SEC Proposes More Frequent Fund Portfolio Disclosures, Adopts Other Rule Changes


Washington, D.C., December 11, 2002 -- The Securities and Exchange Commission today voted to publish for comment rule proposals that would change reporting requirements for funds regulated under the Investment Company Act. It also took action to repeal the Trade-Through Disclosure Rule and adopt measures that will allow Internet investment advisers to register with the Commission.

1. Repeal of Trade-Through Disclosure Rule

The Commission voted to repeal Rule 11Ac1-7 under the Securities Exchange Act of 1934 -- the Trade-Through Disclosure Rule. This rule, adopted in November 2000, requires a broker-dealer to disclose to its customer when that customer's order for an exchange-traded option has been executed at a price inferior to the best published quote. These trades are known as intermarket trade-throughs. A broker-dealer does not have to make this disclosure to its customer if the transaction took place on an options market that participates in a Commission-approved linkage plan that contains provisions reasonably designed to limit intermarket trade-throughs.

History of Trade-Through Disclosure Rule

In August 1999, the options exchanges began to multiply list the most actively traded options. Prior to this time, these options were traded on only one exchange. While this development made the options market more competitive, it also introduced the potential for customers' orders to be executed at prices inferior to the best available price. To address this issue, in July 2000, the Commission approved the Options Intermarket Linkage Plan proposed by three of the exchanges. The linkage plan permitted an options exchange to unilaterally withdraw from the linkage plan with 30 days' notice. Accordingly, the Commission adopted the Trade-Through Disclosure Rule to provide a customer with disclosure in the event that his or her order had been executed at a price inferior to the best available price on an exchange that did not participate in an approved linkage plan.

Recent Amendments to the Linkage Plan

In May 2002, the Commission approved amendments to the linkage plan that limit the options exchanges' ability to withdraw from the linkage plan. The modified linkage plan permits an exchange to withdraw from participation in the linkage plan only if it can satisfy the Commission that it can accomplish, by alternative means, the same goals as the linkage plan of limiting intermarket trade-throughs of prices on other markets. The exchanges were required to begin intermarket testing by Dec. 1, 2002, and to begin the final rollout of the linkage by April 30, 2003.

By incorporating the testing and implementation schedule into the linkage plan, an exchange's failure to achieve testing or implementation by the specified dates would be a violation of a Commission rule. In addition, these amendments assure continuing participation by each options exchange in the linkage until such time as the Commission determines that there is an alternative, satisfactory means to limit intermarket trade-throughs of customer orders and approves an exchange's withdrawal from the linkage plan.

Repeal of Trade-Through Disclosure Rule

Because of the amendments to the linkage plan, the principal purpose of the Trade-Through Disclosure Rule - to require customers' orders to be executed on exchanges that participate in a linkage that limits intermarket trade-throughs or, in the alternative, to provide customers with additional information about the execution of their orders - has been accomplished. For that reason, the Commission proposed to repeal the Trade-Through Disclosure Rule in May 2002 and today voted to approve final repeal, effective upon its publication in the Federal Register.

2. Internet Investment Advisers

The Commission voted to adopt a new rule and amendments under the Investment Advisers Act to exempt certain "Internet investment advisers" from the prohibition on Commission registration. Internet investment advisers provide investment advice to investors online through interactive Web sites. At these interactive Web sites, investors input personal financial data and receive individualized securities or asset allocation recommendations.

The 1996 National Securities Markets Improvement Act (NSMIA) divided regulation of investment advisers between the states and the Commission. Under NSMIA, larger advisers (generally, those with more than $25 million of client assets under management) register with the Commission and do not have to comply with state regulatory laws. Smaller advisers are prohibited from registering with the Commission, but the Commission has authority to permit registration if the operation of the prohibition would be "unfair, a burden on interstate commerce, or otherwise inconsistent with the purpose of [NSMIA]." As a practical matter, these smaller advisers must register in advance with the state securities authorities of every state to avoid inadvertently violating state registration laws. This process imposes costs and burdens on Internet investment advisers unlike those on other state-registered firms, which typically register in one or a few states.

Under the rule adopted by the Commission, only advisory firms using the Internet investment adviser business model could rely on the new rule for registration with the Commission. The Commission drafted the new rule narrowly, so that an Internet investment adviser will be eligible only if it provides investment advice to all of its clients exclusively through the adviser's interactive Web site. Advisers who use the Internet and other electronic communications, such as e-mail, to deliver investment advice to their clients will not be able to rely on the new rule to register with the Commission. Internet investment advisers relying on the new rule, however, may have advised as many as 14 clients through other means during the preceding 12 months.

The effective date for these provisions will be 30 days after their publication in the Federal Register.

3. Shareholder Reports and Quarterly Portfolio Disclosure by Funds

The Commission voted to propose several amendments to its rules and forms that are intended to improve significantly the periodic disclosure that mutual funds and other registered management investment companies provide to their shareholders.

The proposals that the Commission will publish for comment include the following:

  • Quarterly Disclosure of Fund Portfolio Holdings. The proposals would require a registered management investment company (fund) to file its complete portfolio holdings schedule with the Commission on a quarterly basis, rather than semi-annually as currently required. These filings would be publicly available on the Commission's Electronic Data Gathering, Analysis, and Retrieval System (EDGAR). This proposal is intended to enable interested investors, through more frequent access to portfolio information, to monitor whether, and how, a fund is complying with its stated investment objective.
  • Use of Summary Portfolio Schedule. The proposals would permit a fund to include a summary portfolio schedule in its semi-annual reports that are delivered to shareholders in lieu of the complete schedule, provided that the complete portfolio schedule is filed with the Commission and is provided to shareholders upon request, free of charge. The proposed summary portfolio schedule would include - in order of descending value -- each of the fund's 50 largest holdings in unaffiliated issuers and each investment that exceeds one percent of the fund's net asset value. This proposal is intended to provide investors with information about portfolio holdings in a format that is more useful and understandable.
  • Exemption of Money Market Funds from Portfolio Schedule Delivery Requirements. The proposals would exempt money market funds from requirements that they include a portfolio schedule in reports to shareholders, provided that this information is filed with the Commission and is provided to shareholders upon request, free of charge. Because the investments of money market funds must be high-quality, are circumscribed by rules under the Investment Company Act, and have short-term maturities, detailed portfolio information has limited utility for money market fund investors.
  • Tabular or Graphic Presentation of Portfolio Holdings in Shareholder Reports. The proposals would require that fund reports to shareholders include a tabular or graphic presentation of a fund's portfolio holdings by identifiable categories (e.g., industry sector, geographic region, credit quality, or maturity). This presentation is intended to illustrate, in a concise and user-friendly format, the allocation of a fund's investments across asset classes.
  • Enhanced Mutual Fund Expense Disclosure in Shareholder Reports. The proposals would require open-end management investment companies (mutual funds) to disclose mutual fund expenses borne by shareholders during the reporting period in their shareholder reports. Shareholder reports would be required to include: (i) the cost in dollars associated with an investment of $10,000, based on the mutual fund's actual expenses and return for the period; and (ii) the cost in dollars, associated with an investment of $10,000, based on the mutual fund's actual expenses for the period and an assumed return of 5 percent per year. The first figure is intended to permit investors to estimate the actual costs, in dollars, that they bore over the reporting period. The second figure is intended to provide investors with a basis for comparing the level of current period expenses of different mutual funds.
  • Management's Discussion of Fund Performance. The proposals would require a mutual fund to include Management's Discussion of Fund Performance (MDFP) in its annual report to shareholders. Currently, a mutual fund is permitted to include MDFP in either its prospectus or its annual report to shareholders. MDFP is more appropriately located in the annual report, together with other "backward looking" information, such as the mutual fund's financial statements.

Comments concerning these proposals should be received by the Commission within 45 days of their publication in the Federal Register.

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

Last modified: 12/13/2002