[Federal Register Volume 71, Number 191 (Tuesday, October 3, 2006)]
[Rules and Regulations]
[Pages 58257-58273]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E6-16273]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-27504; File No. S7-06-06; File No. 4-512]
RIN 3235-AJ51


Mutual Fund Redemption Fees

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or 
``SEC'') is adopting amendments to a rule under the Investment Company 
Act. The rule, among other things, requires most open-end investment 
companies (``funds'') to enter into agreements with intermediaries, 
such as broker-dealers,

[[Page 58258]]

that hold shares on behalf of other investors in so called ``omnibus 
accounts.'' These agreements must provide funds access to information 
about transactions in these accounts to enable the funds to enforce 
restrictions on market timing and similar abusive transactions. The 
Commission is amending the rule to clarify the operation of the rule 
and reduce the number of intermediaries with which funds must negotiate 
shareholder information agreements. The amendments are designed to 
reduce the costs to funds (and fund shareholders) while still achieving 
the goals of the rulemaking.

DATES: Effective Date: December 4, 2006.
    Compliance Dates: Section III of this Release contains more 
information on applicable compliance dates.

FOR FURTHER INFORMATION CONTACT: Thoreau Bartmann, Staff Attorney, or 
C. Hunter Jones, Assistant Director, Office of Regulatory Policy (202) 
551-6792, Division of Investment Management, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION: The Commission today is adopting amendments 
to rule 22c-2 \1\ under the Investment Company Act of 1940 \2\ (the 
``Investment Company Act'' or the ``Act'').\3\

    \1\ 17 CFR 270.22c-2.
    \2\ 15 U.S.C. 80a.
    \3\ Unless otherwise noted, all references to statutory sections 
are to the Investment Company Act, and all references to ``rule 22c-
2,'' ``the rule,'' or any paragraph of the rule will be to 17 CFR 
270.22c-2.
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Table of Contents

I. Background
II. Discussion
    A. Shareholder Information Agreements
    1. Small Intermediaries
    2. Intermediary Chains
    3. Effect of Lacking an Agreement
    B. Operation of the Rule
    C. Redemption Fees
III. Compliance Dates
IV. Cost-Benefit Analysis
V. Consideration of Promotion of Efficiency, Competition and Capital 
Formation
VI. Paperwork Reduction Act
VII. Final Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Amended Rule

I. Background

    On March 11, 2005, the Commission adopted rule 22c-2 under the 
Investment Company Act to help address abuses associated with short-
term trading of fund shares.\4\ Rule 22c-2 provides that if a fund 
redeems its shares within seven days,\5\ its board must consider 
whether to impose a fee of up to two percent of the value of shares 
redeemed shortly after their purchase (``redemption fee'').\6\ The rule 
also requires such a fund to enter into agreements with its 
intermediaries that provide fund management the ability to identify 
investors whose trading violates fund restrictions on short-term 
trading (``shareholder information agreements'').\7\
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    \4\ See Mutual Fund Redemption Fees, Investment Company Act 
Release No. 26782 (Mar. 11, 2005) [70 FR 13328 (Mar. 18, 2005)] 
(``Adopting Release'').
    \5\ Because the large majority of funds redeem shares within 
seven days of purchase, the practical effect of rule 22c-2, and 
these amendments, would be to require most funds to comply with the 
rule's requirements. Therefore, throughout this Release we may 
describe funds as being ``required to comply'' with a provision of 
the rule, when the actual requirement only applies if a fund redeems 
its shares within seven days. A fund that does not redeem its shares 
within seven days would not be required to comply with those 
provisions of rule 22c-2.
    \6\ Rule 22c-2(a)(1). Under the rule, the board of directors 
must either (i) approve a fee of up to 2% of the value of shares 
redeemed, or (ii) determine that the imposition of a fee is not 
necessary or appropriate. Id. A board, on behalf of the fund, may 
determine that the imposition of a redemption fee is unnecessary or 
inappropriate because, for example, the fund is not vulnerable to 
frequent trading or the nature of the fund makes it unlikely that 
the fund would be harmed by frequent trading. Indeed, a redemption 
fee is not the only method available to a fund to address frequent 
trading in its shares. As we have stated in previous releases, funds 
have adopted different methods to address frequent trading, 
including: (i) Restricting exchange privileges; (ii) limiting the 
number of trades within a specified period; (iii) delaying the 
payment of proceeds from redemptions for up to seven days (the 
maximum delay permitted under section 22(e) of the Act); (iv) 
satisfying redemption requests in-kind; and (v) identifying market 
timers and restricting their trading or barring them from the fund. 
See Adopting Release, supra note 4, at n.9; Disclosure Regarding 
Market Timing and Selective Disclosure of Portfolio Holdings, 
Investment Company Act Release No. 26287 (Dec. 11, 2003) [68 FR 
70402 (Dec. 17, 2003)] at text preceding and following n.14.
    \7\ Under the rule, the fund (or its principal underwriter) must 
enter into a written agreement with each of its financial 
intermediaries under which the intermediary agrees to (i) provide, 
at the fund's request, identity and transaction information about 
shareholders who hold their shares through an account with the 
intermediary, and (ii) execute instructions from the fund to 
restrict or prohibit future purchases or exchanges. The fund must 
keep a copy of each written agreement for six years. Rule 22c-
2(a)(2), (3).
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    After hearing concerns about the operation of the information 
sharing provisions of the rule from fund management companies, in March 
of this year we proposed amendments that would reduce the costs of 
compliance and clarify the rule's application in certain 
circumstances.\8\ The amendments are described in more detail below. We 
received 32 comment letters on the proposed amendments.\9\ Most 
commenters supported the proposal. Today we are adopting those 
amendments substantially as proposed, with some changes that reflect 
the comments we received.
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    \8\ See Mutual Fund Redemption Fees, Investment Company Act 
Release No. 27255 (Feb. 28, 2006) [71 FR 11351 (Mar. 7, 2006)] 
(``2006 Proposing Release'').
    \9\ Comment letters on the 2006 Proposing Release are available 
in File No. S7-06-06, which is accessible at http://www.sec.gov/rules/proposed/s70606.shtml. Comment letters on the 2005 adoption 
are available in File No. S7-11-04, which is accessible at http://www.sec.gov/rules/proposed/s71104.shtml. References to comment 
letters are to letters in those files.
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II. Discussion

A. Shareholder Information Agreements

    The amendments to rule 22c-2 we are adopting today (i) limit the 
types of intermediaries with which funds must enter into shareholder 
information agreements, (ii) address the rule's application when there 
are chains of intermediaries, and (iii) clarify the effect of a fund's 
failure to obtain an agreement with any of its intermediaries.
1. Small Intermediaries
    Rule 22c-2 prohibits a fund from redeeming shares within seven days 
unless, among other things, the fund enters into written agreements 
with its financial intermediaries (such as broker-dealers or retirement 
plan administrators) that hold shares on behalf of other investors.\10\ 
Under those agreements, the intermediaries must agree to provide, at 
the fund's request, shareholder identity (i.e., taxpayer identification 
number or ``TIN'' \11\) and transaction information,\12\ and carry out

[[Page 58259]]

instructions from the fund to restrict or prohibit further purchases or 
exchanges by a shareholder (as identified by the fund) who has engaged 
in trading that violates the fund's frequent trading (e.g. market 
timing) policies.\13\ We designed this provision to enable funds to 
obtain the information that they need to monitor short-term trading in 
omnibus accounts and enforce their market timing policies.
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    \10\ Rule 22c-2(a)(2). The rule excepts a fund from the 
requirement to enter into written agreements if, among other things, 
the fund ``affirmatively permits short-term trading of its 
securities.'' See rule 22c-2(b)(3). ``Financial intermediary'' is 
defined in rule 22c-2(c)(1).
    \11\ Some commenters noted that in the case of foreign 
shareholders, TINs may not always be available, and suggested that 
the rule permit alternate identifiers in those circumstances. See 
Comment Letter of the Investment Company Institute (``ICI'') (Apr. 
10, 2006). In order to accommodate the use of alternative 
identifiers in those circumstances, we have revised the rule to 
allow for the use of Individual Taxpayer Identification Numbers 
(``ITINs'') or other government issued identifiers to identify 
foreign shareholders if a TIN is unavailable. See rule 22c-
2(c)(5)(i).
    \12\ One comment letter submitted after the adoption of rule 
22c-2 expressed concern that the rule's contract provision, 
requiring that agreements with intermediaries mandate the disclosure 
of shareholder information at the fund's request, conflicts with 
Commission rules governing proxy solicitations. See Comment Letter 
of the American Bankers Assoc. (June 6, 2005). The Commission's 
proxy solicitation rules are set forth in Regulation 14A under the 
Securities Exchange Act of 1934, 17 CFR 240.14a-1 to 14b-2. The 
proxy rules govern the disclosure of information in the context of 
proxy solicitations, and do not prohibit banks, broker-dealers and 
other intermediaries from complying with agreements entered under 
rule 22c-2. See 2006 Proposing Release, supra note 8, at n.17.
    \13\ See rule 22c-2(c)(5) (defining ``shareholder information 
agreement,'' which is discussed further in Section II.B below).
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    After we adopted the rule in 2005, many fund managers expressed 
concern that the rule would require them to review a large number of 
their shareholder accounts in order to determine which shareholders are 
``financial intermediaries'' as defined under the rule.\14\ They noted 
that, because the definition encompassed any entity that holds 
securities in nominee name for other investors, it would include, for 
example, a small business retirement plan that holds mutual fund shares 
on behalf of only a few employees and that may not identify itself as a 
financial intermediary to the fund. These commenters emphasized that 
the task of identifying these intermediaries, as well as negotiating 
agreements with them, would be costly and burdensome.
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    \14\ See, e.g., Comment Letter of OppenheimerFunds, Inc. (May 9, 
2005).
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    To address these concerns, earlier this year we proposed to narrow 
the scope of the rule by excluding from the definition of ``financial 
intermediary'' those intermediaries that the fund treats as individual 
investors for purpose of the fund's frequent trading policies. Our 
proposal was premised on the understanding that when a fund places 
restrictions on transactions at the intermediary level (i.e., when the 
fund treats the intermediary itself as an individual investor), the 
fund is unlikely to need data about frequent trading by individual 
shareholders who hold shares through that intermediary, because abusive 
short-term trading by the individual shareholders holding through the 
omnibus account would ordinarily trigger application of those policies 
to the intermediary's trades.\15\ Therefore, transparency regarding 
underlying shareholder transactions executed through these accounts 
seemed unnecessary to achieve the goals of the rule. We believed that 
this new approach would substantially eliminate the need for funds to 
devote resources to identifying intermediaries, because the funds will 
have already identified the relevant intermediaries in the course of 
administering their policies on short-term trading. Commenters agreed 
with our analysis and urged that we adopt the amendments.\16 \
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    \15\ A fund typically exempts from its frequent trading policies 
the transactions of an intermediary that holds fund shares, on 
behalf of its customers, in an omnibus account with the fund. See, 
e.g., Mandatory Redemption Fees For Redeemable Fund Securities, 
Investment Company Act Release No. 26375A, at text accompanying n. 
39 (Mar. 5, 2004) [69 FR 11762 (Mar. 11, 2004)] (``2004 Proposing 
Release''). The fund exempts the intermediary because the daily 
changes in the intermediary's position, on behalf of its various 
customers' purchases and redemptions, result in a single purchase or 
redemption each day in the intermediary's omnibus account. If the 
intermediary were not exempt, its daily net trades would likely 
subject it to redemption fees or trading limitations. See The 
Coalition of Mutual Fund Investors, An Evaluation of the Redemption 
Fee and Market Timing Policies of the Largest Mutual Fund Groups 
(May 5, 2005) (available at http://www.investorscoalition.com/CMFIMarketTimingStudy05.pdf.).
    \16\ See, e.g., Comment Letter of the Investment Company 
Institute (Apr. 10, 2006); Comment Letter of Charles Schwab & Co., 
Inc. (Apr. 10, 2006).
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    Today we are amending the definition of ``financial intermediary'' 
in rule 22c-2 to exclude from that definition any entity that the fund 
treats as an ``individual investor'' for purposes of the fund's 
policies intended to eliminate or reduce dilution of the value of fund 
shares, i.e., frequent trading and redemption fee policies.\17\ As a 
result, if a fund, for example, applies a redemption fee or exchange 
limits to transactions by a retirement plan (an intermediary) rather 
than to the purchases and redemptions of the employees in the plan, 
then the plan would not be considered a ``financial intermediary'' 
under the rule, and the fund would not be required to enter into an 
agreement with that plan.\18\
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    \17\ Rule 22c-2(c)(1)(iv). If a fund has not established 
frequent trading policies and thus has not determined which persons 
it does not treat as individual investors, this exclusion from the 
definition of ``financial intermediary'' would not apply, and the 
fund would need to identify those shareholder accounts that are 
``financial intermediaries.'' See 2006 Proposing Release, supra note 
8, at n.23.
    \18\ We have not, as recommended by some commenters, revised the 
rule to specify the circumstances under which a fund may treat an 
intermediary as an individual investor rather than an intermediary 
for purposes of its frequent trading policies. See, e.g., Comment 
Letter of Charles Schwab & Co., Inc. (Apr. 10, 2006). We continue to 
believe that funds are in the best position to determine the 
treatment of an account as an individual investor under their 
frequent trading policies. Moreover, we believe a fund will have 
little incentive to ``inappropriately'' treat any intermediary as an 
individual shareholder, because the intermediary is free to 
terminate its relationship with the fund.
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    The Commission is making one change from our proposal in response 
to commenters who pointed out that, in some cases, purchase and 
redemption orders are aggregated and submitted by agents of 
intermediaries on behalf of the intermediaries.\19\ These commenters 
stated that under the rule as proposed, it was unclear whether an order 
submitted by an agent of an intermediary would be covered by the rule. 
In order to clarify the rule in response to those comments, we have 
revised it to provide that funds must enter into agreements with ``each 
financial intermediary that submits orders, itself or through its 
agent, to purchase or redeem shares directly to the fund * * *'' 
(changes in italics).\20\ This revision clarifies that funds must enter 
into agreements with financial intermediaries or their agents even if 
the intermediaries submit orders through entities that do not qualify 
as financial intermediaries.
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    \19\ See, e.g., Comment Letter of Matrix Settlement & Clearing 
Services, L.L.C. (Apr. 10, 2006).
    \20\ Rule 22c-2(a)(2). We are also revising paragraph (a)(2)(i) 
of the rule to require that the fund enter into an agreement with 
each such ``intermediary (or its agent).'' Rule 22c-2(a)(2)(i).
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2. Intermediary Chains
    In some cases, an intermediary such as a broker-dealer may hold 
shares of a mutual fund not only on behalf of individual investors, but 
also on behalf of other financial intermediaries, such as pension plans 
or other broker-dealers (``indirect intermediaries'') through one or 
more layers of intermediaries or ``chains.'' After we adopted rule 22c-
2 in 2005, fund managers expressed uncertainty as to how the rule 
applied to these arrangements, and expressed concern how, as a 
practical matter, a fund could obtain shareholder information through 
multiple layers of intermediaries.\21\ In response to these concerns, 
we proposed and are now adopting amendments to clarify the operation of 
the rule as it applies to ``chains of intermediaries.''
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    \21\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc. 
(May 24, 2005).
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    The revised rule requires that a fund (or, on the fund's behalf, 
its principal underwriter or transfer agent \22\) enter

[[Page 58260]]

into a shareholder information agreement \23\ only with those financial 
intermediaries \24\ that submit purchase or redemption orders directly 
to the fund, its principal underwriter or transfer agent, or a 
registered clearing agency (``first-tier intermediaries'').\25\ The 
rule does not require first-tier intermediaries to enter into 
shareholder information agreements with any indirect intermediaries.
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    \22\ When rule 22c-2 was adopted in 2005, it required a fund, or 
a principal underwriter acting on behalf of the fund, to enter into 
shareholder information agreements with intermediaries. In addition 
to the amendments described above, as proposed, we are also revising 
the rule to include a fund's transfer agent as an entity that may 
enter into a shareholder information agreement on the fund's behalf. 
As we noted when we proposed this change, the fund's transfer agent 
often has preexisting agreements with a fund's financial 
intermediaries, and thus permitting transfer agents to enter into 
information agreements may avoid potentially duplicative agreements 
or inefficiencies in the process. See 2006 Proposing Release, supra 
note 8, at text accompanying n.38. If a transfer agent enters into 
an agreement on behalf of the fund, the agreement must require the 
financial intermediary to provide the requested information to the 
fund upon the fund's request. See id. at n.37.
    We are not adopting the proposed revision that would have 
permitted a registered clearing agency to enter into shareholder 
information agreements on behalf of a fund. We received comment from 
the only registered clearing agency that receives orders for 
transactions in fund shares, noting that it does not have the 
capability to serve in this function (because it does not act as an 
agent for funds) and requesting that we revise the final rule to 
reflect this fact. See Comment Letter of the National Securities 
Clearing Corporation (Apr. 10, 2006). We agree with the commenter's 
concern that including this reference to clearing agencies might 
cause confusion.
    \23\ Rule 22c-2(c)(5). The agreement, which must be in writing, 
may be part of another contract or agreement, such as a distribution 
agreement.
    \24\ We understand that retirement plan administrators and other 
persons that maintain the plan's participant records typically 
submit fund shares transactions to the fund or its transfer agent, 
principal underwriter, or a registered clearing agency. The rule as 
we adopted it last year specifically includes these administrators 
and recordkeepers within the definition of a ``financial 
intermediary.'' See rule 22c-2(c)(1)(iii).
    \25\ Rule 22c-2(a)(2). We also considered, as an alternative to 
this requirement, that shareholder information agreements not 
require the collection of any shareholder information from indirect 
intermediaries. We did not take that approach because we are 
concerned that providing such an exception might encourage abusive 
short-term traders to conduct their activities through an indirect 
intermediary in order to avoid detection by the fund.
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    Under the proposed rule amendments, a shareholder information 
agreement would obligate a first-tier intermediary to, upon request of 
the fund, use its best efforts to identify any accountholders who are 
themselves intermediaries, and obtain and forward (or have forwarded) 
the underlying shareholder identity and transaction information from 
those indirect intermediaries farther down the chain.\26\ Some 
commenters expressed concern that shareholder information agreements 
might require first-tier intermediaries (and indirect intermediaries) 
to canvass all of their shareholder accounts to determine which 
accountholders are themselves intermediaries if a fund made a blanket 
request to identify all indirect intermediaries.\27\
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    \26\ See proposed rule 22c-2(c)(5)(iii) (discussed in 2006 
Proposing Release, supra note 8, at Section II.B).
    \27\ See Comment Letter of the Securities Industry Assoc. (Apr 
10, 2006); Comment Letter of Charles Schwab & Co., Inc. (Apr. 10, 
2006).
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    In light of these concerns, we have revised the rule text to 
clarify that a fund, after receiving initial transaction information 
from a first-tier intermediary, must make a specific further request to 
the first-tier intermediary for information on certain 
shareholders.\28\ As adopted, the amended rule defines ``shareholder 
information agreement'' as an agreement under which a financial 
intermediary agrees to ``[u]se best efforts to determine, promptly upon 
request of the fund, whether any specific person about whom it has 
received the identification and transaction information * * * [required 
by the rule], is itself a financial intermediary * * *'' (changes in 
italics).\29\ Under the revised rule, a shareholder information 
agreement need not obligate a first-tier intermediary to perform a 
complete review of its books and records to identify all indirect 
intermediaries. Instead, pursuant to a shareholder information 
agreement, a first-tier intermediary must use its best efforts to 
identify whether or not certain specific accounts identified by the 
fund are indirect intermediaries.\30\ If an indirect intermediary that 
holds an account with a first-tier intermediary does not provide 
underlying shareholder information, the agreement must obligate the 
first-tier intermediary to prohibit, upon the fund's request, that 
indirect intermediary from purchasing additional shares of the fund 
through the first-tier intermediary.\31\
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    \28\ See rule 22c-2(c)(5)(iii). For example, after receiving 
identity and transaction information from a first-tier intermediary, 
the fund could then request information from the first-tier 
intermediary concerning those frequent trading shareholders whose 
transactions were particularly active, in order to determine whether 
those shareholders are themselves intermediaries. Under the 
shareholder information agreement, the first-tier intermediary would 
then be required to use its best efforts to determine, on behalf of 
the fund, whether any of those shareholders are intermediaries 
(i.e., second-tier intermediaries). After the first-tier 
intermediary informs the fund which of the shareholders are second-
tier intermediaries, the fund could then request that the first-tier 
intermediary obtain underlying shareholder transaction information 
from any or all of those second-tier intermediaries.
    \29\ See rule 22c-2(c)(5)(iii).
    \30\ Rule 22c-2(a)(2). A first-tier intermediary also may choose 
to indicate to the fund, when the intermediary initially discloses 
transaction information requested by the fund, which shareholders it 
knows to be indirect intermediaries. This practice may reduce a 
fund's need to request further information about indirect 
intermediaries.
    \31\ Rule 22c-2(c)(5)(iii)(B). Under the rule, therefore, if, 
upon specific request of the fund, an indirect intermediary (such as 
a third-tier intermediary) does not provide information whether one 
or more of its shareholders is an intermediary, then upon further 
request by the fund, the first-tier intermediary would be required 
to restrict or prohibit that indirect intermediary from purchasing 
additional shares of the fund on behalf of other investors.
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3. Effect of Lacking an Agreement
    After we adopted the rule, some commenters expressed concern that 
the rule, which made it unlawful for a fund to redeem a security within 
seven days without entering into a shareholder information agreement, 
could be interpreted to prevent a fund from redeeming any of its shares 
if it failed to enter into an agreement with any intermediary. 
Therefore we proposed, and are today adopting, an amendment to the rule 
that clarifies and further limits the consequences of failing to enter 
into an information agreement.
    Under rule 22c-2, as amended, if a fund does not have an agreement 
with a particular intermediary, the fund thereafter must prohibit that 
intermediary from purchasing securities issued by the fund.\32\ The 
prohibition applies only to the intermediary with which the fund does 
not have an agreement; purchases from other intermediaries will not be 
affected.\33\ One commenter argued that the rule

[[Page 58261]]

should not prohibit purchases that are fully disclosed to the fund.\34\ 
We agree that the fund does not need further information under an 
agreement to scrutinize those purchases. Therefore, we have revised the 
final rule to provide that, if there is no shareholder information 
agreement with a particular intermediary, the fund must prohibit the 
intermediary from purchasing the fund's securities only ``in nominee 
name on behalf of other persons.'' \35\ We have also, for the same 
reason, revised this provision so that it does not apply to the 
intermediary's purchases of fund securities on behalf of the 
intermediary itself.\36\
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    \32\ Rule 22c-2(a)(2)(ii). One commenter suggested that we 
clarify that in these circumstances a ``purchase'' would not include 
the automatic reinvestment of dividends. See Comment Letter of the 
Investment Company Institute (Apr. 10, 2006). We agree that the 
reinvestment of dividends does not present the types of frequent 
trading risks that the rule is designed to help funds prevent. We 
therefore have revised the rule text to clarify that, for purposes 
of this provision, a ``purchase'' does not include the automatic 
reinvestment of dividends. See rule 22c-2(a)(2)(ii).
    \33\ A number of commenters expressed concerns about possible 
conflicts with the Employee Retirement Income Security Act of 1974, 
29 U.S.C. 1001 (``ERISA''), and Department of Labor rules under 
ERISA, in complying with rule 22c-2. They stated that those laws: 
(i) Require certain ``blackout'' disclosures before a plan sponsor 
may carry out a fund's request to prohibit future purchases; and 
(ii) provide a safe harbor under section 404(c) of ERISA from 
liability as a fiduciary only if the plan provides participants an 
adequate number of investment alternatives and the ability to trade 
among them with appropriate frequency, in light of the market 
volatility of those alternatives. See, e.g., Comment Letter of the 
American Bankers Assoc. (Apr. 14, 2006) (citing ERISA section 
101(i), ERISA section 404(c), 29 CFR 2520, and 29 CFR 2550.404c-1); 
Comment Letter of the American Benefits Council (Apr. 10, 2006). Our 
staff has conferred with representatives of the Department of Labor, 
who have advised us that these concerns have been addressed in 
guidance on the duties of employee benefit plan fiduciaries in light 
of alleged abuses involving mutual funds. See Statement of Ann L. 
Combs, Assistant Secretary, Department of Labor, Fiduciary 
Responsibilities Related to Mutual Funds, (Feb. 17, 2004) (available 
at http://www.dol.gov/ebsa/newsroom/sp021704.html) (reasonable 
redemption fees and reasonable plan or investment fund limits on the 
number of times a participant can move in and out of a particular 
investment within a particular period ``represent approaches to 
limiting market timing that do not, in and of themselves, run afoul 
of the `volatility' and other requirements set forth in the 
Department's regulation under section 404(c), provided that any such 
restrictions are allowed under the terms of the plan and clearly 
disclosed to the plan's participants and beneficiaries.'').
    \34\ See Comment Letter of the American Bankers Assoc. at 6 
(Apr. 14, 2006).
    \35\ A similar revision has been made to the same type of 
provision concerning chains of intermediaries. See rule 22c-
2(c)(5)(iii)(B).
    \36\ Rule 22c-2(a)(2)(ii), (c)(5)(iii)(B). One commenter 
requested that the Commission provide further guidance to financial 
intermediaries that attempt to carry out instructions from a fund, 
under rule 22c-2(c)(5)(ii), to ``restrict or prohibit further 
purchases or exchanges'' by a particular investor whom the fund has 
identified as violating its frequent trading policies. See Comment 
Letter of the Committee of Annuity Insurers (submitted by Sutherland 
Asbill & Brennan LLP) (Apr. 10, 2006). The commenter noted that an 
``exchange'' (or transfer) request is actually two simultaneous 
orders: an order to redeem shares of one fund and an order to 
purchase, with the proceeds of the redemption, shares of another 
fund. This commenter questioned whether the rule was meant to 
include both the redemption and purchase order. As noted, the rule 
permits a fund to restrict or prohibit ``exchanges.'' We agree with 
the commenter that an ``exchange'' request includes both a 
redemption order and purchase order, and if a fund instructs an 
intermediary to restrict an ``exchange'' (or a purchase), the 
intermediary may notify the investor that it will not effect the 
redemption portion of a request to exchange into the fund, as well 
as the purchase portion of the request.
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    Some commenters suggested alternative approaches that we have 
decided not to adopt. One recommended that the rule preclude 
intermediaries that lack an agreement with funds from redeeming shares 
within seven days of purchase, rather than prohibiting further 
purchases of fund shares.\37\ This approach is not acceptable to us 
because it would deny investors access to their funds for seven days 
after purchasing shares through such an intermediary, thereby 
penalizing investors for the inability or unwillingness of a fund and 
intermediary to enter into a shareholder information agreement. Another 
commenter argued that the rule should instead preclude a fund from 
making further payments under selling or dealer agreements to 
intermediaries that lack shareholder information agreements.\38\ 
However, all funds do not necessarily have selling or dealer agreements 
with all of their ``financial intermediaries'' as defined in the rule, 
and restricting the rule's scope to those intermediaries that have such 
agreements would likely seriously restrict a fund's ability to gather 
information and enforce its policies. After careful consideration of 
the suggested alternatives, we believe that barring future purchases by 
intermediaries best serves the purposes of the rule.
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    \37\ See Comment Letter of the American Benefits Council (Apr. 
10, 2006).
    \38\ See Comment Letter of Federated Investors, Inc. (submitted 
by ReedSmith LLP) (Apr. 6, 2006).
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B. Operation of the Rule

    When we adopted rule 22c-2, we explained that the shareholder 
information agreement requirement is designed to give fund managers 
(and their chief compliance officers) a compliance tool to monitor 
trading activity in order to detect frequent trading and to assure 
consistent enforcement of fund policies.\39\ But we also explained that 
the rule gives managers flexibility to request information periodically 
such as when circumstances suggested that abusive trading activity is 
occurring.\40\
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    \39\ Adopting Release, supra note 4, at text accompanying n.49.
    \40\ Id. at text following n.42.
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    We recognize that in some cases, frequent use of this tool might be 
costly for funds and intermediaries. Commenters expressed concerns 
about these costs, and several commenters urged us to impose limits on 
the frequency of information requests made by funds pursuant to the 
information agreements.\41\ We are not imposing limits because, as we 
noted in the Adopting Release, we expect funds that are susceptible to 
market timing to use the tool regularly.\42\ Not all funds, however, 
are susceptible to market timing.
---------------------------------------------------------------------------

    \41\ See, e.g., Comment Letter of Massachusetts Mutual Life 
Insurance Company (Apr. 10, 2006); Supplemental Comment Letter of 
the SPARK Institute, Inc. (May 1, 2006).
    \42\ Adopting Release, supra note 4, at text accompanying n.50.
---------------------------------------------------------------------------

    A fund, in determining the frequency with which it should seek 
transaction information from its intermediaries, could consider: (i) 
Unusual trading patterns, such as abnormally large inflows or outflows, 
that may indicate the existence of frequent trading abuses; (ii) the 
risks that frequent trading poses to the fund and its shareholders in 
light of the nature of the fund and its portfolio; (iii) the risks to 
the fund and its shareholders of frequent trading in light of the 
amount of assets held by, or the volume of sales and redemptions 
through, the financial intermediary; and (iv) the confidence the fund 
(and its chief compliance officer \43\) has in the implementation by an 
intermediary of trading restrictions designed to enforce fund frequent 
trading policies or similar restrictions designed to protect the fund 
from abusive trading practices. In some cases, fund managers may seek 
transaction information only occasionally to determine whether the 
intermediary is, in fact, enforcing trading restrictions or imposing 
redemption fees on behalf of the fund.\44\
---------------------------------------------------------------------------

    \43\ See, e.g., Compliance Programs of Investment Companies and 
Investment Advisors, Investment Company Act Release No. 26299, at 
n.69 and accompanying text (Dec. 17, 2003) [68 FR 74714 (Dec. 24, 
2003)] (``[U]nder rule 38a-1, a fund must have procedures reasonably 
designed to ensure compliance with its disclosed policies regarding 
market timing. These procedures should provide for monitoring of 
shareholder trades or flows of money in and out of the funds in 
order to detect market timing activity, and for consistent 
enforcement of the fund's policies regarding market timing.'').
    \44\ Some commenters expressed concern about the ability of 
financial intermediaries to provide information to funds, in light 
of applicable privacy laws. See, e.g., Comment Letter of the 
American General Life Insurance Company, et al (submitted by 
O'Melveny & Myers LLP), (May 9, 2005); 15 U.S.C. 6801-09, 6821-27 
(privacy provisions of Gramm-Leach-Bliley Act); Regulation S-P, 17 
CFR Part 248 (Commission rules implementing privacy provisions for 
funds, broker-dealers, and registered investment advisers). Under 
those laws, financial institutions such as funds, broker-dealers, 
and banks must provide a notice describing the institution's privacy 
policies and an opportunity for consumers to opt out of the sharing 
of information with nonaffiliated third parties. These privacy laws 
also contain important exceptions to the notice and opt-out 
requirements. Under the Commission's privacy rules, for example, 
these requirements do not apply to the disclosure of information 
that is ``necessary to effect, administer, or enforce a transaction 
that a consumer requests or authorizes,'' which includes a 
disclosure that is ``[r]equired, or is a usual, appropriate, or 
acceptable method * * * [t]o carry out the transaction or the 
product or service business of which the transaction is a part * * 
*'' 17 CFR 248.14(a), (b)(2). See also 17 CFR 248.15(a)(7)(i) 
(notice and opt-out requirements not applicable to disclosure of 
information to comply with law). Financial privacy rules that are 
substantially identical to these rules apply to financial 
intermediaries other than broker-dealers, and contain comparable 
exceptions. See, e.g., 12 CFR Part 40 (rules applicable to national 
banks, adopted by the Comptroller of the Currency). We believe that 
the disclosure of information under shareholder information 
agreements, and the fund's request and receipt of information under 
those agreements, are covered by these exceptions. We also note that 
financial institutions often state in their privacy policy notices 
that the institution makes ``disclosures to other nonaffiliated 
third parties as permitted by law.'' See 17 CFR 248.6(b). Therefore 
we believe it will not be necessary for intermediaries such as 
broker-dealers and banks to provide new privacy notices or opt-out 
opportunities to their customers, in order to comply with rule 22c-
2. Commenters on the 2006 Proposing Release generally agreed that 
complying with rule 22c-2 should not require broker-dealers and 
banks to provide new privacy notices to their customers. See Comment 
Letter of the Investment Company Institute (Apr. 10, 2006); Comment 
Letter of the American Bankers Assoc. (Apr. 14, 2006).
    A fund that receives shareholder information for a purpose 
permitted by the privacy rules under the exceptions to consumer 
notice and opt out requirements may not disclose that information 
for other purposes, such as marketing, unless permitted under the 
intermediary's privacy policy. See Adopting Release, supra note 4, 
at n.47.

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[[Page 58262]]

    Some intermediaries have responded to market timing concerns by 
enforcing their own frequent trading policies, which may be different 
from policies established by fund boards. We believe that a fund in 
appropriate circumstances could reasonably conclude that an 
intermediary's frequent trading policies sufficiently protect fund 
shareholders, and could therefore defer to the intermediary's policies, 
rather than seek to apply the fund's policies on frequent trading to 
shareholders who invest through that intermediary. In those 
circumstances, the fund should describe in its prospectus that certain 
intermediaries through which a shareholder may own fund shares may 
impose frequent trading restrictions that differ from those of the 
fund, generally describe the types of intermediaries (e.g., broker-
dealers, insurance company separate accounts, and retirement plan 
administrators), and direct shareholders to any disclosures provided by 
the intermediaries with which they have an account to determine what 
restrictions apply to the shareholder. We note that a fund is required 
to disclose whether each restriction imposed by the fund to prevent or 
minimize frequent trading applies to trades that occur through omnibus 
accounts at intermediaries, and to describe with specificity the 
circumstances, if any, under which each such restriction will not be 
imposed.\45\
---------------------------------------------------------------------------

    \45\ See Item 6(e) of Form N-1A [17 CFR 239.15A and 274.11A]; 
Item 8(e) of Form N-3 [17 CFR 239.17a and 274.11b]; Item 7(e) of 
Form N-4 [17 CFR 239.17b and 274.11c], Item 6(f) of Form N-6 [17 CFR 
239.17c and 274.11d]. These disclosure items would not require a 
fund to describe the frequent trading policies of each intermediary 
to whose policies the fund defers.
---------------------------------------------------------------------------

C. Redemption Fees

    Rule 22c-2 requires fund directors to consider whether to adopt a 
redemption fee, but the rule neither requires funds to adopt such a fee 
nor specifies the terms under which such a fee should be assessed.\46\ 
A number of commenters raised concerns about redemption fees, and 
encouraged us to become involved in establishing the terms and 
conditions under which funds charge them.\47\ A number of commenters, 
for example, urged us to require that fund redemption fee policies 
waive fees that might be imposed as a result of transactions not 
initiated by investors.\48\
---------------------------------------------------------------------------

    \46\ The rule does, however, require that any redemption fee 
charged not exceed two percent and apply to redemptions no less than 
seven days after purchase. See rule 22c-2(a)(1)(i).
    \47\ See, e.g., Supplemental Comment Letter of the SPARK 
Institute, Inc. (May 1, 2006); Comment Letter of the American 
Council of Life Insurers (Apr. 10, 2006); Comment Letter of the 
Committee of Annuity Insurers (submitted by Sutherland Asbill & 
Brennan) (Apr. 10, 2006).
    \48\ See, e.g., Comment Letter of the American Society of 
Pension Professionals & Actuaries (Apr. 10, 2006); Supplemental 
Comment Letter of the SPARK Institute, Inc. (May 1, 2006). Non-
investor initiated transactions may include automatic asset 
rebalancing, automatic distributions, and prearranged periodic 
contributions.
---------------------------------------------------------------------------

    We appreciate the commenters' suggestions that standardizing the 
terms and conditions of redemption fee policies might reduce the costs 
that intermediaries and others (including funds themselves) will bear 
in implementing fund redemption fees. However, we have decided not to 
propose to standardize the terms or conditions to preserve the 
flexibility of each fund to fashion policies that are best suited to 
protect the investors in each fund. We have done this after receiving 
extensive comment on the matter and after observing a lack of consensus 
among industry participants on the appropriate terms of a uniform 
redemption fee.\49\ Although we may reconsider our decision at a later 
time, until then, the terms of redemption fee policies are a matter for 
fund boards to determine.\50\
---------------------------------------------------------------------------

    \49\ See 2006 Proposing Release, supra note 8, at text following 
n.12.
    \50\ Several commenters noted that a number of state insurance 
and contract law issues might arise in connection with a redemption 
fee charged to investors who invest in funds through insurance 
company separate accounts. See, e.g., Supplemental Comment Letter of 
the SPARK Institute, Inc. (May 1, 2006); Comment Letter of the 
American Council of Life Insurers (Apr. 10, 2006). As we stated in 
the 2006 Proposing Release, we believe that because redemption fees 
and frequent trading policies are imposed by the fund, and not the 
insurance company, enforcing those limits or fees with respect to 
these investors should not cause insurance companies to breach their 
contracts. See 2006 Proposing Release, supra note 8, at n.12. 
Moreover, nothing in this rule would preclude a fund that is 
concerned about the legality under existing contracts of imposing 
these limits or fees on certain insurance contractholders, from 
choosing not to impose them with regard to investors whose policies 
would not permit imposition of such limits or fees.
---------------------------------------------------------------------------

III. Compliance Dates

    When the Commission adopted rule 22c-2 in March 2005, we 
established a compliance date of October 16, 2006. In the 2006 
Proposing Release, we requested comment on whether we should extend 
that compliance date. Nearly every commenter requested an extension, 
pointing out the need for significant time to revise agreements with 
intermediaries and change systems to accommodate the transmission and 
receipt of trading information. Commenters requested a variety of 
compliance date extensions, ranging from 6 months to 18 months.
    Today we are extending the compliance date for the shareholder 
information agreement provisions of rule 22c-2. We are extending by 6 
months, until April 16, 2007, the date by which funds must enter into 
shareholder information agreements with their intermediaries.\51\ We 
also are extending by 12 months, until October 16, 2007, the date by 
which funds must be able to request and promptly receive shareholder 
identity and transaction information pursuant to shareholder 
information agreements. This latter extension is designed to allow 
additional time for funds, intermediaries, and others to revise their 
systems to accommodate the request, provision, and use of information 
from intermediaries after the negotiation of shareholder information 
agreements.
---------------------------------------------------------------------------

    \51\ See rule 22c-2(a)(2).
---------------------------------------------------------------------------

    We did not propose, nor did we receive comment on, an extension of 
the compliance date for section 22c-2(a)(1), which requires a fund's 
board to consider the adoption of a redemption fee policy. The 
compliance date for that provision, October 16, 2006, remains in 
effect.

IV. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. As discussed above, the amendments we are adopting today 
will (i) limit the types of intermediaries with which funds must enter 
into shareholder information agreements, (ii) address the rule's 
application when there are chains of intermediaries, and (iii) clarify 
the effect of a fund's failure to obtain an agreement with any of its 
intermediaries. These amendments are designed to respond to concerns 
that commenters identified during the course of implementing rule 22c-
2, and in response to our request for comment on these proposed 
amendments. We believe that the amendments will result in substantial 
cost savings to funds, financial intermediaries, and investors, and 
provide clarification of the rule's requirements.

A. Benefits

    We anticipate that funds, financial intermediaries, and investors 
will benefit from these amendments to rule 22c-2. As discussed more 
fully in the Adopting Release we issued in 2005, rule 22c-2 is designed 
to allow a fund to deter, and to provide the fund and its shareholders 
reimbursement for the costs of, short-term trading in fund shares.\52\
---------------------------------------------------------------------------

    \52\ See Adopting Release, supra note 4, at Section IV.A.

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

[[Page 58263]]

    The amendments to rule 22c-2 that we are adopting today will likely 
result in additional benefits to funds, financial intermediaries, and 
investors. As discussed in the previous sections of this Release, some 
commenters on the Adopting Release argued that the rule's definition of 
``financial intermediary'' was too broad because it would have required 
funds to identify and enter into agreements with a number of 
intermediaries that may not pose a significant short-term trading risk 
to funds, and may have imposed unnecessary costs to market 
participants.\53\ For example, one large fund complex indicated that, 
under the rule as adopted, identifying their ``financial 
intermediaries'' could cost that fund complex $8.5 million or more.\54\ 
These amendments will modify the definition of financial intermediary 
to exclude entities that a fund treats as an individual investor for 
purposes of the fund's policies on market timing or frequent trading. 
We believe that these amendments will reduce the burden on funds of 
identifying those entities that might have qualified as financial 
intermediaries under the rule as adopted, because a fund should already 
know which entities it treats as intermediaries for purposes of its 
policies on market timing or frequent trading.\55\ As further discussed 
in the Paperwork Reduction Act Section below, for purposes of the 
Paperwork Reduction Act we have estimated that identifying the 
intermediaries with which a fund complex must enter into agreements may 
take the average fund complex a total of 250 hours of a service 
representative's time, at a cost of $40 per hour,\56\ for a total 
burden to all funds of 225,000 hours, at a total cost of $9 million. 
These amendments will likely provide a significant benefit because they 
should reduce the costs associated with the intermediary identification 
process.
---------------------------------------------------------------------------

    \53\ See Comment Letter of the Investment Company Institute at 3 
(May 9, 2005). The ICI stated in its 2005 comment letter that, under 
the rule as adopted in 2005, three large fund complexes alone would 
have to evaluate 6.5 million accounts that are ``not in the name of 
a natural person and thus could be held as an intermediary for 
purposes of the rule'' and might have to enter into agreements with 
a significant portion of those accounts that are held in nominee 
name. Id. The ICI noted that many of these accounts are likely 
associated with small retirement plans, small businesses, trusts, 
bank nominees and other entities that are unlike typical financial 
intermediaries such as broker-dealers. It added that funds typically 
do not have agreements with such small entities, other than 
agreements incidental to the opening of an account.
    \54\ See 2006 Proposing Release, supra note 8, at n.48.
    \55\ Under the revised rule, if the fund does not exempt an 
intermediary from its frequent trading policies, i.e. if the fund 
treats the intermediary as an individual investor for purposes of 
those policies, then the entity would not be a ``financial 
intermediary'' (with respect to that fund), and the fund would not 
have to enter into a shareholder information agreement with it. 
These intermediaries might include small retirement plans that do 
not identify themselves as intermediaries or omnibus accounts to the 
fund and request an exemption from the fund's frequent trading 
policies. These intermediaries will likely either have very few 
underlying investors, and/or restrict their transactions so that 
transactions by investors do not trigger application of a redemption 
fee or violate the fund's frequent trading policies.
    \56\ See infra note 95.
---------------------------------------------------------------------------

    By enabling funds to forego the cost of entering into agreements 
with omnibus accountholders that they treat as individual investors, we 
anticipate that the large majority of small omnibus accountholders will 
now fall outside the shareholder information agreement provisions of 
the rule. This will likely result in significant cost and time savings 
to funds and financial intermediaries through reduction of the expenses 
associated with these agreements. The reduction of these costs also may 
benefit fund investors and fund advisers, to the extent that these 
costs may have been passed on to them. We estimate that this will 
significantly reduce the burden on many entities that would otherwise 
have qualified as intermediaries under the rule as adopted, because the 
excluded entities would no longer need to enter into shareholder 
information agreements, or develop and maintain systems to provide the 
relevant information to funds. Commenters on the 2006 Proposing Release 
generally agreed that the rule amendments are likely to reduce costs to 
market participants.\57\
---------------------------------------------------------------------------

    \57\ See, e.g., Comment Letter of the Investment Company 
Institute (Apr. 10, 2006) (``[The proposed approach] should reduce 
the costs and burdens associated with the rules implementation while 
still providing funds access to underlying shareholder 
information.'')
---------------------------------------------------------------------------

    Commenters on the 2005 adoption were also concerned that the rule 
as adopted might have required funds to enter into agreements with 
intermediaries that hold fund shares in the name of other 
intermediaries (a ``chain of intermediaries''), potentially resulting 
in a fund having to enter into agreements with intermediaries with 
which it may not have a direct relationship (i.e., indirect 
intermediaries).\58\ These amendments further clarify and define the 
operation of the rule with respect to intermediaries that invest 
through other intermediaries. These amendments to rule 22c-2 define the 
term ``shareholder information agreement,'' and provide that funds need 
only enter into shareholder information agreements with intermediaries 
that directly submit orders to the fund, its principal underwriter, 
transfer agent, or to a registered clearing agency. Accordingly, funds 
will not need to enter into agreements with indirect intermediaries and 
may incur lower systems development costs related to the collection of 
underlying shareholder information, thereby reducing the costs of 
compliance.
---------------------------------------------------------------------------

    \58\ See Comment Letter of T. Rowe Price Associates, Inc. at 2 
(May 24, 2005); Comment Letter of OppenheimerFunds, Inc. at 3 (May 
9, 2005).
---------------------------------------------------------------------------

    Under the amendments adopted today, a first-tier intermediary, in 
its agreement with the fund, must agree to, upon further request by the 
fund: (i) Provide the fund with the underlying shareholder 
identification and transaction information of any other intermediary 
that trades through the first-tier intermediary (i.e., indirect 
intermediary); or (ii) prohibit the indirect intermediary from 
purchasing, on behalf of others, securities issued by the fund. This 
approach is designed to preserve the investor protection goals of the 
rule by ensuring that funds have the ability to identify short-term 
traders that may attempt to evade the reach of the rule by trading 
through chains of financial intermediaries.
    By defining minimum standards for what must be included in these 
shareholder information agreements, we intended to balance the need for 
funds to acquire shareholder information from indirect intermediaries 
who trade in fund shares, with practical concerns regarding the 
difficulty that funds might face in identifying these intermediaries 
and entering into agreements with them. Because an intermediary that 
trades directly with a fund already has a relationship with its second-
tier intermediaries (and is likely to have a closer relationship than 
the fund to any intermediary that is farther down the ``chain''), a 
first-tier intermediary appears to be in the best position to arrange 
for the provision of information to a fund regarding the transactions 
of shareholders trading through its indirect intermediaries. By 
providing a definition of the term ``shareholder information 
agreement,'' the amended rule clarifies the balance of duties and 
obligations between funds and financial intermediaries. Because first-
tier intermediaries may already have access to the shareholder 
transaction and identification information of their indirect 
intermediaries, they will likely be able to provide this information to 
funds at a minimal cost, especially compared to the significant costs 
that funds would incur if they were required to collect the same 
information from indirect intermediaries themselves. Although first-
tier intermediaries may

[[Page 58264]]

incur some costs in collecting and gathering this information from 
indirect intermediaries, there is a benefit in having the entity that 
has the easiest access to the relevant information have the 
responsibility for arranging for its delivery to funds.
    In general, commenters on the 2006 Proposing Release agreed that 
first tier intermediaries are in a better position than funds to 
collect data from indirect intermediaries,\59\ although one commenter 
disagreed and stated that intermediaries are not in a better position 
than funds to collect information from indirect intermediaries.\60\ We 
continue to believe that the amended rule's approach of having the 
agreements require first-tier intermediaries to identify and collect 
information from indirect intermediaries appears to be the most cost 
effective method of handling the chain of intermediaries issue while 
still effectuating the purposes of the rule. Funds and intermediaries 
are also likely to engage in negotiations that will distribute the 
costs of information sharing between the entities, resulting in 
incentives for funds to narrowly target their information requests.
---------------------------------------------------------------------------

    \59\ See Comment Letter of Massachusetts Mutual Life Insurance 
Company (Apr. 10, 2006); Comment Letter of the Investment Company 
Institute (Apr. 10, 2006).
    \60\ See Supplemental Comment Letter of the SPARK Institute, 
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    As discussed in the previous sections, these amendments clarify the 
result if a fund lacks an agreement with a particular intermediary. In 
such a situation, the fund may continue to redeem securities within 
seven calendar days, but it must prohibit that financial intermediary 
from purchasing fund shares in nominee name, on behalf of any other 
person. Some commenters had stated that the rule, as adopted in 2005, 
could be interpreted to require a different approach to these 
situations.\61\ The amendments will provide the benefit of certainty 
regarding the duties of funds and financial intermediaries under the 
rule without imposing additional costs.
---------------------------------------------------------------------------

    \61\ See Comment Letter of the Investment Company Institute at 4 
(May 9, 2005).
---------------------------------------------------------------------------

B. Costs

    Many commenters expressed concerns about the costs of rule 22c-2 as 
adopted in 2005. As discussed above, we anticipate that the amendments 
adopted today will allow funds, financial intermediaries, and investors 
to incur significantly reduced costs. Although these amendments will 
reduce many of the costs of the rule, they should nonetheless maintain 
the investor protections afforded by the rule.
    One of the primary results of these amendments will be to reduce 
the number of financial intermediaries with which funds must enter into 
shareholder information agreements. This should reduce costs to all 
participants by allowing funds to enter into shareholder information 
agreements only with those intermediaries that hold omnibus accounts 
that are most likely to trade fund shares frequently. The rule's 
investor protections will be maintained because funds will continue to 
monitor the short-term trading activity of the rest of the fund's 
omnibus accounts as if they were individual investors in the fund, 
according to the fund's policies on short-term trading.
    The amendments will reduce the number of entities that will be 
considered financial intermediaries under the rule. Commenters in 2005 
raised concerns about the costs of identifying which accountholders are 
financial intermediaries.\62\ The costs related to this review will be 
greatly reduced under the rule as we have revised it, because we expect 
that a fund will generally already have identified those accountholders 
that it does not treat as an individual investor for purposes of its 
restrictions on short-term trading. As discussed above in the benefits 
section, for purposes of the Paperwork Reduction Act, we have estimated 
that completion of this identification process will cost all funds a 
total of approximately $9 million.
---------------------------------------------------------------------------

    \62\ As discussed above, the ICI noted that, between just three 
large fund complexes, 6.5 million accounts may need to be reviewed, 
and estimated that the total number of accounts which would be 
evaluated by all funds could be in the ``tens of millions.'' Comment 
Letter of the Investment Company Institute at 3 (May 9, 2005). 
OppenheimerFunds noted that, although it has more than 7.5 million 
shareholder accounts in its records, 137,000 or fewer of those 
accounts may qualify as financial intermediaries under the rule as 
adopted last spring. See Comment Letter of OppenheimerFunds, Inc. at 
8 (May 9, 2005). Neither commenter estimated the costs of performing 
this review.
---------------------------------------------------------------------------

    We also received a few comments on the 2005 adoption regarding the 
number of accounts maintained by funds that qualify as financial 
intermediaries.\63\ Commenters indicated that revising the rule to 
address concerns about the definition of financial intermediaries would 
significantly reduce the costs of entering into or modifying these 
agreements, as well as the costs of developing, maintaining and 
monitoring the systems that will collect the shareholder information 
related to these agreements for funds.\64\ Omnibus accountholders that 
previously would have qualified as financial intermediaries are also 
likely to realize substantial savings under the amended rule. When an 
omnibus accountholder is treated as an individual investor (or does not 
trade directly with the fund), such an omnibus account will no longer 
be treated as a financial intermediary and will not incur the costs of 
entering into or modifying agreements with that fund. There will also 
no longer be the start-up and ongoing costs of developing and 
maintaining shareholder information-sharing systems for those 
accountholders.
---------------------------------------------------------------------------

    \63\ OppenheimerFunds estimated that it has 137,000 omnibus 
accounts that might qualify as financial intermediaries, USAA 
Investment Management Company stated that it has ``thousands'' of 
these accounts, and T. Rowe Price estimated 1.3 million accounts 
that are not registered as natural persons. See Comment Letter of 
OppenheimerFunds, Inc. at 8 (May 9, 2005); Comment Letter of USAA 
Investment Management Company at 2 (May 9, 2005); Comment Letter of 
T. Rowe Price Associates, Inc. at 2 (May 24, 2005).
    \64\ See Comment Letter of USAA Investment Management Company at 
2 (May 9, 2005); Comment Letter of the ICI at 3 (May 9, 2005).
---------------------------------------------------------------------------

    In 2005, we received a few comments regarding the costs of 
modifying or entering into shareholder information agreements. One of 
the few commenters that gave specific numbers indicated that it would 
take approximately four hours to modify and/or enter into, follow up 
on, and maintain an agreement on its systems for each account 
identified as a financial intermediary.\65\ The same commenter 
indicated that it may have as many as 137,000 accounts that might 
qualify as financial intermediaries under the rule as adopted. We 
anticipate that the large majority of the omnibus accountholders that 
would have qualified as financial intermediaries under the rule as 
initially adopted, will now be treated as individual investors by 
funds, and therefore no new agreements will be required. As discussed 
in the 2006 Proposing Release, we anticipate that in most cases, 
complying with the amended rule will require a very limited number of 
new agreements between funds and intermediaries (in many cases 
virtually no new agreements would be required).\66\ We understand that 
the number of existing agreements that funds have with their 
intermediaries can vary greatly, from less than 10 agreements for a 
small direct-sold fund, to 3,000 or more agreements for a very large 
fund complex sold through various channels.\67\ Although funds will 
still need to modify the existing agreements

[[Page 58265]]

that they have with their intermediaries (i.e., distribution 
agreements), we believe that these amendments will greatly reduce or 
eliminate the need for most funds to identify and negotiate new 
agreements. Funds are also likely to incur lower costs when modifying 
existing agreements than when entering into new agreements, and the 
actual hours required to modify an existing agreement thus may be less 
than the four hour figure suggested by the commenter.\68\ Accordingly, 
based on the cost data provided by this commenter, we estimate that the 
cost reduction that may result from the amendments for a fund complex 
in a similar position as the commenter could be approximately 536,000 
hours.\69\
---------------------------------------------------------------------------

    \65\ See Comment Letter of OppenheimerFunds, Inc. at 8 (May 9, 
2005).
    \66\ See 2006 Proposing Release, supra note 8, at text following 
n.55.
    \67\ See id.
    \68\ See Comment Letter of OppenheimerFunds, Inc. (May 9, 2005). 
Section VI below contains a discussion, in the context of the 
Paperwork Reduction Act, of some of the estimated costs of the 
shareholder information agreement and information-sharing system 
development and operations aspects of the rule.
    \69\ See Comment Letter of OppenheimerFunds, Inc. (May 9, 2005). 
This estimate is based on the following calculations: 137,000 
potential accounts times 4 hours per account equals 548,000 
potential hours. However, the amendments might eliminate the burden 
of reviewing and modifying those 137,000 potential accounts, and 
could limit the burden to a far reduced number, perhaps 3,000 
agreements for a very large fund. (3,000 agreements to be modified 
times 4 hours equals 12,000 hours.) Instead of potentially incurring 
548,000 hours complying with the agreement portion of the rule, a 
similar fund might incur 12,000 hours in modifying its existing 
agreements, for a savings of 536,000 hours (548,000 potential hours 
minus 12,000 hours equals 536,000 hours saved).
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act as discussed below, we 
have estimated that it will cost all funds and financial intermediaries 
a total of approximately $53,550,000 to enter into and/or modify the 
agreements required under the amended rule.\70\ This represents a 
significant cost reduction from the estimates provided to us in 
response to the rule's adoption.\71\
---------------------------------------------------------------------------

    \70\ See infra Section VII.
    \71\ However, this revised estimate is a significant increase 
over the amount we estimated in the Adopting Release ($3,353,279) 
for funds and intermediaries to enter into shareholder information 
agreements. See Adopting Release, supra note 4, at n.108. In 
response to our request for comment on any aspect of the rule's 
implementation, we received new information and updated estimates 
that noted that the cost of entering into agreements for funds and 
intermediaries would be significantly higher than the estimate 
included in the Adopting Release. After reviewing the comments we 
received in response to the Adopting Release, as well as other 
information received from fund representatives prior to the 2006 
Proposing Release, we estimated in the 2006 Proposing Release that 
on average, a fund complex might incur $250,000 or more in expenses 
related to entering into or modifying the agreements required under 
the rule as adopted. See 2006 Proposing Release, supra note 8, at 
n.59. With approximately 900 fund complexes currently operating, we 
therefore estimate that the agreement portion of the rule as adopted 
could potentially cost all funds a total of approximately 
$225,000,000. Despite the increase in estimated costs for entering 
into agreements that we have included here over the cost estimates 
included in the Adopting Release, we anticipate that the amendments 
will reduce the costs of the agreement portion of the rule as 
adopted by approximately $171,450,000 ($225,000,000 (updated cost 
estimate) minus $53,550,000 (cost estimate after proposed 
amendments) equals $171,450,000 (total potential cost reduction)).
---------------------------------------------------------------------------

    There will also be some costs related to the amendments we are 
adopting to the rule regarding chains of intermediaries. By clearly 
defining the duties that a fund's agreement must impose on 
intermediaries in the ``chain of intermediaries'' context, the proposed 
rule amendments may result in first-tier intermediaries incurring some 
costs that might otherwise have been borne by funds. These may include 
costs related to negotiating agreements (if necessary) with indirect 
intermediaries, processing requests from funds to investigate accounts, 
costs related to collecting and providing the underlying shareholder 
information to funds from the indirect intermediaries and restricting 
further trading by indirect intermediaries if the fund requests it. We 
believe that first-tier intermediaries are in a better position than 
funds to fulfill these obligations. Unlike funds, first-tier 
intermediaries have a direct relationship with second-tier 
intermediaries (and may be in a better position than funds to collect 
information from other indirect intermediaries), and will thus be able 
to identify, communicate with, and collect information from these 
indirect intermediaries at a lower cost than if funds were to conduct 
such activities. First-tier intermediaries are also in a better 
position than funds to identify and gather shareholder information from 
more distant indirect intermediaries because of their relationships 
with second-tier intermediaries.
    As further discussed in connection with the Paperwork Reduction 
Act, we have estimated that the costs of entering into arrangements 
between first-tier and more indirect intermediaries will be 
approximately $63 million.\72\ We anticipate that intermediaries will 
generally use the same systems that they use to provide the required 
underlying shareholder identity and transaction information directly to 
funds to process the information that first-tier intermediaries will 
forward (or have forwarded) to funds from indirect intermediaries, thus 
resulting in significant cost efficiencies.
---------------------------------------------------------------------------

    \72\ See infra note 131 and accompanying text.
---------------------------------------------------------------------------

    Funds and intermediaries may also incur some costs related to 
drafting or revising terms for the agreements required by rule 22c-2. 
We have been informed that industry representatives are working 
together to develop a uniform set of model terms, and anticipate that 
such model terms may significantly reduce the costs related to 
developing individualized agreement terms for each fund and 
intermediary.\73\ As further discussed in the Paperwork Reduction Act 
section of this release, for purposes of the Paperwork Reduction Act, 
we estimate that a typical fund complex will incur a total of 5 hours 
of legal time at $300 per hour in drafting these agreement terms, for a 
total of 4,500 hours for all 900 fund complexes at a total cost of 
$1,350,000.
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    \73\ See Supplemental Comment Letter of the SPARK Institute, 
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    We understand that several service providers are developing systems 
to accommodate the transmission and receipt of transaction information 
between funds and intermediaries pursuant to contracts negotiated to 
comply with rule 22c-2. At least one of these organizations is revising 
the infrastructure that it already has in place, in order to facilitate 
the communication of fund trades and other ``back office'' information 
between funds and financial intermediaries, including the information 
required under the rule. We understand that, with the exception of some 
smaller to mid-sized funds and intermediaries, the large majority of 
funds and intermediaries currently use the organization's existing 
infrastructure to process fund trades.\74\ In addition, some funds, 
intermediaries, or third party vendors may develop their own competing 
or complementary information-sharing systems.\75\
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    \74\ See 2006 Proposing Release, supra note 8, at text following 
n.61.
    \75\ See id. at n.40.
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    Commenters on the 2006 Proposing Release suggested that in 
complying with the amended rule, funds and intermediaries may choose to 
incur certain additional costs in analyzing data received under 
shareholder information agreements, including costs for additional 
staffing, third-party vendors, and data repositories.\76\ Generally, 
any such potential costs would be a consequence of the initial rule 
adoption, and are not a result of these rule amendments. These 
potential costs are also likely to vary significantly among entities 
depending on their size, the services they use, and the frequency with 
which they request and analyze information, among other factors.
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    \76\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc. 
(Apr. 10, 2006); Supplemental Comment Letter of the SPARK Institute, 
Inc. (May 1, 2006).

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[[Page 58266]]

    One commenter on the 2006 Proposing Release noted that, as a large 
fund complex, it had received estimates of up to $730,000 a year for a 
third party to provide information transmittal systems, certain data 
analysis, and data repository services for the information requested 
under shareholder information agreements.\77\ Such third-party vendor 
systems costs will vary significantly depending on the size of the fund 
complex, the frequency that information is requested, the length of 
time the information is stored, any analysis performed, a fund's 
preexisting internal resources, and many other factors. In the 
Paperwork Reduction Act section below, we have estimated the costs we 
believe an average fund will incur in building these systems 
internally, or in using a third party vendor to provide these services. 
The same commenter also suggested that intermediaries might incur third 
party vendor costs to store and process data, and make it available to 
funds, with such costs possibly ranging up to $170,000 in start up 
costs, and $360,000 a year in annual costs.\78\ We have incorporated 
the estimates provided by commenters on the 2006 Proposing Release into 
the cost calculations we made for purposes of the Paperwork Reduction 
Act, and as a result have increased the cost estimates made in this 
release over the estimates provided in the 2006 Proposing Release.\79\
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    \77\ See Comment Letter of T. Rowe Price Associates, Inc. (Apr. 
10, 2006). The commenter has informed our staff that the latest 
estimates it has received have been revised downwards to $620,000 a 
year for these services.
    \78\ Id.
    \79\ See infra Section VI.
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    One commenter also suggested that funds and intermediaries might 
choose to hire additional staff to process information received under 
the rule, although it noted that if the current volume of transactions 
continues, a fund in its position probably would not need to hire 
additional staff.\80\ Other commenters did not estimate the potential 
costs related to hiring additional staff, the number of additional 
staff that might be hired, or the likelihood that more staff would be 
needed. In some circumstances, funds or intermediaries might choose to 
hire additional staff to process information received under the rule, 
but funds and intermediaries are likely to have sufficient staff in 
place to monitor frequent trading abuses that violate fund policies, 
and therefore are unlikely to need more staff under the amended 
rule.\81\ The rule, by requiring funds to set up formalized 
information-sharing networks with their intermediaries, might also 
result in more efficient monitoring of frequent trading by funds and 
possible opportunities to reduce staff.
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    \80\ See Comment Letter of T. Rowe Price Associates, Inc. (Apr. 
10, 2006). During further discussions with the commenter, it noted 
that the cost of hiring one additional analyst to monitor 
information received under rule 22c-2 and these amendments could be 
approximately $35,000-40,000 a year, exclusive of overhead. Although 
we believe that most funds will not need to hire additional staff to 
comply with rule 22c-2, we estimate that the cost of hiring one 
additional senior compliance examiner could be $347,000 a year, 
inclusive of overhead and other expenses (based on compensation 
estimates for a Senior Compliance Examiner, from the Securities 
Industry Assoc., Report on Management & Professional Earnings in the 
Securities Industry (2005), multiplied by 5.35 to account for 
bonuses, firm size, employee benefits, and overhead).
    \81\ See, e.g., Compliance Programs of Investment Companies and 
Investment Advisers, supra note 43 at n.75 and surrounding text.
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    In response to comments received on the 2006 Proposing Release, we 
have revised certain of our cost estimates upwards over those discussed 
in the 2006 Proposing Release. As further described in Section VI 
below, for purposes of the Paperwork Reduction Act, we have estimated 
that all funds will incur a total of approximately $47,500,000 \82\ in 
one-time capital costs to develop or upgrade their software and other 
technological systems to collect, store, and receive the required 
identity and transaction information from intermediaries, and a total 
of $22,655,000 each year thereafter in operation costs related to the 
transmission and receipt of the information.\83\ We have also estimated 
that financial intermediaries may incur $280,000,000 \84\ in one-time 
capital costs to develop or upgrade their software and other 
technological systems to collect, store, and transmit the required 
identity and transaction information to funds and from other 
intermediaries, and a total of $192,500,000 \85\ each year thereafter 
in operation costs related to the transmission and receipt of the 
information. These estimates were made for purposes of the Paperwork 
Reduction Act, and do not include certain costs, discussed above, that 
funds and intermediaries may incur which are not related to collections 
of information required by the rule. For example, the Paperwork 
Reduction Act estimates do not include all potential staffing costs, 
outside vendor analysis of information to discern trading patterns, or 
data repository costs that funds and intermediaries may incur in 
analyzing the information that they may collect under the agreements 
required by the rule. Although these are costs that funds and 
intermediaries may choose to incur, they are not required by the rule, 
and may vary significantly between every fund and intermediary 
depending on the frequency of data requests, their policies on frequent 
trading, their ability to analyze information, and many other factors.
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    \82\ This estimate, as well as many other estimates in this 
section may differ from the estimates made in the 2006 Proposing 
Release. These differences reflect new information provided to us by 
commenters, and are further discussed in Section VI.
    \83\ See infra Section VI.
    \84\ We estimate a total of approximately $327,500,000 in one 
time start-up costs ($280,000,000 + $47,500,000 = $327,500,000) for 
purposes of the Paperwork Reduction Act.
    \85\ We estimate a total of approximately $215,155,000 in 
ongoing annual costs ($192,500,000 + $22,655,000 = $215,155,000) for 
purposes of the Paperwork Reduction Act.
---------------------------------------------------------------------------

    For the reasons discussed above, we anticipate that these 
amendments will not create additional costs beyond the rule as adopted. 
In fact, we anticipate that the amendments will significantly reduce 
costs to most market participants.\86\
---------------------------------------------------------------------------

    \86\ See infra note 135.
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V. Consideration of Promotion of Efficiency, Competition and Capital 
Formation

    Section 2(c) of the Investment Company Act requires the Commission, 
when engaging in rulemaking that requires it to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider whether the action will promote efficiency, competition, 
and capital formation. As discussed in the Cost-Benefit Analysis above, 
these amendments to rule 22c-2 are designed to reduce the burdens of 
the rule as adopted in 2005, while maintaining its investor 
protections. Funds will no longer be required to incur the expense of 
modifying or entering into agreements with omnibus accounts that they 
already effectively monitor by treating as individual investors, and 
would not need to enter into agreements with intermediaries that do not 
trade directly with the fund. These amendments will promote efficiency 
in the capital markets by enabling funds to focus their short-term 
trading deterrence efforts on those omnibus accounts that could be used 
to disguise this type of trading. These amendments will also promote 
efficiency by reducing the number of omnibus accountholders that would 
otherwise incur the expenses of entering into agreements, and of 
establishing and maintaining systems for collecting and sharing 
shareholder information.
    We do not anticipate that these amendments will harm competition.

[[Page 58267]]

They apply to all market participants and, as discussed in the Cost-
Benefit Analysis above, serve to reduce cost burdens for large funds as 
well as small funds.\87\ Some commenters expressed concern that the 
rule as adopted may disproportionately burden small intermediaries, and 
thus hinder competition.\88\ We anticipate that under these amendments, 
most omnibus accounts that are treated by the fund as individual 
investors will be small intermediaries. By excluding these small 
intermediaries from the rule's requirements, the amendments should 
serve to alleviate potential anti-competitive effects on small 
intermediaries.
---------------------------------------------------------------------------

    \87\ See supra Section IV.
    \88\ See, e.g., Comment Letter of the Investment Company 
Institute (May 9, 2005).
---------------------------------------------------------------------------

    These amendments are designed to reduce the costs of imposing 
redemption fees for both funds and intermediaries. Even after these 
amendments, the competitive pressure of marketing funds, especially 
smaller funds, coupled with the costs of imposing redemption fees in 
omnibus accounts, may deter some funds from imposing redemption fees. 
Intermediaries may use their market power to prevent funds from 
applying the fees, or provide incentives for fund groups to waive fees. 
However, by reducing the costs of imposing redemption fees, we believe 
that these amendments will likely reduce such anti-competitive effects.
    We anticipate that these amendments may indirectly foster capital 
formation by reducing the costs of the rule for funds and 
intermediaries. If these cost savings are passed on to investors, they 
may increase investment in funds, thereby promoting capital formation. 
These amendments also may foster capital formation by improving the 
beneficial effect of the rule on investor confidence, because the rule 
is designed to permit funds to deter, and recoup the costs of, abusive 
short-term trading. To the extent that the amended rule enhances 
investor confidence in funds, investors are more likely to make assets 
available through intermediaries for investment in the capital markets.

VI. Paperwork Reduction Act

    As discussed in the Adopting Release,\89\ the rule includes 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995.\90\ The Commission submitted the 
collections of information to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11, and OMB approved these collections of information under 
control number 3235-0620 (expiring 06/30/2009). The title for the 
collection of information requirements associated with the rule is 
``Rule 22c-2 under the Investment Company Act of 1940, Redemption fees 
for redeemable securities.'' An agency may not conduct or sponsor, and 
a person is not required to respond to, a collection of information 
unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \89\ See Adopting Release, supra note 4, at Section V.
    \90\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    In response to the 2006 Proposing Release, we received a number of 
comments on the estimates made in the Paperwork Reduction Act section, 
and which provided additional cost estimates and other information.\91\ 
In light of those comments, we have revised upwards several of the per-
fund estimates made in this section. However, because these amendments 
reduce the number of shareholder information agreements required, we 
estimate that the amendments should, in general, reduce the aggregate 
burden associated with the collections of information required by the 
rule, and will not create new collections of information. We have 
revised our previous burden estimates under the Paperwork Reduction Act 
to reflect (i) new cost and time burden information that we have 
received from market participants, and (ii) the revised number of 
entities that will be affected by the amended rule.
---------------------------------------------------------------------------

    \91\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc. 
(Apr. 10, 2006); Supplemental Comment Letter of the SPARK Institute, 
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    This revised Paperwork Reduction Act section contains a number of 
new cost and hour estimates that are significantly altered from the 
estimates made in the Adopting Release. Some of these estimates are 
based on different methods, and different sources, from those in the 
Adopting Release. Therefore there is not a strict comparability between 
the estimates made here and those made in the Adopting Release. These 
cost estimates, hourly rate estimates, and the methodology used to make 
these proposed estimates are based on comments we received in response 
to the Adopting Release and the 2006 Proposing Release, as well as 
information received from funds, intermediaries, and other market 
participants.\92\
---------------------------------------------------------------------------

    \92\ See 2006 Proposing Release, supra note 8, at Sections VI 
and VIII. In general, the cost estimates provided in this section 
are derived from rounded and weighted averages of the cost estimates 
provided during conversations with industry representatives that 
took place prior to the 2006 Proposing Release, combined with the 
additional information submitted by commenters on that release.
---------------------------------------------------------------------------

    Rule 22c-2 includes two distinct ``collections of information'' for 
purposes of the Paperwork Reduction Act. The first is related to 
shareholder information agreements, including the costs and time 
related to identifying the relevant intermediaries, drafting the 
agreements, negotiating new agreements or modifying existing ones, and 
maintaining the agreements in an easily accessible place. The second is 
related to the costs and time related to developing, maintaining, and 
operating the systems to collect, transmit, and receive the information 
required under the shareholder information agreements.\93\
---------------------------------------------------------------------------

    \93\ This second collection of information does not include 
potential costs or time that funds or intermediaries might incur in 
analyzing or using the provided information.
---------------------------------------------------------------------------

    Both collections of information are mandatory for funds that choose 
to redeem shares within seven days of purchase. These funds will use 
the information collected to ensure that shareholders comply with the 
fund's policies on abusive short-term trading of fund shares. There is 
a six year recordkeeping retention requirement for the shareholder 
information agreements required under the rule. Any responses that are 
provided in the context of the Commission's examination and oversight 
program are generally kept confidential.\94\
---------------------------------------------------------------------------

    \94\ For a discussion of restrictions on the disclosure of 
information under applicable privacy laws, see supra note 44.
---------------------------------------------------------------------------

A. Shareholder Information Agreements

    The Commission staff anticipates that most shareholder information 
agreements will be entered into at the fund complex level, and 
estimates that there are approximately 900 fund complexes. The 
Commission staff understands that the number of intermediaries that 
hold fund shares can vary for each fund complex, from less than 10 for 
some fund complexes to more than 3000 for others. Based on 
conversations with fund and financial intermediary representatives that 
took place prior to the 2006 Proposing Release, our staff estimates 
that, on average, under the revised definition of financial 
intermediary, each fund complex has 300 financial intermediaries. We 
understand that most funds already know and previously identified the 
majority of their intermediaries that they do not treat as individual 
investors. Therefore, funds should expend a limited amount

[[Page 58268]]

of time and costs related to the identification of such intermediaries. 
Our staff estimates that identifying the intermediaries with which a 
fund complex must enter into agreements may take the average fund 
complex 250 hours of a service representative's time at a cost of $40 
per hour,\95\ for a total of 225,000 hours at a cost of $9,000,000.\96\ 
Our staff estimates that for a fund complex to prepare the model 
agreement, or provisions modifying a preexisting agreement, between the 
fund and the intermediaries, it will require a total of 5 hours of 
legal time at $300 per hour, for a total of 4500 hours \97\ at a total 
cost of $1,350,000.
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    \95\ The title and hourly cost of the person performing the 
intermediary identification and entering into agreements may vary 
depending on the fund or financial intermediary. This $40 per hour 
cost is an average estimate for the hourly cost of employing the 
person doing the relevant work, derived from conversations with 
industry representatives that took place prior to the 2006 Proposing 
Release.
    \96\ This estimate is based on the following calculations: 250 
hours times 900 fund complexes equals 225,000 hours, and 225,000 
hours times $40 equals $9,000,000.
    \97\ This estimate is based on the following calculation: 5 
hours times 900 fund complexes equals 4500 hours of legal time.
---------------------------------------------------------------------------

    The Commission staff estimates that for a fund complex to enter 
into or modify a shareholder information agreement with each existing 
intermediary, it will require a total one-time expenditure of 
approximately 2.5 hours of fund time and 1.5 hours of intermediary time 
for each agreement, for a total of 4 hours expended per agreement.\98\ 
Therefore, for an average fund complex to enter into shareholder 
agreements, the fund complex and its intermediaries may expend 
approximately 1200 hours at a cost of $48,000,\99\ and all fund 
complexes and intermediaries may incur a total one-time burden of 
1,080,000 hours at a cost of $43,200,000.\100\ The Commission staff 
understands that there are efforts under way (including an industry 
task force devoted to the project) to produce standardized shareholder 
information-sharing model agreements and terms.\101\ These efforts may 
reduce the costs associated with the agreement provision of the rule 
for both funds and intermediaries.\102\ Finally, the Commission staff 
does not anticipate that funds or intermediaries will incur any new 
costs in maintaining these agreements in an easily accessible place, 
because such maintenance is already done as a matter of course.
---------------------------------------------------------------------------

    \98\ The 4 hour figure represents time incurred by both the fund 
and the financial intermediary for each agreement. The Commission 
staff estimates that this 4 hour figure is comprised of 
approximately 2.5 hours of a fund service representative's time at 
$40 per hour and 1.5 hours of an intermediary representative's time 
at $40 per hour.
    \99\ This estimate is based on the following calculations: 4 
hours times 300 intermediaries equals 1200 hours; and 1200 hours 
times $40 dollars per hour equals $48,000.
    \100\ This estimate is based on the following calculations: 1200 
hours times 900 fund complexes equals 1,080,000 hours; and 1,080,000 
hours times $40 per hour equals $43,200,000.
    \101\ See 2006 Proposing Release, supra note 8, at text 
accompanying n.45.
    \102\ See, e.g., Supplemental Comment Letter of the SPARK 
Institute, Inc. (May 1, 2006).
---------------------------------------------------------------------------

    The staff therefore estimates that, for purposes of the Paperwork 
Reduction Act, the shareholder information agreement provision of the 
rule as revised will require a total of 1,309,500 hours at a total cost 
of $53,550,000.\103\
---------------------------------------------------------------------------

    \103\ This estimate is based on the following calculations: 4500 
hours of legal drafting time plus 1,080,000 hours of agreement 
negotiating time plus 225,000 hours of intermediary identification 
time equals 1,309,500 total hours; and $43,200,000 plus $1,350,000 
plus $9,000,000 equals $53,550,000.
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B. Information-Sharing

    Some funds and intermediaries will incur the system development 
costs discussed in this section, but many will not because they already 
process all of their trades on a fully disclosed basis, use a third 
party administrator to handle their back office work,\104\ or already 
have systems in place that allow intermediaries to transmit the 
shareholder identity and transaction information to funds. Other funds 
and intermediaries may have special circumstances that may increase the 
costs they face in developing and operating systems to comply with the 
rule. The estimates below represent the Commission staff's 
understanding of the average costs that might be encountered by a 
typical fund complex or intermediary in complying with the information-
sharing aspect of the rule as amended.
---------------------------------------------------------------------------

    \104\ Third party administrators maintain accounts for many 
other intermediaries, and therefore incur the costs to develop a 
single system.
---------------------------------------------------------------------------

1. Funds
    The Commission staff understands that various organizations have 
developed, or are in the process of developing, enhancements to their 
systems that will allow funds and intermediaries to share the 
information required by the rule without developing or maintaining 
systems of their own.\105\ Our staff anticipates that most funds and 
intermediaries will use these systems, and will generally make minor 
changes to their back office systems to comply with the rule 
requirements and to match their systems to those of the service 
providers. Our staff estimates that most funds could adapt their in-
house systems to utilize these service providers' systems at a one-time 
cost of approximately $10,000 or less.\106\ Although the costs that 
systems providers will charge may vary, one large provider has 
indicated that it plans to charge a monthly fee of $200 and fees of 25 
cents for every 100 account transactions requested through the 
service.\107\
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    \105\ These service providers systems include the National 
Securities Clearing Corporation's Fund/SERV system, as well as other 
systems being developed by a number of other providers such as 
SunGard, BISYS, AccessData, and Charles Schwab. See, e.g., Comment 
Letter of AccessData Corp. (Apr. 10, 2006).
    \106\ We expect that, in many cases, upgrades to fund transfer 
agents' as well as fund complex's systems will take place, and the 
transfer agents' costs will be charged back to the fund complex
    \107\ See National Securities Clearing Corporation, Networking 
Service to Support SEC Rule 22c-2, Important Notice A 6228, 
P&S 5798 (Apr. 12, 2006) (available at http://www.nscc.com/impnot/notices/notice2006/a6228.pdf.)
---------------------------------------------------------------------------

    As an example of the cost of using these services, if a fund 
complex requests information for 100,000 transactions each week,\108\ 
then it would incur costs of $250 each week, or $13,000 a year, plus 
the monthly fee of $200, equaling $2,400 a year, for a total cost of 
$15,400 a year.\109\ Our staff estimates that approximately 475 fund 
complexes would use these systems (including substantially all of the 
largest, and most of the medium-sized, fund complexes). If all of these 
complexes use these service providers' systems at the rate described 
above, they would incur a one-time system development cost of 
$4,750,000 \110\ and an annual system use cost of approximately 
$7,315,000.\111\ Those 475 fund complexes may also incur system 
development costs related to the processing of information under the 
rule on trades that they receive through other channels than these 
service providers' systems, which we estimate to cost an average 
approximately $50,000 per fund

[[Page 58269]]

complex, and $20,000 annually,\112\ for a total of $23,750,000 \113\ in 
system development costs and $9,500,000 annually.\114\ Our staff 
estimates that the total system development cost for these 475 fund 
complexes that are likely to use these existing systems is $28,500,000 
with annual operation costs of $16,815,000.\115\
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    \108\ The number of transactions and weekly request used here is 
an example, and is not intended to be a guideline as to how often a 
fund should request information under the rule. The frequency of 
information requests could vary significantly based on a wide 
variety of factors, as discussed in Section II.C above.
    \109\ This estimate is based on the following calculations: 
100,000 transaction requests times one quarter of a cent (the charge 
is 25 cents per 100 transactions requested, or one quarter of a cent 
per transaction) equals $250; $250 times 52 weeks equals $13,000; 
$200 monthly charges times 12 months equals $2,400; and $13,000 plus 
$2,400 equals $15,400. The costs of utilizing these services may 
vary widely, based on the frequency funds make information sharing 
requests, and the number of accounts requested.
    \110\ This estimate is based on the following calculation: 475 
fund complexes times $10,000 (one-time system update costs) equals 
$4,750,000.
    \111\ This estimate is based on the following calculation: 475 
fund complexes times $15,400 (annual costs) equals $7,315,000.
    \112\ In response to the 2006 Proposing Release, many commenters 
discussed the difficulty of estimating the costs of creating and 
operating information-sharing systems. As a result, very few 
monetary cost estimates were submitted by commenters. One fund 
commenter did provide some monetary estimates, and noted that 
although it agreed that many of the cost estimates made in the 2006 
Proposing Release were reasonable, it believed that the Commission 
may have underestimated some of the costs it will likely encounter 
when designing and operating information sharing systems. See 
Comment Letter of T. Rowe Price Associates, Inc. (Apr. 10, 2006). 
The commenter noted that additional staffing, data repository, and 
intermediary vendor costs related to information sharing systems may 
result in costs significantly higher than those estimated in the 
Paperwork Reduction Act section of the 2006 Proposing Release. We 
agree that these may be significant costs, but note that the 
estimates made in this section are limited to the scope of the 
Paperwork Reduction Act, and therefore do not include all of the 
costs encountered by funds and intermediaries in implementing the 
rule that are not related to a ``collection of information'' as 
defined under that Act. 44 U.S.C. 3501-3520. Other costs and 
benefits of the rule, including the costs mentioned by that and 
other commenters, are discussed in Section IV of this Release.
    \113\ This estimate is based on the following calculation: 475 
fund complexes times $50,000 system development cost per fund 
complex equals $23,750,000.
    \114\ This estimate is based on the following calculation: 475 
fund complexes times $20,000 annual costs per fund complex equals 
$9,500,000.
    \115\ This estimate is based on the following calculations: 
$23,750,000 plus $4,750,000 (one-time system development costs) 
equals $28,500,000 total start-up costs for fund complexes utilizing 
existing systems; and $7,315,000 plus $9,500,000 equals $16,815,000 
in annual costs.
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    There are approximately 900 fund complexes currently operating, of 
which approximately 475 may use these existing systems, leaving 
approximately 425 fund complexes possibly needing to develop specific 
systems to meet their own particular needs. Our staff understands that 
approximately 75 percent of those fund complexes (or 319 complexes) are 
small to medium-sized direct-sold funds that have a very limited number 
of intermediaries. Our staff anticipates that those 319 fund complexes 
would incur minimal system development costs to comply with the 
information-sharing provisions of the rule, due to the limited number 
of intermediaries with which they interact. Our staff estimates that 
system development costs for handling information under the rule for 
those 319 fund complexes will be approximately $25,000 each, with 
annual operation costs of approximately $10,000, for a total system 
development cost of $7,975,000 \116\ and an annual operations cost of 
$3,190,000.\117\
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    \116\ This estimate is based on the following calculation: 319 
funds times $25,000 equals $7,975,000.
    \117\ This estimate is based on the following calculation: 319 
funds times $10,000 equals $3,190,000.
---------------------------------------------------------------------------

    The remaining approximately 106 fund complexes may face additional 
complexities or special circumstances in developing their systems. Our 
staff estimates that the start-up costs for those fund complexes will 
be approximately $100,000 per fund complex and the annual costs for 
handling the information will be approximately $25,000, for a total 
start-up cost of $10,600,000 and an annual cost of $2,650,000 for these 
fund complexes.\118\
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    \118\ This estimate is based on the following calculations: 106 
funds times $100,000 equals $10,600,00; and 106 funds times $25,000 
equals $2,650,000.
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act, our staff therefore 
estimates that the information-sharing provisions of the rule as 
amended will cost all fund complexes a total of approximately 
$100,625,000 in one-time capital costs to enter into agreements and 
develop or upgrade their software and other technological systems that 
allows them to collect, store, and receive the required identity and 
transaction information from intermediaries, and a total of $22,655,000 
each year thereafter in operation costs related to the transmission and 
receipt of the information.\119\
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    \119\ This estimate is based on the following calculations: 
$28,500,000 (funds that use service providers start-up costs) plus 
$7,975,000 (direct-traded funds' start-up costs) plus $10,600,000 
(other funds' start-up costs) equals $47,075,000 system development 
costs; $47,075,000 (system development costs) plus $53,550,000 
(agreement costs) equals $100,625,000 total fund start-up costs; and 
$16,815,000 (funds that use service providers annual costs) plus 
$3,190,000 (direct-traded funds' annual costs) plus $2,650,000 
(other funds' annual costs) equals $22,655,000 annual funds' costs.
---------------------------------------------------------------------------

2. Intermediaries
    The Commission staff estimates that there are approximately 7000 
intermediaries that may provide information pursuant to the 
information-sharing provisions of rule 22c-2.\120\ Of those 7000 
intermediaries, our staff anticipates that approximately 350 of these 
intermediaries are likely to primarily use the existing systems that 
are in place or under development. The staff understands that these 
approximately 350 intermediaries include several major ``clearing 
brokers'' and third-party administrators that aggregate trades and 
handle the back-end work for thousands of other smaller broker-dealers 
and intermediaries, thereby providing access to these service 
providers' information-sharing systems to a significant majority of all 
intermediaries in the marketplace. Our staff estimates that these 
approximately 350 intermediaries will provide access to systems that 
will allow for the transmission of information required by the rule and 
other processing for the transactions of approximately 80 percent of 
the 7,000 intermediaries (5,600 intermediaries) affected by the rule, 
leaving 1,400 intermediaries that do not in some way utilize these 
systems, that may need to develop their own systems.\121\
---------------------------------------------------------------------------

    \120\ This number is a rounded estimate, based on the number of 
intermediaries that may be affected by the rule. The number consists 
of the following: 2,203 broker-dealers classified as specialists in 
fund shares, 196 insurance companies sponsoring registered separate 
accounts organized as unit investment trusts, approximately 2,400 
banks that sell funds or variable annuities (the number of banks is 
likely over inclusive because it may include a number of banks that 
do not sell registered variable annuities or funds, or banks that do 
their business through a registered broker-dealer on the same 
premises), and approximately 2,000 retirement plans, third-party 
administrators, and other intermediaries (this number may be either 
over or under inclusive, because under the rule as we are amending 
it, the actual number of intermediaries that funds have is dependent 
on the precise application of varying fund policies on short-term 
trading).
    \121\ This number is based on the following calculation: 7,000 
total intermediaries times 20% (the percentage of intermediaries 
that do not use these service providers systems or use the services 
of those 350 intermediaries that use those service provider systems) 
equals 1,400 intermediaries that do not use service providers' 
systems.
---------------------------------------------------------------------------

    Our staff understands that in general, the providers who have 
developed or are developing these information sharing systems charge 
the fund, and not the intermediary, for providing these systems to 
transmit shareholder identity and transaction information, or else 
include access to such systems as a complementary part of their other 
processing systems, and do not charge additional fees to intermediaries 
for its utilization. These intermediaries may be required to develop 
systems to ensure that they are able to transmit the records to these 
service providers in a standardized format.\122\ Our staff estimates 
that it will cost each of these 350 intermediaries approximately 
$200,000 to update its systems to record

[[Page 58270]]

and transmit shareholder identity and transaction records to these 
service providers, and an additional $100,000 each year to operate 
their own systems for communicating with the service providers, for a 
total start-up cost of $70,000,000, and an annual cost of 
$35,000,000.\123\ We understand that these approximately 350 
intermediaries may also have to upgrade their systems to handle rule 
22c-2 information on trades that do not go through the service 
providers' systems. Our staff estimates that it will cost each of those 
350 intermediaries \124\ an additional $400,000 \125\ to update their 
systems, and $250,000 \126\ annually to process this information 
through non-service provider networks, for a total cost of $140,000,000 
in system development costs and $87,500,000 in annual costs to process 
data through non-service provider networks.\127\ We have increased 
these estimates over those made in the 2006 Proposing Release in light 
of the new cost information provided to us by the commenters in 2006. 
Our staff therefore estimates that these approximately 350 
intermediaries will incur a total of approximately $210,000,000 in 
start-up costs and $122,500,000 in annual costs associated with the 
information-sharing provisions of the rule.\128\
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    \122\ Our staff anticipates that in most cases, first-tier 
intermediaries will use the same or slightly modified systems that 
have been developed to identify and transmit shareholder identity 
and transaction information to funds when collecting and 
transmitting this information from indirect intermediaries. 
Therefore, we have also included the costs of developing and 
operating systems to collect information from indirect 
intermediaries and providing the information to funds in these 
estimates.
    \123\ This estimate is based on the following calculations: 350 
broker-dealer times $200,000 (start-up costs) equals $70,000,000; 
and 350 broker-dealer times $100,000 (start-up costs and annual 
costs) equals $35,000,000.
    \124\ The estimate includes higher costs for these 350 
intermediaries in developing systems to handle non-service provider 
information than for remaining intermediaries to handle the same 
data due to our staff's understanding that, in general, these 350 
intermediaries that utilize the service provider's networks 
represent the largest intermediaries in the marketplace, and will 
face the highest costs in complying with the rule.
    \125\ Many of the costs that intermediaries incur in developing 
and operating systems to handle this information may be recouped 
from fund complexes through a variety of methods. However, it is 
unclear what recoupment might take place, and therefore the cost 
estimates for funds and intermediaries are made here prior to any 
potential recoupment.
    \126\ In response to the 2006 Proposing Release, a few 
commenters provided additional cost estimates regarding the costs 
intermediaries may face in designing and operating information 
sharing systems under the amended rule. One commenter estimated that 
some intermediary system start-up costs may range from approximately 
$125,000 to $2,300,000, and that ongoing annual costs may range from 
$150,000 to approximately $1,000,000. See Supplemental Comment 
Letter of the SPARK Institute, Inc. (May 1, 2006). Another commenter 
estimated that for some insurance company intermediaries, the cost 
to comply with all aspects of the redemption fee rule could exceed 
$2,000,000 per company. See Comment Letter of the National 
Association for Variable Annuities (Apr. 7, 2006). We have 
incorporated this additional information into our calculations for 
our revised estimates.
    \127\ This estimate is based on the following calculations: 350 
broker-dealers times $400,000 (start-up costs) equals $140,000,000; 
and 350 broker-dealers times $250,000 (annual costs) equals 
$87,500,000.
    \128\ This estimate is based on the following calculations: 
$70,000,000 (intermediary start-up costs for processing information 
through service providers) plus $140,000,000 (intermediary start-up 
costs for handling information through other channels) equals 
$210,000,000; and $35,000,000 (intermediary annual costs for 
processing information through service providers) plus $87,500,000 
(intermediary annual costs for handling information through other 
channels) equals $122,500,000.
---------------------------------------------------------------------------

    The fund complexes and intermediaries that do not use these service 
providers' systems to process their trades will have to either develop 
their own systems to share information under the rule or engage some 
other third-party administrator to process the information. Our staff 
estimates that approximately 1,400 intermediaries will not utilize 
these service provider systems to process this information, and 
estimates that each of these intermediaries will incur $50,000 in 
system development costs and $50,000 in annual costs in complying with 
the rule, for a total of $70,000,000 in development costs and 
$70,000,000 in annual costs for those intermediaries.\129\
---------------------------------------------------------------------------

    \129\ This estimate is based on the following calculations: 
1,400 intermediaries times $50,000 (development costs) equals 
$70,000,000; and 1,400 intermediaries times $50,000 (annual costs) 
equals $70,000,000.
---------------------------------------------------------------------------

    Although the amended rule does not require first-tier 
intermediaries to enter into agreements with their indirect 
intermediaries to share the indirect intermediaries' underlying 
shareholder data to funds upon a fund's request, we anticipate that in 
many cases, intermediaries will nonetheless enter into such agreements, 
or at least enter into informal arrangements and design methods by 
which to collect the shareholder information. Our staff estimates that 
each of the 7,000 intermediaries potentially affected by the rule will 
spend approximately 150 hours of service representatives' time at $40 
per hour, and 10 hours of legal counsel time at $300 per hour, for a 
total of 1,050,000 hours of service representatives' time at a cost of 
$42,000,000, and 70,000 hours of in-house legal time at a cost of 
$21,000,000 to design and enter into these arrangements with other 
intermediaries.\130\ The Commission staff therefore estimates that 
intermediaries will expend a total of approximately 1,120,000 hours at 
a cost of $63,000,000 to enter into arrangements to ensure the proper 
transmittal of information to funds through chains of 
intermediaries.\131\
---------------------------------------------------------------------------

    \130\ This estimate is based on the following calculations: 
7,000 intermediaries times 150 service representative hours at $40 
per hour equals 1,050,000 hours at a cost of $42,000,000; and 7,000 
intermediaries times 10 hours of in-house legal time at $300 per 
hour equals 70,000 hours at a cost of $21,000,000.
    \131\ This estimate is based on the following calculations: 
1,050,000 service representative hours at $42,000,000 plus 70,000 
in-house counsel hours at $21,000,000 equals 1,120,000 hours at 
$63,000,000.
---------------------------------------------------------------------------

    Our staff estimates that the information-sharing provisions of the 
rule will cost all intermediaries a total of approximately $343,000,000 
in one-time capital costs to enter into agreements and develop or 
upgrade their software and other technological systems to collect, 
store, and transmit the required identity and transaction information 
to funds and from other intermediaries, and a total of $192,500,000 
each year thereafter in operation costs related to the transmission and 
receipt of the information.\132\
---------------------------------------------------------------------------

    \132\ This estimate is based on the following calculations: 
$210,000,000 (intermediaries that use service providers start-up 
costs) plus $70,000,000 (other intermediaries' start-up costs) plus 
$63,000,000 (intermediary agreement costs) equals $343,000,000 in 
intermediary start-up costs; and $122,500,000 (annual costs of 
intermediaries that use service providers) plus $70,000,000 (other 
intermediaries' annual costs) equals $192,500,000 in annual costs.
---------------------------------------------------------------------------

C. Total Costs and Hours Incurred

    For purposes of the Paperwork Reduction Act, our staff estimates 
that the amended rule will have a total collection of information cost 
in the first year to both funds and intermediaries of $443,625,000 in 
one-time start-up costs, and annual operation costs of 
$215,155,000.\133\ Our staff estimates that the weighted average annual 
cost of the rule to funds and intermediaries for each of the first 
three years would be $363,030,000.\134\ The total hours expended by 
both funds and intermediaries in complying with the amended rule will 
be a one-time expenditure of 2,429,500 hours at a total internal cost 
of $116,550,000.\135\ We

[[Page 58271]]

anticipate that there will be a total of approximately 7900 \136\ 
respondents, with approximately 14,310,000 total responses in the first 
year, and 14,040,000 annual responses each year thereafter.\137\
---------------------------------------------------------------------------

    \133\ This estimate is based on the following calculations: 
$100,625,000 (fund start-up costs) plus $343,000,000 (intermediary 
start-up costs) equals $443,625,000 in total start-up costs; and 
$22,655,000 (fund annual costs) plus $192,500,000 (intermediary 
annual costs) equals $215,155,000 in total annual costs.
    \134\ This estimate is based on the following calculations: 
$443,625,000 in total start-up costs plus $645,465,000 (3 years at 
$215,155,000 in total annual costs) equals $1,089,090,000 in total 
costs over a three-year period. $1,089,090,000 divided by three 
years, equals a weighted average cost of $363,030,000 per year.
    \135\ This estimate is based on the following calculations: 
1,309,500 hours at a cost of $53,550,000 in agreement time plus 
1,120,000 hours at a cost of $63,000,000 in chain of intermediary 
arrangement time equals 2,429,500 hours at a cost of $116,550,000.
    For purposes of the Paperwork Reduction Act, Section VI of the 
Adopting Release, supra note 4, included an estimate of the total 
start-up costs to funds and financial intermediaries in complying 
with the collection of information aspect of the rule of 
approximately $1,111,500,000. We now estimate that funds and 
intermediaries will incur the reduced amount of $443,625,000 in 
start-up costs, for a potential cost reduction of approximately 
$667,875,000 resulting from the amendments. In the Adopting Release 
we also estimated that the ongoing annual costs will be 
$390,556,800. We now estimate that after these amendments funds and 
intermediaries will incur the reduced amount of $215,155,000 in 
total annual costs, for a potential ongoing annual cost reduction of 
approximately $175,401,800 resulting from the amendments.
    \136\ This estimate is based on the following calculation: 7,000 
intermediaries plus 900 fund complexes equals 7,900 respondents.
    \137\ This estimate is based on the following calculation: 900 
fund complexes with an average of 300 intermediaries each, equals 
270,000 one time responses for the shareholder information portion 
of the collection (900 funds times 300 intermediaries equals 
270,000). Assuming that each fund requests information from each of 
its intermediaries once each week (we have revised our initial 
monthly assumption to a weekly assumption, although we expect that 
the frequency of requests will vary significantly between funds 
depending on their circumstances), the total number of annual 
responses would be 14,040,000 (270,000 fund intermediaries times 52 
weeks equals 14,040,000 annual responses). Therefore, in the first 
year, there would be 14,310,000 total responses (14,040,000 weekly 
responses plus the 270,000 initial responses required for the 
agreements) and 14,040,000 annual responses thereafter.
---------------------------------------------------------------------------

VII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with 5 U.S.C. 604. It relates to amendments to 
rule 22c-2 under the Investment Company Act, which we are adopting in 
this Release. The Initial Regulatory Flexibility Analysis (``IRFA'') 
which was prepared in accordance with 5 U.S.C. 603 was published in the 
2006 Proposing Release.

A. Need For and Objectives of Rule

    Rule 22c-2 allows funds to recover some, if not all, of the direct 
and indirect (e.g., market impact and opportunity) costs incurred when 
shareholders engage in short-term trading of the fund's shares, and to 
deter this short-term trading. As discussed more fully in Sections I 
and II of this Release, the amendments to rule 22c-2 are necessary to 
clarify the operation of the rule, to enable funds and intermediaries 
to reduce costs associated with entering into agreements under the 
rule, and to enable funds to focus their short-term trading deterrence 
efforts on the entities most likely to violate fund policies. These 
amendments also set forth the limitations on transactions between a 
fund and an intermediary with whom the fund does not have an agreement.

B. Significant Issues Raised By Public Comment

    We requested comment on the IRFA. We specifically requested comment 
on the number of small entities that would be affected by the rule 
amendments, and the likely effect of the amendments on small entities, 
the nature of any impact, and any empirical data supporting the extent 
of the impact. We received a number of comments discussing the impact 
that the rule amendments will have on small entities in the mutual fund 
marketplace. Generally, these comments supported the rule amendments, 
and agreed that the amendments would reduce the costs of compliance 
with the rule for small entities, and would reduce the number of small 
entities that would be required to comply with the rule.\138\ They 
indicated that the rule amendments would reduce costs for all mutual 
fund marketplace participants and would alleviate many of the concerns 
they had expressed with the rule as it was originally adopted.
---------------------------------------------------------------------------

    \138\ See, e.g., Comment Letter of the Investment Company 
Institute (Apr. 10, 2006); Comment Letter of Charles Schwab & Co., 
Inc. (Apr. 10, 2006).
---------------------------------------------------------------------------

    Although most commenters supported the rule amendments, some 
commenters also suggested other changes that may reduce the costs of 
compliance. A few commenters noted that as proposed, the amended rule 
might have posed some difficulties to funds (including small funds) in 
contracting with certain entities that do not qualify as financial 
intermediaries under the rule, but who nevertheless submit trades 
directly to funds on behalf of financial intermediaries.\139\ In light 
of this concern, we have clarified the amended rule to require that if 
a financial intermediary submits orders directly, itself or through its 
agent, the fund must enter into a shareholder information agreement 
with that financial intermediary. This clarification should eliminate 
any confusion and attendant costs to small entities in determining 
whether and with which entities funds must enter into shareholder 
information agreements.
---------------------------------------------------------------------------

    \139\ See, e.g., Comment Letter of T. Rowe Price Associates, 
Inc. (Apr. 10, 2006); Comment Letter of Matrix Settlement & Clearing 
Services, L.L.C. (Apr. 10, 2006); and Comment Letter of the 
Investment Company Institute (Apr. 10, 2006).
---------------------------------------------------------------------------

    Some commenters noted that in some cases (such as foreign 
shareholders) Taxpayer Identification Numbers (``TINs'') may not always 
be available, and suggested that the rule allow for the use of 
alternate forms of identification in those cases.\140\ To reduce the 
costs of compliance, alleviate any confusion, and provide flexibility 
to funds and intermediaries, we have revised the rule to allow for the 
use of Individual Taxpayer Identification Numbers or other government 
issued identifiers when a TIN is not available.
---------------------------------------------------------------------------

    \140\ See Comment Letter of the Investment Company Institute 
(Apr. 10, 2006); Supplemental Comment Letter of the SPARK Institute, 
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    We also received many comments requesting an extension of the 
compliance date. Commenters noted that with the uncertainty 
accompanying the exact requirements of the rule, the significant 
technical challenges associated with compliance, and the current 
unsettled state of contracting and information sharing standards in the 
marketplace it would be very beneficial to provide an extended 
compliance date. We agree, and are extending the compliance date for 
all entities.\141\
---------------------------------------------------------------------------

    \141\ See supra Section III.
---------------------------------------------------------------------------

C. Small Entities Subject to the Rule

    A small business or small organization (collectively, ``small 
entity'') for purposes of the Regulatory Flexibility Act is a fund 
that, together with other funds in the same group of related investment 
companies, has net assets of $50 million or less as of the end of its 
most recent fiscal year.\142\ Of approximately 3,925 funds (2,700 
registered open-end investment companies and 825 registered unit 
investment trusts), approximately 163 are small entities.\143\ A 
broker-dealer is considered a small entity if its total capital is less 
than $500,000, and it is not affiliated with a broker-dealer that has 
$500,000 or more in total capital.\144\ Of approximately 7,000 
registered broker-dealers, approximately 880 are small entities.
---------------------------------------------------------------------------

    \142\ 17 CFR 270.0-10.
    \143\ Some or all of these entities may contain multiple series 
or portfolios. If a registered investment company is a small entity, 
the portfolios or series it contains are also small entities.
    \144\ 17 CFR 240.0-10.
---------------------------------------------------------------------------

    As discussed above, rule 22c-2 provides funds and their boards with 
the ability to impose a redemption fee designed to reimburse the fund 
for the direct and indirect costs incurred as a result of short-term 
trading strategies, such as market timing. These amendments are 
designed to maintain these investor protections while reducing costs to 
market participants and clarifying the operation of the rule. While we 
expect that the rule and these

[[Page 58272]]

amendments will require some funds and intermediaries to develop or 
upgrade software or other technological systems to enforce certain 
market timing policies, or make trading information available in 
omnibus accounts, the amendments we are adopting today are specifically 
designed to reduce the costs incurred by small entities. In particular, 
we anticipate that the changes we are making to the definition of 
financial intermediary will significantly reduce the number of small 
intermediaries that funds must enter into agreements with, and reduce 
the burden of complying with the rule for small funds and small 
intermediaries.

D. Reporting, Recordkeeping, and Other Compliance Requirements

    These amendments do not introduce any new mandatory reporting 
requirements. Rule 22c-2 already contains a mandatory recordkeeping 
requirement for funds that redeem shares within seven days of purchase. 
The fund must retain a copy of the written agreement between the fund 
and financial intermediary under which the intermediary agrees to 
provide the required shareholder information in omnibus accounts.\145\ 
The amendments reduce the number of small entities that would otherwise 
be subject to this recordkeeping requirement.
---------------------------------------------------------------------------

    \145\ Rule 22c-2(a)(3).
---------------------------------------------------------------------------

E. Commission Action to Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs the Commission to consider 
significant alternatives that would accomplish the stated objective, 
while minimizing any significant adverse impact on small entities. 
Alternatives in this category would include: (i) Establishing different 
compliance or reporting standards that take into account the resources 
available to small entities; (ii) clarifying, consolidating, or 
simplifying the compliance requirements under the rule for small 
entities; (iii) using performance rather than design standards; and 
(iv) exempting small entities from coverage of the rule, or any part of 
the rule.
    The Commission does not presently believe that these amendments 
would require the establishment of special compliance requirements or 
timetables for small entities. These amendments are specifically 
designed to reduce any unnecessary burdens on all funds (including 
small funds) and on small intermediaries. To establish special 
compliance requirements or timetables for small entities may in fact 
disadvantage small entities by encouraging larger market participants 
to focus primarily on the needs of larger entities when establishing 
the information-sharing systems envisioned by the rule and these 
proposed amendments, and possibly ignoring the needs of smaller 
entities.
    With respect to further clarifying, consolidating, or simplifying 
the compliance requirements of the rule, using performance rather than 
design standards, and exempting small entities from coverage of these 
amendments or any part of the rule, we believe additional such changes 
would be impracticable. These amendments in effect except a large 
number of smaller entities from the scope of the rule, by revising the 
definition of financial intermediary. We have designed these amendments 
to reduce the cost and compliance burden on small entities to the 
greatest extent practicable while still maintaining the investor 
protections of the rule as adopted.
    Small entities are as vulnerable to the problems uncovered in 
recent enforcement actions and settlements as large entities. 
Therefore, shareholders of small entities are equally in need of 
protection from short-term traders. We believe that the rule and these 
amendments will enable funds to more effectively discourage short-term 
trading of all fund shares, including those held in omnibus accounts. 
Further excepting small entities from coverage of the rule or any part 
of the rule could compromise the effectiveness of the rule. We 
anticipate that the amendments will alleviate much of the burden 
imposed by the rule on small entities, and result in a more cost 
effective system for discouraging short-term trading for all entities. 
Alternatives that we considered but are not adopting included, among 
others, (i) fully exempting all small entities from complying with the 
information-sharing aspect of the rule, (ii) not requiring that the 
information-sharing agreement obligate first-tier intermediaries to 
assist in providing information from indirect intermediaries to funds, 
and (iii) extending the compliance date for small entities.

VIII. Statutory Authority

    The Commission is amending rule 22c-2 pursuant to the authority set 
forth in sections 6(c), 22(c), and 38(a) of the Investment Company Act 
[15 U.S.C. 80a-6(c), 80a-22(c) and 80a-37(a)].

List of Subjects in 17 CFR Part 270

    Investment companies, Reporting and recordkeeping requirements, 
Securities.

Text of Amended Rule

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

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

0
1. The authority citation for part 270 continues to read in part as 
follows:

    Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, and 80a-
39, unless otherwise noted.
* * * * *

0
2. Section 270.22c-2 is revised to read as follows:


Sec.  270.22c-2  Redemption fees for redeemable securities.

    (a) Redemption fee. It is unlawful for any fund issuing redeemable 
securities, its principal underwriter, or any dealer in such 
securities, to redeem a redeemable security issued by the fund within 
seven calendar days after the security was purchased, unless it 
complies with the following requirements:
    (1) Board determination. The fund's board of directors, including a 
majority of directors who are not interested persons of the fund, must 
either:
    (i) Approve a redemption fee, in an amount (but no more than two 
percent of the value of shares redeemed) and on shares redeemed within 
a time period (but no less than seven calendar days), that in its 
judgment is necessary or appropriate to recoup for the fund the costs 
it may incur as a result of those redemptions or to otherwise eliminate 
or reduce so far as practicable any dilution of the value of the 
outstanding securities issued by the fund, the proceeds of which fee 
will be retained by the fund; or
    (ii) Determine that imposition of a redemption fee is either not 
necessary or not appropriate.
    (2) Shareholder information. With respect to each financial 
intermediary that submits orders, itself or through its agent, to 
purchase or redeem shares directly to the fund, its principal 
underwriter or transfer agent, or to a registered clearing agency, the 
fund (or on the fund's behalf, the principal underwriter or transfer 
agent) must either:
    (i) Enter into a shareholder information agreement with the 
financial intermediary (or its agent); or
    (ii) Prohibit the financial intermediary from purchasing in nominee 
name on behalf of other persons, securities issued by the fund. For 
purposes of this

[[Page 58273]]

paragraph, ``purchasing'' does not include the automatic reinvestment 
of dividends.
    (3) Recordkeeping. The fund must maintain a copy of the written 
agreement under paragraph (a)(2)(i) of this section that is in effect, 
or at any time within the past six years was in effect, in an easily 
accessible place.
    (b) Excepted funds. The requirements of paragraph (a) of this 
section do not apply to the following funds, unless they elect to 
impose a redemption fee pursuant to paragraph (a)(1) of this section:
    (1) Money market funds;
    (2) Any fund that issues securities that are listed on a national 
securities exchange; and
    (3) Any fund that affirmatively permits short-term trading of its 
securities, if its prospectus clearly and prominently discloses that 
the fund permits short-term trading of its securities and that such 
trading may result in additional costs for the fund.
    (c) Definitions. For the purposes of this section:
    (1) Financial intermediary means:
    (i) Any broker, dealer, bank, or other person that holds securities 
issued by the fund, in nominee name;
    (ii) A unit investment trust or fund that invests in the fund in 
reliance on section 12(d)(1)(E) of the Act (15 U.S.C. 80a-12(d)(1)(E)); 
and
    (iii) In the case of a participant-directed employee benefit plan 
that owns the securities issued by the fund, a retirement plan's 
administrator under section 3(16)(A) of the Employee Retirement Income 
Security Act of 1974 (29 U.S.C. 1002(16)(A)) or any person that 
maintains the plan's participant records.
    (iv) Financial intermediary does not include any person that the 
fund treats as an individual investor with respect to the fund's 
policies established for the purpose of eliminating or reducing any 
dilution of the value of the outstanding securities issued by the fund.
    (2) Fund means an open-end management investment company that is 
registered or required to register under section 8 of the Act (15 
U.S.C. 80a-8), and includes a separate series of such an investment 
company.
    (3) Money market fund means an open-end management investment 
company that is registered under the Act and is regulated as a money 
market fund under Sec.  270.2a-7.
    (4) Shareholder includes a beneficial owner of securities held in 
nominee name, a participant in a participant-directed employee benefit 
plan, and a holder of interests in a fund or unit investment trust that 
has invested in the fund in reliance on section 12(d)(1)(E) of the Act. 
A shareholder does not include a fund investing pursuant to section 
12(d)(1)(G) of the Act (15 U.S.C. 80a-12(d)(1)(G)), a trust established 
pursuant to section 529 of the Internal Revenue Code (26 U.S.C. 529), 
or a holder of an interest in such a trust.
    (5) Shareholder information agreement means a written agreement 
under which a financial intermediary agrees to:
    (i) Provide, promptly upon request by a fund, the Taxpayer 
Identification Number (or in the case of non U.S. shareholders, if the 
Taxpayer Identification Number is unavailable, the International 
Taxpayer Identification Number or other government issued identifier) 
of all shareholders who have purchased, redeemed, transferred, or 
exchanged fund shares held through an account with the financial 
intermediary, and the amount and dates of such shareholder purchases, 
redemptions, transfers, and exchanges;
    (ii) Execute any instructions from the fund to restrict or prohibit 
further purchases or exchanges of fund shares by a shareholder who has 
been identified by the fund as having engaged in transactions of fund 
shares (directly or indirectly through the intermediary's account) that 
violate policies established by the fund for the purpose of eliminating 
or reducing any dilution of the value of the outstanding securities 
issued by the fund; and
    (iii) Use best efforts to determine, promptly upon request of the 
fund, whether any specific person about whom it has received the 
identification and transaction information set forth in paragraph 
(c)(5)(i) of this section, is itself a financial intermediary 
(``indirect intermediary'') and, upon further request by the fund:
    (A) Provide (or arrange to have provided) the identification and 
transaction information set forth in paragraph (c)(5)(i) of this 
section regarding shareholders who hold an account with an indirect 
intermediary; or
    (B) Restrict or prohibit the indirect intermediary from purchasing, 
in nominee name on behalf of other persons, securities issued by the 
fund.

     Dated: September 27, 2006.

    By the Commission.
Nancy M. Morris,
Secretary.
[FR Doc. E6-16273 Filed 10-2-06; 8:45 am]
BILLING CODE 8010-01-P