Taskforce Recommends Reforms in Fund Breakpoint Practices

A report released by a joint taskforce (the "Taskforce") of the NASD and representatives of broker/dealers and other mutual fund industry participants recommended reforms designed to address errors in the calculation of sales load discounts on front-end load mutual fund shares (commonly referred to as "breakpoint discounts") uncovered in a joint sweep of 43 broker/dealers examined by the staffs of the NASD, the SEC and the New York Stock Exchange earlier in 2003. (Breakpoint discounts are generally available to investors when their purchases of mutual fund shares exceed certain dollar thresholds.) The Taskforce report proposes a number of reforms, including: (1) the creation of a central breakpoint information database to improve broker/dealer access to breakpoint discount rules; (2) enhanced prospectus and website disclosure of breakpoint rules; (3) improved trade confirmations that disclose the entire percentage sales load charged for each front-end load mutual fund purchase and alert investors to breakpoint discount eligibility; (4) standardized checklists for broker/dealers to use in the order-taking process to communicate and gather relevant breakpoint eligibility information; (5) delivery of a disclosure statement regarding breakpoint discount eligibility to investors at or prior to confirmation of the initial purchase of fund shares and periodically thereafter; (6) increased information-sharing of taxpayer identification numbers and broker identification numbers among mutual funds, transfer agents and broker/dealers. The Taskforce called upon industry participants to comply voluntarily with its recommendations. To the extent that industry participants do not voluntarily implement its proposals, the Taskforce recommended that the SEC and self-regulatory organizations adopt rules requiring implementation. SEC Chairman William Donaldson welcomed the Taskforce report and asked the SEC staff to "move ahead" with the Taskforce’s prospectus disclosure recommendations and to develop additional investor protection initiatives concerning the costs and conflicts of interest in mutual fund investments.

The federal banking agencies issued guidance (the "Guidance") on the use of the FRB’s new primary credit program. The Guidance first details how the primary credit program interest rate was set at 100 basis points above the federal funds rate, and how there are no restrictions on the use of the funds and no requirement for institutions to first seek alternative sources of credit. However, the institution must have necessary collateral arrangements and documentation in place, and have at least an adequate CAMELS rating and capitalization. The Guidance then highlights that sound liquidity risk management involves: (1) policies for managing sources and uses of funds; (2) appropriate liquidity measurement systems; (3) adequate internal controls and audits; and (4) comprehensive liquidity contingency planning. As to the last point, the Guidance states that a fundamental principle is ensuring "adequate diversification in the potential sources of funds to be utilized." Finally, in light of the fact that the discount window is a relatively expensive source of funds, the Guidance instructs examiners to view occasional use of the window as appropriate, but to be cognizant of the potential adverse implications of too frequent use of the window.

The OTS issued an Opinion (P-2003-5) preempting substantial portions of the New Jersey Predatory Lending Act (the "NJPLA"). As with previous OTS opinions discussed in the Alert, in rendering the Opinion the OTS relied on the broad authority granted by Congress with respect to federal thrifts, as well as the broad OTS regulations in this area. The Opinion preempted the provisions of the NJPLA purporting to regulate the terms of credit, as well as the detailed compliance scheme imposed by the statute. Notably, as to non-thrift purchasers of loans originated by a thrift, the Opinion states that the NJPLA also should not apply because the statute subjects purchasers and assignees to the same type of claims as could be brought against the original creditor (i.e., the thrift, as to whom those claims are preempted). Moreover, if New Jersey regulators did interpret the law to apply the law to purchasers and assignees, the Opinion states that application of the NJPLA to them would interfere with the ability of federal thrifts to sell mortgages they originate under a uniform federal system, and thus preemption of that application is appropriate.

The OCC issued an interpretive letter ("Letter #969") in which it concluded that a national bank, (the "Bank") could self-deposit (i.e. place fiduciary funds in the commercial, savings or other department of the Bank) fiduciary assets awaiting investment or distribution collectively in a short-term investment fund ("STIF") administered by the Bank. As described in Letter #969, the Bank serves as trustee, executor, administrator, guardian and in other fiduciary capacities for thousands of trust customers and desires to manage certain funds awaiting investment or distribution collectively through a STIF. The OCC states that, under 12 C.F.R.§9.10(b), a national bank may invest its STIF in the bank’s own deposits unless prohibited by applicable law. In Letter #969, the Bank represented that applicable law in those states in which it does business and plans to self-deposit fiduciary funds does not prohibit such self-deposits. Accordingly, the OCC concluded that the conflict of interest restrictions of 12 C.F.R. § 9.12 are not triggered and the Bank may self-deposit fiduciary funds in the Bank’s STIF. The Bank confirmed to the OCC that it would comply with the OCC’s collateral requirements for self-deposits and with all other applicable requirements under the OCC’s Part 9.

The staff of the SEC’s Division of Investment Management (the "Staff") has provided no action relief to permit a closed-end fund (the "Fund") investing primarily in French equity securities to purchase securities issued by unregistered investment companies organized under the laws of, and operated in, France or other European Union Member Countries ("Foreign Funds") in excess of the limitations of Section 12(d)(1)(A) of the Investment Company Act of 1940, as amended (the "1940 Act"). Section 12(d)(1)(A) prohibits a registered investment company from acquiring another investment company’s securities if, after such acquisition, (1) the acquiring company owns more than 3% of the acquired company’s outstanding voting stock, (2) securities of the acquired company represent more than 5% of the acquiring company’s total assets or (3) securities of all investment companies owned by the acquiring company represent more than 10% of the acquiring company’s total assets. In granting relief from Section 12(d)(1)(A), the Staff noted its particular reliance on representations that: (a) the Fund’s board of directors will give Fund fee arrangements certain additional attention in light of the Fund’s Foreign Fund investments; (b) the Fund will invest only in Foreign Funds that do not own securities of other investment companies; (c) before investing in any Foreign Funds, the Fund will issue a press release announcing its intention to invest in Foreign Funds and provide similar disclosure in its prospectus and shareholder reports; and (d) the Fund is closed-end. The Staff also granted no action relief to the Fund and the Foreign Funds with respect to Section 7(d) of the 1940 Act, which prohibits an investment company that is not organized or created under U.S. law from selling or offering its securities in a public offering in the U.S. The Staff highlighted the following facts in granting the Section 7(d) no action relief: (1) the Fund is closed-end; (2) the Fund will not make any "in kind" distribution to shareholders of Foreign Fund securities; (3) the Fund will only purchase a Foreign Fund that has conducted an offering in the U.S. or to U.S. persons if the offering was in accordance with Section 3(c)(7) of the 1940 Act; and (4) the Fund will treat its Foreign Fund holdings as subject to the diversification limitations for "other securities" in Section 5(b)(1) of the 1940 Act.

The House Committee on Financial Services approved an amended version of H.R. 2420, the "Mutual Fund Integrity and Fee Transparency Act of 2003," which will be the subject of a future article in the Alert.

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