THE POSITIONS EXPRESSED IN THIS LETTER MAY HAVE BEEN MODIFIED OR RESCINDED
Annual Industry Comment Letter From the Division of Investment Management
Please consult the Accounting Matters Bibliography for the staff's current position on these matters.
December 30, 1998
To the Chief Financial Officer:
The accounting staff of the Division of Investment Management (the "staff") has prepared this letter to assist investment company registrants and their independent public accountants in addressing certain accounting-related matters. These comments represent the views of the staff of the Division and are not necessarily those of the U.S. Securities and Exchange Commission. The comments addressed in this letter apply to filings, including reports to shareholders, made by registered investment companies.
Average Commission Rate Disclosure [IM-DCFO 1998-01]
This position has been rescinded.
In March 1998, the Commission adopted final amendments to Form N-1A.1 As part of these amendments, the Commission adopted several changes to the financial highlights table. One change is to eliminate disclosure of the average commission rate from the prospectuses of open-end investment companies.2 Thus, the average commission rate is no longer required to be included in the financial highlights table in either the prospectuses or shareholder reports of open-end investment companies.
Although the amendments to Form N-1A are specific to open-end investment companies, several closed-end investment companies have asked whether the average commission rate must be included in their prospectuses and shareholder reports.3 We believe that the same considerations underlying the elimination of the average commission rate from open-end investment company prospectuses and shareholder reports also apply to closed-end investment companies. As a result, we would not object if closed-end investment companies do not disclose the average commission rate in their prospectuses or shareholder reports.
Organization Costs for Open-end Investment Companies [IM-DCFO 1998-02]
This position has been rescinded.
In April 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 provides guidance on the financial reporting of start-up costs and organization costs, and in particular requires all start-up costs and organization costs to be expensed as incurred.4
The effect of SOP 98-5 on the investment company industry is that investment companies no longer can capitalize organization costs as an asset and ratably reduce this asset by amortization.5 As a result of SOP 98-5, we believe that organization costs will be treated in one of the following manners: (1) as a direct expense to the investment company, (2) as an expense to the investment company and a simultaneous reimbursement by the sponsor, in accordance with a reimbursement or excess expense plan, or (3) as an expense of the investment company sponsor, if it intends to incur organization costs on behalf of the investment company. When organization costs are charged as expenses of the investment company as in scenarios "(1)" or "(2)", the financial statements of the investment company that are part of its registration statement should include a statement of operations because the investment company has operating activity.6
We also remind recently formed registrants that SOP 98-5 permits capitalization of organization costs only if the investment company shares are sold to independent third parties prior to June 30, 1998. If the investment company failed to sell shares to independent third parties prior to June 30, 1998, we believe that organization costs should be immediately written off as an expense and/or reimbursed directly by the investment company sponsor.
Financial Reporting for a Master/Feeder Structure [IM-DCFO 1998-03]
We continue to receive questions regarding the reporting requirements for complex investment company structures.7 One such structure is the master/feeder arrangement. Currently, shareholder reports of the feeder contain two sets of financial statements, one for the master and another for the feeder. Section 30 of the Act outlines periodic reporting requirements for registrants. Specifically, Sections 30(e)(1) and (2) require registrants to provide a balance sheet accompanied by a statement of the aggregate value of investments and a list showing the amounts and values of securities owned on the date of the balance sheet.
Questions have arisen as to the proper reporting when the master and feeder have different fiscal year-ends. In such circumstances, we would not object if, at each feeder investment company year-end, the audited shareholder report of the feeder is accompanied by the latest audited shareholder report of the master and by an unaudited balance sheet of the master, and schedule of investments of the master as of the date of the feeder financial statements.8 We remind registrants that the portfolio turnover rate for the master should be disclosed in the financial highlights table contained in the shareholder report and registration statement of the feeder.9
Change in Accountants [IM-DCFO 1998-04]
This position has been modified.
We have received numerous questions regarding the procedures that investment companies must follow when there is a change in accountants. Unlike publicly traded operating companies that file Form 8-K when there is an accountant change, investment companies report an accountant change in Item 77K of Form N-SAR. In addition, we remind registrants that there is a reporting requirement for investment companies under Forms N-1A and N-2.10
To satisfy the reporting requirement of Forms N-1A and N-2, we suggest that investment companies include a narrative summary in the notes to the financial statements contained in shareholder reports, in management's discussion of the investment company's performance,11 or as supplemental information contained in the investment company's shareholder report. Investment companies should include this information in the first shareholder report that is issued subsequent to the Board of Directors' approval. The summary disclosure should conform to the requirements of Item 304 of Regulation S-K.12
Updating Performance Data in the Bar Chart [IM-DCFO 1998-05]
Several registrants have asked whether an investment company must update the performance information in the bar chart required in the prospectus of an open-end investment company when a calendar year-end or calendar quarter-end passes after the investment company has filed a post-effective amendment to its registration statement but before the effective date. Item 2(c)(2)(ii) of Form N-1A requires an investment company to provide its total returns for each of the last 10 calendar years in a bar chart. The Item also requires an investment company to include year-to-date return information as of the most recent quarter in a footnote to the bar chart, if the investment company's fiscal year-end is other than the calendar year-end. We interpret these requirements to mean that an investment company must disclose return information as of the calendar year-end or calendar quarter-end most recently completed prior to the date the investment company files its post-effective amendment that includes its financial statements.13
Directed Brokerage Reporting in Financial Statements [IM-DCFO 1998-06]
A recent study by the Commission's Office of Compliance Inspections and Examinations reported that many investment companies failed to "gross up" expenses paid for under directed brokerage and certain expense offset arrangements (e.g., compensating balance arrangement).14 According to the study, some investment companies failed to gross up their expenses because they deemed the amounts not to be material. Rule 6-07 of Regulation S-X requires the grossing up of expenses regardless of materiality.15 We would not object, however, if an investment company that has grossed-up its expenses in the statement of operations, omits the expense offset line if the rounded amount is zero. Under these circumstances, the investment company should disclose in a footnote the existence of the arrangements and state the total amount of the expenses that were paid under directed brokerage and expense offset arrangements.
Financial Data Schedules [IM-DCFO 1998-07]
We no longer require financial data schedules from registrants who file on Form N-4 and Form S-6. Form N-4 and Form S-6 have been removed from the Filer Manual Appendix E list of investment company forms requiring an Article 6 financial data schedule.
This letter contains information of importance to the company's independent public accountants; therefore, we encourage you to discuss these items with them. Address any questions about the contents of this letter or related matters to John S. Capone, Assistant Chief Accountant, or me, at (202) 942-0590.
Kenneth V. Domingues
||Form N-1A is used by open-end investment companies to register under the
Investment Company Act of 1940 (the "Act") and to register their shares under
the Securities Act of 1933. See Investment Company Act Release No. 23064
(Mar. 13, 1998) [55 FR 13916 (Mar. 23, 1998)] (the "Adopting Release").
||The Adopting Release noted commenters' concern that the average commission
rate was technical information with only marginal benefit for typical investors.
The Adopting Release stated, "At this time, the Commission believes there
continues to be some merit in ensuring that information about the average
commission rate paid by funds is publicly available. The Commission believes
however, that a fund's prospectus appears not to be the most appropriate
document through which to make this information public." 55 FR at 13936.
||See Item 4 of Form N-2 (Financial Highlights). |
||SOP 98-5 applies to all non-governmental entities and is effective for
financial statements for fiscal years beginning after December 15, 1998.
||SOP 98-5 made an exception for entities that report substantially all
investments at market value or fair value, issue and redeem shares, units, or
ownership interests at net asset value, and have sold their shares, units, or
ownership interests to independent third parties before June 30, 1998. For these
entities, existing organization costs can continue to be amortized in the normal
course of business.
Further, SOP 98-5 is silent as to offering costs that generally include: (1)
legal fees pertaining to the company's shares offered for sale, (2) SEC and
state registration fees, (3) underwriting and other similar costs, (4) costs of
printing of prospectuses for sale purposes, and (5) initial fees paid to be
listed on an exchange. The staff has taken the view that offering costs should
be amortized over the shorter of the offering period or one year for open-end
investment companies and unit investment trusts and charged to capital for
closed-end investment companies at the close of the offering period.
||Consistent with our analysis, a series portfolio that elects to expense the
organization costs of the series portfolio is required to prepare a statement of
operations and include it as part of the series portfolio's registration
||See Letter from Lawrence A. Friend, Chief Accountant, Division of
Investment Mangement, Securities and Exchange Commission, to Chief Financial
Officer (November 7, 1997) (discussing "Fund of Funds Considerations").
||For example, if the feeder has a December 31 fiscal year-end and the master
has a September 30 fiscal year-end, the audited December 31 feeder financial
statements would be accompanied by the audited September 30 master financial
statements, and an unaudited master balance sheet and master schedule of
investments as of December 31. |
||See Letter from Carolyn B. Lewis, Assistant Director, Division of
Investment Management, Securities and Exchange Commission, to Registrants
(February 22, 1993) ("The registration statement for the spoke (feeder) should
include all information required by Form N-1A as if the distribution function of
the spoke (feeder) and the management function of the hub (master) were
contained in a single fund."). |
||See Instructions 2(b)(4) and (c)(4) to Item 22 of Form N-1A ("Every
annual report to shareholders required under Rule 30d-1 must contain the
following: The information concerning changes in and disagreements with
accountants and on accounting and financial disclosure required by Item 304 of
Regulation S-K [17 CFR 229.304],") and Instructions 4(d) and 5(d) to Item 23 of
Form N-2. |
||See Item 5 of Form N-1A (Management's Discussion of Fund
||See Item 304 of Regulation S-K [17 CFR 229.304] (Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure).
||For example, if a fund files a post-effective amendment under rule 485(a) on
November 30, then files a post-effective amendment including its financial
statements under rule 485(b) on the following January 30, the fund must update
its bar chart to include return information for the calendar year which ended
between its first filing and its second filing. |
||See Office of Compliance Inspections and Examinations, Securities and
Exchange Commission, Inspection Report
on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual
Funds, (Sept. 22, 1998) |
||See Rule 6-07 of Regulation S-X [17 CFR 210.6-07] ("Statement of
Operations") and Investment Company Act Release No. 21221 (July 21, 1995) [60 FR
38918 (July 28, 1995)] (Payment for Investment Company Services with Brokerage