SEC Proposes Market Timing, Fair-Value Pricing, and Portfolio Holding Disclosure Reforms

Washington, DC, December 11, 2003 - The Securities and Exchange Commission has proposed amendments to Form N-1A under the Investment Company Act of 1940 that would require mutual funds to disclose more information about the risks of market timing, fair-value pricing methodologies, and policies and procedures concerning how funds disclose portfolio securities. The ICI is expected to provide comments on this proposal before the SEC’s February 6, 2004 deadline for public remarks.

Background

Market Timing
The proposal would require a mutual fund to disclose in its prospectus:

• the risks, if any, that frequent purchases and redemptions of fund shares by fund shareholders may present for other shareholders of the fund; and
• whether or not the fund's board of directors has adopted policies and procedures with respect to such frequent purchases and redemptions.

The SEC would also require prospectus disclosure of any arrangement that the fund has with any person to permit frequent purchases and redemptions of its shares, including:

• the identity of such person; and
• any compensation or other consideration received by the fund, its investment adviser, or any other party pursuant to such arrangement.

The Release notes that any such arrangement must be consistent with the antifraud provisions of the federal securities laws and with the fiduciary duties of the fund and its adviser to fund shareholders.

Fair-Value Pricing
The proposal would require a mutual fund to describe in its prospectus the procedures for pricing the fund’s shares, including the method used to value fund shares (market price, fair value, or amortized cost). The proposal would require that a mutual fund provide a brief explanation of:

• the circumstances under which the fund will use fair value pricing; and
• the effects of using fair value pricing. The Release notes that the proposed disclosure should be specific to the fund.

The proposed disclosure would not apply to money market funds, which the Release notes are subject to the pricing requirements of Rule 2a-7 under the Investment Company Act.

Portfolio Holdings
The proposal would require a mutual fund to fully describe in its Statement of Additional Information (SAI) the fund's policies and procedures concerning disclosure of the fund’s portfolio securities to any person. The description would include, among other things, 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, third-party service providers, rating and ranking organizations, and affiliated persons of the fund.

A mutual fund also would have 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;
• any compensation or other consideration received by the fund, its adviser, or any other party in connection with such arrangements;
• any conditions or restrictions placed on the use of disclosed information, including any requirement that the information be kept confidential or any prohibition on trading based on the information, and any procedures to monitor the use of the information;
• the frequency with which information about portfolio securities is disclosed, and the lag, if any, between the date of the information and the date on which it is disclosed; and
• the persons who may authorize disclosure of the fund's portfolio securities.

According to the Release, disclosure of portfolio holdings information to selected third parties would be permissible only if the fund had legitimate business purposes and only if the recipients are subject to “a duty of confidentiality.” The Release offers examples of instances in which selective disclosure may be appropriate, subject to confidentiality agreements and trading restrictions.

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