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SECURITIES AND EXCHANGE COMMISSION

Veterans Affairs Department

CFR Citation: 17 CFR Parts 239 and 274

RIN ID: RIN 3235-AI99

DOCUMENT ID: [Release Nos. 33-8343; IC-26287; File No. S7-26-03]

NOTICE: Part IV

DOCUMENT ACTION: Proposed rule.

SUBJECT CATEGORY: Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings

DATES: Comments must be received on or before February 6, 2004.

DOCUMENT SUMMARY: The Securities and Exchange Commission is proposing amendments to Form N1A under the Securities Act of 1933 and the Investment Company Act of 1940 to require openend management investment companies to disclose in their prospectuses both the risks to shareholders of the frequent purchase and redemption of investment company shares, and the investment company's policies and procedures with respect to such frequent purchases and redemptions. The proposals would also amend Forms N3, N4, and N6 to require similar prospectus disclosure for insurance company separate accounts issuing variable annuity and variable life insurance contracts. The Commission is also proposing to amend Forms N1A and N3 to clarify that openend management investment companies and insurance company managed separate accounts that offer variable annuities, other than money market funds, are required to explain both the circumstances under which they will use fair value pricing and the effects of using fair value pricing. In addition, the Commission is proposing to require openend management investment companies and insurance company managed separate accounts that offer variable annuities to disclose their policies and procedures with respect to the disclosure of their portfolio securities, and any ongoing arrangements to make available information about their portfolio securities.

SUMMARY: Securities and Exchange Commission,

SUPPLEMENTAL INFORMATION

The Securities and Exchange Commission (``Commission'') is proposing for comment amendments to Form N1A [17 CFR 239.15A and 274.11A], Form N3 [17 CFR 239.17a and 274.11b], Form N4 [17 CFR 239.17b and 274.11c], and Form N6 [17 CFR 239.17c and 274.11d], registration forms used by investment companies to register under the Investment Company Act of 1940 (``Investment Company Act'') and to offer their securities under the Securities Act of 1933 (``Securities Act'').
Table of Contents
I. Introduction and Background

A. Forward Pricing and Market Timing

B. Selective Disclosure of Fund Portfolio Holdings

C. Disclosure Proposals

II. Discussion

A. Disclosure Concerning Frequent Purchases and Redemptions of Fund Shares

B. Disclosure of Circumstances Under Which Funds Will Use Fair Value Pricing

C. Selective Disclosure of Fund Portfolio Holdings

D. Compliance Date
III. General Request for Comments
IV. Paperwork Reduction Act
V. Cost Benefit Analysis

A. Benefits

B. Costs

C. Request for Comments
VI. Consideration of Effects on Efficiency, Competition, and Capital Formation
VII. Initial Regulatory Flexibility Analysis
VIII. Consideration of Impact on the Economy
IX. Statutory Authority
Text of Proposed Rule and Form Amendments

I. Introduction and Background

Millions of individual American investors hold shares of openend management investment companies (``mutual funds''), relying on these funds for their retirements, their children's educations, and their other basic financial needs.\2\ The tremendous growth of mutual funds reflects the trust that investors have placed in funds and the regulatory protections provided by the federal securities laws. \2\ A management investment company is an investment company other than a unit investment trust or faceamount certificate company. See section 4 of the Investment Company Act [15 U.S.C. 80a 4]. Management investment companies typically issue shares representing an undivided proportionate interest in a changing pool of securities, and include openend and closedend companies. See T. Lemke, G. Lins, A. Smith III, Regulation of Investment Companies, Vol. I, ch. 4, Sec. 4.04, at 45 (2002). An openend company is a management company that is offering for sale or has outstanding any redeemable securities of which it is the issuer.

Recent allegations regarding late trading and abusive market timing, however, point to instances where it appears that some in the mutual fund industry, and some intermediaries that sell fund shares, have lost sight of their obligations to investors.\3\ These allegations relate to abuses in at least three areas:
\3\ See, e.g., Riva D. Atlas, Another Fund Faces Inquiry Over Trading, NEW YORK TIMES, October 22, 2003, at C4; Tom Lauricella, TwoTier System: For Staid Mutual Fund Industry, Growing Probe Signals Shake UpInvestigators Find Indications of Widespread Abuses Hurting Small InvestorsUnfair Pricing for Big Players, WALL STREET JOURNAL, October 20, 2003, at A1; Brooke A. Masters, Spitzer Alleges Mutual Fund Improprieties, WASHINGTON POST, September 4, 2003, at E1.
[sbull] ``Late trading,'' the practice of placing orders to buy or redeem mutual fund shares after 4 p.m., Eastern time, as of which most funds calculate their net asset value (``NAV''), but receiving the price based on the 4 p.m. NAV;
[sbull] Abuses related to ``market timing,'' including the alleged overriding of stated market timing policies by fund executives to benefit large investors at the expense of small investors, or to benefit the fund's investment adviser; and
[sbull] The selective disclosure by some fund managers of their funds' portfolio holdings in order to curry favor with large investors.

The Commission is extremely concerned by the abuses that have surfaced in the mutual fund industry, and we have taken vigorous enforcement action where abuses have been uncovered.\4\ We also believe,
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however, that regulatory reforms are necessary to help prevent such abuses from recurring in the future. The Commission is proposing a package of rule amendments intended to address abuses that have surfaced in the areas of late trading, market timing, and selective disclosure. In this release, we are proposing disclosure reforms intended to shed more light on market timing and selective disclosure of portfolio holdings. In a second release, we are proposing amendments that would require that an order to purchase or redeem redeemable securities of a registered investment company be received by the company, its designated transfer agent, or a registered securities clearing agency by the time that the fund establishes for calculating its NAV in order to receive that day's price. In addition, we are publishing a release adopting rules requiring registered investment companies and investment advisers to adopt and implement written compliance policies and procedures, review those policies and procedures annually, and designate a chief compliance officer responsible for their administration.
\4\ See, e.g., In the Matter of Putnam Investment Management, LLC, Release No. IC26255 (Nov. 13, 2003) (investment adviser violated antifraud provisions of the federal securities laws by failing to disclose potentially selfdealing shortterm trading of mutual fund shares by several of its employees, and by failing to take adequate steps to detect and deter such trading activity through its own internal controls and its supervision of investment management professionals); In the Matter of James Patrick Connelly, Jr., Release No. IC26209 (Oct. 16, 2003) (vice chairman of investment advisory firm violated antifraud provisions of the federal securities laws by allowing select investors to time mutual funds managed by the firm); In the Matter of Steven B. Markovitz, Release No. IC26201 (Oct. 2, 2003) (hedge fund trader who engaged in late trading of mutual fund shares violated antifraud provisions of the federal securities laws and rule 22c1(a) under the
Investment Company Act).

A. Forward Pricing and Market Timing

Section 22 of the Investment Company Act of 1940 (the ``Investment Company Act'') regulates the pricing, distribution, and redemption of redeemable securities, including mutual fund shares.\5\ Paragraph (c) of section 22 gives the Commission broad power to regulate the pricing of redeemable securities, including the power to prescribe by rule methods for computing the price that a shareholder will receive upon redemption. Rule 22c1(a) under the Investment Company Act requires mutual funds to sell and redeem their shares at a price based on the NAV next computed after receipt of an order. This requirement is referred to as ``forward pricing.'' The purpose of this requirement is to prevent dilution and assure that prices bear an appropriate relation to the current NAV of a mutual fund's shares.\6\ Rule 22c1 generally requires mutual funds to compute their NAVs at least once daily, Monday through Friday, at a specific time or times as determined by their boards.\7\ Typically, mutual funds calculate their NAVs once each day at or near the close of the major U.S. securities exchanges and markets (usually 4 p.m., Eastern time).
\5\ Both mutual funds and unit investment trusts issue redeemable securities. See section 4(2) and 5(a)(1) of the Investment Company Act [15 U.S.C. 80a4(2) and 80a5(a)(1)]. For purposes of simplicity, this section of the release only refers to mutual funds.
\6\ Investment Company Act Release No. 5519 (Oct. 16, 1968) [33 FR 16331 (October 8, 1968) (adopting rule 22c1) (``Rule 22c1 Adopting Release'').
\7\ Rule 22c1(b) under the Investment Company Act [17 CFR 270.22c1(b)].

Mutual funds generally calculate their NAVs by using the closing prices of portfolio securities on the exchange or market on which the securities principally trade. In some cases, however, the closing price of a security held in a mutual fund's portfolio may not reflect its current market value at the time of the fund's NAV calculation, for example, if an event that will affect the value of those securities has occurred since the closing price was established, but before the fund's NAV calculation.\8\
\8\ Investment Company Act Release No. 14244 (Nov. 21, 1984) [49 FR46558, 4655946660 n.7 (Nov. 27, 1984)].

When market quotations for a portfolio security are not readily available (including when market quotations are unreliable), a mutual fund is required to calculate its NAV by using the fair value of that security, as determined in good faith by the fund's board.\9\ In a separate release adopting rule 38a1 under the Investment Company Act, we are reemphasizing the obligation of mutual funds to fair value their securities under certain circumstances. If a mutual fund misprices its shares by failing to use fair value pricing when market quotations for its portfolio securities are unreliable, an investor may take advantage of the disparity between the portfolio securities' last quoted prices and their fair value. When mutual fund shares are mispriced, shortterm traders have an arbitrage opportunity that they can use to exploit the fund and disadvantage the fund's longterm investors by extracting value from the fund without assuming any significant investment risk, through market timing.\10\ Mutual funds that fair value their portfolio securities consistent with their obligations can effectively reduce or eliminate the profit that market timers seek to exploit.\11\ \9\ See Accounting Series Release No. 118 (Dec. 23, 1970) [35 FR 19986 (Dec. 31, 1970)]; Investment Company Act Release No. 14244 (Nov. 21, 1984) [49 FR46558, 4655946660 n.7 (Nov. 27, 1984)]. Subsequent to the issuance of these releases, our staff has reminded funds of their fair valuation obligations. In 1999 and 2001, the Division of Investment Management issued interpretive letters elaborating on funds' obligations under sections 2(a)(41) of the Investment Company Act and rule 22c1 [17 CFR 270.22c1] thereunder. Letter from Douglas Scheidt, Associate Director and Chief Counsel, SEC Division of Investment Management, to Craig S. Tyle, General Counsel, Investment Company Institute (Dec. 8, 1999) (http://www.sec.gov/divisions/investment/guidance/tyle120899.htm ); Letter
from Douglas Scheidt, Associate Director and Chief Counsel, SEC Division of Investment Management, to Craig S. Tyle, General Counsel, Investment Company Institute (Apr. 30, 2001) (http://www.sec.gov/divisions/investment/guidance/tyle043001.htm ).
\10\ See Rule 22c1 Adopting Release, supra note 6 (describing market timing). Market timing may take many forms. In this release, we use the term to refer to arbitrage activity involving the frequent buying and selling of mutual fund shares in order to take advantage of the fact that there may be a lag between a change in the value of a mutual fund's portfolio securities and the reflection of that change in the fund's share price.
\11\ ``Fair valuation'' refers to the process of determining the current market value of a security when market quotations are not readily available (such as when there are no market quotations for the security or if the market quotations for the security are unreliable). When market quotations for a security are not readily available, a fund is required to calculate its NAV by using the fair value of that security, as determined in good faith by the fund's board.

Mutual funds that invest in overseas securities markets are particularly vulnerable to market timers who may take advantage of time zone differences between the foreign markets on which international funds' portfolio securities trade and the U.S. markets which generally determine the time as of which NAV is calculated (``timezone arbitrage''). For example, a market timer may purchase shares of a mutual fund that invests in overseas markets based on events occurring after foreign market closing prices are established, but before the fund's NAV calculation, that are likely to result in higher prices in foreign markets the following day. The market timer would redeem the fund's shares the next day when the fund's share price would reflect the increased prices in foreign markets, for a quick profit at the expense of longterm fund shareholders. Market timing opportunities are not limited to international funds. Mutual funds that invest in small cap securities and other types of investments which are not frequently traded, including highyield bonds, also can be the targets of market timers.\12\
\12\ See Eric Zitzewitz, Who Cares About Shareholders? ArbitrageProofing Mutual Funds, Research Paper No. 1749, Stanford Graduate School of Business Research Paper Series (Oct. 2002), available at http://facultygsb.stanford.edu/zitzewitz/Research/arbitrage1002.pdf (``Zitzewitz''), at 2 (estimating arbitrage
returns available in domestic smallcap equity funds at 2025 percent and estimating arbitrage returns available in convertible and highyield and convertible bond funds at 1025 percent). See also William Goetzmann, Zoran Ivkovich, and K. Geert Rouwenhorst, Day Trading International Mutual Funds: Evidence and Policy Solutions, Working Paper No. ICF0003, Yale School of Management, Yale University (Oct. 2000), available at: http://papers.ssrn.com/paper.taf?abstract_id=217168 , at 78 (describing opportunities for
arbitrage in stale pricing of Russell 2000 index).

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Market timing itself is not illegal. However, market timing may dilute the value of longterm shareholders' interests in a mutual fund if the fund calculates NAV using closing prices that are no longer accurate. Dilution may occur, for example, if fund shares are overpriced because redeeming shareholders will receive a windfall at the expense of the shareholders that remain in the fund. Similarly, dilution may occur when a fund sells its shares at a price lower than its NAV.\13\
\13\ By one estimate, dilution resulting from market timing can cost investors in international stock funds that are focused on a particular geographic region as much as 2.3% of their assets each year, and may cost fund shareholders as a whole up to $4.9 billion per year. See Zitzewitz, supra note 12, at 2 and 16; Jason Greene and Charles Hodges, The Dilution Impact of Daily Fund Flows on Open End Mutual Funds: Evidence and Policy Solutions, 36 Journal of Financial Economics, 131158 (2002) (estimating annualized dilution from market timing of 0.48% in international funds and nearly 1% for a subsample of funds whose daily flows are particularly large).

Market timing also may harm shareholders because it may cause mutual funds to manage their portfolios in a disadvantageous manner. For example, a mutual fund's investment adviser may maintain a larger percentage of its assets in cash or may be forced to liquidate certain portfolio securities prematurely to meet higher levels of redemptions due to market timing. This is particularly true for mutual funds that invest primarily in foreign or emerging market securities, which are often thinly traded. Mutual funds also may incur increased brokerage and administrative costs related to the frequent purchases and redemptions associated with market timing.

In order to discourage market timers, many mutual funds have developed policies and procedures with respect to frequent purchases and redemptions of fund shares. Some mutual funds disclose in their prospectuses that they do not permit market timing, and many mutual funds have taken steps to discourage market timing. These steps may include, for example:
[sbull] Imposing redemption or exchange fees on shares that are redeemed or exchanged within a certain time period following their purchase;
[sbull] Restricting exchange privileges, for example, by restricting exchange requests submitted through a particular medium, such as telephone or facsimile transmission, or received after a certain time of day, or by delaying both the redemption and purchase sides of an exchange;
[sbull] Restricting frequent trading, for example by limiting the total number of exchanges that an investor may make within a certain time period, or by limiting the number of ``round trip'' transactions where an investor purchases shares of a fund, exchanges those shares for shares of a different fund, and then exchanges back into the originally purchased fund;
[sbull] Delaying the payment of the proceeds from the redemption of fund shares for up to seven days;\14\ and
\14\ Under section 22(e) of the Investment Company Act [15 U.S.C. 80a22(e)], in general no registered investment company may suspend the right of redemption, or postpone the date of payment or satisfaction upon redemption of any redeemable security, for more than seven days after the tender of such security to the company or its agent designated for that purpose for redemption.
[sbull] Identifying market timers and restricting their trading privileges or expelling them from the fund.

While many mutual funds disclose in their prospectuses that they discourage market timing, many do not identify with specificity the frequency or type of trading that they consider to be problematic, or the specific steps that they will take to ensure that market timing trades are detected and prevented. Other mutual funds disclose specifically the number of trades that they consider to be problematic and the steps that they take to prevent and detect market timing. Item 7(c) of Form N1A requires mutual funds to disclose in their prospectuses procedures for redeeming the fund's shares, including any restrictions on redemptions; any redemption charges, including how these charges will be collected and under what circumstances the charges will be waived; and the circumstances, if any, under which the fund may delay honoring a request for redemption for a certain time after a shareholder's investment.\15\ Item 8(a)(2) of Form N1A requires a description of exchange privileges, which may be provided in the prospectus or the Statement of Additional Information
(``SAI'').\16\ Item 3 of Form N1A requires a mutual fund to include any exchange fee or redemption fee in the fee table of its prospectus.\17\
\15\ Items 7(c)(1), (c)(2), and (c)(6) of Form N1A. Form N1A is the registration form used by mutual funds to register under the Investment Company Act and to offer their shares under the Securities Act of 1933 [15 U.S.C. 77a].
\16\ Item 8(a)(2) of Form N1A. Similarly, Items in the registration forms for insurance company separate accounts that issue variable annuities and variable life insurance policies require disclosure of provisions and limitations for transfers of contract value among subaccounts of the separate account. Item 8(b)(ii) of Form N3; Item 7(b)(ii) of Form N4; Item 6(b)(2) of Form N6.

The SAI is part of a fund's registration statement and contains information about a fund in addition to that contained in the prospectus. The SAI is required to be delivered to investors upon request and is available on the Commission's Electronic Data Gathering, Analysis, and Retrieval System.
\17\ Item 3 and Instructions 2(b) and 2(c) to Item 3 of Form N 1A. Similarly, Item 3(a) and Instruction 10 to Item 3(a) of Form N 3; Item 3(a) and Instruction 11 to Item 3(a) of Form N4; and Item 3 and Instruction 2(b) to Item 3 of Form N6 require fee table disclosure of fees charged for transfers of contract value among subaccounts.

Other aspects of mutual fund policies and procedures to deter market timing are not explicitly required to be disclosed, however. For example, our registration forms do not explicitly require funds to describe with specificity the circumstances under which restrictions on frequent purchases and redemptions will not be imposed, or the terms of arrangements with particular investors pursuant to which frequent purchases and redemptions are permitted.\18\
\18\ Commission staff sent information requests to 88 of the largest mutual fund complexes, with approximately 90% of the fund industry's total assets and 4,100 individual funds or portfolios under management. Fifty percent of the fund groups that responded to these staff information requests appear to have one or more arrangements with certain shareholders to allow these shareholders to engage in market timing.

We believe that it may be useful to require mutual funds to describe with specificity the restrictions they place on frequent purchases and redemptions and the circumstances and arrangements under which the restrictions are not imposed. These additional disclosure requirements would enable investors to better assess a mutual fund's risks, policies, and procedures in this area, and to determine if a fund's policies and procedures are in line with their expectations. B. Selective Disclosure of Fund Portfolio Holdings

Currently, mutual funds are required to include their complete portfolio holdings in the reports that are delivered to all shareholders twice a year.\19\ In December 2002, we proposed amendments that would require mutual funds to disclose their complete
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portfolio schedules on a quarterly basis.\20\ A significant majority of funds already make their full portfolio schedules publicly available at least quarterly.\21\
\19\ Section 30(e) of the Investment Company Act [15 U.S.C. 80a 29(e)] (requiring a registered investment company to transmit to its stockholders, at least semiannually, reports containing financial statements and other financial information as the Commission may prescribe by rules and regulations); rule 610(c)(1) of Regulation SX [17 CFR 210.610(c)(1)] (requiring that a portfolio schedule be filed in support of the balance sheet entry for investments in securities of unaffiliated issuers).
\20\ Investment Company Act Release No. 25870 (Dec. 18, 2002) [68 FR 160 (Jan. 2, 2003)].
\21\ See Scott Cooley, Tell Investors What They Own, Morningstar Online, Feb. 6, 2002 (more than 70% of funds currently provide monthly or quarterly portfolio disclosure to Morningstar). See also Tom Lauricella and Aaron Lucchetti, To Industry, Silence is Golden Mutual Funds Embrace Disclosure RulesAs Long as it Doesn't Involve Them, Wall Street Journal Europe, Aug. 1, 2002, at M1 (roughly 200 fund firms and 17 of the top 20 largest funds provide quarterly or monthly holdings updates to investors); Survey of Fund Groups' Portfolio Disclosure Policies Summary of Results, Investment Company Institute (2001), available at: http://www.ici.org/port_holdings_appdxa.html .

Recent allegations, however, have highlighted instances where some mutual fund managers may be selectively disclosing their portfolios in order to reward large investors. Specifically, allegations have been made that certain funds gave frequent updates of their portfolio holdings to favored shareholders, enabling these shareholders to use a fund's portfolio information to short the fund's holdings in the same or similar proportions to the fund's established positions.\22\ In addition, more than 30% of mutual fund complexes that responded to a recent Commission examination request for information sent to 88 of the largest such complexes appear to have disclosed portfolio information in circumstances that may have provided certain fund shareholders with the ability to make advantageous decisions to place orders for fund shares. This selective disclosure can facilitate fraud and have severely adverse ramifications for a fund's investors if someone uses that portfolio information to trade against the fund, or otherwise uses the information in a way that would harm the fund.
\22\ See State of New York v. Canary Capital Partners, LLC, et. al., at 25 and 41, (N.Y. Sup. Ct., filed Sept. 3, 2003) available at: http://www.oag.state.ny.us/press/2003/sep/canary_complaint.pdf (alleging that fund group regularly provided investor with detailed breakdowns of the portfolios of the target funds, allowing the investor to sell short the stocks that the portfolios contained); Ian McDonald, Will Funds Disclose MorePublicly?, The Wall Street Journal, Sept. 9, 2003, at C1 (describing allegations that fund groups provided hedge fund with more frequent reports on their fund holdings than were available to other investors).

We are concerned about the misuse of material, nonpublic information that may occur when a mutual fund's portfolio holdings are selectively disclosed and professional traders are given the opportunity to use this information to their advantage to the detriment of fund shareholders. For many issuers, Regulation FD generally requires that when an issuer discloses material information, it do so through public disclosure, not through selective disclosure.\23\ Regulation FD does not, however, apply to mutual funds.\24\ We have concluded that the recent allegations regarding selective disclosure of portfolio holdings by some mutual fund managers suggest that we need to take steps to reinforce funds' and advisers' obligations to prevent the misuse of portfolio holdings information that is selectively disclosed. \23\ Regulation FD [17 CFR 243.100 et seq.]; Investment Company Act Release No. 24599 (Aug. 15, 2000) [65 FR 51716 (Aug. 24, 2000)] (adopting Regulation FD).
\24\ Rule 101(b) of Regulation FD [17 CFR 243.101(b)].

C. Disclosure Proposals

The Commission is proposing form amendments to require better disclosure with respect to the tools that mutual funds use to combat market timing activity. First, in order to enable investors to assess a mutual fund's practices regarding frequent purchases and redemptions of fund shares to determine if they are in line with their expectations, the Commission is proposing to require improved disclosure in fund prospectuses of a mutual fund's risks, policies, and procedures in this area. The proposals would:
[sbull] Require a mutual fund to describe in its prospectus the risks, if any, that frequent purchases and redemptions of fund shares may present for other shareholders;
[sbull] Require a mutual fund to state in its prospectus whether or not the fund's board of directors has adopted policies and procedures with respect to frequent purchases and redemptions of fund shares and, if the board has not adopted any such policies and procedures, state the specific basis for the view of the board that it is appropriate for the fund not to have such policies and procedures;
[sbull] Require a mutual fund to describe any policies and procedures for deterring frequent purchases and redemptions of fund shares, and any arrangements to permit frequent purchases and redemptions of fund shares; and
[sbull] Require similar disclosure in prospectuses for insurance company separate accounts offering variable insurance contracts, with respect to frequent transfers among subaccounts.

Second, we are proposing to clarify instructions to our registration forms to require all mutual funds (other than money market funds) and insurance company managed separate accounts that offer variable annuities to explain in their prospectuses both the circumstances under which they will use fair value pricing and the effects of using fair value pricing. As described above, fair valuation of a fund's portfolio securities, which is required under certain circumstances, can serve to foreclose arbitrage opportunities available to market timers.

In addition, in order to provide greater transparency of fund practices with respect to the disclosure of the fund's portfolio holdings, and to reinforce funds' and advisers' obligations to prevent the misuse of material, nonpublic information, the Commission is proposing to require mutual funds and insurance company managed separate accounts that offer variable annuities to disclose their policies with respect to disclosure of portfolio holdings information. The proposals would:
[sbull] Require a fund to describe in its SAI any policies and procedures with respect to the disclosure of the fund's portfolio securities to any person and any ongoing arrangements to make available information about the fund's portfolio securities to any person; and [sbull] Require a fund to state in its prospectus that a description of the policies and procedures is available in the fund's SAI, and on the fund's Web site, if applicable.
II. Discussion
A. Disclosure Concerning Frequent Purchases and Redemptions of Fund Shares

The Commission is proposing amendments to Form N1A, the registration form used by mutual funds, that would require disclosure of both the risks to fund shareholders of the frequent purchase and redemption of fund shares, and a fund's policies and procedures with respect to such frequent purchases and redemptions.\25\ As discussed above, market timing strategies often involve such frequent purchases and redemptions of fund shares. These proposals are intended to require mutual funds to describe with specificity the restrictions they place on frequent purchases and redemptions, if any, and the circumstances under which any such restriction will not apply. This additional disclosure would enable investors to assess mutual funds' risks, policies, and procedures in this area and determine if a fund's policies and procedures are in line with their
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expectations.\26\ We are also proposing similar amendments to the registration forms for insurance company separate accounts that issue variable annuities and variable life insurance policies.\27\ \25\ Proposed Item 7(e) of Form N1A.
\26\ In our release adopting rule 38a1 under the Investment Company Act, we state that a fund must have procedures reasonably designed to ensure compliance with its disclosed policies regarding market timing.
\27\ Proposed Item 8(e) of Form N3; proposed Item 7(e) of Form N4; proposed Item 6(f) of Form N6.

The amendments that we are proposing to Form N1A would require that a mutual fund's prospectus describe the risks, if any, that frequent purchases and redemptions of fund shares may present for other shareholders of the fund.\28\ These risks may include, among other things, dilution in the value of fund shares held by longterm shareholders, interference with the efficient management of the fund's portfolio, and increased brokerage and administrative costs. The disclosure should be specific to the fund, taking into account its investment objectives, policies, and strategies. For example, we would generally expect a fund that invests in overseas markets to describe the risks of timezone arbitrage.

\28\ Proposed Item 7(e)(1) of Form N1A.

The proposed amendments would also require a mutual fund's prospectus to state whether the fund's board of directors has adopted policies and procedures with respect to frequent purchases and redemptions of fund shares by fund shareholders.\29\ If the fund's board of directors has not adopted any such policies and procedures, the fund's prospectus would be required to include a statement of the specific basis for the view of the board that it is appropriate for the fund not to have such policies and procedures.\30\ On the other hand, if the fund's board of directors has adopted such policies and procedures, the fund's prospectus would be required to include a description of those policies and procedures, including:
\29\ Proposed Item 7(e)(2) of Form N1A.
\30\ Proposed Item 7(e)(3) of Form N1A.
[sbull] Whether or not the fund discourages frequent purchases and redemptions of fund shares by fund shareholders;
[sbull] Whether or not the fund accommodates frequent purchases and redemptions of fund shares by fund shareholders;
[sbull] Any policies and procedures of the fund for deterring frequent purchases and redemptions of fund shares by fund shareholders; and
[sbull] Any policies and procedures of the fund for detecting frequent purchases and redemptions of fund shares, including any arrangements for detecting frequent purchases and redemptions of fund shares through intermediaries, such as investment advisers, broker dealers, transfer agents, and third party administrators.\31\ \31\ Proposed Item 7(e)(4) of Form N1A.

Persons that are not registered as brokerdealers need to consider whether the securities activities that they are undertaking are brokerage activities that require them to register as broker dealers. Section 3(a)(4) of the Securities Exchange Act of 1934 (``Exchange Act'') defines a broker as a person engaged in the business of effecting transactions in securities. It includes several exceptions for certain bank activities. Section 15 of the Exchange Act essentially makes it unlawful for a broker or dealer ``to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security (other than an exempted security or commercial paper, bankers' acceptances, or commercial bills)'' unless the broker or dealer is registered with the Commission.

The description of the mutual fund's policies and procedures, if any, for deterring frequent purchases and redemptions of fund shares by fund shareholders would be required to include any restrictions imposed by the fund to prevent or minimize such frequent purchases and redemptions, including:
[sbull] Any restrictions on the volume or number of purchases, redemptions, or exchanges that a shareholder may make within a given time period;
[sbull] Any exchange fee or redemption fee;
[sbull] Any costs or administrative or other fees or charges that are imposed on shareholders deemed to be engaged in frequent purchases and redemptions of fund shares, together with a description of the circumstances under which such costs, fees, or charges will be imposed; [sbull] Any minimum holding period that is imposed before an investor may make exchanges into another fund;
[sbull] Any restrictions imposed on exchange or purchase requests submitted by overnight delivery, electronically, or via facsimile or telephone; and
[sbull] Any right of the fund to reject, limit, delay, or impose other conditions on exchanges or purchases or to close or otherwise limit accounts based on a history of frequent purchases and redemptions of fund shares, including the circumstances under which such right will be exercised.

The proposals would require that the policies and procedures for deterring frequent purchases and redemptions, including any restrictions imposed to prevent or minimize such frequent purchases and redemptions, be described with specificity.\32\ For example, a fund might state that a 2% redemption fee will be applied to all redemptions within 60 days after purchase or, in describing any restrictions on the volume or number of purchases, redemptions, or exchanges that a shareholder may make within a given time period, a fund might state that it prohibits more than 3 exchanges per year.
\32\ Proposed Item 7(e)(4)(iii) of Form N1A. A fund need not repeat this disclosure to the extent it is provided in the prospectus in response to other Items of Form N1A, including Items 3 (redemption and exchange fees), 7(c) (restrictions on redemptions, and redemption charges), and 8(a)(2) (exchange privileges).

A fund would also be required to indicate whether each restriction applies uniformly in all cases or whether the restriction will not be imposed under certain circumstances. If any restriction will not be imposed under certain circumstances, the fund would be required to describe with specificity the circumstances under which the restriction will not be imposed. \33\

\33\ Proposed Item 7(e)(4)(iii) of Form N1A.

We are also proposing to require a mutual fund to describe in its prospectus any arrangements with any person to permit frequent purchases and redemptions of fund shares.\34\ This description would include the identity of the persons permitted to engage in frequent purchases and redemptions and any compensation or other consideration received by the fund, its investment adviser, or any other party pursuant to such arrangements. A proposed instruction would clarify that the consideration required to be disclosed includes any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment adviser or by any affiliated person of the investment adviser.\35\

We emphasize that a mutual fund that enters into an arrangement with any person to permit frequent purchases and redemptions of fund shares may only do so consistent with the antifraud provisions of the federal securities laws and the fiduciary duties of the fund and its investment adviser to fund shareholders. Disclosure provided pursuant to these proposed amendments would not make lawful conduct that is otherwise unlawful. For example, disclosure would not render lawful an arrangement whereby an investment adviser permits frequent purchases and redemptions of a mutual fund's shares in return for consideration that benefits the adviser, such as an agreement to
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maintain assets in other accounts managed by the adviser.
\34\ Proposed Item 7(e)(5) of Form N1A.

\35\ Proposed Instruction to Item 7(e)(5) of Form N1A.

The proposed amendments to Form N1A would also clarify that the new disclosure that would be required regarding frequent purchases and redemptions of fund shares may not be omitted from the prospectus in reliance on current Item 7(f), which would be redesignated as Item 7(g).\36\ Current Item 7(f) permits funds to omit from the prospectus certain information concerning purchase and redemption procedures if, among other things, the information is included in a separate document that is incorporated by reference into, and filed and delivered with, the prospectus.\37\ We believe that the information required by new Item 7(e) is more appropriately included in the same document as the prospectus.
\36\ Proposed Item 7(g) of Form N1A.

\37\ Item 7(f) of Form N1A.

We are proposing to require similar disclosure in Forms N3,\38\ N 4,\39\ and N6,\40\ the registration forms for insurance company separate accounts that issue variable annuity and variable life insurance contracts, with respect to both the risks of frequent transfers of contract value among subaccounts, and the separate account's policies and procedures with respect to such frequent transfers. However, we are proposing the following modifications to address the different structure of these issuers:
\38\ Proposed Item 8(e) of Form N3. Form N3 is used by all insurance company separate accounts offering variable annuity contracts that are registered under the Investment Company Act as management investment companies.
\39\ Proposed Item 7(e) of Form N4. Form N4 is used by all insurance company separate accounts offering variable annuity contracts that are registered under the Investment Company Act as unit investment trusts. See section 4(2) of the Investment Company Act [15 U.S.C. 80a4(2)] (defining ``unit investment trust''). \40\ Proposed Item 6(f) of Form N6. Form N6 is used by all insurance company separate accounts offering variable life insurance policies that are registered under the Investment Company Act as unit investment trusts.
[sbull] The proposed amendments to Forms N3, N4, and N6 would require disclosure regarding the risks of, and policies and procedures with respect to, frequent transfers of contract value among sub accounts of the registrant. A person attempting to engage in market timing of mutual funds through a variable annuity or variable life insurance contract typically would make taxfree transfers of contract value among subaccounts, each of which invests in a particular underlying mutual fund.\41\
\41\ Increases in the cash values of variable annuity and variable life insurance contractsknown as the ``inside buildup'' are taxdeferred until the contract's surrender or maturity. See I.R.C. section 7702(g) (1986).
[sbull] The proposed amendments to Forms N4 and N6 would require disclosure with respect to whether the separate account or its depositor has policies and procedures with respect to frequent transfers of contract value among subaccounts, rather than whether such policies and procedures have been adopted by the separate account's board of directors. The separate accounts registered on these forms are unit investment trusts, which do not have boards of directors, and the depositor would be responsible for adopting and implementing any policies and procedures.\42\ If neither the separate account nor the depositor has any such policies and procedures, the proposals would require that the prospectus include a statement of the specific basis for the view of the depositor that it is appropriate for the separate account and depositor not to have such policies and procedures.\43\
\42\ Proposed Item 7(e)(ii) of Form N4; proposed Item 6(f)(2) of Form N6.
\43\ Proposed Item 7(e)(iii) of Form N4; proposed Item 6(f)(3) of Form N6.
[sbull] The proposed amendments to Forms N3, N4, and N6 would require disclosure of the risks that frequent transfers of contract value among subaccounts may present not only for other contractowners, but also for other persons who have material rights under the contract (including, in the case of Forms N3 and N4, participants, annuitants, and beneficiaries, and, in the case of Form N6, the insured or beneficiary).\44\
\44\ Proposed Item 8(e)(i) of Form N3; proposed Item 7(e)(i) of Form N4; proposed Item 6(f)(1) of Form N6.
[sbull] The proposed amendments to Forms N3, N4, and N6 that require disclosure of any arrangements for detecting frequent transfers of contract value among subaccounts would not explicitly reference arrangements for detecting transfers through intermediaries, such as investment advisers, brokerdealers, transfer agents, and third party administrators.\45\ Because the variable annuity and variable life insurance contracts registered on these forms are typically held in the name of the contractowner and not an intermediary, insurance companies generally will not need to enter into any such arrangements with intermediaries in order for the insurance company to be able to detect frequent transfers among subaccounts. If an insurance company had any such arrangements with intermediaries, however, disclosure of those arrangements would be required.
\45\ Proposed Item 8(e)(iv)(D) of Form N3; proposed Item 7(e)(iv)(D) of Form N4; proposed Item 6(f)(4)(iv) of Form N6. [sbull] The proposed amendments to Forms N3, N4, and N6 would specifically require disclosure concerning any consideration received by the sponsoring insurance company pursuant to any arrangements to permit frequent transfers of contract value.\46\
\46\ Proposed Item 8(e)(v) of Form N3; proposed Item 7(e)(v) of Form N4; proposed Item 6(f)(5) of Form N6.
[sbull] A proposed Instruction in Form N3 clarifies that consideration received pursuant to arrangements to permit frequent transfers of contract value includes any agreement to maintain assets in the registrant or in other investment companies or accounts managed or sponsored by the investment adviser, the insurance company, or any affiliated person of the investment adviser or the insurance company.\47\ The parallel proposed Instructions in Forms N4 and N6 would include as consideration any agreement to maintain assets in the registrant or in other investment companies or accounts managed or sponsored by any investment adviser of a mutual fund in which a sub account of the registrant is invested, the sponsoring insurance company, or any affiliated person of such an investment adviser or the insurance company.\48\
\47\ Proposed Instruction to Item 8(e)(v) of Form N3.
\48\ Proposed Instruction to Item 7(e)(v) of Form N4; proposed Instruction to Item 6(f)(5) of Form N6.

We request comment generally on the proposals described above and specifically on the following issues:
[sbull] Should we require that mutual funds and insurance company separate accounts make each of the proposed disclosures discussed above? Should we require any additional disclosures?
[sbull] Is the prospectus the appropriate location for each of the proposed disclosures? Would all or part of the disclosure be more appropriately located in the SAI, reports to shareholders, Form NCSR, the registrant's Web site, or another location? Should we permit mutual funds to disclose any of the required information in the separate disclosure document referenced in current Item 7(f) of Form N1A? [sbull] Several Items of Forms N1A, N3, N4, and N6 (e.g., Items 3, 7(c), and 8(a)(2) of Form N1A; Items 3 and 8(b)(ii) of Form N3; Items 3 and 7(b)(ii) of Form N4; and Items 3 and 6(b)(2) of Form N6) call for disclosures that are related to the disclosures called for by the proposals. Should we amend any of these other Items or alter the proposals
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in any way to better coordinate the disclosure requirements of these Items?
[sbull] Exchange traded funds (``ETFs) are investment companies that are registered under the Investment Company Act as openend management investment companies or unit investment trusts. However, unlike typical openend funds or unit investment trusts, ETFs do not sell or redeem their individual shares at NAV. Instead, ETFs sell and redeem their shares at NAV only in large blocks, generally in exchange for a basket of securities that mirrors the composition of the ETF's portfolio, plus a small amount of cash. Shares of ETFs are listed on national securities exchanges for trading, which allows investors to purchase and sell individual ETF shares among themselves at market prices throughout the day. Should ETFs be expressly excluded from the proposed disclosure requirements?
B. Disclosure of Circumstances Under Which Funds Will Use Fair Value Pricing

The Commission is proposing to amend the Instruction to Item 7(a)(1) of Form N1A, and to add a corresponding Instruction to Form N 3, to clarify that all mutual funds and managed separate accounts that offer variable annuities, other than money market funds, are required to explain briefly in their prospectuses both the circumstances under which they will use fair value pricing and the effects of using fair value pricing.\49\ We are proposing to amend this instruction to clearly reflect that funds are required to use fair value prices any time that market quotations for their portfolio securities are not readily available (including when they are not reliable). Money market funds would not be subject to the proposed requirement to disclose the circumstances under which they would use fair value pricing and the effects of such use, because such funds are subject to rule 2a7 under the Investment Company Act, which contains its own detailed pricing requirements.\50\
\49\ Proposed Instruction to Item 7(a)(1) of Form N1A; proposed Instruction to Item 11(c) of Form N3. We are not proposing to amend Forms N4 and N6 because these forms are used by insurance company separate accounts that are organized as unit investment trusts and typically hold only securities issued by underlying mutual funds. These underlying mutual funds are responsible for valuing their own portfolio securities, including, as required, through fair valuation.
\50\ Rule 2a7(c) (describing the requirements for calculating the share price of money market funds using the amortized cost and pennyrounding methods).

We note that the disclosure regarding the circumstances under which a fund would use fair value pricing and the effects of such use should be specific to the fund. For example, if a fund invests exclusively in frequently traded exchange listed securities of large capitalization domestic issuers and calculates its NAV as of the time the exchange typically closes, there may be very limited circumstances in which it would use fair value pricing (e.g., if the exchange on which a portfolio security is principally traded closes early or if trading in a particular portfolio security was halted during the day and did not resume prior to the fund's NAV calculation). By contrast, if a fund invests primarily in securities that are traded on overseas markets, we would expect a fuller discussion of the circumstances under which the fund would use fair value pricing, such as specific events occurring after the close of the overseas exchange that would cause the fund to use fair value pricing. Similarly, we would expect that the description of the effects of using fair value pricing would be fund specific, e.g., minimizing the possibilities for timezone arbitrage, in the case of a fund investing in overseas markets.\51\
\51\ We also note that the Commission is issuing a release adopting new rule 38a1 under the Investment Company Act, which requires funds to adopt policies and procedures that require a fund to monitor for circumstances that may necessitate the use of fair value prices, establish criteria for determining when market quotations are no longer reliable for a particular portfolio security, provide a methodology or methodologies by which the fund determines the current fair value of the portfolio security, and regularly review the appropriateness and accuracy of the method used in valuing securities and make any necessary adjustments.

We request comment generally on the proposed disclosure regarding fair value pricing and specifically on the following issues: [sbull] Is the proposed Instruction requiring funds to explain briefly the circumstances under which they will use fair value pricing and the effects of using fair value pricing appropriate? Is this proposed disclosure necessary in light of the fact that all funds are required to use fair value pricing if market quotations for a portfolio security are not readily available (including when they are not reliable)? Will the disclosure provide useful information to investors about the particular circumstances under which a fund will use fair value pricing and the effects on that fund of using fair value pricing? Should money market funds or any other types of funds not be required to provide the disclosure?
[sbull] Is the fund prospectus the appropriate location for the proposed disclosure, or would the SAI provide investors with adequate access to this information? Are there any other locations, such as Form NCSR, reports to shareholders, or the fund's Web site, that would be more appropriate for this disclosure?
[sbull] Are there cases where disclosure of the circumstances under which a mutual fund will use fair value pricing and the effect on the fund of using fair value pricing may assist investors who intend to engage in market timing strategies? If so, how should we modify the proposed Instruction to address these cases?

C. Selective Disclosure of Fund Portfolio Holdings

We are proposing amendments to Form N1A that would require mutual funds to disclose their policies and procedures with respect to the disclosure of their portfolio securities and any ongoing arrangements to make available information about their portfolio securities.\52\ We are also proposing parallel amendments to Form N3 for managed separate accounts that issue variable annuities.\53\ These amendments are intended to provide greater transparency of fund practices with respect to the disclosure of the fund's portfolio holdings, and to reinforce funds' and advisers' obligations to prevent the misuse of material, nonpublic information.
\52\ Proposed Items 4(d) and 12(f) of Form N1A. In the release adopting rule 38a1 under the Investment Company Act, we state that a fund's compliance policies and procedures should address misuses of nonpublic information, including the disclosure to third parties of material information about the fund's portfolio, its trading strategies, or pending transactions.
\53\ Proposed Items 5(f) and 19(e) of Form N3. We are not proposing to amend Forms N4 and N6 because these forms are used by insurance company separate accounts that are organized as unit investment trusts, which typically hold only securities issued by underlying mutual funds.

We emphasize that a mutual fund or investment adviser that discloses the fund's portfolio securities may only do so consistent with the antifraud provisions of the federal securities laws and the fund's or adviser's fiduciary duties to fund shareholders. Disclosure provided pursuant to these proposed amendments would not make lawful conduct that is otherwise unlawful. Divulging portfolio holdings to selected third parties is permissible only when the fund has legitimate business purposes for doing so and the recipients are subject to a duty of confidentiality. Examples of instances in which selective disclosure of a fund's portfolio securities may be appropriate, subject to confidentiality agreements and trading restrictions, include disclosure for due diligence purposes to an investment
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adviser that is in merger or acquisition talks with the fund's current adviser, disclosure to a newly hired investment adviser or subadviser prior to commencing its duties, or disclosure to a rating agency for use in developing a rating.

Our proposals would require a mutual fund's SAI to describe the fund's policies and procedures with respect to the disclosure of its portfolio securities.\54\ The mutual fund's prospectus would be required to state that a description of its policies and procedures is available in its SAI and, if applicable, on its Web site.\55\ The SAI description of the mutual fund's policies and procedures with respect to the disclosure of its portfolio securities would be required to include:
\54\ Proposed Item 12(f)(1) of Form N1A; proposed Item 19(e)(i) of Form N3.
\55\ Proposed Item 4(d) of Form N1A; proposed Item 5(f) of Form N3.
[sbull] How the policies and procedures apply to disclosure to different categories of persons, including individual investors, institutional investors, intermediaries that distribute the fund's shares, thirdparty service providers, rating and ranking
organizations, and affiliated persons of the fund;\56\
\56\ Proposed Item 12(f)(1)(i) of Form N1A. With respect to managed separate accounts issuing variable annuity contracts registered on Form N3, the categories would include contractowners, participants, annuitants, and beneficiaries. Proposed Item 19(e)(i)(A) of Form N3.
[sbull] Any conditions or restrictions placed on the use of information about portfolio securities that is disclosed, including any requirement that the information be kept confidential or prohibitions on trading based on the information, and any procedures to monitor the use of this information;\57\
\57\ Proposed Item 12(f)(1)(ii) of Form N1A; proposed Item 19(e)(i)(B) of Form N3.
[sbull] The frequency with which information about portfolio securities is disclosed, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed;\58\
\58\ Proposed Item 12(f)(1)(iii) of Form N1A; proposed Item 19(e)(i)(C) of Form N3.
[sbull] Any policies and procedures with respect to the receipt of compensation or other consideration by the fund, its investment adviser, or any other party in connection with the disclosure of information about portfolio securities;\59\
\59\ Proposed Item 12(f)(1)(iv) of Form N1A. With respect to managed separate accounts issuing variable annuity contracts registered on Form N3, this description would also be required to include any policies and procedures with respect to the receipt of compensation or other consideration by the sponsoring insurance company. Proposed Item 19(e)(i)(D) of Form N3.
[sbull] The persons who may authorize disclosure of the fund's portfolio securities;\60\
\60\ Proposed Item 12(f)(1)(v) of Form N1A; proposed Item 19(e)(i)(E) of Form N3.
[sbull] The procedures that the fund uses to ensure that disclosure of information about portfolio securities is in the best interests of fund shareholders, including procedures to address conflicts between the interests of fund shareholders, on the one hand, and those of the fund's investment adviser; principal underwriter; or any affiliated person of the fund, its investment adviser, or its principal underwriter, on the other;\61\ and
\61\ Proposed Item 12(f)(1)(vi) of Form N1A. With respect to managed separate accounts issuing variable annuity contracts registered on Form N3, this description would be required to include the procedures that are used to ensure that disclosure of information about portfolio securities is in the best interests of contractowners, participants, annuitants, and beneficiaries, including procedures to address conflicts between the interests of such persons, on the one hand, and those of the separate account's investment adviser or principal underwriter; the sponsoring insurance company; or any affiliated person of the separate account, its investment adviser or principal underwriter, or the sponsoring insurance company, on the other. Proposed Item 19(e)(i)(F) of Form N3.
[sbull] The manner in which the board of directors exercises oversight of disclosure of the fund's portfolio securities.\62\ \62\ Proposed Item 12(f)(1)(vii) of Form N1A; proposed Item 19(e)(i)(G) of Form N3.
A mutual fund's disclosure of its policies and procedures with respect to the disclosure of its portfolio securities would be required to include any policies and procedures of the fund's investment adviser, or any other third party, that the fund uses or that are used on the fund's behalf.\63\
\63\ Proposed Instruction to Item 12(f)(1) of Form N1A; proposed Instruction to Item 19(e)(i) of Form N3.

We are also proposing to require a mutual fund to describe in its SAI any ongoing arrangements to make available information about the fund's portfolio securities to any person, including the identity of the persons who receive information pursuant to such arrangements and any compensation or other consideration received by the fund, its investment adviser, or any other party in connection with such arrangements.\64\ A proposed instruction would clarify that the consideration required to be disclosed would include any agreement to maintain assets in the fund or in other investment companies or accounts managed by the investment adviser or by any affiliated person of the investment adviser.\65\ As indicated above, however, divulging portfolio holdings to selected third parties is permissible only when the fund has legitimate business purposes for doing so, and legitimate business purposes generally would not include the receipt of consideration by the fund's investment adviser or its affiliates. With respect to these ongoing arrangements, funds would also be required to describe:
\64\ Proposed Item 12(f)(2) of Form N1A. With respect to managed separate accounts issuing variable annuity contracts registered on Form N3, disclosure of any compensation or other consideration received by the sponsoring insurance company would also be required. Proposed Item 19(e)(ii) of Form N3.
\65\ Proposed Instruction to Item 12(f)(2) of Form N1A. With respect to managed separate accounts issuing variable annuity contracts registered on Form N3, the consideration required to be disclosed would also include any agreement to maintain assets in other investment companies or accounts managed or sponsored by the sponsoring insurance company of the registrant or by an affiliated person of such sponsoring insurance company. Proposed Instruction to Item 19(e)(ii) of Form N3.
[sbull] Any conditions or restrictions placed on the use of information about portfolio securities that is disclosed, including any requirement that the information be kept confidential or prohibitions on trading based on the information, and any procedures to monitor the use of this information;
[sbull] The frequency with which information about portfolio securities is disclosed, and the length of the lag, if any, between the date of the information and the date on which the information is disclosed; and
[sbull] The persons who may authorize disclosure of the fund's portfolio securities.\66\
\66\ Proposed Item 12(f)(2) of Form N1A; proposed Item 19(e)(ii) of Form N3.

We request comment generally on the proposed disclosure requirements regarding disclosure of a fund's portfolio securities and specifically on the following issues:
[sbull] Should we require mutual funds and insurance company managed separate accounts to disclose their policies and procedures with respect to the disclosure of portfolio securities to any person? If so, what information should they be required to disclose? [sbull] Are there any types of arrangements that should be excluded from the requirement to disclose ongoing arrangements to make available information about portfolio securities, such as arrangements where the information that is disclosed is subject to a confidentiality requirement or a prohibition on trading based on the information? [sbull] What is the appropriate location for any disclosure about a mutual fund's or separate account's disclosure of its portfolio securities (e.g., prospectus,
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SAI, Form NCSR, Form 8K, shareholder reports, Web site, etc.)? [sbull] In addition to disclosing ongoing arrangements, should we require mutual funds and insurance company managed separate accounts to disclose all instances of selective disclosure of portfolio securities? If so, when should this disclosure be required to be made? What facts should be required to be disclosed regarding each such instance of selective disclosure (e.g., the names of persons or entities who receive portfolio holdings information; the terms of the disclosure, including any compensation paid for the information; the reasons why the disclosure is in the best interests of fund shareholders; the terms of any confidentiality agreement)? Should funds be required to disclose whether the board of directors has approved each individual instance of selective disclosure?
[sbull] Currently, Regulation FD, which governs the selective disclosure of material nonpublic information, does not apply to funds, other than closedend funds.\67\ Should Regulation FD apply to mutual funds or managed separate accounts with respect to their disclosure of portfolio holdings or other information?
\67\ 17 CFR 243.101(b).
[sbull] Are there any other measures that we should consider to reinforce the obligations of funds and their advisers to comply with their fiduciary duties and to prevent the misuse of material, non public information, including the selective disclosure of portfolio holdings information?

D. Compliance Date

If we adopt the proposed disclosure requirements, we expect to require all new registration statements and all posteffective amendments to effective registration statements filed on or after the effective date of the amendments to comply with the proposed amendments. The Commission requests comment on this proposed compliance date.

III. General Request for Comments

The Commission requests comment on the amendments proposed in this release, whether any further changes to our rules or forms are necessary or appropriate to implement the objectives of our proposed amendments, and on other matters that might have an effect on the proposals contained in this release.

IV. Paperwork Reduction Act

Cer

FOR FURTHER INFORMATION CONTACT Kieran G. Brown, Attorney, or Sanjay Lamba, Attorney, Office of Disclosure Regulation, Division of Investment Management, (202) 9420721, at the Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 205490506.