SEC Proposes New Investment Company Governance Requirements, New Investment Adviser Codes of Ethics Requirements, and New Confirmation and Point of Sale Disclosure Requirements
FOR IMMEDIATE RELEASE
Washington, D.C., Jan. 14, 2004 - The Commission today voted to propose three regulatory initiatives designed to better protect the 95 million investors in mutual funds. These initiatives represent the next in a series of securities law reforms pursued by the Commission to address problems identified with the management and sale of mutual funds.
1. Investment Company Governance. Mutual fund boards of directors play an important role in protecting fund investors. They have overall responsibility for the fund, oversee the activities of the fund adviser, and negotiate the terms of the advisory contract, including the amount of the advisory fees and other fund expenses.
The Commission voted to propose amendments to its rules to enhance fund boards' independence and effectiveness and to improve their ability to protect the interests of the funds and fund shareholders they serve. The rule amendments are designed to strengthen the hand of independent directors when dealing with fund management.
- Independent Composition of the Board. Independent directors would be required to constitute at least 75 percent of the fund's board. This requirement is designed to strengthen the presence of independent directors and improve their ability to negotiate lower advisory fees and other important matters on behalf of the fund.
- Independent Chairman. The board would be required to appoint a chairman who is an independent director. The board's chairman typically controls the board's agenda and can have a strong influence on the board's deliberations.
- Annual Self-Assessment. The board would be required to assess its own effectiveness at least once a year. Its assessment would have to include consideration of the board's committee structure and the number of funds on whose boards the directors serve.
- Separate Meetings of Independent Directors. The independent directors would be required to meet in separate sessions at least once a quarter. This requirement could provide independent directors the opportunity for candid discussions about management's performance, and could help improve collegiality.
- Independent Director Staff. The fund would be required to authorize the independent directors to hire their own staff. This requirement is designed to help independent directors deal with matters on which they need outside assistance.
Comments on the proposed rule amendments should be received by the Commission within 45 days of publication in the Federal Register.
2. Codes of Ethics for Investment Advisers. The Commission voted to propose new rule 204A 1 and related rule amendments under the Investment Advisers Act of 1940. New rule 204A 1 would require registered investment advisers to adopt and enforce codes of ethics applicable to their supervised persons.
Investment advisers are fiduciaries that owe their clients a duty of undivided loyalty. The Commission's recent enforcement proceedings suggest that some advisory personnel may have forgotten or ignored this duty. The new rule is designed to prevent fraud by reinforcing the fiduciary principles that must govern the conduct of advisory firms and their personnel. An adviser's code of ethics would have to include certain minimum provisions.
- Standards of Business Conduct. The code would be required to establish standards of conduct that are expected of the adviser's supervised persons and that reflect the adviser's fiduciary duties. Supervised persons would have to acknowledge, in writing, receipt of a copy of the code of ethics.
- Compliance with Federal Securities Laws. An adviser's code of ethics would have to require the adviser's supervised persons to comply with applicable federal securities laws.
- Safeguard Nonpublic Information. The code would have to contain provisions reasonably designed to prevent disclosure of material nonpublic information about the adviser's securities recommendations and clients' securities holdings and transactions to persons without a "need to know."
- Personal Securities Reporting. Advisers' codes of ethics would have to require certain supervised persons ("access persons") to report their personal securities holdings and transactions, including transactions in mutual funds advised by the adviser or an affiliate. Currently, only mutual fund advisers must have a code of ethics requiring their personnel to report their personal securities transactions.
- Pre-Approval of Certain Transactions. The code of ethics would have to require access persons to pre-clear any personal investments in initial public offerings and limited (private) offerings.
- Reporting of Code Violations. The code of ethics would have to require supervised persons to report, promptly, any violations of the adviser's code of ethics to the firm's compliance officer or to another designated person.
Comments on the proposed rule and related amendments should be received by the Commission within 45 days of publication in the Federal Register.
3. 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
The Commission voted to propose two new rules and rule amendments that are designed to enhance the information that 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 (UIT) interests (including insurance company separate accounts that offer variable annuity contracts and variable life insurance policies), and municipal fund securities used for education savings (commonly called 529 plans).
The rules would require disclosure at two key times - first at the point of sale, and second at the completion of a transaction in the transaction confirmation.
Proposed Rule 15c2-3 - Point of Sale 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 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 shares.
The rule would require the broker, dealer or municipal securities dealer to inform its customer about the distribution-related costs that the customer would be expected to incur in connection with the transaction. This would include separate disclosure (either by reference to the value of the purchase, or, if no amount was specified, by reference to a model investment of $10,000) about:
- the amount of sales loads that would be incurred at the time of purchase, and the amount of that load that would be paid to the broker-dealer;
- estimated asset-based sales charges and asset-based service fees paid out of fund assets in the year following the purchase if net asset value remained unchanged; and
- the maximum amount of any deferred sales load that would be associated with the purchase if those shares are sold within one year, along with a statement about how many years a deferred sales load may be in effect.
In addition, the rule would require disclosure of whether the broker, dealer or municipal securities dealer receives revenue sharing or portfolio brokerage commissions from the fund complex, as well as whether it pays differential compensation in connection with transactions in the covered security, if the covered security is either a class B share or a proprietary security.
Customers' right to terminate orders made prior to disclosure - Under the rule, an order made prior to the required point of sale disclosure would be treated as an indication of interest.
Manner of disclosure - The rule would generally require a broker, dealer or municipal securities dealer to give or send the information to the customer in writing using a new standardized form, Schedule 15D. This would be supplemented by oral disclosure if the point of sale occurs at an in-person meeting. If the point of sale occurs through means of an oral communication other than at an in-person meeting, however, then the information would only be disclosed to the customer orally.
Recordkeeping - Brokers, dealers or municipal securities dealers, at the time they disclose information required by the rule, would have to make records of communications sufficient to demonstrate compliance.
Exceptions - The rule would contain a limited exception for transactions resulting from orders that a customer placed via U.S. mail, messenger delivery or a similar third-party delivery service. It also would contain an exception for certain brokers that did not communicate with the customer, except to accept an order, if they reasonably believe another broker provided point of sale disclosure. The rule also would contain other targeted exceptions.
Proposed Rule 15c2-2 - Confirmation Requirement
Proposed rule 15c2-2 would require more quantitative disclosure of the information included in the point of sale document.
Disclosures for purchases - Proposed rule 15c2-2 would require specific disclosures in purchase transactions that build on the point of sale requirements. These requirements would include:
- Cost and remuneration disclosure - Disclosure of the amount of any sales load that the customer has incurred (front end load) or will incur (back end load) at the time of purchase, expressed in dollars and as a percentage of the net amount invested, and 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.
- Revenue sharing and portfolio brokerage disclosure - Disclosure of quantified information about revenue sharing arrangements and portfolio brokerage (i.e., effecting transactions for an issuer's own portfolio). In particular, the rule would require disclosure of (a) revenue sharing payments from persons within the fund complex, and (b) commissions, including riskless principal compensation, associated with portfolio securities transactions on behalf of the issuer of the security, or other securities within the fund complex. This disclosure would be quantified based on the pro rata estimates of the amount of income received by the broker from the fund complex as compared to the assets of the funds. This ratio would then be applied to the assets invested by the particular investor. Disclosure would also be required of any specific revenue sharing arrangement that would be applicable to the transaction.
- Differential compensation disclosure -- Disclosure of whether a broker, dealer or municipal securities dealer pays its salespersons more compensation if they sell securities that carry a deferred sales load, or if they sell "proprietary" securities (that is, securities issued by an affiliate of the broker, dealer or municipal securities dealer).
Periodic disclosure alternative - The rule 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, after an initial confirmation has been sent that meets the requirements of the rule.
Comparison range disclosure - The rule would provide a mechanism to give investors additional context for evaluating the significance of certain information. This context would come from comparison ranges for sales compensation, revenue sharing, and portfolio brokerage commissions, so that investors can see where their particular costs and payments fall in comparison to the median and ranges in the marketplace. The Commission would need to propose additional rules to determine how to obtain and disseminate comparison range information.
General disclosure requirements - For all transactions (sales as well as purchases), the rule would require disclosure of
- the date of the transaction,
- the issuer and class of the security,
- the net asset value of the shares or units and, if different, their public offering price,
- the number of shares purchased or sold by the customer,
- the total dollar amount paid or received in the transaction,
- the net amount of the investment bought or sold in the transaction,
- any commission, markup or other remuneration the broker, dealer or municipal securities dealer will receive from the customer in connection with the transaction, and
- when applicable, 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.
Proposed Amendments to the Commission's General Confirmation Requirements and Form N-1A
The Commission also voted to propose 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 voted to propose amendments to Form N-1A, the registration form for mutual funds, to improve disclosure of sales loads and revenue sharing.
Special Request for Comments from Investors
Finally, these initiatives are intended to give investors "news they can use." In addition to including a special section in the proposal soliciting comments from investors, the Commission intends to reach out to the investor community through a variety of methods, including investor focus groups. This process is intended to design requirements - including standardized disclosure forms - that average investors will find useful and informative.
Comments on these proposals should be received by the Commission within 60 days of publication in the Federal Register.