Investment Management
JULY 2003
House Committee Approves Mutual Fund Legislation
On Wednesday, July 23, 2003, the House Committee
on Financial Services marked up the Mutual Funds
Integrity and Fee Transparency Act of 2003 (“Bill”)
and recommended the Bill to the full House of
Representatives for its consideration. We previously
provided an analysis of the Bill in our K&L
Investment Management Alert dated July 7, 2003,
New Mutual Fund Legislative and Regulatory
Developments.
Congressman Richard H. Baker, Chairman of the
House Subcommittee on Capital Markets and the
member who introduced the Bill, apparently did not
have sufficient bipartisan support to move the Bill
through the Subcommittee. Instead, the Bill went
straight to the Financial Services Committee where
Congressman Michael G. Oxley, Chairman of the
Committee, shepherded the Bill to a bipartisan vote.
The Committee significantly modified the Bill from
its original form, and it now reflects input from the
Securities and Exchange Commission (“SEC”), the
Investment Company Institute and various fund
complexes. The Bill is designed to enhance
independent director governance of fund affairs, as
well as shareholder disclosure of fund operating
expenses, distribution payments and soft dollar
arrangements.
requirement. The amendment was hotly
debated among the members of the Committee,
but eventually passed.
n
In-Person Meetings. The current version of
the Bill would permit the SEC to exempt board
members from participating in board meetings
in person “when such a requirement is
impracticable.” The Committee’s press release
indicated that this exemption is intended for
certain emergency circumstances, presumably
not simply a matter of convenience.
n
Informing Board of Deficiencies. The
current version of the Bill would amend the
Investment Company Act of 1940 (“1940 Act”)
to require that a fund’s board receive a report
from the fund, its investment adviser or
principal underwriter if an SEC inspection
report identifies “significant deficiencies” in
the operation of the fund, the investment
adviser or the principal underwriter. This
disclosure requirement is intended to permit a
board to take immediate steps to investigate
and correct any deficiencies.
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Board’s Fiduciary Duties. The current
version of the Bill would require a fund’s board
to “review,” rather than “supervise,” revenue
sharing, directed brokerage and soft dollar
arrangements relating to a fund. The original
version of the Bill would have imposed a
fiduciary duty on a fund’s board to supervise
such arrangements.
n
Audit Committee Requirements. The audit
committee requirements of the original version
of the Bill remain intact, except for two items.
The current version of the Bill would now:
(1) permit the SEC to exempt audit committee
members from the in-person voting
The significant changes and additions to the Bill are
as follows.
MUTUAL FUND GOVERNANCE
n
Independent Chairman of Board. The
current version of the Bill no longer requires
that the chairman of a fund’s board be an
independent director. Congressman Patrick J.
Tiberi introduced an amendment to the original
version of the Bill that deleted this
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requirement in selecting an independent
auditor; and (2) deem an audit committee
member “independent” if that member does not
receive fees from the fund, the investment
adviser or the principal underwriter. In the
original version of the Bill, independent
members of an audit committee could not
receive fees from the fund and any affiliated
person of the fund.
o
Portfolio Manager’s Holdings. The
current version of the Bill would require
disclosure of a portfolio manager’s
holdings in a fund. This provision was
added to permit investors to determine
whether a portfolio manager’s interests
are aligned with investors of the fund he
or she manages.
o
Portfolio Turnover Rate. The current
version of the Bill would require
disclosure of portfolio turnover and its
effects, rather than disclosure of a fund’s
portfolio transaction costs.
o
Legend on Account Statements. The
current version of the Bill would require
a legend to be placed on account
statements stating that fees have been
deducted and where shareholders may
find more information on fees.
o
Burdens on Small Funds. A provision
was added to the Bill directing the SEC
to consider reducing the burdens on
small funds in making the required
disclosures.
ENHANCED DISCLOSURE OF FEES
AND EXPENSES
n
n
Concept Release on Portfolio Transaction
Costs. The current version of the Bill would
direct the SEC to issue a concept release on
how to disclose more effectively portfolio
transaction costs. This provision addresses the
SEC staff’s concern that portfolio transaction
costs are difficult to quantify, let alone
disclose, as was required in the original version
of the Bill.
Disclosure of Fees and Expenses. There were
several changes to the disclosure requirements
from the original version of the Bill:
o
o
Where to Disclose. Amendments to the
Bill refocus where certain information on
fund fees and expenses should be
disclosed and provide the SEC with some
flexibility. The original version of the
Bill would have required such
information to be disclosed in a
document other than a fund’s prospectus
and statement of additional information
(“SAI”). The Bill now states that it
would be appropriate to disclose
exclusively in the prospectus and/or SAI
information relating to portfolio manager
compensation, portfolio manager
holdings and information regarding a
fund’s “soft dollar” payments for
research and use of “directed brokerage.”
The remaining fund fee and expense
information required to be disclosed by
the Bill may not be disclosed exclusively
in a fund’s prospectus and/or SAI.
Expenses. The current version of the
Bill specifically states that disclosure of
the estimated amount in dollars of a
fund’s operating expenses that is borne
by each shareholder would need to be
shown for each $1,000 invested.
n
Disclosure of Incentive Compensation. The
current version of the Bill would require the
SEC to issue a rule that would require brokers
to disclose to investors whether they have
received extra financial incentives to sell a
particular fund or class of shares.
n
Soft Dollar Recordkeeping. The current
version of the Bill would require investment
advisers engaging in soft dollar transactions to
maintain written soft dollar contracts that
describe the nature and value of the services
provided.
n
Summaries to Shareholders. The current
version of the Bill would require that a
summary of reports provided to a fund’s board
on revenue sharing, directed brokerage and soft
dollar arrangements be included in a fund’s
annual reports to shareholders.
n
Soft Dollar Study. Amendments to the Bill
soften the tone of the section requiring the SEC
to conduct a study and report on soft dollar
arrangements. A significant change in this
section of the Bill is the deletion of any
reference to whether Section 28(e) should be
repealed. The Bill now instructs the SEC to
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consider whether Section 28(e) should be
modified and whether other regulatory or
legislative changes should be considered.
n
No-Load Status. The current version of the
Bill would direct the SEC to clarify the
definition of “no-load” funds to ensure that
investors are not being misled into believing
that a “no-load” fund carries no distribution or
service fees pursuant to Rule 12b-1 under the
1940 Act.
n
Codification of SEC Rules. New provisions
of the Bill codify the SEC’s proxy voting rules
and the proposed rules on compliance
procedures and compliance officers.
Interestingly, the SEC reportedly requested
these codifications.
n
Arbitration Claims. The current version of
the Bill would direct the SEC to study the
recent exponential increase in arbitration cases
involving mutual funds and determine the
reasons for the trend.
ADDITIONAL NEW PROVISIONS IN THE BILL
n
Suspension of Redemptions. New
provisions of the Bill amend Section 22(e) of
the 1940 Act to broaden a fund’s ability to
suspend redemption of shares during any
period in which the principal market for the
securities in which a fund invests is closed or
trading is restricted. Section 22(e) currently
references only the NYSE, rather than the
principal market, and deals solely with
closings, not restricted trading. The current
version of the Bill also would expand SEC
rulemaking authority to permit the SEC to
determine what is the “principal market” for a
security.
DIANE E. AMBLER
202.778.9886
dambler@kl.com
FRANCINE J. ROSENBERGER
202.778.9187
francine.rosenberger@kl.com
Kirkpatrick & Lockhart LLP
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Kirkpatrick & Lockhart LLP maintains one of the leading investment management practices in the United States,
with more than 60 lawyers devoting all or a substantial portion of their practice to this area and its related
specialties. The American Lawyer Corporate Scorecard, published in April 2003, lists K&L as a primary legal
counsel to the investment companies, board members or advisory firms for 15 of the 25 largest mutual fund
complexes. No law firm was mentioned more frequently in the Scorecard.
We represent mutual funds, closed-end funds, insurance companies, broker-dealers, investment advisers, retirement
plans, banks and trust companies, hedge funds, offshore funds and other financial institutions. We also regularly
represent mutual fund distributors, independent directors of investment companies and service providers to the
investment management industry. In addition, we frequently serve as outside counsel to industry associations on a
variety of projects, including legislative and policy matters.
We work with clients in connection with the full range of investment company industry products and activities,
including all types of open-end and closed-end investment companies, funds of hedge funds, variable insurance
products, private and offshore investment funds and unit investment trusts. Our practice involves all aspects of the
investment company business.
We invite you to contact one of the members of the practice, listed below, for additional assistance. You may also
visit our website at www.kl.com for more information, or send general inquiries via email to
investmentmangement@kl.com.
BOSTON
Michael S. Caccese
Philip J. Fina
Mark P. Goshko
Thomas Hickey III
Nicholas S. Hodge
617.261.3133
617.261.3156
617.261.3163
617.261.3208
617.261.3210
mcaccese@kl.com
pfina@kl.com
mgoshko@kl.com
thickey@kl.com
nhodge@kl.com
LOS ANGELES
William P. Wade
310.552.5071
wwade@kl.com
NEW YORK
Beth R. Kramer
Richard D. Marshall
Robert M. McLaughlin
Loren Schechter
212.536.4024
212.536.3941
212.536.3924
212.536.4008
bkramer@kl.com
rmarshall@kl.com
rmclaughlin@kl.com
lschechter@kl.com
SAN FRANCISCO
Eilleen M. Clavere
Jonathan D. Joseph
David Mishel
Mark D. Perlow
Richard M. Phillips
415.249.1047
415.249.1012
415.249.1015
415.249.1070
415.249.1010
eclavere@kl.com
jjoseph@kl.com
dmishel@kl.com
mperlow@kl.com
rphillips@kl.com
WASHINGTON
Clifford J. Alexander
Diane E. Ambler
Catherine S. Bardsley
Arthur J. Brown
Arthur C. Delibert
Robert C. Hacker
Benjamin J. Haskin
Kathy Kresch Ingber
Rebecca H. Laird
Thomas M. Leahey
Cary J. Meer
R. Charles Miller
Dean E. Miller
R. Darrell Mounts
C. Dirk Peterson
Alan C. Porter
Theodore L. Press
Robert H. Rosenblum
William A. Schmidt
Lynn A. Schweinfurth
Donald W. Smith
Robert A. Wittie
Robert J. Zutz
202.778.9068
202.778.9886
202.778.9289
202.778.9046
202.778.9042
202.778.9016
202.778.9369
202.778.9015
202.778.9038
202.778.9082
202.778.9107
202.778.9372
202.778.9371
202.778.9298
202.778.9324
202.778.9186
202.778.9025
202.778.9464
202.778.9373
202.778.9876
202.778.9079
202.778.9066
202.778.9059
calexander@kl.com
dambler@kl.com
cbardsley@kl.com
abrown@kl.com
adelibert@kl.com
rhacker@kl.com
bhaskin@kl.com
kingber@kl.com
rlaird@kl.com
tleahey@kl.com
cmeer@kl.com
cmiller@kl.com
dmiller@kl.com
dmounts@kl.com
dpeterson@kl.com
aporter@kl.com
tpress@kl.com
rrosenblum@kl.com
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dsmith@kl.com
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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein
should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.
© 2003 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.