(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 Responds to House Leader on Mutual Fund Regulation Issues

Against the backdrop of major mutual fund reform legislation moving through the Congress, the SEC responded to a request from Rep. Paul E. Kanjorski, ranking member on the House Capital Markets subcommittee for more information on mutual fund industry issues. Rep. Kanjorski, asked for the information following hearings on H.R.2420, the Mutual Funds Integrity and Fee Transparency Act of 2003.

In its response, the Division of Investment Management pointed out that the staff cannot estimate the cost of compliance with the full range of disclosures contemplated by H.R.2420 because the bill does not set out the details of these disclosure requirements, but instead leaves the specifics to the SEC. In response to a question on corporate governance, the SEC staff said that fund governance practices have improved over the past few years as a result of a number of developments, including the best practice guidelines developed by the Investment Company Institute's advisory committee. Also critical to the improvement was SEC rulemaking designed to strengthen the hand of independent directors and provide investors with more information with which to judge director independence.

The SEC believes that, while many fund boards have adopted excellent governance practices that meet or exceed the advisory committee's best practices, not all funds have embraced them. For example, some funds continue to have former executives or relatives of the adviser serve as independent directors which, while not prohibited by the Investment Company Act, is inconsistent with one of the best practice recommendations. This is why the SEC supports provisions in the bill allowing it to close the gaps in the act that have permitted persons to serve as independent directors who do not appear to be sufficiently independent of fund management.

More broadly, the SEC said it might be time to re-examine the current disclosure regime for mutual funds. While the prospectus serves an important function as the basic disclosure document, noted the SEC, some investors may find the prospectus overwhelming. At the same time, new technologies for delivering information have become available.

A key difficulty in designing an effective disclosure regime for funds, in the SEC's view, is that not all investors have the same appetite for information. For example, institutional investors may have both the desire and ability to digest a wealth of information, while individual investors may be overwhelmed and confused by that same information. To combat this, the SEC seeks to have the information presented in a user-friendly format.

Responding to a question on distribution of the concise fund profile, the SEC noted that the profile is not mandatory and that very few funds have chosen to use it. Adopted in 1998, the fund profile was designed to provide summary key information about a fund.

Funds do not have to distribute their prospectus annually to all shareholders. They do, however, have to deliver a prospectus in connection with the purchase of fund shares. Because of the difficulty of keeping track of the many existing fund shareholders who buy additional shares from time to time, many funds decided it was simpler to distribute the prospectus annually to each existing shareholder rather than track which of them purchased more shares.

There is cost to this, which is ultimately borne by the shareholders, many of whom may not want to receive the new prospectus. As an alternative, the SEC suggests using the profile, rather than the prospectus, as an updating document for existing shareholders, perhaps coupled with availability of the prospectus on request or at the fund's Web site.