SEC Adopts Enhanced Mutual Fund Expense and Portfolio Disclosure; Proposes Improved Disclosure of Board Approval of Investment Advisory Contracts and Prohibition on the Use of Brokerage Commissions to Finance Distribution

FOR IMMEDIATE RELEASE
2004-16

Washington, D.C. Feb. 11, 2004 -- The Securities and Exchange Commission took the following actions today at its open meeting:

Shareholder Reports and Quarterly Portfolio Disclosure by Funds

The Commission adopted several amendments to its rules and forms that are intended to improve significantly the periodic disclosure that mutual funds and other registered management investment companies provide to their shareholders about their costs, portfolio investments, and performance.

The amendments include the following:

• Enhanced Mutual Fund Expense Disclosure in Shareholder Reports. The amendments will require open-end management investment companies (mutual funds) to disclose fund expenses borne by shareholders during the reporting period in their shareholder reports. Shareholder reports will be required to include: (i) the cost in dollars associated with an investment of $1,000, based on the fund’s actual expenses for the period; and (ii) the cost in dollars, associated with an investment of $1,000, based on the fund’s actual expense ratio for the period and an assumed return of 5 percent per year. The first figure is intended to permit investors to estimate the actual costs, in dollars, that they bore over the reporting period. The second figure is intended to provide investors with a basis for comparing the level of current period expenses of different funds. The expense disclosure will also be required to include the fund's expense ratio and the account values as of the end of the period for an initial investment of $1,000.
   
• Quarterly Disclosure of Fund Portfolio Holdings. The amendments will require a registered management investment company (fund) to file its complete portfolio holdings schedule with the Commission on a quarterly basis. These filings will be publicly available through the Commission’s Electronic Data Gathering, Analysis, and Retrieval System (EDGAR). This amendment is intended to enable interested investors, through more frequent access to portfolio information, to monitor whether, and how, a fund is complying with its stated investment objective.
   
• Use of Summary Portfolio Schedule. The amendments will permit a fund to include a summary portfolio schedule in its semi-annual reports that are delivered to shareholders in lieu of the complete schedule, provided that the complete portfolio schedule is filed with the Commission and is provided to shareholders upon request, free of charge. The summary portfolio schedule will include each of the fund’s 50 largest holdings in unaffiliated issuers and each investment that exceeds one percent of the fund’s net asset value. This amendment is intended to provide investors with information about portfolio holdings in a format that is more useful and understandable.
   
• Exemption of Money Market Funds from Portfolio Schedule Delivery Requirements. The amendments will exempt money market funds from including a portfolio schedule in reports to shareholders, provided that this information is filed with the Commission and is provided to shareholders upon request, free of charge. Because the investments of money market funds must be high-quality, are circumscribed by rules under the Investment Company Act of 1940, and have short-term maturities, detailed portfolio information has limited utility for money market fund investors.
   
• Tabular or Graphic Presentation of Portfolio Holdings in Shareholder Reports. The amendments will require fund reports to shareholders to include a tabular or graphic presentation of a fund’s portfolio holdings by identifiable categories (e.g., industry sector, geographic region, credit quality, or maturity). This presentation is intended to illustrate, in a concise and user-friendly format, the allocation of a fund’s investments across asset classes.
   
• Management’s Discussion of Fund Performance. The amendments will require a mutual fund to include Management’s Discussion of Fund Performance (MDFP) in its annual report to shareholders. Currently, a fund is permitted to include MDFP in either its prospectus or its annual report to shareholders. MDFP is more appropriately located in the annual report, together with other “backward looking” information, such as the fund’s financial statements.

The new requirements will apply to shareholder reports and quarterly portfolio disclosure for reporting periods ending on or after 120 days following publication in the Federal Register.

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

The Commission proposed amendments to its rules and forms that would improve the disclosure that mutual funds and other registered management investment companies provide to their shareholders regarding the reasons for the fund board’s approval of an investment advisory contract. The proposals are intended to encourage fund boards to consider investment advisory contracts more carefully and to encourage investors to consider more carefully the costs and value of the services rendered by the fund’s investment adviser.

The proposals would require fund shareholder reports to discuss, in reasonable detail, the material factors and the conclusions with respect to these factors that formed the basis for the board of directors’ approval of any investment advisory contract. The proposed new disclosure would be similar to disclosure currently required in the fund’s Statement of Additional Information, or SAI, and fund proxy statements about the basis for the approval of the fund’s existing advisory contract and any board recommendation that shareholders approve an advisory contract.

The proposals also include several enhancements to the existing disclosure requirements in the SAI and proxy statements that would parallel the proposed disclosure in fund shareholder reports. These enhancements would require the following:

• Selection of Adviser and Approval of Advisory Fee. The proposals would clarify that the fund should discuss both the board’s selection of the investment adviser and its approval of amounts to be paid under the advisory contract.
   
• Specific Factors. The fund would be required to include a discussion of (1) the nature, extent, and quality of the services to be provided by the investment adviser; (2) the investment performance of the fund and the investment adviser; (3) the costs of the services to be provided and profits to be realized by the investment adviser and its affiliates from the relationship with the fund; (4) the extent to which economies of scale would be realized as the fund grows; and (5) whether fee levels reflect these economies of scale for the benefit of fund investors.
   
• Comparison of Fees and Services Provided by Adviser. The fund’s discussion would be required to indicate whether the board relied upon comparisons of the services to be rendered and the amounts to be paid under the contract with those under other investment advisory contracts, such as contracts of the same and other investment advisers with other registered investment companies or other types of clients (e.g., pension funds and other institutional investors).

Comments on the proposed rule amendments will be due approximately 60 days following their publication in the Federal Register.

Prohibition on the Use of Brokerage Commissions to Finance Distribution

The Commission proposed an amendment to rule 12b-1 under the Investment Company Act of 1940 that would prohibit open-end investment companies (mutual funds) from directing commissions from their portfolio brokerage transactions to broker-dealers to compensate them for distributing fund shares. The Commission also asked for comment on the need for additional changes to rule 12b-1.

In an increasingly competitive marketplace, one way that fund advisers reward broker-dealers for promoting mutual fund shares is through brokerage commissions. Advisers often either select broker-dealers that sell fund shares to execute fund portfolio transactions, or rely on another broker-dealer to execute the transactions, but direct a portion of the brokerage commission to selling brokers. The conflicts of interest that surround the use of brokerage commissions (which are fund assets) to finance distribution may harm funds and their shareholders in a number of ways, including compromising best execution, causing advisers and brokers to circumvent limits on sales charges, increasing portfolio turnover, concealing distribution costs, and influencing broker-dealers’ recommendations to their customers.

The proposed rule amendment would:

• prohibit funds from compensating a broker-dealer for promoting or selling fund shares by directing brokerage transactions to that broker-dealer;
   
• prohibit “step-out” and similar arrangements under which a fund directs brokerage commissions to selling brokers that do not execute fund portfolio securities transactions as compensation for selling fund shares; and
   
• require funds that use a selling broker-dealer to execute portfolio securities transactions to adopt, and the fund’s board of directors (including its independent directors) to approve, policies and procedures reasonably designed to prevent: (i) the persons who select executing broker-dealers from taking into account brokers’ distribution efforts; and (ii)  any agreement under which the fund is expected to direct brokerage commissions for distribution.

The Commission also is requesting comment on the need for additional changes to rule 12b-1 to address other issues that have arisen under the rule. One of these issues is the current practice of using 12b-1 fees as a substitute for a sales load. In addition, the Commission is requesting comment on an alternative approach to rule 12b-1 that would require distribution-related costs to be deducted directly from shareholder accounts rather than from fund assets. Finally, the Commission is seeking comment on whether rule 12b-1 continues to serve the purpose for which it was intended, and whether it should be repealed. The comments the Commission receives will determine whether a proposal for further amendments to rule 12b-1 is appropriate.

Comments on the proposed rule amendment and additional request for comment will be due approximately 60 days after the proposed rule is published in the Federal Register.