September 28, 1994
TO: BOARD OF GOVERNORS NO. 98-94
CLOSED-END FUND MEMBERS NO. 29-94
MEMBERS - ONE PER COMPLEX NO. 69-94
SEC RULES MEMBERS NO. 68-94
RE: SEC STAFF REPORT ON PERSONAL INVESTING BY INVESTMENT
COMPANY PERSONNEL
__________________________________________________________
The SEC yesterday released the Division of Investment
Management's long-awaited report on "Personal Investment Activities
of Investment Company Personnel." The significant aspects of the
Report are briefly summarized below and a copy of the Report is
attached.
Findings
The Report sets out the results of the staff's examination of
the personal investment activities of fund managers employed by 30
fund groups and the restrictions and procedures placed on those
activities by the fund groups. In addition, the Report analyzes
Section 17(j) of the Investment Company Act of 1940 and Rule 17j-1
thereunder, which are the principal provisions regulating the
investment activities of fund personnel. Finally, the Report
includes an assessment of the recommendations included in the
Report of the Institute's Advisory Group on Personal Investing (the
"Advisory Group Report").
The data reviewed by the staff "indicates that fund managers
generally have not engaged in extensive investing for their
personal accounts" and that "[w]hen engaging in [such]
transactions, fund managers appear to avoid potential conflicts of
interest situations." There were, however, a small group of funds
who reported extensive personal investment activity by their fund
managers. In several instances, fund personnel reportedly
purchased or sold securities shortly ahead of their funds. The
staff is currently examining such transactions.
Recommendations
Based on these findings, the Report concludes that the
existing regulatory framework governing the personal investment
activities of fund personnel generally has worked well, but could
be improved. The Report's recommendations are as follows:
C The Commission should require every fund to publicly
disclose its policies regarding personal investing by
fund personnel;
C The Commission should require each fund's board of
directors or trustees to review the fund's code of ethics
and compliance matters relating to the code at least
annually;
C The Commission should require fund personnel to disclose
to their employers their personal securities holdings at
the commencement of employment;
C The National Association of Securities Dealers, Inc.
("NASD") should be asked to consider adopting a rule
requiring its member broker-dealers to notify a fund's
investment adviser when one of the adviser's employees
opens a brokerage account and, upon request, to transmit
duplicate trade confirmations and account statements to
the adviser;
C The NASD should be asked to consider prohibiting the
participation by certain personnel in "hot issue" public
offerings; and
C Section 17(j) of the 1940 Act should be amended to
include purchases and sales of instruments other than
securities (such as futures and commodities), and to
clarify that the Section also applies to transactions by
a fund's access persons involving securities and other
instruments related to, but not necessarily the same as,
securities held or to be acquired by the fund.
Ban on Personal Trading; Advisory Group Report's Recommendations
The Report states that in developing these recommendations,
the staff also considered two additional issues that have been the
subject of public discussion. Those include whether personal
investing by access persons should be banned entirely and whether
the standards of conduct recommended by the Advisory Group Report,
or other similar or comparable standards, should be mandatory for
all unds through Commission rules.
Ban on Personal Investing
The staff's decision not to recommend a ban on personal
trading was based on several factors. First, the staff determined
that a ban was not warranted based on its findings that potentially
abusive transactions comprised a small percentage of all personal
securities transactions by fund insiders. Second, the majority of
personal transactions do not create the potential conflicts of
interest with fund shareholders that Section 17(j) and Rule 17j-1
were designed to prevent. Thus, rather than protecting
shareholders, a ban on personal trading could harm them because it
might cause talented individuals to work for money managers not
subject to the 1940 Act. Finally, the staff was not convinced that
a ban would curb further abusive trading by fund insiders.
Advisory Group Report's Recommendations
The Report commends the Advisory Group for "taking a decisive
initiative in addressing the conflicts of interest that can result
from personal investing by fund personnel." Moreover, the Report
states that the staff expects "all funds to adopt the [Advisory
Group] Report's recommendations, in whole or in substantial part,
absent special circumstances." The staff concluded, however, that
these recommendations should not be adopted as Commission rules
because of the need for flexibility in designing codes of ethics
and because no one set of standards would be appropriate for every
fund.
The staff intends to monitor whether funds are adopting the
Advisory Group Report's recommendations. Specifically, the staff
will request a report from the Institute as to the number of
members that have adopted the recommendations and any interpretive,
administrative, or other problems that members have experienced in
implementing the recommendations. On the basis of that report, the
staff may reconsider amending Rule 17j-1 to provide for uniform
code of ethics standards.
Chairman Levitt's Endorsement of the Staff's Report
The staff's Report was released at a hearing held yesterday
before the House Subcommittee on Telecommunications and Finance
concerning, among other things, personal investing activities of
investment company personnel. Chairman Levitt's testimony endorsed
the Report's recommendations. Specifically, he stated that the
Commission "intends to move quickly to put in place several of the
Report's recommendations." He also expressed the view that "these
initiatives, together with the industry's general acceptance of the
principles reflected in the [Advisory Group] Report, will enhance
ethical standards throughout the fund industry and thereby bolster
investor confidence."
Paul Schott Stevens
General Counsel
Attachment