July 31, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Re: Proposed Amendments to Investment Company Advertising Rules (File No. S7-17-02)
Dear Mr. Katz:
Charles Schwab & Co., Inc. ("Schwab")1 welcomes the opportunity to comment on the Securities and Exchange Commission's proposed amendments to the investment company advertising rules.2 The Commission has proposed to amend Rule 482 of the Securities Act of 1933 (the "Securities Act") to eliminate the "substance of which" requirement, enhance required narrative disclosures, and require Rule 482 advertisements containing performance information to include a toll-free telephone number investors can call to obtain the most recent month-end total return quotations. The Commission has also proposed amendments to Rule 134 of the Securities Act to exclude investment companies from relying on the Rule 134, as well as amendments to Rule 156 of the Securities Act to provide additional guidance as to whether statements involving material facts in investment company advertisements might be misleading.
Schwab offers to customers a wide range of mutual fund investments and information through its family of 44 proprietary funds and its Mutual Fund Marketplace® (the "Marketplace"). The Marketplace allows brokerage customers to purchase and redeem shares of approximately 4,500 third party mutual funds.3 As part of its brokerage services, Schwab makes available to current and prospective customers fund information, including performance data, as well as research and online screening tools. These services help educate customers about their investments and provide them with the tools to make meaningful investment decisions. Schwab relies on third party vendors to provide the large volume of necessary fund data and update this information on a regular basis.
We believe that the Commission's proposed amendments to the investment company advertising rules will significantly improve the quality and timeliness of the mutual fund information the industry provides to investors. In particular, we strongly support the proposed elimination of the "substance of which" requirement from Rule 482, which, in our view, will provide funds and other financial intermediaries the flexibility to include additional information in investor communications that will help investors make more informed investment decisions. Moreover, we also support the Commission's efforts to reinforce the applicability of the anti-fraud provisions to investment company advertisements.
However, we believe that the proposed amendments raise issues that should be addressed in the final rules. Schwab strongly supports the comments set forth in the letter submitted to the Commission by the Investment Company Institute (the "ICI"), dated July 31, 2002, on each of the proposed amendments to the investment company advertising rules. We are principally concerned about the impact the proposed amendments would have on financial intermediaries that sponsor mutual fund supermarkets and other similar fund platforms4 (collectively, "Fund Platforms"), and which, in connection with Fund Platform services, make available to current and prospective customers mutual fund performance and other information under Rule 482 ("Fund Platform Materials"). 5
As discussed in greater detail below, Schwab believes that certain provisions of the proposed amendments to Rule 482 are impracticable and unworkable as they apply to Fund Platforms. In particular, Schwab is concerned about the viability of requiring Fund Platforms to (i) include a toll-free telephone number investors can call to obtain recent month-end performance information in Fund Platform Materials that include total return quotations; and (ii) provide month-end performance information to investors by the third calendar day after the most recent month-end. Schwab urges the Commission to permit funds and Fund Platforms to provide month-end performance information as soon as reasonably practicable after month-end.
We also agree with the ICI's recommendation that the Commission allow funds to provide month-end information either by telephone or website. We believe funds, Fund Platforms and other financial intermediaries should have the flexibility to determine the most efficient medium by which to communicate month-end performance to their shareholders and customers.
I. Schwab's Mutual Fund Platform and Services
Schwab currently makes approximately 4,500 mutual funds available to its brokerage customers through the Marketplace (as of June 30, 2002). Schwab also provides to its customers information about the mutual funds in the Marketplace, including fund performance information, on its website and through various other electronic and hard-copy Schwab publications (collectively, "Schwab Materials"). Schwab provides Schwab Materials to its customers as a research tool to help customers evaluate their mutual fund investment options and to make informed and educated investment decisions. Fund information provided on Schwab's website is updated on a monthly basis as soon as practicable (though generally, as discussed below, updated fund information is not made available to Schwab and posted on its website earlier than the tenth business day of the month). Other Schwab Materials generally include month-end or quarter-end fund information, depending on the type of publication and any applicable submission or other requirements.
II. Impact of Month-End Performance by Phone Requirement on Fund Platforms
Under the proposed amendments, Fund Platform Materials containing total return quotations would also need to include a toll-free telephone number investors can call to obtain the most recent month-end performance information. This performance information would need to be made available by the third calendar day following the most recent month-end. In our view, these requirements are impractical and unworkable in their application to Fund Platforms.
As the ICI notes in its comment letter, Fund Platforms typically receive fund performance and other fund information from third-party service providers, such as Morningstar or Lipper. To our knowledge, Fund Platforms rarely receive mutual fund data from these service providers prior to the fifth business day of the month, and, in fact, Schwab in most cases does not receive mutual fund data from its service provider until the seventh business day of the month. After receipt of the mutual fund data, Schwab carefully reviews the integrity of the data for errors or other defects and only uploads the data into its website after this review. Typically, Schwab uploads month-end mutual fund data onto its website within two to three business days after receipt. Thus, in most cases, Schwab currently posts month-end fund information on its website by the tenth business day of the month. Obviously, that timeline may change depending on the surrounding facts and circumstances (e.g., if the data file or transmission contains errors or other defects).
If a Fund Platform cannot comply with the third calendar day or other fixed time period established by the Commission, Fund Platform Materials can include performance information for mutual funds only if they also include the toll-free telephone numbers provided by those mutual funds.6 However, Fund Platform Materials typically include performance information for numerous mutual funds. In these cases, a Fund Platform that seeks to comply with the proposed Rule 482 amendments will incur additional costs and administrative burdens associated with listing toll-free telephone numbers for each of the many mutual funds contained in its Fund Platform Materials.
For example, Schwab publishes on a quarterly basis the Schwab Mutual Fund Select List®, a summary of historically high-performing funds prepared by the Schwab Center for Investment ResearchTM. The Select List includes average annualized total returns for each of the selected mutual funds and other fund information. The number of funds on the Select List varies from year to year and quarter to quarter, but historically has ranged from approximately 70 to 120 mutual funds per issue. Under the proposed Rule 482 amendments, if Schwab cannot provide month-end performance by telephone within the prescribed three-calendar day time period, Schwab would need to provide the toll-free telephone number of each fund on the Select List so that investors could obtain month-end performance information directly from each fund, if desired. As a result, Schwab would need to add another page to its Select List solely for the purpose of listing these toll-free numbers, resulting in additional printing and distribution costs.
Schwab's electronic Rule 482 materials raise similar cost concerns. For example, Schwab currently cannot customize disclosures it makes on the approximately 12,000 fund information webpages Schwab maintains on its website (each a "Fund Details Page").7 Schwab would either need to reprogram its website to permit it to include the appropriate mutual fund toll-free number on each Fund Details Page or, alternatively, establish a link to an independent webpage that lists a toll-free telephone number for each mutual fund.8
Aside from any costs Schwab would incur to implement these changes, there are also administrative burdens and costs associated with maintaining an accurate list of toll-free telephone numbers for each of the thousands of mutual funds that are typically available through its Marketplace. We also are concerned about the potential civil and regulatory liability that a Fund Platform may face if the telephone number provided to it by an investment company is not accurate or updated on a timely basis. For example, if a phone number provided to Schwab by a mutual fund were incorrect, Schwab Materials containing that fund's performance information would not comply with Rule 482, as proposed. As a result, Schwab could be subject to liability under Section 5 of the Securities Act.
Of course, a Fund Platform could avoid the costs, administrative burdens, and potential liability by choosing to exclude all fund performance information from its Fund Platform Materials. This, however, would have an effect on investors that is contrary to that intended by the Commission in proposing the amendments, and it would greatly diminish the value of the services Fund Platforms provide to their customers. Rather than giving investors access to the most recent fund performance information when making investment decisions, customers would not have access to any of the performance information formerly made available by the Fund Platform.
III. Suggested Timeliness Standard
We believe it is vital that Fund Platforms continue to provide fund performance and other fund information to customers. The burdens imposed by the proposed Rule 482 timeliness standard, however, would make it difficult, if not entirely unfeasible, to provide this information to customers in many circumstances. For this reason, Schwab strongly supports the ICI's recommendation that month-end performance information be available "as soon as reasonably practicable after month-end."
Rule 482 currently requires that performance data be as of the most recent practicable date considering the type of investment company and the medium through which the performance information will be conveyed. We believe this same "practicable" standard should apply with respect to the month-end performance by phone requirement and incorporated into proposed Rule 482(g)(2). The practicable standard would permit Schwab and other Fund Platforms to comply with the month-end performance requirement by providing their own toll-free telephone numbers.9 Fund Platforms could then provide performance information without incurring the costs and administrative burdens of providing phone numbers for all mutual funds listed in the Fund Platform Materials.10
If the Commission prefers to establish a prescribed time period for making month-end fund performance information available to investors, Schwab requests that the Commission clarify in the adopting release that the provisions of Rule 482(g)(1) and (2) provide a safe harbor under the rule. We are concerned that any fixed time period established by the Commission under Rule 482(g)(1) may become a de facto timeliness standard that Fund Platforms would bear the burden of overcoming. A Fund Platform that relies on a third party vendor to provide fund performance information ultimately has no control over when it receives that data. Consequently, a Fund Platform, through no fault of its own, may be unable to comply with a prescribed time period under Rule 482(g)(2) if its vendor fails to provide fund performance information on a timely basis, or the information provided contains errors or other defects. In such circumstances, a Fund Platform may be reluctant to provide fund performance information to customers if it is unclear whether Rule 482(g)(2) sets the standard for timeliness of performance data or provides a safe harbor. However, if Rule 482(g)(2) clearly provides a safe harbor, a Fund Platform could still make fund performance information available to its customers on a timely basis, consistent with Rule 482(g), if it distributes that information promptly after receipt of the data from its vendor.
IV. Medium for Communicating Updated Performance Information
The Commission has proposed to require funds to make month-end performance information available through a toll-free telephone number. The Commission recognized that investors have widespread and increasing access to the Internet, but concluded that a toll-free telephone number would ensure the most access to month-end performance information. We believe the Commission underestimates the access the general investing public has to the Internet and fails to weigh the potential costs funds may incur in providing fund performance information by phone against whatever additional access that medium may provide. We strongly support the ICI's position that the Commission should allow funds the flexibility to select the medium by which they make month-end performance information available.
* * * * *
Schwab generally supports the proposed amendments to the investment company advertising rules. However, we strongly encourage the Commission to consider further modifying the proposed changes as discussed in this letter and recommended in the ICI's comment letter. In particular, we urge the Commission to adopt our suggested modifications to the proposed Rule 482 amendments. These modifications address the Commission's desire to provide timely month-end performance information to investors, but also recognize the lack of control Fund Platforms have over mutual fund data and the difficulties Fund Platforms would have in meeting any prescribed deadline.
We would be happy to discuss further with you our thoughts and comments on the proposed amendments to the investment company advertising rules. If you would like further discussion or have any questions about this letter, please contact me at 415-636-3788.
Vice President and Associate General Counsel
Charles Schwab & Co., Inc.
cc: Paul F. Roye, Director
Susan Nash, Associate Director
Division of Investment Management
|1||Schwab, member SIPC/NYSE, is a broker-dealer registered with the Securities and Exchange Commission and is a wholly-owned subsidiary of The Charles Schwab Corporation (NYSE:SCH) ("Schwab Corporation"). Schwab Corporation, though Schwab, U.S. Trust Corporation, CyberTrader, Inc. (member SIPC/NASD) and its other operating subsidiaries, serves approximately 8 million active accounts, including 4.3 million active online accounts (as of June 2002) and is one of the nation's largest financial services firms.|
|2||See Release No. 33-8101; 34-45953; IC-25575, dated May 17, 2002 (the "Proposing Release").|
|3||As previously recognized by the Commission, fund supermarkets provide substantial benefits to investors. They allow investors to consolidate various fund positions in a single brokerage account for which investors receive a consolidated account statement reporting each fund position. Supermarkets also provide key administrative, recordkeeping and shareholder services, such as sub-accounting, transaction processing and settlement, and distribution of confirmations, prospectuses and other regulatory shareholder documents. See Investment Company Institute, SEC No-Action Letter (Oct. 30, 1998).|
|4||While Schwab primarily makes available Rule 482 materials in connection with its operation of its mutual fund supermarket, we recognize that the proposed Rule 482 amendments would also affect other mutual fund platforms and financial intermediaries that provide mutual fund performance and other information to investors as a customer service. For example, retirement plan administrators may provide fund performance information to plan participants in reliance on Rule 482. Similarly, fund performance information for variable annuity investment options made available by a financial intermediary may also be subject to the proposed Rule 482 requirements. We urge the Commission to consider carefully the impact its proposed amendments would have on Fund Platforms and create a standard that is reasonable in its application to both funds and Fund Platforms.|
|5||Because the term "offer" is defined and interpreted broadly under the Securities Act to include any written advertisements that solicit an order for a security or otherwise relate to a security generally, communications including fund performance and other information distributed by Fund Platforms could be deemed a prospectus under Section 2(a)(10) of the Securities Act. Consequently, to avoid any potential violation of Section 5 of the Securities Act, Schwab complies with Rule 482 when making Schwab Materials available to both existing and prospective customers.|
|6||We believe, however, that fund advertisements should not be required to refer investors to a toll-free telephone number for more current performance information if the advertisement itself contains performance data that is current to the most recent month-end and updated on a monthly basis.|
|7|| Schwab creates a Fund Details Page for each share class of the mutual funds available through the Marketplace. Schwab also creates a Fund Details Page for mutual funds that are not available through the Marketplace as a customer service. We believe this further demonstrates the educational purpose of the fund information Schwab provides to its customers. Because Schwab principally distributes fund information as a service to its customers, who rely on these materials to research investments, Schwab (and a similar Fund Platform) is less likely to engage in "techniques that create unrealistic investor expectations or may mislead potential investors." See Proposing Release at p. 6. As such, the policy concerns expressed by the Commission in the proposing release seem less applicable to Fund Platforms.
Schwab estimates that the cost of reprogramming its website would be approximately $70,000. In addition, Schwab will incur ongoing costs associated with maintaining an accurate list of toll-free telephone numbers for each fund and updating its fund webpages as necessary.
|9||Alternatively, the Fund Platform could make this information available on its website if the Commission approves the recommendations made by Schwab in Section IV of this letter and by the ICI in its comment letter.|
|10||For example, a practicable standard would allow Schwab to post performance information on its website on a timely basis under the rule. If a customer calls Schwab's toll-free telephone number for performance information, a Schwab representative could obtain this information from Schwab's website and relate it to the customer. Without a practicable standard, the Schwab representative could provide the toll-free number of the fund, but this would require customers to make a second call to obtain the requested performance information. We believe this two-step process would frustrate investors and undermine the purpose of the proposed amendments.|