(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Adopts Fund, Adviser Compliance Rules

The SEC adopted rule changes to require investment companies to implement compliance policies to prevent violations of the federal securities laws by funds and to prevent violations of the Investment Advisers Act by the funds's advisers. Funds would also be required to review these policies annually and to install a chief compliance officer to administer the policy.

At the open meeting when the SEC issued the proposal, the SEC staff cited a number of examples for the Commission of instances when SEC enforcement actions were needed to address abuses in the mutual fund industry due to inadequate compliance programs. Such abuses included cross-trading, unauthorized trading of a customer account, fraud related to the pricing of private placements, and the misrepresentation of losses.

According to the SEC, fund advisory or distributor personnel have engaged in, or actively assisted others in engaging in, inappropriate market timing, late trading of fund shares, and the misuse of material, nonpublic information about fund portfolios. The Commission concluded that these personnel, including in some cases senior executives of fund advisers, placed their personal interests or the business interests of the fund adviser ahead of the interests of fund shareholders, thus breaching their fiduciary obligations to the funds involved and their shareholders. These individuals have harmed the funds, their management organizations, and the confidence of fund investors, concluded the SEC.

In response, the SEC is conducting an intensive investigation of funds, advisers, broker-dealers and others to identify violations of the federal securities laws and breaches of fiduciary obligations to clients. The agency is also reviewing its rules to determine what changes may be required to prevent this type of conduct.

New Rule 206(4)-7 under the Advisers Act and new Rule 38a-1 under the Investment Company Act will require each registered investment adviser and each fund to adopt and implement compliance programs that conform to the new rules. Failure of an adviser or fund to have adequate compliance policies and procedures in place will constitute a violation of our rules independent of any other securities law violation. According to the SEC, the new rules will thus permit the Commission to address the failure of an adviser or fund to have in place adequate compliance controls, before that failure has a chance to harm clients or investors.

New Investment Advisers Act Rule 206(4)-7 does not enumerate specific elements that advisers must include in their policies and procedures. The SEC noted that many commenters agreed with the agency's assessment that funds and advisers are too varied in their operations for the rules to impose of a single set of universally applicable required elements. Each adviser should adopt policies and procedures that take into consideration the nature of that firm's operations, advised the SEC. The policies and procedures should be designed to prevent violations from occurring, detect violations that have occurred and correct promptly any violations that have occurred.

Investment Company Act Rule 38a-1 requires fund boards to adopt written policies and procedures reasonably designed to prevent the fund from violating the federal securities laws. The procedures must provide for the oversight of compliance by the fund's advisers, principal underwriters, administrators and transfer agents through which the fund.

In light of recent enforcement actions and allegations of fund wrongdoing, the SEC stated that compliance policies should particularly address 1) pricing of portfolio securities and fund shares, 2) processing of fund shares, 3) identification of affiliated persons, 4) protection and prevention of misuse of nonpublic information, 5) compliance with fund governance requirements and 6) market timing.

The SEC also requested comment on measures to enhance the independence and effectiveness of chief compliance officers under the rule and on whether the rule definition of "material compliance matters" that must be reported to fund boards by chief compliance officers adequately addresses concerns that fund boards receive compliance information they reasonably need to know in order to oversee fund compliance. The rules are effective February 5, 2004, with compliance due by October 5, 2004. Comments are due to the SEC on the requested topics by February 5, 2004.

¨ Release No. IA-2204 is reported at ¶87,122 .