Payment for Investment Company Services With Brokerage Commissions

Federal RegisterJul 28, 1995

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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

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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].

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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.

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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