# Payment for Investment Company Services With Brokerage Commissions

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/fr%3A94-20114

## Record

- **Collection:** Federal Register
- **Document type:** Uncategorized Document
- **Published:** August 17, 1994

## Text

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 210, 239, 274
[Release No. 33-7081; IC-20472; S7-22-94]
RIN 3235-AF94

Payment for Investment Company Services With Brokerage
Commissions

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule and form amendments.

-----------------------------------------------------------------------

SUMMARY: The Commission is proposing for comment rule and form
amendments relating to the reporting of expenses by investment
companies. The proposed amendments would require an investment company
to reflect as expenses in its statement of operations certain
liabilities of the company paid by broker-dealers in connection with
the allocation of the company's brokerage transactions to the broker-
dealers. The amendments would also require an investment company to
include expenses paid in this manner in the fee table and financial
highlights table appearing in the company's prospectus, and in
calculating the company's yield. The amendments are designed to enhance
the information provided to investors so that they may be better able
to assess and compare investment company expenses and performance.

DATES: Comments should be received on or before October 17, 1994.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. All comment letters should refer to File
No. S7-22-94. All comments received will be available for public
inspection and copying in the Commission's Public Reference Room, 450
Fifth Street, N.W., Washington, D.C. 20549.

FOR FURTHER INFORMATION CONTACT: Eric C. Freed, Senior Counsel, Office
of Disclosure and Investment Adviser Regulation, (202) 942-0726, or
Anthony Evangelista, Assistant Chief Accountant, (202) 942-0636,
Division of Investment Management, Securities and Exchange Commission,
450 Fifth Street, N.W., Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today
is proposing for comment:
(1) Amendments to rule 6-07 of Regulation S-X [17 CFR 210.6-07].
(2) Amendments to 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'').

Executive Summary

The Commission is proposing to amend rule 6-07 of Regulation S-X,
the regulation setting forth form and content requirements for
financial statements included in registration statements, proxy
statements, annual reports, and shareholder reports under the various
securities laws. The amendments would require a registered investment
company (``fund'') to adjust the amount of expenses reflected in the
statement of operations in its financial statements to include amounts
the fund would have paid to its service providers had a broker-dealer
or any affiliate of the broker-dealer not paid or agreed to pay those
service providers on behalf of the fund in connection with the
allocation of fund transactions to the broker-dealer. The Commission is
also proposing amendments to various fund registration forms to require
that the adjusted expenses be reflected in the fee table and financial
highlights table included in fund prospectuses, in the yield quotation
required in fund Statements of Additional Information, and, as a
result, in yield quotations in fund advertisements and sales
literature. Finally, the Commission is proposing to require that the
financial highlights table disclose the average commission rate paid by
the fund.

I. Background

Some investment companies recently have entered 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,
who is paid directly by the broker.1
---------------------------------------------------------------------------

\1\Brokerage/service arrangements are structurally similar to
the more common research soft-dollar arrangements by 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''). These concerns generally are
not raised by brokerage/service arrangements, which typically
involve the use of a fund's commission dollars to obtain services
that directly and exclusively benefit the fund. Nevertheless, a
fund's investment adviser can benefit from these brokerage/service
arrangements, particularly if a reduction in fund expenses affects
the amount of any expense waiver or reimbursement by the adviser.
The receipt by a fund's adviser of any direct or indirect economic
benefit as the result of these arrangements would almost certainly
violate section 17(e)(1) of the 1940 Act [15 U.S.C. 80a-17(e)(1)],
unless the benefit received fell within the safe harbor provided by
Section 28(e).
---------------------------------------------------------------------------

By entering into a brokerage/service arrangement, a fund can reduce
expenses reported to shareholders in its statement of operations, fee
table, and its expense ratio and can increase its reported yield.2
This is because the costs paid on behalf of the fund by the broker are
embedded in the brokerage commissions the fund pays.3 Under
current accounting treatment, brokerage commissions are reflected in
the cost basis of the purchased securities or as a reduction of the
proceeds from the sale of securities.4 In substance, however, a
brokerage/service arrangement involves a rebate on brokerage
commissions which, if paid in cash to the fund, would not reduce fund
expenses.5
---------------------------------------------------------------------------

\2\A fund is currently required to disclose in footnotes to its
fee table, financial highlights table, and financial statements its
participation in brokerage/service arrangements and the effect the
arrangements may have on the level of brokerage commissions paid by
the fund. To the extent practicable, a fund must also quantify in
these footnotes the effect of brokerage/service arrangements on fund
expenses. This footnote disclosure would no longer be necessary if
the amendments are adopted.
\3\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, as
discussed at note 1 supra and accompanying text, brokerage/service
arrangements do not fall under 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.
\4\See R. Kay & D. Searfoss, Handbook of Accounting and Auditing
12-18 (2d ed. 1989).
\5\Cash rebates would reduce the cost basis of securities
purchased or increase the proceeds from securities sold.
---------------------------------------------------------------------------

As a result of the current accounting treatment of brokerage/
service arrangements, investors may not be able to evaluate fully the
expenses of a fund that pays for services with commission dollars and
accurately compare expenses and yields among funds. This lack of
comparability is particularly significant considering the wide use of
fund expense data by investors.
Brokerage/service arrangements may benefit funds (and their
shareholders) by reducing overall fund costs and increasing total
return,6 particularly if lower commissions are not available to
funds that do not enter into the arrangements.7 The receipt of a
net benefit by a fund does not, however, alter the substance of the
services provided under these arrangements. The services provided are
generally wholly distinct from the execution of securities
transactions, and their reflection as capital costs can distort fund
financial information.8
---------------------------------------------------------------------------

\6\The characterization of costs as expenses or capital items
will not affect a fund's total return calculated in accordance with
Commission standards. The formula for total return is based upon
``ending redeemable value''; expenses and capital costs are both
inherent in this formula. See, e.g., Item 22(b)(i) of Form N-1A.
\7\Entering into a brokerage/service arrangement when lower
commissions are available raises questions whether the fund is
receiving best execution for its transactions. See Securities
Exchange Act Rel. No. 23170 (Apr. 23, 1986) [51 FR 16004 (Apr. 30,
1986)] (``Release 23170'') at Sec. V (discussing best execution
obligations of money managers in the context of section 28(e)).
\8\The Commission believes that a fund's board of directors or
trustees, in connection with its review of brokerage allocation
policies, should be informed of the fund's brokerage/service
arrangements and the effects of the arrangements on fund expenses
and commission rates.
---------------------------------------------------------------------------

The Commission, therefore, is proposing to amend its accounting
rules to require that amounts the fund would have paid for services in
the absence of brokerage/service arrangements be reflected as
``expenses'' in fund financial information and in fund performance
data.

II. Discussion

A. Accounting for Expenses Paid From Brokerage Commissions

1. The Proposed Accounting Method
The Commission is proposing to amend rule 6-07 of Regulation S-
X9 to require that the amounts of the 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.10 The required adjustments to the statement of operations
would be made at the time financial statements are prepared, and no
daily expense accruals for services paid for with commission dollars
would be required. No amounts in the financial statements other than
expenses and the expense ratio would be required to be adjusted.
---------------------------------------------------------------------------

\9\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.
\10\Rule 6-04(15) of Regulation S-X [17 CFR 210.6-04(15)]
requires fund financial statements to disclose material contractual
commitments. Contractual commitments covered by this rule include
material commitments to allocate commission dollars for payment of
fund expenses.
---------------------------------------------------------------------------

Under the proposed amendments, the total of the itemized expenses
in the statement of operations, including the expenses paid with
commission dollars, would be shown as the fund's ``total expenses.'' As
discussed below, the total expense figure also would be used in
determining the fund's expense ratio, its ``Other Expenses'' listed in
the fee table, and its yield. The total expenses would be reduced by
the total amount paid with commission dollars and the remainder shown
on the statement of operations as ``net expenses.''\11\ The following
example illustrates the adjustments to the statement of operations that
would be required by the proposed amendments if custodian fees were
paid with commission dollars:
---------------------------------------------------------------------------

\11\Because only expenses, and not realized gains/losses or
unrealized appreciation/depreciation, would be adjusted in the
statement of operations, the presentation of ``net expenses'' would
be necessary so that net investment income remains the same.

Expenses:
Management Fee............................................... 50
[Other direct fund expenses]................................. 48
Custodian Fee [would include 8 paid by brokers].............. 10
--------
Total Expenses........................................... 108
Fees Paid with Commission Dollars........................ (8)\12\
--------
Net Expenses............................................. 100

The additional ``cost'' reflected on the statement of operations
would be the amount that the fund would have paid for the services if
commission dollars had not been used. If a fund negotiates the service
provider's fees directly with the service provider, the cost of the
services for purposes of making the required adjustments would be the
amount negotiated, presumably the same amount the fund would have paid
for the service in the absence of the arrangement. When the broker
arranges for the services or provides them itself or through an
affiliate, however, the actual cost of the services may not be readily
determinable by the fund. In this case, the proposed amendments would
require that the fund reflect in its financial statements an amount
determined by making a good-faith estimate of the amount the fund would
have paid had it contracted for the services directly in an arms-length
transaction.\13\ Comment is requested whether there are alternative
methods for valuing services provided or arranged by brokers.
---------------------------------------------------------------------------

\12\A footnote would be required to identify the specific
services paid for with commission dollars. Any expense that, as a
result of the proposed amendments, was increased by five percent or
more over the amount paid directly by the fund, as well as the
amount of the increase, would be required to be separately
identified in the footnote. Amounts that were individually less than
five percent of the unadjusted expense could be aggregated. The
total of these amounts, which should equal the amount of the ``Fees
Paid with Commission Dollars'' line item, also would be required to
be stated in the footnote.
\13\The good-faith estimate could 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 services.
---------------------------------------------------------------------------

The amendments would specifically except research services, as that
term is used in section 28(e) of the 1934 Act, from the services the
cost of which must be reflected as expenses.\14\ The cost of research
``purchased'' by an adviser with fund commission dollars could also be
considered an expense of the fund which is not reflected as an expense
in the statement of operations and other financial information. The
Commission is concerned that the adoption of these disclosure rules
might lead some funds to discontinue brokerage/service arrangements and
purchase more research through traditional soft dollar arrangements,
which, under these proposals, would not be required to be treated as an
expense. Comment is requested whether these proposals would have this
effect.
---------------------------------------------------------------------------

\14\Because research services are typically provided to the
adviser, not the fund, the specific exception may be unnecessary.
However, in light of the widespread use of research soft-dollar
arrangements, the Commission is proposing a specific exception.
---------------------------------------------------------------------------

The Commission is studying whether the cost of research services
provided by brokers should be reflected as fund expenses and requests
comment on this issue.\15\ Commenters favoring inclusion of research
services in the amendments should address how such services should be
valued and how the value of the services should be allocated among
clients of the adviser that may benefit from them. If research services
cannot be valued, should the Commission require that assumptions be
made about their value by extrapolation from the brokerage commissions
paid? For example, should the difference between a brokerage commission
paid on a transaction and the lowest commission paid by the fund be
considered a fund expense for research? Alternatively, should the
Commission require only that the values of research services that have
readily ascertainable values be quantified, such as subscriptions to
newspapers, price quotation or valuation services, or research that is
received in return for the direction of a determinable amount of
brokerage?
---------------------------------------------------------------------------

\15\Funds are required to describe their soft-dollar practices
in the Statement of Additional Information that must be provided to
investors upon request. See, e.g., Item 17 of Form N-1A.
---------------------------------------------------------------------------

2. An Alternative Accounting Method
As an alternative to the accounting changes being proposed, funds
could be required 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 require
separating commissions into brokerage and expense components, and
reflecting the expense component as an expense in the financial
statements.
The allocation method would assess the actual economic character of
a fund's brokerage commissions and adjust all fund financial
information to reflect this assessment. Under the allocation method,
the portion of a commission properly allocated to expenses would have
to be estimated and may need to be adjusted as the total amount of
commission dollars paid to the broker increases.\16\ This adjustment,
in turn, would require that the cost bases and sales prices of
particular securities be adjusted periodically based upon the
transactions directed to a particular broker. Therefore, using the
allocation method to account for expenses paid with commission dollars
could prove to be costly and lead to undesirable uncertainties in
accounting.
---------------------------------------------------------------------------

\16\If the benefits received by a fund from a given brokerage/
service arrangement remain constant (e.g., the payment of a
specified fund expense), the portion of each commission used to pay
for that benefit will decrease as the amount of commissions directed
to the broker increases.
---------------------------------------------------------------------------

The Commission requests comment (i) on the ability of funds to
account for amounts paid with commission dollars by the allocation
method, (ii) whether the proposed gross-up method adequately reflects
the economic nature of these arrangements, and (iii) on the costs of
each of these accounting methods compared to their benefits to
investors.

B. The Fee Table and Financial Highlights Table

The Commission is proposing to amend instructions to the items of
the 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'').\17\ The amended instructions would require that the expense
percentages included in a fund's fee table be based upon total expenses
(i.e., that the percentages include amounts paid with commission
dollars).\18\ Similarly, the amendments would revise Form N-1A and Form
N-2 to require that the ``ratio of expenses to average net assets'' in
a fund's ``financial highlights'' table reflect expenses paid with
commission dollars.\19\ The fee table and financial highlights table
are required to be placed prominently in the prospectus, and are
intended to be the primary means for the communication of fund expenses
and performance to shareholders and prospective shareholders.\20\ The
proposed amendments are intended to improve the ability of investors to
use the fee table and financial highlights table to compare fund
expenses.\21\
---------------------------------------------------------------------------

\17\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.
\18\The amended instructions to the fee table would clarify that
the ``Other Expenses'' set forth in the fee table should be
determined by reference to the expense amounts reported in the
fund's statement of operations, including adjustments to reflect
expenses paid with commission dollars. Accordingly, references in
the instructions to the omission of brokerage commissions and other
similar costs (which are not reported on the statement of
operations) would be deleted. The amended instructions are not
intended otherwise to revise the substance of the fee table
requirements. See Instructions 10 to Item 2(a)(i) of Form N-1A;
Instruction 9 to Item 3.1 of Form N-2; Instruction 15 to Item 3(a)
of Form N-3; and Instruction 17 to Item 3(a) of Form N-4.
\19\Item 3(a) of Form N-1A and Item 4.1 of Form N-2. Amendments
to the per share tables in Forms N-3 and N-4 are not being proposed.
\20\Unlike amounts paid with commission dollars, the amounts of
any fee waivers or expense reimbursements would continue to be
deducted from expenses for purposes of the fee table and financial
highlights table. While, as discussed above, a fund bears the cost
of expenses paid by a broker under a brokerage/service arrangement,
it does not bear any cost to the extent an expense is waived or
reimbursed.
\21\The proposed instructions would not require the calculation
of the ``net investment income'' and ``ratio of net income to
average net assets'' entries in the financial highlights table based
upon gross expenses. Net investment income in the financial
highlights table would continue to correspond to the net investment
income reported in the statement of operations.
---------------------------------------------------------------------------

The financial highlights table in fund prospectuses presents key
financial data for each of the last ten fiscal years. Funds may not be
able to readily determine amounts paid with commission dollars during
past years. Therefore, the proposed amendments would not require that
total expenses be reflected in the expense ratio in the financial
highlights table for fiscal years ending before the adoption of the
amendments.\22\ A footnote would be required disclosing the change in
the manner in which expenses have been determined.
---------------------------------------------------------------------------

\22\If these proposals are adopted, the Commission may require
funds to present the grossed-up expense information in statements of
operations and financial highlights tables for the entire fiscal
period ending on or after the date of adoption. Because funds
ordinarily would maintain records related to these arrangements,
this should not be burdensome. Comment is requested whether
reflecting total expenses for the period beginning before adoption
of the rule would be burdensome.
---------------------------------------------------------------------------

C. Performance Information

Commission rules require that any quotation of yield in a mutual
fund advertisement be calculated in accordance with a formula that
reflects fund expenses accrued for the period.\23\ Use of total
expenses in the calculation of a fund's yield may be appropriate to
reflect actual fund expenses and necessary to maintain the value of
yield as an indicator of fund performance.\24\ Therefore, the
Commission is proposing instructions to the yield formulas for funds
(other than money market funds) to require that the costs of services
paid for with brokerage commissions be reflected in quotations of yield
in a fund's registration statement, and, as a result, in its
advertisements.
---------------------------------------------------------------------------

\23\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.
\24\As discussed supra at note 4, the characterization of costs
as expenses or capital items does not affect a fund's total return,
and, therefore, no amendment to the total return formula is being
proposed.
---------------------------------------------------------------------------

As discussed above, the proposed amendments to Regulation S-X would
require that adjustments to fund expenses be made at the end of a
financial statement period.\25\ Those amendments generally would not
require funds to accrue or otherwise determine at the end of the
thirty-day period for which yield is calculated the amount of expenses
paid with brokerage commissions for that period. The proposed
instructions to the yield formulas, therefore, would require funds to
estimate amounts paid with commission dollars for the period of the
yield quotation. Comment is requested on the feasibility of making such
an estimate and whether there are alternative approaches.
---------------------------------------------------------------------------

\25\See Section II.A.1 supra.
---------------------------------------------------------------------------

The proposals would 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 would be amortized and
reflected in that change in value.\26\ 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.\27\ Comment is specifically requested whether the money market
fund yield formula should be revised to reflect the cost of services
paid for with commission dollars as expenses when they are incurred.
Commenters should discuss the extent to which money market funds pay or
can pay expenses through brokerage/service arrangements, and commenters
suggesting revisions to the yield calculation should provide specific
text or formulas.
---------------------------------------------------------------------------

\26\See Item 22(a) of Form N-1A, Item 25(a) of Form N-3, and
Item 21(a) of Form N-4.
\27\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.
---------------------------------------------------------------------------

D. Related Arrangements

The Commission is aware that funds enter into certain other
arrangements that, like brokerage/service arrangements, have the effect
of reducing reported fund expenses. Some funds, for example, have
``compensating balance'' arrangements with their custodians under which
their custodian fees are reduced if they maintain cash on deposit with
the custodians in non-interest bearing accounts. In these arrangements
expenses are reduced by forgoing income rather than by recharacterizing
them as capital items. The Commission requests comment whether an
adjustment to fund expenses similar to that being proposed for
brokerage/service arrangements should be required for these expense
offset arrangements, or whether these arrangements should be addressed
in footnotes to the financial statements. Because a fund that enters
into these arrangements forgoes income, comment also is requested
whether such income should be estimated and reflected in fund financial
information, and how such estimates might be made.
Some custodial arrangements may involve explicit oral or written
understandings regarding the fee reductions that will occur when
uninvested cash balances exceed predetermined levels. Often, however, a
fund's custodian fee reflects an estimate of the income the custodian
expects to derive from the fund's uninvested cash balances, and the
resulting reduction in the fee is not explicitly disclosed in the
custodial agreement. The Commission requests comment whether the amount
of any increase in fund expenses to reflect these arrangements should
include only amounts that are explicit in the agreements, or should
also include amounts implicit in the basic custodian fee.\28\
---------------------------------------------------------------------------

\28\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].
---------------------------------------------------------------------------

E. Average Commission Rates

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 which increase
the cost of securities purchased or reduce the proceeds of securities
sold. The Commission is concerned that adequate information about these
costs currently may not be provided to investors.\29\ The Commission,
therefore, is proposing to require that the average commission rate
paid by a fund (in cents per share) be disclosed in the financial
highlights table next to the portfolio turnover rate.\30\ Other fund
transaction costs, such as mark-ups, mark-downs, and spreads, would not
be included in this commission rate figure. Comment is requested
whether these other costs should be reflected, and, if so, how they
should be calculated or estimated.
---------------------------------------------------------------------------

\29\A fund is currently required to disclose in its Statement of
Additional Information the aggregate amount of any brokerage
commissions it paid during its three most recent fiscal years, as
well as certain data about commissions paid to fund affiliates. Item
17 of Form N-1A.
\30\The new information would only be required for fiscal years
beginning after adoption of the amendments.
---------------------------------------------------------------------------

III. General Request for Comments

Any interested persons wishing to submit written comments on the
rule and form changes that are the subject of this Release, to suggest
additional changes, or to submit comments on other matters that might
have an effect on the proposals contained in this Release, are
requested to do so. Comment is specifically requested regarding the
prevalence and significant terms of brokerage/service arrangements, the
expenses paid through the arrangements, and the effect of the
arrangements on fund expenses and commissions.

IV. Cost/Benefit Analysis

The rule and form changes proposed today are intended to improve
the reporting of investment company expenses and improve the ability of
investors to compare investment company expenses and performance. While
the rule and form changes may increase the costs to funds of preparing
financial statements and fund registration materials, the Commission
believes that any such cost increases would, at most, be minimal. A
fund that has brokerage/service arrangements would be 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. These figures
will normally be readily determinable by the fund. Funds should also be
able to readily estimate expenses paid with brokerage commissions for
purposes of yield calculations. In short, the Commission believes that
the costs of the amendments proposed today would be substantially
outweighed by the benefits to investors of receiving more accurate and
useful financial information about funds.

V. Summary of Initial Regulatory Flexibility Analysis

The Commission has prepared an Initial Regulatory Flexibility
Analysis in accordance with 5 U.S.C. 603 regarding the proposed
amendments. The analysis notes that the rule and form proposals
contained in this Release are intended to provide for the comparability
of fund expenses reflected in fund disclosure documents and
advertisements. Other aggregate cost-benefit information reflected in
the ``Cost/Benefit Analysis'' section of this release also is reflected
in the analysis. A copy of the Initial Regulatory Flexibility Analysis
may be obtained by contacting Eric C. Freed, Securities and Exchange
Commission, 450 Fifth Street, NW., Mail Stop 10-6, Washington, DC
20549.

VI. Text of Proposed 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 proposed to be 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, and 80a-37, unless
otherwise noted.

2. By adding a new paragraph 2(g) to the statements of operations
in Sec. 210.6-07 to read as follows:

Sec. 210.6-07 Statements of operations.

* * * * *
2. Expenses. * * *
(g) If a broker-dealer or an affiliate of the broker-dealer has,
in connection with the direction of 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)]), reflect as the cost of any such services
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. Show the
total amount by which expenses are increased as a corresponding
reduction in total expenses under this caption. In a note to the
financial statements, list each expense that is increased and the
amount of the increase in each expense, except that expenses
increased by less than 5 percent of the unadjusted amount of the
expense may be aggregated. The note should also include the total
amount by which expenses are increased.
* * * * *

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. 80a-1, et seq., 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) of 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'' include 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
regarding fees paid with Registrant's brokerage commissions).
* * * * *
6. By amending Item 3(a) of Part A of Form N-1A (referenced in
Secs. 239.15A and 274.11A) by adding the phrase ``Average Commission
Rate Paid (in cents per share)'' below ``Portfolio Turnover Rate'' and
adding a new Instruction 15 to read as follows:

Form N-1A

* * * * *

Part A. Information Required in a Prospectus

* * * * *

Item 3. Condensed Financial Information

(a) * * *
Instructions: * * *
15. 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 regarding fees paid with Registrant's
brokerage commissions, and including reductions resulting from
complying with paragraphs 2(a) and (f) of Rule 6-07 (17 CFR 210.6-
07) regarding fee waivers and reimbursements. If a change in the
methodology of determining the ratio of expenses to average net
assets results from applying paragraph 2(g) of Rule 6-07 (17 CFR
210.6-07), explain in a note that the ratio reflects fees paid with
brokerage commissions only for fiscal years ending after [the
effective date of the final rule amendments].
* * * * *
7. By redesignating Instructions 7 and 8 to Item 22(b)(ii) as
Instructions 8 and 9, and adding a new Instruction 7 to Item 22(b)(ii)
of Part B of Form N-1A (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 the direction of 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 of 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'' include 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 regarding fees paid with brokerage
commissions).
* * * * *
9. By amending Item 4.1 of part A of Form N-2 (referenced in
Secs. 239.14 and 274.11a-1) by adding the phrase ``Average Commission
Rate Paid (in cents per share)'' below ``Portfolio Turnover Rate'' and
adding a new Instruction 17 to read as follows:

Form N-2

* * * * *

Part A.--Information Required in a Prospectus

* * * * *

Item 4. Financial Highlights

1. General: * * *
Instructions * * *
17. 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 regarding fees paid with Registrant's
brokerage commissions, and including reductions resulting from
complying with paragraphs 2(a) and (f) of Rule 6-07 (17 CFR 210.6-
07) regarding fee waivers and reimbursements. If a change in the
methodology of determining the ratio of expenses to average net
assets results from applying paragraph 2(g) of Rule 6-07 (17 CFR
210.6-07), explain in a note that the ratio reflects fees paid with
brokerage commissions only for fiscal years ending after [the
effective date of the final rule amendments].
* * * * *
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) of 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'' include all expenses (except expenses
reported in other items in the table) that are deducted from
separate account assets. The amounts of expenses 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 regarding fees paid
with Registrant's brokerage commissions).
* * * * *
11. By redesignating Instruction 7 to Item 25(b)(ii) as Instruction
8, and adding a new Instruction 7 to Item 25(b)(ii) of 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 the direction of 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-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) of 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'' include 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 regarding fees paid with the portfolio company's
brokerage commissions).
* * * * *
13. By redesignating Instructions 2 and 3 to Item 21(b)(ii) as
Instructions 3 and 4, and adding a new Instruction 2 to Item 21(b)(ii)
of 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 the direction of 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: August 11, 1994.

By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-20114 Filed 8-16-94; 8:45 am]
BILLING CODE 8010-01-P

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A94-20114. Public record. Not legal advice.