May 20, 1992
TO: BOARD OF GOVERNORS NO. 37-92
SEC RULES MEMBERS NO. 19-92
CLOSED-END FUND MEMBERS NO. 25-92
INVESTMENT ADVISER MEMBERS NO. 23-92
SMALL FUNDS MEMBERS NO. 8-92
UNIT INVESTMENT TRUST MEMBERS NO. 33-92
RE: SEC ISSUES STAFF REPORT ON INVESTMENT COMPANY REGULATION
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The Securities and Exchange Commission today issued a staff
report prepared by the Division of Investment Management entitled
"Protecting Investors: A Half Century of Investment Company
Regulation." The Report includes the Division’s legislative and
regulatory recommendations on changes to the Investment Company
Act of 1940 and provisions of other federal securities laws
regulating investment companies. The Report incorporates many of
the comments the Institute submitted in connection with the
staff’s study. (See Memorandum to SEC Rules Members No. 70-90,
Members-One Per Complex No. 44-90, Closed-End Fund Members -One
Per Complex, Unit Investment Trust Members - One Per Complex,
dated October 9, 1990).
The Institute is sponsoring a special one-day conference on
the recommendations included in the Report on Tuesday, June 23 at
the Grand Hyatt Hotel in Washington, D.C. Details on the
conference are being sent under separate cover.
Set forth below is a summary of the staff’s recommendations
included in the Report. A copy of the Report is attached.
The Scope of the Investment Company Act
A. Asset-Backed Arrangements - The Division recommends
that the Commission adopt a rule exempting asset-backed
arrangements from the Investment Company Act, subject to
conditions intended to address investor protection concerns
presented by these arrangements. The Division’s proposal
recommends requiring that (1) the issuer hold only "eligible
assets" as defined in the Report (essentially, debt instruments),
(2) the issuer primarily hold the assets to maturity or for the
life of the issuer, (3) the issuer does not issue any redeemable
securities, (4) all of the issuer’s securities sold to public
investors be fixed-income securities rated in one of the two
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highest investment grade categories, and (5) the issuer’s assets
not needed for servicing be held in a segregated account by a
qualified trustee or custodian.
B. Private Investment Company Exceptions - The Report
includes several of the recent proposals submitted by the SEC to
Congress as part of its small business initiatives. These
proposals include (1) amending the Investment Company Act to add
a new exception for investment companies whose securities are
owned exclusively by such "qualified purchasers" as designated in
Commission rulemaking, (2) amending Section 3(c)(1) (the private
investment company exemption) to simplify the existing
shareholder attribution provision for applying the 100 investor
limit therein, and (3) amending Section 12(d)(1) to make both
private investment companies and the new "qualified purchaser"
pools subject to the limitations therein governing purchases of
securities of registered investment companies.
C. Pooled Investment Vehicles for Employee Benefit Plan
Assets - The Division recommends that the Commission propose
amending the Securities Act of 1933 to repeal the exemption from
registration for interests in pooled funding vehicles for
participant-directed defined contribution plans and to require
the delivery of prospectuses to plan participants who direct
their investments. In addition, the staff recommends amending
the federal securities laws to require the delivery of semiannual
and annual shareholder reports for the underlying investment
vehicles, including investment companies, to such plan
participants.
Cross-Border Sales of Investment Management Services
A. Internationalization and Investment Companies - The
Division recommends that the Commission propose amending Section
7(d) to permit operating foreign investment companies to sell
shares in the U.S. if they can demonstrate that they are subject
to regulation in their home country that serves the same purposes
as the investor protection provisions under the Investment
Company Act and that permitting their entrance into the U.S.
markets would be in the public interest.
The Division’s proposal would require the Commission, prior
to acting on applications for Section 7(d) orders, to enter into
bilateral regulatory memoranda of understanding with the
securities authorities in the country in which the operating
foreign investment company is organized, which would set forth
representations about the nature and extent of foreign
regulation. The Division believes that the memorandum of
understanding procedure would address the concerns expressed by
the Institute about the barriers facing U.S. funds when offering
shares abroad since the memoranda "would provide a mandate for
bilateral access to each country’s market."
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In addition, the Division suggests that the Commission
support tax law changes to enable U.S. funds securing access to
foreign markets to compete effectively with foreign investment
companies and continue to work with state regulators to eliminate
duplicative substantive regulation of investment companies, which
would ease compliance burdens for both domestic and foreign
funds.
B. The Investment Advisers Act of 1940 - With respect to
the applicability of the Advisers Act to an adviser’s activities
in connection with its foreign clients, the Division proposed
issuing no-action letters narrowing the applicability of the Act
in those instances in accordance with a "conduct" and "effects"
approach. Under this approach, a registered foreign adviser’s
dealings with clients outside of the U.S. generally would not be
regulated under the Act. However, a registered domestic
adviser’s dealings with foreign clients where a sizable amount of
adviser conduct occurs in the U.S. would be subject to the Act.
C. Performance Based Advisory Compensation - The Division
recommends that the Commission propose amending the Advisers Act
to grant the Commission rulemaking authority to allow U.S.
registered advisers to enter into performance fee contracts with
(1) non-U.S. clients to the extent that these compensation
arrangements are lawful in the clients’ home jurisdiction and (2)
clients who the Commission determines by regulation do not need
the protections of the prohibition, based on factors such as
wealth and financial sophistication.
Regulation of Investment Companies
A. Investment Company Governance - The Division recommends
that the Commission propose amending the Investment Company Act
to require that the minimum proportion of independent directors
on investment company boards be increased from forty percent to a
majority and that independent vacancies be filled by the
remaining independent directors. The Division’s proposal also
would give the independent directors the authority to terminate
advisory agreements.
In addition, as recommended by the Institute, the staff
proposes that the Commission amend certain rules under the Act to
streamline requirements for board review and approval of foreign
custody arrangements, domestic securities depositories, and the
time of day for determining net asset value.
B. Shareholder Voting Requirements - The Division
recommends that the Commission propose amending the Act to
eliminate requirements that shareholders ratify the initial
advisory agreement, concur in the board’s selection of fund
auditors, or approve changes in relatively routine investment
policies. The Division also recommends that the Act be amended
to classify as fundamental a fund’s investment objectives,
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thereby requiring shareholder approval of any changes in those
objectives.
In addition, the Division proposes that the Commission
eliminate the requirement that shareholders ratify the initial
Rule 12b-1 plan of a newly organized fund.
Distribution of Mutual Fund Shares
A. Section 22(d) - The Division recommends that the
Commission propose amending Section 22(d) of the Act to repeal
the price maintenance requirement thereunder and replace it with
authority for the Commission to issue orders or rules to limit
the sale of redeemable securities at prices other than the prices
set forth in a fund’s prospectus.
B. Other Distribution Financing Issues - In its Report,
the Division suggests that the Commission should adopt (1) its
outstanding rule (proposed Rule 6c-10) to permit deferred loads,
including installment loads assessed directly on a shareholder’s
account, (2) limited amendments to Rule 12b-1 consistent with the
continued use of spread loads and the proposal by the NASD to
regulate these loads under its maximum sales load rule, and (3) a
new exemptive rule to permit multiple class arrangements.
Unified Fee Investment Companies
The Division recommends that the Commission propose
amending the Act to permit a new type of investment company -- a
unified fee investment company ("UFIC"). A UFIC would have a
single, fixed fee, set by its investment manager, and no sales
charges or redemption fees. All UFIC expenses, except brokerage
commissions on the fund’s own portfolio transactions and
extraordinary costs, would be paid from the fee or the manager’s
own resources. Rule 12b-1 would not apply. Under this proposal,
the Act would prohibit "unconscionable or grossly excessive"
unified fees. The fee would not require shareholder or director
approval nor would it be subject to private litigation.
Mutual Fund Advertising
The Division recommends that the Commission propose
amending the Securities Act to add a new provision for an
"advertising prospectus" for mutual funds, the contents of which
would not be restricted to information "the substance of which"
is contained in the statutory prospectus. The Division’s
proposal also suggests rescinding the special provisions in the
tombstone rule for mutual funds.
In addition, the Division recommends that the Commission
adopt amendments to Rule 482 of the Securities Act to permit
mutual funds to sell shares directly from advertisements ("off-
the-page"). Off-the-page advertisements would be required to
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contain standardized, core information about the fund, such as
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fees and expenses, performance data, investment objectives, and
risks. The advertisements also would be required to inform
investors about the availability of a statutory prospectus, and
the fund still would be required to deliver a statutory
prospectus to investors prior to, or with, the earlier of the
confirmation of the sale or the delivery of the security. In
addition, off-the-page advertisements would still be subject to
prospectus liability under Section 12(2) of the Securities Act.
Variable Insurance Products
The Division recommends that the Commission propose
legislation to amend Sections 26 and 27 of the Act to exempt
variable insurance contracts from the specific charge limitations
under those provisions. The amendment also would provide the
Commission with rulemaking authority to establish standards of
reasonableness for fees and charges if the market should fail to
provide competitive prices or if abusive industry practices
should develop. In connection with this proposal, the Division
states that it will give priority to the development of a
registration form for variable life insurance and standardized
illustrations for variable insurance contracts.
Repurchases and Redemptions of Investment Company Shares
The Division recommends that the Commission adopt (1) a
rule under Section 23 of the Act defining the circumstances under
which closed-end funds may make periodic repurchase offers and
(2) a rule under Section 22(e) permitting open-end funds to make
redemptions on a periodic basis (e.g., monthly, quarterly) or
with an extended period of payment (i.e., longer than seven days,
as currently required). As part of these proposals, the Division
recommends that the Act be amended to add an express requirement
of portfolio liquidity for all open-end funds and for closed-end
funds making periodic repurchases.
Affiliated Transactions
The Division recommends limited changes to the rules
governing affiliated transactions. Specifically, the Division
recommends that the Commission propose changes to Rule 17d-1 to
permit the directors, including the independent directors, to
review and approve all joint transactions with remote affiliates
and also to permit all joint transactions where the investment
company and its affiliates participate on the same terms, except
for the amount of the participation. In addition, the Division
recommends amending Rule 10f-3, which allows limited purchases by
investment companies from underwriting syndicates that contain
affiliates, to permit purchases in overseas markets.
Procedures For Exemptive Orders
The Division recommends that the Commission adopt a rule to
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permit expedited treatment of exemptive applications where there
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is available precedent. Under the proposed procedure, applicants
generally would receive relief no later than 120 days after
filing an application. In addition, the Division recommends that
the Commission expand the Division’s delegated authority to
expedite review of applications.
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We will keep you informed of developments relating to the
legislative and regulatory proposals recommended in the
Division’s Report.
Craig S. Tyle
Vice President - Securities
Attachment