[Federal Register Volume 69, Number 125 (Wednesday, June 30, 2004)]
[Rules and Regulations]
[Pages 39798-39809]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-14755]



[[Page 39797]]

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Part VI





Securities and Exchange Commission





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17 CFR Parts 239, 240, and 274



Disclosure Regarding Approval of Investment Advisory Contracts by 
Directors of Investment Companies; Final Rule

  Federal Register / Vol. 69 , No. 125 / Wednesday, June 30, 2004 / 
Rules and Regulations  

[[Page 39798]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 239, 240, and 274

[Release Nos. 33-8433; 34-49909; IC-26486; 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: Final rule.

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SUMMARY: The Securities and Exchange Commission is adopting 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 amendments 
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 
most recent fiscal half-year. The amendments also are designed to 
encourage improved disclosure in proxy statements regarding the basis 
for the board's recommendation that shareholders approve an advisory 
contract.

DATES: Effective Date: August 5, 2004, except that the amendments to 
Item 12 of Form N-1A,\1\ Item 18 of Form N-2,\2\ and Item 20 of Form N-
3 \3\ are effective January 31, 2006.
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    \1\ 17 CFR 239.15A and 274.11A.
    \2\ 17 CFR 239.14 and 274.11a-1.
    \3\ 17 CFR 239.17a and 274.11b.
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    Compliance Date: All fund reports to shareholders for periods 
ending on or after March 31, 2005, and all fund proxy statements on 
Schedule 14A filed on or after October 31, 2004, are required to comply 
with these amendments. Section II.C. of this release contains more 
information on the compliance date.

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-
0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting amendments \4\ to Schedule 14A,\5\ the 
schedule used by registered investment companies and issuers registered 
under section 12 of the Securities Exchange Act of 1934 (``Exchange 
Act'') \6\ for proxy statements pursuant to section 14(a) of the 
Exchange Act, and Forms N-1A, N-2, and N-3, 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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    \4\ The Commission proposed these amendments in February 2004. 
Investment Company Act Release No. 26350 (Feb. 11, 2004) [69 FR 7852 
(Feb. 19, 2004)] (``Proposing Release'').
    \5\ 17 CFR 240.14a-101.
    \6\ 15 U.S.C. 78a et seq.
    \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
    A. Disclosure Requirement in Shareholder Reports
    B. Disclosure Enhancements
    C. Compliance Date
III. Paperwork Reduction Act
IV. Cost/Benefit Analysis
V. Consideration of Burden on Competition; Promotion of Efficiency, 
Competition, and Capital Formation
VI. Final Regulatory Flexibility Analysis
VII. Statutory Authority
Text of 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 with respect to 
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).
    \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, 235 (S.D.N.Y.) 
(``By giving the directors the right to extend and to 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.''), aff'd, 294 F.2d 415 (2nd Cir. 
1961).
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    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, we adopted 
amendments requiring a fund to provide similar disclosure in its 
Statement of Additional Information

[[Page 39799]]

(``SAI'') \15\ regarding the basis for the board's approval of an 
existing investment advisory contract.\16\
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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 12(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 become 
the subject of debate.\17\ In February 2004, the Commission proposed to 
require enhanced disclosure regarding the board's basis for approving, 
or recommending that shareholders approve, investment advisory 
contracts, in order to encourage fair and reasonable fund fees. 
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.\18\ This 
proposal was part of a larger series of Commission rulemaking 
initiatives that have sought to improve disclosure to investors 
concerning fund fees and charges.\19\
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    \17\ See, e.g., 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) (arguing 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); 
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''). But see Sean Collins, The Expenses of 
Defined Benefit Pension Plans and Mutual Funds, Investment Company 
Institute Perspective (Dec. 2003), available at http://www.ici.org/statements/res/1per09-06.pdf (contending that the management fees of 
mutual funds cover a broader array of services than the fees paid by 
pension funds to external managers, and that mutual funds and 
pension funds incur similar fees for similar portfolio management 
services); Richard M. Phillips, Mutual Fund Independent Directors: A 
Model for Corporate America?, Investment Company Institute 
Perspective, at 7 (Aug. 2003), available at http://www.ici.org/statements/res/2per09-04.pdf (arguing that the effectiveness of fund 
boards should not be measured by reference to the frequency with 
which boards terminate investment advisers).
    \18\ 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'').
    \19\ Investment Company Act Release No. 26464 (June 7, 2004) [69 
FR 33262 (June 14, 2004)] (adopting amendments that require enhanced 
disclosure regarding breakpoint discounts on front-end sales loads); 
Investment Company Act Release No. 26372 (Feb. 27, 2004) [69 FR 
11244 (Mar. 9, 2004)] (adopting requirements for expense disclosure 
in fund shareholder reports); Investment Company Act Release No. 
26341 (Jan. 29, 2004) [69 FR 6438 (Feb. 10, 2004)] (proposing point-
of-sale disclosure and a new confirmation statement for brokers to 
use when selling fund shares); Investment Company Act Release No. 
26313 (Dec. 18, 2003) [68 FR 74820 (Dec. 24, 2003)] (requesting 
comment on measures to improve disclosure of mutual fund transaction 
costs); Investment Company Act Release No. 26195 (Sept. 29, 2003) 
[68 FR 57760 (Oct. 6, 2003)] (adopting amendments requiring 
investment company advertisements to highlight the availability and 
importance of information on fees and charges found in the 
prospectus).
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    The Commission received 22 comment letters relating to the proposed 
amendments from investors, participants in the fund industry, and 
others. The commenters generally supported the Commission's proposals, 
although some expressed concerns regarding portions of the disclosure 
requirements or suggested changes. Today, the Commission is adopting 
these proposed amendments, with modifications to address commenters' 
concerns.
    In addition to the amendments that we are adopting in this release, 
we are amending the fund recordkeeping rule to require that funds 
retain copies of the written materials that directors considered in 
approving an advisory contract. 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 release amending the fund recordkeeping rule 
also includes measures designed to improve the effectiveness of fund 
boards of directors and enhance their independence in dealing with 
matters such as the advisory fee.

II. Discussion

A. Disclosure Requirement in Shareholder Reports

    The Commission is adopting, substantially as proposed, amendments 
to Forms N-1A, N-2, and N-3\20\ that 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.\21\ This 
requirement applies to shareholder reports of open- and closed-end 
management investment companies and insurance company managed separate 
accounts that offer variable annuities.
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    \20\ 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.
    \21\ Item 21(d)(6) of Form N-1A; Instruction 6.e. to Item 23 of 
Form N-2; Instruction 6(v) to Item 27(a) of Form N-3. The amendments 
to Form N-1A in this release reflect the renumbering of items in 
amendments that the Commission recently adopted to the requirements 
for fund shareholder reports, that renumber Item 6 (Management, 
Organization, and Capital Structure), Item 13 (Management), and Item 
22 (Financial Statements) of Form N-1A as Items 5, 12, and 21, 
respectively. See Investment Company Act Release No. 26372, supra 
note 19. These recent amendments also added 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.
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    Several commenters, including investor advocacy groups and fund 
directors, supported the proposed requirement to include disclosure 
regarding the board's basis for approval of any investment advisory 
contract in shareholder reports, agreeing with the Commission that 
shareholder reports are the location where investors are more likely to 
read and benefit from this disclosure. However, some fund industry 
commenters objected to inclusion of the proposed disclosure in 
shareholder reports. These commenters argued that the disclosure could 
be lengthy, and that adding it to shareholder reports could dilute 
their effectiveness. In addition, these commenters noted that 
information in shareholder reports is subject to certification by the 
fund's principal executive and principal financial officers, and argued 
that it would be inappropriate to require fund officers to certify 
disclosure that explains the

[[Page 39800]]

board's basis for approving an advisory contract.\22\
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    \22\ See rule 30a-2(a) under the Investment Company Act 
(requiring reports filed on Form N-CSR to require certifications in 
the form specified in Item 11(a)(2) of Form N-CSR); Item 1 of Form 
N-CSR (requiring copy of report transmitted to shareholders pursuant 
to rule 30e-1 under the Investment Company Act); Item 11(a)(2) of 
Form N-CSR (form of certification).
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    We continue to believe, however, that including disclosure 
regarding the board's basis for approving an advisory contract in 
shareholder reports will provide existing fund shareholders with more 
timely disclosure of the reasons for the board's approval of an 
investment advisory contract. The visibility of this disclosure, 
alongside other current information about a fund, such as investment 
performance and current period dollars and cents expense 
disclosure,\23\ 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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    \23\ The Commission recently adopted rules that require 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. See Investment Company Act Release No. 26372, supra 
note 19.
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    We believe that it is appropriate to require a fund's principal 
executive and financial officers to certify the description of the 
board's evaluation process based on their knowledge.\24\ A certifying 
officer could rely on information contained in the meeting minutes of 
the board and other information regarding the board's evaluation that 
is retained as part of the fund's records.\25\ In addition, a fund's 
board could approve the discussion that is to be included in 
shareholder reports regarding its basis for approving an advisory 
contract, in order to assist the fund's principal executive and 
financial officers in meeting their obligations under the certification 
requirement.
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    \24\ See Paragraph 2 of the certification of Item 11(a)(2) of 
Form N-CSR (requiring officer to certify ``based on his or her 
knowledge''). Cf. Item 3(a) of Form N-CSR (requiring disclosure of 
whether a fund's board of directors has determined that it has at 
least one audit committee financial expert); Item 4(h) of Form N-CSR 
(requiring disclosure of whether the audit committee of a fund's 
board has considered whether the provision of non-audit services 
rendered to the fund's investment adviser and certain related 
parties that were not pre-approved by the audit committee is 
compatible with maintaining the principal accountant's 
independence).
    \25\ See rule 31a-1(b)(4) under the Investment Company Act [17 
CFR 270.31a-1(b)(4)] (requiring funds to maintain minute books of 
directors' or trustees' meetings). The Commission is publishing a 
release adopting amendments to rule 31a-2, the fund recordkeeping 
rule, that require that a fund retain any written information 
considered by the directors in approving the terms or renewal of a 
contract between the fund and an investment adviser.
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    As adopted, the disclosure requirement in fund shareholder reports 
will apply to any new investment advisory contract or contract renewal, 
including subadvisory contracts, approved by the board during the most 
recent fiscal half-year. The proposal would have excluded contracts 
that were approved by shareholders from the disclosure requirement. We 
have determined to include these contracts because we agree with 
commenters that this comprehensive disclosure will better enable 
shareholders to remain up-to-date on advisory contract approvals, 
regardless of whether they were involved in the original approval of 
the contract. We note that directors have the same duty with respect to 
approval of an advisory contract, whether or not the contract is also 
approved by shareholders. We have modified the proposed amendments to 
clarify that a fund is required to provide shareholder reports 
disclosure only regarding board approvals during the fund's most recent 
fiscal half-year.\26\ Thus, if the board approves a contract during the 
first half of a fiscal year, the disclosure would be required in the 
semi-annual report for that period, but need not be repeated in the 
annual report.
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    \26\ Item 21(d)(6) of Form N-1A; Instruction 6.e. to Item 23 of 
Form N-2; Instruction 6(v) to Item 27(a) of Form N-3.
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    Because fund shareholder reports will now contain disclosure with 
respect to all advisory contracts approved by the board, we are 
removing the existing requirement for disclosure in the SAI of Forms N-
1A, N-2, and N-3 with respect to the board's approval of any existing 
investment advisory contract. We agree with commenters who argued that 
requiring discussion of the board's basis for approving an advisory 
contract in multiple locations is duplicative.
    However, we also agree with commenters who argued that it is 
important for investors to have access to information about advisory 
contract approvals before investing in a fund. For that reason, we are 
requiring that a fund prospectus state that a discussion regarding the 
board of directors' basis for approving any investment advisory 
contract is available in the fund's annual or semi-annual report to 
shareholders, as applicable.\27\ This disclosure will be required to 
indicate the dates covered by the relevant shareholder report, so that 
a shareholder may easily request the appropriate report. The disclosure 
will be required to appear adjacent to other prospectus disclosure 
about the fund's investment adviser.\28\
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    \27\ Item 5(a)(1)(iii) of Form N-1A; Item 9.1.b.(4) of Form N-2; 
Item 6(b)(iii) of Form N-3.
    \28\ Item 5(a)(1)(ii) of Form N-1A; Item 9.1.b.(3) of Form N-2; 
Item 6(b)(ii) of Form N-3.
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    The amendments we are adopting today will therefore result in 
complementary disclosure requirements in fund shareholder reports, 
prospectuses, and proxy statements. The disclosure requirement in 
shareholder reports will provide existing fund shareholders with 
information about any board approval of an investment advisory contract 
during the most recent fiscal half-year. The prospectus disclosure 
requirement will inform prospective investors that this information is 
available in shareholder reports. Finally, the existing disclosure 
requirement in fund proxy statements will continue to apply to any 
recommendation that shareholders approve an investment advisory 
contract.
    Several commenters recommended that funds be either encouraged or 
required to disclose information concerning board approval of 
investment advisory contracts on their Web sites. These commenters 
argued that Web site disclosure would provide investors with quick and 
easy access to this information at low cost. We note that we have 
recently taken steps to encourage Web site disclosure of fund 
shareholder reports, by proposing amendments that would require that 
the cover page of a fund prospectus state whether the fund makes 
available its shareholder reports on or through its Web site.\29\
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    \29\ See Investment Company Act Release No. 26383 (Mar. 11, 
2004) [69 FR 12752 (Mar. 17, 2004)] (proposed Item 1(b)(1) of Form 
N-1A, Item 1.1.d of Form N-2, and Item 1(a)(vi) of Form N-3).
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B. Disclosure Enhancements

    We are adopting several enhancements to the existing proxy 
statement disclosure requirements and are including these same 
enhancements in the new shareholder reports disclosure requirement. 
These enhancements clarify and reinforce a fund's obligation under the 
existing proxy disclosure requirement to discuss the material factors 
and the conclusions with respect thereto that formed the board's basis 
for recommending that the shareholders approve an advisory contract. 
They are intended to address our concerns that some funds do not 
provide adequate specificity regarding

[[Page 39801]]

the board's basis for its decision. We are adopting the enhancements 
substantially as proposed, with some modifications to address 
commenters' concerns.
    Selection of Adviser and Approval of Advisory Fee. The amendments 
clarify that the fund's discussion must 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.\30\ Two commenters objected to the use of the phrase 
``selection of the investment adviser,'' arguing that this language 
suggests that the annual review and approval of the advisory contract 
is an annual opportunity to replace the investment adviser, and that it 
is not the role of the directors, except in the most egregious 
circumstances, to override the investors' choice of an adviser. We 
note, however, that although we would not expect that fund boards would 
routinely replace investment advisers, the board does have a duty to 
monitor the adviser's performance of its duties under the advisory 
contract, and to consider replacing the adviser if necessary. The 
directors' decision to renew an investment advisory contract, in 
effect, constitutes the selection of the investment adviser.
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    \30\ Item 21(d)(6)(i) of Form N-1A; Instruction 6.e.(i) to Item 
23 of Form N-2; Instruction 6(v)(A) to Item 27(a) of Form N-3; Item 
22(c)(11)(i) of Schedule 14A.
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    Specific Factors. The amendments will require a fund 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.\31\
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    \31\ Id. Courts have used similar factors in determining whether 
investment advisers 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) (``Gartenberg'') (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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    We are adding an instruction to clarify that if any of the 
enumerated factors is not relevant to the board's evaluation of an 
investment advisory contract, the discussion must note this and explain 
the reasons why that factor is not relevant.\32\ This instruction is 
intended to address the concerns of commenters who argued that the 
proposal should be modified to allow for less or different disclosure 
with respect to advisory contracts with ``non-sponsor advisers'' (i.e., 
investment advisers, including subadvisers, to funds that are sponsored 
by third parties unaffiliated with the adviser). These commenters 
claimed that more tailored disclosure would be appropriate for such 
advisory contracts because the relationship between an unaffiliated 
subadviser or a non-sponsor adviser and a fund is truly ``arm's-
length.'' They also argued that the factors that directors would 
consider in approving an advisory contract with an unaffiliated 
subadviser or non-sponsor adviser are different.
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    \32\ Instruction 3 to Item 21(d)(6) of Form N-1A; Instruction 
6.f. to Item 23 of Form N-2; Instruction 6(vi) to Item 27(a) of Form 
N-3; Instruction 2 to Item 22(c)(11) of Schedule 14A.
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    The instruction we are adding will permit a fund, including a fund 
with a non-sponsor adviser, to tailor its disclosure to its particular 
circumstances. At the same time, it will require each fund to address 
each of the enumerated factors, either substantively or by explaining 
why the factor is not relevant. This degree of uniformity in the 
discussion is designed to facilitate investor understanding of board 
approvals of investment advisory contracts. We emphasize that it is 
important that a fund disclose how a board evaluated and approved all 
investment advisory contracts, including contracts with non-sponsor 
advisers, such as unaffiliated subadvisers. Under the Investment 
Company Act, a fund's board plays an important role in the selection 
and oversight of the fund's adviser and subadvisers, and the fact that 
these contracts are the result of ``arm's length'' negotiations does 
not remove the need for board oversight.\33\ Unaffiliated subadvisers 
may, for example, have other material business arrangements with the 
fund's adviser or principal underwriter, which the board should 
consider in the course of evaluating a subadviser's contract.\34\
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    \33\ See Investment Company Act Release No. 26230 (Oct. 23, 
2003) [68 FR 61720, 61723 (Oct. 29, 2003)] (``Manager of Managers 
Proposing Release'') (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).
    \34\ See Manager of Managers Proposing Release, supra note 33, 
68 FR at 61723 n. 37 (noting that, in carrying out its obligations 
under section 15(c) of the Investment Company Act, a board should 
consider any material business arrangements between the adviser or 
principal underwriter and the subadviser, including the involvement 
of the subadviser in the distribution of the fund's shares).
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    We note that the amendments are not intended to require disclosure 
of the amount of the fee paid to an unaffiliated subadviser if that 
information would not otherwise be required to be disclosed. For 
example, if a manager of managers fund is not otherwise required to 
disclose separately the fee paid to each subadviser, the amendments 
would not require this disclosure.\35\
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    \35\ Sponsors of manager of managers funds have represented that 
they are able to negotiate lower fees with subadvisers if they do 
not have to disclose those fees separately, and in our exemptive 
orders we have provided them relief from our disclosure 
requirements. See, e.g., Endeavor Series Trust, Investment Company 
Act Release Nos. 24054 (Sept. 27, 1999) [64 FR 53428 (Oct. 1, 1999)] 
(notice) and 24108 (Oct. 22, 1999) [70 SEC Docket 3081 (Nov. 23, 
1999)] (order); Frank Russell Investment Company, Investment Company 
Act Release Nos. 21108 (June 2, 1995) [60 FR 30321 (June 8, 1995)] 
(notice) and 21169 (June 28, 1995) [59 SEC Docket 2105 (July 25, 
1995)] (order). The Commission has proposed form amendments that, if 
adopted, would permit a manager of managers fund to disclose only 
the aggregate amount of advisory fees that it pays to subadvisers as 
a group, rather than the fee paid to each unaffiliated subadviser. 
Manager of Managers Proposing Release, supra note 33, 68 FR at 
61722.
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    Under the amendments, a fund's discussion is required to state how 
the board evaluated the costs of the services to be provided and the 
profits to be realized by the investment adviser and its affiliates 
from the relationship with the fund. One commenter argued that, to the 
extent that actual operating cost and profit information is required, 
such disclosure could have harmful competitive effects on investment 
advisers, and that in any event disclosure of specific cost and profit 
figures is not necessary to help investors understand the board's 
evaluation of this factor. We wish to clarify that disclosure of 
specific proprietary information about the operating costs and profits 
of the investment adviser and its affiliates is not necessary to meet 
this requirement.
    Comparison of Fees and Services Provided by Adviser. The fund's 
discussion will 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 registered investment companies or

[[Page 39802]]

other types of clients (e.g., pension funds and other institutional 
investors). If the board relied upon such comparisons, the discussion 
will be required to describe the comparisons that were relied on and 
how they assisted the board in concluding that the contract should be 
approved.\36\
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    \36\ Item 21(d)(6)(i) of Form N-1A; Instruction 6.e.(i) to Item 
23 of Form N-2; Instruction 6(v)(A) to Item 27(a) of Form N-3; Item 
22(c)(11)(i) of Schedule 14A.
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    Commenters were divided on the proposed requirement with respect to 
comparisons of fees and services. Several commenters supported the 
proposed requirement, arguing that any responsible board would at least 
seek to compare the terms of the contract under consideration with 
relevant terms for similar funds, and that by encouraging boards to 
compare the compensation funds pay to their advisers with the 
compensation that other institutional investors pay, there may be a 
downward pressure on fund advisory fees. By contrast, one commenter 
objected to the requirement insofar as it relates to comparisons with 
other types of clients, particularly pension funds. This commenter 
argued that fund boards typically do not use such comparisons as a 
basis for approving or renewing advisory contracts, but that, to avoid 
providing negative disclosure that the board did not consider the use 
of such comparisons, fund boards may feel compelled to consider this 
factor, notwithstanding its lack of relevance. We are adopting the 
requirement as proposed because we believe that information concerning 
whether and, if so, how the board relies on comparisons is important in 
understanding the board's decision. As adopted, the amendment requires 
a description of the comparisons upon which the board relied and how 
they assisted the board in concluding that the contract should be 
approved, and does not require an enumeration of the types of 
comparisons that the board did not use.
    Evaluation of Factors. The existing SAI and proxy statement 
requirements state that conclusory statements or a list of factors will 
not be considered sufficient disclosure, and that a fund's discussion 
must relate the factors to the specific circumstances of the fund and 
the investment advisory contract.\37\ We are clarifying this by 
requiring that the fund's discussion state how the board evaluated each 
factor. For example, it will 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.\38\
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    \37\ 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.
    \38\ Instruction 2 to Item 21(d)(6) of Form N-1A; Instruction 
6.f. to Item 23 of Form N-2; Instruction 6(vi) to Item 27(a) of Form 
N-3; Instruction 1 to Item 22(c)(11) of Schedule 14A.
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    Commenters' views on this proposed requirement were divided. On the 
one hand, some commenters agreed that the requirement that the 
discussion state how the board evaluated each factor would be useful in 
ensuring that the discussion has reasonable detail and does not rely on 
boilerplate disclosure. On the other hand, some commenters argued that 
detailed information regarding the factors that the board considered 
and the conclusions it reached is not of interest to most shareholders, 
and that, as a factual matter, boards typically determine whether to 
approve an advisory contract based on the totality of the factors 
considered. We believe that the proposed requirement will elicit more 
useful information than the existing requirement. It would be difficult 
for a board to reach a final conclusion as to whether to approve an 
advisory contract without reaching conclusions as to each material 
factor that forms the basis for the board's approval. Therefore, a 
discussion of the board's evaluation of the individual factors is 
important in order to help investors understand how the board reached 
its decision on whether to approve such a contract.\39\
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    \39\ In determining whether an advisory fee violates section 
36(b) of the Investment Company Act, courts have similarly evaluated 
the evidence with respect to the individual factors enumerated in 
Gartenberg before reaching a conclusion as to the ultimate issue. 
See, e.g., Gartenberg, supra note 31; Kalish v. Franklin Advisers, 
Inc., 742 F.Supp. 1222, 1228-1250 (S.D.N.Y. 1990), aff'd, 928 F.2d 
590 (2nd Cir.), cert. denied, 502 U.S. 818 (1991); Krinsk v. Fund 
Asset Management, 715 F.Supp. 472, 486-503 (S.D.N.Y. 1988), aff'd, 
875 F.2d 404 (2nd Cir.), cert. denied, 493 U.S. 919 (1989); Schuyt 
v. Rowe Price Prime Reserve Fund, Inc., 663 F.Supp. 962, 973-989 
(S.D.N.Y.), aff'd, 835 F.2d 45 (2nd Cir. 1987), cert. denied, 485 
U.S. 1034 (1988).
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C. Compliance Date

    The effective date for the amendments to the requirements for fund 
reports to shareholders and proxy statements is August 5, 2004. All 
fund reports to shareholders with respect to periods ending on or after 
March 31, 2005, and all proxy statements filed on or after October 31, 
2004, will be required to comply with the amendments. We are selecting 
the March 31, 2005 compliance date so that a fund will only be required 
to comply with the new disclosure requirements prospectively, with 
respect to board approvals occurring on or after October 1, 2004. This 
will give funds sufficient time to update their recordkeeping 
procedures in light of the new disclosure requirements, and to 
determine whether additional procedures for board approval of the 
disclosure that will be required in shareholder reports are needed in 
order to enable the fund's principal executive and financial officers 
to certify this disclosure. All initial registration statements on 
Forms N-1A, N-2, and N-3, and all post-effective amendments that are 
annual updates to effective registration statements, filed on or after 
the transmission to shareholders of a report containing the required 
disclosure must include the prospectus disclosure stating that a 
discussion regarding the board's basis for approving any investment 
advisory contract is available in the fund's shareholder reports.
    The effective date for the amendments to Item 12 of Form N-1A, Item 
18 of Form N-2, and Item 20 of Form N-3 that remove the current SAI 
disclosure requirement with respect to the board's approval of any 
existing investment advisory contract is January 31, 2006. By that 
date, every fund should have begun providing disclosure in its 
shareholder reports regarding the board's decision to approve the 
fund's investment advisory contract. Prior to January 31, 2006, a fund 
may omit disclosure in its SAI with respect to any board approval of an 
investment advisory contract if it has previously provided the required 
disclosure with respect to that board approval in a shareholder report.

III. Paperwork Reduction Act

    As explained in the Proposing Release, certain provisions of the 
amendments contain ``collection of information'' requirements within 
the meaning of the Paperwork Reduction Act of 1995.\40\ 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,

[[Page 39803]]

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.
---------------------------------------------------------------------------

    \40\ 44 U.S.C. 3501, et seq.
---------------------------------------------------------------------------

    Rule 30e-1 (OMB Control No. 3235-0025) was adopted under Section 
30(e) of the Investment Company Act.\41\ 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 \42\ and Section 5 of the Securities Act.\43\ 
Rule 20a-1 (OMB Control No. 3235-0158) was adopted pursuant to Section 
20(a) of the Investment Company Act.\44\
---------------------------------------------------------------------------

    \41\ 15 U.S.C. 80a-29(e).
    \42\ 15 U.S.C. 80a-8(a).
    \43\ 15 U.S.C. 77e.
    \44\ 15 U.S.C. 80a-20(a).
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    We are adopting amendments to the requirements for fund shareholder 
reports in Forms N-1A, N-2, and N-3 that will 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 most recent fiscal half-year. 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 removing requirements from 
Forms N-1A, N-2, and N-3 that require funds to provide disclosure in 
the SAI of these forms with respect to the basis of the board's 
approval of any advisory contract, and we are adding a provision 
requiring funds to provide a reference in the prospectus to the 
availability of the new disclosure in fund shareholder reports. 
Finally, we are adopting amendments to Schedule 14A that will clarify 
and reinforce funds' existing obligation to provide disclosure in proxy 
statements of the board of directors' basis for a recommendation that 
shareholders approve an investment advisory contract.
    We published notice soliciting comments on the collection of 
information requirements in the Proposing Release and submitted these 
requirements to the Office of Management and Budget (``OMB'') for 
review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11.\45\ OMB 
approved these collection requirements. We received no comments on the 
collection of information requirements.
---------------------------------------------------------------------------

    \45\ See Proposing Release, supra note 1, 69 FR at 7855-7856.
---------------------------------------------------------------------------

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 amendments, contains collection of 
information requirements.\46\ 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.
---------------------------------------------------------------------------

    \46\ 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.
---------------------------------------------------------------------------

    We estimate that there are approximately 3,800 investment companies 
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.\47\ We continue to estimate 
that the proposed amendments will increase the estimated burden hours 
for complying with rule 30e-1 by 2 hours per portfolio annually. 
Accordingly, the estimated total annual hour burden for all funds for 
complying with rule 30e-1 is 1,108,396 hours (1,088,984 hours + (9,706 
portfolios x 2 hours)).
---------------------------------------------------------------------------

    \47\ The estimates of the number of mutual fund portfolios 
registered on Form N-1A, the number of closed-end funds registered 
on Form N-2, and the number of sub-accounts of managed separate 
accounts registered on Form N-3 are based on the Commission staff's 
analysis of reports filed on Form N-SAR in 2003.
---------------------------------------------------------------------------

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 estimated total annual hour burden for preparing 
registration statements on Form N-1A is 1,142,296 hours.\48\ In the 
Proposing Release, we estimated that the proposed amendments would not 
increase the hour burden for filing registration statements on Form N-
1A.
---------------------------------------------------------------------------

    \48\ This number includes additional hour burdens that would be 
imposed if the Commission adopts its recently proposed rules 
relating to portfolio manager disclosure (30,998 additional hours), 
and disclosure of sales loads and revenue sharing in connection with 
the proposals for new mutual fund confirmation and point of sale 
disclosure (1,968 additional hours). Investment Company Act Release 
No. 26383 (Mar. 11, 2004) [69 FR 12752, 12759 (Mar. 17, 2004)]; 
Exchange Act Release No. 49148 (Jan. 29, 2004) [69 FR 6438, 6474 
(Feb. 10, 2004)].
---------------------------------------------------------------------------

    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 8,455 
portfolios. We estimate that the amendments we are adopting to Form N-
1A that remove the current requirement for a fund to provide disclosure 
in the SAI concerning the board's basis for approving an existing 
investment advisory contract will reduce the hour burden per portfolio 
per filing of an initial registration statement by 2 hours and will 
reduce the hour burden per portfolio per filing of a post-effective 
amendment to a registration statement by 2 hours, thereby reducing the 
total annual hour burden by 17,876 hours.\49\ In addition, we estimate 
that the amendments we are adopting that require a fund to provide a 
reference in its prospectus to the availability of the required 
disclosure in fund shareholder reports will have no impact on the hour 
burden for filing registration statements on Form N-1A. Thus, the 
estimated total annual hour burden for all funds for preparation and 
filing of initial registration statements and post-effective amendments 
to Form N-1A will be 1,124,420 hours (1,142,296 hours-17,876 hours).
---------------------------------------------------------------------------

    \49\ This estimate is based on the following calculation: (2 
hours x 483 portfolios) + (2 hours x 8,455 portfolios) = 17,876 
hours.
---------------------------------------------------------------------------

Form N-2

    Form N-2, including the proposed amendments, contains collection of 
information requirements. The likely respondents to this information 
collection are closed-end funds registering with the Commission. 
Compliance with the disclosure requirements of Form N-2 is mandatory. 
Responses to the disclosure requirements are not confidential.
    The current estimated total annual hour burden for preparing an 
initial registration statement on Form N-2 is

[[Page 39804]]

134,844 hours.\50\ In the Proposing Release, we estimated that the 
proposed amendments would not increase the hour burden for filing 
registration statements on Form N-2.
---------------------------------------------------------------------------

    \50\ This number includes the additional hour burden that would 
be imposed if the Commission adopts its recently proposed rules 
relating to portfolio manager disclosure (2,492 additional hours). 
See Investment Company Act Release No. 26383, supra note 48.
---------------------------------------------------------------------------

    The Commission estimates that, on an annual basis, 234 closed-end 
funds file initial registration statements on Form N-2, and 38 closed-
end funds file post-effective amendments on Form N-2. We estimate that 
the amendments we are adopting to Form N-2 that remove the current 
requirement for a fund to provide disclosure in the SAI concerning the 
board's basis for approving an existing investment advisory contract 
will reduce the hour burden per portfolio per filing of an initial 
registration statement by 2 hours and will reduce the hour burden per 
portfolio per filing of a post-effective amendment to a registration 
statement by 2 hours, thereby reducing the total annual hour burden by 
544 hours.\51\ In addition, we estimate that the amendments we are 
adopting that require a fund to provide a reference in its prospectus 
to the availability of the required disclosure in fund shareholder 
reports will have no impact on the hour burden for filing registration 
statements on Form N-2. Thus, the estimated total annual hour burden 
for all closed-end funds for preparation and filing of initial 
registration statements and post-effective amendments to Form N-2 will 
be 134,300 hours (134,844 hours - 544 hours).
---------------------------------------------------------------------------

    \51\ This estimate is based on the following calculation: (2 
hours x 234 portfolios) + (2 hours x 38 portfolios) = 544 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 
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 estimated total annual hour burden for preparing 
registration statements on Form N-3 is 34,832 hours.\52\ In the 
Proposing Release, we estimated that the proposed amendments would not 
increase the hour burden for filing registration statements on Form N-
3.
---------------------------------------------------------------------------

    \52\ This number includes the additional hour burden that would 
be imposed if the Commission adopts its recently proposed rules 
relating to portfolio manager disclosure (170 additional hours). See 
Investment Company Act Release No. 26383, supra note 48.
---------------------------------------------------------------------------

    The Commission estimates that, on an annual basis, initial 
registration statements covering 3 portfolios are filed on Form N-3 and 
post-effective amendments covering 35 portfolios are filed on Form N-3. 
We estimate that the amendments we are adopting to Form N-3 that remove 
the current requirement for a fund to provide disclosure in the SAI 
concerning the board's basis for approving an existing investment 
advisory contract will reduce the hour burden per portfolio per filing 
of an initial registration statement by 2 hours and will reduce the 
hour burden per portfolio per filing of a post-effective amendment to a 
registration statement by 2 hours, thereby reducing the total annual 
hour burden by 76 hours.\53\ In addition, we estimate that the 
amendments we are adopting that require a fund to provide a reference 
in its prospectus to the availability of the required disclosure in 
fund shareholder reports will have no impact on the hour burden for 
filing registration statements on Form N-3. Thus, the estimated total 
annual hour burden for all funds for preparation and filing of initial 
registration statements and post-effective amendments to Form N-3 will 
be 34,756 hours (34,832 hours - 76 hours).
---------------------------------------------------------------------------

    \53\ This estimate is based on the following calculation: (2 
hours x 3 portfolios) + (2 hours x 35 portfolios) = 76 hours.
---------------------------------------------------------------------------

Proxy Statements

    Rule 20a-1, including the proposed amendments to Schedule 14A, 
contains collection of information requirements.\54\ 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.
---------------------------------------------------------------------------

    \54\ The 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.
---------------------------------------------------------------------------

    The amendments to Schedule 14A will 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 continue to estimate that the amendments will not increase 
the hour burden for complying with the requirements of rule 20a-1.

IV. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. The amendments that the Commission is adopting will require 
funds to improve the disclosure that they provide regarding the fund 
board's basis for approving, or recommending that shareholders approve, 
an investment advisory contract. Specifically, the amendments will:
     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 most recent fiscal half-year;
     Require a fund to provide a statement in its prospectus 
about the availability of the required disclosure in fund shareholder 
reports; 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 amendments we are adopting will 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 amendments will 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 this disclosure in 
shareholder reports may encourage fund boards to engage in more 
vigorous and independent oversight of investment advisory contracts. 
This increased oversight by

[[Page 39805]]

fund boards will also benefit investors. The requirement that funds 
provide a statement in the prospectus about the availability of the new 
disclosure in shareholder reports will further this goal by assisting 
investors in finding the new disclosure.
    We also are removing current requirements from Forms N-1A, N-2, and 
N-3 that require funds to provide disclosure in the SAI with respect to 
the basis of the board's approval of any advisory contract, since this 
disclosure will now be available in shareholder reports. For purposes 
of the Paperwork Reduction Act, we have estimated that the amendments 
to Forms N-1A, N-2, and N-3 will reduce the annual hour burden for 
filing each form by 17,876 hours, 544 hours, and 76 hours, 
respectively, for a total reduction in annual burden of 18,496 hours. 
We estimate that this reduction in the annual hour burden will equal 
total internal cost savings of $1,549,410 annually, or approximately 
$408 per investment company.\55\ The removal of these disclosure 
requirements also will result in some external cost savings, but 
because this disclosure was included in a fund's SAI, which is 
typically not typeset, and is only required to be provided to 
shareholders upon request, we estimate that these savings will be 
minimal.
---------------------------------------------------------------------------

    \55\ These figures are based on a Commission estimate that 
approximately 3,800 investment companies would be subject to the 
amendments and an estimated hourly wage rate of $83.77. The estimate 
of the number of investment companies is based on data derived from 
the Commission's EDGAR filing system. The estimated wage rate is a 
blended rate, based on published hourly wage rates for assistant/
associate general counsels ($82.05) and programmers ($42.05) in New 
York City, and the estimate that staff in these categories will 
divide time equally on compliance with the disclosure requirements, 
yielding a weighted wage rate of $62.05 (($82.05 x .50) + (42.05 x 
.50))= $62.05). See Securities Industry Association, Report on 
Management & Professional Earnings in the Securities Industry 2003 
(Sept. 2003). 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 $83.77 ($62.05 x 1.35) = $83.77). This estimated wage rate for 
compliance attorneys differs from the estimate in the Proposing 
Release, which was based on published compensation for compliance 
attorneys in New York City ($74.22) contained in the Securities 
Industry Association's Report on Management & Professional Earnings 
in the Securities Industry 2001 (Oct. 2001).
---------------------------------------------------------------------------

    The amendments will also clarify and reinforce funds' obligation 
under the existing disclosure requirements in 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 will also benefit investors.

B. Costs

    The amendments will 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 new disclosure requirements will 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 amendments will 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 new disclosure requirements will 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 will equal total internal costs of $1,626,143 
annually, or approximately $428 per investment company.\56\ In 
addition, we have estimated that the amendments to Schedule 14A will 
have no impact on the hour burden for complying with rule 20a-1 under 
the Investment Company Act.
---------------------------------------------------------------------------

    \56\ See supra note 55.
---------------------------------------------------------------------------

    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 will 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 will 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.\57\ We estimate that there are approximately 257 
million fund shareholder accounts which would send out 231 million 
reports to shareholders annually that will include the required 
disclosure.\58\ 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.
---------------------------------------------------------------------------

    \57\ 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)].
    \58\ 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.
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act, we have estimated that 
the amendments that we are adopting that require a fund to provide a 
reference in its prospectus to the availability of the required 
disclosure in fund shareholder reports will not result in an increase 
in internal costs. Similarly, we expect that the external costs of 
providing the new prospectus disclosure will be minimal, because this 
disclosure will not add significant length to the prospectus.

V. 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.\59\ In addition, section 2(c) of the Investment Company Act,\60\ 
section 2(b) of the Securities Act,\61\ and section 3(f) of the 
Exchange Act \62\ 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

[[Page 39806]]

protection of investors, whether the action will promote efficiency, 
competition, and capital formation. In the Proposing Release, we 
requested comment on whether the proposed amendments would promote 
efficiency, competition, and capital formation. We received no comments 
on this issue.
---------------------------------------------------------------------------

    \59\ 15 U.S.C. 78w(a)(2).
    \60\ 15 U.S.C. 80a-2(c).
    \61\ 15 U.S.C. 77(b).
    \62\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The 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 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 amendments 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 amendments have no effect 
on capital formation.
    As noted above, we believe that the amendments will benefit 
investors. We note that funds currently are required to provide similar 
disclosure in their SAIs and in relevant proxy statements.

VI. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``Analysis'') has been 
prepared in accordance with 5 U.S.C. 604, and relates to the 
Commission's rule and form amendments under the Securities Act, the 
Exchange Act, and the Investment Company Act to encourage better, more 
prominent, and more timely disclosure to shareholders about the basis 
on which the board of directors of a fund approves, and recommends 
shareholder approval of, investment advisory contracts. An Initial 
Regulatory Flexibility Analysis (``IRFA''), which was prepared in 
accordance with 5 U.S.C. 603, was published in the release proposing 
these amendments.

A. Reasons for, and Objectives of, Amendments

    Sections I and II of this Release describe the reasons for and 
objectives of the amendments. As discussed in detail above, the 
amendments adopted by the Commission 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. Significant Issues Raised by Public Comment

    In the IRFA for the proposed amendments, we requested comment on 
any aspect of the IRFA, including the number of small entities that 
would be affected by the proposed amendments, the likely impact of the 
proposal on small entities, the nature of any impact, and we asked 
commenters to provide any empirical data supporting the extent of the 
impact. We received no comment letters on the IRFA.

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.\63\ 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.\64\ We estimate that few, 
if any, registered separate accounts registered on Form N-3 are small 
entities.\65\
---------------------------------------------------------------------------

    \63\ 17 CFR 270.0-10.
    \64\ 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.
    \65\ 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

    These amendments will:
     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 most recent fiscal half-year;
     Require a fund to provide a statement in its prospectus 
about the availability of the required disclosure in fund shareholder 
reports; 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. These amendments also require that funds 
provide a statement in the prospectus about the availability of this 
disclosure in shareholder reports. We note, with respect to the 
amendments to the disclosure requirements in fund proxy statements, 
that these amendments 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. Finally, these amendments remove existing 
requirements that funds provide similar disclosure in the SAI. We 
expect that the cost of compliance with the amendments to the existing 
disclosure requirements in proxy statements, and the amendments 
requiring a reference in the fund prospectus to the new disclosure in 
shareholder reports, will be minimal. We believe the benefits that will 
result to shareholders through better information with respect to their 
fund board's evaluation of such advisory contracts justify these 
potential costs.

E. Agency Action To Minimize Effect on Small Entities

    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 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

[[Page 39807]]

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 disclosure amendments will 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 is required by the 
amendments to be provided to shareholders by all funds, not just funds 
that are not considered small entities.
    We have endeavored through the 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 amendments to the same degree as 
other investment companies. Further 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 
disclosure will be more useful to investors if there are enumerated 
informational requirements.

VII. Statutory Authority

    The Commission is adopting amendments to Schedule 14A pursuant to 
authority set forth in sections 14 and 23(a)(1) of the Exchange Act 
\66\ and sections 20(a) and 38 of the Investment Company Act.\67\ The 
Commission is adopting 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 \68\ and sections 8, 15, 24(a), 30, and 38 of the 
Investment Company Act.\69\
---------------------------------------------------------------------------

    \66\ 15 U.S.C. 78n and 78w(a)(1).
    \67\ 15 U.S.C. 80a-20, 80a-37.
    \68\ 15 U.S.C. 77e, 77f, 77g, 77j, and 77s(a).
    \69\ 15 U.S.C. 80a-8, 80a-15, 80a-24(a), 80a-29, and 80a-37.
---------------------------------------------------------------------------

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 Rule and Form Amendments

0
For the reasons set out in the preamble, the Commission amends Title 
17, Chapter II of the Code of Federal Regulations as follows:

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

0
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, 77sss, 78c, 
78l, 78m, 78n, 78o(d), 78u-5, 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 
79l, 79m, 79n, 79q, 79t, 80a-8, 80a-24, 80a-26, 80a-29, 80a-30, and 
80a-37, unless otherwise noted.
* * * * *

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

0
2. The authority citation for Part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless 
otherwise noted.
* * * * *

0
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. Include the following in the 
discussion:
    (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. Also indicate in the discussion 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, 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.
    Instructions. 1. Conclusory statements or a list of factors will 
not be considered sufficient disclosure. 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.
    2. If any factor enumerated in paragraph (c)(11)(i) of this Item 22 
is not relevant to the board's evaluation of the investment advisory 
contract for which approval is sought, note this and explain the 
reasons why that factor is not relevant.
* * * * *

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

0
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.
* * * * *

[[Page 39808]]


0
5. Form N-1A (referenced in Sec. Sec.  239.15A and 274.11A) is amended 
by:
0
a. Adding Item 5(a)(1)(iii);
0
b. Removing Item 12(b)(10), including the Instruction; and
0
c. Adding Item 21(d)(6).
    The additions read as follows:

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

FORM N-1A

* * * * *

PART A: INFORMATION REQUIRED IN A PROSPECTUS

* * * * *

Item 5. Management, Organization, and Capital Structure

    (a) * * *
    (1) * * *
    (iii) Include a statement, adjacent to the disclosure required by 
paragraph (a)(1)(ii) of this Item, that a discussion regarding the 
basis for the board of directors approving any investment advisory 
contract of the Fund is available in the Fund's annual or semi-annual 
report to shareholders, as applicable, and providing the period covered 
by the relevant annual or semi-annual report.
* * * * *

PART B: INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION

* * * * *

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 Fund's most recent fiscal half-year, discuss in 
reasonable detail the material factors and the conclusions with respect 
thereto that formed the basis for the board's approval. Include the 
following in the discussion:
    (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. Also indicate in the discussion 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, 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. 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.
    3. If any factor enumerated in paragraph (d)(6)(i) of this Item is 
not relevant to the board's evaluation of an investment advisory 
contract, note this and explain the reasons why that factor is not 
relevant.
* * * * *

0
6. Form N-2 (referenced in Sec. Sec.  239.14 and 274.11a-1) is amended 
by:
0
a. Removing ``and'' from the end of Item 9.1.b(2);
0
b. Removing the period from the end of Item 9.1.b(3) and in its place 
adding ``; and'';
0
c. Adding Item 9.1.b(4);
0
d. Removing Item 18.13;
0
e. Redesignating Items 18.14 through 18.16 as Items 18.13 through 
18.15;
0
f. Adding Instructions 6.e and 6.f to Item 23; and
0
g. In Instruction 8.a to Item 23, revising the reference ``Item 18.16'' 
to read ``Item 18.15''.
    The 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

* * * * *

PART A: INFORMATION REQUIRED IN A PROSPECTUS

* * * * *

Item 9. Management

    1. * * *
    b. * * *
    (4) a statement, adjacent to the disclosure required by paragraph 
1.b.(3) of this Item, that a discussion regarding the basis for the 
board of directors approving any investment advisory contract of the 
Registrant is available in the Registrant's annual or semi-annual 
report to shareholders, as applicable, and providing the period covered 
by the relevant annual or semi-annual report.
* * * * *

PART B: INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION

* * * * *

Item 23. Financial Statements

* * * * *
    Instructions.
* * * * *
    6. * * *
    e. If the Registrant's board of directors approved any investment 
advisory contract during the Registrant's most recent fiscal half-year, 
discuss in reasonable detail the material factors and the conclusions 
with respect thereto that formed the basis for the board's approval. 
Include the following in the discussion:
    (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

[[Page 39809]]

investors. Also indicate in the discussion 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, 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.
    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. 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. If any factor enumerated 
in Instruction 6.e.(i) to this Item is not relevant to the board's 
evaluation of an investment advisory contract, note this and explain 
the reasons why that factor is not relevant.
* * * * *

0
7. Form N-3 (referenced in Sec. Sec.  239.17a and 274.11b) is amended 
by:
0
a. Removing ``and'' from the end of Item 6(b)(i);

0
b. At the end of Item 6(b)(ii), adding ``and'';
0
c. Adding Item 6(b)(iii);
0
d. Removing Item 20(l);
0
e. Redesignating Items 20(m) through 20(o) as Items 20(l) through 
20(n);
0
f. Removing ``and'' from the end of Instruction 6(iii) to Item 27(a);
0
g. Removing the period from the end of Instruction 6(iv) to Item 27(a) 
and in its place adding a semi-colon;
0
h. Adding Instructions 6(v) and 6(vi) to Item 27(a); and
0
i. In Instruction 8(i) to Item 27(a), revising the reference ``Item 
20(o)'' to read ``Item 20(n)''.
    The 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.

FORM N-3

* * * * *

PART A: INFORMATION REQUIRED IN A PROSPECTUS

* * * * *

Item 6. Management

* * * * *
    (b) * * *
    (iii) a statement, adjacent to the disclosure required by paragraph 
(b)(ii) of this Item, that a discussion regarding the basis for the 
board of directors approving any investment advisory contract of the 
Registrant is available in the Registrant's annual or semi-annual 
report to shareholders, as applicable, and providing the period covered 
by the relevant annual or semi-annual report;
* * * * *

PART B: INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION

* * * * *

Item 27. Financial Statements

    (a) * * *
    Instructions:
* * * * *
    6. * * *
    (v) If the Registrant's board of managers approved any investment 
advisory contract during the Registrant's most recent fiscal half-year, 
discuss in reasonable detail the material factors and the conclusions 
with respect thereto that formed the basis for the board's approval. 
Include the following in the discussion:
    (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. Also 
indicate in the discussion 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, 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; and
    (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). 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. If any factor enumerated in Instruction 6(v)(A) to this Item 
is not relevant to the board's evaluation of an investment advisory 
contract, note this and explain the reasons why that factor is not 
relevant.
* * * * *

    By the Commission.

    Dated: June 23, 2004.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-14755 Filed 6-29-04; 8:45 am]
BILLING CODE 8010-01-P