SECURITIES ANDEXCHANGE COMMISSION

Washington, D. C. 20549(202) 755-4846

FOR RELEASE: 12 noon, Thursday, March 16, 1978

MUTUAL FUND ADVERTISINGAn Aadress by Roberta 5. Karme1, Commissioner

Securities and ExChange oammission

Mutual Funds and InvestmentManagement Conference

Tucson, ArizonaMarch 16, 1978

ADDRESS BY R~BERTA S. KARMELJ COMMISSIONERSECURIIIES AND E~CHANGE COMMISSION*

MUTUAL rUNDS ANO INVESTMENT MANAGEMENTCONFERENCETUCSONJ ARIZONA - MARCH 16} 1978

MUTUAL FUND ADVERTISING

LAST WEEKJ CHAIRMAN WILLIAMS ANNOUNCED THE SELECTIONOF SYD MENDELSOHN AS DIRECTOR OF THE DIVISION OF INVESTMENTMANAGEMENT AND A REEXAMINATION OF THE RELATIONSHIPS WHICH HAVEEVOLVED BETWEEN THE COMMISSION AND THE MUTUAL FUND INDUSTRY.CHAIRMAN WILLIAMS STATED THAT "THE OBJECTIVE OF THIS REVIEWWOULD BE TO SEARCH FOR WAYS IN WHICH THE INDUSTRY • • • CANBE ENCOURAGED TO ASSUME GREATER RESPONSIBILITY FOR THE ADMIN-ISTRATION OF THE BUSINESS ACTIVITIES OF PERSONS REGULATEDUNDER THE INVESTMENT COMPANY AND INVESTMENT ADVISERS ACTS}WHILE AT THE SAME TIME PRESERVING THE COMMISSION'S ABILITYTO ENSURE THAT REQUIREMENTS OF THE FEDERAL SECURITIES LAWSARE SATISFIED." THE CHAIRMAN THEN WENT TO CHINA} PRESUMABLYTO SEEK OUT NEW MODELS FOR MUTUAL FUND REr,ULATTON ANn ~FNTSYD AND ME TO THIS CONFERENCE} PRESUMABLY TO SEEK OUT NEWRELATIONSHIPS WITHIN THE MUTUAL FUND INDUSTRY.

*THE SECURITIES AND EXCHANGE COMMISSIONJ AS A MATTER OF POLICYJQISCLAIMS RESPONSIBILITY FOR SPEECHES BY ANY OF ITS COMMISSIONERS.'HE VIEWS EXPRESSED HERIN ARE THOSE OF THE SPEAKER AND DO NOT

. NECESSARILY REFLECT THE VIEWS OF THE COMMISSION.

- 2 -

IN ANY EVENT; r AM PELJr,HTJ:PTO 'RE f"lF.~F. .•'; 1

AND I INTEND TO SPEAK TO YOU THIS MORNING ON A SUBJECT ONWHICH YOU HAVE ASKED FOR AND SHOULD RECEIVE GREATER RESPON-SIBILITY FOR YOUR BUSINESS ACTIVITIES -- INVESTMENT COMPANYADVERTISING.

LAST MONTH~ THE INVESTMENT COMPANY INSTITUTE SENT DAVESILVER TO THE COMMISSION TABLE TO PLEAD YOUR CASE FORREGULATORY REFORM IN THE DISTRIBUTION OF MUTUAL FUND SHARES~PARTICULARLY WITH RESPECT TO INVESTOR COMMUNICATIONS. DAVEABLY EXPRESSED YOUR DISSATISFACTION WITH THE PRESENT REGULATORYSCHEME~ WHICH HE CHARACTERIZED AS "A CONFUSED MASS OF OVER-LAPPING AND SEEMINGLY ARBITRARY RULES." SINCE EACH OF THEAMENDMENTS TO THE SEC's RULES OVER THE PAST FIVE YEARS HASBEEN CHARACTERIZED BY US AS AN EXTENSIVE LIBERALIZATION~DAVE DID NOT ASK FOR ANY FURTHER LIBERALIZATION OF THE RULES.INSTEAD HE ASKED FOR A SYSTEM OF ADVERTISING RESTRICTIONSWHICH WOULD PERMIT MUTUAL FUND PROMOTIONAL LITERATURE TO BECIRCULATED ON THE SAME BASIS AS HARD-CORE PORNOGRAPHY. IHAVE GIVEN THAT PROPOSAL MY ATTENTION~ AND CONCLUDED THATIN VIEW OF THE ADMONITIONS IN THE 1975 ACT AMENDMENTS THAT THECOMMISSION MUST CONSIDER THE EFFECTS OF ITS RULEMAKING ONCOMPETITION~ WE WOULD BE UNABLE TO COUNTENANCE THAT SORT OF ATIE-IN ARRANGEMENT.

'

- 3 -I BELIEVE THAT THE PROBLEMS OF MUTUAL

FUND DISTRIBUTION ARE DIRECTLY RELATED TO THE PROBLEMS OFCAPITAL FORMATION AND THAT THE PROPOSALS WHICH THE leI MADETO THE COMMISSION ON FEBRUARY 9 DESERVE A SERIOUS RESPONSE.WHILE I AM ONLY HERE TO SPEAK FOR MYSELF AND NOT FOR THE COMMIS-SIONJ AS ALL OF YOU KNOWJ I HOPE THAT MY ADDRESS TODAY CANCONTRIBUTE TO A MEANINGFUL DIA~OGUE BETWEEN THE COM-MISSION AND THE INDUSTRY CONCERNING THE EXPENSES OF MUTUALFUND DISTRIBUTION. I WOULD LIKE TO BEGIN BY SETTING FORTHMY UNDERSTANDING OF THE ICI's PROPOSALJ SO THAT YOU CANCORRECT ME IF I MISUNDERSTOOD DAVE SILVER'S PRESENTATION.

THE ICI HAS SUGGESTED THAT THE SEC ADOPT A SINGLEADVERTISING RULE WHICH WOULD REPLACE ALL EXISTING RULES DEAL-ING WITH THE REGULATION OF ADVERTISING OF MUTUAL FUNDS.THE ESSENCE OF THIS PROPOSED RULE WOULD BE THE PROHIBITIONOF FRAUDULENT OR MISLEADING COMMUNICATIONS TO PROSPECTIVEPURCHASERS OF MUTUAL FUNDS' SHARES. As A PART OF THIS PRO-POSED RULEJ THE rcr SUGGE~T~ THAT WE ESTABLISH AN "ADVERTISINGCODE" WHICH WOULD ENUNCIATE THE COMMUNICATIONS WHICH THECOMMISSION FINDS CLEARLY MISLEADING AND WHICH WOULD ESTABLISHA LIMITED NUMBER OF "SAFE HARBOR" EXAMPLESJ PARTICULARLY INTHE AREA OF TABLESJ CHARTS AND OTHER GRAPHIC REPRESENTATIONS.UNDER THE PROPOSALJ ADVERTISEMENTS WOULD INDICATE THENECESSITY FOR OBTAINING A STATUTORY PROSPECTUS BEFORE AFINAL SALE COULD BE CONSUMMATED.

- 4 -ACCORDING TO RESPONSES TO QUESTIONS WHICH I ASKED

DURING THE ICI's PRESENTATION TO THE COMMISSION~ IFCOMMUNICATIONS UNDER THE PROPOSED RULE SATISFY THEADVERTISING CODE INCLUDED WITHIN THE RULE~ THEN THOSECOMMUNICATIONS WOULD BE EXEMPTED FROM THE DEFINITION OFA "PROSPECTUS" AS THAT TERM IS USED IN SECTIONS 5 AND 12OF THE SECURITIES ACT OF 1933. SHOULD ANY COMMUNICATIONSVIOLATE THAT CODE~ THEN SUCH COMMUNICATIONS WOULD REMAINPROSPECTUSES FOR THE PURPOSES OF SECTIONS 5 AND 12.FALSE OR MISLEADING ADVERTISEMENTS WOULD ALSO VIOLATE THEANTI-FRAUD PROVISIONS OF THE SECURITIES LAWS. THE ROLEOF THE COMMISSION'S STAFF AND OF THE NASD IN ADMINISTERINGTHIS PROPOSED NEW RULE WAS LEFT UNCLEAR~ PARTICULARLY WITHREGARD TO WHETHER THERE WOULD BE ANY MECHANISM ESTABLISHEDWHEREBY PARTICULAR ADVERTISEMENTS WOULD BE PRE-CLEAREDBEFORE USE.

IN OUR MASS CONSUMER-ORIENTED SOCIETY~ ADVERTISING HASBECOME INCREASINGLY RESPECTABLE AS A COMMUNICATIONS AS WELLAS A SALES VEHICLE. A VARIETY OF ECONOMIC AND LEGALDEVELOPMENTS HAS PRESUADED THE MUTUAL FUND INDUSTRY THATIT IS BURDENED BY OBSOLETE AND UNNECESSARY RESTRICTIONSON ITS ABILITY TO COMMUNICATE WITH THE PUBLIC~ AS WELL ASSELL ITS PRODUCTS.

- 5 -NET SALES OF MUTUAL FUND SHARES IN JANUARY TOTALED

$172.4 MILLION1 THE LARGEST MARGIN OF SALES OVER REDEMPTIONSIN THREE YEARS1 AND FOR ALL OF 19771 THERE WERE NET SALES OF$373.5 ~ILLION. NEVERTHELESS1 DURING THE FIVE PRECEDINGYEARS1 1972 TO 19761 NET REDEMPTIONS OF MUTUAL FUND SHARESTOTALED $6.1 BILLION. FURTHERI THE RECENT REVERSAL OF THENET REDEMPTION TREND IS DUE IN LARGE PART TO SALES OF MUNICIPALBOND FUNDS. EQUITY FUNDS REMAIN IN THE DOLDRUMS.

I WOULD LIKE TO SEE THE SALES OF EQUITY FUNDS INCREASEI

JUST AS YOU WOULDI BECAUSE THAT WOULD INDICATE THAT NEEDEDCAPITAL INVESTMENT IN OUR PUBLIC CORPORATIONS IS OCCURRING.I AM DISTRESSED THAT THE GOVERNMENTI BY WAY OF MUNICIPAL BONDOFFERINGS OR OTHERWISEI IS BECOMING INCREASINGLY RESPONSIBLEFOR RAISING INVESTMENT CAPITAL. As A COMMISSIONER AT THESEC I IT WOULD BE EASIER TO PRESIDE OVER A HEALTHIER SECURITIESINDUSTRYI THRIVING IN A BETTER ECONOMY. THEREFORE 1 I WISHYOU WELL IN YOUR EFFORTS TO IMPROVE UPON EXISTING MUTUAL FUNDDI-STRIBUTION ARRANGEMENTS. BUTI I AM PERSONALLY SKEPTICALTHAT MORE AGGRESSIVE ADVERTISING WILL SELL YOUR PRODUCTSWHEN THE ECONOMIC INCENTIVES TO BUY THEM ARE LACKING.

- 6 -NEVERTHELESS~ I DO BELIEVE THAT THE MUTUAL FUND

INDUSTRY IS ENTITLED TO COMPETE ON FAIR TERMS WITH OTHERFINANCIAL INSTITUTIONS FOR THE INVESTMENT DOLLAR. INRECENT Y:EARS~MUTUAL FUNDS HAVE EXPERIENCED INCREASEDCOMPETITION FROM OTHER FINANCIAL INSTITUTIONS AND MONEYMANAGERS AS A PART OF A GENERAL INCREASE IN COMPETITIONBETWEEN THE SECURITIES INDUSTRY AND THE BANKING ANDINSURANCE INDUSTRIES. To THE EXTENT THAT SUCH COMPETITORSARE FREE FROM REGULATORY RESTRAINTS AND ARE ABLE TO USEMORE AGGRESSIVE ADVERTISING TECHNIQUES~ THE MUTUAL FUNDINDUSTRY HAS JUSTIFIABLE COMPLAINTS.

By REASON OF THE SECURITIES ACT AMENDMENTS OF 1975AND RECENT DECISIONS IN VARIOUS AREAS~ THE COMMISSIONMUST INCREASINGLY CONSIDER THE ANTI-COMPETITIVE ASPECTS

\

OF OUR RULES~ AND THE BURDEN OF NEW RULES ON COMPETITION.IN THE CONTEXT OF SUCH CONCERNS~ THE COMMISSION SHOULDCONSIDER CAREFULLY THE EFFECT OF ADVERTISING REGULATIONUPON THE ABILITY OF NEW MUTUAL FUNDS TO ENTER THE MARKET-pLACE~ THE ABILITY OF MUTUAL FUNDS TO COMPETE WITH OTHERFINANCIAL INSTITUTIONS FOR INVESTMENT DOLLARS~ AND THEABILITY OF SMALL FUNDS TO SURVIVE IN COMPETITION WITHLARGER FUNDS.

- 7 -ANOTHER FACTOR WHICH HAS AFFECTED THE IMPORTANCE

WHICH THE MUTUAL FUND INDUSTRY ATTACHES TO ADVERTISINGIS THE RELATIVELY RECENT INCREASE IN THE INDUSTRY'SUSE OF NO-LOAD. IN 1977} NO-LOAD SALES ACCOUNTED FORq8% OF ALL SALES (INCLUDING MONEY MARKET SALES)} ASCOMPARED WITH ABOUT 10% IN 1970. THE INCREASEIN THE ROLE OF NO-LOAD UNDOUBTEDLY IS RELATED TO THEDISCONTINUANCE OF THE USE OF "SOFT DOLLARS" OF BROKERAGEALLOCATION TO SELL THEIR SHARES.

THERE ALSO HAVE BEEN CHANGES IN THE LEGAL CLIMATESURROUNDING THE REGULATION OF ADVERTISING IN GENERAL.SEVERAL RECENT SUPREME COURT CASES DEALING WITH THEAPPLICABILITY OF THE FIRST AMENDMENT TO COMMERCIAL SPEECH}INCLUDING ADVERTISEMENT~HAVE HELD THAT SUCH SPEECH ISNO LONGER WHOLLY OUTSIDE THE PROTECTION OF THE FIRSTAMENDMENT. NEVERTHELESS} COMMERCIAL SPEECH MAY BEREGULATED BY THE GOVERNMENT IF SUCH REGULATIONS AREREASONABLY RELATED TO VALID GOVERNMENTAL OBJECTIVES.FURTHER} THE FIRST AMENDMENT DOES NOT PROVIDE LICENSEFOR COMMERCIAL SPEECH WHICH IS FALSE} MISLEADING ORDECEPTIVE.

IN 1976} THE SUPREME COURT IN VIRGINIA STATE BOARDOF PHARMACY V. VIRGINIA CONSUMERS COUNCIL} 425 U.S. 748(1976)} INVALIDATED A VIRGINIA STATUTE PROHIBITING PRICEADVERTISEMENTS BY PHARMACISTS OF PRESCRIPTION DRUGS.

- 8 -THE COURT REFERRED TO A FUNDAMENTAL RIGHT OF CONSUMERS TORECEIVE INFORMATION AND TO THE ESSENTIAL ROLE OF ADVERTISINGIN PROVIDING INFORMATION NECESSARY TO THE FUNCTIONING OFAN ECONOMY SUCH AS OURS. THE COURT DID NOT~ HOWEVER~APPLY ITS TRADITIONAL TEST UNDER THE FIRST AMENDMENTACCORDING TO WHICH ANY GOVERNMENTAL PROHIBITION ON SPEECHIS INVALID UNLESS SUPPORTED BY A "COMPELLING INTEREST".RATHER~ THE COURT UTILIZED A BALANCING TEST WHEREBY THEREGULATION WAS EXAMINED TO DETERMINE WHETHER THE STATE'SLEGITIMATE REGULATORY OBJECTIVES COULD BE ACHIEVED WITHLESS INFRINGEMENT OF--FIRSTAMENDMENT Rlr,HTS.

LAST YEAR~ THE SUPREME COURT~ IN BATES V. STATE BAROF ARIZONA~ U.S. ~ 97 S.CT. 2691 (1977) RULEDTHAT A STATE COULD NOT IMPOSE A BLANKET SUPPRESSION OFADVERTISEMENT OF ROUTINE LEGAL SERVICES. THE COURT FOUNDIT "PECULIAR TO DENY THE CONSUMER~ ON THE GROUND THEINFORMATION IS INCOMPLETE~ AT LEAST SOME OF THE RELEVANTINFORMATION NEEDED TO REACH AN INFORMED DECISION."

PROFESSOR DAVID RATNER RECENTLY PREPARED A MEMORANDUMFOR THE ICI ARGUING THAT THE LINE OF CASES TYPIFIED BYVIRGINIA PHARMACY AND BATES CONSTITUTIONALLY LIMITS THECOMMISSION'S AUTHORITY TO REGULATE MUTUAL FUND ADVERTISING.

- 9 -ALTHOUGH PROFESSOR RATNER'S ARGUMENT HAS A SUPERFtCIALAPPEAL~ ITS LOGICAL CONCLUSION IS A HOLDING THAT SECTION 5 OFTHE 1933 ACT~ AS APPLIED TO INVESTMENT COMPANIES IS UNCONSTI-TUTIONAL UNDER THE FIRST AMENDMENT. I DOUBT THE SUPREME COURTWOULD SO HOLD. IN 'EACH OF THE CASES RELIED UPON BY PROFESSORRATNER~ THE EFFECT OF THE STATUTE OR REGULATION INVALIDATEDWAS TO LIMIT OR BAR THE INFORMATION WHICH COULD BE PRESENTEDTO CONSUMERS~ WHILE SECTION 5 REQUIRES EXPANSIVE DISCLOSURE.

NEVERTHELESS~ THE RECENT AWARENESS THAT ADVERTISINGIS ENTITLED TO SOME CONSTITUTIONAL PROTECTION UNDER THEFIRST AMENDMENT SHOULD INFLUENCE THE COMMISSION'S RULEMAKING.I BELIEVE WE WILL BE SENSITIVE TO THE RULING BY THE SUPREMECOURT THAT REGULATION OF ADVERTISING SHOULD BE ACCOMPLISHED~WHERE POSSIBLE~ IN THE MANNER THAT LEAST INFRINGES UPONTHE RIGHTS OF CONSUMERS TO RECEIVE INFORMATION~ WHILE ATTHE SAME TIME~ WE ATTEMPT TO ACHIEVE OUR LEGITIMATEREGULATORY OBJECTIVE OF PROTECTING INVESTORS FROM MISLEADINGINFORMATION IN CONNECTION WITH OFFERINGS OF SECURITIES.

THE COMMISSION IS WILLING TO CONSIDER FULLY ANDSERIOUSLY~ THE ICI's PROPOSAL FOR CHANGE IN THE REGULATIONOF MUTUAL FUND ADVERTISING. BUT ANY PRESCRIPTIONS FORREFORM BY SEC RULEMAKING MUST TAKE INTO CONSIDERATIONTHE LIMITATIONS OF THE EXISTING STATUTORY FRAMEWORK ANDTHE CONCERN OF THE COMMISSION FOR THE PROTECTION OFINVESTORS -- THE POLICY WHICH UNDERLIES THAT STATUTORYFRAMEWORK.

- 10'-I AM SURE YOU ARE AS FAMrLIAR.AS I' AM WITH HOW'THE

COMPLEXITIES OF PROHIBITION AND DEFIN1TION IN THE SECURITIESACT OF 1933 rMPACT UPON MUTUAL FUND ADVERTISING. I WOULDLIKE TO REVIEW WITH YOU BRIEFLY THOSE RELEVANT PROVISIONSOF OUR STATUTES TO REMIND YOU THAT WE ARE NOT WRITlNG ONA CLEAN SLATE. HOWEVER INGENIOUS THE COMMISSION AND ITSSTAFF MAY BE" ACHIEVI,NG GREATER ADVERTISING FREEDOM WITHINTHE CONFINES OF SECTION 5 IS AN ELUSIVE ENDEAVOR.

UNDER SECTION 5(A) OF THE SECURITIES ACT OF 19331 AMUTUAL FUND MAY NOT OFFER ANY SHARES TO THE PUBLIC UNLESSIT HAS FILED A REGISTRATION STATEMENT WITH THE COMMISSION"OR SELL ANY SHARES UNLESS THE REGISTRATION STATEMENT HASBEEN DECLARED EFFECTIVE. THE REGISTRATION STATEMENT OF AMUTUAL FUND MUST CONTAIN SUCH INFORMATION AS IS SPECIFIEDIN SECTION 8(B) OF THE INVESTMENT COMPANY ACT. UNDERSECTION 5(B) OF THE SECURITIES ACT A MUTUAL FUND" INOFFERING OR SELLING ITS SHARES MAY NOT USE ANY PROSPECTUSWHICH DOES NOT CONTAIN ALL THE INFORMATION SPECIFIED INSECTION 10(A) OF THE ACT.

ALTHOUGH AN ADVERTISEMENT WOULD NOT BE REGARDED AS A"PROSPECTUS" BY A CONSUMER UNTUTORED IN THE SECURITES LAWS" .THE DEFINITIONAL SECTIONS OF THE SECURITIES ACT DO SO.SECTION 2(10) DEFlNES THE TERM "'PROSPECTUS" TO lNCLUDE ANYNOTICE" CIRCULAR" ADVERTrSEMENT" LETTER OR C:OMMUtUCATlONWHICH OFFERS ANY S(CURrTY FOR SALE.

- 11 -THEREFORE~ UNLESS OTHERWISE EXCEPTED FROM THAT DEFINITION~SUCH COMMUNICATIONS MUST MEET THE REQUIREMENTS OF A SECTION 10(A)STATUTORY PROSPECTUS.

NEVERTHELESS~ ABBREVIATED COMMUNICATIONS TO PROSPECTIVEPURCHASERS ARE PERMITTED. SECTION 10(B) OF THE SECURITIESACT AUTHORIZES THE COMMISSION BY RULE TO ALLOW THE USE OFPROSPECTUSES WHICH SUMMARIZE OR OMIT THE INFORMATION CONTAINEDIN A FULL SECTION 10(A) PROSPECTUS. THE TYPE OF COMMUNICATIONSPECIFIED IN EXISTING RULE 434A IS A SUMMARY PROSPECTUS.THE TYPE OF COMMUNICATION SUGGESTED IN PROPOSED RULE 434DIS AN OMITTING PROSPECTUS.

SECTION 2(10)(A) OF THE SECURITIES ACT EXCEPTS FROMTHE TERM "PROSPECTUS" COMMUNICATIONS WHICH ARE ACCOMPANIEDOR PRECEDED BY A FULL SECTION 10(A) PROSPECTUS. HOWEVER~SUCH SALES LITERATURE IS STILL SUBJECT TO THE ANTI-FRAUDPROVISIONS OF THE SECURITIES LAWS. SECTION 2(10)(B)~EXCEPTS FROM THE TERM "PROSPECTUS" CERTAIN LIMITEDCOMMUNICATIONS~ COMMONLY KNOWN AS "TOMBSTONE ADS".IN THE CASE OF REGISTERED INVESTMENT COMPANIES~ RULE 134EXPANDS THE TYPE AND AMOUNT OF INFORMATION INCLUDABLE INTOMBSTONE ADS 'BEYOND THAT. PERMITTED TO'OTHER' ISSUERSi

- 12 .You ARE WELL AWARE THAT THERE ARE POTENTIAL ADVERSE MONETARY

CONSEQUENCES FOR VIOLATIONS OF THE SECURITIES LAWS. INADDITION TO IMPLIED RIGHTS OF ACTION UNDER THE ANTI-FRAUDPROVISIONS OF THE SECURITIES EXCHANGE ACT OF 1934~SECTION 12(2) OF THE SECURITIES ACT AFFORDS A PRIVATERIGHT OF ACTION TO INVESTORS WHO HAVE PURCHASED A SECURITYPURSUANT TO A FALSE OR MISLEADING PROSPECTUS OR ORALCOMMUNICATION.

THE STATEMENT OF POLICY WHICH HAS BECOME SUCH ANANATHEMA TO THE MUTUAL FUND INDUSTRY IS ACTUALLY A SAFEHARBOR FOR THE PREPARATION OF SALES LITERATURE. UNDERSECTION 24(B) OF THE INVESTMENT COMPANY ACT~ A MUTUALFUND IS REQUIRED TO FILE WITH THE COMMISSION COPIES OFANY ADVERTISEMENT OR OTHER SALE LITERATURE WITHIN 10 DAYSAFTER SUCH LITERATURE IS USED. THE COMMISSION DOES NOTDECLARE THE SALES LITERATURE EFFECTIVE OR OTHERWISEREVIEW IT EXCEPT FOR AFTER THE FACT COMPLIANCE WITH OURANTI-FRAUD PROVISIONS.

SINCE 1950~ HOWEVER~ THE COMMISSION HAS PROMULGATEDA STATEMENT OF POLICY ON THE SALES LITERATURE OF MUTUALFUNDS. IT WAS ISSUED "SO THAT ISSUERS~ UNDERWRITERS ANDDEALERS MAY UNDERSTAND CERTAIN OF THE TYPES OF ADVERTISINGAND SALES LITERATURE WHICH THE COMMISSION CONSIDERS MAYBE VIOLATIVE OF THE STATUTORY STANDARDS~. THE STATEMENTOF POLICY CONTAINS TWO TYPES OF GUIDELINES BY EXAMPLE:(1) TYPES OF MATERIALLY MISLEADING STATEMENTS; AND (2)APPROVED CHARTS OR TABLES WHICH ARE NOT MISLEADING.

- 13 -THE NASD AS PART OF ITS SELF-REGULATORY FUNCTION1 ADMINISTERS

THE SEC's STATEMENT OF POLICY AND PROVIDES INTERPRETATIVE ADVICETO ITS MEMBERS. THROUGH THE USE OF INFORMAL PRE-CLEARANCEPROCEDURES I THE NASD HAS TRANSFORMED THE SEC's STATEMENT OFPOLICY INTO A DISCLOSURE STANDARD FOR NASD MEMBERS. THECOMMISSION WILL NOT ORDINARILY PRE-CLEAR SALES LITERATURE OFMUTUAL FUNDS TO DETERMINE WHETHER SUCH LITERATURE COMPLIESWITH OUR STATEMENT OF POLICY.

IF I CORRECTLY UNDERSTAND THE PROPOSAL MADE TO US BY THEICI LAST MONTH1 THE STATEMENT OF POLICY WOULD BE REPLACED BYAN INDUSTRY DRAFTED CODE OF ADVERTISING REGULATIONS1 WHICHWOULD BE SELF-EXECUTING. PURSUANT TO SECTION 2(10) (B)ADVERTISEMENTS WHIGH COMPLY WITH THE CODE WOULD BE EXEMPT FROMTHE DEFINITION OF "PROSPECTUS". ANY ADVERTISEMENT WHICH DIDNOT COMPLY WITH THE CODE WOULD BE AN ILLEGAL PROSPECTUS1 ANDVIOLATE SECTION 5. PRESENT PROVISIONS OF RULE 134 WHICH PERMITSMUTUAL FUNDS GREATER LATITUDE IN TOMBSTONE ADS THAN OTHER ISSUERSHAVE WOULD PRESUMABLY BE REPEALED. WHETHER ANY SECTION lOeB)PROSPECTUS I AS CONTEMPLATED BY RULE 434A OR PROPOSED RULE 434DWOULD BE UTILIZED IN THE ICI PROPOSAL IS UNCLEAR TO ME.

Now THAT I HAVE FINALLY FOUND MY WAY THROUGH THAT MAZE OFINTRICATE STATUTORY ANALYSIS1 I AM NOT CERTAIN WHETHER THEREARE ANY OPEN SPACES BEYOND THE HEDGES. I AM REMINDED BY THEPROGNOSTICATION OF BAYLESS MANNING THAT WE ARE SUFFERING FROMTOO MUCH LAW1 WHICH HE CALLED "HYPERLEXIS ••• A FORM OF SOCIALILLNESS THAT HAS A LITERALLY FATAL POTEN~IAL FOR THE OPERATIONOF THE AMERICAN POLITICAL SYSTEM." 33 BUSINESS LAWYER 436 (1977).

- 14 -HOWEVER~ IF YOU ARE STILL WITH ME~ I WILL TRY TO TAKE YOUTHROUGH THOSE OPTIONS WHICH SEEM TO ME TO BE OPEN TO US.

FIRST~ THERE IS THE ALTERNATIVE PRESENTED BY THE ICI'sPROPOSAL WHICH I HAVE BEEN DISCUSSING. WE NEED MORE SPECIFICITY.WITH REGARD TO THIS PROPOSAL. I HAVE ALREADY MENTIONED THENEED TO UNDERSTAND WHAT SHOULD BE THE ROLE OF THE NASD ANDTHE COMMISSION STAFF~ AND WHETHER AND TO WHAT EXTENT THERESHOULD BE A PRE-CLEARANCE MECHANISM. IN ADDITION~ WE NEEDTO UNDERSTAND THE ICI's POSITION WITH REGARD TO THE CIRCUMSTANCESUNDER WHICH FUNDS COULD INCUR LIABILITY TO INVESTORS AS ARESULT OF MISLEADING COMMUNICATIONS TO POTENTIAL PURCHASERS.WOULD NEGLIGENT VIOLATIONS OF THE INDUSTRY ADVERTISING CODEBE ACTIONABLE? IF SO~ UNDER WHAT SECTIONS OF THE SECURITIESLAWS? WHAT LEGAL CONSEQUENCES WOULD FLOW AS THE RESULT OF ACOMMUNICATION WHICH~ WHILE MATERIALLY MISLEADING~ DOES NOT VIOLATEANY PARTICULAR PROVISION OF THE ADVERTISING CODE? WOULDDIRECTORS BE LIABLE FOR DEFECTIVE ADVERTISEMENTS? HowWOULD COMMUNICATIONS PURSUANT TO THE ADVERTISING CODEINTERFACE WITH A SECTION ID(A) STATUTORY PROSPECTUS?

IN THE EVENT YOU FIND THESE QUESTIONS TOO HARD TOANSWERJ LET US TURN TO A SECOND ALTERNATIVEJ -- THEUTILIZATION OF AN OMITTING PROSPECTUS AS PROPOSED BYRULE 434DJ EITHER AS IT IS CURRENTLY CONTEMPLATEP OR WITHMODIFICATIONS. SOME OF THE PROVISIONS OF THAT PROPOSEDRULE HAVE RECEIVED ~ SIGNIFICANT AMOUNT OF CRITICISM.

- 15 -I HAVE EVEN LESS RESPONSIBILITY FOR WHAT THE COMMISSIONSAID IN PROPOSING RULE 434D THAN THE COMMISSION HAS FOR WHATI SAY HERE TODAYJ AND AS ALL OF YOU KNOWJ I MUST DISCLAIMANY COMMISSION RESPONSIBILITY FOR ANY OF THESE REMARKS.ACCORDINGLYJ I WILL ADMIT TO MY PERSONAL OPINION THAT SOMEOF THE CRITICAL COMMENT OF RULE 434D IS JUSTIFIED. THE RULE'S.FAILURE TO PERMIT THE USE OF RADIO AND TELEVISION ADVERTISEMENTSSHOULD BE RECONSIDERED. I AM DUBIOUS ABOUT THE WISDOM OF THE600 WORD LIMITATION. ON THE OTHER HANDJ THE LIMITATION OFUSE OF ADVERTISEMENTS UNDER THE RULE IN DIRECT MAILINGS SEEMSVALID. THE VERY PURPOSE OF THE RULE WOULD BE TO PERMITADVERTISING IN A SITUATION IN WHICH THE USE OF A FULL PROSPECTUSIS NOT FEASIBLE. SUCH A SITUATION EXISTS IN THE CASE OFNEWSPAPER ADVERTISEMENTJ WHERE IT IS NOT POSSIBLE TO SEND AFULL PROSPECTUS TO ALL SUBSCRIBERS OR PURCHASERS OF THENEWSPAPER AND NOT ECONOMICAL TO PUBLISH A FULL PROSPECTUS INTHE NEWSPAPER ITSELF. IN A DIRECT MAILINGJ SALES LITERATUREIS ALREADVALLOWEDJ WHEN ACCOMPANIED OR PRECEDED BY A FULLSTATUTORY PROSPECTUS.

A THIRD ALTERNATIVE AVAILABLE TO THE COMMISSION IS TOREVISE RULE 134 TO PROVIDE THAT MUTUAL FUNDS MAY USE ANYINFORMATION IN THEIR ADVERTISEMENTS WHICH IS NOT MATERIALLYFALSE OR MISLEADING. ADs WHICH ARE NOT FALSE OR MISLEADINGWOULD BE EXCEPTED FROM THE DEFINITION OF A PROSPECTUS FORALL PURPOSESJ WHILE MISLEADING ADS WOULD REMAIN PROSPECTUSESFOR THE PURPOSES OF CIVIL LIABILITY UNDER SECTION 12(2).OF COURSEJ THE GENERAL ANTI-FRAUD PROVISIONS WOULD ALSOAPPLY.

- 16-IF FUNDS WANTED TO USE SIMPLE TOMBSTONE ADS SUCH AS THOSEPERMITTED FOR OPERATING COMPANIES~ THEN SUCH ADS COULDSTILL BE EXCEPTED FROM THE TERM "PROSPECTUS" FOR ALLPURPOSES. WHILE THIS ALTERNATIVE SOUNDS MUCH LIKE THEICI's PROPOSAL~ IT IS MORE RADICAL. THE STATEMENT OFPOLICY WOULD BE RESCINDED AND IT WOULD NOT BE REPLACED BY

...ANY NEW SAFE HARBORS~ SUCH AS AN INDUSTRY ADVERTISING CODE.EACH FUND WOULD HAVE TO DETERMINE FOR ITSELF WHETHER ITSADVERTISEMENTS ARE TRUTHFUL OR DECEPTIVE~ AND THEN BE WILLINGTO DEFEND THAT DETERMINATION IN ANY LITIGATION WHICH MIGHTQUESTION IT.

A FOURTH POSSIBLE ALTERNATIVE IS LEGISLATIVE CHANGE~WHICH MAY BE REQUIRED TO ACHIEVE YOUR OBJECTIVES. SUCHLEGISLATION COULD AMEND THE SECURITIES ACT~ PROVIDE EXEMPTIONSTO SECTIONS 2(10) AND 5 FOR MUTUAL FUND ADVERTISING AND SALES~AND SUBJECT THEM TO SOME ALTERNATIVE DISCLOSURE SCHEME.ALTHOUGH I HAVE NO SPECIFIC IDEAS ABOUT THE FORM OR SUBSTANCEOF SUCH LEGISLATION TO GIVE YOU TODAY~ IT IS AN ALTERNATIVEWHICH IS WORTH YOUR CONSIDERATION.

THE FINAL ALTERNATIVE WHICH r WILL MENTION IS TO RETAINTHE STATUS QUO. COMMENTS ON PROPOSED RULE 434D AND THE ICI'sRECENT PRESENTATION INDICATE THAT ADVERTISING UNDER THEEXISTING TOMBSTONE RULE~ AS EXPANDED~ IS EXTENSIVE. FEARWAS EVEN EXPRESSED THAT ADOPTION OF RULE 434D MIGHT LEAD TOMORE RESTRICTIVE INTERPRETATIONS OF WHAT IS PERMITTED BYRULE 134. ARE YOUR SALES ACTIVITIES REALLY HAMPERED BYRULE 134 IN ITS PRESENT FORM~ OR BY ECONOMIC CONDITIONS?

- ~

- 17 -To THE ~XTENT THAT EXPANSION OF THE SCOPE OF ADVERTISINGWILL B~ ACCOMPANIED BY A CORRESPONDING EXPANSION OFPOSSIBLE LIABILITYI SOME OF THE INDUSTRY MIGHT PREFERTHE RELATIVE SAFETY OF EXISTING REGULATION.

My PERSONAL INCLINATIONI ALTHOUGH I AM OPEN TOCONTRARY PERSUASIONI IS THAT MUTUAL FUNDS SHOULD BE ALLOWEDFREE EXPRESSION IN THEIR ADVERTISEMENTS AND SALES LITERATUREBUlJ BE LIABLE TO INVESTORS IN THE EVENT THAT THEIRCOMMUNICATIONS ARE MISLEADING. IN ANY EVENT I I WHOLE-HEARTEDLY CONCUR WITH YOUR POSITION THAT ANY REGULATORYCHANGES SHOULD SERVE TO SIMPLIFY RATHER THAN TO COMPLICATEFURTHER THE EXISTING SCHEMEl BOTH FROM THE POINT OF VIEWOF THE INDUSTRY AND THE COMMISSION'S STAFF.

IT IS OFTEN REMARKED THAT IT TAK~MORE TIME TO WRITEA SHORT MEMORANDUM THAN A LONG ONE. SIMILARLY IT IS HARDERAND MORE TIME CONSUMING TO EFFECTIVELY REGULATE WITHSIMPLE RATHER THAN COMPLEX LAWS. IT WOULD PLEASE MEGREATLY TO DISCOVER THAT THE INDUSTRY AND THE COMMISSIONHAVE THE WILL AND THE SKILL TO DE-REGULATE INVESTMENTCOMPANIESI WITH RESPECT TO ADVERTISING RESTRICTIONS ANDMANY OTHER MATTERS.

You MUST DECIDEI HOWEVER I THAT YOU ARE WILLING TO PAYTHE PRICE FOR FREEDOM FROM GOVERNMENT INTERFERENCE IN YOURBUSINESS DECISIONS. You MUST BE READY TO ACCEPT THEGREATER RESPONSIBILITY AND POSSIBLE LIABILITY WHICH DE-REGULATION WOULD BRING.

- 18 -NEITHER THE"GOVERNMENT NOR THE INDUSTRY ARE IN A POSITIONTO TOLERATE DECREASED INVESTOR PROTECTION OR CONFIDENCEUNDER THE GUISE OF REFORM.