[Federal Register Volume 69, Number 33 (Thursday, February 19, 2004)]
[Proposed Rules]
[Pages 7852-7862]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-3535]



[[Page 7851]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 239, 240, 274



Disclosure Regarding Approval of Investment Advisory Contracts By 
Directors of Investment Companies; Proposed Rule

  Federal Register / Vol. 69, No. 33 / Thursday, February 19, 2004 / 
Proposed Rules  

[[Page 7852]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 240, and 274

[Release Nos. 33-8364; 34-49219; IC-26350; File No. S7-08-04]
RIN 3235-AJ10


Disclosure Regarding Approval of Investment Advisory Contracts by 
Directors of Investment Companies

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing rule and 
form amendments under the Securities Act of 1933, the Securities 
Exchange Act of 1934, and the Investment Company Act of 1940 to improve 
the disclosure provided by registered management investment companies 
about how their boards of directors evaluate and approve, and recommend 
shareholder approval of, investment advisory contracts. The proposed 
amendments would require a registered management investment company to 
provide disclosure in its reports to shareholders regarding the 
material factors and the conclusions with respect to those factors that 
formed the basis for the board's approval of advisory contracts during 
the reporting period. The proposals also are designed to encourage 
improved disclosure in the registration statements of registered 
management investment companies regarding the basis for the board's 
approval of existing advisory contracts, and in proxy statements 
regarding the basis for the board's recommendation that shareholders 
approve an advisory contract.

DATES: Comments must be received on or before April 26, 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. S7-08-04; this file number should be included 
in the subject line if electronic mail is used. All comments received 
will be posted on the Commission's Internet Web site (http://www.sec.gov) and made available for public inspection and copying in 
the Commission's Public Reference Room, 450 Fifth Street, NW., 
Washington, DC 20549.\1\
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    \1\ We do not edit personal identifying information, such as 
names or electronic mail addresses, from hard copy or electronic 
submissions. You should submit only information that you wish to 
make available publicly.

FOR FURTHER INFORMATION CONTACT: Deborah D. Skeens, Senior Counsel, or 
Paul G. Cellupica, Assistant Director, Office of Disclosure Regulation, 
Division of Investment Management, (202) 942-0721, at the Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
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0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is proposing for comment amendments to Schedule 
14A,\2\ the schedule used by registered investment companies and 
issuers registered under section 12 of the Securities Exchange Act of 
1934 (``Exchange Act'')\3\ for proxy statements pursuant to section 
14(a) of the Exchange Act, and Forms N-1A,\4\ N-2,\5\ and N-3,\6\ 
registration forms used by management investment companies to register 
under the Investment Company Act of 1940 (``Investment Company Act'') 
\7\ and to offer their securities under the Securities Act of 1933 
(``Securities Act'').\8\
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    \2\ 17 CFR 240.14a-101.
    \3\ 15 U.S.C. 78a et seq.
    \4\ 17 CFR 239.15A and 274.11A.
    \5\ 17 CFR 239.14 and 274.11a-1.
    \6\ 17 CFR 239.17a and 274.11b.
    \7\ 15 U.S.C. 80a-1 et seq.
    \8\ 15 U.S.C. 77a et seq.
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Table of Contents

I. Background
II. Discussion
III. Request For Comments
IV. Paperwork Reduction Act
V. Cost/Benefit Analysis
VI. Consideration of Burden on Competition; Promotion of 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. Background

    Unlike most business organizations, registered management 
investment companies (``funds'') \9\ are typically organized by an 
investment adviser that is responsible for the day-to-day operations of 
the fund. In most cases, the investment adviser is organized as a 
corporation, whose shareholders may have an interest in the fund that 
is quite different from the interests of the fund's shareholders. One 
of the key areas where the interests of fund shareholders and 
shareholders of the investment adviser diverge is fees. While fund 
shareholders ordinarily prefer lower fees to achieve greater returns, 
shareholders of the fund's investment adviser often want to maximize 
profits through higher fees.
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    \9\ 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. A closed-end 
company is any management company other than an open-end company. 
See Section 5 of the Investment Company Act [15 U.S.C. 80a-5]. Open-
end companies generally offer and sell new shares to the public on a 
continuous basis. Closed-end companies generally engage in 
traditional underwritten offerings of a fixed number of shares and, 
in most cases, do not offer their shares to the public on a 
continuous basis.
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    The Investment Company Act relies on fund boards of directors to 
police conflicts of interest, including conflicts with respect to fees 
to be received by investment advisers. Section 15(a) makes it unlawful 
for any person to serve as an investment adviser to a fund, except 
pursuant to a written contract that has been approved by a majority 
vote of the fund's shareholders and that continues in effect for not 
more than two years, unless its continuance is approved at least 
annually by the board of directors or a majority vote of the 
shareholders.\10\ In addition, Section 15(c) requires that the terms of 
any advisory contract, and any renewal thereof, be approved by a vote 
of the majority of the disinterested directors.\11\ Section 15(c) also 
requires a fund's directors to request and evaluate, and an investment 
adviser to a fund to furnish, such information as may reasonably be 
necessary to evaluate the terms of any advisory contract.\12\ As part 
of their fiduciary duties with respect to fund fees, boards of 
directors are required to evaluate the material factors applicable to a 
decision to approve an investment advisory contract. \13\
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    \10\ 15 U.S.C. 80a--15(a).
    \11\ We refer to directors who are not ``interested persons'' of 
the fund as ``independent directors'' or ``disinterested 
directors.'' The term ``interested person'' is defined in Section 
2(a)(19) [15 U.S.C. 80a-2(a)(19)] of the Investment Company Act.
    \12\ 15 U.S.C. 80a-15(c). We recently proposed amendments to 
rule 31a-2, the fund recordkeeping rule, that would require funds to 
retain copies of the written materials that directors consider in 
approving an advisory contract under section 15 of the Investment 
Company Act. See Investment Company Act Release No. 26323 (Jan. 15, 
2004) [69 FR 3472, 3477 (Jan. 23, 2004)].
    \13\ See, e.g., Burks v. Lasker, 441 U.S. 471, 483 (1979) 
(``Congress consciously chose to address the conflict-of-interest 
problem through the [Investment Company] Act's independent-directors 
section.''); Brown v. Bullock, 194 F. Supp. 207 (S.D.N.Y.), aff'd, 
294 F.2d 415 (2nd Cir. 1961) (``By giving the directors the right to 
extend and terminate the [investment advisory] contract, the Act 
necessarily also imposes upon the directors the fiduciary duty to 
use these powers intelligently, diligently and solely for the 
interests of the company and its stockholders.'').

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[[Page 7853]]

    Since 1994, we have required fund proxy statements seeking approval 
of an investment advisory contract to include a discussion of the 
material factors that form the basis of the fund board's recommendation 
that shareholders approve the contract.\14\ In 2001, as part of an 
initiative intended to enhance the independence and effectiveness of 
fund boards, we adopted amendments requiring a fund to provide similar 
disclosure in its Statement of Additional Information (``SAI'') \15\ 
regarding the basis for the board's approval of an existing investment 
advisory contract.\16\ This requirement was intended to provide 
shareholders with specific information on how directors evaluate and 
approve investment advisory contracts, including, in particular, the 
fees paid by the fund to the adviser.
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    \14\ Item 22(c)(11) of Schedule 14A. See Investment Company Act 
Release No. 20614 (Oct. 13, 1994) [59 FR 52689 (Oct. 19, 1994)] 
(adopting amendments to Schedule 14A).
    \15\ 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 (``EDGAR'').
    \16\ Item 13(b)(10) of Form N-1A (registration statement for 
open-end management investment companies); Item 18.13 of Form N-2 
(registration statement for closed-end management investment 
companies); Item 20(l) of Form N-3 (registration statement for 
separate accounts organized as management investment companies that 
offer variable annuity contracts); Investment Company Act Release 
No. 24816 (Jan. 2, 2001) [66 FR 3734, 3744 (Jan. 16, 2001)] 
(adopting requirement for disclosure in SAI of basis for board's 
approval of advisory contract).
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    Recently, concerns have been raised regarding the adequacy of 
review of advisory contracts and management fees by fund boards. In 
particular, the level of fees charged by investment advisers to mutual 
fund clients, especially in comparison to those charged by the same 
advisers to pension plans and other institutional clients, has come 
under scrutiny.\17\ Some have argued that advisory fees charged by 
investment advisers for equity pension funds are substantially lower 
than advisory fees charged by investment advisers for equity mutual 
funds because advisory fees for pension funds are negotiated through 
arm's-length bargaining.\18\ Some have also argued that the process by 
which fund boards determine to renew advisory contracts is often 
cursory, at best.\19\
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    \17\ See, e.g., Carla Fried, Pressure Builds to Cut Fund Fees, 
The New York Times, Jan. 11, 2004, at sec. 3, p. 26 (discussing 
continuing concern among federal and state regulators over level of 
fund advisory fees); Yuka Hayashi and Tom Lauricella, Fund Report 
Disputes Critics' Study--Trade Group Rebuts Figures Cited by New 
York's Spitzer on High Management Fees, The Wall Street Journal, 
Jan. 7, 2004, at D9 (discussing debate over whether mutual fund 
investors pay significantly higher fees than pension funds and other 
large investors for similar money-management services). See also 
Testimony of John C. Bogle, Oversight Hearing on the Mutual Fund and 
Investment Advisory Industry Before the U.S. Senate Governmental 
Affairs Committee, Subcommittee on Financial Management, 108th 
Cong., 1st. Sess. (November 3, 2003) (``If the management fees that 
represent the major portion of [fund] costs were subject to arm's 
length negotiation between funds and their managers, it is true that 
tens of billions of dollars could be saved and added to investor 
returns year after year after year.'')
    \18\ John P. Freeman and Stewart L. Brown, Mutual Fund Advisory 
Fees: The Cost of Conflicts of Interest, 26 Iowa Journal of 
Corporation Law 609, 634 (Spring 2001) (``Freeman/Brown Study''). 
But see Sean Collins, The Expenses of Defined Benefit Pension Plans 
and Mutual Funds, Investment Company Institute Perspective (December 
2003), available at http://www.ici.org/pdf/per12-03.pdf (arguing 
that Freeman/Brown Study failed to take into account significant 
differences in organizational structure and expense structure 
between mutual funds and equity pension funds).
    \19\ See, e.g., Special Report: Perils in the Savings Pool--
Mutual Funds, The Economist, Nov. 8, 2003, at 65 (arguing that fund 
boards tend to ``rubber-stamp'' their advisers' contracts without 
question); Testimony of Gary Gensler, Hearing before the U.S. House 
of Representatives Committee on Financial Services, Subcommittee on 
Capital Markets, Insurance and Government Sponsored Enterprises, 
108th Cong., 1st Sess. (Mar. 12, 2003) (arguing that ``mutual fund 
boards fire their advisers with about the same frequency that race 
horses fire their jockeys'').
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    The Commission recently proposed amendments to the fund 
recordkeeping rule to require that funds retain copies of the written 
materials that directors considered in approving an advisory 
contract.\20\ This recordkeeping requirement will facilitate our 
compliance examiners' review of whether directors are obtaining the 
necessary information to make an informed assessment of the advisory 
contract. The Commission has also proposed measures to enhance the 
independence of fund boards of directors by requiring funds that rely 
on certain exemptive rules to increase the percentage of their 
independent directors from a majority to 75 percent and requiring that 
these boards be led by a chairman who is an independent director.\21\ A 
fund board may be more effective when negotiating with the fund adviser 
over matters such as the advisory fee when the board is composed of a 
super-majority of independent directors and led by an independent 
chairman.
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    \20\ See Investment Company Act Release No. 26323 (Jan. 15, 
2004) [69 FR 3472 (Jan 23, 2004)].
    \21\ Id.
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    Today we are taking steps to encourage fair and reasonable fund 
fees through increased transparency. Increased transparency with 
respect to investment advisory contracts, and fees paid for advisory 
services, will assist investors in making informed choices among funds 
and encourage fund boards to engage in vigorous and independent 
oversight of advisory contracts.\22\ The Commission is proposing 
enhanced disclosure regarding the board's basis for approving, or 
recommending that shareholders approve, investment advisory contracts. 
These proposals are intended to provide existing fund shareholders with 
more timely information about the basis for the board's approval of any 
investment advisory contract. In addition, the proposals are designed 
to reinforce the existing obligation of a fund to provide meaningful 
disclosure in the SAI and proxy statements about the basis for the 
board's approval of the fund's existing advisory contract and any board 
recommendation that shareholders approve an advisory contract. We have 
previously reminded funds that ``boilerplate'' disclosure is not 
appropriate, but we remain concerned that some funds do not provide 
adequate specificity regarding the board's basis for its decision.\23\
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    \22\ See Statement of the Commission Regarding the Enforcement 
Action Against Alliance Capital Management, L.P., SEC Press Release 
2003-176 (Dec. 18, 2003) http://www.sec.gov/news/press/2003-176.htm 
(stating Commission's view that the best way to ensure fair and 
reasonable fees ``is a marketplace of vigorous, independent, and 
diligent mutual fund boards coupled with fully-informed investors 
who are armed with complete, easy-to-digest disclosure about the 
fees paid and the services rendered'').
    \23\ See Investment Company Act Release No. 24816, supra note, 
66 FR at 3744.
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    Today's proposal is one step in a larger series of Commission 
rulemaking initiatives that have sought to improve disclosure to 
investors concerning fund fees and charges. The Commission is adopting 
rules that will require mutual funds to include in shareholder reports 
information regarding the dollar amount of expenses paid by investors 
on an ongoing basis for investing in the fund. The Commission also 
recently adopted amendments requiring investment company advertisements 
to highlight the availability and importance of information on fees and 
charges found in the prospectus \24\ and has proposed amendments to the 
mutual fund prospectus that would require enhanced disclosure regarding 
breakpoint discounts on front-end sales loads.\25\ In addition, the 
Commission published a concept release seeking views regarding

[[Page 7854]]

improving disclosure of transaction costs.\26\ Finally, the Commission 
recently proposed new rules that would require broker-dealers to 
provide their customers with targeted information, at the point of sale 
and in transaction confirmations, regarding the costs and conflicts of 
interest that arise from the distribution of mutual fund shares.\27\ 
Together, these initiatives are intended to enhance significantly the 
information that fund investors receive about fees and charges.
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    \24\ See Investment Company Act Release No. 26195 (Sept., 29, 
2003) [68 FR 57760 (Oct. 6, 2003)].
    \25\ See Investment Company Act Release No. 26298 (Dec. 17, 
2003) [68 FR 74732 (Dec. 24, 2003)].
    \26\ See Investment Company Act Release No. 26313 (Dec. 18, 
2003) [68 FR 74820 (Dec. 24, 2003)].
    \27\ See Investment Company Act Release No. 26341 (Jan. 29, 
2004) [69 FR 6438 (Feb. 10, 2004)].
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II. Discussion

    The Commission is proposing amendments to Forms N-1A, N-2, and N-3 
\28\ that would require fund shareholder reports to discuss, in 
reasonable detail, the material factors and the conclusions with 
respect thereto that formed the basis for the board of directors' 
approval of any investment advisory contract.\29\ This requirement 
would apply to shareholder reports of open- and closed-end management 
investment companies and insurance company managed separate accounts 
that offer variable annuities. The required disclosure would be similar 
to disclosure currently required in the SAI and fund proxy statements 
about the basis for the approval of the fund's existing advisory 
contract and any board recommendation that shareholders approve an 
advisory contract. The shareholder reports disclosure would be required 
for any new investment advisory contract or contract renewal, including 
subadvisory contracts, approved during the semi-annual period covered 
by the report, other than a contract that was approved by 
shareholders.\30\ In the case of contracts approved by shareholders, a 
fund is already required to provide similar disclosure in a proxy 
statement.\31\
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    \28\ Open-end management investment companies use Form N-1A to 
register under the Investment Company Act and to offer their shares 
under the Securities Act. Closed-end management investment companies 
use Form N-2, and insurance company managed separate accounts that 
offer variable annuities use Form N-3.
    \29\ Proposed Item 21(d)(6) of Form N-1A; proposed Instruction 
6.e. to Item 23 of Form N-2; proposed Instruction 6(v) to Item 27(a) 
of Form N-3. The proposed amendments to Form N-1A reflect amendments 
that the Commission is adopting to the requirements for fund 
shareholder reports that renumber Item 13 (Management) and Item 22 
(Financial Statements) of Form N-1A as Items 12 and 21, 
respectively. The amendments that the Commission is adopting also 
add Item 21(d) to Form N-1A, Instruction 6 to Item 23 to Form N-2, 
and Instruction 6(v) to Item 27(a) of Form N-3, containing 
requirements for annual and semi-annual reports to shareholders for 
each respective registration form.
    \30\ The disclosure would be required for approvals of 
subadvisory contracts where shareholder approval of the contract is 
not required. See Investment Company Act Release No. IC-26230 (Oct. 
23, 2003) [68 FR 61720 (Oct. 29, 2003)] (proposing rules that would 
codify exemptive orders issued for ``manager of manager'' funds that 
permit such funds to operate without obtaining shareholder approval 
when the fund's principal investment adviser hires a new subadviser 
or replaces an existing subadviser).
    We are also adding an instruction to the existing disclosure 
requirements for the SAI, clarifying that these requirements apply 
to both approvals of new advisory contracts and contract renewals, 
and to subadvisory contracts. See proposed Instruction 1 to Item 
12(b)(10) of Form N-1A; proposed Instruction 1 to Item 18.13 of Form 
N-2; proposed Instruction 1 to Item 20 of Form N-3.
    \31\ See Item 22(c)(11) of Schedule 14A.
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    Our proposal is intended to provide existing fund shareholders with 
more timely disclosure of the reasons for the board's approval of an 
investment advisory contract. We believe that the visibility of this 
disclosure, alongside other current information about a fund, such as 
investment performance and current period dollars and cents expense 
disclosure,\32\ may encourage funds to provide a meaningful explanation 
of the board's basis for approving an investment advisory contract. 
This, in turn, may encourage fund boards to consider investment 
advisory contracts more carefully and investors to consider more 
carefully the costs and value of the services rendered by the fund's 
investment adviser.
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    \32\ The Commission is also publishing a release adopting rules 
that will require registered open-end management investment 
companies to include in shareholder reports Management's Discussion 
of Fund Performance and information regarding the dollar amount of 
expenses paid by investors on an ongoing basis.
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    Our proposals would result in parallel disclosure requirements in 
fund shareholder reports, the SAI, and fund proxy statements. The 
proposed disclosure requirement in shareholder reports would provide 
existing shareholders information about any board approval of an 
investment advisory contract during the period covered by the report, 
other than a contract that was approved by shareholders. The existing 
requirement in proxy statements, which applies to any recommendation 
that shareholders approve an investment advisory contract, complements 
this shareholder reports disclosure. Finally, the existing SAI 
requirement provides prospective investors information about board 
approval of any existing investment advisory contract.
    We are proposing several enhancements to the existing SAI and proxy 
statement disclosure requirements and are proposing that these same 
enhancements be included in the new shareholder reports disclosure 
requirement. These enhancements would clarify and reinforce a fund's 
obligation under the existing disclosure requirements to discuss the 
material factors and the conclusions with respect thereto that formed 
the board's basis for approving, or recommending that the shareholders 
approve, an advisory contract. They are intended to address our 
concerns that some funds do not provide adequate specificity regarding 
the board's basis for its decision. Specifically, our proposal would 
require a fund to discuss the following in its shareholder reports, in 
its SAI, and in relevant proxy statements.
    Selection of Adviser and Approval of Advisory Fee. The proposed 
amendments would clarify that the fund's discussion should include 
factors relating to both the board's selection of the investment 
adviser, and its approval of the advisory fee and any other amounts to 
be paid under the advisory contract.\33\
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    \33\ Proposed Items 12(b)(10)(i) and 21(d)(6)(i) of Form N-1A; 
proposed Item 18.13(a) and proposed Instruction 6.e.(i) to Item 23 
of Form N-2; proposed Item 20(l)(i) and proposed Instruction 6(v)(A) 
to Item 27(a) of Form N-3; proposed Item 22(c)(11)(i) of Schedule 
14A.
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    Specific Factors. The fund would be required to include a 
discussion including, but not limited to, the following: (1) The 
nature, extent, and quality of the services to be provided by the 
investment adviser; (2) the investment performance of the fund and the 
investment adviser; (3) the costs of the services to be provided and 
profits to be realized by the investment adviser and its affiliates 
from the relationship with the fund; (4) the extent to which economies 
of scale would be realized as the fund grows; and (5) whether fee 
levels reflect these economies of scale for the benefit of fund 
investors.\34\
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    \34\ Id. Courts have used similar factors in determining whether 
directors have met their fiduciary obligations under Section 36(b) 
of the Investment Company Act [15 U.S.C. 80a-35(b)]. See, e.g., 
Gartenberg v. Merrill Lynch Asset Management, Inc., 694 F.2d 923, 
929 (2nd Cir. 1982) (examining several factors, including ``the 
adviser-manager's cost in providing the service, the nature and 
quality of the service, the extent to which the adviser-manager 
realizes economies of scale as the fund grows larger, and the volume 
of orders which must be processed by the manager'').
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    Comparison of Fees and Services Provided by Adviser. The fund's 
discussion would be required to indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other

[[Page 7855]]

registered investment companies or other types of clients (e.g., 
pension funds and other institutional investors). If the board relied 
upon such comparisons, the discussion would be required to describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved.\35\
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    \35\ Proposed Items 12(b)(10)(i) and 21(d)(6)(i) of Form N-1A; 
proposed Item 18.13(a) and proposed Instruction 6.e.(i) to Item 23 
of Form N-2; proposed Item 20(l)(i) and proposed Instruction 6(v)(A) 
to Item 27(a) of Form N-3; proposed Item 22(c)(11)(i) of Schedule 
14A.
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    Evaluation of Factors. The existing proxy and SAI requirements 
state that conclusory statements or a list of factors will not be 
considered sufficient disclosure, and that a fund's discussion should 
relate the factors to the specific circumstances of the fund and the 
investment advisory contract.\36\ We are clarifying this by requiring 
that the fund's discussion state how the board evaluated each factor. 
For example, it would not be sufficient to state that the board 
considered the amount of the investment advisory fee without stating 
what the board concluded about the amount of the fee and how that 
affected its determination that the contract should be approved.\37\
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    \36\ See Instruction to Item 13(b)(10) of Form N-1A; Instruction 
to Item 18.13 of Form N-2; Instruction to Item 20(l) of Form N-3; 
Instruction to Item 22(c)(11) of Schedule 14A.
    \37\ Proposed Instruction 2 to Item 12(b)(10) and proposed 
Instruction 2 to Item 21(d)(6) of Form N-1A; proposed Instruction 2 
to Item 18.13 and proposed Instruction 6.f. to Item 23 of Form N-2; 
proposed Instruction 2 to Item 20(l) and proposed Instruction 6(vi) 
to Item 27(a) of Form N-3; proposed Instruction to Item 22(c)(11) of 
Schedule 14A.
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    If we adopt the proposed amendments, we would expect to require all 
fund reports to shareholders, all registration statements and post-
effective amendments that are either annual updates to effective 
registration statements or that add a new series, and all fund proxy 
statements filed on or after the effective date of the amendments to 
comply with the proposed amendments.

III. 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. We request comment specifically on 
the following issues.
     Would inclusion of the proposed disclosure in 
reports to shareholders be useful to investors? Should we expand our 
proposal to require disclosure in shareholder reports with respect to 
all investment advisory contracts approved by the board during the 
reporting period, including contracts that were also approved by 
shareholders? Should disclosure regarding the basis of the board's 
approval of an advisory contract be required in any additional location 
(e.g., the prospectus, fund websites)?
     Should disclosure regarding the basis of the 
board's approval of an existing investment advisory contract continue 
to be required in the SAI if we adopt the proposed shareholder reports 
requirement? If we remove the disclosure requirement from the SAI, 
should we require funds to include a cross-reference in the prospectus 
or the SAI to the disclosure in shareholder reports?
     Are our proposed enhancements to the existing 
SAI and proxy statement disclosure requirements, which we are also 
proposing be included in the new shareholder reports disclosure 
requirement, appropriate? Will they result in more meaningful 
disclosure? Will the fact that we have enumerated certain specific 
matters that should be included in the discussion encourage funds to 
omit other, equally significant matters from the discussion?
     If a fund's board did not rely upon comparisons 
of the services to be rendered and the amounts to be paid under the 
contract with those under other investment advisory contracts, should 
the fund be required to disclose the reasons why the board did not do 
so?
     Should a fund be required to disclose whether, 
and if so, how, the board separately assessed amounts to be paid for 
portfolio management services and amounts to be paid for services other 
than portfolio management?
     Is there any additional relevant information 
that we should require funds to disclose? Will any of our proposed 
disclosure requirements have a chilling effect on boards' consideration 
of investment advisory contracts?
     What should the compliance date for the 
amendments be?

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.\38\ 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) ``Rule 
30e-1 under the Investment Company Act of 1940, Reports to Stockholders 
of Management Companies''; (2) ``Form N-1A under the Investment Company 
Act of 1940 and Securities Act of 1933, Registration Statement of Open-
End Management Investment Companies''; (3) ``Form N-2--Registration 
Statement of Closed-End Management Investment Companies''; (4) ``Form 
N-3--Registration Statement of Separate Accounts Organized as 
Management Investment Companies''; and (5) ``Rule 20a-1 under the 
Investment Company Act, Solicitations of Proxies, Consents, and 
Authorizations.'' An agency may not conduct or sponsor, and a person is 
not required to respond to, a collection of information unless it 
displays a currently valid OMB control number.
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    \38\ 44 U.S.C. 3501, et seq.
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    Rule 30e-1 (OMB Control No. 3235-0025) was adopted under section 
30(e) of the Investment Company Act.\39\ Form N-1A (OMB Control No. 
3235-0307), Form N-2 (OMB Control No. 3235-0026), and Form N-3 (OMB 
Control No. 3235-0316) were adopted pursuant to section 8(a) of the 
Investment Company Act \40\ and section 5 of the Securities Act.\41\ 
Rule 20a-1 (OMB Control No. 3235-0158) was adopted pursuant to section 
20(a) of the Investment Company Act.\42\
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    \39\ 15 U.S.C. 80a-29(e).
    \40\ 15 U.S.C. 80a-8(a).
    \41\ 15 U.S.C. 77e.
    \42\ 15 U.S.C. 80a-20(a).
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    We are proposing amendments to the requirements for fund 
shareholder reports in Forms N-1A, N-2, and N-3 that would require 
funds to provide disclosure regarding the material factors that formed 
the basis for the board of directors' approval of an investment 
advisory contract during the relevant reporting period. The additional 
burden hours imposed by these amendments are reflected in the 
collection of information requirements for shareholder reports required 
by rule 30e-1 under the Investment Company Act. In addition, we are 
proposing amendments to Forms N-1A, N-2, and N-3 that would clarify and 
reinforce funds' existing obligation to provide disclosure in the SAI 
of these forms regarding the board's basis for approving any existing 
investment advisory contract. Finally, we are proposing amendments to 
Schedule 14A that would clarify and reinforce funds' existing 
obligation to provide disclosure in proxy statements of the board of 
directors' basis for a recommendation

[[Page 7856]]

that shareholders approve an investment advisory contract.

Shareholder Reports

    Rule 30e-1, which requires funds to include in the shareholder 
reports the information that is required by the fund's registration 
statement form including the proposed amendments, contains collection 
of information requirements.\43\ The respondents to this collection of 
information requirement are funds registered on Forms N-1A, N-2, and N-
3. Compliance with the disclosure requirements of rule 30e-1 is 
mandatory. Responses to the disclosure requirements will not be kept 
confidential.
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    \43\ The amendments are to the shareholder reports requirements 
in Forms N-1A, N-2, and N-3. Rule 30e-1(a) under the Investment 
Company Act [17 CFR 270.30e-1(a)] requires funds to include in the 
shareholder reports the information that is required by the fund's 
registration statement form.
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    We estimate that there are approximately 3,800 funds subject to 
rule 30e-1. The current approved hour burden for preparing and filing 
semi-annual or annual shareholder reports in compliance with rule 30e-1 
is 143.3 hours per report per fund, or a total of 1,088,984 annual 
burden hours (143.3 hours per report x 2 reports x 3,800 funds).
    We currently estimate that the 3,800 funds filing annual and semi-
annual shareholder reports pursuant to rule 30e-1 include 9,706 
portfolios, including 8,938 portfolios of open-end management 
investment companies (``mutual funds'') registered on Form N-1A, 733 
closed-end funds registered on Form N-2, and 35 sub-accounts of managed 
separate accounts registered on Form N-3.\44\ We estimate that the 
proposed amendments will increase the estimated burden hours for 
complying with rule 30e-1 by 2 hours per portfolio annually. 
Accordingly, if the proposed amendments were adopted, we estimate the 
total annual hour burden for all funds for complying with rule 30e-1 
would be 1,108,396 hours (1,088,984 hours + (9,706 portfolios x 2 
hours)).
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    \44\ The estimates of the number of mutual fund portfolios 
registered on Form N-1A and the number of closed-end funds 
registered on Form N-2 are based on the Commission staff's analysis 
of reports filed on Form N-SAR in 2003. The estimate of the number 
of sub-accounts of managed separate accounts registered on Form N-3 
is based on the staff's analysis of reports filed on Form N-SAR in 
2003.
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Forms N-1A, N-2, and N-3

    The purpose of Forms N-1A, N-2, and N-3 is to meet the registration 
and disclosure requirements of the Securities Act and the Investment 
Company Act and to provide investors with information necessary to 
evaluate an investment in a fund. Forms N-1A, N-2, and N-3 contain 
collection of information requirements. The likely respondents to the 
information collection in Form N-1A are open-end funds registering with 
the Commission. The likely respondents to the information collection in 
Form N-2 are closed-end funds registering with the Commission on Form 
N-2. The likely respondents to the information collection in Form N-3 
are separate accounts, organized as management investment companies and 
offering variable annuities, registering with the Commission on Form N-
3. Compliance with the disclosure requirements of Forms N-1A, N-2, and 
N-3 is mandatory. Responses to the disclosure requirements are not 
confidential.
    The proposed amendments to Forms N-1A, N-2, and N-3 would clarify 
and reinforce funds' existing obligation to provide disclosure in these 
forms regarding the board's basis for approving any existing investment 
advisory contract. Because funds are already required to provide 
disclosure in appropriate detail regarding the material factors and the 
conclusions with respect thereto that formed the board's basis for 
approving an existing investment advisory contract, we estimate that 
the proposed amendments will not increase the hour burden for filing 
registration statements on these forms.

Proxy Statements

    Rule 20a-1, including the proposed amendments to Schedule 14A, 
contains collection of information requirements.\45\ The respondents to 
this collection of information requirement include funds registered on 
Forms N-1A, N-2, and N-3. Compliance with the disclosure requirements 
of rule 20a-1 is mandatory. Responses to the disclosure requirements 
are not confidential.
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    \45\ The proposed amendments are to Item 22 of Schedule 14A. 
Rule 20a-1 requires funds to comply with Regulation 14A, Schedule 
14A, and all other rules and regulations adopted pursuant to section 
14(a) of the Exchange Act that would be applicable to a proxy 
solicitation if it were made in respect of a security registered 
pursuant to section 12 of the Exchange Act. The annual responses to 
rule 20a-1 reflect the number of proxy and information statements 
that are filed by funds.
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    The proposed amendments to Schedule 14A would clarify and reinforce 
funds' existing obligation to provide disclosure in proxy statements 
regarding the board's basis for recommending that shareholders approve 
an investment advisory contract. Because funds are already required to 
provide disclosure in appropriate detail regarding the material factors 
and the conclusions with respect thereto that formed the board's basis 
for recommending shareholder approval of an investment advisory 
contract, we estimate that the proposed amendments will not increase 
the hour burden for complying with the requirements of rule 20a-1.

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 Fifth Street, NW., Washington, DC 20549-0609, with 
reference to File No. S7-08-04. Requests for materials submitted to OMB 
by the Commission with regard to this collection of information should 
be in writing, refer to File No. S7-08-04, and be submitted to the 
Securities and Exchange Commission, Office of Filing and Information 
Services, 450 Fifth Street, NW., Washington, DC 20549-0609. OMB is 
required to make a decision concerning the collection of information 
between 30 and 60 days after publication of this release. Consequently, 
a comment to OMB is best assured of having its full effect if OMB 
receives it within 30 days after publication of this Release.

V. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. Our proposals would require funds to improve the disclosure 
that they provide regarding the fund board's basis for approving, or 
recommending that shareholders approve, an investment

[[Page 7857]]

advisory contract. Specifically, the proposals would:
     Require fund shareholder reports to discuss, in 
reasonable detail, the material factors and the conclusions with 
respect to those factors that formed the basis for the board's approval 
of an advisory contract during the reporting period;
     Enhance the existing requirement for a fund to 
provide disclosure in its SAI about the board's basis for approving any 
investment advisory contract; and
     Enhance the existing requirement for a fund to 
provide disclosure in a proxy statement seeking approval of an 
investment advisory contract about the board's basis for its 
recommendation that shareholders approve the contract.

A. Benefits

    The Commission's proposals would improve the disclosure provided by 
funds about how their boards of directors evaluate and approve, and 
recommend shareholder approval of, investment advisory contracts. 
First, the proposals would provide existing fund shareholders with more 
timely information about the basis for the board's approval of 
investment advisory contracts. The increased visibility of this 
disclosure resulting from its inclusion in shareholder reports may 
encourage funds to provide a meaningful explanation of the board's 
basis for approving an investment advisory contract. This, in turn, may 
benefit investors by encouraging them to consider more carefully the 
costs and value of the services rendered by the fund's investment 
adviser, and by enabling them to make more informed choices among 
funds.
    In addition, the increased visibility of the proposed disclosure in 
shareholder reports may encourage fund boards to engage in more 
vigorous and independent oversight of investment advisory contracts. 
This increased oversight by fund boards would also benefit investors.
    The proposals would also amend the current disclosure requirements 
in proxy statements and in a fund's SAI. These proposed amendments 
would clarify and reinforce funds' obligation under the existing 
disclosure requirements in the SAI and proxy statements to discuss the 
material factors and the conclusions with respect thereto that formed 
the basis for the board's approval of the fund's existing advisory 
contract, or its recommendation that shareholders approve an investment 
advisory contract. This improved disclosure in proxy statements and in 
the SAI would also benefit investors.
    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 funds to provide 
disclosure in their shareholder reports regarding the fund board's 
basis for approving an investment advisory contract. We estimate that 
complying with the proposed new disclosure requirements would entail a 
relatively small financial burden. Funds currently are required to 
provide similar disclosure in their SAIs and in relevant proxy 
statements, and the required information regarding a fund board's 
evaluation of each advisory contract should be readily available to 
management and to the fund board. Therefore, we expect that the cost of 
compiling this information should be minimal, and the primary costs 
attributable to the proposed amendments would be those of reporting 
this information. These costs may include both internal costs (for 
attorneys and non-legal staff to prepare and review the required 
disclosure) and external costs (for printing, and typesetting, and 
mailing of the disclosure).
    For purposes of the Paperwork Reduction Act, we have estimated that 
the proposed new disclosure requirements would increase the annual hour 
burden for completing a shareholder report in compliance with rule 30e-
1 under the Investment Company Act by 19,412 hours. We estimate that 
this additional burden would equal total internal costs of $1,523,454 
annually, or approximately $401 per fund.\46\ We have estimated that 
the proposed amendments to Forms N-1A, N-2, and N-3 will have no impact 
on the hour burden for filing registration statements on these forms. 
In addition, we have estimated that the proposed amendments to Schedule 
14A will have no impact on the hour burden for complying with rule 20a-
1 under the Investment Company Act.
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    \46\ These internal cost estimates 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 $78.48. This estimated wage rate is a blended rate, based on 
published hourly wage rates for compliance attorneys ($74.22) and 
programmers ($42.05) in New York City, and the estimate that 
professional and non-professional staff will divide time equally on 
compliance with the disclosure requirements, yielding a weighted 
wage rate of $58.135 (($74.22 x .50) + ($42.05 x .50)) = $58.135). 
See Securities Industry Association, Report on Management & 
Professional Earnings in the Securities Industry 2001 (Oct. 2001) 
(for most current rate for compliance attorneys in New York City); 
Securities Industry Association, Report on Management & Professional 
Earnings in the Securities Industry 2002 (Sep. 2002) (for most 
current rate for programmers in New York City). 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 $78.48 ($58.135 x 1.35 = 
$78.48).
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    The external costs of providing the enhanced disclosure in fund 
shareholder reports regarding the process by which a fund board reviews 
and approves an investment advisory contract are expected to be 
limited, but would depend on the individual circumstances of each fund 
and its contractual relationships with its advisers and sub-advisers, 
and the nature of the process by which the board determines whether to 
approve the fund's advisory contract. We estimate that the additional 
disclosure that would be required in shareholder reports may add one 
additional page to a fund's annual or semi-annual report, at a cost of 
$0.02 per page.\47\ We estimate that there are approximately 257 
million fund shareholder accounts which would send out 231 million 
reports to shareholders annually that would include the required 
disclosure.\48\ Therefore, we estimate that the additional disclosure 
in shareholder reports will cost approximately $4,620,000 ((231 million 
shareholder reports x $0.02 per page) in external costs for funds 
annually.
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    \47\ This cost per page is based on an estimate that the typical 
shareholder report is approximately 25 pages long and costs $.52 to 
print and deliver. See Securities Act Release No. 33-7766 (Nov. 4, 
1999) [64 FR 62540, 62543 (Nov. 16, 1999)].
    \48\ Investment Company Institute, Mutual Fund Fact Book 65 
(43rd ed. 2003), at 63 (estimating approximately 251 million 
shareholder accounts associated with mutual funds). In addition, we 
estimate that there are approximately 2 million shareholder accounts 
associated with closed-end funds registered on Form N-2 and 
approximately 4 million shareholder accounts associated with managed 
separate accounts registered on Form N-3. These figures are based on 
the Commission staff's analysis of reports filed on Form N-SAR in 
2003. We estimated the number of shareholder reports by reducing the 
number of accounts by 10% to reflect an estimated 10% savings in the 
number of reports that must be delivered to shareholders due to 
householding rules.
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    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,

[[Page 7858]]

the proposed amendments. Commenters are requested to provide empirical 
data and other factual support for their views to the extent possible.

VI. Consideration of Burden on Competition; Promotion of Efficiency 
Competition, and Capital Formation

    Section 23(a)(2) of the Exchange Act requires us, when adopting 
rules under the Exchange Act, to consider the impact that any new rule 
would have on competition. Section 23(a)(2) also prohibits us from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\49\ In addition, section 2(c) of the Investment Company Act,\50\ 
section 2(b) of the Securities Act,\51\ and section 3(f) of the 
Exchange Act \52\ 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.
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78w(a)(2).
    \50\ 15 U.S.C. 80a-2(c).
    \51\ 15 U.S.C. 77(b).
    \52\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The proposed amendments are designed to encourage better, more 
visible, and more timely disclosure to fund shareholders about the 
material factors, and the conclusions with respect to those factors, 
that formed the basis for the decision of a fund's board of directors 
to approve or renew an investment advisory contract, or to recommend 
approval of an investment advisory contract. These amendments may 
thereby improve efficiency. By increasing transparency with respect to 
advisory fees, the proposed amendments may assist investors in making 
informed choices among funds and encourage fund boards to engage in 
vigorous and independent oversight of advisory contracts, which may 
promote more efficient allocation of investments by investors and more 
efficient allocation of assets among competing funds. These proposals 
may also improve competition, as enhanced transparency regarding the 
board's basis for approving an investment advisory contract may 
encourage investors to consider more carefully the costs and value of 
the services rendered by the fund's investment adviser. Finally, the 
proposed amendments have no effect on capital formation.
    As noted above, we believe that the proposed amendments would 
benefit investors. We note that funds currently are required to provide 
similar disclosure in their SAIs and in relevant proxy statements. We 
request comment on whether the proposed amendments, if adopted, would 
promote efficiency, competition, and capital formation. We also request 
comment on any anti-competitive effects of the proposed amendments. 
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 section 3(a) of the Regulatory 
Flexibility Act.\53\ It relates to the Commission's proposed rule and 
form amendments to Schedule 14A under the Exchange Act and to Forms N-
1A, N-2, and N-3 under the Investment Company Act.
---------------------------------------------------------------------------

    \53\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for, and Objectives of, Proposed Amendments

    Section I of this Release describes the background and reasons for 
the proposed form amendments. Section II of this Release discusses the 
objectives of the proposed form amendments. As we discuss in detail 
above, these proposals are designed to increase the transparency of the 
information that a fund provides regarding the board's basis for 
approving an investment advisory contract, or recommending that 
shareholders approve an investment advisory contract.

B. Legal Basis

    The Commission is proposing amendments to Schedule 14A pursuant to 
authority set forth in sections 14 and 23(a)(1) of the Exchange Act 
\54\ and sections 20(a) and 38 of the Investment Company Act.\55\ The 
Commission is proposing amendments to Forms N-1A, N-2, and N-3 pursuant 
to authority set forth in sections 5, 6, 7, 10, and 19(a) of the 
Securities Act \56\ and sections 8, 15, 24(a), 30, and 38 of the 
Investment Company Act.\57\
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    \54\ 15 U.S.C. 78n and 78w(a)(1).
    \55\ 15 U.S.C. 80a-20, 80a-37.
    \56\ 15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a).
    \57\ 15 U.S.C. 80a-8, 80a-15, 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.\58\ Approximately 145 investment companies registered on Form N-
1A meet this definition, and approximately 70 investment companies 
registered on Form N-2 meet this definition.\59\ We estimate that few, 
if any, registered separate accounts registered on Form N-3 are small 
entities.\60\
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    \58\ 17 CFR 270.0-10.
    \59\ This estimate is based on an analysis by the Division of 
Investment Management staff of information from databases compiled 
by third-party information providers, including Morningstar, Inc. 
and Lipper.
    \60\ This estimate is based on figures compiled by Division of 
Investment Management staff regarding separate accounts registered 
on Form N-3. 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

    As described above, the proposals would:
     Require fund shareholder reports to discuss, in 
reasonable detail, the material factors and the conclusions with 
respect to these factors that formed the basis for the board's approval 
of an advisory contract during the relevant reporting period;
     Enhance the existing requirements for a fund to 
provide disclosure in its SAI about the board's basis for approving any 
existing investment advisory contract; and
     Enhance the existing requirements for a fund to 
provide disclosure in a proxy statement seeking approval of an 
investment advisory contract about the board's basis for its 
recommendation that shareholders approve the contract.
    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. These include the costs related to providing this 
disclosure in shareholder reports. These costs also could include 
expenses for legal fees. We note, with respect to the proposed 
amendments to the disclosure requirements in the SAI and proxy 
statements, that these proposals would clarify and reinforce funds' 
obligation under the existing disclosure requirements to discuss the 
board's basis for approving, or recommending shareholder approval of, 
any existing investment advisory contract. Therefore, we expect that 
the cost of compliance with the proposed amendments to the existing 
disclosure requirements in the SAI and proxy statements should be 
minimal. We believe the benefits that will result to shareholders 
through

[[Page 7859]]

better information with respect to their fund board's evaluation of 
such advisory contracts justify these potential costs.
    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 registrants. 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 amendments would provide 
shareholders with greater transparency regarding the fund board's basis 
for approving an investment advisory contract, or recommending that 
shareholders approve an investment advisory contract. Different 
disclosure requirements for funds that are small entities may create 
the risk that the shareholders in these funds would be less able to 
consider the costs and value of the services rendered by the fund's 
investment adviser, and less able to make informed choices among funds. 
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. Based on our 
past experience, we believe the proposed disclosure would be more 
useful to investors if there were enumerated informational 
requirements.

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. S7-08-
04; 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, and also will be posted on the 
Commission's Internet Web site (http://www.sec.gov).\61\
---------------------------------------------------------------------------

    \61\ 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.
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VIII. Consideration of Impact on the Economy

    For purposes of the Small Business Enforcement Fairness Act of 
1996,\62\ a rule is ``major'' if it results or is likely to result in:
---------------------------------------------------------------------------

    \62\ Pub. L. 104-21, Title II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million 
or more;
     A major increase in costs or prices for 
consumers or individual industries; or
     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 Schedule 14A pursuant to 
authority set forth in sections 14 and 23(a)(1) of the Exchange Act 
\63\ and sections 20(a) and 38 of the Investment Company Act.\64\ The 
Commission is proposing amendments to Forms N-1A, N-2, and N-3 pursuant 
to authority set forth in sections 5, 6, 7, 10, and 19(a) of the 
Securities Act \65\ and sections 8, 15, 24(a), 30, and 38 of the 
Investment Company Act.\66\
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    \63\ 15 U.S.C. 78n and 78w(a)(1).
    \64\ 15 U.S.C. 80a-20, 80a-37.
    \65\ 15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a).
    \66\ 15 U.S.C. 80a-8, 80a-15, 80a-24(a), 80a-29, and 80a-37.
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List of Subjects

17 CFR Parts 239 and 240

    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 general authority citation for Part 239 is revised to read 
as follows:

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

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

    2. The general authority citation for Part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 78c, 
78d, 78e, 78f, 78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n,

[[Page 7860]]

78o, 78p, 78q, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 79q, 79t, 77eee, 
77ggg, 77nnn, 77sss, 77ttt, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 
80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless 
otherwise noted.
* * * * *
    3. Section 240.14a-101 is amended by revising paragraph (c)(11) of 
Item 22 to read as follows:


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

* * * * *
    Item 22. Information required in investment company proxy 
statement.
* * * * *
    (c) * * *
    (11) Discuss in reasonable detail the material factors and the 
conclusions with respect thereto that form the basis for the 
recommendation of the board of directors that the shareholders approve 
an investment advisory contract. The discussion should include:
    (i) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Fund under the contract. This would include, 
but not be limited to, a discussion of the nature, extent, and quality 
of the services to be provided by the investment adviser; the 
investment performance of the Fund and the investment adviser; the 
costs of the services to be provided and profits to be realized by the 
investment adviser and its affiliates from the relationship with the 
Fund; the extent to which economies of scale would be realized as the 
Fund grows; and whether fee levels reflect these economies of scale for 
the benefit of Fund investors. The discussion should also indicate 
whether the board relied upon comparisons of the services to be 
rendered and the amounts to be paid under the contract with those under 
other investment advisory contracts, such as contracts of the same and 
other investment advisers with other registered investment companies or 
other types of clients (e.g., pension funds and other institutional 
investors). If the board relied upon such comparisons, the discussion 
should describe the comparisons that were relied on and how they 
assisted the board in determining to recommend that the shareholders 
approve the advisory contract; and
    (ii) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Fund such as soft 
dollar arrangements by which brokers provide research to the Fund or 
its investment adviser in return for allocating Fund brokerage.
    Instruction. Conclusory statements or a list of factors will not be 
considered sufficient disclosure. The discussion should relate the 
factors to the specific circumstances of the Fund and the investment 
advisory contract for which approval is sought and state how the board 
evaluated each factor. For example, it is not sufficient to state that 
the board considered the amount of the investment advisory fee without 
stating what the board concluded about the amount of the fee and how 
that affected its determination to recommend approval of the contract.
* * * * *

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

    4. 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.
* * * * *
    5. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is 
amended by:
    a. Revising Item 12(b)(10); and
    b. Adding new Item 21(d)(6).
    The revision and addition read as follows:

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

Form N-1A

* * * * *

Item 12. Management of the Fund

* * * * *
    (b) * * *
    (10) Discuss in reasonable detail the material factors and the 
conclusions with respect thereto that formed the basis for the board of 
directors approving any existing investment advisory contract. The 
discussion should include:
    (i) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Fund under the contract. This would include, 
but not be limited to, a discussion of the nature, extent, and quality 
of the services to be provided by the investment adviser; the 
investment performance of the Fund and the investment adviser; the 
costs of the services to be provided and profits to be realized by the 
investment adviser and its affiliates from the relationship with the 
Fund; the extent to which economies of scale would be realized as the 
Fund grows; and whether fee levels reflect these economies of scale for 
the benefit of Fund investors. The discussion should also indicate 
whether the board relied upon comparisons of the services to be 
rendered and the amounts to be paid under the contract with those under 
other investment advisory contracts, such as contracts of the same and 
other investment advisers with other registered investment companies or 
other types of clients (e.g., pension funds and other institutional 
investors). If the board relied upon such comparisons, the discussion 
should describe the comparisons that were relied on and how they 
assisted the board in concluding that the contract should be approved; 
and
    (ii) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Fund such as soft 
dollar arrangements by which brokers provide research to the Fund or 
its investment adviser in return for allocating Fund brokerage.
Instructions
    1. Board approvals covered by this item include both approvals of 
new investment advisory contracts and approvals of contract renewals. 
Investment advisory contracts covered by this item include subadvisory 
contracts.
    2. Conclusory statements or a list of factors will not be 
considered sufficient disclosure. The discussion should relate the 
factors to the specific circumstances of the Fund and the investment 
advisory contract and state how the board evaluated each factor. For 
example, it is not sufficient to state that the board considered the 
amount of the investment advisory fee without stating what the board 
concluded about the amount of the fee and how that affected its 
decision to approve the contract.

Item 21. Financial Statements

* * * * *
    (d) * * *
    (6) Statement Regarding Basis for Approval of Investment Advisory 
Contract. If the board of directors approved any investment advisory 
contract during the period covered by the report, other than a contract 
that was approved by shareholders during the period, discuss in 
reasonable detail the material factors and the conclusions with respect 
thereto that formed the basis for the board's approval. The discussion 
should include:
    (i) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Fund under the contract. This would include, 
but not be limited to, a discussion of the nature, extent, and quality 
of the services to be provided by the

[[Page 7861]]

investment adviser; the investment performance of the Fund and the 
investment adviser; the costs of the services to be provided and 
profits to be realized by the investment adviser and its affiliates 
from the relationship with the Fund; the extent to which economies of 
scale would be realized as the Fund grows; and whether fee levels 
reflect these economies of scale for the benefit of Fund investors. The 
discussion should also indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other registered investment companies or other types of clients 
(e.g., pension funds and other institutional investors). If the board 
relied upon such comparisons, the discussion should describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved; and
    (ii) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Fund such as soft 
dollar arrangements by which brokers provide research to the Fund or 
its investment adviser in return for allocating Fund brokerage.
Instructions
    1. Board approvals covered by this item include both approvals of 
new investment advisory contracts and approvals of contract renewals. 
Investment advisory contracts covered by this item include subadvisory 
contracts.
    2. Conclusory statements or a list of factors will not be 
considered sufficient disclosure. The discussion should relate the 
factors to the specific circumstances of the Fund and the investment 
advisory contract and state how the board evaluated each factor. For 
example, it is not sufficient to state that the board considered the 
amount of the investment advisory fee without stating what the board 
concluded about the amount of the fee and how that affected its 
decision to approve the contract.
* * * * *
    6. Form N-2 (referenced in Sec. Sec.  239.14 and 274.11a-1) is 
amended by:
    a. Revising Item 18.13; and
    b. Adding new Instructions 6.e and 6.f to Item 23.
    The revision and additions read as follows:

    Note: The text of Form N-2 does not and this amendment will not 
appear in the Code of Federal Regulations.

Form N-2

* * * * *

Item 18. Management

* * * * *
    13. Discuss in reasonable detail the material factors and the 
conclusions with respect thereto that formed the basis for the board of 
directors approving any existing investment advisory contract. The 
discussion should include:
    (a) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Registrant under the contract. This would 
include, but not be limited to, a discussion of the nature, extent, and 
quality of the services to be provided by the investment adviser; the 
investment performance of the Registrant and the investment adviser; 
the costs of the services to be provided and profits to be realized by 
the investment adviser and its affiliates from the relationship with 
the Registrant; the extent to which economies of scale would be 
realized as the Registrant grows; and whether fee levels reflect these 
economies of scale for the benefit of the Registrant's investors. The 
discussion should also indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other registered investment companies or other types of clients 
(e.g., pension funds and other institutional investors). If the board 
relied upon such comparisons, the discussion should describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved; and
    (b) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Registrant such as 
soft dollar arrangements by which brokers provide research to the 
Registrant or its investment adviser in return for allocating the 
Registrant's brokerage.
Instructions
    1. Board approvals covered by this item include both approvals of 
new investment advisory contracts and approvals of contract renewals. 
Investment advisory contracts covered by this item include subadvisory 
contracts.
    2. Conclusory statements or a list of factors will not be 
considered sufficient disclosure. The discussion should relate the 
factors to the specific circumstances of the Registrant and the 
investment advisory contract and state how the board evaluated each 
factor. For example, it is not sufficient to state that the board 
considered the amount of the investment advisory fee without stating 
what the board concluded about the amount of the fee and how that 
affected its decision to approve the contract.
* * * * *

Item 23. Financial Statements

* * * * *
Instructions
* * * * *
    6. * * *
    e. If the Registrant's board of directors approved any investment 
advisory contract during the period covered by the report, other than a 
contract that was approved by shareholders during the period, discuss 
in reasonable detail the material factors and the conclusions with 
respect thereto that formed the basis for the board's approval. The 
discussion should include:
    (i) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Registrant under the contract. This would 
include, but not be limited to, a discussion of the nature, extent, and 
quality of the services to be provided by the investment adviser; the 
investment performance of the Registrant and the investment adviser; 
the costs of the services to be provided and profits to be realized by 
the investment adviser and its affiliates from the relationship with 
the Registrant; the extent to which economies of scale would be 
realized as the Registrant grows; and whether fee levels reflect these 
economies of scale for the benefit of the Registrant's investors. The 
discussion should also indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other registered investment companies or other types of clients 
(e.g., pension funds and other institutional investors). If the board 
relied upon such comparisons, the discussion should describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved; and
    (ii) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Registrant such as 
soft dollar arrangements by which brokers provide

[[Page 7862]]

research to the Registrant or its investment adviser in return for 
allocating the Registrant's brokerage.
    f. board approvals covered by Instruction 6.e. to this Item include 
both approvals of new investment advisory contracts and approvals of 
contract renewals. Investment advisory contracts covered by Instruction 
6.e. include subadvisory contracts. Conclusory statements or a list of 
factors will not be considered sufficient disclosure under Instruction 
6.e. The discussion should relate the factors to the specific 
circumstances of the Registrant and the investment advisory contract 
and state how the board evaluated each factor. For example, it is not 
sufficient to state that the board considered the amount of the 
investment advisory fee without stating what the board concluded about 
the amount of the fee and how that affected its decision to approve the 
contract.
* * * * *
    7. Form N-3 (referenced in Sec. Sec.  239.17 and 274.11b) is 
amended by:
    a. Revising Item 20(l).
    b. Adding new Instructions 6(v) and 6(vi) to Item 27(a).
    The revision and additions read as follows:

    Note: The text of Form N-3 does not and this amendment will not 
appear in the Code of Federal Regulations.

Item 20. Management

* * * * *
    (l) Discuss in reasonable detail the material factors and the 
conclusions with respect thereto that formed the basis for the board of 
managers approving any existing investment advisory contract. The 
discussion should include:
    (i) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Registrant under the contract. This would 
include, but not be limited to, a discussion of the nature, extent, and 
quality of the services to be provided by the investment adviser; the 
investment performance of the Registrant and the investment adviser; 
the costs of the services to be provided and profits to be realized by 
the investment adviser and its affiliates from the relationship with 
the Registrant; the extent to which economies of scale would be 
realized as the Registrant grows; and whether fee levels reflect these 
economies of scale for the benefit of the Registrant's investors. The 
discussion should also indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other registered investment companies or other types of clients 
(e.g., pension funds and other institutional investors). If the board 
relied upon such comparisons, the discussion should describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved; and
    (ii) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Registrant such as 
soft dollar arrangements by which brokers provide research to the 
Registrant or its investment adviser in return for allocating the 
Registrant's brokerage.
Instructions
    1. Board approvals covered by this item include both approvals of 
new investment advisory contracts and approvals of contract renewals. 
Investment advisory contracts covered by this item include subadvisory 
contracts.
    2. Conclusory statements or a list of factors will not be 
considered sufficient disclosure. The discussion should relate the 
factors to the specific circumstances of the Registrant and the 
investment advisory contract and state how the board evaluated each 
factor. For example, it is not sufficient to state that the board 
considered the amount of the investment advisory fee without stating 
what the board concluded about the amount of the fee and how that 
affected its decision to approve the contract.
* * * * *

Item 27. Financial Statements

    (a) * * *
Instructions
* * * * *
    6. * * *
    (v) If the Registrant's board of managers approved any investment 
advisory contract during the period covered by the report, other than a 
contract that was approved by shareholders during the period, discuss 
in reasonable detail the material factors and the conclusions with 
respect thereto that formed the basis for the board's approval. The 
discussion should include:
    (A) Factors relating to both the board's selection of the 
investment adviser and approval of the advisory fee and any other 
amounts to be paid by the Registrant under the contract. This would 
include, but not be limited to, a discussion of the nature, extent, and 
quality of the services to be provided by the investment adviser; the 
investment performance of the Registrant and the investment adviser; 
the costs of the services to be provided and profits to be realized by 
the investment adviser and its affiliates from the relationship with 
the Registrant; the extent to which economies of scale would be 
realized as the Registrant grows; and whether fee levels reflect these 
economies of scale for the benefit of the Registrant's investors. The 
discussion should also indicate whether the board relied upon 
comparisons of the services to be rendered and the amounts to be paid 
under the contract with those under other investment advisory 
contracts, such as contracts of the same and other investment advisers 
with other registered investment companies or other types of clients 
(e.g., pension funds and other institutional investors). If the board 
relied upon such comparisons, the discussion should describe the 
comparisons that were relied on and how they assisted the board in 
concluding that the contract should be approved; and
    (B) If applicable, any benefits derived or to be derived by the 
investment adviser from the relationship with the Registrant such as 
soft dollar arrangements by which brokers provide research to the 
Registrant or its investment adviser in return for allocating the 
Registrant's brokerage.
    (vi) Board approvals covered by Instruction 6(v) to this Item 
include both approvals of new investment advisory contracts and 
approvals of contract renewals. Investment advisory contracts covered 
by Instruction 6(v) include subadvisory contracts. Conclusory 
statements or a list of factors will not be considered sufficient 
disclosure under Instruction 6(v). The discussion should relate the 
factors to the specific circumstances of the Registrant and the 
investment advisory contract and state how the board evaluated each 
factor. For example, it is not sufficient to state that the board 
considered the amount of the investment advisory fee without stating 
what the board concluded about the amount of the fee and how that 
affected its decision to approve the contract.

    Dated: February 11, 2004.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. 04-3535 Filed 2-18-04; 8:45 am]
BILLING CODE 8010-01-P