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- ICI Comment Letters
Statement of Matthew P. Fink
President, Investment Company Institute
Before the Special Committee
on the Year 2000 Technology Problem,
United States Senate
On Mutual Fund Industry Preparations
for the Year 2000
September 17, 1998
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Table of Contents
I. Oral Statement of Matthew P. Fink
II. Executive Summary
IV.The Structure and Operations of Mutual Funds
V. Mutual Fund Industry Preparations for the Year 2000
VI. Portfolio Companies
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I. Oral Statement of Matthew P. Fink
I am Matthew P. Fink, President of the Investment Company Institute, the national association of the American mutual fund industry. I appreciate the opportunity to testify today on the industry’s preparations for the Year 2000.
The mutual fund industry takes this issue very seriously. We cannot afford to do otherwise, since the industry’s well-being depends on the confidence of investors.
In considering Y2K issues in the context of the fund industry, it is important to bear in mind three points.
First, because mutual funds are subject to a stringent and unique regulatory regime under the Investment Company Act of 1940, they have a special and heightened sense of urgency with respect to Y2K. Mutual funds are required to determine the price for their shares every business day—without exception. Equally important, mutual funds must offer shareholders the right to sell their shares back to the fund every business day. Other businesses may face the risk of damaging relationships with customers because of Y2K; mutual funds face that risk and the simultaneous risk of failing to comply with critical legal requirements. Funds therefore recognize the need to devote substantial efforts to resolving Y2K issues to ensure they meet investor expectations and comply with the law.
Second, the fund industry has substantial experience dealing with modifications of large-scale computer operations. Systems changes have been required on a regular basis both to comply with new legal requirements and to meet the competitive challenge of continually enhancing shareholder services. Although Y2K issues present some novel complexities, the fund industry is relatively well-conditioned to address these issues.
Third, the arrival of Y2K will have no impact on the protections provided to investors under the Investment Company Act of 1940. If mutual funds experience any Y2K-related problems, fund shareholders will remain protected by federal requirements.
To put in context the efforts that mutual fund firms are undertaking to prepare for Y2K, it may be helpful to understand the structure of a typical mutual fund organization. I refer you to the diagram. The mutual fund itself is a pool of assets that is usually managed by other entities and has no employees. In nearly all cases, fund operations are conducted by third parties. It is very common for the fund’s investment adviser —the firm that selects securities for the fund’s portfolio—and the fund’s principal underwriter—the firm that arranges for the sale of fund shares—to be part of the same overall organization as the fund or funds they serve. That is why the diagram includes the investment adviser and principal underwriter with the mutual fund itself in the inner circle.
Let me turn to service providers.
While some funds have an affiliated transfer agent that maintains shareholder accounts and performs other related functions, many funds use independent transfer agents. The fund custodian, which is responsible for safekeeping of fund assets, is usually an unaffiliated bank. The diagram shows the transfer agent and custodian, along with other important service providers, including pricing services, institutional broker-dealers and independent sales forces, in the bigger circle surrounding the fund complex.
The mutual fund industry is hard at work on Y2K issues. Funds’ Y2K compliance efforts span both internal computer systems and programs and systems and programs that interface with those of third parties. And, as the representatives from DST and State Street Bank will attest first-hand, major mutual fund service providers also are methodically and diligently working on Y2K issues, in coordination with their mutual fund clients.
The fund industry is keeping the Securities and Exchange Commission apprised about the status of Y2K compliance efforts through Institute member surveys and informal contacts with the staff. We expect the Commission to adopt Y2K reporting requirements for investment advisers soon—similar requirements are already in place for transfer agents and broker-dealers. The adviser reports will address mutual fund Y2K compliance efforts and should give the Commission a clearer picture of the Y2K compliance status of the mutual fund industry.
Fund organizations are actively communicating with fund shareholders about Y2K issues, not only through prospectus disclosure but also on their websites, in newsletters and brochures, and in response to telephone inquiries.
A variety of interested parties are scrutinizing the industry’s Y2K compliance efforts. These parties include, among others, mutual fund directors, fund shareholders, regulators and the financial media. In addition, the mutual fund industry has a captive insurance company which is focusing on mutual funds’ Y2K compliance status. Such oversight reinforces the already strong incentives for the industry to address Y2K issues thoroughly and responsibly.
Like mutual funds and their service providers, many of the companies in which funds invest rely on computers in carrying out their businesses. In appropriate cases, we understand that fund investment advisers are reviewing the Y2K compliance status of fund portfolio companies and considering this along with any other factors that the adviser deems relevant to making investment decisions.
We applaud the efforts of this Committee, of Chairman Bennett and of SEC Chairman Arthur Levitt to promote meaningful Y2K disclosure by securities issuers. We believe those efforts will increase the availability of reliable information, which enhances an adviser’s ability to make sound judgments on behalf of the fund and its shareholders.
Thank you for the opportunity to appear before you today. I would be happy to answer any questions.
When considering Y2K issues in the context of the mutual fund industry, it is important to bear in mind that:
Funds are subject to a stringent and unique regulatory regime under the Investment Company Act of 1940. Funds recognize the need to devote substantial efforts to resolving Y2K issues in order to ensure compliance with these regulatory requirements.
Based on their experience in dealing with computer systems modifications on a regular basis, mutual fund industry participants are relatively well-conditioned to address Y2K issues.
The arrival of Y2K will have no impact on the protections afforded to investors under the Investment Company Act of 1940. If mutual funds experience Y2K-related problems, the consequences to investors most likely would be in the nature of temporary administrative glitches.
Y2K compliance is a very high priority matter for mutual fund firms that is receiving attention at senior management levels. For example, fund firms are engaging in efforts internally to identify and remediate Y2K problems. Many firms have dedicated staffs for this purpose, have established separate Y2K budgets, and provide periodic progress reports to their funds’ boards of directors concerning Y2K compliance.
Mutual fund firms also are assessing their interdependencies with various service providers with whom the funds (or their investment advisers or principal underwriters) exchange critical data, and are monitoring the Y2K compliance progress of these service providers. They are engaging in private testing of interfaces with major service providers. Many fund firms have participated or will participate in "street-wide" Y2K testing that the Securities Industry Association and National Securities Clearing Corporation are coordinating.
Mutual funds are keeping regulators and investors informed about Y2K issues through a variety of means.
The mutual fund industry’s Y2K efforts are subject to oversight by fund boards of directors, shareholders, regulators and other parties.
Where appropriate, investment advisers are reviewing the Y2K readiness of companies in which they invest on behalf of mutual funds.
Good morning. My name is Matthew P. Fink. I am President of the Investment Company Institute, the national association of the American investment company industry. The Institute’s membership includes 7,288 open-end investment companies (mutual funds), 450 closed-end investment companies, and 9 sponsors of unit investment trusts. Its mutual fund members have assets of about $5.092 trillion, accounting for approximately 95% of total industry assets, and have over 62 million individual shareholders.
I appreciate the opportunity to testify on the mutual fund industry’s preparations for the Year 2000, also known as "Y2K." As members of the Committee are aware, there is concern that computer systems that are programmed to read only two-digit dates will assume that 01/01/00 is January 1, 1900, rather than January 1, 2000. Unless this problem is corrected, it could have widespread adverse consequences.
The mutual fund industry takes this issue very seriously. The industry’s continued success is predicated on maintaining the confidence of investors. Thus, it is critically important that we strive for the smoothest possible transition to the 21st century.
Today I will begin by briefly describing the structure and operations of mutual funds. I will then outline the steps funds are taking to prepare for Y2K, including undertaking internal Y2K compliance efforts, working with their major service providers and participating in industry-wide testing, communicating with regulators, and communicating with shareholders. I will also discuss oversight of mutual funds’ Y2K compliance efforts by regulators and others. Finally, I will cover Y2K issues related to portfolio companies in which mutual funds invest.
No one can guarantee that there will be no problems when the Year 2000 arrives—in fact, some temporary glitches are probably inevitable. When considering this issue in the context of the mutual fund industry, however, it is important to bear in mind three points.
First, mutual funds are subject to a stringent and unique regulatory regime under the Investment Company Act of 1940. For example, funds are required to price their shares on a daily basis and to offer shareholders the ability to redeem fund shares on a daily basis. Thus, in addition to the business incentives to devote substantial efforts and resources to resolving Y2K issues, which mutual funds share with other companies, funds also must undertake these efforts in order to ensure that they comply with regulatory requirements.
Second, the industry is highly automated and thus relies heavily on the use of computer systems. While this reinforces the need for the industry to take the Y2K issue seriously, it also serves to demonstrate that problems involving modifications of large-scale computer operations are not unusual for our industry. For example, changes to these systems are made on a regular basis in order to comply with new regulatory requirements1 and to offer new or enhanced services to investors.
Thus, in general, the mutual fund industry (including its major service providers) is accustomed to modifying, re-building or re-engineering computer systems as part of day-to-day business operations. The Y2K problem differs from other instances of systems overhaul because it permeates all systems, and the need to coordinate the efforts of numerous parties presents substantial challenges. Nevertheless, based on their experience in dealing with computer systems modifications on a regular basis, mutual fund industry participants are relatively well-conditioned to address Y2K issues.
A third important point is that mutual fund assets are well-protected and can be expected to remain so as of January 1, 2000 and beyond.2 To the extent that the industry experiences any Y2K-related problems, the consequences to fund shareholders of such problems most likely would be in the nature of delayed statements or other temporary administrative glitches. It would be most unfortunate if investors and savers, including mutual fund shareholders, became fearful that their money could disappear as a result of Y2K. As the millennium approaches, it may be appropriate at some point for Congress and regulators to convey a message of reassurance to all investors and savers so as to avoid any unnecessary panic.
IV. The Structure and Operations of Mutual
A. The Mutual Fund
A mutual fund is an investment company that pools the money of many investors and invests it in a wide variety of stocks, bonds, or money market instruments. An investor in a mutual fund buys shares of the fund. Most mutual funds continuously offer new shares. Each share represents a proportionate interest in the securities held in the fund’s portfolio. Mutual fund shares are redeemable, which means that an investor has the right to sell his or her shares back to the fund at any time at their current net asset value.
Mutual funds are organized under state laws as corporations or business trusts and are governed by a board of directors (or trustees).3 The directors of a mutual fund have oversight responsibility for the management of the fund’s business affairs. They must exercise the care that a reasonably prudent person would take with his or her own business. They are expected to exercise sound business judgment, establish procedures, and undertake oversight and review of the performance of the investment adviser, principal underwriter, and others that perform services for the fund.
B. The Mutual Fund Organization
Most mutual funds are externally managed by a separate entity. Thus, they do not have employees of their own and all of their operations are conducted by third parties that include affiliated companies and independent contractors. Mutual funds’ primary service providers include the investment adviser, the principal underwriter, the transfer agent, and the custodian.
In most cases, the fund’s investment adviser and its principal underwriter are part of the same overall organization as the fund or funds they serve.4 The transfer agent to a mutual fund may be either an "internal" transfer agent that is part of the mutual fund organization, or an "external" transfer agent that provides substantially all transaction processing and shareholder services to unaffiliated mutual fund clients.5 The fund’s custodian is usually an unaffiliated bank.
Other important mutual fund service providers include various intermediaries that sell fund shares, institutional broker-dealers through which investment advisers purchase and sell fund portfolio securities, and pricing services.
A diagram depicting a typical mutual fund organization, including the fund’s key service providers, is attached as Exhibit A. [Ed’s Note: Exhibits not included here.]
C. Mutual Funds’ Principal Service Providers
The functions performed by the principal service providers to mutual funds are outlined below. Each of these entities performs services pursuant to a contract with the fund. All of the entities listed are subject to federal regulation either by the SEC or by bank regulators.
1. Investment Adviser
An investment adviser to a mutual fund is responsible for selecting portfolio investments consistent with the fund’s investment objectives and policies, as described in its prospectus.
2. Principal Underwriter
As noted above, most mutual funds continuously offer new shares. Fund shares are offered to the public at a price based on the current value of fund assets (plus a sales charge, if applicable). Mutual funds usually distribute their shares through a principal underwriter. The principal underwriter arranges for the sale of fund shares to the public. Fund shares are sold to investors primarily in two ways. In some cases, investors purchase fund shares directly from the fund or its principal underwriter. In other cases, fund shares are distributed through a sales force, which may be employees of the fund’s principal underwriter or of independent firms (as discussed further under "Independent Sales Force," below).
3. Transfer Agent
Fund transfer agents maintain records of shareholder accounts, which reflect daily investor purchases, redemptions, and account balances. Transfer agents typically serve as dividend disbursing agents, and their duties as such involve calculating dividends, authorizing payment by the custodian, and maintaining dividend payment records. They also prepare and mail to shareholders periodic account statements, federal income tax information, and other shareholder notices. In many cases, transfer agents also prepare and mail statements confirming transactions and reflecting share balances. In addition, transfer agents maintain customer service departments that respond to telephone and mail inquiries concerning the status of shareholder transactions and accounts.
The Investment Company Act of 1940 requires mutual funds to keep their portfolio securities in the custody of a qualified bank or otherwise protect them pursuant to SEC rules. Nearly all mutual funds use bank custodians. The custodian’s primary responsibilities are safekeeping of the fund’s portfolio securities and cash, clearing and settling transactions, collecting and distributing income, and reporting and processing corporate actions.
The selection of custodians for foreign securities is governed by special requirements designed to ensure that fund assets held by those custodians are adequately protected.6 Mutual funds typically rely to a significant extent on the expertise of their U.S. custodians in selecting foreign subcustodians.7
D. Other Important Service Providers
The service providers described below typically contract with the principal underwriter (in the case of an independent sales force) or the adviser (institutional broker-dealers and pricing services), rather than directly with the fund.
1. Independent Sales Force
As mentioned above, some mutual funds distribute their shares through an independent sales force. Such a sales force may include employees of broker-dealer firms, financial planners, bank representatives, and insurance agents.
2. Institutional Broker-Dealers
The investment adviser purchases and sells securities for the fund’s portfolio through institutional broker-dealers.
3. Pricing Services
In order to price their shares daily, as required by the Investment Company Act, mutual funds must determine the value of their portfolio holdings each day.8 Many funds use independent, third-party pricing services to assist in this process. Pricing services often collect and transmit market prices of portfolio securities to funds and also provide prices for those portfolio securities for which market quotations are not available.
V. Mutual Fund Industry Preparations For the Year
Specific steps that mutual fund firms are taking to prepare for Y2K are described below. The information provided below is based on, among other things, a recent Institute survey of the status of members’ Y2K compliance efforts ("1998 survey"),9 discussions with members at Institute committee and other meetings, and informal conversations with members.
A. Internal Y2K Compliance Efforts
All available indications are that Y2K compliance is a very high priority matter for mutual fund companies and it is receiving attention at senior management levels. Many firms have dedicated staffs working on Y2K compliance, have established separate budgets for Y2K compliance, and provide periodic reports to their mutual funds’ boards of directors concerning the progress of Y2K compliance efforts.
The Institute’s 1998 survey indicates, among other things, that 89 percent of the firms responding had planned to complete a risk assessment for Y2K issues by July 1998. Over 96 percent had expected to have performed an inventory of software applications by that time, and 95 percent of firms had planned to have established a comprehensive methodology to become Y2K compliant as of July 1998. According to our survey, over 75 percent of the firms completing the survey plan to be Y2K compliant by December 1998.10
B. Working with Major Service Providers
As discussed above, mutual funds themselves are pools of assets whose operations rely on various service providers. The fund itself typically does not have its own computer systems. Rather, the system that runs mutual fund operations is usually that of the fund’s sponsor (which may be its investment adviser or another organization). This system, in turn, typically is linked to those of the custodian, transfer agent, broker-dealers, pricing services, and other service providers.
Consequently, mutual fund firms have been assessing their interdependencies with these various parties with whom the funds (or their investment advisers or principal underwriters) exchange critical data. Fund groups routinely request information and assurances from such parties regarding their Year 2000 compliance status.11
Mutual fund firms are conducting private testing of their interfaces with major service providers. In addition, for over a year, the Securities Industry Association and the National Securities Clearing Corporation have been coordinating plans for "street-wide" Y2K testing designed to ensure that securities transactions clear and settle among all parties after January 1, 2000. The overall effort encompasses nine "product settlement groups;" mutual fund investor transactions (i.e., transactions in mutual fund shares) constitute one of the groups. Several Institute members, as well as the Institute, participated in the development of the Mutual Fund Test Plan. The plan was issued on April 1, 1998 and called for initial tests to be conducted in July and October 1998. The overall results of the July test were very positive. The few, minor problems that did arise were not related to Y2K issues but rather involved issues associated with using newly-established test environments and coordinating test scripts. They were quickly resolved. Comprehensive street-wide testing is scheduled to take place in March 1999.
Most of the major users of central clearing facilities for transactions in mutual fund shares have participated or will participate in these initial tests. Virtually all of such users will be participating in the March 1999 testing.
Institute members also are monitoring the Y2K compliance progress of intermediaries that sell the members’ funds (where applicable), institutional broker-dealers through which fund portfolio securities (as opposed to shares of the fund) are purchased and sold, and pricing services that supply price information for fund portfolio securities.
C. Communicating with Regulators
An important part of the industry’s Y2K compliance efforts is keeping regulators informed about the status of these efforts. Some avenues through which this information has been or will be communicated are described below.
1. Institute Surveys
In April 1997, at the request of the SEC staff, the Institute surveyed its members regarding their Y2K compliance plans. The Institute forwarded the survey results to the SEC for use in responding to a Congressional request for information about the Y2K readiness of the securities industry. As noted above, the Institute surveyed its members again this year and provided the results to the SEC for use in its June 1998 report to Congress. The Institute has regular contacts with SEC staff members that provide opportunities to discuss Y2K and other issues.
2. SEC Reporting Requirements
The SEC recently adopted rules requiring certain registered transfer agents and broker-dealers to file Year 2000 readiness reports with the SEC.12 Under the transfer agent rule, all covered transfer agents must complete Part I of Form TA-Y2K, which is a check-the-box style report on the status of the transfer agent’s Y2K remediation efforts. Non-bank transfer agents must also complete Part II of the form, which requires a narrative discussion of efforts to address Y2K problems. Similarly, the broker-dealer rule requires all covered broker-dealers to complete a check-the-box style questionnaire, and larger broker-dealers must also provide a narrative discussion of their efforts to prepare for the Year 2000. Each rule required an initial report to be filed with the SEC by August 31, 1998; a second report is due by April 30, 1999.
The SEC also has proposed, and is likely to adopt, Y2K reporting requirements for registered investment advisers.13 As proposed, Part II of Form ADV-Y2K would require information about the Y2K compliance status of any mutual funds advised by an adviser completing the form.
The information provided in these various reports should help give the SEC a clearer picture of the mutual fund industry’s Y2K compliance status and identify organizations that may need to accelerate their progress in order to meet the challenges of the new millennium.
D. Communicating with Shareholders
As mentioned above, the confidence of investors is critical to the mutual fund industry’s success. Many mutual fund organizations are taking steps to keep investors informed about Y2K issues in an effort to preserve their confidence. Institute members are communicating with their shareholders about Y2K issues through several means.
First, in accordance with SEC guidance regarding the disclosure obligations of investment companies and investment advisers with respect to the Year 2000,14 mutual fund prospectuses typically contain disclosure that alerts investors to possible Y2K issues, briefly describes the steps that are being taken to address them, and notes that the fund is unable to guarantee that no Y2K problems will arise.
Second, many mutual fund organizations have posted information about Y2K issues on their websites. Third, mutual fund organizations have used newsletters, statement inserts, or other publications to keep shareholders informed about Y2K issues.15 Fourth, many fund groups have telephone representatives who respond to investor inquiries about the organization’s Y2K compliance status.
Mutual fund firms thus are making efforts on several fronts to keep shareholders informed and to assure them that all reasonable steps are being taken to address Y2K issues. Well-informed shareholders are less likely to panic or take irrational action such as redeeming their mutual fund shares when the Year 2000 draws nearer.
E. Oversight of Mutual Fund Industry Y2K Efforts
Mutual fund firms have every incentive to address Y2K issues in a thorough and responsible fashion. Their efforts—quite appropriately—are being subjected to scrutiny by a variety of interested parties.
For example, as part of their general oversight responsibilities, mutual fund boards of directors routinely are requesting (and receiving) periodic reports from fund advisers or other responsible parties concerning the status of Y2K compliance efforts. Fund shareholders likewise are requesting assurances that appropriate steps are being taken to address any potential Y2K problems.
In addition, the SEC has focused on Y2K compliance in recent inspections of mutual funds, investment advisers, and transfer agents and, as discussed above, is requiring certain of these entities to file Y2K readiness reports. Also, earlier this year, the National Association of Securities Dealers, Inc. required its members (which include almost all mutual fund principal underwriters) to complete a questionnaire concerning their Y2K compliance status.16
Moreover, ICI Mutual Insurance Company, the captive insurance company that provides fidelity bond and directors and officers’/errors and omissions liability insurance coverage to participants in the mutual fund industry,17 is requesting detailed information from policy holders about Y2K remediation efforts in connection with its ongoing insurance underwriting process.18 Thus, yet another body is focusing on the efforts that fund organizations are engaging in to become Y2K compliant. As a result, fund organizations have an additional incentive to keep their Y2K efforts on track—it may help them avoid the possibility of exclusions, higher premiums, or other consequences based on Y2K risks when renewing their insurance coverage.
Similarly, Comdisco, a major supplier of disaster recovery services for the mutual fund industry, recently issued guidelines for customers wishing to participate in its "Ready Y2K Program." Only those firms meeting the guidelines will be eligible for certain disaster recovery services in the event of a Y2K related failure.
VI. Portfolio Companies
Just like mutual funds and their various service providers, many of the issuers of securities in which mutual funds invest rely on computers in carrying out their businesses and could experience problems if those computer systems are not Y2K compliant. The risk that the value of securities in which a fund invests could be affected by the Y2K compliance status of the issuer is one of many factors that a mutual fund’s investment adviser may need to assess when determining which securities to buy, sell, or hold for the fund.
Thus, in many cases, as part of their normal research process, mutual fund investment advisers are reviewing issuers’ efforts to address potential Y2K problems. This may include, for example, interviewing company officials and gathering other available information (such as reports that public companies file with the SEC). The results of the adviser’s research are considered along with all of the other factors that the adviser deems relevant to making an appropriate investment decision.
In certain other cases, however, this type of analysis may not be done because it would be inconsistent with the fund’s investment objectives and policies, as disclosed in the fund’s prospectus. For example, index funds typically have as their objective seeking to match the performance of a securities index. Therefore, it is not necessary and, in fact, would be inappropriate for the manager of such a fund to consider the issuer’s Y2K risk exposure as an investment criterion.
In all cases, it is important that the investment adviser retain the discretion to evaluate this factor in the manner and to the extent that it deems appropriate in the particular circumstances (including, among other things, prospectus disclosure concerning the fund’s investment objectives and policies and concerning how the adviser selects securities for the fund’s portfolio). This is precisely what shareholders (through the fund) pay the adviser to do on their behalf. And, due to the competitive nature of the mutual fund industry, fund advisers have a very strong incentive to make good judgments so as to maximize shareholder value consistent with the investment objectives and policies of the fund.19
Where portfolio companies’ Y2K readiness is a relevant consideration, the adviser’s ability to make sound judgments is enhanced by the availability of reliable information about such companies’ readiness.20 We applaud the efforts of Committee Chairman Bennett and SEC Chairman Arthur Levitt to promote meaningful Y2K disclosure by securities issuers.
The mutual fund industry is deeply involved in efforts to identify and remediate computer problems that could otherwise occur with the arrival of the Year 2000. These efforts encompass both internal systems and programs and systems and programs that interface with those of third parties. The industry is keeping regulators and investors informed about Y2K issues through a variety of means, and the industry’s efforts are subject to oversight by regulators and others. Finally, where appropriate, investment advisers are reviewing the Y2K readiness of companies in which they invest on behalf of mutual funds.
Thank you for the opportunity to participate at this hearing on Y2K issues. We commend the Committee for its strong leadership in this area. We would be pleased to provide any additional information that the Committee might request.
1For example, in 1993, the Securities and Exchange Commission adopted rule amendments that shortened the standard settlement cycle for most securities transactions from five business days to three business days. See SEC Release No. 33-7022; 34-33023; IC-19768 (October 6, 1993). This change required extensive modifications to computer systems throughout the securities industry, including the fund industry.
2For example, as discussed below, the Investment Company Act of 1940 requires that a qualified custodian (usually a bank) hold custody of mutual fund assets. The arrival of Y2K will have no impact on this and other protections afforded to shareholders under the Investment Company Act and related rules.
3The Investment Company Act of 1940 requires that at least 40 percent of a fund’s board of directors be independent of the fund’s investment adviser or principal underwriter. Where the principal underwriter is affiliated with the investment adviser, which is typically the case, a majority of the directors must be independent. In fact, virtually all fund boards have a majority of independent directors. Independent fund directors serve as watchdogs for shareholder interests and protect them against potential conflicts of interest.
5In some cases, a mutual fund employs an external transfer agent but the mutual fund organization itself performs limited shareholder servicing functions such as telephone communication, written correspondence, or account research. In addition, internal transfer agents include both the "remote" transfer agent that contracts with an outside service company for use of its data processing system, and the "captive," or fully internal, organization that utilizes its own computer resources and shareholder accounting system.
7We understand that the major U.S. custodian banks are performing due diligence with respect to the Y2K status of foreign subcustodians within their global network. The U.S. custodian keeps its mutual fund clients apprised of these efforts.
8See Rule 2a-4 under the Investment Company Act of 1940, which provides that a mutual fund must calculate its net asset value by valuing securities for which market quotations are readily available at their market value and other securities and assets at their fair value as determined in good faith by the fund’s board of directors.
9A copy of the survey is attached as Exhibit B. [Ed. Note: Exhibits are omitted here.] The Institute distributed the survey to members in March 1998. To date, we have received responses from 82 firms, representing 67% of industry assets. Many firms’ Y2K compliance efforts have further progressed since they responded to the survey. The Institute expects to conduct another survey in April 1999.
10We note that Morningstar recently conducted an informal survey of several mutual fund firms’ Y2K compliance efforts. Based on the 15 responses received, Morningstar concluded that "[m]utual fund companies appear to be hard at work readying their computer systems for problems associated with the Year 2000 . . . ." Valerie Putchaven, "Squashing the Y2K Bug.”
11The Institute and ICI Mutual Insurance Company will be co-sponsoring a conference on Y2K issues for mutual funds in October. A copy of the preliminary conference program is attached as Exhibit C. [Ed. Note: Exhibits are omitted here.] Among those who have agreed to speak are representatives of several of the major independent suppliers of mutual fund transfer agency and custody services. This forum will provide additional opportunities for mutual fund firms and these third party service providers to exchange information and coordinate compliance efforts.
13SEC Release No. IA-1728 (June 30, 1998).
14See Statement of the Commission Regarding Disclosure of Year 2000 Issues and Consequences by Public Companies, Investment Advisers, Investment Companies, and Municipal Securities Issuers, SEC Release No. 33-7558; IA-1738; IC-23366; International Series Release No. 1149 (July 29, 1998).
16See Special NASD Notice to Members 97-96 (December 1997).
19Moreover, mutual funds typically have broadly diversified portfolios. Thus, the risks of holding any single security can be offset by the different risk/reward characteristics of other securities in the portfolio. It is well-recognized that it is not appropriate to judge the performance of an investment adviser by focusing on individual securities in isolation.