[Federal Register Volume 60, Number 145 (Friday, July 28, 1995)]
[Rules and Regulations]
[Pages 38918-38925]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-18472]
[[Page 38917]]
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Part III
Securities and Exchange Commission
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17 CFR Parts 210, 239, and 274
Payment for Investment Company Services With Brokerage Commissions;
Final Rule
Federal Register / Vol. 60, No. 145 / Friday, July 28, 1995 / Rules
and Regulations
[[Page 38918]]
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.
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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 Dates: 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 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, NW., 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
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
\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.
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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 reflected in the cost basis of the purchased securities or as a
reduction of the proceeds from the sale of securities.
\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 expenses. Therefore, references in
this release to ``commissions'' or ``commission dollars'' rather
than ``spreads'' or ``mark-ups'' are not intended to indicate
otherwise.
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.
\3\ Investment Company Act Release No. 20472 (Aug. 11, 1994) [59
FR 42187 (Aug. 17, 1994)] (``Proposing Release'').
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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
[[Page 38919]]
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
\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.
\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
\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.
\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.
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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 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.
\11\ Securities lending arrangements may raise other issues
under the federal securities laws. The Commission is not addressing
in this release the merits of any particular securities lending
arrangements.
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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.
\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.
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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
[[Page 38920]]
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.
\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.
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.
\15\ Proposing Release, supra note 3, at section II.D.
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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:
\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.
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
\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.
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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
\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 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)].
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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
[[Page 38921]]
making assumptions about the value of research services.
\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.
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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 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
\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.
\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.
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.
\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.
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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.
\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.
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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 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
\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 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.
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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.
\32\ See, e.g. Item 22(b)(ii) of Form N-1A.
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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 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
\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.
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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
[[Page 38922]]
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
\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].
---------------------------------------------------------------------------
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 equity securities on which commissions are charged
on trades.36
\36\ Instruction 16 to Item 3 of Form N-1A, and Instruction 18
to Item 4 of Form N-2.
---------------------------------------------------------------------------
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\
\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.
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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.
2. 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.
3. 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 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:
[[Page 38923]]
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
Sec. 210.6-07 to read as follows:
Sec. 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 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 Secs. 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).
* * * * *
6. By amending Item 3(a) in Part A of Form N-1A (referenced in
Secs. 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
[[Page 38924]]
(referenced in Secs. 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 * * *
(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 Secs. 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
Secs. 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
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 Secs. 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 Secs. 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. 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
[[Page 38925]]
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 Secs. 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 Secs. 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.
* * * * *
Dated: July 21, 1995.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-18472 Filed 7-27-95; 8:45 am]
BILLING CODE 8010-01-P