(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.)

House Bill Would Bring Sarbanes-Oxley Reform Approach to Fund Industry

A bill that would apply the reform approach of the Sarbanes-Oxley Act to mutual funds has been introduced by Rep. Richard H. Baker, chairman of the Capital Markets Subcommittee. The Mutual Funds Integrity and Fee Transparency Act, H.R.2420, would require all mutual funds to abide by the same audit committee standards required of exchange-listed companies under the Sarbanes-Oxley Act. The measure also builds on the Sarbanes-Oxley Act by furthering the independence and accountability of mutual fund directors.

The bill keys off of a comprehensive SEC report on the operation of mutual funds and how they disclose information to investors that was recently submitted to the subcommittee in response to a number of questions posed earlier to the SEC by Rep. Baker. The bill is co-sponsored by full Financial Services Committee Chairman Michael G. Oxley. Rep. Baker hopes that work can begin on this measure before the Independence Day recess. There is currently no companion bill in the Senate.

The bill is a comprehensive reform measure equal parts a disclosure and corporate governance regime. It enhances governance by requiring two-thirds of all board directors to be independent, including the fund chairman. Currently, the Investment Company Act requires 40 percent of the board to be independent, which increases to 50 percent for funds using certain key exemptions.

Similarly, the definition of an independent director is strengthened by excluding persons with business or close family relationships with the fund company. The measure also directs the SEC to require funds to disclose how portfolio managers are compensated.

In an effort to address conflict of interest situations, the bill would require fund advisers to submit an annual report to directors on revenue sharing, directed brokerage and soft-dollar arrangements. It also imposes a fiduciary obligation on fund directors to supervise these arrangements and ensure that they are in the best interests of the fund. Specifically, the fund's board would supervise the investment adviser's direction of the company's brokerage transactions and determine that the direction of fund brokerage is in the best interests of the shareholders.

The measure would enhance transparency by requiring funds to provide investors with improved disclosure outside the prospectus of estimated operating expenses, portfolio transaction costs, soft dollar arrangements, directed brokerage arrangements and revenue sharing arrangements. The bill directs the SEC to conduct a study of soft-dollar arrangements and consider the implications of repealing the safe harbor for them.