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Regulatory Landscape Changed Significantly in 01

This past year was particularly active in terms of mutual fund regulation, according to industry lawyers. A number of initiatives from the Securities and Exchange Commission that had been discussed in recent years, including independent fund director and after-tax reporting issues, came to fruition in 2001.

For starters, the SEC has a new chairman. Harvey Pitt took office as head of the Commission this August, replacing Laura Unger, who served as interim chair following Arthur Levitt's resignation in December of 2000. At Pitt's confirmation hearing in May, he said that he wanted the SEC to lead a review of its regulations, many of which are outdated. At the time, the Investment Company Institute and industry lawyers alike were not sure what specific rules might be changed, and that has not become clearer since. The review will likely happen in 2002, but to what degree it will focus on mutual funds is anyone's guess.

Levitt's Legacy

Although Levitt was already gone, some of the regulation issues initiated during the reign of the investor-friendly chairman were implemented in 2001. In January, the SEC adopted rules regarding the disclosure of after-tax returns. Funds that claim to control the effect of taxes on returns, and any others that want to report after-tax returns, now must conform to the SEC's guidelines, which calls for the disclosure of one-, five-, and 10-year before-tax, after-tax and after-tax post-liquidation returns. That rule went into effect for advertisements and sales materials earlier this month and will go into effect for prospectuses on Feb. 15, 2002.

Another rule adopted by the SEC in January requires funds that have names which suggest a particular investment focus to invest at least 80% of assets in accordance with the its name. The previous policy was that 65% of the assets had to comply with the fund's name.

"One of the really big regulatory issues that came out of 2001 was the final rules on independent directors," said Alan Rosenblat, an attorney with Philadephia-based law firm Dechert. The Commission had been working on those for some time, and they finally adopted regulations."

A fund board's membership must now be made up of a majority of independent directors, The new rules require funds to disclose more information about the identity and experience of their directors, what fund shares they own and any potential conflicts of interest between a director and a fund, according to the SEC. Also, the new rules require funds to disclose the role a board of directors plays in governing a fund.

The Valuation Conundrum

Another significant area of regulation in 2001 was the SEC's attempt at fair valuation guidance. The SEC sent a letter to the ICI in April, which focused on how "significant events" in foreign markets that close as much as 12-15 hours ahead of U.S. markets can create arbitrage opportunities, and hurt long-term shareholders. The SEC said that funds should constantly monitor global affairs and implement fair valuation practices whenever necessary. The letter was met with a great deal of confusion on the part of the fund industry, and a white paper from the ICI on best practices is expected soon. Also, it is expected that the SEC will have to issue further guidance on the subject.

While the beginning of the year saw much activity in terms of SEC regulation regarding mutual funds, it ended somewhat slowly.

From a legislative perspective, the "Economic Growth and Tax Relief Reconciliation Act of 2001" that Congress passed in May had an immediate effect on mutual fund firms. Beginning Jan. 1, the new law increases contribution limits in qualified retirement plan and IRA participants. The bill also increased contribution limits to Education IRAs and Qualified Tuition Programs (529s), and eased certain restrictions on both. That, in addition to wider public awareness, prompted firms to aggressively develop 529 programs this year. Fidelity, Putnam, Oppenheimer, T. Rowe Price, and Franklin Templeton are just some of the firms that announced 529 programs and agreements, citing the bill as a catalyst for that market.

In next week's issue we will take a look ahead to 2002 and review proposed legislation that will impact the industry as well as what is afoot at the SEC in terms of regulatory initiatives.