Securities and Exchange Commission

17 CFR Parts 239, 240 and 274

Release Nos. 33-8358; 34-49148; IC-26341; File No. S7-06-04

RIN 3235-AJ11; 3235-AJ12; 3235-AJ13; 3235-AJ14

Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain Mutual Funds and Other Securities, and Other Confirmation Requirement Amendments, and Amendments to the Registration Form for Mutual Funds

Agency: Securities and Exchange Commission.

Action: Proposed rule.

Summary: The Securities and Exchange Commission is proposing two new rules and rule amendments under the Securities Exchange Act of 1934 that are designed to enhance the information broker-dealers provide to their customers in connection with transactions in certain types of securities. The two new rules would require broker-dealers to provide their customers with targeted information, at the point of sale and in transaction confirmations, regarding the costs and conflicts of interest that arise from the distribution of mutual fund shares, unit investment trust interests (including insurance securities), and municipal fund securities used for education savings. The Commission is also proposing conforming amendments to its general confirmation rule, as well as amendments to that rule to provide investors with additional information about call features of debt securities and preferred stock. Finally, the Commission is proposing amendments to Form N-1A, the registration form for mutual funds, to improve disclosure of sales loads and revenue sharing.

Dates: Comments must be submitted on or before April 12, 2004.

Addresses: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following E-mail address: rule-comments@sec.gov. All comment letters should refer to File No. S7-06-04; this file number should be included on the subject line if E-mail is used. Comment letters will be available for inspection and copying in the Commission's Public Reference Room at the same address. Electronically submitted comment letters will be posted on the Commission's Internet Web site (http://www.sec.gov).¹

For Further Information Contact: With respect to Securities Exchange Act rules 10b-10, 15c2-2, and 15c2-3, contact Catherine McGuire, Chief Counsel, Paula R. Jenson, Deputy Chief Counsel, Joshua S. Kans, Special Counsel, or David W. Blass, Attorney, at 202/942-0073, Office of Chief Counsel, Division of Market Regulation, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-1001.

With respect to Form N-1A, contact Tara L. Royal, Senior Counsel, Office of Disclosure Regulation, at 202/ 942-0721, Division of Investment Management, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0506.

Supplementary Information: The Securities and Exchange Commission ("SEC" or "Commission") is publishing for comment proposed rules 15c2-2 and 15c2-3, as well as amendments to rule 10b-10 under the Securities Exchange Act of 1934 ("Exchange Act") and proposed amendments to Form N-1A under the Securities Act of 1933 ("Securities Act") and the Investment Company Act of 1940 ("Investment Company Act").

Table of Contents

1. Executive Summary
    
2. Introduction
    
3. Special Request for Comments from Investors
    
4. Improved Confirmation Disclosure for Transactions in Mutual Fund Shares, Unit Investment Trust Interests and 529 Plan Interests
    
5. Point of Sale Disclosure for Transactions in Mutual Fund Shares, Unit Investment Trust Interests and 529 Plan Interests
    
6. Prospectus Disclosure
    
7. Disclosure Related to Transactions in Callable Preferred Stock and Callable Debt Securities, and Other Amendments to Rule 10b-10
    
8. Paperwork Reduction Act Analysis
    
9. Costs and Benefits of the Proposed Rule and Rule Amendments
    
10. Consideration of Burden on Promotion of Efficiency, Competition, and Capital Formation
     
11. Consideration of Impact on the Economy
     
12. Initial Regulatory Flexibility Analysis
     
13. Statutory Authority

Text of Proposed Rules

I. Executive Summary

The Commission is publishing for comment two proposed new rules and rule amendments under the Exchange Act. The proposed new rules seek to improve investor access to material information about investments in open-end management investment company securities, unit investment trust interests, and municipal fund securities used for education savings. The proposals would accomplish that by requiring brokers, dealers and municipal securities dealers² to make additional disclosures, beyond those currently required, in transaction confirmations that they provide to customers at the time of a transaction, and also by requiring point of sale disclosure of material information prior to the transaction.

The proposed new confirmation rules would require brokers, dealers and municipal securities dealers to provide customers with information about distribution-related costs that investors incur when they purchase those types of securities. The confirmation rule proposals would also require disclosure of distribution-related arrangements involving those types of securities that pose conflicts of interest for brokers, dealers and municipal securities dealers, as well as their associated persons. These disclosures would promote more informed decision-making by investors in securities issued by open-end management investment companies (also referred to here as "mutual funds" or "funds"), interests issued by unit investment trusts or "UITs" (including insurance company separate accounts that offer variable annuity contracts and variable life insurance policies) and securities issued by education savings "529" plans.

The proposed new point of sale disclosure rule would require brokers, dealers and municipal securities dealers to provide point of sale disclosure to customers about costs and conflicts of interest. In contrast to confirmation disclosure, which a customer will not receive in writing until after a transaction has been effected, point of sale disclosure would specifically require that investors be provided with information that they can use as they determine whether to enter into a transaction to purchase one of those types of securities.   

The proposed new point of sale disclosure and confirmation rules and rule amendments also would clarify that the rules do not provide safe harbors for activity that would violate the antifraud provisions of the federal securities laws or other legal requirements.

We are also proposing amendments to the Commission's general confirmation rule to require broker-dealers to provide customers with additional information in connection with transactions in callable preferred stock and debt securities, and to make additional conforming and technical changes to the rule.

Finally, we are proposing to amend Form N-1A, the registration form used by mutual funds to register under the Investment Company Act and to offer their securities under the Securities Act, to require improved disclosure regarding sales loads and revenue sharing arrangements.

In proposing this rule, we have requested comments on a variety of issues. We wish to emphasize that we particularly hope to receive comments from investors. As part of this proposed rulemaking, we have also proposed new forms for confirmation disclosure and point of sale disclosure. We want to know whether the forms clearly communicate the information that investors need to make investment decisions, and whether the forms will provide investors with the information they need, at the time they need it.

II. Introduction

The Commission is proposing new rule 15c2-2 under the Exchange Act, which would govern the obligations of brokers (including municipal securities brokers),³ dealers and municipal securities dealers to disclose transaction-related information in confirmations or other documents when customers buy or sell certain investment company securities and municipal fund securities.⁴ The Commission also is proposing new rule 15c2-3 under the Exchange Act, which would govern the obligation of brokers, dealers and municipal securities dealers to disclose information to investors prior to effecting transactions in those securities.

The proposed new rules respond to concerns that investors in mutual fund shares, UIT interests (including certain insurance company separate accounts that issue variable insurance products) and municipal fund securities used for education savings lack adequate information about certain distribution-related costs, as well as certain distribution arrangements, that create conflicts of interest for brokers, dealers, municipal securities dealers, and their associated persons. Those costs and other distribution arrangements have evolved substantially since 1977, when the Commission adopted its general confirmation rule, rule 10b-10.⁵ We believe that disclosure of information about those costs and conflicts can help investors make better informed investment decisions.

Proposed rule 15c2-2 would require specific confirmation disclosure of information about front-end and deferred sales fees ("loads") and other distribution-related costs that directly impact the returns earned by investors in mutual fund shares, UIT interests and 529 plan securities. It also would require brokers, dealers and municipal securities dealers to disclose their compensation for selling those securities, and to disclose information about revenue sharing arrangements and portfolio brokerage arrangements that create conflicts of interest for them. Moreover, the proposed rule would require brokers, dealers and municipal securities dealers to inform customers about whether their salespersons or other associated persons receive extra compensation for selling certain fund shares or fund share classes.

As part of this rulemaking process, the Commission intends to withdraw a no-action letter that the Commission's Division of Market Regulation granted to the Investment Company Institute ("ICI") in 1979, related to confirmation disclosure of mutual fund sales loads and related fees.⁶ The relief granted by that letter is inconsistent with proposed rule 15c2-2, which would mandate specific disclosure of load information on customer confirmations.

To avoid redundancy with proposed new rule 15c2-2, we are also proposing to modify rule 10b-10 to exclude certain transactions in mutual fund shares and UIT interests from the rule's scope, and to make other changes consistent with proposed rule 15c2-2.⁷ In addition, we are proposing to modify rule 10b-10 to clarify, consistent with proposed rule 15c2-2, that the rule does not provide a safe harbor for activity that would violate the antifraud provisions of the federal securities laws or other legal requirements.

Because confirmation disclosure does not provide information to investors prior to transactions in securities — i.e., at the time they make investment decisions — we also are proposing new rule 15c2-3 to require brokers, dealers and municipal securities dealers to provide point of sale disclosure to customers prior to effecting transactions in mutual fund shares, UIT interests and 529 plan securities. The proposed rule would enable investors to see transaction-specific information about distribution-related costs, and about remuneration arrangements that lead to conflicts of interest for their brokers, dealers or municipal securities dealers. That information would enable investors to better understand the costs and conflicts associated with investments in those securities prior to entering into transactions, which should promote better informed investment decision-making. The Commission also proposes to amend Form N-1A⁸ to require improved disclosure by mutual funds regarding sales loads and revenue sharing arrangements.

In addition, the Commission also proposes to amend rule 10b-10 to require broker-dealers to disclose whenever preferred stock can be called by the issuer. Rule 10b-10 requires similar disclosure for transactions in debt securities that are callable by the issuer. The Commission further proposes to amend rule 10b-10 to require disclosure of the date of first call for certain transactions in callable debt securities.

III. Special Request for Comments from Investors

Brokers may have conflicts of interest when they sell mutual funds and other investments. For instance, your broker may get paid more if you purchase one fund over another, or the broker may receive other fees or payments from a fund for selling its shares.

We have proposed two new forms that would require brokers to tell you how much you must pay when you buy a particular fund and how much your broker and the firm will receive for selling that fund. These two forms are designed to provide you with information at two points in time — either orally or in writing immediately before your broker places the order (which is also called the "point-of-sale") and in a written confirmation statement after the transaction occurs. The purpose of the forms is to give you enough information so that you can understand what conflicts your broker and the firm have. That way, when a broker recommends a particular fund, you can assess with full knowledge whether the investment is better for you or for your broker.

We want to know whether the forms clearly communicate the information you need to make your investment decisions. If not, why not? We further want to know whether the forms will provide you with the information you need at the time you need to receive it. If not, when would you want to receive the information? Finally, we would like to know what improvements, if any, you would make to the forms.

IV. Improved Confirmation Disclosure for Transactions in Mutual Fund Shares, Unit Investment Trust Interests and 529 Plan Interests

A. Investors Need Better Disclosure about Distribution-related Costs and Conflicts

1. Types of distribution-related costs and conflicts

This proposal is intended to improve investors' ability to obtain information about costs and conflicts arising from transactions in mutual fund shares, UIT interests, and municipal fund securities used for education savings.⁹ Open-end management investment company shares and UIT interests are securities issued by investment companies that are registered with the Commission under the Investment Company Act.¹⁰ Municipal fund securities — which are popularly known as "529" plans after the section of the Internal Revenue Code that governs the federal tax treatment of those securities — are issued by tuition programs that are sponsored by state governments to provide investment vehicles that parents and others can use to save for educational expenses.¹¹ While 529 plan securities differ from mutual fund shares because the states that issue those securities are not registered under the Investment Company Act, municipal fund securities can provide investors with investment alternatives that are similar to those provided by mutual fund shares. Moreover, the assets that underlie municipal fund securities may be invested in shares of registered investment companies.¹²

a. Distribution-related costs

Mutual fund investors may, directly or indirectly, incur distribution-related costs that can reduce their investment returns. The type and amount of those costs often vary among funds and among share classes issued by the same fund.¹³ Some mutual funds issue share classes that impose sales fees, or loads, on investors when they purchase the fund shares ("front-end" sales loads). Mutual funds may also sell share classes with sales loads that investors must pay when they redeem fund shares ("deferred" or "back-end" sales loads).¹⁴ The amount of the deferred sales load, generally calculated as the lesser of a percentage of the value of the initial investment or the account's value upon redemption, typically declines each year that the investor holds the shares, and eventually disappears entirely. Some mutual funds also use their assets to pay distribution-related expenses, including compensation of broker-dealers in connection with distributing fund shares, under plans adopted pursuant to rule 12b-1 under the Investment Company Act ("12b-1 fees").¹⁵ Sales loads and asset-based sales charges and service fees reduce the returns that investors earn on their mutual fund investments. Not all mutual funds are sold subject to front-end or deferred sales loads or impose asset-based sales charges and service fees.

b. Conflicts-of-interest

As discussed in detail below, broker-dealers that sell mutual fund shares to customers may participate in distribution arrangements that create conflicts of interest for the broker-dealers as well as their personnel. Those arrangements can give broker-dealers a heightened financial incentive to sell particular funds or share classes, and therefore may lead a broker-dealer to provide some groups of funds with heightened visibility and access to the broker-dealer's sales force, or otherwise influence the way that broker-dealers and their associated persons market those funds or share classes to customers. Those arrangements therefore pose special confirmation disclosure issues. Moreover, some of those arrangements may violate NASD rules, and the failure to disclose relevant information about those arrangements — regardless of whether disclosure specifically is required by the confirmation rules — also may violate the antifraud provisions of the federal securities laws.

As part of those distribution arrangements, broker-dealers that sell mutual fund shares generally earn sales fees from the fund's principal underwriter at the time of sale. Alternatively, the principal underwriter may pay the selling broker-dealer sales fees attributable to a particular sales transaction over time, for as long as the customer holds the shares purchased.¹⁶ The amount of those sales fees is not uniform, however, and a broker-dealer may receive a higher fee for selling a particular dollar amount of shares issued by one fund rather than shares issued by another fund, or for selling one share class rather than other share classes issued by the same fund and available to the customer.

Broker-dealers also may be paid in other ways for distributing fund shares, such as through revenue sharing payments from a fund's investment adviser.¹⁷ In some cases, a broker-dealer may receive payments from a fund or a fund's affiliates that are characterized as service fees, recordkeeping and transfer fees, seminar sponsorships or other types of payments that ostensibly compensate the broker-dealer for costs that it incurs as part of its mutual fund distribution activities.¹⁸ Broker-dealers may also be compensated for distribution through receiving commissions for portfolio transactions executed on behalf of the fund or affiliated funds, even though the broker-dealer may not necessarily execute those transactions.¹⁹

These types of distribution-related arrangements may give broker-dealers heightened incentives to market the shares of particular mutual funds, or particular classes of fund shares. Those incentives may be reflected in a broker-dealer's use of "preferred lists" that explicitly favor the distribution of certain funds, or they may be reflected in other ways, including incentives or instructions that the broker-dealer provides to its managers or its salespersons.²⁰ Such incentives create conflicts between broker-dealers' financial interests and their agency duties to customers.²¹

In addition to conflicts of interest at the firm level, associated persons of broker-dealers face conflicts arising from financial incentives that promote the sale of some shares or share classes — or "differential compensation." Associated persons may receive higher commissions when they sell shares of a particular fund than they would if they sold the same dollar amount of the shares of another fund.²² They may also receive higher commissions when they sell a particular class of shares within a fund than they would if they sold the same dollar amount of another share class within that same fund.²³ Other forms of differential compensation may include a broker-dealer waiving certain fees or reimbursement of certain expenses ordinarily borne by an associated person, when the associated person sells the shares of particular mutual funds. Broker-dealers may also sponsor sales contests that provide cash compensation to representatives and managers for meeting certain sales goals.²⁴ Associated persons, moreover, may receive additional fees in the years after a sale, such as fees that some funds pay to broker-dealers for providing shareholder services.²⁵ Each of those types of arrangements may motivate broker-dealer personnel to promote the sale of some funds over others. The funds that are favored by those arrangements may include proprietary funds that are affiliated with the broker-dealer, or funds whose advisers pay revenue sharing to the broker-dealer. Differential compensation may give the associated person an incentive to improperly limit the range of mutual fund choices presented to customers, or may affect the associated person's recommendations.

UITs, which include certain insurance company separate accounts that issue variable insurance products (i.e., variable annuity contracts and variable life insurance policies),²⁶ are subject to similar distribution-related costs and conflicts.

c. Costs and conflicts related to 529 plans

Compensation practices for municipal fund securities used for education savings, or "529" plans, raise many of the same issues. Those securities may be sold subject to loads that can reduce the returns they produce. At times, brokers, dealers and municipal securities dealers that distribute municipal fund securities also may participate in distribution-related arrangements that create conflicts of interest for them, including revenue sharing payments and the use of portfolio commissions to reward distribution. In some cases, a broker, dealer or municipal securities dealer chooses to distribute only the municipal fund securities issued by a particular state, and does not provide its customers with the opportunity to invest in 529 plans issued by other states, even though those other plans may have lower loads or lower expense ratios, or may provide state income tax benefits that are absent from the plans being offered.

The associated persons of brokers, dealers and municipal securities dealers selling 529 plans may also receive incentives, such as differential compensation, that create conflicts of interest for them. Moreover, in contrast to NASD rules applicable to the distribution of mutual fund shares, associated persons of brokers, dealers and municipal securities dealers are not generally precluded from receiving non-cash compensation for selling municipal fund securities.²⁷

2. Current confirmation disclosure requirements for mutual funds and municipal fund securities

Rule 10b-10 under the Exchange Act requires broker-dealers to disclose specific information to their customers about securities transactions.²⁸ While the rule generally directs broker-dealers to disclose the required information at or before the completion of each securities transaction,²⁹ broker-dealers may also disclose the information monthly or quarterly in limited situations, such as when a customer has entered into a periodic plan for purchasing mutual fund shares.³⁰ The rule requires disclosure of, among other information, the identity of the security, the number of shares purchased or sold, and the price at which the transaction was effected. When a broker-dealer acts as the customer's agent, it must also disclose the amount of the remuneration it receives from the customer. For agency transactions in which the broker-dealer also participates in the distribution of the securities, it must disclose the source and amount of remuneration that it receives from third parties.³¹

The Commission and its staff have taken the position, with respect to mutual fund transactions, that a broker-dealer may satisfy its rule 10b-10 obligations without providing customers with a transaction-specific document that discloses information about loads or third-party remuneration, so long as the customer receives a fund prospectus that adequately discloses that information. This position had its genesis in a statement by the Commission when it adopted rule 10b-10. In response to comments related to the rule's disclosure requirement about third-party remuneration, the Commission suggested that prospectus disclosure would be an adequate substitute for confirmation disclosure, explaining:

[I]n the case of offerings registered under the Securities Act of 1933, the final prospectus delivered to the customer should generally set forth the information required by the proviso with respect to source and amount of remuneration. . . . In such situations the information specified in the proviso need not be separately set forth in the confirmation.³²

In other words, the Commission was of the view that broker-dealer disclosure of third-party remuneration would be redundant if the customer received a prospectus disclosing that information.³³

The Commission's staff reflected that position in a 1979 letter to the Investment Company Institute, in which the Division of Market Regulation stated that it would not recommend enforcement action against broker-dealers that did not provide transaction-specific disclosure about mutual fund loads and related charges, so long as the customer received a prospectus that "disclosed the precise amount of the sales load or other charges or a formula that would enable the customer to calculate the precise amount of those fees."³⁴  

The Commission later discussed how Rule 10b-10 disclosure obligations apply to mutual fund transactions in an amicus brief filed with the Second Circuit in 2000.³⁵ That brief focused on the adequacy of prospectus disclosure by broker-dealers that received third-party remuneration — in the form of rule 12b-1 payments from funds and revenue sharing payments from fund investment advisers — in connection with sweeping customer funds into money market accounts. We concluded that the prospectus disclosure at issue substituted for confirmation disclosure, when the prospectuses included the information required to be disclosed by Form N-1A, including the maximum rule 12b-1 fees payable by the funds as a percentage of net assets, and noted the presence of "significant amounts" of non-rule 12b-1 payments by the funds' investment advisers. In arriving at that conclusion, we interpreted the rule 10b-10 Adopting Release as establishing the general principle that "delivery of a prospectus containing sufficient disclosure can satisfy a broker-dealer's obligations under Rule 10b-10." Recognizing that "there is no precise standard as to how much disclosure the Rule currently requires," we went on to note that the staff's 1979 letter, with its "precise amount" standard for prospectus disclosure of loads and related fees, did not apply to third-party remuneration because precision was not necessary to inform customers about conflicts of interest.

While the Commission has never directly addressed the disclosure of payments to a broker-dealer in the form of portfolio brokerage commissions, the same principles apply. Currently, if a prospectus is not delivered at or before completion of the transaction, or if the prospectus fails to disclose the fact that the fund pays portfolio brokerage commissions to broker-dealers that participate in distribution, or fails to disclose information about the degree of the resulting conflict, then the transaction confirmation must provide information about the source and amount of those payments.³⁶

In one case before the Second Circuit, we viewed the disclosures at issue as meeting the requirements of rule 10b-10, but we went on to state: "We are not saying that this is necessarily all the disclosure about these types of fees that should be required as a matter of policy."³⁷ We also noted that we had directed the staff to make recommendations to us about whether to require new disclosures or to refine the existing disclosures.³⁸ The Second Circuit also questioned whether the prospectus disclosure at issue adequately placed investors on notice about the receipt of those payments and any resulting conflicts of interest.³⁹ The rules we propose today address those concerns.

3. Concerns about the adequacy of current disclosure practices

The disclosure rules we are proposing are designed to respond to the ways in which the mutual fund industry and its distribution practices have evolved in the years since the 1977 adoption of rule 10b-10 and the staff's 1979 letter to the ICI.

During the past quarter century, the number of mutual fund customers, the value of mutual fund investments, and the number of mutual funds all have increased exponentially.⁴⁰ The public increasingly has placed retirement savings into mutual funds through individual retirement accounts and other retirement plans. In addition, distribution costs and broker-dealer conflicts have grown more complex. Since 1980, many funds have offered multiple share classes, including class B shares with deferred sales loads that can have the effect of obscuring the distribution costs borne by investors. Many mature funds continue to rely on rule 12b-1 fees to pay for distribution, even though those fees were intended by the Commission to be short-term tools for helping funds gather assets. The increase in the number of mutual funds has made broker-dealer "shelf space" more critical to investment companies, leading to revenue sharing and other distribution arrangements that quietly compensate broker-dealers for distribution. The growth of funds affiliated with broker-dealers has also generated special broker-dealer marketing incentives to promote the distribution of those affiliated "proprietary" funds. In addition, the development of fund "supermarkets" sponsored by broker-dealers has led to related arrangements in which a fund or its affiliates compensates broker-dealers in ways that are not generally disclosed to investors. Moreover, the introduction of highly promoted 529 plans has brought many new investors into products that themselves invest in mutual funds and that are associated with similar distribution-related costs and conflicts.

Those changes raise significant concerns about the adequacy of current disclosure practices. For example, we are concerned that some investors may misunderstand the costs associated with purchasing mutual fund shares and 529 plan securities because they lack transaction-specific confirmation and point of sale information about loads and fees.

In late 2002, in response to learning that some mutual fund investors did not receive appropriate volume discounts on the front-end sales loads they paid — commonly known as "breakpoint discounts" -NASD, the ICI, and the Securities Industry Association ("SIA") convened a task force to recommend industry-wide changes relating to breakpoints.⁴¹ The task force issued a report in July 2003 recommending, among other changes, that mutual fund confirmations include front-end sales load disclosure.⁴² The task force also recommended that the Commission staff revisit its 1979 letter to the ICI. ⁴³ While the task force was studying the issue, the Commission also received a rulemaking petition on behalf of a mutual fund customer asking the Commission to require broker-dealer confirmations to specifically disclose the front-end sales loads that customers incur with mutual fund transactions.⁴⁴

Our concerns, however, go beyond the adequacy of front-end load disclosure. More complete disclosure also may help customers understand the costs associated with purchasing fund share classes that carry deferred sales loads, as well as the potential conflicts of interest that broker-dealers and their associated persons have in connection with the sale of those share classes. For example, when the amount invested reaches certain breakpoint discount levels, associated persons of broker-dealers generally are paid more for selling class B shares than for selling shares of other classes. Because class A shares typically carry front-end sales loads while class B shares do not, some investors may be inclined to purchase class B shares believing that they are cheaper, even though class B shares generally carry contingent deferred sales loads and higher 12b-1 fees. NASD has issued an alert informing investors that, before purchasing class B shares, "you should determine whether this investment is in your interest, and not just in the interest of your broker or adviser who may receive higher commissions from the sale of Class B shares than other classes of fund shares."⁴⁵ In fact, questions have been raised about whether class B shares ever would be appropriate for most investors.⁴⁶ Recent enforcement actions have underscored how those types of compensation arrangements produce conflicts of interest that lead associated persons of broker-dealers to act against the interests of their customers.⁴⁷

Investors also lack information about whether their broker-dealers receive revenue sharing or other third-party remuneration to distribute particular mutual funds. Prospectus disclosure does not identify which individual broker-dealers receive revenue sharing, let alone quantify those arrangements. Yet the magnitude of revenue sharing payments — estimated in 2001 to be $2 billion annually⁴⁸ — suggests that those arrangements influence the mutual fund choices that broker-dealers and their representatives present to investors. Prospectus disclosure, moreover, is not designed to inform investors about whether their particular broker-dealers are compensated in other ways for distributing fund shares, such as by receiving commissions for fund portfolio brokerage transactions.

Broker-dealer compensation practices related to proprietary funds raise additional disclosure issues. In 1994, a committee was formed at the request of the Commission's Chairman to examine securities industry compensation practices, identify actual and perceived conflicts of interest, and identify "best practices" for controlling those conflicts. The committee raised a number of concerns in its 1995 report, including concerns about the practice of offering higher payouts for selling proprietary mutual funds. It recommended that broker-dealers pay identical commissions to registered representatives for selling proprietary and non-proprietary products within a product category.⁴⁹ While some broker-dealers followed that recommendation, its adoption has not been uniform.⁵⁰

In September 2003, NASD requested comment on proposed rules to require member firms to disclose certain information about revenue sharing and differential compensation to customers at account opening or, if no account is established, at the time the customer first purchases shares of an investment company.⁵¹ Stating that those compensation arrangements could create conflicts of interest for broker-dealers and their associated persons, NASD added, "Disclosure of revenue sharing and differential cash compensation arrangements would enable investors to evaluate whether a registered representative's particular product recommendation was inappropriately influenced by these arrangements." The Commission will consider the proposal in the event that NASD submits it as a proposed rule change. We note, however, that NASD's proposal is geared to giving customers generalized access to information about revenue sharing and differential compensation at the time the customer is evaluating potential mutual fund investments. That particular focus would complement the disclosures we propose today — which would improve disclosure of transaction-specific information about distribution-related costs and arrangements that lead to conflicts of interest. Investors who have access to relevant transaction-specific information about those costs and conflicts of interest should be better prepared to scrutinize the adequacy of the investment choices presented by their broker-dealers as well as the recommendations their broker-dealers make.⁵²

B. New Rule and Proposed Amendments Regarding Cost and Conflict Disclosure

1. Proposed rule 15c2-2

To provide investors with adequate access to information regarding the costs of their investments, as well as the conflicts of interest their broker-dealers face, the Commission is proposing a new rule to require brokers, dealers and municipal securities dealers to provide their customers with certain information in connection with certain transactions in mutual fund shares, UIT interests and 529 plan shares. Because those securities have special distribution and compensation practices, the Commission is proposing to address those disclosure requirements in a new rule, rather than in rule 10b-10. A broker, dealer or municipal securities dealer that misstates information in a confirmation delivered pursuant to proposed rule 15c2-2 with an intent to mislead may be subject to liability under the antifraud provisions of section 10(b) and rule 10b-5.

Proposed rule 15c2-2 would retain much of the disclosure framework of rule 10b-10, while also providing customers of brokers, dealers and municipal securities dealers with targeted cost and conflict information that is relevant to purchases and sales of those securities.⁵³ Accordingly, the preliminary note to proposed rule 15c2-2 would explain that the rule requires brokers, dealers and municipal securities dealers to provide specified information in writing to customers at or before completion of a transaction in certain investment company securities or municipal fund securities. The preliminary note also would state that rule 10b-10 would continue to set forth the confirmation requirements that apply to broker-dealer transactions in other securities. More generally, as is the case under current law, disclosure provided pursuant to the proposed rules would not derogate from a broker-dealer's other legal obligations to customers, such as in the context of making recommendations or suitability determinations.

a. No safe harbor from antifraud provisions or other legal requirements

Proposed rule 15c2-2, like rule 10b-10, would not function as a safe harbor for non-disclosure that constitutes deception or that otherwise violates a securities firm's legal obligations. Rather, it would provide a minimal benchmark for disclosing certain costs and conflicts related to the distribution of these securities, in a manner that would be accessible to investors and that could fit on a single piece of paper. In setting forth the minimum level of disclosure, the proposed rule also would not preclude additional disclosures, as appropriate. While we believe the information required to be disclosed under the proposed rule is material to investors, there may be other information that is material for purposes of alerting investors about the costs of these transactions and the conflicts raised by them.⁵⁴ That is true even in instances where the confirmation rules specifically address the categories of information at issue, but do not require disclosure of the information in question.

Accordingly, we propose to make that point explicit in the preliminary note to proposed rule 15c2-2. Currently, the preliminary note to rule 10b-10 explains that the confirmation disclosure requirements do not exhaust a firm's obligation under the general antifraud provisions of the federal securities laws to disclose additional information to a customer at the time of the customer's investment decision. We are aware, however, that a court has interpreted rule 10b-10 to limit disclosure obligations in a way that is inconsistent with our intent.⁵⁵ To clarify our intent, the preliminary note to proposed rule 15c2-2 would state that the confirmation disclosure requirements are not determinative of, and do not exhaust, a broker's, dealer's or municipal securities dealer's disclosure obligations under the antifraud provisions of the federal securities laws or under any other legal requirements.⁵⁶

b. Securities transactions covered

The disclosure requirements of proposed rule 15c2-2 would apply to transactions by brokers, dealers and municipal securities dealers⁵⁷ on behalf of customers in "covered securities." Proposed paragraph (f)(6) of rule 15c2-2 would define the term "covered security" as: (i) any security issued by an "open-end company," as defined by section 5(a)(1) of the Investment Company Act, that is not traded on a national securities exchange⁵⁸; (ii) any security issued by a "unit investment trust," as that term is defined by Section 4(2) of the Investment Company Act, other than an ETF that is traded on a national securities exchange or facility of a national securities association, or a unit investment trust that is the subject of a secondary market transaction⁵⁹; and (iii) any "municipal fund security." Proposed paragraph (f)(12) of rule 15c2-2 would define a "municipal fund security" as any municipal security that is issued pursuant to a qualified state tuition program as defined by Section 529 of the Internal Revenue Code [26 U.S.C. 529], and that is issued by an issuer that, but for the application of Section 2(b) of the Investment Company Act, would constitute an investment company within the meaning of Section 3 of the Investment Company Act.⁶⁰

• The Commission requests comment on the proposed definition of "covered security," including whether the definition appropriately encompasses all the types of securities having distribution practices that warrant targeted confirmation disclosure of information about distribution-related costs and conflicts.
   
• The Commission seeks comment on whether proposed rule 15c2-2 should encompass transactions in all UIT interests, given the differences in distribution practices between UIT interests and other securities within the scope of the proposed rule. While some UIT interests are associated with revenue sharing (e.g., revenue sharing with respect to the underlying funds of variable annuity contracts and variable life insurance policies), commenters are invited to address the extent to which revenue sharing and other arrangements that raise conflict of interest issues are not associated with the distribution of UIT interests.
   
• The Commission also seeks comment about whether proposed rule 15c2-2 should also apply to other types of investment company securities, such as ETF shares. Commenters moreover are invited to address whether the rule also should apply to closed-end investment companies generally, or to particular closed-end companies such as "interval funds" that make regular repurchase offers.⁶¹ Do transactions in closed-end company shares at those times raise the types of costs or conflicts that warrant proposed rule 15c2-2's disclosure requirements?
   
• We also request comment about whether persons other than brokers, dealers or municipal securities dealers also should be required deliver confirmations to investors pursuant to proposed rule 15c2-2. Commenters are invited to discuss whether other persons that participate in the distribution of covered securities — such as banks — are subject to the same or similar conflicts of interest as brokers, dealers and municipal securities dealers. Commenters also are invited to discuss whether the Commission should propose rules to require those other persons to disclose confirmation information on or before the completion of such transactions.
   
• In addition, the Commission requests comment on whether a transitional period is necessary to make adjustments necessary to deliver confirmations that comply with proposed rule 15c2-2.

c. Schedule 15C and the form of disclosure

Proposed rule 15c2-2 would require brokers, dealers and municipal securities dealers to disclose a range of cost and conflict information arising from transactions in covered securities. To be effective, this information would have to be disclosed in a manner that is clear and that provides useful context to investors.⁶² Thus, paragraph (a) of proposed rule 15c2-2 would require a broker, dealer or municipal securities dealer to make the required disclosures (other than disclosures subject to the periodic disclosure alternative, discussed below) in a manner that is "consistent with Schedule 15C" under the Exchange Act. Proposed Schedule 15C, which is set forth at Figure 1, would establish the format for disclosing the required information to investors. While much of the form would be standardized, we have included flexibility to accommodate implementation costs as well as the fact that confirmations are business forms traditionally utilized by brokers, dealers and municipal securities dealers for their own business purposes. Proposed Schedule 15C has six main parts: A, general information; B, distribution-cost information; C, broker-dealer compensation information; D, differential compensation information; E, breakpoint discount information, and F, explanations and definitions. Proposed paragraph (f)(4) of rule 15c2-2 would provide that the term "consistent with Schedule 15C" means using Schedule 15C, or using a similar layout of disclosure so long as: (i) all information specified in Schedule 15C is set forth in the confirmation; (ii) information specified in Sections B through F of Schedule 15C (if applicable) is included with no change, including the use of bold print for data items printed in bold in Schedule 15C, and in the order set forth in Schedule 15C; and (iii) information specified in Section A of Schedule 15C is displayed prominently.

Proposed Schedule 15C would not only provide the format for disclosing quantitative information about a transaction, but also would provide definitions and explanatory information intended to help make the quantitative information more useful to investors. By supplementing the required disclosures with explanations of the meaning of terms such as net asset value,⁶³ revenue sharing and portfolio brokerage commissions, and by explaining why investors may wish to scrutinize information about revenue sharing and differential compensation, proposed Schedule 15C is intended to help give investors the tools they need to ask the right questions and to make informed decisions. Attachments 1, 2 and 3 to this proposal set forth examples of confirmations that are consistent with Schedule 15C.

• We are not at this time proposing a form for disclosures made pursuant to proposed rule 15c2-2's periodic disclosure alternative. Because of the variance in the types of transactions that could be disclosed pursuant to this alternative, we do not believe that a standardized disclosure form would be appropriate. We request comment, however, on whether standardized disclosure should be required with respect to periodic disclosures. If so, should the format follow Schedule 15C? In the event a customer invests in multiple securities, including mutual fund shares, UIT interests and 529 plan securities, should the information pertaining to each be in a separate section? Alternatively, should there be separate forms for each category of investment. Commenters are invited to send prototype forms reflecting their view.
   
• The Commission also requests comment on whether proposed Schedule 15C is an appropriate template for disclosing information to customers. The Commission also requests comment on whether disclosure should be required to be in the exact form of proposed Schedule 15C, rather than merely consistent with it.
   
• The Commission further requests comment on whether it is appropriate for the proposed form of Schedule 15C to combine quantitative information with explanatory and definitional information. Commenters are invited to address the issue of whether the inclusion of both types of materials may conflict with the business purposes that confirmations fundamentally address. Commenters also are invited to discuss whether there are preferable alternatives for providing explanatory and definitional information that would permit investors to fully use the information set forth in the confirmation.

d. General and purchase-specific disclosure requirements

As outlined above, the disclosure requirements of proposed rule 15c2-2 in large part are based on existing rule 10b-10, with modifications to alert customers to targeted information about the special cost and conflicts raised by transactions in mutual fund shares and municipal fund securities.

Paragraph (a) of proposed rule 15c2-2 would provide that it is unlawful for any broker, dealer or municipal securities dealer to effect any customer transaction in, or to induce any customer purchase or sale of, any covered security unless the broker, dealer or municipal securities dealer complies with the requirements set forth in paragraphs (b), (c), (d) and (e) of the rule. Paragraph (b) would set forth general disclosure requirements under the rule. Paragraph (c) would set forth additional disclosures that customers shall receive when they purchase mutual fund shares, UIT interests and municipal fund securities, because purchase transactions implicate the costs and conflicts associated with the distribution of these securities. Paragraph (d) would set forth alternative requirements for periodic reporting. Paragraph (e) would set forth the requirement to disclose median information and comparison ranges for the types of information required under paragraphs (b), (c) and (d).

i. General disclosure requirements

Proposed paragraphs (b)(1) and (b)(2) of rule 15c2-2 would require disclosure of the date of the transaction, and the issuer and class of the covered security. Those requirements are similar to the requirements of rule 10b-10(a)(1). While rule 10b-10(a)(1) does not specifically mention share class, disclosure of class, when applicable, is necessary to identify the security.

Proposed paragraph (b)(3) of rule 15c2-2 would require disclosure of both the net asset value of the shares or units and, if different, their public offering price.⁶⁴ Rule 10b-10(a)(1) only requires disclosure of price. Fund share classes that charge front-end sales loads are sold to investors at a public offering price that exceeds the net asset value by the size of the load. Providing customers with information about both price and net asset value would help them verify whether they are obtaining the benefit of any applicable breakpoints, and would make the costs associated with front-end sales loads more transparent in general.

Proposed paragraph (b)(4) of rule 15c2-2 would require disclosure of the number of shares of a covered security purchased or sold by the customer. It also would require the total dollar amount paid or received in the transaction and the net amount of the investment bought or sold in the transaction, which would be equal to the number of shares or units bought or sold multiplied by the net asset value of those shares or units. Rule 10b-10(a)(1) requires disclosure of the number of shares. Specific disclosure of the dollar value of the transaction — equal to the number of shares bought or sold multiplied by the transaction price — would help safeguard against misunderstandings about the value of the transaction. Confirmations already typically contain information about the dollar value of the transaction, together with the price of the shares and the number of shares bought or sold.

Proposed paragraph (b)(5) of rule 15c2-2 would require disclosure of any commission, markup or other remuneration the broker, dealer or municipal securities dealer will receive from the customer in connection with the transaction. Rule 10b-10(a)(2)(i)(B) already requires disclosure of remuneration from customers. This remuneration is distinct from dealer concessions and other types of sales fees that a broker, dealer or municipal securities dealer may receive from the fund or its primary distributor. Remuneration from customers also is distinct from any sales load that the customer may pay in connection with a transaction. Both of those would be disclosed separately.⁶⁵ Under proposed paragraph (b)(5), a broker, dealer or municipal securities dealer often would not be required to disclose any information because the firm would receive all of its compensation from the issuer or distributor of the covered security, or other third parties, rather than directly from the customer. Proposed paragraph (b)(5) would require separate disclosure or commissions or other compensation from the customer, however, when a broker, dealer or municipal securities dealer, such as a fund "supermarket," charges its customer a commission or service fee for purchasing a fund.⁶⁶

Proposed paragraph (b)(6) of rule 15c2-2 would require disclosure, for any transaction in which a customer sells a covered security, of the amount of any deferred sales loads incurred by the customer. Rule 10b-10 does not explicitly require that disclosure, although rule 10b-10 does require disclosure of price, and the deferred sales load charged to a customer at the time of sale does affect the effective price that the customer receives. Disclosure of the deferred sales loads that customers incur when they sell their shares would make those distribution costs more transparent.⁶⁷

Proposed paragraph (b)(7) of rule 15c2-2, when applicable, would require disclosure of the fact that a broker, dealer or municipal securities dealer is not a member of the Securities Investor Protection Corporation ("SIPC"), or that the broker, dealer or municipal securities dealer clearing or carrying the customer account is not a member of SIPC.⁶⁸ That disclosure would not be required, however, if the customer sends funds or securities directly to, or receives funds or securities directly from, the issuer or its transfer agent, custodian, or other designated agent that is not an associated person of the broker, dealer or municipal securities dealer, and if that other person would provide disclosure on behalf of the broker, dealer or municipal securities dealer. This would be consistent with the disclosure requirement of rule 10b-10(a)(9).⁶⁹

• The Commission requests comment on whether these proposed general disclosure requirements would provide customers with adequate information about transactions in covered securities. Commenters particularly are invited to discuss whether all of these proposed general disclosure requirements are appropriate to transactions in securities that have a substantial insurance component, such as variable life insurance policies.⁷⁰
   
• Commenters may also wish to discuss whether all of these proposed general disclosure requirements are appropriate to transactions in variable annuities. Commenters are invited to discuss any issues they believe are relevant to the application of proposed rule 15c2-2 to variable insurance products, as well as any modifications they believe could improve the proposed rule's effectiveness as applied to variable insurance products. Specifically, commenters may wish to address whether alternative or additional disclosure requirements would provide investors with more useful information for transactions in variable insurance products. In addition, we invite comment on whether to use a single confirmation for transactions in both the contract or policy and the underlying funds. Commenters should address whether such a single confirmation is appropriate under the federal securities laws.

ii. Additional disclosures for purchases

Proposed rule 15c2-2(c) would require additional disclosures when customers purchase covered securities.

(a) Cost disclosure

Proposed paragraph (c)(1) of rule 15c2-2 would require disclosure of the amount of any sales load that the customer has incurred or will incur at the time of purchase, expressed in dollars and as a percentage of the net amount invested,⁷¹ together with information about the potential relevance of breakpoint discounts. Specifically, proposed paragraph (c)(1)(i) would apply if the customer will incur a sales load at the time of sale, and would require disclosure of information about the availability of breakpoints as reflected in Schedule 15C with regard to the covered security, including a statement about what is the applicable sales load that is set forth in the prospectus, in light of any breakpoint discount and the value of the securities position. In determining the value of the position that may be subject to a breakpoint discount, the broker-dealer should consider net asset value, public offering price, historic cost or any other measurement that reflects the covered security's particular method of providing breakpoint discounts. This proposed paragraph therefore requires disclosure not only of the sales load actually incurred at the time of purchase, but also the sales load that should have been charged based on the availability of breakpoint discounts.⁷²

Alternatively, proposed paragraph (c)(1)(ii) would apply if the customer will not incur a sales load at the time of sale, and would require disclosure of information about the availability of breakpoints as reflected in Schedule 15C with regard to a different class of the covered security, including a statement of the sales load that the customer would have incurred at the time of sale if the transaction had been in that different class of the covered security. In other words, for transactions in share classes without a front-end sales load, the proposed paragraph would require disclosure of information about the sales load that would have been charged had a share class with a front-end load been purchased.⁷³

Proposed paragraph (f)(17) of rule 15c2-2 would define "sales load" to have the meaning set forth in Section 2(a)(35) of the Investment Company Act.⁷⁴ Proposed paragraph (f)(13) would define "net amount invested" to mean the price paid to purchase the covered securities less any applicable sales loads. Proposed paragraph (f)(18) of rule 15c2-2 would define "securities position" to mean the value of the purchase of covered securities; the value of securities that are subject to rights of accumulation under the terms of the prospectus with respect to the covered security or a related class of the covered security, to the extent known by the broker, dealer or municipal securities dealer, including the value of such securities purchased in other accounts or by other persons; and the value of any such securities that are the subject of letters of intent that may be considered in computing a breakpoint with respect to the covered security or a related class of the covered security.

As discussed above, any sales load that an investor may pay to a fund's principal underwriter is distinct from the commission that the investor may pay to a broker, dealer or municipal securities dealer.⁷⁵ Providing customers with information about the amount of the sales load they pay when they purchase covered securities would enable them to more effectively monitor potential breakpoint discounts and would make the impact of distribution costs generally more transparent. Moreover, brokers, dealers and municipal securities dealers are well positioned to provide load information to customers on a transaction-by-transaction basis. Confirmation disclosure should make this information more readily accessible to customers, rather than expecting them to turn to a prospectus to calculate the amount of the load paid.⁷⁶

Proposed paragraph (c)(2) to rule 15c2-2 would require disclosure of the potential amount of deferred sales loads⁷⁷ (other than a deferred sales load of no more than one percent that expires no later than one year after purchase, when no other sales load would be incurred).⁷⁸ We recognize that broker-dealers would rarely, if ever, know in advance when an investor may redeem those shares, and therefore would generally not be able to disclose the specific amount of a deferred sales load. Investors nonetheless have an interest in seeing transaction-specific information about the potential cost of deferred sales loads. Deferred sales loads cannot exceed a specified percentage of the net asset value or the offering price at the time of purchase.⁷⁹ In practice, a deferred sales load may equal the lesser of a specified percentage of the net asset value at the time of purchase — which can be calculated as a dollar amount by multiplying that percentage by the net asset value and the number of shares purchased — or a specified percentage of the net asset value at the time of sale. Accordingly, proposed paragraph (c)(2) would require the broker, dealer or municipal securities dealer to disclose, on a year-by-year basis for as long as the deferred load may be in effect, information about the maximum amount of the load expressed in dollars. Proposed paragraph (c)(2) also would require disclosure of the maximum deferred sales load as a percentage of net asset value at the time of purchase or sale, as applicable.⁸⁰ This not only would improve the transparency of distribution costs, but also would promote balanced comparisons between the distribution costs associated with front-end load share classes and those associated with deferred sales load share classes.

Proposed paragraph (c)(3) of rule 15c2-2 would require disclosure of any asset-based sales charges and service fees paid in connection with the customer's purchase of covered securities. Proposed paragraph (f)(1) of rule 15c2-2 would define "asset-based sales charges" as all asset-based charges incurred in connection with the distribution of a covered security, paid by the issuer or paid out of assets of covered securities owned by the issuer. Proposed paragraph (f)(2) of rule 15c2-2 would define "asset-based service fee" as all asset-based amounts paid for personal service and/or the maintenance of shareholder accounts by the issuer, or paid out of assets of covered securities owned by the issuer. Those terms would encompass rule 12b-1 fees and any similar types of distribution or service fees incurred by issuers. Those terms, moreover, would be broad enough to require disclosure when the issuer of the covered security itself does not directly pay these fees, but instead invests in other covered securities that incur those fees.⁸¹ We recognize that because the amount of rule 12b-1 or similar fees would be linked to net asset value, a broker, dealer or municipal securities dealer would rarely, if ever, know in advance what amount of those fees would be attributable to the shares purchased in a particular transaction. This amount could be particularly uncertain because a fund's board of directors may later determine not to renew the fund's rule 12b-1 plan. The proposed rule therefore would require brokers, dealers and municipal securities dealers to disclose asset-based sales charges and asset-based service fees as a percentage of net asset value, and also to disclose an estimate of the total annual dollar amount of asset-based sales charges and asset-based service fees that would be associated with the shares purchased if net asset value were to remain unchanged (and assuming that the level of fees paid out of assets under a rule 12b-1 plan or similar distribution arrangement remains unchanged).

• The Commission requests comment on whether these requirements would provide customers with an appropriate amount of information about the amount of distribution-related costs they or the issuer would incur in connection with their purchases. If not, please describe additional disclosure that would be helpful. Commenters are specifically invited to comment on whether the proposed requirements related to deferred sales loads would provide disclosure that is sufficiently clear to customers.
   
• The Commission also requests comment on whether these requirements would appropriately be applied to all types of covered securities, or whether in certain circumstances the disclosure requirements should be modified or eliminated. Commenters in particular may wish to address how disclosure of front-end loads as a percentage of the net amount invested would apply to securities which include a life insurance component, such as variable life insurance policies, and whether alternative disclosure requirements would be preferable for those products.⁸² Commenters also may address whether all of these requirements are appropriately applied to variable annuities. Commenters should address whether and how up-front bonus payments on variable insurance products and the recapture of such bonus payments should be disclosed.
   
• The Commission further requests comment about how proposed Schedule 15C could best disclose sales loads and asset-based fees in percentage terms, based on the customer's investment. This disclosure needs to reflect the fact that while front-end sales loads will equal a percentage of the present value of the securities being purchased, deferred sales loads and asset-based fees can be a function of the future value of those securities. How can Schedule 15C best state those percentages in a way that is accurate and readily understood?⁸³

(b) Sales fee disclosure

Proposed paragraph (c)(4) of rule 15c2-2 would require disclosure of any dealer concession that the broker, dealer or municipal securities dealer earns in connection with the transaction, expressed in dollars and as a percentage of the net amount invested. Proposed paragraph (f)(8) of rule 15c2-2 would define "dealer concession" as fees that the broker, dealer or municipal securities dealer will earn at the time of the sale, in connection with the transaction, from the issuer of the covered security, an agent of the issuer, the primary distributor, or any other broker, dealer or municipal securities dealer. That amount would be distinct from the commission that the broker, dealer or municipal securities dealer may receive directly from the customer, as well as any load that the investor may pay to the fund's principal underwriter.⁸⁴ Because a dealer concession constitutes part of the broker's, dealer's or municipal securities dealer's financial stake in selling the security to the customer, the amount of that stake is relevant to customers so they can better scrutinize the adequacy of the investment options with which they were presented, as well as any recommendations they received.

• The Commission requests comment about whether this requirement is adequate to inform customers about the incentives associated with sales fees and, if not, suggestions as to how it could be modified to do so.

(c) Revenue sharing and portfolio brokerage disclosure

Proposed rule 15c2-2 also seeks to put customers on notice about the existence of arrangements that lead to conflicts of interest, and provide information about the degree of those conflicts. That goal cannot be satisfied by superficial changes, such as boilerplate confirmation language that may attract the attention only of those investors who already are attuned to the potential impacts of revenue sharing. For this reason, the proposed rule would place quantified information about the arrangements directly in front of investors, so they may immediately evaluate its importance and determine whether to seek additional information.

Proposed paragraph (c)(5) of rule 15c2-2 would require disclosure of information related to revenue sharing payments and portfolio securities transaction commissions received by the broker, dealer or municipal securities dealer. The proposed rule specifically would require disclosure of information about two types of arrangements: (i) revenue sharing payments from persons within the fund complex; and (ii) commissions, including riskless principal compensation, associated with portfolio securities transactions on behalf of the issuer of the covered security, or other covered securities within the fund complex.⁸⁵ Because revenue sharing and portfolio brokerage arrangements may be linked in part or in whole to a firm's success in distributing securities on behalf of an entire fund complex, the information would be disclosed on the basis of the firm's sales on behalf of the fund complex, rather than on a fund-by-fund basis.⁸⁶

Proposed paragraph (f)(16) of rule 15c2-2 would define "revenue sharing" as any arrangement or understanding by which a person within a fund complex, other than the issuer of the covered security, pays a broker, dealer or municipal securities dealer, or any associated person of the broker, dealer or municipal securities dealer, apart from dealer concessions or other sales fees that would be disclosed pursuant to paragraph (b)(4). This definition of revenue sharing would encompass payments that have a variety of labels — including payments that may be characterized as having purposes other than paying a broker, dealer or municipal securities dealer for "shelf space." For example, in responding to NASD's recent proposal regarding disclosure of revenue sharing and differential compensation, the SIA stated that revenue sharing arrangements are used to reimburse broker-dealers for a variety of expenses, such as reviewing fund prospectuses.⁸⁷ While recognizing that brokers, dealers or municipal securities dealers incur expenses in connection with selling and distributing mutual fund shares and maintaining customers accounts, just as they incur expenses in connection with selling other types of securities and maintaining those customer accounts, payments that arguably reimburse firms for these expenses may still influence the firms to promote the sale of particular funds. Moreover, payments that have the effect of reimbursing broker-dealers for expenses that they would incur in their normal course of business, or that exceed the expenses the broker-dealers actually incur, act as subsidies that create conflicts of interest. The proposed definition of revenue sharing excludes payments made by the issuer of the covered security, because those other payments, such as payments for transfer agent services, do not raise the same conflict of interest concerns that are the subject of this proposed rulemaking.⁸⁸

Proposed paragraph (f)(14) of rule 15c2-2 would define "portfolio securities transaction" as any transaction involving securities owned by the issuer of a covered security, or owned by any other issuer within the same fund complex. The required disclosure of commissions associated with portfolio transactions would include disclosure of commissions received by a broker, dealer or municipal securities dealer as part of a "soft dollar" arrangement. Proposed paragraph (f)(10) of rule 15c2-2 would define "fund complex" to include the issuer of the covered security (including the sponsor, depositor or trustee of a unit investment trust, and any insurance company issuing a variable annuity contract or variable life insurance policy), the issuer of any other covered security that holds itself out to investors as a related company for purposes of investment or investor services, any agent or investment adviser for such issuer, and any affiliated person of any such issuer or any such investment adviser.⁸⁹

For both revenue sharing and portfolio brokerage commissions, a broker, dealer or municipal securities dealer would be required to disclose information about amounts directly or indirectly earned from the fund complex by: (A) the broker, dealer or municipal securities dealer; (B) any associated person (as defined in Sections 3(a)(18) and 3(a)(32) of the Exchange Act) that is a broker, dealer or municipal securities dealer, and (C) if the covered security is not a proprietary covered security, any other associated person. Proposed paragraph (f)(15) of rule 15c2-2 would define the term "proprietary covered security" as any covered security as to which the broker, dealer or municipal securities dealer is an affiliated person, as defined by Section 2(a)(3) of the Investment Company Act, of the issuer, or is an associated person of the issuer's investment adviser or principal underwriter, or, in the case of a covered security that is an interest in a UIT, is an associated person of a sponsor, depositor or trustee of the covered security.

Those amounts should be disclosed as a percentage of the total net asset value represented by such broker's, dealer's or municipal securities dealer's (including brokers, dealers and municipal securities dealers that fall in category (B) above) total sales of covered securities (as measured by cumulative net asset value) on behalf of the fund complex over the four most recent calendar quarters, updated each calendar quarter. The required disclosure also would set forth the total dollar amount of revenue sharing or portfolio brokerage commissions that the broker, dealer or municipal securities dealer may expect to receive in connection with the transaction, calculated by multiplying that percentage by the net amount invested in the transaction. Firms would have 30 days to update the information following the end of the calendar quarter.⁹⁰

By requiring disclosure of information about amounts paid to affiliates, as well information about amounts paid directly to the broker, dealer or municipal securities dealer, the proposed rule would inform investors about the firm's conflicts of interest even when the firm does not directly receive payment. Amounts received by affiliates that are not brokers, dealers or municipal securities dealers would not be included with respect to transactions involving proprietary covered securities, to avoid requiring disclosure of management fees and other payments between funds and investment advisers and any other service providers that are associated with the broker, dealer and municipal securities dealer.⁹¹

Moreover, to the extent that the broker, dealer or municipal securities dealer has entered into a revenue sharing arrangement or understanding that would result in a specific amount of remuneration in connection with purchases of the covered security, the broker, dealer or municipal securities dealer would have to disclose that expected remuneration as a percentage of the net amount invested in the covered securities, and would have to disclose the total dollar amount of remuneration it may expect to receive in connection with the transaction.⁹²

Disclosing information about revenue sharing and portfolio brokerage commissions in the context of the firm's total sales on behalf of a fund complex, instead of simply disclosing the absolute dollar values the firm has received from the fund complex, would enable customers to see information about a firm's selling stake in a standardized manner, regardless of whether a customer's particular broker, dealer or municipal securities dealer is large or small, and regardless of whether the covered security is issued by a large or small fund complex.⁹³ Disclosure of this information would alert customers to the existence and magnitude of revenue sharing and portfolio commission arrangements that cause conflicts of interest for brokers, dealers and municipal securities dealers and their associated persons. At the same time, disclosure of the particular arrangements applicable to the transaction will provide information to investors about the most direct incentives for such transactions.

Proposed rule 15c2-2 is not intended to preempt or otherwise negate other provisions of law that may apply. We note that NASD rule 2830(k)(1) bars broker-dealers from favoring the distribution of funds that pay portfolio brokerage commissions.⁹⁴ We wish to stress that the proposal to require broker-dealers to disclose information about receipt of portfolio brokerage commissions in no way should be read to condone favoring distribution of funds that pay portfolio brokerage commissions, and would not prevent a broker-dealer from being held liable for violating that NASD rule. Moreover, a mutual fund that uses brokerage commissions to promote the distribution of another mutual fund may also be in violation of the Investment Company Act. Nor would proposed rule 15c2-2 protect a firm from other forms of liability, such as liability under agency law principles.

• The Commission requests comment on whether the proposed definition of revenue sharing appropriately encompasses all distribution arrangements that pose conflicts of interest to brokers, dealers and municipal securities dealers. Commenters particularly are invited to discuss whether the definition should include additional distribution-related arrangements that lead to conflicts of interest, such as distribution-related payments to other affiliates of brokers, dealers and municipal securities dealers. Commenters also are invited to discuss whether the definition should exclude certain arrangements that compensate brokers, dealers or municipal securities dealers for actual expenses they incur (such as mailing expenses) as part of activities that they would not generally be expected to perform as part of a securities business.
   
• In addition, commenters are invited to provide information about which specific payment streams would be encompassed by the proposed definition of revenue sharing, the dollar value of those payment streams, and the uses of those payments.
   
• Commenters also are invited to discuss whether the rule should use a term other than "revenue sharing," given that the proposed disclosure requirement would encompass more than the traditional use of the term "revenue sharing" in the mutual fund industry, which is limited to payments from an investment adviser to the broker, dealer or municipal securities dealer. Commenters suggesting alternative terms should explain why those are preferable. Moreover, commenters are invited to discuss whether the definition of revenue sharing appropriately excludes payments made by the issuer of the covered security, and whether the proposed rule should require disclosure of payments made out of the issuer's assets, such as transfer agent payments, that lead to conflicts, regardless of whether those payments already would be accounted for in fund financial statements and are subject to oversight by the fund's board of directors.
   
• More generally, the Commission requests comment on whether the proposal for disclosure of revenue sharing and portfolio brokerage arrangements would provide sufficient information to investors. Commenters particularly are invited to discuss whether firms should be required to disclose absolute dollar amounts of revenue sharing and portfolio commissions, in addition to or in lieu of disclosing those payments in percentage terms and in terms of the amount of the transaction. Commenters also are invited to discuss whether these arrangements more appropriately should be disclosed on a different basis than for 12 month periods, updated quarterly. We request comment on whether the proposed approach takes sufficient account of the fact that revenue sharing arrangements at times may consist of separate revenue streams arising from a firm's new sales of fund shares and its prior sales of fund shares. Given that it is conceivable that a fund complex may pay different levels of revenue sharing depending on the fund, or may pay revenue sharing only in connection with selected funds, commenters are invited to discuss whether the proposed approach can be improved to account for differences in revenue sharing practices between different funds in the same complex.
   
• Commenters also are invited to discuss whether, when calculating revenue sharing and portfolio brokerage commissions as a percentage of a broker's, dealer's, or municipal securities dealer's sales on behalf of a fund complex, that percentage should be based on all sales, or whether certain transactions such as transactions involving money market funds should be excluded from the denominator used to calculate those percentages. We also request comment on whether there are alternative ways to effectively inform investors of material information about arrangements that lead to conflicts of interest, while posing lower disclosure costs. In that regard, commenters may wish to discuss whether investors can be adequately informed about revenue sharing and portfolio commission arrangements through disclosures of approximate percentage ranges or dollar ranges, possibly in conjunction with checkboxes. Finally, commenters are invited to discuss whether disclosure of portfolio brokerage commissions is appropriate given existing restrictions on those relationships influencing fund distribution.⁹⁵

(d) Differential compensation disclosure

Proposed paragraph (c)(6) of rule 15c2-2 would require disclosure of whether a broker, dealer or municipal securities dealer pays differential compensation to associated persons related to purchases of two specific types of securities: (i) covered securities that carry a deferred sales load (other than a deferred load of no more than one percent that expires no later than one year after purchase, when no other sales load would be incurred),⁹⁶ and (ii) shares of "proprietary covered securities" that are issued by an affiliate of the broker, dealer or municipal securities dealer. If a customer purchased a proprietary covered security that carries a deferred sales load, both disclosures would be required. The proposed rule would provide for affirmative, negative or "not applicable" disclosure about differential compensation to alert customers to the presence of compensation practices that provide incentives leading to conflicts for associated persons.

Disclosure of differential compensation would be limited to transactions in those two types of securities because of the special concerns they raise. Securities that carry a deferred sales load — such as class B shares — may appear more appealing to investors than shares with a front-end sales load, but their long-term costs may be greater and the personnel of a broker, dealer or municipal securities dealer may be more highly compensated for selling them, particularly when the same investment in a share class with a front-end sales load would have been entitled to a breakpoint discount. Moreover, a broker, dealer or municipal securities dealer may pay its personnel extra compensation for selling securities of issuers affiliated with the broker, dealer or municipal securities dealer. While a broker, dealer or municipal securities dealer also may pay extra compensation for selling securities that generate revenue sharing, revenue sharing would be disclosed elsewhere on the confirmation.

The proposed rule would define the term "differential compensation" differently depending on the securities transaction at issue. With respect to customer purchases of a class of covered security associated with a deferred sales load (other than a deferred load of no more than one percent that expires no later than one year after purchase, when no other sales load would be incurred), proposed paragraph (f)(9)(i) of rule 15c2-2 would define "differential compensation" as any form of higher compensation (including total commissions, reimbursement or avoidance of charges or expenses, or other cash or non-cash compensation) that a broker, dealer or municipal securities dealer can be expected to pay to any associated person in connection with the sale of a stated dollar amount of that class of covered security over the next year, based on its current practices and assuming no change in the shares' net asset value if applicable, compared with the compensation that the associated person would have been paid over the next year in connection with the sale of the same dollar amount of another class of the same security that is associated with a front-end sales load. ⁹⁷ The broker, dealer or municipal securities dealer would have to disclose the existence of differential compensation related to securities with a deferred end sales loads whenever any associated person — salesperson or supervisor — is paid more to sell a security that has a deferred sales load — i.e., differential compensation.⁹⁸ Disclosure of those incentives should be useful to investors, especially given the recent instances in which associated persons were found to have inappropriately placed customers into class B shares to increase their own compensation.⁹⁹ Investors have an interest in knowing whether salespersons or other associated persons have those higher incentives.¹⁰⁰ The proposed rule only relates to remuneration expected to be paid in the next year when identifying the presence or absence of differential compensation, because short-term compensation reflects the associated person's most immediate financial incentive and because of the difficulty of estimating the near-term value of later revenues. We note, however, that an associated person may receive significant compensation after the first year for selling some share classes.¹⁰¹

In the case of customer purchases of proprietary covered securities, proposed paragraph (f)(9)(ii) of rule 15c2-2 would define "differential compensation" as: (A) any practice by which a broker, dealer or municipal securities dealer pays an associated person a higher percentage of the firm's gross dealer concession in connection with selling a proprietary covered security than the percentage of the gross dealer concession that the firm would pay in connection with selling the same dollar amount of any non-proprietary covered security offered by the firm; and (B) other practices of a broker, dealer or municipal securities dealer that cause an associated person to earn a higher rate of compensation in connection with selling a proprietary covered security, such as additional cash compensation or the imposition, allocation, or waiver of expenses, overhead costs, or ticket charges. That aspect of the proposed rule takes percentage payment rates into account, rather than absolute dollar amounts, because that would lead to more effective disclosure.¹⁰² Proposed paragraph (f)(11) of rule 15c2-2 would define the term "gross dealer concession" as the total amount of any discounts, concessions, fees, service fees, commissions, or asset-based sales charges received by the broker, dealer or municipal securities dealer from the issuer in connection with the sale and distribution of a covered security, other than portfolio brokerage commissions for transactions effected on behalf of the issuer.¹⁰³ As discussed above in the context of revenue sharing, proposed paragraph (f)(15) of rule 15c2-2 would define the term "proprietary covered security" as any covered security as to which the broker, dealer or municipal securities dealer is an affiliated person, as defined by Section 2(a)(3) of the Investment Company Act, of the issuer, or is an associated person of the issuer's investment adviser or principal underwriter, or, in the case of a covered security that is an interest in a UIT, is an associated person of a sponsor, depositor or trustee of the covered security. The broker, dealer or municipal securities dealer would be required to disclose the existence of differential compensation related to the sale of proprietary funds because investors would benefit from knowing whether salespersons or other associated persons may receive higher incentives, which create conflicts of interest for them.¹⁰⁴

The proposed rule would not require brokers, dealers or municipal securities dealers to identify all instances in which an associated person has a higher financial stake to sell the shares of one fund than another. Rather, the proposed rule is targeted toward transactions in securities without front-end sales loads and proprietary securities because other aspects of the proposed rule 15c2-2 should provide customers with information about other conflicts of interest facing the broker, dealer or municipal securities dealer. This point of sale proposal is intended to alert customers to additional information about the existence conflicts that otherwise would be hidden.¹⁰⁵

• We seek comment on whether this proposal would adequately place customers on notice about the conflicts associated with differential compensation. We specifically request comment on whether brokers, dealers and municipal securities dealers should be required to disclose payment of differential compensation in contexts other than transactions involving shares with deferred sales loads and proprietary covered securities (such as in the context of fund complexes that pay revenue sharing to the broker, dealer or municipal securities dealer).
   
• We also specifically request comment about whether the proposed approach for defining differential compensation in transactions involving securities with a deferred sales load — which focuses on compensation per dollar of covered security sold, rather than on compensation as a percentage of the dealer concession — should apply to other transactions in light of the fact that dealer concessions can vary widely among funds.¹⁰⁶
   
• We also request comment on whether the definition of "proprietary covered security" is sufficiently broad.  We further request comment on whether firms should be required to disclose information about their receipt of ongoing asset-based payments from funds (sometimes known as "trailing commissions"), or information about their payment of those fees to associated persons.¹⁰⁷ We moreover request comment on whether firms should be required to account for remuneration received after the first year when determining whether associated persons receive differential compensation in connection with selling share classes without a front-end load.
   
• Finally, we request comment on whether, in addition to disclosure about the fact that associated persons receive differential compensation, customers should receive information about the amount of any differential compensation received by associated persons. If so, how should the differential compensation be quantified? What time period or periods would be most relevant and useful to investors?

iii. Provisions not included in general and purchase-specific requirements

Proposed rule 15c2-2 would not incorporate several provisions of rule 10b-10 that do not appear material to customer transactions in mutual fund shares, UIT interests and municipal fund securities. In particular, proposed rule 15c2-2 would not require disclosure of whether the broker, dealer or municipal securities dealer is acting in the capacity of agent or principal¹⁰⁸ because those firms would act in an agency capacity for the transactions at issue. For the same reason, the rule 10b-10 disclosure standards for principal transactions¹⁰⁹ would not be incorporated into proposed rule 15c2-2. Proposed rule 15c2-2 also would not incorporate requirements for disclosing information about the person from whom the security was purchased,¹¹⁰ payment for order flow,¹¹¹ odd-lot differentials¹¹² and several requirements specific to transactions in debt securities.¹¹³

• The Commission requests comment on whether it would be appropriate to include any of those requirements in proposed rule 15c2-2. Commenters who believe that proposed rule 15c2-2 should be expanded to encompass transactions in additional types of securities also should address what additional disclosure provisions such inclusion would require.

e. Periodic disclosure alternative

Proposed paragraph (d) of rule 15c2-2 would permit brokers, dealers and municipal securities dealers to disclose the required information periodically, rather than transaction-by-transaction, in certain limited circumstances involving transactions in a "covered securities plan" or in no-load open-end money market funds. This provision is based on the periodic disclosure requirements of rule 10b-10(b), but modified to be consistent with the targeted disclosure standards of proposed rule 15c2-2. Proposed paragraph (f)(5) of rule 15c2-2 would define "covered securities plan" as any plan for direct purchase or sale of a covered security pursuant to certain retirement or pension plans or other agreements or arrangements.¹¹⁴ While this definition in large part would be analogous to the rule 10b-10 definition of "investment company plan," it also would encompass arrangements for automatic reinvestment of dividends or other distributions paid by the issuer of a covered security. The periodic disclosure alternative of proposed rule 15c2-2 would require a broker, dealer or municipal securities dealer to provide quarterly disclosure for transactions involving covered securities plans, and monthly disclosure for money market fund transactions subject to the periodic disclosure alternative.¹¹⁵

This disclosure would encompass summary information designed to inform investors about costs and conflicts, consistent with the general and purchase-specific disclosure requirements in other provisions of proposed rule 15c2-2. In general, it would require disclosure of the same types of information that are required by paragraphs (b) and (c), but some information would be disclosed in summary form that reflects all transactions within a period, rather than each individual transaction. Proposed paragraph (d)(2) of rule 15c2-2 would require disclosure of each transaction, and of the total number of shares in the customer's account at the end of the period. It would further require, for each transaction, disclosure of the general information related to date, issuer and class of the security, price and net asset value, number of shares, the total amount paid or received and the net amount of the investment bought or sold, commissions from the customer, deferred sales load charges, and SIPC membership.¹¹⁶ Also, to the extent applicable, it would require disclosure of information about front-end sales loads charged to the customer,¹¹⁷ and about dealer concessions received by the firm.¹¹⁸ As of the date of the final purchase or reinvestment during the period, the provision would require disclosure of information about revenue sharing and portfolio brokerage commission arrangements¹¹⁹ and about differential compensation.¹²⁰ Based on the total value of the purchases and reinvestments during the period, and the net asset value at the end of the period, the rule would also require disclosure of information related to deferred sales loads¹²¹ and to asset-based sales charges and service fees such as rule 12b-1 fees.¹²²

Proposed paragraph (d)(3) of rule 15c2-2 would require a broker, dealer or municipal securities dealer to provide the customer with written notification before it could take advantage of the periodic disclosure alternative. Moreover, the broker, dealer or municipal securities dealer would be required to provide the customer with at least one written disclosure document consistent with the general and purchase-specific disclosure standards at the time of each purchase of a particular security within a covered securities plan, prior to relying on the periodic disclosure alternative.¹²³ This latter requirement is intended to help customers to receive timely notice about the costs and conflicts raised by purchases involving each security that is the subject of the covered securities plan.

• The Commission requests comment on whether any periodic disclosure alternative is appropriate, in light of the distribution-related concerns associated with covered securities.
   
• The Commission also requests comment on whether this proposal strikes the right balance between alerting investors to the distribution-related issues associated with these securities and minimizing firms' cost of disclosure. Should we require periodic disclosures to be made more frequently? If so, commenters are requested to suggest alternative time frames and their reasons for believing they would provide more meaningful information to investors.
   
• We also request comment about whether permitting some categories of information to be disclosed in summary fashion is appropriate, or if broker-dealers should be required to provide all the transaction-by-transaction information otherwise required by the rule in the periodic statements.

f. Other provisions and definitions

Proposed paragraph (g) of rule 15c2-2 would permit the Commission to exempt any broker, dealer or municipal securities dealer from the provisions of the rule with regard to any transactions or any class of transactions, when the Commission finds that firm will provide alternative procedures to effect the purposes of the rule. Rule 10b-10 has a similar exemptive provision.¹²⁴

Proposed paragraph (f)(3) of rule 15c2-2 would also use the same definition of the term "completion of the transaction" as is found in rule 10b-10.¹²⁵ In addition, proposed paragraph (f)(7) of rule 15c2-2, consistent with rule 10b-10, would provide that the term "customer" does not include any broker, dealer or municipal securities dealer.¹²⁶ Because the two confirmation rules have parallel goals, it is appropriate for those definitions to be the same.

g. Comparison range disclosure

Proposed paragraph (e) of rule 15c2-2 would provide a mechanism to give investors additional context for evaluating the significance of certain required disclosures by requiring brokers, dealers and municipal securities dealers to provide comparison information. In many cases, including disclosures about sales loads, asset-based sales charges and service fees, revenue sharing and portfolio brokerage commissions, investors could benefit from knowing how the position of the broker, dealer or municipal securities dealer compares to industry practices. Investors may obtain that context if they are provided information about where costs and payments fall in comparison to the median and ranges in the marketplace. In the case of disclosures of loads, asset-based sales charges and service fees, and dealer concessions, these comparisons would be based on the median of, and the ranges associated with, 95 percent of the transactions involving the same type of covered security (i.e., mutual fund, unit investment trust or 529 plan). In the case of disclosures of revenue sharing and portfolio brokerage, these would be the medians and the ranges associated with 95 percent of the brokers, dealers or municipal securities dealers that distribute the same type of covered security. Median and 95th percentile range information are accepted statistical methods that, applied here, would provide a snapshot about whether a cost or conflict is typical or is an outlier. The Commission would publish the medians and comparison ranges from time to time in the Federal Register.¹²⁷ The Commission would publish those medians and ranges in percentage form. Firms would have to update median and percentage range information on their confirmations within 90 days of their publication. If adopted, this requirement would not take effect until 90 days after the Commission publishes the initial schedule of comparison ranges.

• We request comment about the utility and implementation of this proposal to disclose median and comparison range information. For example, in calculating comparison ranges related to loads and dealer concessions, to what extent is it appropriate to take into account the type of security (such as equity fund, debt fund, money market fund, or blend) that is the subject of the transaction. Are there specific categories of covered securities that would lead to the fairest "apples to apples" comparisons? Should all UITs be in a single category, or would it be necessary, for example, to separate variable annuities, variable life insurance, and other UITs? Should issuers of covered securities, or brokers, dealers or municipal securities dealers, be able to select the comparison category applicable to particular securities, or should the Commission assign covered securities to specific categories? Should median and percentile range information related to covered securities be weighted to account for the relative sales of covered securities? In other words, should covered securities that are more highly sold have a higher weight in calculating the medians and 95th percentile ranges? Similarly, should median and range information related to brokers, dealers and municipal securities dealers be weighted to account for relative sales by those firms? In other words, should brokers, dealers and municipal securities dealers that sell more covered securities have a higher weight in calculating the medians and 95th percentile ranges? Should transactions be compared to other transactions of a similar dollar amount? Moreover, should confirmations disclose comparison information that is more specific than medians and 95th percentile ranges, such as by stating the percentile rank of the loads, other costs or compensation associated with a transaction? Should the Commission be responsible for analyzing the information used to calculate medians and comparison ranges, or should the Commission permit or require the disclosure of median and comparison range information published by a vendor or other third-party source? Should the Commission establish standards for vendors or other third parties to derive and publish that information?

We recognize that implementing these reporting requirements for medians and comparison ranges will require additional rulemaking to implement reporting requirements to permit the Commission or its vendors to gather information to calculate appropriate medians and comparison ranges.

• What entities should be required to disclose information that is necessary to calculate median and comparative range information? In particular, should investment companies or brokers, dealers and municipal securities dealers be required to provide us with information to expedite the calculation of comparison ranges?

There will be additional opportunity to comment about those requirements at the time of a reporting requirement proposal. If we conclude that publication of median and comparison range information is not feasible due to implementation issues, then brokers, dealers and municipal securities dealers would not be required to disclose median and comparative range information.

If we conclude that comparative information would be useful to investors in this context, we may consider implementing comparative information disclosure requirements in other contexts, as well.

h. Disclosures about transactions effected by multiple firms

The requirements of proposed rule 15c2-2 would apply to every broker, dealer or municipal securities dealer that effects a transaction in a covered security, including transactions effected by more than one broker, dealer or municipal securities dealer. As is the case today, customers whose transactions have been effected in the context of an introducing-clearing arrangement nonetheless may receive a single confirmation if the two brokers, dealers or municipal securities dealers enter into a written agreement — disclosed to the customer — that determines the responsibilities of each, including the responsibility to provide confirmations to customers.¹²⁸

Although a customer may receive a single confirmation for a transaction effected as part of an introducing-clearing arrangement, proposed rule 15c2-2 would require specific disclosure of sales fees, revenue sharing and portfolio brokerage commissions received by any broker, dealer or municipal securities dealer that effects a transaction. It is important that an investor see information about those types of remuneration specifically attributed to each broker, dealer or municipal securities dealer, so the investor may evaluate conflicts of interest. Thus, a single confirmation still shall separately disclose the sales fees, revenue sharing and portfolio brokerage commissions earned by each firm.¹²⁹ That may require a broker, dealer or municipal securities dealer that receives sales fees, revenue sharing or portfolio brokerage to convey responsive information to the firm that sends out the confirmation, which may require enhancement of existing flows of information. There are other instances in which a broker, dealer or municipal securities dealer may effect transactions in covered securities in conjunction with another broker, dealer or municipal securities dealer. For example, a broker, dealer or municipal securities dealer may solicit persons at their workplaces, as part of an employer-sponsored marketing arrangement, to invest in covered securities. Although the broker, dealer or municipal securities dealer that solicits transactions may be paid on a transaction-basis, the customer accounts may be opened at a different firm. Proposed rule 15c2-2 would require disclosure of payments to the broker, dealer or municipal securities dealer soliciting the transaction, even if it does not maintain the account.¹³⁰

• We request comment on whether proposed rule 15c2-2 would result in adequate disclosure of information about distribution-related costs and conflicts connected with transactions effected by more than one broker, dealer or municipal securities dealer. Commenters are invited to discuss any potential implementation issues associated with the proposed rule, including any operational challenges or difficulties that the requirement may pose to introducing and clearing firms or other firms that together effect securities transactions. Commenters may also wish to discuss the application of the proposed rule to the principal underwriter or distributor of a covered security.

2. Amendments to rule 10b-10

Because proposed rule 15c2-2, if adopted, would govern confirmation disclosure of purchases and sales in investment company securities, we also propose to amend rule 10b-10 to exclude those securities.¹³¹ In particular, we propose to amend paragraph (a) of rule 10b-10 to provide that the rule does not apply to securities excluded by paragraph (g) of the rule. Proposed paragraph (g) would provide that rule 10b-10 does not extend to transactions in: (i) U.S. Savings Bonds, (ii) municipal securities, and (iii) any other security that is defined as a "covered security" by rule 15c2-2. Transactions in savings bonds and municipal securities already are excluded from the application of rule 10b-10. The Commission also proposes amending the preliminary note to rule 10b-10 to clarify the application of the rule.¹³²

Two other changes to rule 10b-10 are necessary to accommodate the addition of proposed rule 15c2-2. First, we propose to modify paragraph (a)(9) of rule 10b-10, which, when applicable, requires disclosure when a broker-dealer that effects a transaction is not a member of SIPC. As currently written, that paragraph contains an exception for certain transactions in open-end investment companies and UITs. Because proposed rule 15c2-2 would encompass transactions in those securities, we propose eliminating that exception from rule 10b-10.¹³³

Second, we propose to modify the periodic reporting alternative permitted by paragraph (b) of rule 10b-10. That alternative applies to transactions effected pursuant to a "periodic plan" or "investment company plan," or to transactions in no-load money market funds. Because the latter two categories would be encompassed within the periodic alternative of rule 15c2-2, we propose deleting them from the scope of the periodic alternative of rule 10b-10. Because the term will no longer be used in the rule, we also propose removing the definition of "investment company plan" from rule 10b-10.

Finally, we propose to modify the preliminary note of rule 10b-10 to be consistent with the preliminary note of proposed rule 15c2-2. As explained above, this would reflect the fact that the confirmation disclosure requirements are not determinative of, and do not exhaust, a broker-dealer's disclosure obligations under the antifraud provisions of the federal securities laws or under any other legal requirements.

V. Point of Sale Disclosure for Transactions in Mutual Fund Shares, Unit Investment Trust Interests and 529 Plan Interests

In addition to the tailored confirmation requirements of rule 15c2-2, the Commission is also proposing rule 15c2-3, which would require brokers, dealers and municipal securities dealers to provide customers with specified information at the point of sale — prior to the time they purchase mutual fund shares, UIT interests and 529 plan securities. Investors, therefore, would have this information before they finalize their investment decision to purchase a covered security, regardless of whether the transaction is solicited or unsolicited. The proposed rule would not apply to transactions in which an investor sells a covered security, because those transactions do not raise the same special cost and conflict concerns.

The new rule is designed to be consistent with the existing obligations of brokers, dealers and municipal securities dealers under the antifraud provisions of the securities laws, which at times require a broker, dealer or municipal securities dealer to disclose information about particular costs and conflicts prior to effecting a transaction in a covered security.¹³⁴ It is also intended to supplement the prudent business ethic of firms that assure their customers will be apprised of key facts prior to sales, to avoid surprises and broken trades. Point of sale disclosure should also complement confirmation disclosure, which provides a retrospective record of the complete terms of a transaction for customers to assess in determining whether the transaction occurred as described and whether they received any applicable breakpoint discounts.¹³⁵ A broker, dealer or municipal securities dealer that misstates information in a point of sale disclosure with an intent to mislead may be subject to liability under the antifraud provisions of section 10(b) and rule 10b-5.

The preliminary note to proposed rule 15c2-3, consistent with the preliminary note to proposed rule 15c2-2 and the proposed amendment to the preliminary note of rule 10b-10, would state that the point of sale disclosure requirements are not determinative of, and do not exhaust, a broker's, dealer's or municipal securities dealer's disclosure obligations under the antifraud provisions of the federal securities laws or under any other legal requirements.

Paragraph (a) of proposed rule 15c2-3 would provide that it is unlawful for any broker, dealer or municipal securities dealer to effect a purchase of any covered security for a customer unless the broker, dealer or municipal securities dealer delivers to the customer, at the point of sale, quantified information regarding distribution-related costs and the dealer concession that would be connected with the purchase, along with qualitative information about revenue sharing, portfolio brokerage commissions and differential compensation.

A. Securities Transactions and Persons Covered

The point of sale disclosure requirements of proposed rule 15c2-3 would govern purchase transactions in the same securities that are subject to the confirmation requirements of proposed rule 15c2-2, because those are the securities that raise the cost and conflict issues that warrant this type of disclosure requirement. Accordingly, the disclosure requirements of proposed rule 15c2-3 would apply to transactions in "covered securities." Paragraph (f)(2) of proposed rule 15c2-3 provides that the term "covered security" has the meaning set forth in rule 15c2-2.

• We request comment on whether this proposed rule appropriately encompasses the types of securities that raise distribution-related concerns that warrant point of sale disclosure. Commenters specifically are invited to address whether this type of disclosure requirement could have the effect of directing investors away from mutual funds and related securities.¹³⁶
   
• We also request comment about whether persons other than brokers, dealers or municipal securities dealers also should be required disclose information to investors prior to transactions in covered securities. Commenters are invited to discuss whether other persons that participate in the distribution of covered securities — such as banks — are subject to the same or similar conflicts of interest as brokers, dealers and municipal securities dealers. Commenters also are invited to discuss whether the Commission should propose rules to require those other persons to disclose specific information to investors prior to transactions, or to disclose confirmation information on or before the completion of such transactions.
   
• Commenters may also wish to discuss whether the point of sale disclosure requirements of proposed rule 15c2-3 would be appropriate to transactions in variable annuities. Commenters are invited to discuss any issues they believe would be relevant to the application of proposed rule 15c2-3 to variable insurance products, as well as any modifications they believe could improve the proposed rule's effectiveness as applied to variable insurance products. Specifically, commenters may wish to address whether point of sale disclosure would provide investors with more useful information for transactions in variable insurance products. In addition, we invite comment on whether point of sale disclosure is appropriate at or prior to the time the contract or policy is entered into or at the time the underlying funds are allocated. Commenters should address whether such point of sale disclosure is appropriate under the federal securities laws.

B. Timing of Disclosure

Proposed rule 15c2-3 would require the broker, dealer or municipal securities dealer to deliver information at the point of sale. Proposed paragraph (f)(1) of the rule would define "point of sale" differently depending on the relationship between the broker, dealer or municipal securities dealer and the customers that it solicits. Generally, the time of the point of sale would be immediately prior to the time that the broker, dealer or municipal securities dealer accepts the order from the customer. In the case of transactions in which the customer has not opened an account with the broker, dealer or municipal securities dealer, or in which the broker, dealer or municipal securities dealer does not accept the order from the customer — such as may be the case with workplace marketing of 529 plans — the point of sale would be the time that the broker, dealer or municipal securities dealer first communicates with the customer about the covered security, specifically or in conjunction with other potential investments.

This definition of point of sale is geared to be as simple as possible while avoiding disclosure gaps. For most transactions, the time of disclosure is based on the time that the broker, dealer or municipal securities dealer receives the order from the customer — a standard that should allow customers to consider material information when they make their investment decisions. That standard would not work, however, in the case of brokers, dealers or municipal securities dealers that solicit transactions in covered securities — and receive compensation in connection with those transactions — without opening accounts for or handling orders from the investors who make those purchases.¹³⁷ Because the investors solicited by those firms instead would contact another broker, dealer or municipal securities dealer or the issuer to complete those transactions, it would not be feasible to trigger the disclosure obligations of those soliciting brokers, dealers or municipal securities dealers on the time that an order is accepted.¹³⁸