SEC Proposes Fund Subadviser and Short Sale Rules; Adopts Changes to Rule 10b-18


Washington, D.C., Oct. 22, 2003 -- The Securities and Exchange Commission today voted to propose a new rule and rule amendments concerning shareholder approval of subadvisory arrangements at investment companies; to amend Rule 10b-18 and related disclosure regulations; to propose new rules and rule amendments and issue an interpretive release dealing with regulation of short sales.

The Commission decided to propose new Rule 15a-5 under the Investment Company Act and amendments to Form N-1A under the Securities Act of 1933 and the Investment Company Act. The amendments would allow an investment adviser to serve as a subadviser to an investment company (fund) without shareholder approval, under certain conditions.

The Investment Company Act prohibits an investment adviser from serving a fund unless the fund's shareholders have voted to approve the adviser. In the past ten years, many funds have begun to operate as "manager of managers" funds, in which the principal investment adviser does not directly manage the fund's portfolio investments, but instead hires and supervises other investment advisers (i.e., subadvisers) to manage the fund's investments.

In a manager of managers fund, the principal adviser changes subadvisers based on their performance, much as a fund's investment adviser changes its portfolio manager employees based on their performance. The ability to hire and fire subadvisers without the delay and expense of a shareholder vote benefits shareholders by allowing the fund to quickly terminate a poorly performing subadviser and hire another. Therefore, the Commission has issued exemptive orders to funds that have sought to operate in this way, and the proposed amendments would make this relief available to all manager of managers funds.

The rule amendments the Commission is proposing would exempt funds from the shareholder vote requirement if

  • hiring the subadviser would not increase management fees paid by shareholders;
  • the subadviser has an arm's length relationship with the principal adviser (i.e., it is not affiliated, except that a wholly-owned subsidiary of the principal adviser can be replaced by another wholly-owned subsidiary);
  • shareholders of the fund have authorized the fund to operate as a "manager of managers" fund; and
  • within 90 days after hiring a new subadviser, the fund notifies shareholders of the change.

A manager of managers fund would also be required to disclose in its prospectus that the principal adviser can retain and discharge subadvisers without shareholder approval, subject to board approval.

Comments on the proposed rule amendments will be due by Jan. 8, 2004.

The Commission also voted to adopt amendments to Rule 10b-18 under the Securities Exchange Act of 1934. Rule 10b-18 provides issuers with a safe harbor from liability for manipulation if they repurchase their common stock in the open market in accordance with the rule's manner, time, price, and volume conditions. The amendments will update the rule's provisions to reflect market developments since the rule's adoption including

  • easing the timing condition to allow issuers that meet an average daily trading volume and public float test to stay in the market longer and qualify for the safe harbor;
  • extending the safe harbor to certain after-hours repurchases;
  • amending the pricing condition to apply a uniform price limit for all issuers;
  • increasing the volume limitation to 100% of average daily trading volume following a market-wide suspension;
  • modifying the block exception to include block repurchases in applying the 25% average daily trading volume limitation, or alternatively, to purchase one block per week; and
  • stating the scope of safe harbor eligibility with respect to mergers, acquisitions and similar transactions.

To enhance the transparency of issuer repurchases, the Commission voted to adopt amendments to Regulations S-K and S-B, Exchange Act Forms 10-Q, 10-K, 10-QSB, 10-KSB, 20-F, and Form N-CSR under the Exchange Act and Investment Company Act of 1940 to require periodic disclosure of all issuer repurchases of equity securities, regardless of whether the repurchases are effected in accordance with Rule 10b-18. The amendments will require issuers to disclose, among other things, the total number of shares repurchased, the average price paid per share, and the number of shares repurchased as part of a publicly announced plan or program.

These provisions will be effective 30 days after publication in the Federal Register.

Finally, the Commission voted to propose new short sale regulation under Regulation SHO, which would modernize and replace Rules 3b-3, 10a-1, and 10a-2 under the Exchange Act. Regulation SHO would include the following.

  • A uniform short sale price test, Rule 201, applicable to exchange-listed and Nasdaq NMS securities, wherever traded, that would restrict all short sales to a price above the consolidated best bid
    • Proposed Rule 201 would incorporate some exceptions in current Rule 10a-1, and include additional exceptions to address situations involving locked and crossed markets, short sales executed at a volume weighted average price, broker-dealer executions of customer "long" sales on a riskless principal basis, and short sales by broker-dealers to fill customer limit buy orders as required by the federal securities laws or rules of the self-regulatory organizations.
  • A temporary Rule 202(T) that would suspend, on a two-year pilot basis, the operation of the proposed bid test of Rule 201 for a select group of liquid securities
  • New "locate" and delivery requirements under proposed Rule 203 to address abusive so-called naked short selling
    • Rule 203 would incorporate provisions of the existing SRO "locate" rules into a uniform Commission rule applicable to all equity securities, wherever they are traded.
    • Rule 203 would also impose additional requirements on securities that have a substantial amount of failures to deliver.
  • Rule 200 of Regulation SHO, which would define the term "short sale" to allow multi-service broker-dealers to aggregate their positions by separate trading units; and modify the definition of ownership of a security to address security futures products and unconditional contracts to purchase securities.

The Commission also voted to

  • propose amendments to Rule 105 of Regulation M (short selling prior to a public offering) to eliminate the shelf offering exception; and
  • issue an interpretive release providing all market participants with guidance regarding the use of "married put" transactions when aggregating positions under current Rule 3b-3 for determining compliance with current Rule 10a-1 and Rule 105 of Regulation M. A "married put" is the purchase of an option to sell (i.e., a put option) a certain number of securities at a particular price by a specified time, bought contemporaneously with the same number of underlying securities.

The Commission will solicit comment on the proposals for a period of 60 days following their publication in the Federal Register.

The full text of detailed releases concerning each of these items will be posted to the SEC Web site as soon as possible.

Last modified: 10/22/2003