-------------------- BEGINNING OF PAGE #1 -------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 210, 239, and 274
Release No. 33-7197; IC-21221; FR-46; S7-22-94
RIN 3235-AF94
Payment for Investment Company Services with Brokerage
Commissions
AGENCY: Securities and Exchange Commission.
ACTION: Final amendments to rules and forms.
SUMMARY: The Securities and Exchange Commission is adopting rule
and form amendments relating to the reporting of expenses by
investment companies. The amendments require an investment
company to reflect as expenses in its statement of operations and
in other financial information certain liabilities of the company
paid by broker-dealers in connection with allocation of the
company's brokerage transactions to the broker-dealers and
liabilities reduced by certain expense offset arrangements. In
addition, the amendments require an investment company to
disclose the average commission rate it paid in connection with
the purchase and sale of portfolio securities, subject to a de
minimis exception. The amendments are intended to enhance the
information provided to investors so that they may be better able
to assess and compare investment company expenses and yield
information.
DATES: EFFECTIVE DATE: The amendments are effective September
1, 1995.
COMPLIANCE DATE: Proxy statements and shareholder
reports filed with the Commission and quotations of yield by
investment companies in advertisements or sales literature
published or distributed on or after December 1, 1995 must comply
with the amendments. Required compliance for financial
information appearing in registration statements is staggered to
reflect the affected investment companies' annual updating
schedules. A more detailed discussion of the compliance dates
appears in section II.G of this release.
FOR FURTHER INFORMATION CONTACT: Karen J. Garnett, Attorney,
Office of Disclosure and Investment Adviser Regulation, (202)
942-0728, or Anthony Evangelista, Assistant Chief Accountant,
(202) 942-0636, Division of Investment Management, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, DC
20549.
SUPPLEMENTARY INFORMATION: The Securities and Exchange
Commission ("Commission") today is adopting amendments to:
(1) Rule 6-07 of Regulation S-X [17 CFR 210.6-07]; and
(2) Form N-1A [17 CFR 239.15A, 274.11A], Form N-2 [17 CFR
239.14, 274.11a-1], Form N-3 [17 CFR 239.17a, 274.11b], and Form
N-4 [17 CFR 239.17b, 274.11c] under the Securities Act of 1933
[15 U.S.C. 77a et seq.] ("1933 Act") and the Investment Company
Act of 1940 [15 U.S.C. 80a-1 et seq.] ("1940 Act").
TABLE OF CONTENTS
I. BACKGROUND
II. DISCUSSION
A. Accounting for Expenses
1. Brokerage/Service Arrangements
2. Expense Offset Arrangements
3. Accounting Method
4. Financial Statement Note Disclosure
B. Exception for Research Services
C. Fee Table and Financial Highlights Table
D. Yield
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E. Average Commission Rates
F. Effective Date
G. Compliance Dates
1. Registration Statements
2. Yield Information
3. Proxy Statements and Shareholder Reports
H. Filing Requirements for Post-Effective Amendments
III. COST/BENEFIT ANALYSIS
IV. REGULATORY FLEXIBILITY ANALYSIS
V. STATUTORY AUTHORITY
TEXT OF RULE AND FORM AMENDMENTS
I. BACKGROUND
Some investment companies enter into arrangements under
which a broker-dealer agrees to pay the cost of certain products
or services provided to the investment company in exchange for
fund brokerage ("brokerage/service arrangements"). Under a
typical brokerage/service arrangement, a broker agrees to pay a
fund's custodian fees or transfer agency fees and, in exchange,
the fund agrees to direct a minimum amount of brokerage to the
broker. The fund usually negotiates the terms of the contract
with the service provider, which is paid directly by the
broker.-[1]-
By entering into a brokerage/service arrangement, a fund can
reduce expenses reported to shareholders in its statement of
operations, fee table, and expense ratio and can increase its
reported yield. A fund is able to decrease expenses and increase
yield under these arrangements because the costs paid on behalf
of the fund by the broker are embedded in the brokerage
commissions the fund pays.-[2]- Brokerage commissions are
---------- FOOTNOTES ----------
-[1]- Brokerage/service arrangements are structurally similar
to the more common research soft dollar arrangements
under which an investment adviser uses client
commission dollars to obtain research services. In a
research soft dollar arrangement, however, the receipt
of a benefit by an adviser through the use of its
clients' commission dollars raises conflict of interest
concerns addressed by the safe harbor provisions of
section 28(e) of the Securities Exchange Act of 1934
("1934 Act") [15 U.S.C. 78bb(e)]. These concerns
generally are not raised by brokerage/service
arrangements, which typically involve use of a fund's
commission dollars to obtain services that directly and
exclusively benefit the fund.
-[2]- The staff has stated that the safe harbor provided by
section 28(e) of the 1934 Act does not encompass soft
dollar arrangements under which research services are
acquired as a result of principal transactions, i.e.,
when a broker buys or sells securities for or from its
own account. U.S. Department of Labor (pub. avail.
July 25, 1990). Because brokerage/service arrangements
do not rely on the Section 28(e) safe harbor, a fund
may use principal as well as agency transactions to
accumulate credits with brokers for the payment of fund
(continued...)
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reflected in the cost basis of the purchased securities or as a
reduction of the proceeds from the sale of securities.
On August 11, 1994, the Commission proposed for public
comment amendments to its accounting rules that would require
fund financial data to reflect amounts the fund would have paid
to its service providers if a broker-dealer or any affiliate of
the broker-dealer had not paid or agreed to pay those service
providers on behalf of the fund in connection with a
brokerage/service arrangement.-[3]- As proposed, the amendments
would require that the adjusted expenses be reflected in a fund's
fee table and financial highlights table included in the fund's
prospectus, and in the yield quotations in the fund's
advertisements and sales literature. In addition, the proposed
amendments would require that the financial highlights table
disclose the average commission rate paid by the fund.
The Commission received comments on the Proposing Release
from 104 commenters.-[4]- Commenters that addressed the
substance of the Commission's proposals generally expressed
support for the proposed amendments.-[5]- These commenters
expressed their belief that the proposals would enhance the
information provided to investors so that they may be better able
to assess and compare investment company expenses and
performance. The Commission is adopting the proposed amendments
with several modifications that reflect the comments
received.-[6]-
---------- FOOTNOTES ----------
-[2]-(...continued)
expenses. Therefore, references in this release to
"commissions" or "commission dollars" rather than
"spreads" or "mark-ups" are not intended to indicate
otherwise.
-[3]- Investment Company Act Release No. 20472 (Aug. 11,
1994) [59 FR 42187 (Aug. 17, 1994)] ("Proposing
Release").
-[4]- The Commission received a total of 108 comment letters,
as four commenters provided two letters each. The
comment letters and a summary of comments prepared by
the Commission's staff are available for public
inspection and copying in the Commission's public
reference room in File No. S7-22-94.
-[5]- Seventy-one of the 104 commenters, however, limited
their comments to the issue of whether the Commission
should require funds to include as expenses the cost of
research services provided by brokers. See infra
section II.B.
-[6]- As discussed in section II.A.2 below, one of these
changes requires funds to reflect as expenses
liabilities reduced in connection with certain expense
offset arrangements.
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II. DISCUSSION
A. Accounting for Expenses
1. Brokerage/Service Arrangements
The Commission is adopting, substantially as proposed,
amendments to rule 6-07 of Regulation S-X-[7]- to require that
the amounts of various expenses (such as custody fees, transfer
agency fees, printing and legal fees, and other miscellaneous
fees) listed in a fund's statement of operations be adjusted, or
"grossed-up," to include amounts paid with commission
dollars.-[8]- The rule amendments require funds to make
adjustments to their statements of operations at the time
financial statements are prepared, but do not require daily
expense accruals for services paid with commission dollars. The
rule amendments do not require funds to adjust amounts in the
financial statements other than expenses and the expense
ratio.-[9]-
---------- FOOTNOTES ----------
-[7]- Article 6 of Regulation S-X specifies the contents of
financial statements included in registration
statements, proxy statements and shareholder reports of
registered investment companies. Rule 6-07 of
Regulation S-X sets forth the requirements for
investment company statements of operations.
-[8]- The staff previously has required funds to disclose in
footnotes to the fee table, financial highlights table,
and financial statements their participation in
brokerage/service arrangements and the effect these
arrangements may have on the level of brokerage
commissions paid to the fund. See Proposing Release,
supra note 3, at n.2. The amendments to rule 6-07
eliminate the need for this disclosure and therefore
the staff will no longer require such footnotes.
-[9]- The Proposing Release explained that a fund's
investment adviser can benefit from brokerage/service
arrangements, particularly if a reduction in fund
expenses affects the amount of any expense waiver or
reimbursement by the adviser. Proposing Release, supra
note 3, at n.1. Section 17(e)(1) of the 1940 Act [15
U.S.C. 80a-17(e)(1)] makes it unlawful for an
affiliated person of a fund (such as its adviser) to
accept from any source compensation (other than regular
wages) for the purchase or sale of fund shares. The
receipt by a fund's adviser of any direct or indirect
economic benefit as a result of brokerage/service
arrangements would almost certainly violate section
17(e)(1), unless the benefit received fell within the
safe harbor provided by section 28(e) of the 1934 Act.
See supra note 1. However, the Commission believes
that if a fund adviser voluntarily imposes a limitation
on the fund's expenses or waives its fees, the fund's
brokerage/service arrangements would not violate
section 17(e)(1). Similarly, if compliance with
expense limitations imposed by statute or by contract
is measured by reference to the fund's total expenses
(i.e., expenses adjusted to include the cost of
services provided under brokerage/service
arrangements), a fund's brokerage/service arrangements
would not result in a violation of section 17(e)(1).
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A majority of the commenters that addressed the substance of
the proposal supported the proposed accounting changes. These
commenters agreed that the gross-up adjustment to expenses would
accurately reflect the economic effect of these arrangements,
would assist investors in comparing expenses among funds, and
would be consistent with current industry reporting standards for
statements of operations. Fund industry commenters stated that
the method proposed for reflecting broker-paid liabilities as
fund expenses was appropriate and not burdensome.-[10]- Some
commenters, however, opposed the proposal, asserting that
grossing-up fund expenses would not provide meaningful disclosure
to investors and could mislead investors about the benefits to
the fund of brokerage/service arrangements. Other commenters
objected to the proposal arguing that it would cause funds to
overstate expenses.
Commenters opposing the proposed amendments asserted, in
effect, that comparable commission rates might be paid by funds
that choose not to enter into brokerage/service arrangements,
and, therefore fund services provided under brokerage/service
arrangements should be treated as "free" services and payments by
brokers should be ignored. If brokers made these payments to
funds in the form of cash, however, fund expenses would not be
affected. Thus, it is merely the form these payments take,
rather than their substance, that has permitted such payments to
reduce fund expenses. To the extent that investors benefit from
these arrangements (which the Proposing Release acknowledged they
may), the benefit is reflected in overall fund return rather than
as a reduction of fund expenses -- a result that more accurately
reflects these arrangements as a rebate on brokerage.
2. Expense Offset Arrangements
a. Fee Reductions. Some funds enter into
arrangements that, like brokerage/service arrangements, have the
effect of reducing reported fund expenses. In these arrangements
("expense offset arrangements"), however, expenses are reduced by
foregoing income rather than by recharacterizing them as capital
items. For example, a fund may have a "compensating balance"
arrangement with its custodian under which the custodian reduces
its fees if the fund maintains cash on deposit with the custodian
in non-interest or below market interest bearing accounts.
Similarly, a fund may enter into a securities lending agreement
under which the fund permits the custodian to loan fund
securities to third parties (typically unrelated broker-dealers)
in exchange for a reduction in custody fees.-[11]- Expense
---------- FOOTNOTES ----------
-[10]- In the Proposing Release, the Commission requested
comment on an alternative accounting method that would
require funds to allocate each commission paid between
execution cost and payment for fund services, and to
present their financial statements based upon those
allocations. This method would have required funds to
separate commissions into brokerage and expense
components, and reflect the expense component as an
expense in the financial statements. Commenters that
addressed the alternative accounting method were
uniformly opposed to it on grounds that it would be
impractical, costly, and burdensome for funds to
calculate, as well as difficult to audit.
-[11]- Securities lending arrangements may raise other issues
under the federal securities laws. The Commission is
(continued...)
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offset arrangements may involve explicit oral or written
agreements regarding the amount of fee reductions. A fund's
custody fee may, however, reflect an estimate of the income the
custodian expects to derive from an expense offset arrangement,
and the resulting fee reduction is not expressly stated in the
custodial agreement.
The Commission requested comment whether an adjustment to
fund expenses similar to that proposed for brokerage/service
arrangements should be required for expense offset arrangements,
or whether these arrangements should be addressed in footnotes to
the financial statements.-[12]- In addition, the Commission
requested comment whether the amount of any increase in fund
expenses to reflect these arrangements should include only
amounts that are explicit in the agreement, or should also
include amounts implicit in the basic custodian fee.
Most of the commenters addressing this issue supported an
adjustment to fund expenses for expense offset arrangements.
Commenters generally stated that requiring disclosure for expense
offset arrangements would be consistent with requirements
relating to brokerage/service arrangements. Commenters were
divided, however, on whether the amount of any increase in fund
expenses should include only amounts that are explicit in
agreements between the fund and the service provider.
The amendments to rule 6-07 of Regulation S-X, as adopted,
require funds to include as expenses the amount of any reduction
in fees or expenses arising from expense offset
arrangements.-[13]- A fund's statement of operations must
reflect as the cost of services provided the amount that the fund
would have paid in the absence of the expense offset
arrangement.-[14]- The requirement only applies to agreements
that provide for specified or reasonably ascertainable fee
reductions in exchange for use by another person of the fund's
assets. It does not apply to fee reductions that are implicit in
the service provider's basic fee.
---------- FOOTNOTES ----------
-[11]-(...continued)
not addressing in this release the merits of any
particular securities lending arrangements.
-[12]- Footnote disclosure of compensating balance
arrangements under which the withdrawal or use of cash
or cash items is restricted, either legally or as a
practical matter, is currently required by rule 6-04.5
of Regulation S-X [17 CFR 210.6-04.5]. In addition,
Rule 6-04.11 of Regulation S-X [17 CFR 210.6-04.11]
requires fund balance sheets to state the value of
securities loaned and to indicate the nature of
collateral received as security for the loan.
-[13]- Rule 6-07.2(g)(2) of Regulation S-X [17 CFR 210.6-
07.2(g)(2)]. Under the amendments, expense offset
arrangements include arrangements under which a service
provider reduces its fees in return for the use of fund
assets as well as arrangements under which another
person, in return for the use of fund assets, makes
payment to a fund service provider which in turn
reduces its fees charged to the fund.
-[14]- Amendments to fund registration forms adopted today
incorporate similar requirements for fund prospectuses
by reference to rule 6-07.
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b. Foregone Income. The Commission also
requested comment whether funds should be required to estimate
income foregone under expense offset arrangements and reflect
such amounts in fund financial information.-[15]- The Commission
asked commenters to suggest methods for estimating income
foregone under these arrangements. Some commenters supported
such a requirement, suggesting that funds should make a
"reasonable estimate" of foregone income. Other commenters noted
the difficulty of estimating lost income and expressed concern
that such a requirement could result in misleading financial
information. Moreover, one commenter argued that, in order to
estimate lost income, a fund would have to assume income, which
is inconsistent with generally accepted accounting principles
("GAAP") and could prevent auditors from issuing an unqualified
report that fund financial statements are prepared in accordance
with GAAP.
The Commission shares certain of these concerns and has
therefore decided not to require funds to reflect in fund
financial information income foregone as a result of expense
offset arrangements. As amended, rule 6-07 requires a fund that
enters into an expense offset arrangement to include in a
footnote to financial statements a statement that the fund could
have invested the assets used by the other person in an income-
producing asset if it had not agreed to a reduction in fees or
expenses under an expense offset arrangement.
3. Accounting Method
Under rule 6-07, as amended, a fund's total expenses
reported in the statement of operations must include expenses
paid under brokerage/service and expense offset
arrangements.-[16]- Total expenses are then reduced by the total
amount paid under brokerage/service and expense offset
arrangements. The remainder appears on the statement of
operations as "net expenses."-[17]- The following example
illustrates adjustments to the statement of operations required
by the amended rule:
---------- FOOTNOTES ----------
-[15]- Proposing Release, supra note 3, at section II.D.
-[16]- A fund must also use the total expense figure to
calculate its expense ratio, its "Other Expenses"
listed in the fee table, and its yield. See infra
sections II.C and II.D.
-[17]- Because only expenses, and not realized gains/losses or
unrealized appreciation/depreciation, are adjusted in
the statement of operations, the presentation of "net
expenses" is necessary to ensure that net investment
income is not affected by the adjustment to expenses.
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Expenses
Management Fee . . . . . . . . . . . . . . $ 50
[Other direct fund expenses] . . . . . . . 48
Custodian Fee [would include 8 paid by brokers] 10
-----
Total Expenses . . . . . . . . . . . . 108
Fees Paid Indirectly-[18]- . . . . . . (8)
-----
Net Expenses . . . . . . . . . . 100
-----
The increase in "Total Expenses," and the offsetting "Fees
Paid Indirectly," reflect the amount that the fund would have
paid for services in the absence of brokerage/service and expense
offset arrangements. If a fund directly negotiates the service
provider's fees, the cost of the services for purposes of making
the required adjustments is the amount negotiated, presumably the
same amount the fund would have paid for the service in the
absence of the arrangement. If the fund cannot readily determine
the actual cost of such services, e.g., when a broker arranges
for the services or provides them itself or through an affiliate,
the fund must make a good-faith estimate of the amount it would
have paid if it had contracted for the services directly in an
arms-length transaction.-[19]-
4. Financial Statement Note Disclosure
As proposed, the amendments to rule 6-07 would have required
a fund to identify separately in a note to the financial
statements any expense that the amendments would require to be
increased by five percent or more over the amount of the
unadjusted expense.-[20]- Several commenters urged the
Commission to require less detailed note disclosure, arguing that
shareholders were not interested in individual expense amounts.
In response to these concerns, the amended rule requires a fund
to state separately in a note to the financial statements the
total of expense increases resulting from brokerage/service and
expense offset arrangements (which together should be equal to
the amount of the "Fees Paid Indirectly" line item in the
statement of operations). The amended rule also requires a fund
to state in the footnote each category of expense that is
increased by an amount equal to at least five percent of total
expenses.-[21]-
---------- FOOTNOTES ----------
-[18]- As amended, rule 6-07 requires funds to include a
footnote to the financial statements that states
separately the total amount of expenses paid through
brokerage/service arrangements and the total amount of
expenses paid through expense offset arrangements. See
infra section II.A.4.
-[19]- The good-faith estimate may be based upon price quotes
for the services obtained by the fund or the amount
funds of similar size and having similar investment
objectives pay for the same services.
-[20]- Proposing Release, supra note 3, at n.12. The
amendments, as proposed, would have permitted funds to
aggregate amounts that individually were less than five
percent of the unadjusted expense and required funds to
state the total of these amounts.
-[21]- The five percent threshold is consistent with an
existing provision of rule 6-07 that requires funds to
(continued...)
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B. Exception for Research Services
As proposed, the requirement to adjust reported expenses to
include amounts paid with commission dollars excepted the cost of
research services (as that term is used in section 28(e) of the
1934 Act) provided by broker-dealers.-[22]- Most commenters
believed that the exception was appropriate. Many pointed out
the difficulties of allocating research received by the adviser
among accounts when the brokerage of those accounts is used to
acquire the research.-[23]- Some also asserted that it would be
difficult to value research services, particularly when combined
with brokerage services, while others objected to making
assumptions about the value of research services.
A minority of commenters supported the additional disclosure
of research soft dollar practices. These commenters expressed
concern that such practices pose the same hidden expense problems
as brokerage/service arrangements, and that such practices may be
more likely to raise conflicts of interest than brokerage/service
arrangements. None of the commenters, however, suggested a
feasible approach for valuing-[24]- or allocating-[25]- research
---------- FOOTNOTES ----------
-[21]-(...continued)
state separately expense items that exceed five percent
of the total expenses shown in the statement of
operations. Rule 6-07.2(b) [17 CFR 210.6-07.2(b)].
-[22]- See supra note 1. Because research services are
typically provided to the adviser, not the fund, the
specific exception may be unnecessary. In light of the
widespread use of research soft dollar arrangements,
however, the Commission is adopting a specific
exception.
-[23]- Twenty commenters expressly opposed allocation of
research on an account-specific basis, stating that
such a requirement would be burdensome (with no
corresponding benefit to investors), costly, arbitrary
or impossible.
-[24]- One commenter recommended that fund advisers be
required to make a good faith estimate of what soft
dollar research would have cost in an arms-length
transaction. This approach, however, would require
fund advisers to report positive values for unsolicited
and unused research, which could distort fund expenses
if receipt of the research was incidental to brokerage
direction decisions made wholly on the basis of the
broker's execution capabilities. In addition, good
faith estimates may be difficult to make if the
services provided are unlike those available for hard
dollars.
-[25]- One commenter recommended that expenses incurred on
behalf of more than one fund be allocated in accordance
with written formulas approved by the board of
directors of each fund. While it is possible that a
board of directors may be in a position to provide
guidance to an adviser in allocating the cost or value
of research among series of a series fund or among
funds having a common board of directors, it is
unlikely that a board would be in such a position with
respect to other clients of the adviser.
-------------------- BEGINNING OF PAGE #10 -------------------
services for purposes of disclosure. Because of the practical
difficulties of valuing and allocating research services, the
amendments except the cost of research services from the
requirement to gross up fund expenses.-[26]-
C. Fee Table and Financial Highlights Table
The Commission also proposed amendments to the instructions
to items of fund registration forms that require funds to include
in their prospectuses a table presenting the expenses paid by
fund shareholders, either directly or out of the assets of the
fund (the "fee table").-[27]- Most commenters supported these
amendments and the Commission is adopting them as proposed.
The amended instructions require that expense percentages
included in a fund's fee table be based upon total expenses
(i.e., expenses that include amounts paid in connection with
brokerage/service arrangements and expense offset arrangements).
Similarly, the "ratio of expenses to average net assets"
("expense ratio") in a fund's financial highlights table must
reflect total expenses.-[28]- Funds must also include a footnote
to the financial highlights table disclosing the change in the
manner in which expenses have been determined.
D. Yield
The Commission is adopting, substantially as proposed,
amendments to the instructions to yield formulas for funds (other
than money market funds) that require a fund to include the cost
of services paid with brokerage commissions in yield quotations
appearing in the fund's registration statement and, as a result,
in its advertisements.-[29]- The amended instructions require
funds to estimate amounts paid with commission dollars for the
period of the yield quotation.-[30]- A majority of commenters
---------- FOOTNOTES ----------
-[26]- The Commission recently proposed new disclosure
requirements for soft-dollar practices. Investment
Advisers Act Rel. No. 1469 (Feb. 14, 1995) [60 FR 9750
(Feb. 21, 1995)] ("Adviser Soft Dollar Release"). The
Commission requested comment on the valuation issue in
the Adviser Soft Dollar Release. If the comments
received in response to the Adviser Soft Dollar Release
suggest a feasible way to address these issues without
imposing burdens that outweigh the benefits of
disclosure, the Commission may reconsider the exception
for research services provided in the amendments
adopted today.
-[27]- Item 2(a)(i) of Form N-1A, Item 3.1 of Form N-2, Item
3(a) of Form N-3, and Item 3(a) of Form N-4.
-[28]- Item 3(a) of Form N-1A and Item 4.1 of Form N-2. The
Commission did not propose amendments to the per share
tables in Forms N-3 and N-4.
-[29]- Paragraph (e)(1) of rule 482 under the 1933 Act [17 CFR
230.482(e)(1)] requires that yield quotations included
in fund advertisements be calculated in accordance with
the formulas specified in fund registration forms. The
yield formulas are set forth in Item 22(b)(ii) of Form
N-1A, Item 25(b)(ii) of Form N-3, and Item 21(b)(ii) of
Form N-4.
-[30]- The amendments to Regulation S-X require funds to
adjust expenses at the end of a financial statement
(continued...)
-------------------- BEGINNING OF PAGE #11 -------------------
addressing this proposal expressed support for the requirement.
These commenters stated that the proposed requirement would
prevent funds from overstating yield and would be consistent with
the Commission's objective of enhancing investors' ability to
compare expenses and yields among funds.-[31]-
The amendments do not require funds to adjust yield
calculations to reflect expense offset arrangements. Because the
formula for calculating yield requires funds to reduce income by
expenses,-[32]- any increase in expenses to reflect expense
offset arrangements would require a corresponding increase in
income by an estimate of income foregone as a result of the
arrangement. As discussed above, the amendments do not require
estimates of foregone income in the statement of operations.
Moreover, because expense offset arrangements generally reduce
both income and expenses by similar amounts, reflection of (or
failure to reflect) these arrangements in calculation of fund
yield should have a minimal effect on the reported yield.
E. Average Commission Rates
The Commission proposed to require funds to disclose the
average commission rate paid by a fund in the financial
highlights table next to the portfolio turnover rate. Brokerage
commissions and other costs incurred in connection with the
execution of a fund's portfolio transactions are not reflected in
the fund's statement of operations, financial highlights table,
or fee table because these costs are treated as capital items
that increase the cost of securities purchased or reduce the
---------- FOOTNOTES ----------
-[30]-(...continued)
period, but generally would not require funds to accrue
or otherwise determine at the end of the 30-day period
for which yield is calculated the amount of expenses
paid with brokerage commissions for that period.
-[31]- The amendments do not revise the manner in which yield
is calculated by money market funds. The money market
fund yield formula is based upon the net change in the
value of a hypothetical account, and any spread or
mark-up paid by a fund is amortized and reflected in
that change in value. See, e.g., Item 22(a) of Form N-
1A. Therefore, requiring money market funds to include
fees paid with commission dollars in the calculation of
yield would result in those fees being counted twice.
The same double-counting problem does not arise with
respect to non-money market funds because the yield
formula for those funds generally requires that the
amortization of premium and accretion of discount on
debt securities be based upon the market value of the
security, rather than the initial purchase price. See,
e.g., Instruction 1(a) to Item 22(b)(ii) of Form N-1A.
The mark-up or spread paid by the fund upon the
purchase of a security is not reflected in the
security's market value and therefore would not be a
part of any premium amortized or discount accreted for
the purposes of calculating yield. Only two commenters
addressed the question of revising the yield formula
for money market funds. Both of these commenters
agreed with the Commission's analysis of the effect of
brokerage/service arrangements on money market fund
yield, and both were opposed to such revisions.
-[32]- See, e.g. Item 22(b)(ii) of Form N-1A.
-------------------- BEGINNING OF PAGE #12 -------------------
proceeds of securities sold. The Commission was concerned that
funds may not provide adequate information about these costs to
investors,-[33]- particularly in light of the fact that these
costs can reflect the cost of research and other benefits the
fund adviser may receive in connection with its direction of fund
brokerage.-[34]-
Most fund industry commenters opposed the proposal,
asserting that disclosure of average commission rates either
would not be meaningful or would be confusing for most investors
because average commission rates do not reflect spreads and
quality of execution. Furthermore, they argued, factors
affecting commission rates, such as the size of the order, the
market in which the security trades, and the nature of the
brokerage firm capital commitment to the trade, would preclude
any useful comparison between funds. Other commenters expressed
concern that requiring funds to disclose average commission rates
would induce funds to place undue emphasis on lower commission
rates rather than quality of execution.
The Commission believes that disclosure of average
commission rates can improve investors' ability to evaluate and
compare fund brokerage costs, and is adopting the requirement as
proposed. While many factors may affect commission rates, many
similar factors affect other fund costs. The Commission believes
that a comparison of average commission rates among funds will be
a useful bench-mark for investors and therefore is adopting the
disclosure requirement substantially as proposed.-[35]-
One commenter urged the Commission to exclude from the
requirement to disclose average commission rates funds that have
a de minimis amount of transactions on which brokerage
commissions are paid. Because commission rate information may
have limited value in such circumstances, the Commission has
adopted an exclusion for funds that, during any fiscal year,
invest on average less than ten percent of their net assets in
---------- FOOTNOTES ----------
-[33]- A fund is required to disclose in its Statement of
Additional Information the aggregate amount of
brokerage commissions it paid to fund affiliates during
its three most recent fiscal years. Item 17(b) of Form
N-1A.
-[34]- See supra notes 1 and 2.
-[35]- The Commission has added instructions to the various
fund registration forms describing the method for
calculating average commission rate. Instruction 17 to
Item 3 of Form N-1A, and Instruction 19 to Item 4 of
Form N-2. The instruction requires funds to compute
the average commission rate paid by dividing the total
dollar amount of commissions paid during the fiscal
year by the total number of shares purchased and sold
during the fiscal year for which commissions were
charged. Funds must convert commissions paid in
foreign currencies into US dollars and cents per share.
Mark-ups, mark-downs, and spreads on shares traded on a
principal basis are not included in the average
commission rate figure unless they are disclosed on
confirmations prepared in accordance with rule 10b-10
under the 1934 Act [17 CFR 240.10b-10].
-------------------- BEGINNING OF PAGE #13 -------------------
equity securities on which commissions are charged on
trades.-[36]-
F. Effective Date
The amendments are effective September 1, 1995. All funds
may elect to comply with the amendments before the effective date
or before the compliance dates described below.
G. Compliance Dates
1. Registration Statements
a. Current Registrants. Registered investment
companies must amend their registration statements to comply with
the rule amendments no later than the next post-effective
amendment updating financial statements pursuant to section
10(a)(3) of the 1933 Act to reflect information for fiscal years
ending on or after the effective date.-[37]- Information
regarding average commission rates, however, must be provided
only for fiscal years beginning on or after the effective
date.-[38]-
b. New Registrants. Funds with registration
statements effective on or after the effective date of these rule
amendments must first reflect these rule amendments in financial
information contained in post-effective amendments filed
thereafter. (1) Yield Information
Yield quotations appearing in fund advertisements or other
sales literature published or distributed on or after December 1,
1995 must be calculated in accordance with the rule amendments.
2. Proxy Statements and Shareholder Reports
Financial information covering fiscal years ending on or
after the effective date contained in proxy statements and
shareholder reports filed with the Commission must comply with
the amendments.
H. Filing Requirements for Post-Effective Amendments
Post-effective amendments to fund registration statements
made for purpose of complying with these rule amendments may be
made pursuant to the immediate effectiveness provisions of rule
485(b) under the 1940 Act [17 CFR 230.485(b)], provided that the
post-effective amendment otherwise meets the conditions for
immediate effectiveness under that rule.
III. COST/BENEFIT ANALYSIS
The rule and form changes adopted today are intended to
improve the reporting of investment company expenses and the
ability of investors to compare investment company expenses and
yield. While these amendments may increase the cost to funds of
preparing financial statements and registration materials, the
Commission believes that any such cost increases would, at most,
be minimal. A fund that has brokerage/service or expense offset
arrangements is required to add two captions and a footnote to
its statement of operations and replace the net expense figures
---------- FOOTNOTES ----------
-[36]- Instruction 16 to Item 3 of Form N-1A, and Instruction
18 to Item 4 of Form N-2.
-[37]- The financial highlights table in fund prospectuses
presents financial data for each of the last ten fiscal
years. The amendments do not require funds to reflect
total expenses in the expense ratio of the financial
highlights table for fiscal years ending before the
effective date.
-[38]- This requirement is consistent with the Commission's
proposal. See Proposing Release, supra note 3, at
n.30.
-------------------- BEGINNING OF PAGE #14 -------------------
currently disclosed in its fee table and financial highlights
table with total expense figures. Funds generally should be
readily able to determine these figures. Commenters on the
proposal stated that funds should also be readily able to
estimate expenses paid with brokerage commissions for purposes of
yield calculations. Thus, the Commission believes that the costs
of the amendments will not be significant and will be
substantially outweighed by the benefits to investors of
receiving more accurate and useful financial information about
funds.
IV. REGULATORY FLEXIBILITY ANALYSIS
A summary of the Initial Regulatory Flexibility Analysis,
prepared in accordance with 5 U.S.C. 603, was published in the
Proposing Release. No comments were received on this analysis.
The Commission has prepared a final Regulatory Flexibility
Analysis, a copy of which may be obtained by contacting Karen J.
Garnett, Office of Disclosure and Investment Adviser Regulation,
Securities and Exchange Commission, 450 Fifth Street, N.W.,
Washington, DC 20549.
V. STATUTORY AUTHORITY
The Commission is amending rule 6-07 of Regulation S-X and
the various fund registration forms under the authority of
section 7 of the 1933 Act [15 U.S.C. 77g] and sections 8 and
38(a) of the 1940 Act [15 U.S.C. 80a-8, 80a-37(a)]. The
authority citations for the rule and form amendments precede the
text of the amendments.
TEXT OF RULE AND FORM AMENDMENTS
List of Subjects
17 CFR Part 210
Accounting, Reporting and recordkeeping requirements,
Securities
17 CFR Parts 239 and 274
Investment companies, Reporting and recordkeeping
requirements, Securities
For the reasons set out in the preamble, Chapter II, Title
17 of the Code of Federal Regulations is amended as follows:
PART 210 - FORM AND CONTENT OF AND REQUIREMENTS FOR FINANCIAL
STATEMENTS, SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF
1934, PUBLIC UTILITY HOLDING COMPANY ACT OF 1935, INVESTMENT
COMPANY ACT OF 1940, AND ENERGY POLICY AND CONSERVATION ACT OF
1975
1. The authority citation for part 210 continues to read
as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77aa(25),
77aa(26), 78l, 78m, 78n, 78o(d), 78w(a), 78ll(d), 79e(b), 79j(a),
79n, 79t(a), 80a-8, 80a-20, 80a-29, 80a-30, 80a-37a, unless
otherwise noted.
2. By adding paragraph 2.(g) to the Statements of
Operations 210.6-07 to read as follows:
210.6-07 Statements of operations.
* * * * *
2. Expenses. * * *
(g)(1) Brokerage/Service Arrangements. If a broker-dealer
or an affiliate of the broker-dealer has, in connection with
directing the person's brokerage transactions to the broker-
dealer, provided, agreed to provide, paid for, or agreed to pay
for, in whole or in part, services provided to the person (other
than brokerage and research services as those terms are used in
Section 28(e) of the Securities Exchange Act of 1934 [15 U.S.C.
78bb(e)]), include in the expense items set forth under this
-------------------- BEGINNING OF PAGE #15 -------------------
caption the amount that would have been incurred by the person
for the services had it paid for the services directly in an
arms-length transaction.
(2) Expense Offset Arrangements. If the person has entered
into an agreement with any other person pursuant to which such
other person reduces, or pays a third party which reduces, by a
specified or reasonably ascertainable amount, its fees for
services provided to the person in exchange for use of the
person's assets, include in the expense items set forth under
this caption the amount of fees that would have been incurred by
the person if the person had not entered into the agreement.
(3) Financial Statement Presentation. Show the total
amount by which expenses are increased pursuant to paragraphs (1)
and (2) of this paragraph 2.(g) as a corresponding reduction in
total expenses under this caption. In a note to the financial
statements, state separately the total amounts by which expenses
are increased pursuant to paragraphs (1) and (2) of this
paragraph 2.(g), and list each category of expense that is
increased by an amount equal to at least 5 percent of total
expenses. If applicable, the note should state that the person
could have employed the assets used by another person to produce
income if it had not entered into an arrangement described in
paragraph 2.(g)(2) of this section.
* * * * *
PART 239 - FORMS PRESCRIBED UNDER THE SECURITIES ACT OF 1933
PART 274 - FORMS PRESCRIBED UNDER THE INVESTMENT COMPANY
ACT
OF 1940
3. The authority citation for Part 239 continues to read,
in part, as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 77sss, 78c,
78l, 78m, 78n, 78o(d), 78w(a), 78ll(d), 79e, 79f, 79g, 79j, 79l,
79m, 79n, 79q, 79t, 80a-8, 80a-29, 80a-30 and 80a-37, unless
otherwise noted.
* * * * *
4. The authority citation for Part 274 continues to read
as follows:
Authority: 15 U.S.C. 77f, 77g, 77h, 77j, 77s, 78c(b), 78l,
78m, 78n, 78o(d), 80a-8, 80a-24, and 80a-29, unless otherwise
noted.
Note: The text of Form N-1A does not and the amendments will not
appear in the Code of Federal Regulations.
5. By revising the introductory text of Instruction 10 to
Item 2(a)(i) in Part A of Form N-1A (referenced in 239.15A and
274.11A) to read as follows:
Form N-1A
* * * * *
Part A Information Required in a Prospectus
* * * * *
Item 2. Synopsis
(a)(i) * * *
Instructions: * * *
10. "Other Expenses" includes all expenses (except
nonrecurring account fees and expenses reported in other items of
the table) that are deducted from fund assets or charged to all
shareholder accounts. The amounts of expenses deducted from fund
assets are the amounts shown as expenses in the Registrant's
statement of operations (including increases resulting from
complying with paragraph 2(g) of Rule 6-07 [17 CFR 210.6-07] of
Regulation S-X).
* * * * *
-------------------- BEGINNING OF PAGE #16 -------------------
6. By amending Item 3(a) in Part A of Form N-1A
(referenced in 239.15A and 274.11A) by adding the phrase
"Average Commission Rate Paid" below "Portfolio Turnover Rate",
by redesignating Instructions 13 and 14 as Instructions 14 and
15, and adding Instructions 13, 16, and 17 to read as follows:
Form N-1A
* * * * *
Part A Information Required in a Prospectus
* * * * *
Item 3. Condensed Financial Information
(a) * * *
Instructions:
* * * * *
Ratios/Supplemental Data
* * * * *
13. Compute the "ratio of expenses to average net assets"
using the amount of expenses shown in the Registrant's statement
of operations for the relevant fiscal year, including increases
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR
210.6-07] of Regulation S-X, and including reductions resulting
from complying with paragraphs 2(a) and (f) of Rule 6-07
regarding fee waivers and reimbursements. If a change in the
methodology for determining the ratio of expenses to average net
assets results from applying paragraph 2(g) of Rule 6-07, explain
in a note that the ratio reflects fees paid with brokerage
commissions and fees reduced in connection with specific
agreements only for fiscal years ending after September 1, 1995.
* * * * *
Average Commission Rate Paid
16. A Registrant that invests not more than ten percent of
the value of its average net assets in equity securities on which
commissions are charged on trades may omit "average commission
rate paid." Compute average net assets based on amounts invested
at the end of each fiscal quarter.
17. Compute the "average commission rate paid" as follows:
(A) divide the total dollar amount of commissions paid during the
fiscal year by (B) the total number of shares purchased and sold
during the fiscal year for which commissions were charged. Carry
the amount of the average commission rate paid to no fewer than
four decimal places. Convert commissions paid in foreign
currency into U.S. dollars and cents per share using consistently
either the prevailing exchange rate on the date of the
transaction or average exchange rate over such period as related
transactions took place. Do not include mark-ups, mark-downs, or
spreads paid on shares traded on a principal basis unless such
mark-ups, mark-downs, or spreads are disclosed on confirmations
prepared in accordance with rule 10b-10 under the 1934 Act [17
CFR 240.10b-10].
* * * * *
7. By redesignating Instructions 7 and 8 to Item 22(b)(ii)
as Instructions 8 and 9, and adding Instruction 7 to Item
22(b)(ii) in Part B of Form N-1A (referenced in 239.15A and
274.11A) to read as follows:
Form N-1A
* * * * *
Part B Information Required in a Statement of Additional
Information
* * * * *
Item 22. Calculation of Performance Data
* * * * *
(b) Other Registrants * * *
-------------------- BEGINNING OF PAGE #17 -------------------
(ii) Yield. * * *
Instructions: * * *
7. If a broker-dealer or an affiliate (as defined in
paragraph (b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-
X) of the broker-dealer has, in connection with directing the
Registrant's brokerage transactions to the broker-dealer,
provided, agreed to provide, paid for, or agreed to pay for, in
whole or in part, services provided to the Registrant (other than
brokerage and research services as those terms are used in
Section 28(e) of the Securities Exchange Act of 1934 [15 U.S.C.
78bb(e)]), add to expenses accrued for the period an estimate of
additional amounts that would have been accrued for the period if
the Registrant had paid for the services directly in an arms-
length transaction.
* * * * *
Note: The text of Form N-2 does not and the amendments will not
appear in the Code of Federal Regulations.
8. By revising Instruction 9 to Item 3.1 in Part A of Form
N-2 (referenced in 239.14 and 274.11a-1) to read as follows:
Form N-2
* * * * *
Part A--Information Required in a Prospectus
* * * * *
Item 3. Fee Table and Synopsis
1. * * *
Instructions * * *
9. "Other Expenses" includes all expenses (except fees and
expenses reported in other items in the table) that are deducted
from the Registrant's assets and will be reflected as expenses in
the Registrant's statement of operations (including increases
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR
210.6-07] of Regulation S-X).
* * * * *
9. By amending Item 4.1 in Part A of Form N-2 (referenced
in 239.14 and 274.11a-1) by adding "l. Average Commission Rate
Paid" below "k. Portfolio Turnover Rate", by redesignating
Instruction 16 as Instruction 17, and adding Instructions 16, 18
and 19 to read as follows:
Form N-2
* * * * *
Part A--Information Required in a Prospectus
* * * * *
Item 4. Financial Highlights
1. General: * * *
Instructions * * *
Ratios and Supplemental Data * * *
16. Compute the "ratio of expenses to average net assets"
using the amount of expenses shown in the Registrant's statement
of operations for the relevant fiscal year, including increases
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR
210.6-07] of Regulation S-X, and including reductions resulting
from complying with paragraphs 2(a) and (f) of Rule 6-07
regarding fee waivers and reimbursements. If a change in the
methodology for determining the ratio of expenses to average net
assets results from applying paragraph 2(g) of Rule 6-07, explain
in a note that the ratio reflects fees paid with brokerage
commissions and fees reduced in connection with specific
agreements only for fiscal years ending after September 1, 1995.
* * * * *
Average Commission Rate Paid
-------------------- BEGINNING OF PAGE #18 -------------------
18. A Registrant that invests not more than ten percent of
the value of its average net assets in equity securities on which
commissions are charged on trades may omit "average commission
rate paid." Compute average net assets based on amounts invested
at the end of each fiscal quarter.
19. Compute the "average commission rate paid" as follows:
(A) divide the total dollar amount of commissions paid during the
fiscal year by (B) the total number of shares purchased and sold
during the fiscal year for which commissions were charged. Carry
the amount of the average commission rate paid to no fewer than
four decimal places. Convert commissions paid in foreign
currency into U.S. dollars and cents per share using consistently
either the prevailing exchange rate on the date of the
transaction or average exchange rate over such period as related
transactions took place. Do not include mark-ups, mark-downs, or
spreads paid on shares traded on a principal basis unless such
mark-ups, mark-downs, or spreads are disclosed on confirmations
prepared in accordance with rule 10b-10 under the 1934 Act [17
CFR 240.10b-10].
* * * * *
Note: The text of Form N-3 does not and the amendments will not
appear in the Code of Federal Regulations.
10. By revising the introductory text of Instruction 15 to
Item 3(a) in Part A of Form N-3 (referenced in 239.17a and
274.11b) to read as follows:
Form N-3
* * * * *
Part A Information Required in a Prospectus
* * * * *
Item 3. Synopsis
(a) * * *
Instructions: * * *
15. "Other Expenses" includes all expenses (except fees and
expenses reported in other items in the table) that are deducted
from separate account assets and will be reflected as expenses in
the Registrant's statement of operations (including increases
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR
210.6-07] of Regulation S-X).
* * * * *
11. By redesignating Instruction 7 to Item 25(b)(ii) as
Instruction 8, and adding Instruction 7 to Item 25(b)(ii) in Part
B of Form N-3 (referenced in 239.17a and 274.11b) to read as
follows:
Form N-3
* * * * *
Part B Information Required in a Statement of Additional
Information
* * * * *
Item 25. Calculation of Performance Data
* * * * *
(b) Other Accounts * * *
(ii) Yield. * * *
Instructions: * * *
7. If a broker-dealer or an affiliate (as defined in
paragraph (b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-
X) of the broker-dealer has, in connection with directing the
Registrant's brokerage transactions to the broker-dealer,
provided, agreed to provide, paid for, or agreed to pay for, in
whole or in part, services provided to the Registrant (other than
brokerage and research services as those terms are used in
Section 28(e) of the Securities Exchange Act of 1934 [15 U.S.C.
-------------------- BEGINNING OF PAGE #19 -------------------
78bb(e)]), add to expenses accrued for the period an estimate of
additional amounts that would have been accrued for the period if
the Registrant had paid for the services directly in an arms-
length transaction.
* * * * *
Note: The text of Form N-4 does not and the amendments will not
appear in the Code of Federal Regulations.
12. By revising the introductory text of Instruction 17 to
Item 3(a) in Part A of Form N-4 (referenced in 239.17b and
274.11c) to read as follows:
Form N-4
* * * * *
Part A Information Required in a Prospectus
* * * * *
Item 3. Synopsis
(a) * * *
Instructions: * * *
17. "Other Expenses" includes all expenses (except
management fees) that are deducted from portfolio company assets.
The amounts of expenses are the amounts shown as expenses in the
portfolio company's statement of operations (including increases
resulting from complying with paragraph 2(g) of Rule 6-07 [17 CFR
210.6-07] of Regulation S-X).
* * * * *
13. By redesignating Instructions 2 and 3 to Item 21(b)(ii)
as Instructions 3 and 4, and adding Instruction 2 to Item
21(b)(ii) in Part B of Form N-4 (referenced in 239.17b and
274.11c) to read as follows:
Form N-4
* * * * *
Part B Information Required in a Statement of Additional
Information
* * * * *
Item 21. Calculation of Performance Data
* * * * *
(b) Other Sub-Accounts * * *
(ii) Yield. * * *
Instructions: * * *
2. If a broker-dealer or an affiliate (as defined in
paragraph (b) of Rule 1-02 [17 CFR 210.1-02(b)] of Regulation S-
X) of the broker-dealer has, in connection with directing the
portfolio company's brokerage transactions to the broker-dealer,
provided, agreed to provide, paid for, or agreed to pay for, in
whole or in part, services provided to the portfolio company
(other than brokerage and research services as those terms are
used in Section 28(e) of the Securities Exchange Act of 1934 [15
U.S.C. 78bb(e)]), add to expenses accrued for the period an
estimate of additional amounts that would have been accrued for
the period if the portfolio company had paid for the services
directly in an arms-length transaction.
* * * * *
By the Commission
Jonathan G. Katz
Secretary
July 26, 1995