SEC Chairman Announces Near Term Mutual Fund Regulatory Agenda.

At an open meeting of the SEC on December 3 at which it took action on rulemaking proposals aimed at late trading, market timing and selective portfolio disclosure, SEC Chairman William Donaldson outlined the SEC's mutual fund regulatory agenda for the coming months. In the remainder of December, the SEC will consider (a) a proposal regarding better disclosure of breakpoint discount opportunities and (b) a concept release on disclosure of portfolio transaction costs. January meeting agendas include consideration of proposals regarding: (1) additional confirmation statement disclosure concerning sales loads and other charges incurred in purchasing mutual fund shares, as well as selling brokers' compensation and incentives; (2) reporting by portfolio managers of personal trading in funds they manage; (3) an interpretive release clarifying how Rule 12b-1 under the Investment Company Act of 1940 applies to funds' use of brokerage commissions to facilitate distribution of fund shares; (4) corporate governance proposals to require that (i) fund boards have independent chairmen, (ii) 75% of a fund's directors be independent, (iii) independent directors have the authority to retain staff, (iii) fund boards conduct an annual self-evaluation of effectiveness, including consideration of the number of funds overseen and committee structure, (iv) boards focus on and preserve documents and information used to determine the reasonableness of management fees relative to performance, quality of service and stated objectives and (v) funds make additional disclosure with respect to board determinations regarding the appropriateness of management fee levels; and (5) adoption of a final rule to require semi-annual disclosure of the dollar amount of fees and expenses paid by shareholders. Additional proposals aimed at market timing abuses will be considered in February, including a proposal that would require mutual funds to impose a mandatory redemption fee on market timers; the SEC also expects to act on any recommendations that result from the work of the NASD's Omnibus Account Task Force.

SEC Proposes Amendments to Rule Governing Pricing of Mutual Fund Shares

The SEC proposed amendments to its rule requiring forward pricing of shares of registered open-end investment companies ("mutual funds") in an effort to prevent late trading. Rule 22c-1 under the Investment Company Act of 1940 (the "1940 Act") generally requires mutual funds, their principal underwriters and dealers to sell and redeem shares at a price based on the net asset value next computed after receipt of an order to buy or redeem. In general, the Rule requires mutual funds to calculate net asset value at least once daily Monday through Friday; most mutual funds calculate net asset value at 4:00 p.m. Eastern time. The SEC's proposed amendments to Rule 22c-1 would require that all purchase and redemption orders with respect to a mutual fund's shares be received by either (i) the mutual fund, (ii) a single transfer agent, designated by the mutual fund in its registration statement, that is required by a written contract to receive order information and maintain a record of the date and time it receives the information ("designated transfer agent") or (iii) a registered clearing agency (i.e., Fund/SERV), no later than the fund's pricing time, the time as of which the mutual fund prices its securities, in order to receive that day's price. As a result, for a fund that calculates net asset v alue as of 4:00 p.m., fund intermediaries such as broker-dealers, banks and retirement plan administrators would have to submit orders to the fund, its designated transfer agent or a registered clear agency by 4:00 p.m. in order to receive that day's price; orders received after 4:00 p.m. would receive the next day's price. The amendments would also provide that purchase and redemption orders become irrevocable as of the next pricing time after receipt, in order to prevent cancellation or modification of orders after the applicable pricing time. The amendments create new exceptions to the forward pricing requirement for (a) emergencies --e.g., when a dealer is unable to submit an order, or a transfer agent is unable to receive an order, as a result of a power failure or natural disaster or (b) "conduit funds" such as feeder funds in a master-feeder structure. The SEC indicated that it would expect to provide a one year transition period if the amendments are adopted generally as proposed. The proposing release also requests comment on an alternative approach to preventing late trading that would permit a fund intermediary to submit orders after a fund's pricing time if the intermediary has adopted additional protections designed to prevent late trading. Comments on the proposed amendments are due by February 6, 2004.

SEC Issues Proposed Rules for Disclosure Regarding Market Timing, Selective Disclosure of Portfolio Holdings and the Use of Fair Value Pricing

The SEC issued proposed amendments to Forms N-1A, N-3, N-4 and N-6 under the Securities Act of 1933, as amended (the "1933 Act"), and the 1940 Act, that would require specific new disclosures regarding market timing policies, fair value pricing practices and the selective disclosure of portfolio holdings by mutual funds and insurance company separate accounts issuing annuity contracts. The proposed amendments would require mutual funds to provide prospectus disclosure describing the fund-specific risks to shareholders of frequent purchases and redemptions of fund shares ("frequent trading"), and stating whether the fund's board of directors has adopted policies and procedures with respect to frequent trading. Mutual funds would be required to describe such policies and procedures, including (a) a statement of whether or not the fund discourages or accommodates frequent trading, (b) a specific description of any policies for detecting or deterring frequent trading activity, (c) a description of any arrangements for detecting frequent trading of fund shares through fund intermediaries, such as investment advisers, broker-dealers, transfer agents, and third-party administrators, and (d) a description of any restrictions imposed by the fund to prevent or minimize frequent trading (such as redemption fees), as well as any specific circumstances under which these restrictions will not be imposed by the fund. If a fund lacks policies and procedures with respect to frequent trading, its prospectus would have to provide the specific basis for the fund's failure to adopt such measures. The proposed amendments would require a mutual fund to disclose in its prospectus any arrangements to permit frequent trading, including the identity of the persons permitted to engage in frequent trading and any compensation or other consideration received by the fund, its investment adviser or any other party pursuant to such arrangements. The SEC emphasized that any arrangement to permit frequent trading may only be entered into consistent with the antifraud provisions of the 1933 Act and the 1940 Act and the fiduciary duties of the fund and its investment adviser to fund shareholders. Under the proposed amendments, all mutual funds, other than money market funds, would have to provide specific prospectus disclosure explaining the circumstances under which they will price portfolio securities at fair value and the effects of fair value pricing. Finally, the proposed amendments would require mutual fund prospectuses to describe fund policies and procedures with respect to the disclosure of portfolio holdings and any arrangements to make available such information to certain shareholders. If the proposed amendments are adopted, the SEC plans to require all new registration statements and all post-effective amendments to effective registration statements filed on or after the effective date of the proposed amendments to comply with these changes. The SEC has requested comment on numerous aspects of the proposed amendments. Comments must be received by the SEC on or before February 6, 2004.

Additional Mutual Fund Legislation Introduced in Senate

Senators Jon Corzine (D-NJ) and Christopher Dodd (D-CT), members of the Senate Committee on Banking, Housing, and Urban Affairs, recently introduced S.1971, the "Mutual Fund Investor Confidence Restoration Act," and Senator John Kerry (D-MA) introduced S.1958, "Mutual Fund Investor Protection Act." The bills include significant overlap between each other, the Baker Bill (see the June 17, 2003 and November 25, 2003 issues of the Alert for a discussion of this bill), S.1822, the "Mutual Funds Transparency Act of 2003," (see the November 11, 2003 issue of the Alert for a discussion of S. 1822) and recent and proposed SEC regulatory action (as discussed elsewhere in this issue). Notable provisions unique to S. 1971 include (a) a requirement that each board include an audit committee financial expert and (b) certification of various fund compliance matters by a fund's chairman of the board (as compared to the Baker Bill's requirement that all independent directors make the relevant certifications). S. 1958 is distinguished primarily by its focus on (a) increased penalties for securities law violations related to the offer, sale and pricing of mutual fund shares, which include bringing certain of these offenses within the scope of the RICO statute, and (b) the establishment of the Mutual Fund Oversight Board. (For an overview of the events that have prompted the introduction of this legislation, Goodwin Procter has prepared a chronology of market timing and late trading regulatory and enforcement activity that is available upon request.)

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