COURT RULES AGAINST FUNDS FOR VIOLATIONS OF SECURITIES LAWS RESULTING FROM FAILURE TO REGISTER UNDER STATE BLUE SKY LAWS

March 12, 1991 TO: SEC RULES MEMBERS NO. 21-91 STATE SECURITIES MEMBERS NO. 13-91 UNIT INVESTMENT TRUST MEMBERS NO. 12-91 RE: COURT RULES AGAINST FUNDS FOR VIOLATIONS OF SECURITIES LAWS RESULTING FROM FAILURE TO REGISTER UNDER STATE BLUE SKY LAWS __________________________________________________________ The U.S. District Court for the District of Columbia ruled in favor of the SEC in an action brought against a family of mutual funds, the adviser to the funds and the principal officer of the adviser and each of the funds for violating federal securities laws stemming from the defendants' failure to register shares of the funds under state securities laws. The SEC alleged a number of causes of action against the defendants including violations of the Securities Act (Section 17(a)), the Investment Company Act (Sections 22(c), 34(b), and 15(a); rule 22c-1), the Investment Advisers Act (Sections 204 and 206(1), (2) and (4)) and the Exchange Act (Sections 10(b) and 17A(d)(1); rules 10b-5 and 17Ad-13(a)). The funds changed their manner of business in the early 1970's and closed their sales offices, terminated their sales personnel, and operated thereafter strictly on a "mail order" basis. In connection with this change, the funds ceased renewing their registrations under state Blue Sky laws and allowed then existing registrations to lapse. The defendants asserted that their decision to discontinue state registrations was based on an opinion of counsel that such registration was not required. The defendants took the position that sales were only effected in the District of Columbia, where the adviser maintains its principal office, a jurisdiction that does not require registration. The SEC argued that as a result of the funds' shares not being registered under state Blue Sky laws (which they were required to have been since the funds have shareholders in all fifty states), the funds accrued undisclosed and unrecognized liabilities for fees, penalties, and shareholder rescission suits. (The SEC estimates that the unpaid registration fees ranged from $694,020 to $3.4 million). As a result of the defendants' failure to recognize these liabilities from 1971 to 1989, the court found that the funds materially misstated the net asset value of the funds' shares and omitted from the funds' financial statements and prospectuses material information relating to any liabilities or potential liabilities resulting from their failure to register under state law. It is of particular significance that with respect to the issue of materiality, the court found that "defendants have failed to refute that a reasonable shareholder of mutual fund shares would find an omission of one cent or more per share material." In support of its finding, the court cited to the testimony of Gene Gohlke (then Acting Director of the Division of Investment Management) that "in the mutual fund industry the most important indicator of materiality is NAV, which is calculated daily to the nearest penny" and took judicial notice that financial publications report daily changes of one cent or more in mutual fund shares. A copy of the court's Order and Memorandum are attached. We will keep you informed of developments. Amy B.R. Lancellotta Assistant General Counsel Attachment