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Securities Industry Seeks Compromise with Funds on Affiliated Transactions


WASHINGTON - The leading trade group for broker/dealers is hoping to reach an agreement with the Investment Company Institute on a proposal modifying the rules which prohibit transactions between a broker/dealer and a mutual fund.

The SIA has had some "communications" with the ICI in hopes that the two trade groups could agree on a proposal to revise the provision in the Investment Company Act which prohibits affiliated transactions, said Michael D. Udoff, associate general counsel of the Securities Industry Association, last week. Udoff declined to comment on specifics, but said the SIA hopes to "find some common ground" on the issue.

An ICI spokesperson was not available for comment. In a letter last month to the SIA, however, Matthew Fink, president of the ICI, said the SIA had moved unilaterally on the proposed change to the affiliated transactions law and that the SIA's action represented a "significant departure" from the usual practice in which the two trade groups discuss in advance proposals which affect one another.

Sen. Phil Gramm (R-Tex.), chairman of the Senate Banking Committee, in March solicited proposals to revise or eliminate what he called outdated securities laws. Gramm said last month that his committee had received suggestions from regulators and trade groups such as the SIA and the Bond Market Association.

The committee hopes to hold hearings on legislation in June, said Christi Harlan, a spokesperson for Gramm. She declined to comment on specific proposals but expressed dismay over the dispute between the ICI and the SIA.

"Senator Gramm strongly desires that people stop shooting at one another's proposals," Harlan said.

Section 17(a) of the Investment Company Act prohibits broker/dealers from selling securities to an affiliated mutual fund or buying securities from that fund. The SEC has the power to grant exemptions from that prohibition.

The SIA asked Gramm to consider legislation which would permit broker/dealers and affiliated funds to buy and sell securities between one another when the securities can be readily traded. Udoff said revising the law to permit some affiliated transactions ultimately would provide more competitive prices for mutual funds and their shareholders.

The SIA's proposal and other federal securities laws still would provide investors protection from a broker/dealer engaging in unfair transactions with a fund, Udoff said. He estimated that the proprietary funds of broker/dealers account for more than $1 trillion of the more than $5.5 trillion in assets under management in the mutual fund industry.

The SEC is adamantly opposed to the SIA's proposal. Paul Roye, director of the SEC's division of investment management, said in a speech at the ICI's general membership meeting here two weeks ago that the prohibition against affiliated transactions is crucial to safe-guarding the fiduciary duty which a fund owes its shareholders.

The prohibition also provides protection for fund companies, Roye said. In instances where a broker/dealer sells securities to an affiliated fund and the price of the securities then drops, "plaintiffs' lawyers could have a field day, suing everyone connected to the transaction, the affiliated dealer, the portfolio manager and even the independent directors" who approved the transaction, Roye said.

"While Section 17(a) protects the fund and its investors, it also protects management companies by drawing a clear line" between accepted and prohibited transactions, he said.

In his letter last month to the SIA, Fink said the SIA proposal was "entirely objectionable to the mutual fund industry." Fink said Section 17(a) was enacted in response to a "wide array of abuses" which occurred in the mutual fund and closed-end fund industries in the 1920s and 1930s. The ICI supports seeking exemptions from the SEC rule in special cases rather than amending Section 17(a), Fink said.

"Although economics and market conditions have changed dramatically since 1940, the reasons for enacting Section 17 remain as valid today as they were when first enacted," Fink said.