450 Lexington Avenue New York, N.Y

Transcription

1 Memorandum for: Interested Persons 450 Lexington Avenue New York, N.Y January 25, 2005 Re: Disclosure of Revenue-Sharing Arrangements This memorandum outlines the disclosure requirements related to revenuesharing arrangements in connection with the distribution of mutual fund shares (i) proposed on January 29, 2004 by the Securities and Exchange Commission (the SEC ) in Release No ; IC (the Release ) and (ii) required by the Edward D. Jones & Co. ( Edward Jones ) settlement with the SEC of December 22, 2004 (the Settlement ). While the SEC s proposed rules are not effective at this time, best practice with respect to disclosure of revenue sharing is expected to expand considerably, in particular in light of the Settlement. This memorandum summarizes those portions of the Release and the Settlement order which are relevant to disclosure concerning revenue sharing. The enhanced disclosure is expected to appear in mutual fund prospectuses, pointof-sale and confirmation documents as well as websites of broker-dealers, advisers and mutual funds. The Release and the Settlement have been prompted by the SEC s concern that distribution arrangements, such as revenue sharing, create a heightened financial incentive for broker-dealers and investment advisers to sell particular funds or classes of shares and, therefore, may influence which funds and classes broker-dealers and advisers recommend to customers. The disclosure is intended to achieve greater transparency in highlighting the potential conflicts of interests arising from revenue-sharing arrangements. I. The Release The Release proposes new rules and amendments to existing rules under the Securities Exchange Act of 1934 designed to enhance the point-of-sale, confirmation and prospectus disclosure related to the costs and conflicts of interest associated with the transactions by broker-dealers in certain securities, including open-end management investment company securities other than those traded on a national securities exchange ( mutual fund securities ). The Release requires enhanced disclosure (i) at or before completion of a transaction in mutual fund securities (proposed rule 15c2-2); (ii) at the point of sale (proposed rule 15c2-3); and (iii) on Form N-1A (proposed Item 8(c)).

2 A. Proposed Rule 15c2-2 Substance of disclosure: Disclosure under rule 15c2-2 will be made pursuant to a proposed Schedule 15C. The SEC seeks to capture disclosure regarding a broad variety of revenue-sharing payments received by broker-dealers from persons within a fund complex other than the issuer, which may cause a conflict of interest to the broker-dealer. Specifically, a broker-dealer would be required to disclose information about amounts directly or indirectly earned from the fund complex by (i) the broker-dealer and (ii) any associated person of the broker-dealer who is a brokerdealer. In addition, where the security is not a proprietary security, disclosure of any amounts earned from the fund complex by any associated person of the broker-dealer would also be required. The amounts are to be disclosed as a percentage of the total net asset value represented by the broker-dealer s total sales of the securities (as measured by cumulative net asset value) on behalf of the fund complex over the four most recent calendar quarters, updated each calendar quarter. This will allow investors to evaluate the magnitude of the broker-dealer firm s stake in selling the particular fund complex securities. In addition, the disclosure would set forth the total dollar amount of revenue-sharing commissions that the broker-dealer may expect to receive in connection with the particular transaction. Furthermore, the rule would require disclosure of comparison ranges to enable investors to gauge how the broker-dealer s position compares to industry practices. With respect to revenue-sharing arrangements, the comparisons would be based on the median of, and the ranges associated with, 95% of the brokerdealers that distribute the same type of mutual fund securities. The SEC proposes to publish, from time to time, the medians and comparison ranges. Manner of disclosure: The disclosure under Rule 15c2-2 would be made in writing at or before the completion of a transaction in mutual fund securities. Periodic disclosure alternative: In certain limited circumstances, broker-dealers would be permitted to provide disclosure required by rule 15c2-2 periodically, rather than on a transaction-by-transaction basis. Periodic disclosure would be permitted with respect to transactions involving (i) direct purchase or sale of mutual fund securities pursuant to retirement plans or other periodic purchase arrangements (quarterly disclosure) and (ii) no-load open-end money market funds (monthly disclosure). In general, periodic disclosure would have to include the same type of information as required for disclosure in connection with a transaction 2

3 confirmation; however, certain information would be disclosed in summary form, reflecting all transactions within a period, rather than each individual transaction. Disclosure concerning revenue sharing would be required as of the date of the final purchase or reinvestment within the period. B. Proposed Rule 15c2-3 Substance of disclosure: Rule 15c2-3 is designed to provide specified information to investors at the point of sale. The rule applies only to purchases of mutual fund securities and not sales. Disclosure proposed under rule 15c2-3 would be made on proposed Schedule 15D and, under certain circumstances, would be supplemented by oral disclosure. Under the proposed rule, information concerning revenue-sharing arrangements disclosed at the point of sale would be only of qualitative nature; the broker-dealer would need to disclose whether it receives revenue-sharing commissions from the fund complex. Quantitative information would not be required under the proposed rules, although the SEC has solicited comments on whether quantitative disclosure would also be appropriate at point of sale. Manner of disclosure: Disclosure pursuant to proposed rule 15c2-3 will be made in writing at the point of sale, that is, generally, prior to the time the broker-dealer accepts an investor s purchase order. Oral disclosure is to supplement written information where the point of sale occurs at an in-person meeting. Additionally, where the point of sale occurs through means of oral communication other than at an inperson meeting, the information must be disclosed to the investor orally at the point of sale. C. Prospectus Disclosure The Release also proposes to amend Form N-1A to require that a mutual fund include brief disclosure in its prospectus regarding revenue-sharing payments. If any person within a fund complex makes revenue-sharing payments, this fact would need to be disclosed in the prospectus. The prospectus would also need to disclose that specific information about revenue sharing to an investor s financial intermediary is included in the confirmation or period statements, as the case may be, under Rule 15c2-2 and in the point-of-sale disclosure under Rule 15c2-3. II. The Settlement The Settlement was entered into to curtail certain abuses committed by Edward Jones in connection with the distribution of mutual funds where the funds or their affiliates agreed to make revenue-sharing payments to Edward Jones (so- 3

4 called Preferred Mutual Family Program). As part of the Settlement, Edward Jones agreed to provide investors with the following information on the revenuesharing arrangements: A. Website Disclosure Edward Jones agreed to disclose on its website the existence of the Preferred Mutual Family Program and the funds participating in the program; the amount of revenue-sharing payments received by Edward Jones from each of the program funds based on a reasonable estimate from historical experience, expressed in basis points or dollars; the total amount of revenue-sharing payments (in dollars) that Edward Jones receives annually (this information is to be updated on an annual basis); the source of the revenue-sharing payments; that the brokerage s investment representatives and equity partners may benefit financially from the revenue-sharing payments; and that the firm does not receive revenue-sharing payments from funds which are not part of the Preferred Mutual Family Program. Furthermore, Edward Jones agreed to send such information to each new customer upon the opening of an account, as well as to all of its customers at or before the completion of each transaction in mutual funds. Investors may be provided with the information quarterly where they purchase mutual fund securities pursuant to a periodic plan. Edward Jones has recently made the disclosure required by the Settlement available on its website. We have attached the disclosure in Annex A to this memorandum. B. Prospectus Disclosure In the Settlement order, the SEC pointed out that the prospectuses issued by the funds participating in the Preferred Mutual Family Program failed to include adequate disclosure concerning the revenue sharing and the conflict of interest it posed for Edward Jones. As a result, Edward Jones was charged with reviewing the fund prospectuses to ensure that adequate disclosure concerning the existence of the arrangements and the dimension of the conflict is included. 4

5 Should you have any questions or require additional information with respect to the foregoing, please do not hesitate to contact either of the undersigned. Susan Betteridge Baker ( ) Barbora Moring ( ) 2005 Davis Polk & Wardwell 5

6

7

8