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June 11, 2003
TO: BOARD OF GOVERNORS No. 28-03
CLOSED-END INVESTMENT COMPANY MEMBERS No. 49-03
DIRECTOR SERVICES COMMITTEE No. 8-03
PRIMARY CONTACTS - MEMBER COMPLEX No. 45-03
SEC RULES MEMBERS No. 71-03
RE: MUTUAL FUNDS LEGISLATION INTRODUCED; HEARING ANNOUNCED
House Capital Markets Subcommittee Chairman Richard H. Baker today introduced
H.R. 2420, the “Mutual Funds Integrity and Fee Transparency Act of 2003” (the “Act”), which is
intended “to improve transparency relating to the fees and costs that mutual fund investors
incur and to improve corporate governance of mutual funds.” Chairman Baker announced that
the Capital Markets Subcommittee will hold a hearing on the legislation on June 18th. The bill is
summarized below.1
Transparency of Mutual Fund Costs
The bill would direct the SEC, within 270 days after the date of enactment of the Act, to
adopt rules to require an open-end management investment company to disclose the following:
• the estimated amount, in dollars, of the operating expenses of the fund that are
borne by each shareholder;
• the structure of, or method used to determine, the compensation of individuals
employed by the investment adviser of the fund to manage the portfolio of the fund;
• the portfolio transaction costs of the fund, including commissions paid with respect
to the trading of portfolio securities, set forth in a manner that facilitates comparison
among funds;
• information concerning the fund’s policies and practices with respect to soft dollar
arrangements, specifically, the payment of brokerage commissions to a broker who
provides research services, and information concerning the fund’s policies and
1 Copies of the bill and the section-by-section analysis are available at
http://financialservices.house.gov/news.asp?FormMode=release&id=343&NewsType=1.
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practices with respect to the payment of brokerage commissions to a broker who
facilitates the sale and distribution of the fund’s shares;
• information concerning revenue sharing (i.e., payments by any person other than the
fund that are intended to facilitate the sale and distribution of the fund’s shares); and
• information concerning breakpoint discounts on front-end sales loads for which an
investor may be eligible, including the minimum purchase amounts required for
such discounts.
The bill would require this disclosure in the quarterly statement or other periodic report
to shareholders or other appropriate disclosure document. The bill provides that disclosure
would not be considered to be made in an appropriate document if it is made exclusively in a
prospectus or statement of additional information, or both. The bill would permit the SEC to
require that the disclosure be made in a prospectus or SAI, so long as that disclosure is also
provided in another appropriate document. The bill also would permit the SEC to consider
whether a document provided by a broker or dealer, rather than the fund, may be an
appropriate disclosure document, e.g., for disclosure of information concerning revenue sharing
payments.
Obligations Regarding Certain Distribution and Soft Dollar Arrangements
The bill would amend Section 15 of the Investment Company Act to require each
investment adviser to a registered investment company to annually provide the fund’s board of
directors with a report on:
• payments made by the adviser (or an affiliate) to promote the sale of fund shares
(“revenue sharing arrangements”);
• services provided to the fund or paid for by brokers executing securities transactions for
the fund (or its affiliate) (“directed brokerage arrangements”); and
• research services obtained by the adviser (or its affiliate) from a broker as result of
securities transactions effected on behalf of the fund (“soft dollar arrangements”).
The bill would impose a fiduciary obligation on fund directors to supervise these
arrangements and to determine that the direction of fund brokerage is in the best interests of the
fund’s shareholders and that any revenue sharing arrangements are consistent with the Act, e.g.,
are not disguised payments from fund assets, and are in the best interests of the fund’s
shareholders. The SEC would be given rulemaking authority under the bill to implement the
above requirements.
Mutual Fund Governance
The bill would amend Section 10(a) of the Investment Company Act to require two-
thirds of a fund’s board to be independent and to require that the chairman of the board be
independent.
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The bill would amend the definition of “interested person” in Section 2(a)(19) of the
Investment Company Act to exclude persons with (1) a material business relationship with the
fund, its investment adviser or principal underwriter (or any of their affiliated persons), or (2) a
close familial relationship with any natural person who is an adviser or principal underwriter to
the fund (or any of their affiliated persons). The bill would delete from Section 2(a)(19)
references to broker-dealers and lenders as interested persons to permit the SEC to include
persons with such material business relationships as interested persons in a rule adopted
pursuant to its new authority provided under the Act.
Audit Committee Requirements
The bill would amend Section 32 of the Investment Company Act to require the audit
committee of a registered management company, rather than the independent directors of the
full board, to be responsible for the selection of the auditor. The bill also would amend Section
32 to make it unlawful for any such fund to file with the SEC any financial statement signed or
certified by an independent public accountant unless the fund is in compliance with the
following standards:
• The audit committee must be directly responsible for the appointment, compensation,
and oversight of auditors and the auditors must report directly to the audit committee.
• Each member of the audit committee must be “independent.” In order to be considered
“independent,” a member of an audit committee may not, other than in his or her
capacity as a member of the audit committee, the board of directors, or any other board
committee (1) accept any consulting, advisory, or other compensatory fee from the fund
or any affiliated person of the fund, or (2) be an “interested person” of the fund, as that
term is defined in Section 2(a)(19) of the Investment Company Act.
• Each audit committee must establish procedures for the receipt, retention, and treatment
of complaints regarding accounting, internal accounting controls, or auditing matters,
including procedures for the confidential, anonymous submission by employees of the
fund and its affiliated persons of concerns regarding questionable accounting or
auditing matters.
• Each audit committee must have the authority to engage independent counsel and other
advisers, as it determines necessary to carry out its duties.
• Each fund must provide appropriate funding, as determined by the audit committee, for
payment of compensation to the auditors and any advisers employed by the audit
committee.
The bill would amend Section 32 of the Investment Company Act to define “audit
committee” to mean (1) a committee of the board of directors that oversees the accounting and
financial reporting processes of the fund and audits of its financial statements, an (2) if no such
committee exists, the full board of directors.
The bill would amend Section 10A(m) of the Securities Exchange Act to exempt
registered investment companies from the requirements of Section 10A(m) (the codification of
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Section 301 of the Sarbanes-Oxley Act) effective one year after enactment of the Act. This
exemption would not, however, preclude one of the exchanges or Nasdaq from imposing audit
committee requirements on listed funds in appropriate circumstances.
The bill would require the SEC to issue final rules to implement the above requirements
within 180 days after enactment of the Act.
SEC Study and Report on Soft Dollar Arrangements
The bill would direct the SEC to conduct a study of the use of soft dollars by investment
advisers. The bill would require the SEC, in preparing the report, to examine trends in soft
dollar use during the preceding three years, the types of services provided, the extent to which
use of soft dollars impairs the ability of investors to evaluate and compare expenses of
investment companies, and the transparency of such arrangements. Finally, the bill would
require that the study address the SEC’s view of whether Section 28(e) of the Exchange Act
should be repealed or modified. The SEC would be required to submit its study to Congress
within 18 months of the date of enactment of the Act.
Matthew P. Fink
President