GCD. Investment Management Update. Gardner Carton & Douglas. New Audit Committee Financial Expert Requirements

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1 GCD Gardner Carton & Douglas A Service to Our Clients and Friends Investment Management Update February 2003 New Audit Committee Financial Expert Requirements The SEC is requiring funds to disclose in their annual reports whether or not their audit committees have at least one audit committee financial expert. Audit Committee Financial Expert Disclosure Requirements Under the new requirements, fund boards must determine whether or not their audit committees have at least one audit committee financial expert. A board s determination must be disclosed annually in the fund s annual report filed on Form N-CSR. If a board determines that its audit committee has at least one expert, this disclosure must include: the name of the expert, and whether that person is independent (to be independent, a director must: (1) not accept, directly or indirectly, any fees from the fund other than those paid in connection with board service and (2) be disinterested within the meaning of the Investment Company Act of 1940). If a fund s board determines that it has more than one audit committee financial expert serving on its audit committee, the fund may disclose the above information for each of those individuals. If a board determines that no audit committee financial experts serve on its audit committee, the annual disclosure must explain why this is the case. The rules do not require that audit committees have an audit committee financial expert. INSIDE... SEC Adopts Rules To Strengthen Auditor Independence - page 2 Disclosure of Voting Proxy Policies and Records - page 3 Attorney Standards of Professional Conduct - page 3 Codes of Ethics for Principal Officers - page 5 Form N-CSR - page 5 SEC Adopts Rules Permitting More Transactions with Fund Affiliates - page 6 SEC Proposes Changes to Fund Shareholder Reports - page 7 Other Developments of Interest - page 8 Who Is an Audit Committee Financial Expert? An audit committee financial expert is someone who has the following attributes: an understanding of generally accepted accounting principles and financial statements, the ability to assess the general application of those principles and financial statements, experience preparing, auditing, analyzing, or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to those that can reasonably be expected to be raised by the fund s financial statements, or experience supervising one or more persons engaged in those activities, an understanding of internal controls and procedures for financial reporting, and an understanding of audit committee functions. A person must have acquired these attributes through: education and experience as a principal financial officer, principal accounting officer, controller, public accountant, or auditor (or experience in positions that involve similar functions), experience actively supervising one of the positions listed above, experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements, or other relevant experience. According to the SEC, while mutual fund financial statements may be simpler than those of some operating companies, an investment company s audit committee would benefit from having one or more members who meet the definition of audit committee financial expert. Safe Harbor from Liability The new requirements seek to provide a safe harbor from liability for audit committee financial experts by clarifying that (1) an audit committee financial expert will not be deemed an expert under the Federal securities laws, and (2) the designation of a person as an audit committee financial expert does not impose any additional duties, obligations or liability on that person and does not affect the duties,

2 obligations or liability of any other member of the audit committee or board of directors. Mutual funds will have to comply with these new requirements on or after July 15, 2003, depending on their fiscal yearend. SEC Adopts Rules To Strengthen Auditor Independence The SEC has adopted new rules and rule amendments aimed at enhancing the independence of public accountants. Under these new requirements: 1. Accounting firms, subject to small exceptions, will lose their independence vis-à-vis a mutual fund if: the lead or concurring partner, or any former member of the fund s audit engagement team that provided more than 10 hours of audit, review or attest services, that partner is hired by (1) the fund, (2) another fund in the same complex, or (3) any entity in the complex responsible for the financial reporting or operations of any fund in the complex, the employment involves a financial reporting oversight role (overseeing those who prepare the client s financial statements) related to the operations or financial reporting of the fund, and the employment occurs within one year of the commencement of procedures for the fund s current audit engagement. 2. Accounting firms cannot provide an audit client any of the following services: bookkeeping, information technology (other than services preapproved by the client s audit committee that do not relate to financial statements or accounting records), appraisals and fairness reports, actuarial consultation, internal audit outsourcing, management functions (auditors will be permitted to assess the effectiveness of internal accounting and risk management controls), human resources consultation, broker-dealer, investment adviser or investment banking assistance, and legal consultation and expert advice unrelated to the audit (including providing consulting services to the client s legal counsel in connection with litigation or other proceedings). The SEC has noted that the first five services mentioned above would not be prohibited if it is reasonable to conclude that the results of these services will not be subject to audit procedures during an audit of the client s financial statements. Also, an accounting firm may continue to provide tax services if: (1) the client s audit committee approves those services and (2) none of the services fall into one of the prohibited categories identified above. 3. Lead and reviewing partners who perform audit (including review and attest) services for the client (1) will rotate off the engagement after five consecutive years and, (2) following the rotation, will not be allowed to provide the client with the same lead and reviewing partner audit services for five consecutive years. Certain other partners (namely, those who provide more than 10 hours of audit services to the client and some who perform services for subsidiaries) will be required to rotate off after seven years and will be subject to a two-year time out period. Under the SEC s new requirements, mutual funds that are part of one complex constitute a single client and audits performed during a continuous 12-month period for funds that are in the same complex count as a single year. 4. All permissible non-audit services and all audit, review or attest engagements for a fund, its investment adviser and its parent companies, subsidiaries and sister corporations that provide services to the fund ( affiliated service providers ) must be: approved by the fund s audit committee before the engagement begins, or rendered pursuant to existing audit committee pre-approval policies, so long as: (1) those policies are detailed as to the particular service, (2) the audit committee is informed of each service, and (3) the policies do not delegate to management the audit committee s responsibilities under the Securities Exchange Act of These pre-approval requirements apply only to services relating directly to the operations and financial reporting of the mutual fund. An accounting firm will not lose its independence if it renders non-audit services that are not pre-approved in the manner described above, so long as: (1) the aggregate amount of the services provided to the fund or any of the affiliated service providers identified above is no more than 5% of the total amount paid to the audit firm by the fund and its affiliated service providers during the fiscal year, (2) the fund did not recognize at the time of the engagement that the services were non-audit services requiring pre-approval, and (3) the services are approved by the audit committee (or one of its members delegated by the audit committee to approve those services) prior to completion of the audit. 2

3 5. Accounting firms will lose their independence if, during an audit engagement or professional engagement period, any lead or reviewing partner (and certain other partners) receives or earns compensation for procuring engagements with the audit client for services other than audit, review or attest services. 6. Accounting firms will be required to report annually to a mutual fund s audit committee: all critical accounting policies and practices used by the client, all alternative accounting treatments within GAAP for policies and practices related to material items that have been discussed with management, including all their ramifications and the treatment preferred by the accounting firm, other material written communications between the accounting firm and management, and all non-audit services provided to the fund and its affiliated service providers that the audit committee did not pre-approve. If this annual communication does not occur within 90 days before filing the fund s financial statements, accounting firms must provide an update within that 90-day period. As the SEC points out, the adopted rules, in effect, would require an accountant of an investment company complex where the individual funds have different fiscal year ends to communicate the required information no more frequently than four times during a calendar year. 7. Mutual funds will be required to disclose in their financial statement filings and in certain proxy and information statements: the fees paid by a fund to the fund s principal accountants for each of the two most recent fiscal years (the disclosure will be made separately for each) for (1) audit services, (2) audit-related services, (3) tax services and (4) all other services, for each of the last three categories above, what percentage of each was rendered in compliance with the de-minimis requirements discussed in Item 4, above, and any pre-approval policies developed by the audit committee. Funds also must disclose the aggregate non-audit fees billed by the accountants for each of the two most recent fiscal years to the fund and its affiliated service providers, and whether the provision of non-audit services that were not pre-approved and were provided to the affiliated service providers is compatible with maintaining the accountant s independence. Disclosure of Proxy Voting Policies and Records The SEC has adopted a new rule and rule amendments requiring (1) funds to disclose their proxy voting policies and proxy votes and (2) investment advisers to adopt proxy voting policies. Investment Companies Fund registration statements will have to disclose the policies and procedures a fund uses to vote proxies relating to portfolio securities. This disclosure must include the procedures used to decide how to vote on matters that present a conflict of interest between a fund and its adviser or certain other affiliates. Funds must comply with this requirement in filings made on or after July 1, Funds must use new Form N-PX to file, by August 31 each year, their complete proxy voting record for the 12-month period ended June 30. Among the information to be disclosed on the new Form is: the matter voted on, whether the matter was proposed by the issuer or a shareholder, whether and how the fund cast its vote, and whether the fund voted for or against management. Funds must make their first proxy voting disclosures no later than August 31, Funds must make their entire proxy voting record available to shareholders, without charge, upon request. Funds may use their web sites for this purpose. Investment Advisers Investment advisers that exercise proxy voting authority over client securities must adopt written policies and procedures for voting proxies relating to those securities. The policies and procedures must be reasonably designed to ensure the adviser votes client securities in the best interests of clients... and must address how the adviser will vote on matters that present a conflict of interest between the adviser and its clients. Investment advisers must describe these policies and procedures to their clients and provide a copy upon request. Investment advisers also must tell clients how they may obtain information from the adviser about votes relating to their portfolio securities. Attorney Standards of Professional Conduct The SEC has adopted new rules, as directed by the Sarbanes- Oxley Act, addressing standards of professional conduct for attorneys practicing before the SEC. These rules require attorneys to report evidence of a material violation up the ladder. 3

4 Conduct Covered by the Rules An attorney s reporting obligation is triggered if he or she becomes aware of evidence of a material violation by an issuer or any of its officers, directors, employees or agents. This means that if an attorney believes it is reasonably likely that a violation of the securities laws or a fiduciary duty has occurred, is ongoing or soon will occur, the attorney must report the violation up-the-ladder. Reporting Up-the-Ladder Reports of actual or expected violations initially must be made to the issuer s chief legal officer (CLO) and, if the attorney wishes, also the CEO. The attorney may go to any board committee comprised entirely of independent directors (or to the full board if there are no committees like this) if the attorney believes it would be futile to report, in the first instance, to the CLO and CEO. Once the attorney has made a report, the CLO may (1) refer the matter to a qualified legal compliance committee (QLCC), if one has been established or (2) inquire into the facts asserted by the attorney and determine that: there is no actual or expected violation (in which case the CLO must advise the reporting attorney of the basis for this determination), or the reporting attorney is correct. In this case, the CLO must take all reasonable steps to cause the issuer to adopt an appropriate response and inform the reporting attorney of this action. How Do Attorneys Respond After Reporting? 1. The attorney receives an appropriate response. Reporting attorneys are not required to take any further steps if, within a reasonable period, the CLO or CEO provides a response that enables the reporting attorney to conclude that: no material violation has occurred, is ongoing or soon will occur, the issuer has adopted appropriate remedial measures, including appropriate steps or sanctions to stop the actual or potential violation and minimize the likelihood of its recurrence, or the issuer, with the consent of its board, the QLCC or other committee to whom a report could be made, has hired an attorney to review the evidence of the violation and either has (i) implemented remedial recommendations made by the attorney or (ii) been advised by the attorney that there is a colorable defense that the issuer could assert. 2. The attorney does not receive an appropriate response from the CLO or CEO. If the reporting attorney does not receive, in a timely fashion, one of these appropriate responses, the attorney must report the violation up-the-ladder to the issuer s audit committee, another board committee comprised solely of independent directors or the full board (if these committees do not exist). 3. The attorney does not receive an appropriate response after reporting up-the-ladder. If a reporting attorney does not reasonably believe that there has been a timely, appropriate response, the attorney must explain why he or she believes that to the CLO, CEO and the directors to whom the attorney reported. Qualified Legal Compliance Committee The final rules allow for, but do not require, the creation of a QLCC to handle reports of material violations from reporting attorneys. If established, the QLCC must consist of at least one member of the audit committee and two or more independent directors. A QLCC (or an existing board committee that intends to fulfill the functions of a QLCC, such as the audit committee) must: have written procedures for the confidential receipt and handling of reports of possible violations, and have the authority and responsibility [to] : inform the CLO and CEO of its receipt of reports of possible violations, determine if an investigation is necessary, and, if so, to: (1) notify the audit committee or the full board, (2) begin the investigation (which may be conducted by the CLO or outside attorneys) and (3) retain additional experts as the QLCC deems necessary, and at the conclusion of the investigation, (1) recommend, by majority vote, that the issuer implement an appropriate response and (2) inform the CLO, CEO and the full board of the results of the investigation and remedial measures to be adopted. If an issuer fails to take remedial steps recommended by the QLCC, the QLCC has the authority and responsibility, acting by majority vote, to take all other appropriate actions, including the authority to notify the Commission.... Attorneys who make their report to the QLCC satisfy all of their reporting requirements and [are] not required to assess the issuer s response to the reported evidence of a material violation. Investment Advisers and In-House Attorneys The SEC has suggested that an investment adviser s in-house attorneys have joint clients: the investment adviser and any funds on whose filings the in-house attorneys work. Presumably, these are most, if not all, the funds advised by the investment adviser. Accordingly, the SEC has noted that an attorney employed by an investment adviser who becomes aware of evidence of a material violation that is material to the investment company [emphasis added]... has a duty to report that evidence up-the-ladder within the investment company. Attorneys who work in an adviser s in-house legal 4

5 department, therefore, could be faced with having to report up two ladders the adviser s and the fund s. While in its proposing release the Commission asserted that [f]airness and candor between co-clients... normally preclude any expectation of confidentiality, many believe that this portion of the new requirements could have a chilling effect on the communication between officers and attorneys of an investment adviser. * * * The SEC is soliciting additional comments on its controversial noisy withdrawal proposal and is proposing an alternative approach. Original Noisy Withdrawal Proposal Under the SEC s original proposal, an outside (as opposed to an in-house) attorney who (1) reports up-the-ladder, (2) does not receive a timely, appropriate response and (3) believes that a current or expected violation is likely to result in substantial injury to the issuer or investors, would have to: end the engagement, indicate to the SEC (within one business day) that the engagement terminated for professional considerations, and promptly disaffirm SEC filings that the attorney helped prepare or that the attorney believes may be false or misleading. If a violation already had occurred, the attorney would be allowed to withdraw, provided there is no ongoing effect such, as, for example, inaccurate disclosure on which investors still may rely. While in-house attorneys faced with the same circumstances would not be required to effect a noisy withdrawal, they would, among other things, have to notify the SEC, within one business day, of their intent to disaffirm any tainted SEC filings that they helped prepare. Alternative Proposal Under the SEC s proposed alternative, an attorney would not have to effect a noisy withdrawal nor disaffirm filings. Rather, the attorney would be required to: withdraw from the engagement, and notify the issuer, in writing, that the withdrawal was based on professional considerations. In-house attorneys would not have to withdraw but would have to stop work on any matter concerning the suspected violation and notify the issuer, in writing, of their belief that the issuer has not provided an appropriate response to the reported violation. Under the alternative proposal, the issuer (not the attorney) would be required to notify the SEC of the attorney s written notice of withdrawal (or cessation of work on a matter). Funds would be required to, within two business days of receipt of the notice, file a report of the notice and the circumstances relating to it. If an issuer failed to notify the SEC of an attorney s written notice, the attorney could inform the SEC. Codes of Ethics for Principal Officers The SEC has adopted codes of ethics requirements relating to mutual funds principal officers. Funds must disclose annually, on Form N-CSR, whether they have adopted a code of ethics applying to their principal executive officer, financial officer, accounting officer or controller, or persons performing similar functions. If no code has been adopted, the fund must explain why. Funds also are required to disclose changes to, and waivers of, their code. For purposes of these requirements, code of ethics means written standards that are reasonably designed to deter wrongdoing and to promote : honest and ethical conduct, full, fair, accurate, timely, and understandable disclosure in fund filings and public communications, compliance with all applicable laws, prompt reporting of violations of the code, and accountability for adherence to the code. Mutual funds may have a separate code of ethics, one that is different than the Rule 17j-1 code they currently have in place, to address the Commission s new requirements. Alternatively, the new requirements may be incorporated into a fund s existing code if: (1) the code addresses the elements summarized above and (2) those elements apply to the required officers. Mutual funds will have to comply with these new requirements on or after July 15, 2003, depending on their fiscal yearend. Form N-CSR The SEC has adopted amendments to Rule 30b2-1 to require funds to file shareholder reports on Form N-CSR. The Form will contain: a copy of required shareholder reports, information regarding disclosure controls and procedures (discussed below), and an exact form of the certification to be filed in compliance with the requirements of the Sarbanes-Oxley Act (this certification by the fund s CEO and CFO relates to all information filed on the Form). The SEC has adopted new Rule 30a-3, requiring funds to maintain and regularly evaluate the effectiveness of controls and procedures designed to ensure that the information contained in Form N-CSR is processed, summarized and reported on a timely basis. Mutual funds, under the supervision of their principal executive and financial 5

6 officers, must conduct an evaluation of their controls and procedures within ninety days prior to filing their N-CSR. The effective date of these new requirements is March 1, Because of a transition period granted by the Commission, funds will not be required to file their reports on Form N-CSR until their annual or semi-annual period ending on or after April 1, SEC Adopts Rules Permitting More Transactions with Fund Affiliates The SEC has adopted a new Rule and several rule amendments under the 1940 Act that will permit funds to enter into certain affiliate transactions that are currently prohibited by the Act. The Rules were adopted in substantially the same form presented in the SEC s proposing release last April. The changes, which are effective as of February 24, 2003, will: (1) expand current exemptions for funds to engage in transactions with portfolio affiliates (companies of which a fund owns at least 5% of the outstanding voting securities), and (2) permit funds to engage in transactions with subadvisers (or their affiliates) of other funds in the same complex. Transactions with Portfolio Affiliates Sections 17(a) and 17(d) of the Act generally prohibit a fund and its affiliated persons from engaging in principal transactions and entering into joint arrangements with each other. Rules 17a-6 and 17d-1(d)(5) provide some relief from these prohibitions. Under those Rules, a fund may enter into a principal transaction or joint arrangement with a portfolio affiliate so long as certain other affiliates (such as the fund s adviser): (1) are not parties to the transaction, and (2) do not have a financial interest in a party to the transaction. These Rules, however, are not broad enough to allow a fund to enter into a transaction with a portfolio affiliate of another fund in the same fund complex (an affiliated fund). As a result, the SEC has amended Rules 17a-6 and 17d-1(d)(5) to permit a fund to enter into transactions with portfolio affiliates of an affiliated fund. Because Rules 17a-6 and 17d-1(d)(5) do not clearly define the term financial interest, the SEC has amended the Rules to reflect that a financial interest does not include any interest that a fund s board determines to be immaterial. The SEC has clarified that having a financial interest in a party to a transaction is a problem under the amended Rules only if that interest: exists at the time of the transaction, has existed within 6 months of the transaction, or will exist as a result of an arrangement in place at the time of the transaction. Finally, amended Rule 17d-1(d)(5) will eliminate the requirement that a fund commit no more than 5% of its assets to a joint enterprise with a portfolio affiliate. The SEC has indicated that funds are not subject to a similar percentage limitation when engaging in principal transactions with portfolio affiliates and has acknowledged that the limitation may not serve any useful purpose. Transactions with Subadvisers of Affiliated Funds With the advent of manager-of-managers arrangements, the SEC has granted numerous orders exempting subadvisers from various sections of the Act enacted to prevent or limit transactions between a fund and its affiliates. These Sections include 17(a), 17(e), 10(f) and 12(d)(3). The SEC s relief generally has been granted to subadvisers that: (1) manage a discrete portion (a sleeve ) of a fund and wish to enter into transactions with another sleeve of the fund, or (2) wish to enter into transactions with other funds in the same complex as the fund that they manage. We refer to these subadvisers as second-tier affiliated subadvisers and to the funds or portions of funds that they don t subadvise as secondtier affiliated funds. The SEC has codified the orders it has previously issued in one new rule and three rule amendments. Principal Transactions New Rule 17a-10 New Rule 17a-10 permits a second-tier affiliated subadviser to engage in a principal transaction otherwise prohibited by Section 17(a) with any second-tier affiliated fund (or a company controlled by that fund) if: that subadviser is affiliated with the fund solely by reason of the subadvisory relationship, the subadvisers involved in the principal transaction have in their subadvisory agreements a clause prohibiting them from consulting with each other regarding securities transactions for the fund, and when the second-tier affiliated fund is a separately managed portion of the same fund, its subadvisory agreements limit each subadviser s advisory responsibility to a discrete portion of the fund. Transactions with Subadvisers as Brokers Rule 17e-1 Section 17(e)(2) of the Act limits the payments that an affiliate of a fund may receive for purchasing and selling securities on a securities exchange on behalf of the fund to the usual and customary broker s commissions. Rule 17e-1 requires, in part, that: (1) the fund s board of directors review transactions to ensure that, in compliance with procedures adopted by the board, payments are in line with customary brokers commissions, and (2) the fund maintains a record of such transactions. The SEC has amended Rule 17e-1 to permit a secondtier affiliated subadviser to receive payments from a second-tier affiliated fund for services rendered as a 6

7 broker without complying with the conditions set forth above. This relief would be available only if: the second-tier affiliated subadviser is affiliated with the fund it advises solely by reason of its subadvisory relationship, the second-tier affiliated subadviser and the subadviser of the second-tier affiliated fund have in their subadvisory agreements a clause prohibiting them from consulting with each other regarding securities transactions, and when the second-tier affiliated fund is a separately managed portion of the same fund, its subadvisory agreements limit each subadviser s advisory responsibility to a discrete portion of the fund. Purchases During Primary Offering Underwritten by Subadvisers Rule 10f-3 Section 10(f) of the Act prohibits a fund from purchasing any security during an underwriting or selling syndicate if the fund has certain affiliated relationships with a principal underwriter of that security. Rule 10f-3 provides relief from Section 10(f) if, among other things, the fund, together with any other funds advised by the fund s adviser and subadviser(s), purchases no more than 25% of the offering. The SEC has amended Rule 10f-3 to: treat each series of a series company, and each separately managed portion of a fund s portfolio, as a separately registered investment company, require aggregation, for purposes of reaching the 25% threshold, of not only purchases by funds that are advised by the same investment adviser but also by accounts over which the adviser has discretionary authority, and clarify that the aggregation of purchases must only be done with respect to an adviser or subadviser if that adviser or subadviser (or its affiliate) is a participant in the underwriting syndicate. Funds wishing to rely on amended Rule 10f-3 must be in compliance with the Rule by April 23, Because the effective date of the amendments (including amendments to Rule 10f-3) is February 24, 2003, between that date and April 23, 2003 funds may rely on either Rule 10f-3 as amended or on current Rule 10f-3. Ownership of Securities Issued by Subadvisers Rule 12d3-1 Section 12(d)(3) of the Act prohibits funds from purchasing securities issued by entities engaged in securities-related businesses (such as advisers, broker-dealers and underwriters). Rule 12d3-1 provides relief to funds by allowing them to invest up to 5% of their assets in securities of an issuer deriving more than 15% of its gross revenues from a securities-related business. However, a fund may not acquire securities issued by its own investment adviser, subadviser(s), or any of their affiliates. Amended Rule 12d3-1 permits a fund to acquire securities of one of its subadvisers or its affiliates, provided the decision to acquire those securities is made by a different subadviser to the fund one that is not affiliated with the subadviser whose securities are being purchased. Under the amended Rule: the subadviser that is (or whose affiliate is) issuing the securities must be affiliated with the fund only by reason of its subadvisory relationship with the fund, and the advisory contracts of the subadvisers involved in the transaction must include a clause prohibiting them from consulting with each other regarding securities transactions and must limit their responsibility to providing advice to a discrete portion of the fund. S E C P r o p o s e s C h a n g e s t o F u n d S h a r e h o l d e r R e p o r t s The SEC has proposed rule and form amendments aimed at improving the quality of disclosure in fund shareholder reports. Under the proposals, an investment company would be permitted to summarize its portfolio holdings in shareholder reports (as opposed to including a complete schedule of its holdings), provided it files its complete schedule of holdings with the SEC. A fund also would have to: (1) include a graphic or tabular presentation of its holdings in shareholder reports, (2) make quarterly filings of its complete schedule of holdings, (3) disclose in shareholder reports expenses borne by shareholders during the reporting period and (4) include management s discussion of fund performance in its annual report. Summary Portfolio Schedule Under the SEC s proposal, instead of filing a complete schedule of its holdings, a fund may include in shareholder reports a schedule, in order of descending value, of the fund s 50 largest holdings in unaffiliated issuers and any investments that exceed 1% of the fund s NAV. A fund that uses the proposed summary portfolio schedule would be required to: file its complete portfolio schedule semi-annually on proposed Form N-CSR, and make its complete portfolio schedule available to shareholders upon request and free of charge (and discloses this in its shareholder reports). Under the proposals, a money market fund would be permitted to omit the schedule of investments from its shareholder reports, provided it complies with the two conditions outlined above. 7

8 Tabular or Graphic Presentation of Portfolio Holdings The SEC proposes that funds be required to include in their shareholder reports a presentation using tables, graphs or charts to illustrate a fund s asset allocation across asset classes. Funds would be free to choose both the categories to be used and the format. Quarterly Filing of Complete Portfolio Schedule The SEC also proposes that funds file their complete portfolio holdings on a quarterly basis. Funds would file their holdings on Form N-CSR in the second and fourth quarters and on newly proposed Form N-Q in the first and third quarters. These filings would be made within 60 days of the end of the quarter. Funds would not have to send these quarterly reports to shareholders, unless they were requested by shareholders. Fund Expenses and Management s Discussion of Fund Performance The SEC proposes that funds disclose in their shareholder reports expenses borne by shareholders during the reporting period. Shareholder reports would be required to include: how much a $10,000 investment cost a shareholder based on the fund s actual expenses and return for the period, how much a $10,000 investment cost a shareholder based on the fund s actual expenses for the period and an assumed 5% return per year, and a narrative explaining the above disclosures. This disclosure is intended to supplement the fee disclosure in the prospectus and help shareholders better understand the actual dollar costs associated with investing in a fund. Finally, if the SEC s proposals are adopted, funds would be required to include in their annual report management s discussion of fund performance. This is not a significant change because it is currently required to be included in either the fund s prospectus or annual report and most funds already include it in their annual report. Comments on the proposed amendments are due by February 14, Other Developments of Interest SEC Considers Establishing a New SRO To Oversee Mutual Funds The SEC will be seeking comments on a proposal to set up a new self-regulatory organization to closely monitor the fund industry. If created, the new SRO would conduct routine examinations of funds and investment advisers and function much like the National Association of Securities Dealers. The SEC is expected to formalize its proposal sometime in February. Supreme Court Denies Petition To Hear Krantz Case In January, the U.S. Supreme Court declined to review Krantz v. Prudential Investments Fund Management, LLC. The plaintiff had claimed that the mutual fund directors were not independent because they served on multiple fund boards within a single fund complex, which resulted in allegedly substantial directors fees. Proposed Rule 3a-8 The SEC has proposed new Rule 3a-8 under the 1940 Act to provide research and development companies an exclusive safe harbor from the definition of investment company under the Act. Proposed Rule 3a-8 is designed to allow companies, that invest in securities as a means of funding their research and development activities, greater flexibility to raise and invest capital without being subjected to the restrictions of the Act. INVESTMENT MANAGEMENT GROUP Jeffrey R. Blumberg (312) jblumberg@gcd.com Paul H. Dykstra (312) pdykstra@gcd.com Glenn E. Ferencz (312) gferencz@gcd.com Gary W. Howell (312) ghowell@gcd.com Marielle V. Lifshitz (312) mlifshitz@gcd.com Charles R. Manzoni, Jr. (312) cmanzoni@gcd.com Joseph H. Nesler (312) jnesler@gcd.com Paulita Pike (312) ppike@gcd.com Nabil Sabki (312) nsabki@gcd.com Jeffrey S. Shamberg (312) jshamberg@gcd.com Gardner Carton & Douglas is a Limited Liability Company This client memorandum is not intended as legal advice, which may often turn on specific facts. Readers should seek specific legal advice before acting with regard to the subjects mentioned here N. Wacker Drive Suite 3700 Chicago, IL Promotional Material 1301 K Street, N.W. Suite 900, E. Tower Washington, D.C