Charles Schwab & Co., Inc.

February 18, 2003

Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609

Re: Proposed Rule: Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies (File No. S7-51-02)

Dear Mr. Katz:

Charles Schwab & Co., Inc. ("Schwab"), on behalf of itself and its affiliated families of SchwabFunds®and Excelsior Funds,1 welcomes the opportunity to comment on the Securities and Exchange Commission's proposed rule and form amendments under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940 to improve the periodic disclosure provided by registered management investment companies ("Funds") to investors about Fund investments, costs and performance (the "Proposed Amendments").2 The Proposed Amendments principally would:

  • permit Funds to include a summary portfolio schedule in shareholder reports and exempt money market funds from the portfolio schedule requirements in shareholder reports, provided that Funds file a complete portfolio schedule with the Commission and make the schedule available free of charge to shareholders upon request;

  • require Funds to include a tabular or graphic presentation of their portfolio holdings in shareholder reports by sector, geographic region or other reasonably identifiable category;

  • require Funds to file their complete portfolio holdings with the Commission on a quarterly basis, rather than only semi-annually as currently required; and

  • require Funds to disclose in shareholder reports the cost in dollars associated with a $10,000 investment based on (i) the Fund's actual expenses and return for the reporting period, and (ii) the Fund's actual expenses for the reporting period and an assumed return of five percent per year.

In general, Schwab strongly supports each of the Proposed Amendments as set forth by the Commission, which we believe will substantially improve the value and utility of Fund shareholder reports. We would like to take this opportunity, however, to offer our views on (i) two aspects of the proposed summary portfolio schedule amendment, (ii) the compliance date and, most importantly, (iii) the proposed disclosure of Fund expenses.

I. Disclosure of Fund Expenses

Schwab strongly supports the Commission's proposal to require Funds to disclose in shareholder reports Fund expenses borne by shareholders during the reporting period. We believe the Commission's proposed example, which uses two expense figures based on the Fund's actual expenses and return for the reporting period and the Fund's actual expenses for the reporting period and an assumed five percent return per year, serves two important ends: First, it enables an investor to estimate the actual expenses the investor paid during the reporting period and may pay on an on-going basis. Second, it allows an investor to compare in a meaningful way the costs of investing in one Fund with the costs of investing in other similar Funds.3

Schwab also strongly supports the Commission's determination not to propose the alternative approach recommended by the United States General Accounting Office that would have required disclosure of the exact dollar figure for expenses paid by an investor in quarterly account statements ("Personalized Expense Disclosure"). In the Proposing Release, the Commission recognized that the costs and "logical complexities" associated with Personalized Expense Disclosure in quarterly account statements outweighs the minimal benefits such disclosure would provide to Fund investors. The Commission also correctly noted that Personalized Expense Disclosure is particularly burdensome to broker-dealers, financial advisers and other third-party financial intermediaries that must prepare and distribute account statements for customers that hold position in numerous unaffiliated Funds.

While Schwab agrees with and supports the Commission's decision not to propose Personalized Expense Disclosure, we wish to reiterate our concerns about this alternative in response to the Commission's request for comment on the utility and cost of providing this disclosure.4 We believe that Personalized Expense Disclosure would be confusing to our customers and tremendously expensive to implement and maintain.

We are strongly committed to providing information that empowers customers to become smarter investors. Schwab makes available to both existing and prospective brokerage customers a wide variety of offline and online educational information, tools and other resources that seek to educate investors about mutual fund investing and that emphasize the importance of understanding and comparing mutual fund fees when making fund investments. If Personalized Expense Disclosure resulted in investors being more educated about Fund expenses, it would potentially be worth the enormous expense on Schwab and on the industry. However, we do not believe that Personalized Expense Disclosure would provide information that would help investors to make meaningful investment decisions.

a. Potentially Misleading Fee Comparisons

The primary reason for fee disclosure is to enable investors to compare fees for funds in the same asset category and make an informed investment decision on that basis. Personalized Expense Disclosure on account statements would not help investors understand whether the fees paid for a particular Fund were higher or lower than other Funds in the same category, nor would it provide any context for comparison. Instead, Personalized Expense Disclosure could be potentially misleading and cause investor confusion.

For example, an investor might own an actively managed equity growth fund and a short-term bond market index fund. Because the bond fund would likely have lower expense fees than the equity fund, and the investor's actual fund expenses would therefore be lower for the bond fund than the equity fund during the reporting period, the investor may focus solely on the low expenses of the bond fund without regard to the differences in investment objectives and investment management style of the two funds. More importantly, Personalized Expense Disclosure would not in any way help the investor understand how the expenses of either the bond fund or the equity fund compared with other mutual funds in its asset class.

Similarly, an investor might own two equity funds with different investment objectives, management styles and expense ratios, such as an international equity growth fund and a domestic large-cap index fund. In such cases, as in the preceding example as well, the number and total dollar value of shares owned in each fund will also likely be different. Not only would the investor be unable to compare the two equity funds due to the different investment objectives and management styles of the funds as discussed above, but the investor would not be able to compare directly the fees of the funds because of the differences in the value and number of shares held. These examples demonstrate the limited value and utility of Personalized Expense Disclosure and the potential investor confusion such disclosure may cause.

b. Needlessly Complex and Burdensome Account Statements

Personalized Expense Disclosure would not only fail to provide a meaningful basis for fund expense comparison, but it would be expensive and impractical for financial intermediaries to administer, particularly broker-dealers like Schwab that sponsor mutual fund supermarkets. For example, Personalized Expense Disclosure would require Schwab, on a daily basis, to collect fee information from approximately 4,000 mutual funds available to brokerage customers in our Mutual Fund Marketplace®. Currently, Funds provide this information semi-annually or at most quarterly, and they generally do not provide it until at least 60 days after the end of the half-year or quarter. Upon receipt of this daily fee information, Schwab would then have to calculate the fee paid by each customer based on the customer's mutual fund holdings that day-and of course for many mutual funds, such as money market funds, customers' holdings change on a daily basis. Schwab serves over 2.7 million households with fund assets, with holdings representing over 14 million mutual fund positions. Schwab calculates that the implementation and administration of Personalized Expense Disclosure would require at least $4 million in systems modifications and over $5 million in annual, on-going administration costs. In our view, this sum could be put to better use in providing lower costs and more meaningful investor information and tools to Schwab customers.

In addition to the substantial implementation and administrative costs, we believe that Personalized Expense Disclosure would be difficult to administer. Schwab must produce account statements within five business days after each month or quarter end. For Schwab to produce nearly 8 million quarterly customer statements within this five-business-day window, we must begin printing the statements within hours after the close of business at the end of the period. Any delay in a data feed from one of approximately 4,000 third party mutual funds could put Schwab at risk of missing this deadline or force Schwab to send out the statements without the expense information. In addition, many of Schwab's customers hold numerous mutual funds in their accounts. Providing Personalized Expense Disclosure for multiple mutual funds, combined with any explanations necessary to provide some context for the information, could add pages to the length of every account statement, resulting not only in additional administrative burdens, but additional costs as well.

c. The Commission's Proposal is More Useful and Cost-Effective

The only tangible benefit provided by Personalized Expense Disclosure is that it provides investors with the exact dollar amount of the fees paid by the investor. But without the ability to use this information to understand how the fees paid compare to other similar Funds in the same asset category, this disclosure has limited value. Personalized Expense Disclosure would not serve that purpose. Most importantly, there is no reason to impose on the brokerage and mutual fund industries the exorbitant costs and administrative burdens Personalized Expense Disclosure would entail when the Commission has provided a far more valuable and meaningful alternative that balances an investor's need for fund expense disclosure against the burdens Personalized Expense Disclosure would impose.

Moreover, the Commission's proposed Fund expense disclosure serves as a far superior investor resource for comparing Funds expenses than Personalized Expense Disclosure, helping investors make better, more educated Fund investment decisions. We believe that disclosure of Fund expenses in shareholder reports as proposed by the Commission, in conjunction with the fee information currently in Fund prospectuses, will reinforce to investors the message that Fund costs do matter.

II. Summary Portfolio Schedule

We believe use of a summary portfolio schedule in Fund Shareholder reports will result in more meaningful disclosure to Fund investors. Limiting disclosure to the top 50 holdings and any holdings in excess of one percent of the Fund's net assets will help investors focus on the most important Fund holdings (i.e., those most likely to affect Fund performance), while reducing unnecessary printing and mailing costs.

While we agree that the use of a summary portfolio schedule in Fund shareholder reports provides many benefits to investors and Funds alike, we do not believe that the summary portfolio schedule should require short-term debt instruments of the same issuer and fully collateralized repurchase agreements to be aggregated and treated as a single issue. Aggregation may not be appropriate in every case and could even be misleading, because different types of short-term debt and different maturities of the same type of short-term debt of a single issuer may have different credit risk profiles due to, for example, different types of credit enhancement and different credit ratings. We believe aggregation of fully collateralized repurchase agreements (notwithstanding disclosure indicating the range of dates of the repurchase agreements, the total purchase price of the securities, the total amount to be received upon repurchase, the range of repurchase rates, and a description of the securities subject to the repurchase agreements) would not provide shareholders with an accurate assessment of counterparty risk. In addition, requiring aggregation may impose additional costs on Funds where the items being aggregated do not provide meaningful disclosure.

The Proposed Amendments would also require a Fund that uses a summary portfolio schedule to send a complete portfolio schedule of investments to any shareholder upon request within three business days of its receipt of such request, by first-class mail or other means designed to ensure prompt delivery. We agree that shareholders should have prompt access to the complete portfolio schedule, but we urge the Commission to permit a Fund to provide this information exclusively through posting the complete portfolio schedule on its website. Such an approach would be consistent with the Commission's recent actions in allowing a Fund the flexibility to choose making its proxy voting record available to shareholders either upon request or by making available an electronic version on or through the Fund's website.5 Schwab does not anticipate that there will be a substantial number of shareholders who request a complete portfolio schedule. Given the widespread and increasing access investors now have to the Internet, requiring Funds to print and mail a complete portfolio schedule to benefit the limited number of shareholders who request this information seems an unnecessary expense to impose on a Fund and, ultimately, Fund shareholders. As in the case of proxy voting records, ensuring that information about a Fund's portfolio holdings is readily available to interested shareholders, while allowing Funds to choose how to make this information available in the most cost-efficient manner, strikes the right balance.

III. Compliance Date

The Commission has proposed that Funds comply with the Proposed Amendments on or after the effective date of the amendments. Because the systems necessary to prepare the additional calculations required by the Proposed Amendments will require the purchase, integration and testing of additional components and redesign of our regulatory documents, Schwab requests that this compliance date be extended to require compliance for all reports filed for periods ending 120 days after the effective date. We believe that the additional 120 days will allow sufficient time for Funds and financial intermediaries to ensure that the applicable systems and materials are thoroughly tested and complete.

* * * * *

We appreciate the opportunity to comment on the Proposing Release and would be happy to discuss further with you our thoughts and comments. If you would like further discussion or have any questions about this letter, please contact the undersigned at 415-636-3788.


Sandra Burke
VP & 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 is the principal underwriter for the SchwabFunds family of 45 mutual funds with more than $144 billion in assets (as of February 2003). The Excelsior Funds is an actively managed family of funds with more than $12 billion in assets (as of February 2003) that is advised by wholly-owned subsidiaries of the U.S. Trust Corporation, a wholly-owned subsidiary of Schwab Corporation. Schwab Corporation, through its operating subsidiaries, serves approximately 8 million active accounts (as of February 2003) and is one of the nation's largest financial services firms.
2 See Release Nos. 33-8164; 34-47023; IC-25870 (December 18, 2002).
3 We urge the Commission to consider simplifying the proposed expense disclosure by requiring only one dollar amount figure as suggested by the Investment Company Institute. Providing the cost in dollars of a $10,000 investment in a fund based on the fund's actual expenses and return would avoid potential investor confusion over two dollar amounts. At the same time, it would accomplish the Commission's purpose of increasing awareness by investors of the fees that they pay.
4 We previously articulated our views on the questionable value of Personalized Expense Disclosure and the substantial costs implementation of that alternative would entail. See letter from David S. Pottruck, President and Co-CEO, The Charles Schwab Corporation, to The Honorable Arthur Levitt, Jr., Chairman, SEC (Sept. 7, 2000).
5 See Release Nos. 33-8188; 34-47304; IC-25922 (January 31, 2003) at n. 49 (disclosure of investment company proxy voting records).