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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Statement at the SEC Open Meeting


Annette Nazareth

Director, Division of Market Regulation
U.S. Securities & Exchange Commission

Washington, D.C.

January 14, 2004

Thank you, Chairman Donaldson, and Commissioners Glassman, Goldschmid, Atkins, and Campos.

The Division is recommending that the Commission propose two new rules to improve investor access to information about the costs and conflicts of interest that arise from the distribution of mutual fund shares, unit investment trust interests and municipal fund securities used for education savings, commonly called "529 plans." Our goals in crafting these rules are twofold: to ensure that investors are told whether their broker has a conflict of interest and to better enable investors to fully comprehend the costs associated with investing in these products. The first rule, Exchange Act Rule 15c2-2, would require targeted disclosure of the costs and conflicts in customer transaction confirmations. The second rule, Exchange Act Rule 15c2-3, would require "point of sale" disclosure of some of these costs and conflicts, prior to the customer agreeing to enter into the transaction.

We also are proposing conforming changes to the Commission's general confirmation rule, Exchange Act Rule 10b-10. In addition, we are proposing that the Commission amend this rule to enhance disclosure about the call provisions of callable debt securities, and to require disclosure about call provisions of preferred stock.

As you know, broker-dealers are not currently required to include information about sales loads or 12b-1 fees in their transaction confirmations for purchases of mutual fund shares. Similarly, they are not specifically required by Rule 10b-10 to include information in confirmations about revenue sharing and other sales incentives that cause conflicts of interest for them. Those limitations stem, in part, from positions that the Commission took in the late 1970s, when compensation arrangements for selling mutual funds were significantly less varied and less complex. In addition, at that time mutual funds did not rely as heavily on broker-dealers for distribution of their shares.

Today, mutual fund complexes have a variety of ways to compensate broker-dealers for their distribution services and all of the compensation arrangements are a cost to the investor. In addition to sales fees (which broker-dealers earn at the time of the transaction, and which often are different from the loads paid by customers to the fund) - broker-dealers often receive a continuing stream of asset-based 12b-1 fees from their customers' mutual fund investments. Broker-dealers may also be compensated for their distribution efforts through revenue sharing arrangements with the advisor or other affiliate of a fund. They also may receive payments that are characterized as service fees, recordkeeping or transfer fees, or continuing education sponsorships. Moreover, funds may reward broker-dealers for mutual fund sales with "portfolio brokerage commissions" - that is, commissions for effecting trades for the fund's own portfolio.

Broker-dealers may also pay differential compensation to their sales personnel. For example, registered representatives may be paid more for selling their customers B shares than A shares of the same fund - because the firm earns more from sales of B shares. Similarly, registered representatives may receive a larger percentage of the payments made to the broker-dealer by proprietary funds than they do for the sale of other fund shares.

All of these payment streams, of course, create tremendous incentives for broker-dealers and registered representatives to promote the sale of some fund shares over others. The proposals you are considering today are intended to provide investors with information concerning the conflicts of interest raised by these payment practices, as well as the real costs investors incur with their fund investments.

Disclosure problems, however, are not limited to transactions in mutual funds. The growth of state-sponsored 529 plans raises similar concerns. Because investors in those programs may be particularly inexperienced - and because these plans are exempt from disclosure under the Investment Company Act of 1940 - heightened cost and conflict disclosure in this context may be even more critical. The distribution of unit investment trust interests, particularly insurance securities, raises similar cost and conflict issues.

In sum, we believe that current marketing and payment practices in mutual funds, UITs, and 529 plans indicate a need to require broker-dealers to provide enhanced cost and conflict disclosure to investors.

As Chairman Donaldson noted, the primary goal of this proposal is to give investors tools they can use to better understand distribution-related costs on their investments, and arrangements that create conflicts of interest for their broker-dealers. Investors who have better access to information, can make better investment decisions. Thus, we are proposing to require broker-dealers to give their customers some fundamental information about their costs and conflicts of interest at the point of sale - when the customers can factor it into their investment decisions - as well as additional information in their transaction confirmations - when the customers can factor it into their decisions of whether to make additional investments of the same type.

Improving disclosure in this area is particularly challenging because of the complexity of the arrangements that can lead to costs and conflicts. One way we hope to make this information more understandable is by providing comparison ranges for certain types of payments - sales loads paid by customers, as well as sales fees, revenue sharing, and portfolio brokerage commissions paid to broker-dealers. These comparison ranges would show investors what the industry norms are - so they could easily assess where their investment falls within the range. During the comment period, we plan to develop more fully the process for collecting and analyzing data to calculate these comparison ranges. We would like to stress that, while comparison ranges have long been used in other contexts - such as automobile fuel efficiency and appliance energy efficiency - this would be a novel concept in securities regulation. Traditionally, the Commission has not required regulated entities to disclose information that does not directly pertain to them.

We are hopeful that these proposals strike the right balance by requiring disclosure of a sufficient amount of relevant information, while ensuring that it is understandable and in an accessible format. We expect the notice and comment process will give us useful feedback on whether we have hit the mark. During the comment period, we will work closely with the Commission's Office of Investor Education and Assistance, as well as other Commission offices, to reach out to the public to better understand whether the proposals reflect the information that investors want to know, and if that information is "user friendly." This will be an educational process for us, and we hope to get input from a wide range of investors, investor groups, and industry participants.

I would now like to ask Joshua Kans of my staff to outline the specific terms of the proposals we are recommending.



Modified: 01/14/2004