[13325]
April 2, 2001
TO: BOARD OF GOVERNORS No. 15-01
DIRECTOR SERVICES COMMITTEE No. 3-01
PRIMARY CONTACTS - MEMBER COMPLEX No. 25-01
SEC RULES MEMBERS No. 27-01
RE: ROYE AND FINK REMARKS AT 2001 MUTUAL FUNDS CONFERENCE
Paul F. Roye, Director of the Securities and Exchange Commission’s Division of
Investment Management, and Institute President Matthew P. Fink each delivered a keynote
address at the 2001 Mutual Funds and Investment Management Conference. Copies of their
speeches are attached, and they are summarized below.
Paul Roye’s Address
In his address, Mr. Roye focused on: (i) recent Commission actions impacting the mutual
fund industry, such as the fund governance rules, the Division of Investment Management’s fee
study and disclosure of after-tax returns; (ii) issues the Division hopes to address during the
next year, including shareholder communications, providing flexibility in the affiliated
transactions area and revising the rules governing fund advertising; and (iii) various
Commission initiatives, such as monitoring hedge funds, new products and technologies, and
reviewing the Division’s processes.
Recent Actions
With respect to the fund governance rules, Mr. Roye expressed the view that the
Commission’s initiatives give fund directors the tools, access and power they need “to fulfill
their legal duty and moral mandate as shareholder representatives.” He noted that “there are
limits to what SEC rules can and/or should do” and thus encouraged fund groups to review
their fund governance framework and “embrace the ICI’s best practice recommendations for
fund governance.”
Mr. Roye then briefly summarized the findings and recommendations in the Division’s
fee study. He highlighted the staff’s recommendation that the Commission review the
requirements of Rule 12b-1, stating that “modifications to Rule 12b-1 may be needed to reflect
changes in the manner in which funds are marketed and distributed.” In addition, the
Commission should consider whether to give additional or different guidance to fund directors
2with respect to their review of Rule 12b-1 plans, “including whether the factors suggested by
the 1980 adopting release are still valid.” Mr. Roye encouraged the industry and others “to
weigh in and provide thoughts and ideas as to how Rule 12b-1 should be modified.”
On the topic of after-tax disclosure, Mr. Roye detailed the Commission’s various reasons
for standing firm on the use of the highest federal tax bracket for the after-tax return calculation.
He also emphasized that using the short-term capital gains rate for the one-year after-tax return
number is relevant to inform investors of the tax consequences of short-term trading, and that
“the most logical place” for the disclosure of after-tax numbers is alongside the fund’s pre-tax
returns.
Current Issues
Mr. Roye reported that the staff is continuing to study how to improve shareholder
reports and financial statement presentations. With regard to the recent focus on the disclosure
of portfolio holdings, Roye acknowledged that “there are costs, burdens and risks that must be
considered,” and stated that a better alternative to more frequent disclosure to all shareholders
“might be to provide the information more frequently only for those shareholders that request
it, or to use technology such as the Internet to meet the needs of shareholders who want this
additional information.” Regarding affiliated transactions, Mr. Roye described recent no-action
letters whereby the staff has attempted to provide flexibility in this area. Roye noted that the
staff is continuing its review of the need for rules that would permit certain other affiliated
transactions to proceed without the need for exemptive relief, including proposed amendments
to expand the scope of Rule 17a-8, which involves fund mergers, and a rule that would codify
exemptive relief given to permit funds to invest cash in affiliated money market funds.
Mr. Roye indicated that the Division expects to recommend that the Commission
propose amendments to Rule 482 “to enhance funds’ ability to provide investors with better
and timelier information in fund advertising,” and eliminate the requirement that the substance
of the information contained in advertisements be included in the statutory prospectus. Roye
stated that Rule 482 revisions also “will serve as an occasion to remind funds that technical
compliance with the rule may nevertheless run afoul of the antifraud prohibitions of the federal
securities laws.” In connection with this proposed rulemaking, Roye stated that the staff has
been “exploring how to promote the use of more current performance information,” with the
ultimate goal of seeking to promote balance and responsibility in fund advertising. Prior to this
rulemaking, Roye confirmed, the staff plans to publish a legal bulletin “that will remind funds
that their advertisement should not mislead investors and that mere compliance with Rule 482
is not the end of the analysis.”
Commission Initiatives
Mr. Roye acknowledged the Institute’s concerns regarding inappropriate hedge fund
activities, and informed attendees that the Commission is monitoring carefully (i) the conflict of
interest issues and the potential for abuse involved with fund managers sponsoring and
advising hedge funds and other alternative investments, and (ii) “those mutual funds that are
using hedge fund type strategies, such as short selling, and the aggressive use of leverage and
derivatives.” Roye also announced that the staff is working on a concept release regarding
actively managed exchange traded funds (“ETFs”). The staff’s goal is “to gain a better
3understanding of the various perspectives on the issues surrounding actively managed ETFs,”
to enable them to better evaluate any proposals for these types of products as they are
presented through the exemptive process on a case-by-case basis. Roye also emphasized the
Commission’s dedication to fighting Internet securities fraud, and discussed OCIE’s current
sweep of Internet advisers that is aimed at gaining a better understanding of how these advisers
operate, and monitoring their compliance with the federal securities laws. In addition, Roye
reported that the staff is currently analyzing whether “so-called web-based baskets of
securities … are appropriately regulated and how they fit within the federal securities laws.”
In conclusion, Mr. Roye announced that the Division’s Deputy Director is undertaking a
review of the Division’s systems and procedures “to make recommendations as to how we can
improve the way in which we service registrants, respond to investors and fulfill our
responsibilities” – in short, to enhance the staff’s ability to “work smart.”
Matt Fink’s Address
In his address, Mr. Fink shared his views on what the industry and its regulators must
do to maintain the industry’s tradition of trust and excellence and continue to be, in the words
of President Theodore Roosevelt, “wise on time” for investors. Based on the theory that “we
can’t focus only on perfecting mutual fund regulation without considering the larger universe
of investment management products and services in which mutual funds operate,” Mr. Fink
focused his remarks on hedge funds, Internet advisory services, and disclosure. He also spoke
about needed reform in the Commission’s administration of the self-dealing prohibitions of
Section 17 of the 1940 Act.
Mr. Fink stated that the fallout from the collapse of unregulated hedge funds, such as
Long Term Capital Management, affects all investors, not just those sophisticated investors who
knowingly accept such risks. He noted that some hedge fund advocates are suggesting that
hedge funds have “outgrown” their offering and advertising restrictions, leading to plans for an
on-line hedge fund supermarket and suggestions that broad-based marketing of hedge funds
would not put small investors at risk. Mr. Fink also mentioned “ominous reports that some
individual sales personnel are trying to circumvent the law by pooling the assets of small
investors to meet the financial thresholds for hedge fund investing.” Calling for the application
of “basic, common sense controls” of hedge funds, Mr. Fink recommended two things the
industry must do to be “wise on time” for investors in this area: (i) require adequate disclosure
of hedge fund operations, and (ii) ensure that the safeguards established by Congress in 1940
and 1996 are not “leached away through mass advertising of risky pools that are unsuitable for
all investors.”
Mr. Fink remarked that, while technology “is a tremendous boon for investors” it also
creates “significant dangers for the unwary.” He therefore urged the SEC to consider a review
of how technology is changing the ways Americans obtain investment advice and review online
services to see if the Commission needs to modify its rules or seek additional statutory
authority to address investor protection concerns. While specifically not advocating that every
element of Advisers Act regulation be applied to all on-line advisory services, or that every
Investment Company Act regulation be immediately imposed on all discretionary advisory
programs, Mr. Fink encouraged taking a “hard look” at whether technological developments
4are leading to the creation of products and services that, “when examined functionally,
implicate the vital policy concerns at the heart of these two statutes.”
On the topic of disclosure, Mr. Fink pointed out that a variety of managed investments,
such as commingled retirement funds, wrap accounts, variable insurance accounts and
individually managed accounts, all essentially offer investors the same services, although “the
content and the frequency of the disclosure received by investors varies from product to
product.” Mr. Fink therefore cautioned that being “wise on time” for investors requires that
“all investors, not just those who invest in mutual funds, receive full and fair disclosure.”
With respect to Section 17(a), Mr. Fink noted that dedication to the 1940 Act’s core
principles and ongoing opposition to efforts to repeal Section 17(a) should not “translate into
inflexible adherence to archaic, technical restrictions if they no longer fit the reality of modern
markets.” Mr. Fink therefore encouraged the staff to change certain restrictions on affiliated
transactions that no longer make sense, in order to better serve investors.
Doretha VanSlyke Zornada
Assistant Counsel
Attachments
Note: Not all recipients receive the attachments. To obtain copies of the attachments to which this memo refers,
please call the ICI Library at (202) 326-8304 and request the attachments for memo 13325. ICI Members may retrieve
this memo and its attachments from ICINet (http://members.ici.org).
Attachment no. 1 (in .pdf format)