redemptions 
due to market timing. This is particularly true for mutual funds that 
invest primarily in foreign or emerging market securities, which are 
often thinly traded. Mutual funds also may incur increased brokerage 
and administrative costs related to the frequent purchases and 
redemptions associated with market timing.
    In order to discourage market timers, many mutual funds have 
developed policies and procedures with respect to frequent purchases 
and redemptions of fund shares. Some mutual funds disclose in their 
prospectuses that they do not permit market timing, and many mutual 
funds have taken steps to discourage market timing. These steps may 
include, for example:
    [sbull] Imposing redemption or exchange fees on shares that are 
redeemed or exchanged within a certain time period following their 
purchase;
    [sbull] Restricting exchange privileges, for example, by 
restricting exchange requests submitted through a particular medium, 
such as telephone or facsimile transmission, or received after a 
certain time of day, or by delaying both the redemption and purchase 
sides of an exchange;
    [sbull] Restricting frequent trading, for example by limiting the 
total number of exchanges that an investor may make within a certain 
time period, or by limiting the number of ``round trip'' transactions 
where an investor purchases shares of a fund, exchanges those shares 
for shares of a different fund, and then exchanges back into the 
originally purchased fund;
    [sbull] Delaying the payment of the proceeds from the redemption of 
fund shares for up to seven days;\14\ and
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    \14\ Under section 22(e) of the Investment Company Act [15 
U.S.C. 80a-22(e)], in general no registered investment company may 
suspend the right of redemption, or postpone the date of payment or 
satisfaction upon redemption of any redeemable security, for more 
than seven days after the tender of such security to the company or 
its agent designated for that purpose for redemption.
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    [sbull] Identifying market timers and restricting their trading 
privileges or expelling them from the fund.
    While many mutual funds disclose in their prospectuses that they 
discourage market timing, many do not identify with specificity the 
frequency or type of trading that they consider to be problematic, or 
the specific steps that they will take to ensure that market timing 
trades are detected and prevented. Other mutual funds disclose 
specifically the number of trades that they consider to be problematic 
and the steps that they take to prevent and detect market timing. Item 
7(c) of Form N-1A requires mutual funds to disclose in their 
prospectuses procedures for redeeming the fund's shares, including any 
restrictions on redemptions; any redemption charges, including how 
these charges will be collected and under what circumstances the 
charges will be waived; and the circumstances, if any, under which the 
fund may delay honoring a request for redemption for a certain time 
after a shareholder's investment.\15\ Item 8(a)(2) of Form N-1A 
requires a description of exchange privileges, which may be provided in 
the prospectus or the Statement of Additional Information 
(``SAI'').\16\ Item 3 of Form N-1A requires a mutual fund to include 
any exchange fee or redemption fee in the fee table of its 
prospectus.\17\
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    \15\ Items 7(c)(1), (c)(2), and (c)(6) of Form N-1A. Form N-1A 
is the registration form used by mutual funds to register under the 
Investment Company Act and to offer their shares under the 
Securities Act of 1933 [15 U.S.C. 77a].
    \16\ Item 8(a)(2) of Form N-1A. Similarly, Items in the 
registration forms for insurance company separate accounts that 
issue variable annuities and variable life insurance policies 
require disclosure of provisions and limitations for transfers of 
contract value among sub-accounts of the separate account. Item 
8(b)(ii) of Form N-3; Item 7(b)(ii) of Form N-4; Item 6(b)(2) of 
Form N-6.
    The SAI is part of a fund's registration statement and contains 
information about a fund in addition to that contained in the 
prospectus. The SAI is required to be delivered to investors upon 
request and is available on the Commission's Electronic Data 
Gathering, Analysis, and Retrieval System.
    \17\ Item 3 and Instructions 2(b) and 2(c) to Item 3 of Form N-
1A. Similarly, Item 3(a) and Instruction 10 to Item 3(a) of Form N-
3; Item 3(a) and Instruction 11 to Item 3(a) of Form N-4; and Item 3 
and Instruction 2(b) to Item 3 of Form N-6 require fee table 
disclosure of fees charged for transfers of contract value among 
sub-accounts.
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    Other aspects of mutual fund policies and procedures to deter 
market timing are not explicitly required to be disclosed, however. For 
example, our registration forms do not explicitly require funds to 
describe with specificity the circumstances under which restrictions on 
frequent purchases and redemptions will not be imposed, or the terms of 
arrangements with particular investors pursuant to which frequent 
purchases and redemptions are permitted.\18\
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    \18\ Commission staff sent information requests to 88 of the 
largest mutual fund complexes, with approximately 90% of the fund 
industry's total assets and 4,100 individual funds or portfolios 
under management. Fifty percent of the fund groups that responded to 
these staff information requests appear to have one or more 
arrangements with certain shareholders to allow these shareholders 
to engage in market timing.
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    We believe that it may be useful to require mutual funds to 
describe with specificity the restrictions they place on frequent 
purchases and redemptions and the circumstances and arrangements under 
which the restrictions are not imposed. These additional disclosure 
requirements would enable investors to better assess a mutual fund's 
risks, policies, and procedures in this area, and to determine if a 
fund's policies and procedures are in line with their expectations.

B. Selective Disclosure of Fund Portfolio Holdings

    Currently, mutual funds are required to include their complete 
portfolio holdings in the reports that are delivered to all 
shareholders twice a year.\19\ In December 2002, we proposed amendments 
that would require mutual funds to disclose their complete

[[Page 70405]]

portfolio schedules on a quarterly basis.\20\ A significant majority of 
funds already make their full portfolio schedules publicly available at 
least quarterly.\21\
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    \19\ Section 30(e) of the Investment Company Act [15 U.S.C. 80a-
29(e)] (requiring a registered investment company to transmit to its 
stockholders, at least semi-annually, reports containing financial 
statements and other financial information as the Commission may 
prescribe by rules and regulations); rule 6-10(c)(1) of Regulation 
S-X [17 CFR 210.6-10(c)(1)] (requiring that a portfolio schedule be 
filed in support of the balance sheet entry for investments in 
securities of unaffiliated issuers).
    \20\ Investment Company Act Release No. 25870 (Dec. 18, 2002) 
[68 FR 160 (Jan. 2, 2003)].
    \21\ See Scott Cooley, Tell Investors What They Own, Morningstar 
Online, Feb. 6, 2002 (more than 70% of funds currently provide 
monthly or quarterly portfolio disclosure to Morningstar). See also 
Tom Lauricella and Aaron Lucchetti, To Industry, Silence is Golden--
Mutual Funds Embrace Disclosure Rules--As Long as it Doesn't Involve 
Them, Wall Street Journal Europe, Aug. 1, 2002, at M1 (roughly 200 
fund firms and 17 of the top 20 largest funds provide quarterly or 
monthly holdings updates to investors); Survey of Fund Groups' 
Portfolio Disclosure Policies Summary of Results, Investment Company 
Institute (2001), available at: http://www.ici.org/port_holdings_appdxa.html.
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    Recent allegations, however, have highlighted instances where some 
mutual fund managers may be selectively disclosing their portfolios in 
order to reward large investors. Specifically, allegations have been 
made that certain funds gave frequent updates of their portfolio 
holdings to favored shareholders, enabling these shareholders to use a 
fund's portfolio information to short the fund's holdings in the same 
or similar proportions to the fund's established positions.\22\ In 
addition, more than 30% of mutual fund complexes that responded to a 
recent Commission examination request for information sent to 88 of the 
largest such complexes appear to have disclosed portfolio information 
in circumstances that may have provided certain fund shareholders with 
the ability to make advantageous decisions to place orders for fund 
shares. This selective disclosure can facilitate fraud and have 
severely adverse ramifications for a fund's investors if someone uses 
that portfolio information to trade against the fund, or otherwise uses 
the information in a way that would harm the fund.
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    \22\ See State of New York v. Canary Capital Partners, LLC, et. 
al., at 25 and 41, (N.Y. Sup. Ct., filed Sept. 3, 2003) available 
at: http://www.oag.state.ny.us/press/2003/sep/canary_complaint.pdf 
(alleging that fund group regularly provided investor with detailed 
breakdowns of the portfolios of the target funds, allowing the 
investor to sell short the stocks that the portfolios contained); 
Ian McDonald, Will Funds Disclose More--Publicly?, The Wall Street 
Journal, Sept. 9, 2003, at C1 (describing allegations that fund 
groups provided hedge fund with more frequent reports on their fund 
holdings than were available to other investors).
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    We are concerned about the misuse of material, nonpublic 
information that may occur when a mutual fund's portfolio holdings are 
selectively disclosed and professional traders are given the 
opportunity to use this information to their advantage to the detriment 
of fund shareholders. For many issuers, Regulation FD generally 
requires that when an issuer discloses material information, it do so 
through public disclosure, not through selective disclosure.\23\ 
Regulation FD does not, however, apply to mutual funds.\24\ We have 
concluded that the recent allegations regarding selective disclosure of 
portfolio holdings by some mutual fund managers suggest that we need to 
take steps to reinforce funds' and advisers' obligations to prevent the 
misuse of portfolio holdings information that is selectively disclosed.
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    \23\ Regulation FD [17 CFR 243.100 et seq.]; Investment Company 
Act Release No. 24599 (Aug. 15, 2000) [65 FR 51716 (Aug. 24, 2000)] 
(adopting Regulation FD).
    \24\ Rule 101(b) of Regulation FD [17 CFR 243.101(b)].
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C. Disclosure Proposals

    The Commission is proposing form amendments to require better 
disclosure with respect to the tools that mutual funds use to combat 
market timing activity. First, in order to enable investors to assess a 
mutual fund's practices regarding frequent purchases and redemptions of 
fund shares to determine if they are in line with their expectations, 
the Commission is proposing to require improved disclosure in fund 
prospectuses of a mutual fund's risks, policies, and procedures in this 
area. The proposals would:
    [sbull] Require a mutual fund to describe in its prospectus the 
risks, if any, that frequent purchases and redemptions of fund shares 
may present for other shareholders;
    [sbull] Require a mutual fund to state in its prospectus whether or 
not the fund's board of directors has adopted policies and procedures 
with respect to frequent purchases and redemptions of fund shares and, 
if the board has not adopted any such policies and procedures, state 
the specific basis for the view of the board that it is appropriate for 
the fund not to have such policies and procedures;
    [sbull] Require a mutual fund to describe any policies and 
procedures for deterring frequent purchases and redemptions of fund 
shares, and any arrangements to permit frequent purchases and 
redemptions of fund shares; and
    [sbull] Require similar disclosure in prospectuses for insurance 
company separate accounts offering variable insurance contracts, with 
respect to frequent transfers among sub-accounts.
    Second, we are proposing to clarify instructions to our 
registration forms to require all mutual funds (other than money market 
funds) and insurance company managed separate accounts that offer 
variable annuities to explain in their prospectuses both the 
circumstances under which they will use fair value pricing and the 
effects of using fair value pricing. As described above, fair valuation 
of a fund's portfolio securities, which is required under certain 
circumstances, can serve to foreclose arbitrage opportunities available 
to market timers.
    In addition, in order to provide greater transparency of fund 
practices with respect to the disclosure of the fund's portfolio 
holdings, and to reinforce funds' and advisers' obligations to prevent 
the misuse of material, non-public information, the Commission is 
proposing to require mutual funds and insurance company managed 
separate accounts that offer variable annuities to disclose their 
policies with respect to disclosure of portfolio holdings information. 
The proposals would:
    [sbull] Require a fund to describe in its SAI any policies and 
procedures with respect to the disclosure of the fund's portfolio 
securities to any person and any ongoing arrangements to make available 
information about the fund's portfolio securities to any person; and
    [sbull] Require a fund to state in its prospectus that a 
description of the policies and procedures is available in the fund's 
SAI, and on the fund's Web site, if applicable.

II. Discussion

A. Disclosure Concerning Frequent Purchases and Redemptions of Fund 
Shares

    The Commission is proposing amendments to Form N-1A, the 
registration form used by mutual funds, that would require disclosure 
of both the risks to fund shareholders of the frequent purchase and 
redemption of fund shares, and a fund's policies and procedures with 
respect to such frequent purchases and redemptions.\25\ As discussed 
above, market timing strategies often involve such frequent purchases 
and redemptions of fund shares. These proposals are intended to require 
mutual funds to describe with specificity the restrictions they place 
on frequent purchases and redemptions, if any, and the circumstances 
under which any such restriction will not apply. This additional 
disclosure would enable investors to assess mutual funds' risks, 
policies, and procedures in this area and determine if a fund's 
policies and procedures are in line with their

[[Page 70406]]

expectations.\26\ We are also proposing similar amendments to the 
registration forms for insurance company separate accounts that issue 
variable annuities and variable life insurance policies.\27\
---------------------------------------------------------------------------

    \25\ Proposed Item 7(e) of Form N-1A.
    \26\ In our release adopting rule 38a-1 under the Investment 
Company Act, we state that a fund must have procedures reasonably 
designed to ensure compliance with its disclosed policies regarding 
market timing.
    \27\ Proposed Item 8(e) of Form N-3; proposed Item 7(e) of Form 
N-4; proposed Item 6(f) of Form N-6.
---------------------------------------------------------------------------

    The amendments that we are proposing to Form N-1A would require 
that a mutual fund's prospectus describe the risks, if any, that 
frequent purchases and redemptions of fund shares may present for other 
shareholders of the fund.\28\ These risks may include, among other 
things, dilution in the value of fund shares held by long-term 
shareholders, interference with the efficient management of the fund's 
portfolio, and increased brokerage and administrative costs. The 
disclosure should be specific to the fund, taking into account its 
investment objectives, policies, and strategies. For example, we would 
generally expect a fund that invests in overseas markets to describe 
the risks of time-zone arbitrage.
---------------------------------------------------------------------------

    \28\ Proposed Item 7(e)(1) of Form N-1A.
---------------------------------------------------------------------------

    The proposed amendments would also require a mutual fund's 
prospectus to state whether the fund's board of directors has adopted 
policies and procedures with respect to frequent purchases and 
redemptions of fund shares by fund shareholders.\29\ If the fund's 
board of directors has not adopted any such policies and procedures, 
the fund's prospectus would be required to include a statement of the 
specific basis for the view of the board that it is appropriate for the 
fund not to have such policies and procedures.\30\ On the other hand, 
if the fund's board of directors has adopted such policies and 
procedures, the fund's prospectus would be required to include a 
description of those policies and procedures, including:
---------------------------------------------------------------------------

    \29\ Proposed Item 7(e)(2) of Form N-1A.
    \30\ Proposed Item 7(e)(3) of Form N-1A.
---------------------------------------------------------------------------

    [sbull] Whether or not the fund discourages frequent purchases and 
redemptions of fund shares by fund shareholders;
    [sbull] Whether or not the fund accommodates frequent purchases and 
redemptions of fund shares by fund shareholders;
    [sbull] Any policies and procedures of the fund for deterring 
frequent purchases and redemptions of fund shares by fund shareholders; 
and
    [sbull] Any policies and procedures of the fund for detecting 
frequent purchases and redemptions of fund shares, including any 
arrangements for detecting frequent purchases and redemptions of fund 
shares through intermediaries, such as investment advisers, broker-
dealers, transfer agents, and third party administrators.\31\
---------------------------------------------------------------------------

    \31\ Proposed Item 7(e)(4) of Form N-1A.
    Persons that are not registered as broker-dealers need to 
consider whether the securities activities that they are undertaking 
are brokerage activities that require them to register as broker-
dealers. Section 3(a)(4) of the Securities Exchange Act of 1934 
(``Exchange Act'') defines a broker as a person engaged in the 
business of effecting transactions in securities. It includes 
several exceptions for certain bank activities. Section 15 of the 
Exchange Act essentially makes it unlawful for a broker or dealer 
``to effect any transactions in, or to induce or attempt to induce 
the purchase or sale of, any security (other than an exempted 
security or commercial paper, bankers' acceptances, or commercial 
bills)'' unless the broker or dealer is registered with the 
Commission.
---------------------------------------------------------------------------

    The description of the mutual fund's policies and procedures, if 
any, for deterring frequent purchases and redemptions of fund shares by 
fund shareholders would be required to include any restrictions imposed 
by the fund to prevent or minimize such frequent purchases and 
redemptions, including:
    [sbull] Any restrictions on the volume or number of purchases, 
redemptions, or exchanges that a shareholder may make within a given 
time period;
    [sbull] Any exchange fee or redemption fee;
    [sbull] Any costs or administrative or other fees or charges that 
are imposed on shareholders deemed to be engaged in frequent purchases 
and redemptions of fund shares, together with a description of the 
circumstances under which such costs, fees, or charges will be imposed;
    [sbull] Any minimum holding period that is imposed before an 
investor may make exchanges into another fund;
    [sbull] Any restrictions imposed on exchange or purchase requests 
submitted by overnight delivery, electronically, or via facsimile or 
telephone; and
    [sbull] Any right of the fund to reject, limit, delay, or impose 
other conditions on exchanges or purchases or to close or otherwise 
limit accounts based on a history of frequent purchases and redemptions 
of fund shares, including the circumstances under which such right will 
be exercised.
    The proposals would require that the policies and procedures for 
deterring frequent purchases and redemptions, including any 
restrictions imposed to prevent or minimize such frequent purchases and 
redemptions, be described with specificity.\32\ For example, a fund 
might state that a 2% redemption fee will be applied to all redemptions 
within 60 days after purchase or, in describing any restrictions on the 
volume or number of purchases, redemptions, or exchanges that a 
shareholder may make within a given time period, a fund might state 
that it prohibits more than 3 exchanges per year.
---------------------------------------------------------------------------

    \32\ Proposed Item 7(e)(4)(iii) of Form N-1A. A fund need not 
repeat this disclosure to the extent it is provided in the 
prospectus in response to other Items of Form N-1A, including Items 
3 (redemption and exchange fees), 7(c) (restrictions on redemptions, 
and redemption charges), and 8(a)(2) (exchange privileges).
---------------------------------------------------------------------------

    A fund would also be required to indicate whether each restriction 
applies uniformly in all cases or whether the restriction will not be 
imposed under certain circumstances. If any restriction will not be 
imposed under certain circumstances, the fund would be required to 
describe with specificity the circumstances under which the restriction 
will not be imposed. \33\
---------------------------------------------------------------------------

    \33\ Proposed Item 7(e)(4)(iii) of Form N-1A.
---------------------------------------------------------------------------

    We are also proposing to require a mutual fund to describe in its 
prospectus any arrangements with any person to permit frequent 
purchases and redemptions of fund shares.\34\ This description would 
include the identity of the persons permitted to engage in frequent 
purchases and redemptions and any compensation or other consideration 
received by the fund, its investment adviser, or any other party 
pursuant to such arrangements. A proposed instruction would clarify 
that the consideration required to be disclosed includes any agreement 
to maintain assets in the fund or in other investment companies or 
accounts managed by the investment adviser or by any affiliated person 
of the investment adviser.\35\
    We emphasize that a mutual fund that enters into an arrangement 
with any person to permit frequent purchases and redemptions of fund 
shares may only do so consistent with the antifraud provisions of the 
federal securities laws and the fiduciary duties of the fund and its 
investment adviser to fund shareholders. Disclosure provided pursuant 
to these proposed amendments would not make lawful conduct that is 
otherwise unlawful. For example, disclosure would not render lawful an 
arrangement whereby an investment adviser permits frequent purchases 
and redemptions of a mutual fund's shares in return for consideration 
that benefits the adviser, such as an agreement to

[[Page 70407]]

maintain assets in other accounts managed by the adviser.
---------------------------------------------------------------------------

    \34\ Proposed Item 7(e)(5) of Form N-1A.
    \35\ Proposed Instruction to Item 7(e)(5) of Form N-1A.
---------------------------------------------------------------------------

    The proposed amendments to Form N-1A would also clarify that the 
new disclosure that would be required regarding frequent purchases and 
redemptions of fund shares may not be omitted from the prospectus in 
reliance on current Item 7(f), which would be redesignated as Item 
7(g).\36\ Current Item 7(f) permits funds to omit from the prospectus 
certain information concerning purchase and redemption procedures if, 
among other things, the information is included in a separate document 
that is incorporated by reference into, and filed and delivered with, 
the prospectus.\37\ We believe that the information required by new 
Item 7(e) is more appropriately included in the same document as the 
prospectus.
---------------------------------------------------------------------------

    \36\ Proposed Item 7(g) of Form N-1A.
    \37\ Item 7(f) of Form N-1A.
---------------------------------------------------------------------------

    We are proposing to require similar disclosure in Forms N-3,\38\ N-
4,\39\ and N-6,\40\ the registration forms for insurance company 
separate accounts that issue variable annuity and variable life 
insurance contracts, with respect to both the risks of frequent 
transfers of contract value among sub-accounts, and the separate 
account's policies and procedures with respect to such frequent 
transfers. However, we are proposing the following modifications to 
address the different structure of these issuers:
---------------------------------------------------------------------------

    \38\ Proposed Item 8(e) of Form N-3. Form N-3 is used by all 
insurance company separate accounts offering variable annuity 
contracts that are registered under the Investment Company Act as 
management investment companies.
    \39\ Proposed Item 7(e) of Form N-4. Form N-4 is used by all 
insurance company separate accounts offering variable annuity 
contracts that are registered under the Investment Company Act as 
unit investment trusts. See section 4(2) of the Investment Company 
Act [15 U.S.C. 80a-4(2)] (defining ``unit investment trust'').
    \40\ Proposed Item 6(f) of Form N-6. Form N-6 is used by all 
insurance company separate accounts offering variable life insurance 
policies that are registered under the Investment Company Act as 
unit investment trusts.
---------------------------------------------------------------------------

    [sbull] The proposed amendments to Forms N-3, N-4, and N-6 would 
require disclosure regarding the risks of, and policies and procedures 
with respect to, frequent transfers of contract value among sub-
accounts of the registrant. A person attempting to engage in market 
timing of mutual funds through a variable annuity or variable life 
insurance contract typically would make tax-free transfers of contract 
value among sub-accounts, each of which invests in a particular 
underlying mutual fund.\41\
---------------------------------------------------------------------------

    \41\ Increases in the cash values of variable annuity and 
variable life insurance contracts--known as the ``inside buildup''--
are tax-deferred until the contract's surrender or maturity. See 
I.R.C. section 7702(g) (1986).
---------------------------------------------------------------------------

    [sbull] The proposed amendments to Forms N-4 and N-6 would require 
disclosure with respect to whether the separate account or its 
depositor has policies and procedures with respect to frequent 
transfers of contract value among sub-accounts, rather than whether 
such policies and procedures have been adopted by the separate 
account's board of directors. The separate accounts registered on these 
forms are unit investment trusts, which do not have boards of 
directors, and the depositor would be responsible for adopting and 
implementing any policies and procedures.\42\ If neither the separate 
account nor the depositor has any such policies and procedures, the 
proposals would require that the prospectus include a statement of the 
specific basis for the view of the depositor that it is appropriate for 
the separate account and depositor not to have such policies and 
procedures.\43\
---------------------------------------------------------------------------

    \42\ Proposed Item 7(e)(ii) of Form N-4; proposed Item 6(f)(2) 
of Form N-6.
    \43\ Proposed Item 7(e)(iii) of Form N-4; proposed Item 6(f)(3) 
of Form N-6.
---------------------------------------------------------------------------

    [sbull] The proposed amendments to Forms N-3, N-4, and N-6 would 
require disclosure of the risks that frequent transfers of contract 
value among sub-accounts may present not only for other contractowners, 
but also for other persons who have material rights under the contract 
(including, in the case of Forms N-3 and N-4, participants, annuitants, 
and beneficiaries, and, in the case of Form N-6, the insured or 
beneficiary).\44\
---------------------------------------------------------------------------

    \44\ Proposed Item 8(e)(i) of Form N-3; proposed Item 7(e)(i) of 
Form N-4; proposed Item 6(f)(1) of Form N-6.
---------------------------------------------------------------------------

    [sbull] The proposed amendments to Forms N-3, N-4, and N-6 that 
require disclosure of any arrangements for detecting frequent transfers 
of contract value among sub-accounts would not explicitly reference 
arrangements for detecting transfers through intermediaries, such as 
investment advisers, broker-dealers, transfer agents, and third party 
administrators.\45\ Because the variable annuity and variable life 
insurance contracts registered on these forms are typically held in the 
name of the contractowner and not an intermediary, insurance companies 
generally will not need to enter into any such arrangements with 
intermediaries in order for the insurance company to be able to detect 
frequent transfers among sub-accounts. If an insurance company had any 
such arrangements with intermediaries, however, disclosure of those 
arrangements would be required.
---------------------------------------------------------------------------

    \45\ Proposed Item 8(e)(iv)(D) of Form N-3; proposed Item 
7(e)(iv)(D) of Form N-4; proposed Item 6(f)(4)(iv) of Form N-6.
---------------------------------------------------------------------------

    [sbull] The proposed amendments to Forms N-3, N-4, and N-6 would 
specifically require disclosure concerning any consideration received 
by the sponsoring insurance company pursuant to any arrangements to 
permit frequent transfers of contract value.\46\
---------------------------------------------------------------------------

    \46\ Proposed Item 8(e)(v) of Form N-3; proposed Item 7(e)(v) of 
Form N-4; proposed Item 6(f)(5) of Form N-6.
---------------------------------------------------------------------------

    [sbull] A proposed Instruction in Form N-3 clarifies that 
consideration received pursuant to arrangements to permit frequent 
transfers of contract value includes any agreement to maintain assets 
in the registrant or in other investment companies or accounts managed 
or sponsored by the investment adviser, the insurance company, or any 
affiliated person of the investment adviser or the insurance 
company.\47\ The parallel proposed Instructions in Forms N-4 and N-6 
would include as consideration any agreement to maintain assets in the 
registrant or in other investment companies or accounts managed or 
sponsored by any investment adviser of a mutual fund in which a sub-
account of the registrant is invested, the sponsoring insurance 
company, or any affiliated person of such an investment adviser or the 
insurance company.\48\
---------------------------------------------------------------------------

    \47\ Proposed Instruction to Item 8(e)(v) of Form N-3.
    \48\ Proposed Instruction to Item 7(e)(v) of Form N-4; proposed 
Instruction to Item 6(f)(5) of Form N-6.
---------------------------------------------------------------------------

    We request comment generally on the proposals described above and 
specifically on the following issues:
    [sbull] Should we require that mutual funds and insurance company 
separate accounts make each of the proposed disclosures discussed 
above? Should we require any additional disclosures?
    [sbull] Is the prospectus the appropriate location for each of the 
proposed disclosures? Would all or part of the disclosure be more 
appropriately located in the SAI, reports to shareholders, Form N-CSR, 
the registrant's Web site, or another location? Should we permit mutual 
funds to disclose any of the required information in the separate 
disclosure document referenced in current Item 7(f) of Form N-1A?
    [sbull] Several Items of Forms N-1A, N-3, N-4, and N-6 (e.g., Items 
3, 7(c), and 8(a)(2) of Form N-1A; Items 3 and 8(b)(ii) of Form N-3; 
Items 3 and 7(b)(ii) of Form N-4; and Items 3 and 6(b)(2) of Form N-6) 
call for disclosures that are related to the disclosures called for by 
the proposals. Should we amend any of these other Items or alter the 
proposals

[[Page 70408]]

in any way to better coordinate the disclosure requirements of these 
Items?
    [sbull] Exchange traded funds (``ETFs) are investment companies 
that are registered under the Investment Company Act as open-end 
management investment companies or unit investment trusts. However, 
unlike typical open-end funds or unit investment trusts, ETFs do not 
sell or redeem their individual shares at NAV. Instead, ETFs sell and 
redeem their shares at NAV only in large blocks, generally in exchange 
for a basket of securities that mirrors the composition of the ETF's 
portfolio, plus a small amount of cash. Shares of ETFs are listed on 
national securities exchanges for trading, which allows investors to 
purchase and sell individual ETF shares among themselves at market 
prices throughout the day. Should ETFs be expressly excluded from the 
proposed disclosure requirements?

B. Disclosure of Circumstances Under Which Funds Will Use Fair Value 
Pricing

    The Commission is proposing to amend the Instruction to Item 
7(a)(1) of Form N-1A, and to add a corresponding Instruction to Form N-
3, to clarify that all mutual funds and managed separate accounts that 
offer variable annuities, other than money market funds, are required 
to explain briefly in their prospectuses both the circumstances under 
which they will use fair value pricing and the effects of using fair 
value pricing.\49\ We are proposing to amend this instruction to 
clearly reflect that funds are required to use fair value prices any 
time that market quotations for their portfolio securities are not 
readily available (including when they are not reliable). Money market 
funds would not be subject to the proposed requirement to disclose the 
circumstances under which they would use fair value pricing and the 
effects of such use, because such funds are subject to rule 2a-7 under 
the Investment Company Act, which contains its own detailed pricing 
requirements.\50\
---------------------------------------------------------------------------

    \49\ Proposed Instruction to Item 7(a)(1) of Form N-1A; proposed 
Instruction to Item 11(c) of Form N-3. We are not proposing to amend 
Forms N-4 and N-6 because these forms are used by insurance company 
separate accounts that are organized as unit investment trusts and 
typically hold only securities issued by underlying mutual funds. 
These underlying mutual funds are responsible for valuing their own 
portfolio securities, including, as required, through fair 
valuation.
    \50\ Rule 2a-7(c) (describing the requirements for calculating 
the share price of money market funds using the amortized cost and 
penny-rounding methods).
---------------------------------------------------------------------------

    We note that the disclosure regarding the circumstances under which 
a fund would use fair value pricing and the effects of such use should 
be specific to the fund. For example, if a fund invests exclusively in 
frequently traded exchange listed securities of large capitalization 
domestic issuers and calculates its NAV as of the time the exchange 
typically closes, there may be very limited circumstances in which it 
would use fair value pricing (e.g., if the exchange on which a 
portfolio security is principally traded closes early or if trading in 
a particular portfolio security was halted during the day and did not 
resume prior to the fund's NAV calculation). By contrast, if a fund 
invests primarily in securities that are traded on overseas markets, we 
would expect a fuller discussion of the circumstances under which the 
fund would use fair value pricing, such as specific events occurring 
after the close of the overseas exchange that would cause the fund to 
use fair value pricing. Similarly, we would expect that the description 
of the effects of using fair value pricing would be fund specific, 
e.g., minimizing the possibilities for time-zone arbitrage, in the case 
of a fund investing in overseas markets.\51\
---------------------------------------------------------------------------

    \51\ We also note that the Commission is issuing a release 
adopting new rule 38a-1 under the Investment Company Act, which 
requires funds to adopt policies and procedures that require a fund 
to monitor for circumstances that may necessitate the use of fair 
value prices, establish criteria for determining when market 
quotations are no longer reliable for a particular portfolio 
security, provide a methodology or methodologies by which the fund 
determines the current fair value of the portfolio security, and 
regularly review the appropriateness and accuracy of the method used 
in valuing securities and make any necessary adjustments.
---------------------------------------------------------------------------

    We request comment generally on the proposed disclosure regarding 
fair value pricing and specifically on the following issues:
    [sbull] Is the proposed Instruction requiring funds to explain 
briefly the circumstances under which they will use fair value pricing 
and the effects of using fair value pricing appropriate? Is this 
proposed disclosure necessary in light of the fact that all funds are 
required to use fair value pricing if market quotations for a portfolio 
security are not readily available (including when they are not 
reliable)? Will the disclosure provide useful information to investors 
about the particular circumstances under which a fund will use fair 
value pricing and the effects on that fund of using fair value pricing? 
Should money market funds or any other types of funds not be required 
to provide the disclosure?
    [sbull] Is the fund prospectus the appropriate location for the 
proposed disclosure, or would the SAI provide investors with adequate 
access to this information? Are there any other locations, such as Form 
N-CSR, reports to shareholders, or the fund's Web site, that would be 
more appropriate for this disclosure?
    [sbull] Are there cases where disclosure of the circumstances under 
which a mutual fund will use fair value pricing and the effect on the 
fund of using fair value pricing may assist investors who intend to 
engage in market timing strategies? If so, how should we modify the 
proposed Instruction to address these cases?

C. Selective Disclosure of Fund Portfolio Holdings

    We are proposing amendments to Form N-1A that would require mutual 
funds to disclose their policies and procedures with respect to the 
disclosure of their portfolio securities and any ongoing arrangements 
to make available information about their portfolio securities.\52\ We 
are also proposing parallel amendments to Form N-3 for managed separate 
accounts that issue variable annuities.\53\ These amendments are 
intended to provide greater transparency of fund practices with respect 
to the disclosure of the fund's portfolio holdings, and to reinforce 
funds' and advisers' obligations to prevent the misuse of material, 
non-public information.
---------------------------------------------------------------------------

    \52\ Proposed Items 4(d) and 12(f) of Form N-1A. In the release 
adopting rule 38a-1 under the Investment Company Act, we state that 
a fund's compliance policies and procedures should address misuses 
of nonpublic information, including the disclosure to third parties 
of material information about the fund's portfolio, its trading 
strategies, or pending transactions.
    \53\ Proposed Items 5(f) and 19(e) of Form N-3. We are not 
proposing to amend Forms N-4 and N-6 because these forms are used by 
insurance company separate accounts that are organized as unit 
investment trusts, which typically hold only securities issued by 
underlying mutual funds.
---------------------------------------------------------------------------

    We emphasize that a mutual fund or investment adviser that 
discloses the fund's portfolio securities may only do so consistent 
with the antifraud provisions of the federal securities laws and the 
fund's or adviser's fiduciary duties to fund shareholders. Disclosure 
provided pursuant to these proposed amendments would not make lawful 
conduct that is otherwise unlawful. Divulging portfolio holdings to 
selected third parties is permissible only when the fund has legitimate 
business purposes for doing so and the recipients are subject to a duty 
of confidentiality. Examples of instances in which selective disclosure 
of a fund's portfolio securities may be appropriate, subject to 
confidentiality agreements and trading restrictions, include disclosure 
for due diligence purposes to an investment

[[Page 70409]]

adviser that is in merger or acquisition talks with the fund's current 
adviser, disclosure to a newly hired investment adviser or sub-adviser 
prior to commencing its duties, or disclosure to a rating agency for 
use in developing a rating.
    Our proposals would require a mutual fund's SAI to describe the 
fund's policies and procedures with respect to the disclosure of its 
portfolio securities.\54\ The mutual fund's prospectus would be 
required to state that a description of its policies and procedures is 
available in its SAI and, if applicable, on its Web site.\55\ The SAI 
description of the mutual fund's policies and procedures with respect 
to the disclosure of its portfolio securities would be required to 
include:
---------------------------------------------------------------------------

    \54\ Proposed Item 12(f)(1) of Form N-1A; proposed Item 19(e)(i) 
of Form N-3.
    \55\ Proposed Item 4(d) of Form N-1A; proposed Item 5(f) of Form 
N-3.
---------------------------------------------------------------------------

    [sbull] How the policies and procedures apply to disclosure to 
different categories of persons, including individual investors, 
institutional investors, intermediaries that distribute the fund's 
shares, third-party service providers, rating and ranking 
organizations, and affiliated persons of the fund;\56\
---------------------------------------------------------------------------

    \56\ Proposed Item 12(f)(1)(i) of Form N-1A. With respect to 
managed separate accounts issuing variable annuity contracts 
registered on Form N-3, the categories would include contractowners, 
participants, annuitants, and beneficiaries. Proposed Item 
19(e)(i)(A) of Form N-3.
---------------------------------------------------------------------------

    [sbull] Any conditions or restrictions placed on the use of 
information about portfolio securities that is disclosed, including any 
requirement that the information be kept confidential or prohibitions 
on trading based on the information, and any procedures to monitor the 
use of this information;\57\
---------------------------------------------------------------------------

    \57\ Proposed Item 12(f)(1)(ii) of Form N-1A; proposed Item 
19(e)(i)(B) of Form N-3.
---------------------------------------------------------------------------

    [sbull] The frequency with which information about portfolio 
securities is disclosed, and the length of the lag, if any, between the 
date of the information and the date on which the information is 
disclosed;\58\
---------------------------------------------------------------------------

    \58\ Proposed Item 12(f)(1)(iii) of Form N-1A; proposed Item 
19(e)(i)(C) of Form N-3.
---------------------------------------------------------------------------

    [sbull] Any policies and procedures with respect to the receipt of 
compensation or other consideration by the fund, its investment 
adviser, or any other party in connection with the disclosure of 
information about portfolio securities;\59\
---------------------------------------------------------------------------

    \59\ Proposed Item 12(f)(1)(iv) of Form N-1A. With respect to 
managed separate accounts issuing variable annuity contracts 
registered on Form N-3, this description would also be required to 
include any policies and procedures with respect to the receipt of 
compensation or other consideration by the sponsoring insurance 
company. Proposed Item 19(e)(i)(D) of Form N-3.
---------------------------------------------------------------------------

    [sbull] The persons who may authorize disclosure of the fund's 
portfolio securities;\60\
---------------------------------------------------------------------------

    \60\ Proposed Item 12(f)(1)(v) of Form N-1A; proposed Item 
19(e)(i)(E) of Form N-3.
---------------------------------------------------------------------------

    [sbull] The procedures that the fund uses to ensure that disclosure 
of information about portfolio securities is in the best interests of 
fund shareholders, including procedures to address conflicts between 
the interests of fund shareholders, on the one hand, and those of the 
fund's investment adviser; principal underwriter; or any affiliated 
person of the fund, its investment adviser, or its principal 
underwriter, on the other;\61\ and
---------------------------------------------------------------------------

    \61\ Proposed Item 12(f)(1)(vi) of Form N-1A. With respect to 
managed separate accounts issuing variable annuity contracts 
registered on Form N-3, this description would be required to 
include the procedures that are used to ensure that disclosure of 
information about portfolio securities is in the best interests of 
contractowners, participants, annuitants, and beneficiaries, 
including procedures to address conflicts between the interests of 
such persons, on the one hand, and those of the separate account's 
investment adviser or principal underwriter; the sponsoring 
insurance company; or any affiliated person of the separate account, 
its investment adviser or principal underwriter, or the sponsoring 
insurance company, on the other. Proposed Item 19(e)(i)(F) of Form 
N-3.
---------------------------------------------------------------------------

    [sbull] The manner in which the board of directors exercises 
oversight of disclosure of the fund's portfolio securities.\62\
---------------------------------------------------------------------------

    \62\ Proposed Item 12(f)(1)(vii) of Form N-1A; proposed Item 
19(e)(i)(G) of Form N-3.

A mutual fund's disclosure of its policies and procedures with respect 
to the disclosure of its portfolio securities would be required to 
include any policies and procedures of the fund's investment adviser, 
or any other third party, that the fund uses or that are used on the 
fund's behalf.\63\
---------------------------------------------------------------------------

    \63\ Proposed Instruction to Item 12(f)(1) of Form N-1A; 
proposed Instruction to Item 19(e)(i) of Form N-3.
---------------------------------------------------------------------------

    We are also proposing to require a mutual fund to describe in its 
SAI any ongoing arrangements to make available information about the 
fund's portfolio securities to any person, including the identity of 
the persons who receive information pursuant to such arrangements and 
any compensation or other consideration received by the fund, its 
investment adviser, or any other party in connection with such 
arrangements.\64\ A proposed instruction would clarify that the 
consideration required to be disclosed would include any agreement to 
maintain assets in the fund or in other investment companies or 
accounts managed by the investment adviser or by any affiliated person 
of the investment adviser.\65\ As indicated above, however, divulging 
portfolio holdings to selected third parties is permissible only when 
the fund has legitimate business purposes for doing so, and legitimate 
business purposes generally would not include the receipt of 
consideration by the fund's investment adviser or its affiliates. With 
respect to these ongoing arrangements, funds would also be required to 
describe:
---------------------------------------------------------------------------

    \64\ Proposed Item 12(f)(2) of Form N-1A. With respect to 
managed separate accounts issuing variable annuity contracts 
registered on Form N-3, disclosure of any compensation or other 
consideration received by the sponsoring insurance company would 
also be required. Proposed Item 19(e)(ii) of Form N-3.
    \65\ Proposed Instruction to Item 12(f)(2) of Form N-1A. With 
respect to managed separate accounts issuing variable annuity 
contracts registered on Form N-3, the consideration required to be 
disclosed would also include any agreement to maintain assets in 
other investment companies or accounts managed or sponsored by the 
sponsoring insurance company of the registrant or by an affiliated 
person of such sponsoring insurance company. Proposed Instruction to 
Item 19(e)(ii) of Form N-3.
---------------------------------------------------------------------------

    [sbull] Any conditions or restrictions placed on the use of 
information about portfolio securities that is disclosed, including any 
requirement that the information be kept confidential or prohibitions 
on trading based on the information, and any procedures to monitor the 
use of this information;
    [sbull] The frequency with which information about portfolio 
securities is disclosed, and the length of the lag, if any, between the 
date of the information and the date on which the information is 
disclosed; and
    [sbull] The persons who may authorize disclosure of the fund's 
portfolio securities.\66\
---------------------------------------------------------------------------

    \66\ Proposed Item 12(f)(2) of Form N-1A; proposed Item 
19(e)(ii) of Form N-3.
---------------------------------------------------------------------------

    We request comment generally on the proposed disclosure 
requirements regarding disclosure of a fund's portfolio securities and 
specifically on the following issues:
    [sbull] Should we require mutual funds and insurance company 
managed separate accounts to disclose their policies and procedures 
with respect to the disclosure of portfolio securities to any person? 
If so, what information should they be required to disclose?
    [sbull] Are there any types of arrangements that should be excluded 
from the requirement to disclose ongoing arrangements to make available 
information about portfolio securities, such as arrangements where the 
information that is disclosed is subject to a confidentiality 
requirement or a prohibition on trading based on the information?
    [sbull] What is the appropriate location for any disclosure about a 
mutual fund's or separate account's disclosure of its portfolio 
securities (e.g., prospectus,

[[Page 70410]]

SAI, Form N-CSR, Form 8-K, shareholder reports, Web site, etc.)?
    [sbull] In addition to disclosing ongoing arrangements, should we 
require mutual funds and insurance company managed separate accounts to 
disclose all instances of selective disclosure of portfolio securities? 
If so, when should this disclosure be required to be made? What facts 
should be required to be disclosed regarding each such instance of 
selective disclosure (e.g., the names of persons or entities who 
receive portfolio holdings information; the terms of the disclosure, 
including any compensation paid for the information; the reasons why 
the disclosure is in the best interests of fund shareholders; the terms 
of any confidentiality agreement)? Should funds be required to disclose 
whether the board of directors has approved each individual instance of 
selective disclosure?
    [sbull] Currently, Regulation FD, which governs the selective 
disclosure of material non-public information, does not apply to funds, 
other than closed-end funds.\67\ Should Regulation FD apply to mutual 
funds or managed separate accounts with respect to their disclosure of 
portfolio holdings or other information?
---------------------------------------------------------------------------

    \67\ 17 CFR 243.101(b).
---------------------------------------------------------------------------

    [sbull] Are there any other measures that we should consider to 
reinforce the obligations of funds and their advisers to comply with 
their fiduciary duties and to prevent the misuse of material, non-
public information, including the selective disclosure of portfolio 
holdings information?

D. Compliance Date

    If we adopt the proposed disclosure requirements, we expect to 
require all new registration statements and all post-effective 
amendments to effective registration statements filed on or after the 
effective date of the amendments to comply with the proposed 
amendments. The Commission requests comment on this proposed compliance 
date.

III. General Request for Comments

    The Commission requests comment on the amendments proposed in this 
release, whether any further changes to our rules or forms are 
necessary or appropriate to implement the objectives of our proposed 
amendments, and on other matters that might have an effect on the 
proposals contained in this release.

IV. Paperwork Reduction Act

    Certain provisions of the proposed amendments contain ``collection 
of information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 [44 U.S.C. 3501, et seq.], and the Commission is 
submitting the proposed collections of information to the Office of 
Management and Budget (``OMB'') for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The titles for the collections of 
information are: (1) ``Form N-1A under the Investment Company Act of 
1940 and Securities Act of 1933, Registration Statement of Open-End 
Management Investment Companies'; (2) ``Form N-3--Registration 
Statement of Separate Accounts Organized as Management Investment 
Companies''; (3) ``Form N-4--Registration Statement of Separate 
Accounts Organized as Unit Investment Trusts''; and (4) ``Form N-6 
under the Investment Company Act of 1940 and the Securities Act of 
1933, Registration Statement of Insurance Company Separate Accounts 
Registered as Unit Investment Trusts that Offer Variable Life Insurance 
Policies.'' An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid OMB control number.
    Form N-1A (OMB Control No. 3235-0307), Form N-3 (OMB Control No. 
3235-0316), Form N-4 (OMB Control No. 3235-0318), and Form N-6 (OMB 
Control No. 3235-0503) were adopted pursuant to section 8(a) of the 
Investment Company Act [15 U.S.C. 80a-8(a)] and section 5 of the 
Securities Act [15 U.S.C. 77e].
    We are proposing amendments to Form N-1A to require mutual funds to 
provide improved disclosure regarding their policies and procedures 
with respect to frequent purchases and redemptions of fund shares. The 
proposals also would amend Forms N-3, N-4, and N-6 to require similar 
disclosure in prospectuses for insurance company separate accounts 
offering variable insurance contracts, with respect to frequent 
transfers among sub-accounts. In addition, we are proposing amendments 
to clarify instructions to Forms N-1A and N-3 to require all mutual 
funds (other than money market funds) and managed separate accounts 
that issue variable annuities, to explain in their prospectuses the 
circumstances under which they will use fair value pricing, and the 
effects of using fair value pricing.
    Finally, we are proposing amendments to Form N-1A to require 
disclosure regarding mutual funds' policies and procedures with respect 
to the selective disclosure of their portfolio holdings to any person. 
We are also proposing parallel amendments to Form N-3 for managed 
separate accounts that issue variable annuities.

Form N-1A

    Form N-1A, including the proposed amendments, contains collection 
of information requirements. The likely respondents to this information 
collection are open-end funds registering with the Commission. 
Compliance with the disclosure requirements of Form N-1A is mandatory. 
Responses to the disclosure requirements are not confidential.
    The current hour burden for preparing an initial registration 
statement on Form N-1A is 809 hours per portfolio. The current annual 
hour burden for preparing post-effective amendments of Form N-1A is 101 
hours per portfolio. The Commission estimates that, on an annual basis, 
registrants file initial registration statements on Form N-1A covering 
483 portfolios, and file post-effective amendments on Form N-1A 
covering 6,542 portfolios. An additional burden of 1,694 hours for the 
preparation and filing of initial registration statements and 22,897 
hours for the filing of post-effective amendments is expected to result 
from the Commission's recent proposed rulemaking relating to ``fund of 
funds'' arrangements.\68\ Thus, the Commission estimates that the 
current total annual hour burden for the preparation and filing of Form 
N-1A is 1,076,080 hours.\69\
---------------------------------------------------------------------------

    \68\ See Investment Company Act Release No. 26198 (Oct. 2, 2003) 
(``Fund of Funds Proposing Release'').
    \69\ This estimate is based on the following calculation: (809 
hours x 483 portfolios) + (101 hours x 6,542 portfolios) = 1,051,489 
hours. The additional annual hour burden of 24,591 hours (22,897 + 
1,694) resulting from the proposed rules described in the Fund of 
Funds Proposing Release yield a total annual hour burden of 
1,076,080 hours.
---------------------------------------------------------------------------

    We estimate that the proposed amendments would increase the hour 
burden per portfolio per filing of an initial registration statement by 
10 hours and would increase the hour burden per portfolio per filing of 
a post-effective amendment to a registration statement by 4 hours. 
Thus, if the proposed amendments to Form N-1A are adopted, the total 
annual hour burden for all funds for preparation and filing of initial 
registration statements and post-effective amendments to Form N-1A 
would be 1,107,078 hours ((10 hours x 483 portfolios) + (4 hours x 
6,542 portfolios) + 1,076,080 hours).

Form N-3

    Form N-3, including the proposed amendments, contains collection of 
information requirements. The likely respondents to this information 
collection are separate accounts, organized as management investment

[[Page 70411]]

companies offering variable annuities, registering with the Commission 
on Form N-3. Compliance with the disclosure requirements of Form N-3 is 
mandatory. Responses to the disclosure requirements are not 
confidential.
    The current annual hour burden for preparing an initial 
registration statement on Form N-3 is 915.2 hours per portfolio. The 
current annual hour burden for preparing post-effective amendments of 
Form N-3 is 150.4 hours per portfolio. The Commission estimates that, 
on an annual basis, 3 initial registration statements will be filed on 
Form N-3 and 38 post-effective amendments will be filed on Form N-3. We 
estimate that the average number of portfolios per filing is 4, and 
therefore that annually there are a total of 12 portfolios covered by 
initial registration statements on Form N-3 and 152 portfolios covered 
by post-effective amendments on Form N-3. The Fund of Funds Proposing 
Release would require additional cumulative burdens of 42 hours and 49 
hours, respectively. Thus, we estimate that the current total annual 
hour burden for the preparation and filing of Form N-3 is 33,934 
hours.\70\
---------------------------------------------------------------------------

    \70\ This estimate is based on the following calculation: (915.2 
hours x 12 portfolios) + (150.4 hours x 152 portfolios) + (42 hours 
+ 49 hours) = 33,934.2 hours.
---------------------------------------------------------------------------

    We estimate that the proposed amendments would increase the hour 
burden per portfolio per filing of an initial registration statement on 
Form N-3 by 10 hours and would increase the hour burden per portfolio 
per filing of a post-effective amendment to a registration statement on 
Form N-3 by 4 hours. Thus, if the proposed amendments to Form N-3 are 
adopted, the total annual hour burden for all funds for preparation and 
filing of initial registration statements and post-effective amendments 
on Form N-3 would be 34,662 hours ((10 hours x 12 portfolios) + (4 
hours x 152 portfolios) + 33,934 hours).

Form N-4

    Form N-4, including the proposed amendments, contains collection of 
information requirements. The likely respondents to this information 
collection are separate accounts, organized as unit investment trusts 
that offer variable annuity contracts, registering with the Commission 
on Form N-4. Compliance with the disclosure requirements of Form N-4 is 
mandatory. Responses to the disclosure requirements are not 
confidential.
    The current annual hour burden for preparing an initial 
registration statement on Form N-4 is 273.2 hours per separate account. 
The current annual hour burden for preparing a post-effective amendment 
on Form N-4 is 195 hours per separate account. The Commission estimates 
that annually, 157 initial registration statements are filed on Form N-
4 and 1,242 post-effective amendments are filed on Form N-4. The Fund 
of Funds Proposing Release would require additional cumulative burdens 
of 39.5 hours and 310.5 hours, respectively. Thus, we estimate that the 
current total annual hour burden for the preparation and filing of Form 
N-4 is 285,432 hours.\71\
---------------------------------------------------------------------------

    \71\ This estimate is based on the following calculation: (273.2 
hours x 157 separate accounts) + (195 hours x 1,242 separate 
accounts) + (39.5 hours + 310.5 hours) = 285,432.4 hours.
---------------------------------------------------------------------------

    We estimate that the proposed amendments would increase the hour 
burden per filing of an initial registration statement on Form N-4 by 5 
hours and would increase the hour burden per filing of a post-effective 
amendment to a registration statement on Form N-4 by 2 hours. Thus, if 
the proposed amendments to Form N-4 are adopted, the total annual hour 
burden for separate accounts for preparation and filing of initial 
registration statements and post-effective amendments on Form N-4 would 
be 288,701 hours ((5 hours x 157 portfolios) + (2 hours x 1,242 
portfolios) + 285,432 hours).

Form N-6

    Form N-6, including the proposed amendments, contains collection of 
information requirements. The likely respondents to this information 
collection are separate accounts, organized as unit investment trusts 
that offer variable life insurance policies, registering with the 
Commission on Form N-6. Compliance with the disclosure requirements of 
Form N-6 is mandatory. Responses to the disclosure requirements are not 
confidential.
    The current annual hour burden for preparing an initial 
registration statement on a Form N-6 is 765 hours per separate account. 
The current annual hour burden for preparing a post-effective amendment 
filed as an annual update on Form N-6 is 65 hours, and the annual hour 
burden for preparing a post-effective amendment filed for other 
purposes is 10 hours. The Commission estimates that annually, 50 
initial registration statements, 150 post-effective amendments that are 
annual updates, and 350 additional post-effective amendments are filed 
on Form N-6. The Fund of Funds Proposing Release would require 
additional cumulative burdens of 12.5 hours for initial registration 
statements, and 37.5 hours for annual update post-effective amendments 
and additional post-effective amendments. Thus, we estimate that the 
current total annual hour burden for the preparation and filing of Form 
N-6 is 51,550 hours.\72\
---------------------------------------------------------------------------

    \72\ This estimate is based on the following calculation: (765 
hours x 50 initial registration statements) + (65 hours x 150 annual 
update post-effective amendments) + (10 hours x 350 additional post-
effective amendments) + (12.5 hours + 37.5 hours) = 51,550 hours.
---------------------------------------------------------------------------

    We estimate that the proposed amendments would increase the hour 
burden per filing of an initial registration statement on Form N-6 by 5 
hours, and would increase the hour burden per filing of a post-
effective amendment that is an annual update on Form N-6 by 2 hours. 
Thus, if the proposed amendments to Form N-6 are adopted, the total 
annual hour burden for separate accounts for preparation and filing of 
initial registration statements and post-effective amendments on Form 
N-6 would be 52,100 hours ((5 hours x 50 portfolios) + (2 hours x 150 
portfolios) + 51,550 hours).

Request for Comments

    We request your comments on the accuracy of our estimates. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) 
Evaluate whether the proposed collection of information is necessary 
for the proper performance of the functions of the agency, including 
whether the information will have practical utility; (ii) evaluate the 
accuracy of the Commission's estimate of burden of the proposed 
collection of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) evaluate whether there are ways to minimize the 
burden of the collection of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Room 10102, 
New Executive Office Building, Washington, DC 20503, and should send a 
copy to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 5th Street, NW., Washington, DC 20549-0609, with 
reference to File No. S7-26-03. OMB is required to make a decision 
concerning

[[Page 70412]]

the collection of information between 30 and 60 days after publication 
of this release. Consequently, a comment to OMB is best assured of 
having its full effect if OMB receives it within 30 days after 
publication of this Release.

V. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. Our proposals would require mutual funds to provide enhanced 
disclosure about their policies and procedures with respect to frequent 
purchases and redemptions of fund shares. Specifically, the proposals 
would:
    [sbull] Require a mutual fund to describe in its prospectus the 
risks, if any, that frequent purchases and redemptions of fund shares 
may present for other shareholders;
    [sbull] Require a mutual fund to state in its prospectus whether or 
not the fund's board of directors has adopted policies and procedures 
with respect to frequent purchases and redemptions of fund shares and, 
if the board has not adopted any such policies and procedures, state 
the specific basis for the view of the board that it is appropriate for 
the fund not to have such policies and procedures;
    [sbull] Require a mutual fund to describe any policies and 
procedures for deterring frequent purchases and redemptions of fund 
shares, and any arrangements to permit frequent purchases and 
redemptions of fund shares; and
    [sbull] Require similar disclosure in prospectuses for insurance 
company separate accounts offering variable insurance contracts, with 
respect to frequent transfers among sub-accounts.
    The Commission is also proposing amendments to clarify instructions 
to our registration forms for mutual funds and insurance company 
managed separate accounts that offer variable annuities to require that 
all such funds (other than money market funds) explain in their 
prospectuses both the circumstances under which they will use fair 
value pricing and the effects of using fair value pricing.
    In addition, our proposals would require mutual funds, and 
insurance company managed separate accounts that offer variable 
annuities, to disclose their policies with respect to the disclosure of 
portfolio holdings information. The proposals would:
    [sbull] Require a fund to describe in its SAI any policies and 
procedures with respect to the disclosure of the fund's portfolio 
securities to any person and any ongoing arrangements to make available 
information about the fund's portfolio securities to any person; and
    [sbull] Require a fund to state in its prospectus that a 
description of the policies and procedures is available in the fund's 
SAI, and on the fund's Web site, if applicable.

A. Benefits

    The proposed form amendments will benefit fund investors by 
providing them with more detailed information about mutual fund 
practices relating to frequent purchases and redemptions of fund shares 
(or, in the case of insurance company separate accounts offering 
variable insurance products, frequent transfers of contract value among 
sub-accounts). These proposals are intended to require mutual funds and 
insurance company separate accounts to describe with specificity the 
restrictions they place on frequent purchases and redemptions (or 
frequent transfers among sub-accounts), if any, and the circumstances 
under which a restriction will not apply. Market timing arbitrage 
strategies often involve such frequent purchases and redemptions of 
mutual fund shares or frequent transfers among sub-accounts of 
insurance company separate accounts. By increasing transparency of 
funds' policies and procedures in this area, the proposals are designed 
to help restore investor confidence in the fairness of fund operations 
and in the practices and procedures of intermediaries selling fund 
shares. This additional disclosure would enable investors to assess 
funds' risks, policies, and procedures in this area and determine if a 
fund's policies and procedures are in line with the investor's 
expectations. In addition, these proposed amendments may benefit fund 
shareholders by deterring decisions relating to portfolio management 
that are motivated by considerations of the interests of the fund or 
the fund's adviser rather than the interests of fund shareholders.
    The proposed amendments to Forms N-1A and N-3 relating to fair 
value pricing also will benefit investors by clarifying that all mutual 
funds and managed separate accounts that offer variable annuities, 
other than money market funds, are required to explain both the 
circumstances under which they will use fair value pricing and the 
effects of using such pricing. These amendments would clearly reflect 
that funds are required to use fair value prices any time that market 
quotations for their portfolio securities are not readily available 
(including when they are not reliable). Fair valuation of a fund's 
portfolio securities, which is required under certain circumstances, 
can serve to foreclose arbitrage opportunities available to market 
timers.
    Similarly, the proposed amendments to Forms N-1A and N-3 relating 
to funds' policies and procedures with respect to the selective 
disclosure of portfolio holdings information may benefit investors by 
providing greater transparency of fund practices relating to the 
disclosure of the fund's portfolio holdings, and reinforcing funds' and 
advisers' obligations to prevent the misuse of material, non-public 
information. We have no means by which to quantify these benefits, 
however.
    We seek comment on the benefits of the proposed amendments (and any 
alternatives suggested by commenters) as well as any data quantifying 
those benefits.

B. Costs

    The proposals would impose new requirements on mutual funds to 
provide disclosure of their policies and procedures with respect to 
frequent purchases and redemptions of fund shares (or frequent 
transfers of contract value among sub-accounts, in the case of 
insurance company separate accounts offering variable insurance 
contracts), and selective disclosure of portfolio holdings information. 
We estimate that complying with the proposed new disclosure 
requirements would entail a relatively small financial burden. The 
information regarding a fund's policies and procedures in these areas 
should be readily available to management and the board of directors of 
a fund. Therefore, we expect that the cost of compiling and reporting 
this information should be limited.
    Our proposals would require additional disclosure by a mutual fund 
in its prospectus regarding its policies and procedures relating to 
frequent purchases and redemptions by fund shareholders and additional 
disclosure by an insurance company separate account that issues 
variable insurance products in its prospectus regarding its policies 
and procedures relating to frequent transfers among sub-accounts. In 
addition, we are proposing to require each mutual fund and insurance 
company managed separate account to describe in its SAI any policies 
and procedures regarding the disclosure of the fund's portfolio 
holdings information, and to state in its prospectus that a description 
of those policies and procedures is available in the fund's SAI.\73\ 
These costs may include both internal costs (for attorneys

[[Page 70413]]

and other non-legal staff of a fund, such as computer programmers, to 
prepare and review the required disclosure) and external costs (for 
printing and typesetting of the disclosure).\74\ For purposes of the 
Paperwork Reduction Act, we have estimated that the proposed new 
disclosure requirements would add 35,545 hours to the burden of 
completing Forms N-1A, N-3, N-4, and N-6.\75\ We estimate that this 
additional burden would equal total internal costs of $1,608,411 
annually, or approximately $423 per fund.\76\
---------------------------------------------------------------------------

    \73\ The proposed amendments that would clarify mutual funds' 
and insurance company managed separate accounts' disclosure 
requirements with respect to fair value pricing are not expected to 
result in any significant costs.
    \74\ We note that, with respect to our proposals regarding 
mutual funds' policies and procedures with respect to frequent 
purchases and redemptions and insurance company separate accounts' 
policies and procedures with respect to frequent transfers among 
sub-accounts, in many cases funds currently provide disclosure in 
their prospectuses or elsewhere of the limitations that they place 
on frequent trading in order to discourage market timing.
    \75\ This would represent 30,998 additional hours for Form N-1A, 
728 additional hours for Form N-3, 3,269 additional hours for Form 
N-4, and 550 additional hours for Form N-6.
    \76\ These figures are based on a Commission estimate that 
approximately 3,800 investment companies would be subject to the 
proposed amendments and an estimated hourly wage rate of $45.25. The 
estimate of the number of investment companies is based on data 
derived from the Commission's EDGAR filing system. The estimated 
wage figure is based on published compensation for compliance 
attorneys outside New York City ($37.60) and programmers ($29.44), 
and the estimate that attorneys and programmers would divide time 
equally on compliance with the proposed disclosure requirements, 
yielding a weighted wage rate of $33.52 (($37.60 x .50) + (29.44 x 
.50)) = $33.52). See Securities Industry Association, Report on 
Management & Professional Earnings in the Securities Industry 2002 
(Sept. 2002). This weighted wage rate was then adjusted upward by 
35% for overhead, reflecting the costs of supervision, space, and 
administrative support, to obtain the total per hour internal cost 
of $45.25 (33.52 x 1.35) = $45.25.
---------------------------------------------------------------------------

    The external costs of providing the new prospectus disclosure 
relating to frequent purchases and redemptions of mutual fund shares 
and frequent transfers among sub-accounts of insurance company separate 
accounts may or may not be significant, depending on the complexity of 
a fund's policies and procedures in these areas, the extent to which 
restrictions on frequent purchases and redemptions or transfers among 
sub-accounts apply uniformly in all cases or will not be imposed under 
certain circumstances, and the extent to which a fund currently 
provides specific disclosure in this area. We expect that the external 
costs of providing the new disclosure relating to each mutual fund's 
and insurance company managed separate account's policies and 
procedures with respect to disclosure of portfolio holdings information 
would be minimal, because the required description of a fund's policies 
and procedures with respect to the disclosure of the fund's portfolio 
securities to any person and any ongoing arrangements to make available 
information about the fund's portfolio securities will be required in 
the fund's SAI, which is delivered to investors upon request.\77\
---------------------------------------------------------------------------

    \77\ A fund would be required to state in its prospectus that a 
description of its policies and procedures is available in the 
fund's SAI, and on the fund's Web site, if applicable.
---------------------------------------------------------------------------

    We request comment on the nature and magnitude of our estimates of 
the costs of the additional disclosure that would be required if our 
proposals were adopted.

C. Request for Comments

    We request comments on all aspects of this cost-benefit analysis, 
including identification of any additional costs or benefits of, or 
suggested alternatives to, the proposed amendments. Commenters are 
requested to provide empirical data and other factual support for their 
views to the extent possible.

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

    Section 2(c) of the Investment Company Act [15 U.S.C. 80a-2(c)] and 
section 2(b) of the Securities Act [15 U.S.C. 77(b)] require the 
Commission, when engaging in rulemaking that requires it to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider, in addition to the protection of investors, 
whether the action will promote efficiency, competition, and capital 
formation.
    The proposed amendments are intended to provide greater 
transparency for mutual fund shareholders regarding a fund's policies 
and procedures with respect to frequent purchases and redemptions of 
fund shares (or frequent transfers of contract value among sub-
accounts, in the case of insurance company separate accounts offering 
variable insurance contracts), and selective disclosure of portfolio 
holdings information. These changes may improve efficiency. The 
enhanced disclosure requirements are intended to enable shareholders to 
make a more informed assessment as to whether a particular fund is in 
line with shareholders' investment objectives, which could promote more 
efficient allocation of investments by investors and more efficient 
allocation of assets among competing funds. The proposed amendments may 
also improve competition, as enhanced disclosure may prompt funds to 
compete to provide investors with policies and procedures that 
effectively protect long-term investors from harmful market timing, and 
from the misuse of portfolio holdings information through selective 
disclosure. Finally, the effects of the proposed amendments on capital 
formation are unclear.
    Although, as noted above, we believe that the proposed amendments 
would benefit investors, the magnitude of the effect of the proposed 
amendments on efficiency, competition, and capital formation, and the 
extent to which they would be offset by the costs of the proposals, are 
difficult to quantify. We note that, with respect to our proposals 
regarding funds' policies and procedures with respect to frequent 
purchases and redemptions (or frequent transfers among sub-accounts), 
in many cases funds currently provide disclosure in their prospectuses 
or elsewhere of the limitations that they place on frequent trading in 
order to discourage market timing.
    We request comment on whether the proposed amendments, if adopted, 
would promote efficiency, competition, and capital formation. 
Commenters are requested to provide empirical data and other factual 
support for their views if possible.

VII. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis (``Analysis'') has 
been prepared in accordance with 5 U.S.C. 603, and relates to the 
Commission's proposed form amendments under the Securities Act and the 
Investment Company Act to require funds to provide additional 
disclosure about their policies and procedures with respect to frequent 
purchases and redemptions of mutual fund shares (or, with respect to 
insurance company separate accounts, frequent transfers among sub-
accounts) and selective disclosure of fund portfolio holdings to any 
person. Specifically, the proposals would:
    [sbull] Require a mutual fund to describe in its prospectus the 
risks, if any, that frequent purchases and redemptions of fund shares 
may present for other shareholders;
    [sbull] Require a mutual fund to state in its prospectus whether or 
not the fund's board of directors has adopted policies and procedures 
with respect to frequent purchases and redemptions of fund shares and, 
if the board has not adopted any such policies and procedures, state 
the specific basis for the view of the board that it is appropriate for 
the fund not to have such policies and procedures;
    [sbull] Require a mutual fund to describe any policies and 
procedures for

[[Page 70414]]

deterring frequent purchases and redemptions of fund shares, and any 
arrangements to permit frequent purchases and redemptions of fund 
shares; and
    [sbull] Require similar disclosure in prospectuses for insurance 
company separate accounts offering variable insurance contracts, with 
respect to frequent transfers among sub-accounts.
    The Commission is also proposing amendments to clarify instructions 
to our registration forms for mutual funds and insurance company 
managed separate accounts that offer variable annuities to require that 
all such funds (other than money market funds) explain in their 
prospectuses both the circumstances under which they will use fair 
value pricing and the effects of using fair value pricing.
    As noted above, the Commission also is proposing to require mutual 
funds, and insurance company managed separate accounts that offer 
variable annuities, to disclose their policies with respect to 
disclosure of portfolio holdings information. The proposals would:
    [sbull] Require a fund to describe in its SAI any policies and 
procedures with respect to the disclosure of the fund's portfolio 
securities to any person and any ongoing arrangements to make available 
information about the fund's portfolio securities to any person; and
    [sbull] Require a fund to state in its prospectus that a 
description of the policies and procedures is available in the fund's 
SAI, and on the fund's Web site, if applicable.

A. Reasons for, and Objectives of, Proposed Amendments

    Recent allegations regarding late trading, abusive market timing, 
and other abuses point to instances where it appears that some in the 
mutual fund industry, and some intermediaries that sell fund shares, 
have lost sight of their obligations to investors. The proposed 
amendments include disclosure reforms intended to shed more light on 
market timing and selective disclosure of portfolio holdings 
information. The proposals are intended to require mutual funds to 
describe with specificity the restrictions they place on frequent 
purchases and redemptions, if any, and the circumstances under which 
any such restriction will not apply. The proposals would require 
similar disclosure by insurance company separate accounts that offer 
variable insurance contracts, with respect to the restrictions, if any, 
that they place on frequent transfers among sub-accounts. This 
additional disclosure would enable investors to assess mutual funds' 
and insurance company separate accounts' risks, policies, and 
procedures in this area and determine if the policies and procedures 
are in line with their expectations. The proposed amendments also are 
intended to provide greater transparency of mutual fund and insurance 
company managed separate account practices with respect to the 
disclosure of a fund's portfolio holdings, and to reinforce funds' and 
advisers' obligations to prevent the misuse of material, non-public 
information. The proposals are part of a package of rule amendments 
intended to address abuses that have surfaced in the areas of late 
trading, market timing, and selective disclosure.

B. Legal Basis

    The Commission is proposing amendments to Forms N-1A, N-3, N-4, and 
N-6 pursuant to authority set forth in sections 5, 6, 7, 10, and 19(a) 
of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a)], and 
sections 8, 22, 24(a), 30, and 38 of the Investment Company Act [15 
U.S.C. 80a-8, 80a-22, 80a-24(a), 80a-29, and 80a-37].

C. Small Entities Subject to the Rule

    For purposes of the Regulatory Flexibility Act, an investment 
company is a small entity if it, together with other investment 
companies in the same group of related investment companies, has net 
assets of $50 million or less as of the end of its most recent fiscal 
year.\78\ Approximately 145 investment companies registered on Form N-
1A meet this definition.\79\ We estimate that few, if any, registered 
separate accounts registered on Form N-3, N-4, or N-6 are small 
entities.\80\
---------------------------------------------------------------------------

    \78\ 17 CFR 270.0-10.
    \79\ This estimate is based on analysis by the Division of 
Investment Management staff of information from databases compiled 
by third-party information providers, including Morningstar, Inc. 
and Lipper.
    \80\ This estimate is based on figures compiled by Division of 
Investment Management staff regarding separate accounts registered 
on Forms N-3, N-4, and N-6. In determining whether an insurance 
company separate account is a small entity for purposes of the 
Regulatory Flexibility Act, the assets of insurance company separate 
accounts are aggregated with the assets of their sponsoring 
insurance companies. Rule 0-10(b) under the Investment Company Act 
[17 CFR 270.0-10(b)].
---------------------------------------------------------------------------

D. Reporting, Recordkeeping, and Other Compliance Requirements

    The proposed amendments would require a mutual fund to disclose in 
its prospectus both the risks to shareholders of the frequent purchase 
and redemption of fund shares, and the fund's policies and procedures 
with respect to frequent purchases and redemptions of fund shares. The 
proposals would require similar prospectus disclosure for insurance 
company separate accounts issuing variable insurance contracts. The 
proposed amendments would also clarify that all mutual funds and 
insurance company managed separate accounts that issue variable 
annuities, other than money market funds, are required to explain both 
the circumstances under which they will use fair value pricing, and the 
effects of using fair value pricing. Finally, the proposals would 
require mutual funds and insurance company managed separate accounts 
that issue variable annuities to disclose their policies and procedures 
with respect to the disclosure of their portfolio securities to any 
person and any ongoing arrangements to make available information about 
their portfolio securities.
    The Commission estimates some one-time formatting and ongoing costs 
and burdens that would be imposed on all funds, including funds that 
are small entities. We note, however, that in many cases funds 
currently provide disclosure in their prospectuses of the limitations 
that they place on frequent trading in order to discourage market 
timing. For purposes of the Paperwork Reduction Act, we have estimated 
that the proposed new disclosure requirements would increase the hour 
burden per portfolio per filing of an initial registration statement on 
Form N-1A by 10 hours and would increase the hour burden per portfolio 
per filing of a post-effective amendment to a registration statement by 
4 hours. We estimate that this additional burden would increase total 
internal costs of an initial filing by $452.50 per mutual fund 
portfolio annually, and would increase total costs of filing a post-
effective amendment by $181 per mutual fund portfolio annually.\81\
---------------------------------------------------------------------------

    \81\ These figures are based on an estimated hourly wage rate of 
$45.25. See supra note 76.
---------------------------------------------------------------------------

    The external costs of providing the new prospectus disclosure 
relating to frequent purchases and redemptions of mutual fund shares 
and frequent transfers among sub-accounts of insurance company separate 
accounts that issue variable insurance contracts may or may not be 
significant, depending on the complexity of a fund's policies and 
procedures in these areas, the extent to which restrictions on frequent 
purchases and redemptions or frequent transfers among sub-accounts 
apply uniformly in all cases or will not be imposed under certain 
circumstances, and the extent to which a fund currently provides 
specific

[[Page 70415]]

disclosure in this area. We expect that the external costs of providing 
the new disclosure relating to a mutual fund's or insurance company 
managed separate account's policies and procedures with respect to 
disclosure of portfolio holdings information would be minimal, because 
the required description of a fund's policies and procedures with 
respect to the disclosure of the fund's portfolio securities to any 
person and any ongoing arrangements to make available information about 
the fund's portfolio securities will be required in the fund's SAI, 
which is delivered to investors upon request.
    The Commission solicits comment on the effect the proposed 
amendments would have on small entities.

E. Duplicative, Overlapping or Conflicting Federal Rules

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

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small issuers. In 
connection with the proposed amendments, the Commission considered the 
following alternatives: (i) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources available to small entities; (ii) the clarification, 
consolidation, or simplification of compliance and reporting 
requirements under the proposed amendments for small entities; (iii) 
the use of performance rather than design standards; and (iv) an 
exemption from coverage of the proposed amendments, or any part 
thereof, for small entities.
    The Commission believes at the present time that special compliance 
or reporting requirements for small entities, or an exemption from 
coverage for small entities, would not be appropriate or consistent 
with investor protection. The proposed disclosure amendments would 
provide shareholders with greater transparency of mutual funds' 
policies and procedures with respect to frequent purchases and 
redemptions of fund shares (and, with respect to insurance company 
separate accounts that issue variable insurance contracts, frequent 
transfers among sub-accounts) and mutual funds' and insurance company 
managed separate accounts' policies and procedures with respect to 
selective disclosure of their portfolio holdings. Different disclosure 
requirements for funds that are small entities may create the risk that 
the shareholders in these funds would not be as able as investors in 
larger funds to assess a fund's risks, policies, and procedures with 
respect to frequent purchases and redemptions of fund shares, as well 
as a fund's practices with respect to the disclosure of its portfolio 
holdings. We believe it is important for the disclosure that would be 
required by the proposed amendments to be provided to shareholders by 
all funds, not just funds that are not considered small entities.
    We have endeavored through the proposed amendments to minimize the 
regulatory burden on all funds, including small entities, while meeting 
our regulatory objectives. Small entities should benefit from the 
Commission's reasoned approach to the proposed amendments to the same 
degree as other investment companies. Further clarification, 
consolidation, or simplification of the proposals for funds that are 
small entities would be inconsistent with the Commission's concern for 
investor protection. Finally, we do not consider using performance 
rather than design standards to be consistent with our statutory 
mandate of investor protection in the present context.

G. Solicitation of Comments

    The Commission encourages the submission of written comments with 
respect to any aspect of this Analysis. Comment is specifically 
requested on the number of small entities that would be affected by the 
proposed amendments and the likely impact of the proposals on small 
entities. Commenters are asked to describe the nature of any impact and 
provide empirical data supporting the extent of the impact. These 
comments will be considered in the preparation of the Final Regulatory 
Flexibility Analysis, if the proposed amendments are adopted, and will 
be placed in the same public file as comments on the proposed 
amendments themselves. Comments should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW., Washington, DC 20549-0609. Comments also may be 
submitted electronically at the following e-mail address: [email protected]. All comment letters should refer to File No. S7-26-
03; this file number should be included on the subject line if e-mail 
is used. Comment letters will be available for public inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549-0102. Electronically submitted comment 
letters also will be posted on the Commission's Internet Web site 
(http://www.sec.gov).\82\
---------------------------------------------------------------------------

    \82\ We do not edit personal identifying information, such as 
names or electronic mail addresses, from electronic submissions. You 
should submit only information that you wish to make available 
publicly.
---------------------------------------------------------------------------

VIII. Consideration of Impact on the Economy

    For purposes of the Small Business Enforcement Fairness Act of 
1996,\83\ a rule is ``major'' if it results or is likely to result in:
---------------------------------------------------------------------------

    \83\ Pub. L. 104-21, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

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

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

IX. Statutory Authority

    The Commission is proposing amendments to Forms N-1A, N-3, N-4, and 
N-6 pursuant to authority set forth in sections 5, 6, 7, 10, and 19(a) 
of the Securities Act [15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a)] and 
sections 8, 22, 24(a), 30, and 38 of the Investment Company Act [15 
U.S.C. 80a-8, 80a-22, 80a-24(a), 80a-29, and 80a-37].

List of Subjects

17 CFR Part 239

    Reporting and recordkeeping requirements, Securities.

17 CFR Part 274

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Proposed Rule and Form Amendments

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

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

    1. 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.

[[Page 70416]]

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

    2. 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.

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


    3. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is 
amended by:
    a. In Instruction 6 to Item 1(b)(1), revising the reference ``Item 
7(f)'' to read ``Item 7(g)'';
    b. In Instruction 6 to Item 1(b)(1), revising the reference ``Item 
7(f)(3)'' to read ``Item 7(g)(3)'';
    c. In Item 4, revising the title and adding new paragraph (d);
    d. In Item 7, revising the Instruction to paragraph (a)(1);
    e. In Item 7, redesignating paragraphs (e) and (f) as paragraphs 
(f) and (g), respectively;
    f. In Item 7, adding paragraph (e);
    g. In newly redesignated Item 7(f)(2)(i), revising the reference 
``paragraph (e)(1)'' to read ``paragraph (f)(1)'';
    h. In newly redesignated paragraph (g) of Item 7, revising the 
introductory text;
    i. In paragraph (a)(2) of Item 8, revising the reference ``Item 
7(f)'' to read ``Item 7(g)''; and
    j. In Item 12, adding paragraph (f).
    The additions and revisions read as follows:

Form N-1A

* * * * *

Item 4. Investment Objectives, Principal Investment Strategies, Related 
Risks, and Disclosure of Portfolio Holdings

* * * * *
    (d) Portfolio Holdings. State that a description of the Fund's 
policies and procedures with respect to the disclosure of the Fund's 
portfolio securities is available (i) in the Fund's SAI; and (ii) on 
the Fund's Web site, if applicable.
* * * * *

Item 7. Shareholder Information

    (a) * * *
    (1) * * *
    Instruction. A Fund (other than a Money Market Fund) must provide a 
brief explanation of the circumstances under which it will use fair 
value pricing and the effects of using fair value pricing.
* * * * *
    (e) Frequent Purchases and Redemptions of Fund Shares.
    (1) Describe the risks, if any, that frequent purchases and 
redemptions of Fund shares by Fund shareholders may present for other 
shareholders of the Fund.
    (2) State whether or not the Fund's board of directors has adopted 
policies and procedures with respect to frequent purchases and 
redemptions of Fund shares by Fund shareholders.
    (3) If the Fund's board of directors has not adopted any such 
policies and procedures, provide a statement of the specific basis for 
the view of the board that it is appropriate for the Fund not to have 
such policies and procedures.
    (4) If the Fund's board of directors has adopted any such policies 
and procedures, describe those policies and procedures, including:
    (i) Whether or not the Fund discourages frequent purchases and 
redemptions of Fund shares by Fund shareholders;
    (ii) Whether or not the Fund accommodates frequent purchases and 
redemptions of Fund shares by Fund shareholders;
    (iii) Any policies and procedures of the Fund for deterring 
frequent purchases and redemptions of Fund shares by Fund shareholders, 
including any restrictions imposed by the Fund to prevent or minimize 
frequent purchases and redemptions. Describe each of these policies, 
procedures, and restrictions with specificity. Indicate whether each of 
these restrictions applies uniformly in all cases or whether the 
restriction will not be imposed under certain circumstances. Describe 
with specificity the circumstances under which any restriction will not 
be imposed. Include a description of the following restrictions, if 
applicable:
    (A) Any restrictions on the volume or number of purchases, 
redemptions, or exchanges that a shareholder may make within a given 
time period;
    (B) Any exchange fee or redemption fee;
    (C) Any costs or administrative or other fees or charges that are 
imposed on shareholders deemed to be engaged in frequent purchases and 
redemptions of Fund shares, together with a description of the 
circumstances under which such costs, fees, or charges will be imposed;
    (D) Any minimum holding period that is imposed before an investor 
may make exchanges into another Fund;
    (E) Any restrictions imposed on exchange or purchase requests 
submitted by overnight delivery, electronically, or via facsimile or 
telephone; and
    (F) Any right of the Fund to reject, limit, delay, or impose other 
conditions on exchanges or purchases or to terminate or otherwise limit 
accounts based on a history of frequent purchases and redemptions of 
Fund shares, including the circumstances under which such right will be 
exercised; and
    (iv) Any policies and procedures of the Fund for detecting frequent 
purchases and redemptions of Fund shares, including any arrangements 
for detecting frequent purchases and redemptions of Fund shares through 
intermediaries, such as investment advisers, broker-dealers, transfer 
agents, and third party administrators.
    (5) Describe any arrangements with any person to permit frequent 
purchases and redemptions of Fund shares, including the identity of the 
persons permitted to engage in frequent purchases and redemptions 
pursuant to such arrangements, and any compensation or other 
consideration received by the Fund, its investment adviser, or any 
other party pursuant to such arrangements.
    Instruction. The consideration required to be disclosed by Item 
7(e)(5) includes any agreement to maintain assets in the Fund or in 
other investment companies or accounts managed by the investment 
adviser or by any affiliated person of the investment adviser.
* * * * *
    (g) Separate Disclosure Document. A Fund may omit from the 
prospectus information about purchase and redemption procedures 
required by Items 7(b)-(d) and 8(a)(2), other than information that is 
also required by Item 7(e), and provide it in a separate document if 
the Fund:
* * * * *

Item 12. Description of the Fund and Its Investments and Risks

* * * * *
    (f) Disclosure of Portfolio Holdings.
    (1) Describe the Fund's policies and procedures with respect to the 
disclosure of the Fund's portfolio securities to any person, including:
    (i) How the policies and procedures apply to disclosure to 
different categories of persons, including individual investors, 
institutional investors, intermediaries that distribute the Fund's 
shares, third-party service providers, rating and ranking 
organizations, and affiliated persons of the Fund;
    (ii) Any conditions or restrictions placed on the use of 
information about portfolio securities that is disclosed, including any 
requirement that the

[[Page 70417]]

information be kept confidential or prohibitions on trading based on 
the information, and any procedures to monitor the use of this 
information;
    (iii) The frequency with which information about portfolio 
securities is disclosed, and the length of the lag, if any, between the 
date of the information and the date on which the information is 
disclosed;
    (iv) Any policies and procedures with respect to the receipt of 
compensation or other consideration by the Fund, its investment 
adviser, or any other party in connection with the disclosure of 
information about portfolio securities;
    (v) The persons who may authorize disclosure of the Fund's 
portfolio securities;
    (vi) The procedures that the Fund uses to ensure that disclosure of 
information about portfolio securities is in the best interests of Fund 
shareholders, including procedures to address conflicts between the 
interests of Fund shareholders, on the one hand, and those of the 
Fund's investment adviser; principal underwriter; or any affiliated 
person of the Fund, its investment adviser, or its principal 
underwriter, on the other; and
    (vii) The manner in which the board of directors exercises 
oversight of disclosure of the Fund's portfolio securities.
    Instruction. Include any policies and procedures of the Fund's 
investment adviser, or any other third party, that the Fund uses, or 
that are used on the Fund's behalf, with respect to the disclosure of 
the Fund's portfolio securities to any person.
    (2) Describe any ongoing arrangements to make available information 
about the Fund's portfolio securities to any person, including the 
identity of the persons who receive information pursuant to such 
arrangements. Describe any compensation or other consideration received 
by the Fund, its investment adviser, or any other party in connection 
with such arrangements, and provide the information described by 
paragraphs (f)(1)(ii), (iii), and (v) of Item 12 with respect to such 
arrangements.
    Instruction. The consideration required to be disclosed by Item 
12(f)(2) includes any agreement to maintain assets in the Fund or in 
other investment companies or accounts managed by the investment 
adviser or by any affiliated person of the investment adviser.
* * * * *
    4. Form N-3 (referenced in Sec. Sec.  239.17a and 274.11b) is 
amended by:
    a. In Item 5, adding paragraph (f).
    b. In Item 8, adding paragraph (e).
    c. In Item 11, adding an Instruction to paragraph (c).
    d. In Item 19, adding paragraph (e).
    The additions read as follows:

Form N-3

* * * * *

Item 5. General Description of Registrant and Insurance Company

* * * * *
    (f) State that a description of the Registrant's policies and 
procedures with respect to the disclosure of the Registrant's portfolio 
securities is available (A) in the Registrant's Statement of Additional 
Information; and (B) on the Registrant's Web site, if applicable.
* * * * *

Item 8. General Description of Variable Annuity Contracts

* * * * *
    (e)(i) Describe the risks, if any, that frequent transfers of 
contract value among sub-accounts of the Registrant may present for 
other contractowners and other persons (e.g., participants, annuitants, 
or beneficiaries) who have material rights under the variable annuity 
contracts.
    (ii) State whether or not the Registrant's board of managers has 
adopted policies and procedures with respect to frequent transfers of 
contract value among sub-accounts of the Registrant.
    (iii) If the Registrant's board of managers has not adopted any 
such policies and procedures, provide a statement of the specific basis 
for the view of the board that it is appropriate for the Registrant not 
to have such policies and procedures.
    (iv) If the Registrant's board of managers has adopted any such 
policies and procedures, describe those policies and procedures, 
including:
    (A) Whether or not the Registrant discourages frequent transfers of 
contract value among sub-accounts of the Registrant;
    (B) Whether or not the Registrant accommodates frequent transfers 
of contract value among sub-accounts of the Registrant;
    (C) Any policies and procedures of the Registrant for deterring 
frequent transfers of contract value among sub-accounts of the 
Registrant, including any restrictions imposed by the Registrant to 
prevent or minimize frequent transfers. Describe each of these 
policies, procedures, and restrictions with specificity. Indicate 
whether each of these restrictions applies uniformly in all cases or 
whether the restriction will not be imposed under certain 
circumstances. Describe with specificity the circumstances under which 
any restriction will not be imposed. Include a description of the 
following restrictions, if applicable:
    (1) Any restrictions on the volume or number of transfers that may 
be made within a given time period;
    (2) Any transfer fee;
    (3) Any costs or administrative or other fees or charges that are 
imposed on persons deemed to be engaged in frequent transfers of 
contract value among sub-accounts of the Registrant, together with a 
description of the circumstances under which such costs, fees, or 
charges will be imposed;
    (4) Any minimum holding period that is imposed before a transfer 
may be made from a sub-account into another sub-account of the 
Registrant;
    (5) Any restrictions imposed on transfer requests submitted by 
overnight delivery, electronically, or via facsimile or telephone; and
    (6) Any right of the Registrant to reject, limit, delay, or impose 
other conditions on transfers or to terminate or otherwise limit 
contracts based on a history of frequent transfers among sub-accounts, 
including the circumstances under which such right will be exercised; 
and
    (D) Any policies and procedures of the Registrant for detecting 
frequent transfers of contract value among sub-accounts of the 
Registrant.
    (v) Describe any arrangements with any person to permit frequent 
transfers of contract value among sub-accounts of the Registrant, 
including the identity of the persons permitted to engage in frequent 
transfers pursuant to such arrangements, and any compensation or other 
consideration received by the Registrant, its investment adviser, the 
Insurance Company, or any other party pursuant to such arrangements.
    Instruction:
    The consideration required to be disclosed by Item 8(e)(v) includes 
any agreement to maintain assets in the Registrant or in other 
investment companies or accounts managed or sponsored by the investment 
adviser, the Insurance Company, or any affiliated person of the 
investment adviser or the Insurance Company.
* * * * *

Item 11. Purchases and Contract Value

* * * * *
    (c) * * *
    Instruction:
    A Registrant (other than a money market fund or sub-account) must 
provide a brief explanation of the

[[Page 70418]]

circumstances under which it will use fair value pricing and the 
effects of using fair value pricing.
* * * * *

Item 19. Investment Objectives and Policies

* * * * *
    (e)(i) Describe the Registrant's policies and procedures with 
respect to the disclosure of the Registrant's portfolio securities to 
any person, including:
    (A) How the policies and procedures apply to disclosure to 
different categories of persons, including contractowners, 
participants, annuitants, beneficiaries, institutional investors, 
intermediaries that distribute the Registrant's contracts, third-party 
service providers, rating and ranking organizations, and affiliated 
persons of the Registrant;
    (B) Any conditions or restrictions placed on the use of information 
about portfolio securities that is disclosed, including any requirement 
that the information be kept confidential or prohibitions on trading 
based on the information, and any procedures to monitor the use of this 
information;
    (C) The frequency with which information about portfolio securities 
is disclosed, and the length of the lag, if any, between the date of 
the information and the date on which the information is disclosed;
    (D) Any policies and procedures with respect to the receipt of 
compensation or other consideration by the Registrant, its investment 
adviser, the Insurance Company, or any other party in connection with 
the disclosure of information about portfolio securities;
    (E) The persons who may authorize disclosure of the Registrant's 
portfolio securities;
    (F) The procedures that the Registrant uses to ensure that 
disclosure of information about portfolio securities is in the best 
interests of contractowners, participants, annuitants, and 
beneficiaries, including procedures to address conflicts between the 
interests of such persons, on the one hand, and those of the 
Registrant's investment adviser or principal underwriter; the Insurance 
Company; or any affiliated person of the Registrant, its investment 
adviser or principal underwriter; or the Insurance Company, on the 
other; and
    (G) The manner in which the board of managers exercises oversight 
of disclosure of the Registrant's portfolio securities.
    Instruction:
    Include any policies and procedures of the Registrant's investment 
adviser, or any other third party, that the Registrant uses, or that 
are used on the Registrant's behalf, with respect to the disclosure of 
the Registrant's portfolio securities to any person.
    (ii) Describe any ongoing arrangements to make available 
information about the Registrant's portfolio securities to any person, 
including the identity of the persons who receive information pursuant 
to such arrangements. Describe any compensation or other consideration 
received by the Registrant, its investment adviser, the Insurance 
Company, or any other party in connection with such arrangements, and 
provide the information described by paragraphs (e)(i)(B), (C), and (E) 
of Item 19 with respect to such arrangements.
    Instruction:
    The consideration required to be disclosed by Item 19(e)(ii) 
includes any agreement to maintain assets in the Registrant or in other 
investment companies or accounts managed or sponsored by the investment 
adviser, the Insurance Company, or any affiliated person of the 
investment adviser or the Insurance Company.
* * * * *
    5. Item 7 of Form N-4 (referenced in Sec. Sec.  239.17b and 
274.11c) is amended by adding paragraph (e), to read as follows:

Form N-4

* * * * *

Item 7. General Description of Variable Annuity Contracts

* * * * *
    (e)(i) Describe the risks, if any, that frequent transfers of 
contract value among sub-accounts of the Registrant may present for 
other contractowners and other persons (e.g., participants, annuitants, 
or beneficiaries) who have material rights under the variable annuity 
contracts.
    (ii) State whether or not the Registrant or depositor has policies 
and procedures with respect to frequent transfers of contract value 
among sub-accounts of the Registrant.
    (iii) If neither the Registrant nor the depositor has any such 
policies and procedures, provide a statement of the specific basis for 
the view of the depositor that it is appropriate for the Registrant and 
depositor not to have such policies and procedures.
    (iv) If the Registrant or depositor has any such policies and 
procedures, describe those policies and procedures, including:
    (A) Whether or not the Registrant or depositor discourages frequent 
transfers of contract value among sub-accounts of the Registrant;
    (B) Whether or not the Registrant or depositor accommodates 
frequent transfers of contract value among sub-accounts of the 
Registrant;
    (C) Any policies and procedures of the Registrant or depositor for 
deterring frequent transfers of contract value among sub-accounts of 
the Registrant, including any restrictions imposed by the Registrant or 
depositor to prevent or minimize frequent transfers. Describe each of 
these policies, procedures, and restrictions with specificity. Indicate 
whether each of these restrictions applies uniformly in all cases or 
whether the restriction will not be imposed under certain 
circumstances. Describe with specificity the circumstances under which 
any restriction will not be imposed. Include a description of the 
following restrictions, if applicable:
    (1) Any restrictions on the volume or number of transfers that may 
be made within a given time period;
    (2) Any transfer fee;
    (3) Any costs or administrative or other fees or charges that are 
imposed on persons deemed to be engaged in frequent transfers of 
contract value among sub-accounts of the Registrant, together with a 
description of the circumstances under which such costs, fees, or 
charges will be imposed;
    (4) Any minimum holding period that is imposed before a transfer 
may be made from a sub-account into another sub-account of the 
Registrant;
    (5) Any restrictions imposed on transfer requests submitted by 
overnight delivery, electronically, or via facsimile or telephone; and
    (6) Any right of the Registrant or depositor to reject, limit, 
delay, or impose other conditions on transfers or to terminate or 
otherwise limit contracts based on a history of frequent transfers 
among sub-accounts, including the circumstances under which such right 
will be exercised; and
    (D) Any policies and procedures of the Registrant or depositor for 
detecting frequent transfers of contract value among sub-accounts of 
the Registrant.
    (v) Describe any arrangements with any person to permit frequent 
transfers of contract value among sub-accounts of the Registrant, 
including the identity of the persons permitted to engage in frequent 
transfers pursuant to such arrangements, and any compensation or other 
consideration received by the Registrant, the depositor, or any other 
party pursuant to such arrangements.
    Instruction:
    The consideration required to be disclosed by Item 7(e)(v) includes 
any agreement to maintain assets in the Registrant or in other 
investment companies or accounts managed or sponsored by the depositor, 
any

[[Page 70419]]

investment adviser of a portfolio company, or any affiliated person of 
the depositor or of any such investment adviser.
* * * * *
    6. Item 6 of Form N-6 (referenced in Sec. Sec.  239.17c and 
274.11d) is amended by adding paragraph (f), to read as follows:

Form N-6

* * * * *

Item 6. General Description of Contracts

* * * * *
    (f) Frequent Transfers among Sub-accounts of the Registrant.
    (1) Describe the risks, if any, that frequent transfers of Contract 
value among sub-accounts of the Registrant may present for other 
Contractowners and other persons (e.g., the insured or beneficiaries) 
who have material rights under the Contract.
    (2) State whether or not the Registrant or Depositor has policies 
and procedures with respect to frequent transfers of Contract value 
among sub-accounts of the Registrant.
    (3) If neither the Registrant nor the Depositor has any such 
policies and procedures, provide a statement of the specific basis for 
the view of the Depositor that it is appropriate for the Registrant and 
Depositor not to have such policies and procedures.
    (4) If the Registrant or Depositor has any such policies and 
procedures, describe those policies and procedures, including:
    (i) Whether or not the Registrant or Depositor discourages frequent 
transfers of Contract value among sub-accounts of the Registrant;
    (ii) Whether or not the Registrant or Depositor accommodates 
frequent transfers of Contract value among sub-accounts of the 
Registrant;
    (iii) Any policies and procedures of the Registrant or Depositor 
for deterring frequent transfers of Contract value among sub-accounts 
of the Registrant, including any restrictions imposed by the Registrant 
or Depositor to prevent or minimize frequent transfers. Describe each 
of these policies, procedures, and restrictions with specificity. 
Indicate whether each of these restrictions applies uniformly in all 
cases or whether the restriction will not be imposed under certain 
circumstances. Describe with specificity the circumstances under which 
any restriction will not be imposed. Include a description of the 
following restrictions, if applicable:
    (A) Any restrictions on the volume or number of transfers that may 
be made within a given time period;
    (B) Any transfer fee;
    (C) Any costs or administrative or other fees or charges that are 
imposed on persons deemed to be engaged in frequent transfers of 
Contract value among sub-accounts of the Registrant, together with a 
description of the circumstances under which such costs, fees, or 
charges will be imposed;
    (D) Any minimum holding period that is imposed before a transfer 
may be made from a sub-account into another sub-account of the 
Registrant;
    (E) Any restrictions imposed on transfer requests submitted by 
overnight delivery, electronically, or via facsimile or telephone; and
    (F) Any right of the Registrant or Depositor to reject, limit, 
delay, or impose other conditions on transfers or to terminate or 
otherwise limit Contracts based on a history of frequent transfers 
among sub-accounts, including the circumstances under which such right 
will be exercised; and
    (iv) Any policies and procedures of the Registrant or Depositor for 
detecting frequent transfers of Contract value among sub-accounts of 
the Registrant.
    (5) Describe any arrangements with any person to permit frequent 
transfers of Contract value among sub-accounts of the Registrant, 
including the identity of the persons permitted to engage in frequent 
transfers pursuant to such arrangements, and any compensation or other 
consideration received by the Registrant, the Depositor, or any other 
party pursuant to such arrangements.
    Instruction. The consideration required to be disclosed by Item 
6(f)(5) includes any agreement to maintain assets in the Registrant or 
in other investment companies or accounts managed or sponsored by the 
Depositor, any investment adviser of a Portfolio Company, or any 
affiliated person of the Depositor or of any such investment adviser.
* * * * *

    Dated: December 11, 2003.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 03-31070 Filed 12-16-03; 8:45 am]
BILLING CODE 8010-01-P