108TH CONGRESS

1ST SESSION H. R. 2420

AN ACT

To improve transparency relating to the fees and

costs that mutual fund investors incur and to improve corporate governance of mutual funds.

108TH CONGRESS

1ST SESSION H. R. 2420

AN ACT

To improve transparency relating to the fees and costs that

mutual fund investors incur and to improve corporate

governance of mutual funds.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,
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1 SECTION 1. SHORT TITLE.

2 (a) SHORT TITLE.—This Act may be cited as the

3 ‘‘Mutual Funds Integrity and Fee Transparency Act of

4 2003’’.

5 (b) TABLE OF CONTENTS.—

Sec. 1. Short title.

TITLE I—INTEGRITY AND FEE TRANSPARENCY

Sec. 101. Improved transparency of mutual fund costs.

Sec. 102. Obligations regarding certain distribution and soft dollar arrangements.

Sec. 103. Mutual fund governance.

Sec. 104. Audit committee requirements for investment companies.

Sec. 105. Trading restrictions.

Sec. 106. Definition of no-load mutual fund.

Sec. 107. Informing directors of significant deficiencies.

Sec. 108. Exemption from in person meeting requirements.

Sec. 109. Proxy voting disclosure.

Sec. 110. Incentive compensation and mutual fund sales.

Sec. 111. Commission study and report regulating soft dollar arrangements.

Sec. 112. Study of arbitration claims.

TITLE II—PREVENTION OF ABUSIVE MUTUAL FUND PRACTICES

Sec. 201. Prevention of fraud; internal compliance and control procedures.

Sec. 202. Ban on joint management of mutual funds and hedge funds.

Sec. 203. Short term trading by interested persons prohibited.

Sec. 204. Elimination of stale prices.

Sec. 205. Prevention of unfair after-hours trading.

Sec. 206. Report on adequacy of remedial actions.

6 TITLE I—INTEGRITY AND FEE

7 TRANSPARENCY

8 SEC. 101. IMPROVED TRANSPARENCY OF MUTUAL FUND

9 COSTS.

10 (a) REGULATION REVISION REQUIRED.—Within 270

11 days after the date of enactment of this Act, the Securities

12 and Exchange Commission shall revise regulations under

13 the Securities Act of 1933, the Securities Exchange Act

14 of 1934, or the Investment Company Act of 1940, or any
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1 combination thereof, to require, consistent with the protec2 tion of investors and the public interest, improved disclo3 sure with respect to an open-end management investment

4 company, in the quarterly statement or other periodic re5 port to shareholders or other appropriate disclosure docu6 ment, of the following:

7 (1) The estimated amount, in dollars for each

8 $1,000 of investment in the company, of the oper9 ating expenses of the company that are borne by

10 shareholders.

11 (2) The structure of, or method used to deter12 mine, the compensation of individuals employed by

13 the investment adviser of the company to manage

14 the portfolio of the company, and the ownership in15 terest of such individuals in the securities of the

16 company.

17 (3) The portfolio turnover rate of the company,

18 set forth in a manner that facilitates comparison

19 among investment companies, and a description of

20 the implications of a high turnover rate for portfolio

21 transaction costs and performance.

22 (4) Information concerning the company’s poli23 cies and practices with respect to the payment of

24 commissions for effecting securities transactions to a

25 member of an exchange, broker, or dealer who—
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1 (A) furnishes advice, either directly or

2 through publications or writings, as to the value

3 of securities, the advisability of investing in,

4 purchasing, or selling securities, and the avail5 ability of securities or purchasers or sellers of

6 securities;

7 (B) furnishes analyses and reports con8 cerning issuers, industries, securities, economic

9 factors and trends, portfolio strategy, and the

10 performance of accounts; or

11 (C) facilitates the sale and distribution of

12 the company’s shares.

13 (5) Information concerning payments by any

14 person other than the company that are intended to

15 facilitate the sale and distribution of the company’s

16 shares.

17 (6) Information concerning discounts on front18 end sales loads for which investors may be eligible,

19 including the minimum purchase amounts required

20 for such discounts.

21 (b) APPROPRIATE DISCLOSURE DOCUMENT.—

22 (1) IN GENERAL.—For purposes of subsection

23 (a), a disclosure shall not be considered to be made

24 in an appropriate disclosure document if the disclo25 sure is made exclusively in a prospectus or state-
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1 ment of additional information, or both such docu2 ments.

3 (2) EXCEPTIONS.—Notwithstanding paragraph

4 (1), the disclosures required by paragraph (2) and

5 (4) of subsection (a) may be considered to be made

6 in an appropriate disclosure document if the disclo7 sure is made exclusively in a prospectus or state8 ment of additional information, or both such docu9 ments.

10 (c) CONCEPT RELEASE REQUIRED.—

11 (1) IN GENERAL.—The Commission shall issue

12 a concept release examining the issue of portfolio

13 transaction costs incurred by investment companies,

14 including commission, spread, opportunity, and mar15 ket impact costs, with respect to trading of portfolio

16 securities and how such costs may be disclosed to

17 mutual fund investors in a manner that will enable

18 investors to compare such costs among funds.

19 (2) REPORT AND RECOMMENDATIONS RE20 QUIRED.—The Commission shall submit a report on

21 the findings from the concept release required by

22 paragraph (1), as well as legislative and regulatory

23 recommendations, if any, to the Committee on Fi24 nancial Services of the House of Representatives and

25 the Committee on Banking, Housing, and Urban Af-
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1 fairs of the Senate, no later than 270 days after the

2 date of enactment of this Act.

3 (d) ADDITIONAL REQUIREMENT FOR FEE STATE4 MENT.—

5 (1) IN GENERAL.—Not later than 270 days

6 after the date of enactment of this Act, the Commis7 sion shall prescribe a rule to require, with respect to

8 an open-end management investment company, in

9 the quarterly statement or other periodic report, or

10 other appropriate disclosure document, a statement

11 informing shareholders that such shareholders have

12 paid fees on their investments, that such fees have

13 been deducted from the amounts shown on the state14 ments, and where such shareholders may find addi15 tional information regarding the amount of these

16 fees.

17 (2) APPROPRIATE DISCLOSURE DOCUMENT.—

18 The statement required by paragraph (1) shall not

19 be considered to be made in an appropriate disclo20 sure document unless such statement is—

21 (A) made in each periodic statement to a

22 shareholder that discloses the value of the hold23 ings of the shareholder in the securities of the

24 company; and
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1 (B) prominently displayed, in a location in

2 close proximity to the statement of the shares

3 account value.

4 (e) REDUCING BURDENS ON SMALL FUNDS.—In pre5 scribing rules under this section, the Commission shall

6 give consideration to methods for reducing for small in7 vestment companies the burdens of making the disclosures

8 required by such rules, consistent with the public interest

9 and the protection of investors.

10 SEC. 102. OBLIGATIONS REGARDING CERTAIN DISTRIBU11 TION AND SOFT DOLLAR ARRANGEMENTS.

12 (a) REPORTING REQUIREMENT.—Section 15 of the

13 Investment Company Act of 1940 (15 U.S.C. 80a–15) is

14 amended by adding at the end the following new sub15 section:

16 ‘‘(g) OBLIGATIONS REGARDING CERTAIN DISTRIBU17 TION AND SOFT DOLLAR ARRANGEMENTS.—

18 ‘‘(1) REPORTING REQUIREMENTS.—Each in19 vestment adviser to a registered investment company

20 shall, no less frequently than annually, submit to the

21 board of directors of the company a report on—

22 ‘‘(A) payments during the reporting period

23 by the adviser (or an affiliated person of the

24 adviser) that were directly or indirectly made

25 for the purpose of promoting the sale of shares
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1 of the investment company (referred to in para2 graph (2) as a ‘revenue sharing arrangement’);

3 ‘‘(B) services to the company provided or

4 paid for by a broker or dealer or an affiliated

5 person of the broker or dealer (other than bro6 kerage and research services) in exchange for

7 the direction of brokerage to the broker or deal8 er (referred to in paragraph (2) as a ‘directed

9 brokerage arrangement’); and

10 ‘‘(C) research services obtained by the ad11 viser (or an affiliated person of the adviser)

12 during the reporting period from a broker or

13 dealer the receipt of which may reasonably be

14 attributed to securities transactions effected on

15 behalf of the company or any other company

16 that is a member of the same group of invest17 ment companies (referred to in paragraph (2)

18 as a ‘soft dollar arrangement’).

19 ‘‘(2) FIDUCIARY DUTY OF BOARD OF DIREC20 TORS.—The board of directors of a registered invest21 ment company shall have a fiduciary duty—

22 ‘‘(A) to review the investment adviser’s di23 rection of the company’s brokerage trans24 actions, including directed brokerage arrange25 ments and soft dollar arrangements, and to de-
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1 termine that the direction of such brokerage is

2 in the best interests of the shareholders of the

3 company; and

4 ‘‘(B) to review any revenue sharing ar5 rangements to ensure compliance with this Act

6 and the rules adopted thereunder, and to deter7 mine that such revenue sharing arrangements

8 are in the best interests of the shareholders of

9 the company.

10 ‘‘(3) SUMMARIES OF REPORTS IN ANNUAL RE11 PORTS TO SHAREHOLDERS.—In accordance with reg12 ulations prescribed by the Commission under para13 graph (4), annual reports to shareholders of a reg14 istered investment company shall include a summary

15 of the most recent report submitted to the board of

16 directors under paragraph (1).

17 ‘‘(4) REGULATIONS.—The Commission shall

18 adopt rules and regulations implementing this sec19 tion, which rules and regulations shall, among other

20 things, prescribe the content of the required reports.

21 ‘‘(5) DEFINITION.—For purposes of this

22 subsection—

23 ‘‘(A) the term ‘brokerage and research

24 services’ has the same meaning as in section
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1 28(e)(3) of the Securities Exchange Act of

2 1934; and

3 ‘‘(B) the term ‘research services’ means

4 the services described in subparagraphs (A) and

5 (B) of such section.’’.

6 (b) CONTRACTUAL RECORDS.—Within 270 days after

7 the date of enactment of this Act, the Securities and Ex8 change Commission shall, by rule prescribed pursuant to

9 section 28(e) of the Securities Exchange Act of 1934 (15

10 U.S.C. 78bb(e)), require that—

11 (1) if any research services (as such term is de12 fined in section 15(g)(5)(B) of the Investment Com13 pany Act of 1940, as amended by subsection (a) of

14 this section)—

15 (A) are provided by a member of an ex16 change, broker, or dealer who effects securities

17 transactions in an account, and

18 (B) are prepared or provided by a party

19 that is unaffiliated with such member, broker,

20 or dealer,

21 any person exercising investment discretion with re22 spect to such account shall maintain a copy of the

23 written contract between the person preparing such

24 research and the member of an exchange, broker, or

25 dealer; and
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1 (2) such contract shall describe the nature and

2 value of the services provided.

3 SEC. 103. MUTUAL FUND GOVERNANCE.

4 (a) DIRECTOR INDEPENDENCE.—Section 10(a) of

5 the Investment Company Act of 1940 (15 U.S.C. 80a–

6 10) is amended by striking ‘‘60 per centum’’ and inserting

7 ‘‘one-third’’.

8 (b) DEFINITION OF INTERESTED PERSON.—Section

9 2(a)(19) of the Investment Company Act of 1940 (15

10 U.S.C. 80a–2(a)(19)) is amended—

11 (1) in subparagraph (A)—

12 (A) by striking clause (vi) and redesig13 nating clause (vii) as clause (vi); and

14 (B) by amending clause (v) to read as fol15 lows:

16 ‘‘(v) any natural person who is a

17 member of a class of persons who the

18 Commission, by rule or regulation, deter19 mines are unlikely to exercise an appro20 priate degree of independence as a result

21 of—

22 ‘‘(I) a material business or pro23 fessional relationship with the com24 pany or any affiliated person of the

25 company, or
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1 ‘‘(II) a close familial relationship

2 with any natural person who is an af3 filiated person of the company,’’; and

4 (2) in subparagraph (B)—

5 (A) by striking clause (vi) and redesig6 nating clause (vii) as clause (vi); and

7 (B) by amending clause (v) to read as fol8 lows:

9 ‘‘(v) any natural person who is a

10 member of a class of persons who the

11 Commission, by rule or regulation, deter12 mines are unlikely to exercise an appro13 priate degree of independence as a result

14 of—

15 ‘‘(I) a material business or pro16 fessional relationship with such invest17 ment adviser or principal underwriter

18 (or affiliated person thereof), or

19 ‘‘(II) a close familial relationship

20 with a natural person who is such in21 vestment adviser or principal under22 writer (or affiliated person thereof),’’.
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1 SEC. 104. AUDIT COMMITTEE REQUIREMENTS FOR INVEST2 MENT COMPANIES.

3 (a) AMENDMENTS.—Section 32 of the Investment

4 Company Act of 1940 (15 U.S.C. 80a–31) is amended—

5 (1) in subsection (a)—

6 (A) by striking paragraphs (1) and (2) and

7 inserting the following:

8 ‘‘(1) such accountant shall have been selected

9 at a meeting held within 30 days before or after the

10 beginning of the fiscal year or before the annual

11 meeting of stockholders in that year by the vote,

12 cast in person, of a majority of the members of the

13 audit committee of such registered company;

14 ‘‘(2) such selection shall have been submitted

15 for ratification or rejection at the next succeeding

16 annual meeting of stockholders if such meeting be

17 held, except that any vacancy occurring between an18 nual meetings, due to the death or resignation of the

19 accountant, may be filled by the vote of a majority

20 of the members of the audit committee of such reg21 istered company, cast in person at a meeting called

22 for the purpose of voting on such action;’’; and

23 (B) by adding at the end the following new

24 sentence: ‘‘The Commission, by rule, regulation,

25 or order, may exempt a registered management

26 company or registered face-amount certificate
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1 company subject to this subsection from the re2 quirement in paragraph (1) that the votes by

3 the members of the audit committee be cast at

4 a meeting in person when such a requirement

5 is impracticable, subject to such conditions as

6 the Commission may require.’’; and

7 (2) by adding at the end the following new sub8 section:

9 ‘‘(d) AUDIT COMMITTEE REQUIREMENTS.—

10 ‘‘(1) REQUIREMENTS AS PREREQUISITE TO FIL11 ING FINANCIAL STATEMENTS.—Any registered man12 agement company or registered face-amount certifi13 cate company that files with the Commission any fi14 nancial statement signed or certified by an inde15 pendent public accountant shall comply with the re16 quirements of paragraphs (2) through (6) of this

17 subsection and any rule or regulation of the Com18 mission issued thereunder.

19 ‘‘(2) RESPONSIBILITY RELATING TO INDE20 PENDENT PUBLIC ACCOUNTANTS.—The audit com21 mittee of the registered company, in its capacity as

22 a committee of the board of directors, shall be di23 rectly responsible for the appointment, compensa24 tion, and oversight of the work of any independent

25 public accountant employed by such registered com-
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1 pany (including resolution of disagreements between

2 management and the auditor regarding financial re3 porting) for the purpose of preparing or issuing the

4 audit report or related work, and each such inde5 pendent public accountant shall report directly to

6 the audit committee.

7 ‘‘(3) INDEPENDENCE.—

8 ‘‘(A) IN GENERAL.—Each member of the

9 audit committee of the registered company shall

10 be a member of the board of directors of the

11 company, and shall otherwise be independent.

12 ‘‘(B) CRITERIA.—In order to be considered

13 to be independent for purposes of this para14 graph, a member of an audit committee of a

15 registered company may not, other than in his

16 or her capacity as a member of the audit com17 mittee, the board of directors, or any other

18 board committee—

19 ‘‘(i) accept any consulting, advisory,

20 or other compensatory fee from the reg21 istered company or the investment adviser

22 or principal underwriter of the registered

23 company; or
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1 ‘‘(ii) be an ‘interested person’ of the

2 registered company, as such term is de3 fined in section 2(a)(19).

4 ‘‘(4) COMPLAINTS.—The audit committee of the

5 registered company shall establish procedures for—

6 ‘‘(A) the receipt, retention, and treatment

7 of complaints received by the registered com8 pany regarding accounting, internal accounting

9 controls, or auditing matters; and

10 ‘‘(B) the confidential, anonymous submis11 sion by employees of the registered company

12 and its investment adviser or principal under13 writer of concerns regarding questionable ac14 counting or auditing matters.

15 ‘‘(5) AUTHORITY TO ENGAGE ADVISERS.—The

16 audit committee of the registered company shall

17 have the authority to engage independent counsel

18 and other advisers, as it determines necessary to

19 carry out its duties.

20 ‘‘(6) FUNDING.—The registered company shall

21 provide appropriate funding, as determined by the

22 audit committee, in its capacity as a committee of

23 the board of directors, for payment of

24 compensation—
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1 ‘‘(A) to the independent public accountant

2 employed by the registered company for the

3 purpose of rendering or issuing the audit re4 port; and

5 ‘‘(B) to any advisers employed by the audit

6 committee under paragraph (5).

7 ‘‘(7) AUDIT COMMITTEE.—For purposes of this

8 subsection, the term ‘audit committee’ means—

9 ‘‘(A) a committee (or equivalent body) es10 tablished by and amongst the board of directors

11 of a registered investment company for the pur12 pose of overseeing the accounting and financial

13 reporting processes of the company and audits

14 of the financial statements of the company; and

15 ‘‘(B) if no such committee exists with re16 spect to a registered investment company, the

17 entire board of directors of the company.’’.

18 (b) CONFORMING AMENDMENT.—Section 10A(m) of

19 the Securities Exchange Act of 1934 is amended by add20 ing at the end the following new paragraph:

21 ‘‘(7) EXEMPTION FOR INVESTMENT COMPA22 NIES.—Effective one year after the date of enact23 ment of the Mutual Funds Integrity and Fee Trans24 parency Act of 2003, for purposes of this subsection,

25 the term ‘issuer’ shall not include any investment
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1 company that is registered under section 8 of the In2 vestment Company Act of 1940.’’.

3 (c) IMPLEMENTATION.—Not later than 180 days

4 after the date of enactment of this Act, the Securities and

5 Exchange Commission shall issue final regulations to

6 carry out section 32(d) of the Investment Company Act

7 of 1940, as added by subsection (a) of this section.

8 SEC. 105. TRADING RESTRICTIONS.

9 Subsection (e) of section 22 of the Investment Com10 pany Act of 1940 (15 U.S.C. 80a–22(e)) is amended to

11 read as follows:

12 ‘‘(e) TRADING RESTRICTIONS.—

13 ‘‘(1) PROHIBITION AND EXCEPTIONS.—No reg14 istered investment company shall suspend the right

15 of redemption, or postpone the date of payment or

16 satisfaction upon redemption of any redeemable se17 curity in accordance with its terms for more than

18 seven days after the tender of such security to the

19 company or its agents designated for that purpose

20 for redemption, except—

21 ‘‘(A) for any period (i) during which the

22 principal market for the securities in which the

23 company invests is closed, other than customary

24 week-end and holiday closings; or (ii) during

25 which trading on such exchange is restricted;
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1 ‘‘(B) for any period during which an emer2 gency exists as a result of which (i) disposal by

3 the company of securities owned by it is not

4 reasonably practicable; or (ii) it is not reason5 ably practicable for such company fairly to de6 termine the value of its net assets; or

7 ‘‘(C) for such other periods as the Com8 mission may by order permit for the protection

9 of security holders of the company.

10 ‘‘(2) COMMISSION RULES.—The Commission

11 shall by rules and regulations—

12 ‘‘(A) determine the conditions under which

13 trading shall be deemed to be restricted;

14 ‘‘(B) determine the conditions under which

15 an emergency shall be deemed to exist; and

16 ‘‘(C) provide for the determination by each

17 company, subject to such limitations as the

18 Commission shall determine are necessary and

19 appropriate for the protection of investors, of

20 the principal market for the securities in which

21 the company invests.’’.

22 SEC. 106. DEFINITION OF NO-LOAD MUTUAL FUND.

23 Within 270 days after the date of enactment of this

24 Act, the Securities and Exchange Commission shall, by
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1 rule adopted by the Commission or a self-regulatory orga2 nization (or both)—

3 (1) clarify the definition of ‘‘no-load’’ as such

4 term is used by investment companies that impose

5 any fee under a plan adopted pursuant to rule 12b6 1 of the Commission’s rules (17 C.F.R. 270.12b–1);

7 and

8 (2) require disclosure to prevent investors from

9 being misled by the use of such terminology by the

10 company or its adviser or principal underwriter.

11 SEC. 107. INFORMING DIRECTORS OF SIGNIFICANT DEFI12 CIENCIES.

13 Section 42 of the Investment Company Act of 1940

14 (15 U.S.C. 80a–41) is amended by adding at the end the

15 following new subsection:

16 ‘‘(f) INFORMING DIRECTORS OF SIGNIFICANT DEFI17 CIENCIES.—If the report of an inspection by the Commis18 sion of a registered investment company identifies signifi19 cant deficiencies in the operations of such company, or of

20 its investment adviser or principal underwriter, the com21 pany shall provide such report to the directors of such

22 company.’’.
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1 SEC. 108. EXEMPTION FROM IN PERSON MEETING RE2 QUIREMENTS.

3 Section 15(c) of the of the Investment Company Act

4 of 1940 (15 U.S.C. 80a–15(c)) is amended by adding at

5 the end the following new sentence: ‘‘The Commission, by

6 rule, regulation, or order, may exempt a registered invest7 ment company subject to this subsection from the require8 ment that the votes of its directors be cast at a meeting

9 in person when such a requirement is impracticable, sub10 ject to such conditions as the Commission may require.’’.

11 SEC. 109. PROXY VOTING DISCLOSURE.

12 Section 30 of the Investment Company Act of 1940

13 (15 U.S.C. 80a–29) is amended by adding at the end the

14 following new subsection:

15 ‘‘(k) PROXY VOTING DISCLOSURE.—Every registered

16 management investment company, other than a small

17 business investment company, shall file with the Commis18 sion not later than August 31 of each year an annual re19 port, on a form prescribed by the Commission by rule, con20 taining the registrant’s proxy voting record for the most

21 recent twelve-month period ending on June 30. The finan22 cial statements of every such company shall state that in23 formation regarding how the company voted proxies relat24 ing to portfolio securities during the most recent 12-month

25 period ending on June 30 is available—
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1 ‘‘(1) without charge, upon request, by calling a

2 specified toll-free (or collect) telephone number; or

3 on or through the company’s website at a specified

4 Internet address; or both; and

5 ‘‘(2) on the Commission’s website.’’.

6 SEC. 110. INCENTIVE COMPENSATION AND MUTUAL FUND

7 SALES.

8 (a) COMMISSION RULE REQUIRED.—Within 270

9 days after the date of enactment of this Act, the Commis10 sion shall by rule prohibit, as a means reasonably designed

11 to prevent fraudulent, deceptive, or manipulative acts and

12 practices, the sale of the securities of an investment com13 pany or of municipal fund securities by a broker or dealer

14 or by a municipal securities broker or dealer without the

15 disclosure of—

16 (1) the amount and source of sales fees, pay17 ments by persons other than the investment com18 pany that are intended to facilitate the sale and dis19 tribution of the securities, and commissions for ef20 fecting portfolio securities transactions, or other

21 payments, paid to such broker or dealer, or munic22 ipal securities broker or dealer, or associated person

23 thereof in connection with such sale;
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1 (2) any commission or other fees or charges the

2 investor has paid or will or might be subject to, in3 cluding as a result of purchases or redemptions;

4 (3) any conflicts of interest that any associated

5 person of the investor’s broker or dealer or munic6 ipal securities broker or dealer may face due to the

7 receipt of differential compensation in connection

8 with such sale; and

9 (4) information about the estimated amount of

10 any asset-based distribution expenses incurred, or to

11 be incurred, by the investment company in connec12 tion with the investor’s purchase of the securities.

13 (b) BENCHMARKS.—In connection with the rule re14 quired by subsection (a), the Commission shall, to the ex15 tent practical, establish standards for such disclosures.

16 (c) DEFINITIONS.—

17 (1) DIFFERENTIAL COMPENSATION.—For pur18 poses of this section, an associated person of a

19 broker or dealer shall be considered to receive dif20 ferential compensation if such person receives any

21 increased or additional remuneration, in whatever

22 form—

23 (A) for sales of the securities of an invest24 ment company or municipal fund security that

25 is affiliated with, or otherwise specifically des-
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1 ignated by, such broker or dealer or municipal

2 securities broker or dealer, as compared with

3 the remuneration for sales of securities of an

4 investment company or municipal fund security

5 offered by such broker or dealer or municipal

6 securities broker or dealer that are not so affili7 ated or designated; or

8 (B) for the sale of any class of securities

9 of an investment company or municipal fund se10 curity as compared with the remuneration for

11 the sale of a class of securities of such invest12 ment company or municipal fund security (of13 fered by such broker or dealer or municipal se14 curities broker or dealer) that charges a sales

15 load (as defined in section 2(a)(35) of the In16 vestment Company Act of 1940 (15 U.S.C.

17 80a–2(a)(35)) only at the time of such a sale.

18 (2) MUNICIPAL FUND SECURITY.—For pur19 poses of this section, a municipal fund security is

20 any municipal security issued by an issuer that, but

21 for the application of section 2(b) of the Investment

22 Company Act of 1940 (15 U.S.C. 80a–2(b)), would

23 constitute an investment company within the mean24 ing of section 3 of the Investment Company Act of

25 1940 (15 U.S.C. 80a–3).
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1 SEC. 111. COMMISSION STUDY AND REPORT REGULATING

2 SOFT DOLLAR ARRANGEMENTS.

3 (a) STUDY REQUIRED.—

4 (1) IN GENERAL.—The Commission shall con5 duct a study of the use of soft dollar arrangements

6 by investment advisers as contemplated by section

7 28(e) of the Securities Exchange Act of 1934 (15

8 U.S.C. 78bb(e)).

9 (2) AREAS OF CONSIDERATION.—The study re10 quired by this section shall examine—

11 (A) the trends in the average amounts of

12 soft dollar commissions paid by investment ad13 visers and investment companies in the past 3

14 years;

15 (B) the types of services provided through

16 soft dollar arrangements;

17 (C) the benefits and disadvantages of the

18 use of soft dollars for investors, including the

19 extent to which use of soft dollar arrangements

20 affects the ability of mutual fund investors to

21 evaluate and compare the expenses of different

22 mutual funds;

23 (D) the potential or actual conflicts of in24 terest (or both potential and actual conflicts)

25 created by soft dollar arrangements, including

26 whether certain potential conflicts are being
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1 managed effectively by other laws and regula2 tions specifically addressing those situations,

3 the role of the board of directors in managing

4 these potential or actual (or both) conflicts, and

5 the effectiveness of the board in this capacity;

6 (E) the transparency of such soft dollar

7 arrangements to investment company share8 holders and investment advisory clients of in9 vestment advisers, the extent to which enhanced

10 disclosure is necessary or appropriate to enable

11 investors to better understand the impact of

12 these arrangements, and an assessment of

13 whether the cost of any enhanced disclosure or

14 other regulatory change would result in benefits

15 to the investor; and

16 (F) whether such section 28(e) should be

17 modified, and whether other regulatory or legis18 lative changes should be considered and adopted

19 to benefit investors.

20 (b) REPORT REQUIRED.—The Commission shall sub21 mit a report on the study required by subsection (a) to

22 the Committee on Financial Services of the House of Rep23 resentatives and the Committee on Banking, Housing, and

24 Urban Affairs of the Senate, no later than one year after

25 the date of enactment of this Act.
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1 SEC. 112. STUDY OF ARBITRATION CLAIMS.

2 (a) STUDY REQUIRED.—The Securities and Ex3 change Commission shall conduct a study of the increased

4 rate of arbitration claims and decisions involving mutual

5 funds since 1995 for the purposes of identifying trends

6 in arbitration claim rates and, if applicable, the causes of

7 such increased rates and the means to avert such causes.

8 (b) REPORT.—The Securities and Exchange Commis9 sion shall submit a report on the study required by sub10 section (a) to the Committee on Financial Services of the

11 House of Representatives and the Committee on Banking,

12 Housing, and Urban Affairs of the Senate not later than

13 one year after the date of enactment of this Act.

14 TITLE II—PREVENTION OF ABU15 SIVE MUTUAL FUND PRAC16 TICES

17 SEC. 201. PREVENTION OF FRAUD; INTERNAL COMPLIANCE

18 AND CONTROL PROCEDURES.

19 (a) AMENDMENT.—Subsection (j) of section 17 of the

20 Investment Company Act of 1940 (15 U.S.C. 80a–17(j))

21 is amended to read as follows:

22 ‘‘(j) DETECTION AND PREVENTION OF FRAUD.—

23 ‘‘(1) COMMISSION RULES TO PROHIBIT FRAUD,

24 DECEPTION, AND MANIPULATION.—It shall be un25 lawful for any affiliated person of or principal under26 writer for a registered investment company or any
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1 affiliated person of an investment adviser of or prin2 cipal underwriter for a registered investment com3 pany, to engage in any act, practice, or course of

4 business in connection with the purchase or sale, di5 rectly or indirectly, by such person of any security

6 held or to be acquired by such registered investment

7 company, or any security issued by such registered

8 investment company or by an affiliated registered in9 vestment company, in contravention of such rules

10 and regulations as the Commission may adopt to de11 fine, and prescribe means reasonably necessary to

12 prevent, such acts, practices, or courses of business

13 as are fraudulent, deceptive or manipulative.

14 ‘‘(2) CODES OF ETHICS.—Such rules and regu15 lations shall include requirements for the adoption of

16 codes of ethics by registered investment companies

17 and investment advisers of, and principal under18 writers for, such investment companies establishing

19 such standards as are reasonably necessary to pre20 vent such acts, practices, or courses of business.

21 Such rules and regulations shall require each such

22 registered investment company to disclose such

23 codes of ethics (and any changes therein) in the

24 periodic report to shareholders of such company, and

25 to disclose such code of ethics and any waivers and
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1 material violations thereof on a readily accessible

2 electronic public information facility of such com3 pany and in such additional form and manner as the

4 Commission shall require by rule or regulation.

5 ‘‘(3) ADDITIONAL COMPLIANCE PROCEDURES.—

6 Such rules and regulations shall—

7 ‘‘(A) require each investment company and

8 investment adviser registered with the Commis9 sion to adopt and implement policies and proce10 dures reasonably designed to prevent violation

11 of the Securities Act of 1933 (15 U.S.C. 78a et

12 seq.), the Securities Exchange Act of 1934 (15

13 U.S.C. 78a et seq.), the Sarbanes-Oxley Act of

14 2002 (15 U.S.C. 7201 et seq.), the Trust In15 denture Act of 1939 (15 U.S.C. 77aaa et seq.),

16 the Investment Company Act of 1940 (15

17 U.S.C. 80a–1 et seq.), the Investment Advisers

18 Act of 1940 (15 U.S.C. 80b et seq.), the Secu19 rities Investor Protection Act of 1970 (15

20 U.S.C. 78aaa et seq.), subchapter II of chapter

21 53 of title 31, United States Code, chapter 2 of

22 title I of Public Law 91–508 (12 U.S.C. 1951

23 et seq.), or section 21 of the Federal Deposit

24 Insurance Act (12 U.S.C. 1829b);
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1 ‘‘(B) require each such company and ad2 viser to review such policies and procedures an3 nually for their adequacy and the effectiveness

4 of their implementation;

5 ‘‘(C) require each such company to appoint

6 a chief compliance officer to be responsible for

7 overseeing such policies and procedures—

8 ‘‘(i) whose compensation shall be ap9 proved by the members of the board of di10 rectors of the company who are not inter11 ested persons of such company;

12 ‘‘(ii) who shall report directly to the

13 members of the board of directors of the

14 company who are not interested persons of

15 such company, privately as such members

16 request, but no less frequently than annu17 ally; and

18 ‘‘(iii) whose report to such members

19 shall include any violations or waivers of,

20 and any other significant issues arising

21 under, such policies and procedures; and

22 ‘‘(D) require each such company to estab23 lish policies and procedures reasonably designed

24 to protect any officer, director, employee, con25 tractor, subcontractor, or agent of such com-
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1 pany from retaliation, including discharge, de2 motion, suspension, harassment, or any other

3 manner of discrimination in the terms and con4 ditions of employment, because of any lawful

5 act done by such officer, director, employee,

6 contractor, subcontractor, or agent to provide

7 information, cause information to be provided,

8 or otherwise assist in an investigation that re9 lates to any conduct which such officer, direc10 tor, employee, contractor, subcontractor, or

11 agent reasonably believes constitutes a violation

12 of the securities laws or the code of ethics of

13 such investment company.

14 ‘‘(4) SELF-CERTIFICATION.—Such rules and

15 regulations shall require the members of the board

16 of directors who are not interested persons of each

17 registered open-end investment company to certify,

18 in the periodic report to shareholders, or other ap19 propriate disclosure document, that—

20 ‘‘(A) procedures are in place for verifying

21 that the determination of current net asset

22 value of any redeemable security issued by the

23 company used in computing periodically the

24 current price for the purpose of purchase, re25 demption, and sale complies with the require-
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1 ments of the Investment Company Act of 1940

2 and the rules and regulations thereunder, and

3 the company is in compliance with such proce4 dures;

5 ‘‘(B) procedures are in place for the over6 sight of the flow of funds into and out of the

7 securities of the company, and the company is

8 in compliance with such procedures;

9 ‘‘(C) procedures are in place to ensure that

10 investors are receiving any applicable discounts

11 on front-end sales loads that are disclosed in

12 the company’s prospectus;

13 ‘‘(D) procedures are in place to ensure

14 that, if the company’s shares are offered as dif15 ferent classes of shares, such classes are de16 signed in the interests of investors, and could

17 reasonably be an appropriate investment option

18 for an investor;

19 ‘‘(E) procedures are in place to ensure that

20 information about the company’s portfolio secu21 rities is not disclosed in violation of the securi22 ties laws or the company’s code of ethics;

23 ‘‘(F) the members of the board of directors

24 who are not interested persons of the company

25 have reviewed and approved the compensation
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1 of the company’s portfolio manager in connec2 tion with their consideration of the investment

3 advisory contract under section 15(c);

4 ‘‘(G) the company has established and en5 forces a code of ethics as required by paragraph

6 (2) of this subsection; and

7 ‘‘(H) the company is in compliance with

8 the additional requirements of paragraph (3) of

9 this subsection.’’.

10 (b) DEADLINE FOR RULES.—The Securities and Ex11 change Commission shall prescribe rules to implement the

12 amendment made by subsection (a) of this section within

13 90 days after the date of enactment of this Act.

14 SEC. 202. BAN ON JOINT MANAGEMENT OF MUTUAL FUNDS

15 AND HEDGE FUNDS.

16 (a) AMENDMENT.—Section 15 of the Investment

17 Company Act of 1940 (15 U.S.C. 80a-15) is further

18 amended by adding at the end the following new sub19 section:

20 ‘‘(h) BAN ON JOINT MANAGEMENT OF MUTUAL

21 FUNDS AND HEDGE FUNDS.—

22 ‘‘(1) PROHIBITION OF JOINT MANAGEMENT.—It

23 shall be unlawful for any individual to serve or act

24 as the portfolio manager or investment adviser of a

25 registered open-end investment company if such in-
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1 dividual also serves or acts as the portfolio manager

2 or investment adviser of an investment company

3 that is not registered or of such other categories of

4 companies as the Commission shall prescribe by rule

5 in order to prohibit conflicts of interest, such as con6 flicts in the selection of the portfolio securities.

7 ‘‘(2) EXCEPTIONS.—Notwithstanding para8 graph (1), the Commission may, by rule, regulation,

9 or order, permit joint management by a portfolio

10 manager in exceptional circumstances when nec11 essary to protect the interest of investors, provided

12 that such rule, regulation, or order requires—

13 ‘‘(A) enhanced disclosure by the registered

14 open-end investment company to investors of

15 any conflicts of interest raised by such joint

16 management; and

17 ‘‘(B) fair and equitable policies and proce18 dures for the allocation of securities to the port19 folios of the jointly managed companies, and

20 certification by the members of the board of di21 rectors who are not interested persons of such

22 registered open-end investment company, in the

23 periodic report to shareholders, or other appro24 priate disclosure document, that such policies
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1 and procedures of such company are fair and

2 equitable.

3 ‘‘(3) DEFINITION.—For purposes of this sub4 section, the term ‘portfolio manager’ means the indi5 vidual or individuals who are designated as respon6 sible for decision-making in connection with the se7 curities purchased and sold on behalf of a registered

8 open-end investment company, but shall not include

9 individuals who participate only in making research

10 recommendations or executing transactions on behalf

11 of such company.’’.

12 (b) DEADLINE FOR RULES.—The Securities and Ex13 change Commission shall prescribe rules to implement the

14 amendment made by subsection (a) of this section within

15 90 days after the date of enactment of this Act.

16 SEC. 203. SHORT TERM TRADING BY INTERESTED PERSONS

17 PROHIBITED.

18 (a) SHORT TERM TRADING PROHIBITED.—Section

19 17 of the Investment Company Act of 1940 (15 U.S.C.

20 80a–17) is further amended by adding at the end the fol21 lowing new subsection:

22 ‘‘(k) SHORT TERM TRADING PROHIBITED.—It shall

23 be unlawful for any officer, director, partner, or employee

24 of a registered investment company, any affiliated person,

25 investment adviser, or principal underwriter of such com-
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1 pany, or any officer, director, partner, or employee of such

2 an affiliated person, investment adviser, or principal un3 derwriter, to engage in short-term transactions, as such

4 term is defined by the Commission by rule, in any securi5 ties of which such company, or any affiliate of such com6 pany, is the issuer, except that this subsection shall not

7 prohibit transactions in money market funds, other funds

8 the investment policy of which expressly permits short9 term transactions, or such other categories of registered

10 investment companies as the Commission shall specify by

11 rule.’’.

12 (b) INCREASED REDEMPTION FEES PERMITTED FOR

13 SHORT TERM TRADING.—Within 90 days after the date

14 of enactment of this Act, the Securities and Exchange

15 Commission shall revise rule 11a–3 of its rules under the

16 Investment Company Act of 1940 (17 CFR 270.11a–30),

17 or other rules of the Commission, as necessary to permit

18 an investment company to charge redemption fees in ex19 cess of 2 percent upon the redemption of any securities

20 of such company that are redeemed within such period

21 after their purchase as the Commission specifies in such

22 rule to prevent short term trading that is unfair to the

23 shareholders of such company.

24 (c) DEADLINE FOR RULES.—The Securities and Ex25 change Commission shall prescribe rules to implement the
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1 amendment made by subsection (a) of this section within

2 90 days after the date of enactment of this Act.

3 SEC. 204. ELIMINATION OF STALE PRICES.

4 Within 90 days after the date of enactment of this

5 Act, the Securities and Exchange Commission shall pre6 scribe, by rule or regulation, standards concerning the ob7 ligation of registered open-end investment companies

8 under the Investment Company Act of 1940 to apply and

9 use fair value methods of determination of net asset value

10 when market quotations are unavailable or do not accu11 rately reflect the fair market value of the companies’ port12 folio securities, in order to prevent dilution of the interests

13 of long-term investors or as necessary in the other inter14 ests of investors. Such rule or regulation shall identify,

15 in addition to significant events, the conditions or cir16 cumstances from which such obligation will arise, such as

17 the need to value securities traded on foreign exchanges,

18 and the methods by which fair value methods shall be ap19 plied in such events, conditions, and circumstances.

20 SEC. 205. PREVENTION OF UNFAIR AFTER-HOURS TRADING.

21 (a) ADDITIONAL RULES REQUIRED.—Within 90 days

22 after the date of enactment of this Act, the Securities and

23 Exchange Commission shall issue rules to prevent trans24 actions in the securities of any registered open-end invest25 ment company in violation of section 22 of the Investment
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1 Company Act of 1940 (15 U.S.C. 80a–22), including

2 after-hours trades that are executed at a price based on

3 a net asset value that was determined as of a time prior

4 to the actual execution of the transaction.

5 (b) TRADES COLLECTED BY INTERMEDIARIES.—

6 Such rules shall permit execution of such after-hours

7 trades that are provided to the registered open-end invest8 ment company by a broker-dealer, retirement plan admin9 istrator, or other intermediary, after the time as of which

10 such net asset value was determined, if such trades are

11 collected by such intermediaries subject to procedures that

12 are—

13 (1) designed to prevent the acceptance of trades

14 by such intermediaries after the time as of which net

15 asset value was determined; and

16 (2) subject to an independent annual audit to

17 verify that the procedures do not permit the accept18 ance of trades after the time as of which such net

19 asset value was determined.

20 (c) INDEPENDENTLY MAINTAINED SYSTEMS.—Such

21 rules shall permit firms that utilize computer systems and

22 procedures provided by unaffiliated entities to collect

23 transactions to satisfy the independent audit requirements

24 under subsection (b)(2) by means of an independent audit

25 obtained by such unaffiliated entity.
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1 SEC. 206. REPORT ON ADEQUACY OF REMEDIAL ACTIONS.

2 (a) REPORT REQUIRED.—Within 180 days of enact3 ment, the Securities and Exchange Commission shall sub4 mit a report to the Committee on Financial Services of

5 the House of Representatives and the Committee on

6 Banking, Housing, and Urban Affairs of the Senate on

7 market timing and late trading of mutual funds.

8 (b) REQUIRED CONTENTS OF REPORT.—The report

9 required by this section shall include the following:

10 (1) The economic harm of market timing and

11 late trading of mutual fund shares on long-term mu12 tual fund shareholders.

13 (2) The findings by the Commission’s Office of

14 Compliance, Inspections and Examinations, and the

15 actions taken by the Commission’s Division of En16 forcement, regarding—

17 (A) illegal late trading practices;

18 (B) illegal market timing practices; and

19 (C) market timing practices that are not in

20 violation of prospectus disclosures.

21 (3) When the Commission became aware that

22 the use of market timing practices was harming

23 long-term shareholders, and the circumstances sur24 rounding the Commission’s discovery of that activity.
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1 (4) The steps the Commission has taken since

2 becoming aware of market timing practices to pro3 tect long-term mutual fund investors.

4 (5) Any additional legislative or regulatory ac5 tion that is necessary to protect long-term mutual

6 fund shareholders against the detrimental effects of

7 late trading and market timing practices.

Passed the House of Representatives November 19,

2003.

Attest:

Clerk.