[Federal Register: October 3, 2006 (Volume 71, Number 191)]
[Rules and Regulations]
[Page 58257-58273]
[DOCID:fr03oc06-8]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-27504; File No. S7-06-06; File No. 4-512]
RIN 3235-AJ51

Mutual Fund Redemption Fees

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is adopting amendments to a rule under the Investment Company
Act. The rule, among other things, requires most open-end investment
companies (``funds'') to enter into agreements with intermediaries,
such as broker-dealers,

that hold shares on behalf of other investors in so called ``omnibus
accounts.'' These agreements must provide funds access to information
about transactions in these accounts to enable the funds to enforce
restrictions on market timing and similar abusive transactions. The
Commission is amending the rule to clarify the operation of the rule
and reduce the number of intermediaries with which funds must negotiate
shareholder information agreements. The amendments are designed to
reduce the costs to funds (and fund shareholders) while still achieving
the goals of the rulemaking.

DATES: Effective Date: December 4, 2006.
    Compliance Dates: Section III of this Release contains more
information on applicable compliance dates.

FOR FURTHER INFORMATION CONTACT: Thoreau Bartmann, Staff Attorney, or
C. Hunter Jones, Assistant Director, Office of Regulatory Policy (202)
551-6792, Division of Investment Management, Securities and Exchange
Commission, 100 F Street, NE., Washington, DC 20549-5041.

SUPPLEMENTARY INFORMATION: The Commission today is adopting amendments
to rule 22c-2 \1\ under the Investment Company Act of 1940 \2\ (the
``Investment Company Act'' or the ``Act'').\3\

    \1\ 17 CFR 270.22c-2.
    \2\ 15 U.S.C. 80a.
    \3\ Unless otherwise noted, all references to statutory sections
are to the Investment Company Act, and all references to ``rule 22c-
2,'' ``the rule,'' or any paragraph of the rule will be to 17 CFR
270.22c-2.
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Table of Contents

I. Background
II. Discussion
    A. Shareholder Information Agreements
    1. Small Intermediaries
    2. Intermediary Chains
    3. Effect of Lacking an Agreement
    B. Operation of the Rule
    C. Redemption Fees
III. Compliance Dates
IV. Cost-Benefit Analysis
V. Consideration of Promotion of Efficiency, Competition and Capital
Formation
VI. Paperwork Reduction Act
VII. Final Regulatory Flexibility Analysis
VIII. Statutory Authority
Text of Amended Rule

I. Background

    On March 11, 2005, the Commission adopted rule 22c-2 under the
Investment Company Act to help address abuses associated with short-
term trading of fund shares.\4\ Rule 22c-2 provides that if a fund
redeems its shares within seven days,\5\ its board must consider
whether to impose a fee of up to two percent of the value of shares
redeemed shortly after their purchase (``redemption fee'').\6\ The rule
also requires such a fund to enter into agreements with its
intermediaries that provide fund management the ability to identify
investors whose trading violates fund restrictions on short-term
trading (``shareholder information agreements'').\7\
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    \4\ See Mutual Fund Redemption Fees, Investment Company Act
Release No. 26782 (Mar. 11, 2005) [70 FR 13328 (Mar. 18, 2005)]
(``Adopting Release'').
    \5\ Because the large majority of funds redeem shares within
seven days of purchase, the practical effect of rule 22c-2, and
these amendments, would be to require most funds to comply with the
rule's requirements. Therefore, throughout this Release we may
describe funds as being ``required to comply'' with a provision of
the rule, when the actual requirement only applies if a fund redeems
its shares within seven days. A fund that does not redeem its shares
within seven days would not be required to comply with those
provisions of rule 22c-2.
    \6\ Rule 22c-2(a)(1). Under the rule, the board of directors
must either (i) approve a fee of up to 2% of the value of shares
redeemed, or (ii) determine that the imposition of a fee is not
necessary or appropriate. Id. A board, on behalf of the fund, may
determine that the imposition of a redemption fee is unnecessary or
inappropriate because, for example, the fund is not vulnerable to
frequent trading or the nature of the fund makes it unlikely that
the fund would be harmed by frequent trading. Indeed, a redemption
fee is not the only method available to a fund to address frequent
trading in its shares. As we have stated in previous releases, funds
have adopted different methods to address frequent trading,
including: (i) Restricting exchange privileges; (ii) limiting the
number of trades within a specified period; (iii) delaying the
payment of proceeds from redemptions for up to seven days (the
maximum delay permitted under section 22(e) of the Act); (iv)
satisfying redemption requests in-kind; and (v) identifying market
timers and restricting their trading or barring them from the fund.
See Adopting Release, supra note 4, at n.9; Disclosure Regarding
Market Timing and Selective Disclosure of Portfolio Holdings,
Investment Company Act Release No. 26287 (Dec. 11, 2003) [68 FR
70402 (Dec. 17, 2003)] at text preceding and following n.14.
    \7\ Under the rule, the fund (or its principal underwriter) must
enter into a written agreement with each of its financial
intermediaries under which the intermediary agrees to (i) provide,
at the fund's request, identity and transaction information about
shareholders who hold their shares through an account with the
intermediary, and (ii) execute instructions from the fund to
restrict or prohibit future purchases or exchanges. The fund must
keep a copy of each written agreement for six years. Rule 22c-
2(a)(2), (3).
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    After hearing concerns about the operation of the information
sharing provisions of the rule from fund management companies, in March
of this year we proposed amendments that would reduce the costs of
compliance and clarify the rule's application in certain
circumstances.\8\ The amendments are described in more detail below. We
received 32 comment letters on the proposed amendments.\9\ Most
commenters supported the proposal. Today we are adopting those
amendments substantially as proposed, with some changes that reflect
the comments we received.
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    \8\ See Mutual Fund Redemption Fees, Investment Company Act
Release No. 27255 (Feb. 28, 2006) [71 FR 11351 (Mar. 7, 2006)]
(``2006 Proposing Release'').
    \9\ Comment letters on the 2006 Proposing Release are available
in File No. S7-06-06, which is accessible at http://www.sec.gov/rules/proposed/s70606.shtml.
 Comment letters on the 2005 adoption

are available in File No. S7-11-04, which is accessible at http://www.sec.gov/rules/proposed/s71104.shtml.
 References to comment

letters are to letters in those files.
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II. Discussion

A. Shareholder Information Agreements

    The amendments to rule 22c-2 we are adopting today (i) limit the
types of intermediaries with which funds must enter into shareholder
information agreements, (ii) address the rule's application when there
are chains of intermediaries, and (iii) clarify the effect of a fund's
failure to obtain an agreement with any of its intermediaries.
1. Small Intermediaries
    Rule 22c-2 prohibits a fund from redeeming shares within seven days
unless, among other things, the fund enters into written agreements
with its financial intermediaries (such as broker-dealers or retirement
plan administrators) that hold shares on behalf of other investors.\10\
Under those agreements, the intermediaries must agree to provide, at
the fund's request, shareholder identity (i.e., taxpayer identification
number or ``TIN'' \11\) and transaction information,\12\ and carry out

instructions from the fund to restrict or prohibit further purchases or
exchanges by a shareholder (as identified by the fund) who has engaged
in trading that violates the fund's frequent trading (e.g. market
timing) policies.\13\ We designed this provision to enable funds to
obtain the information that they need to monitor short-term trading in
omnibus accounts and enforce their market timing policies.
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    \10\ Rule 22c-2(a)(2). The rule excepts a fund from the
requirement to enter into written agreements if, among other things,
the fund ``affirmatively permits short-term trading of its
securities.'' See rule 22c-2(b)(3). ``Financial intermediary'' is
defined in rule 22c-2(c)(1).
    \11\ Some commenters noted that in the case of foreign
shareholders, TINs may not always be available, and suggested that
the rule permit alternate identifiers in those circumstances. See
Comment Letter of the Investment Company Institute (``ICI'') (Apr.
10, 2006). In order to accommodate the use of alternative
identifiers in those circumstances, we have revised the rule to
allow for the use of Individual Taxpayer Identification Numbers
(``ITINs'') or other government issued identifiers to identify
foreign shareholders if a TIN is unavailable. See rule 22c-
2(c)(5)(i).
    \12\ One comment letter submitted after the adoption of rule
22c-2 expressed concern that the rule's contract provision,
requiring that agreements with intermediaries mandate the disclosure
of shareholder information at the fund's request, conflicts with
Commission rules governing proxy solicitations. See Comment Letter
of the American Bankers Assoc. (June 6, 2005). The Commission's
proxy solicitation rules are set forth in Regulation 14A under the
Securities Exchange Act of 1934, 17 CFR 240.14a-1 to 14b-2. The
proxy rules govern the disclosure of information in the context of
proxy solicitations, and do not prohibit banks, broker-dealers and
other intermediaries from complying with agreements entered under
rule 22c-2. See 2006 Proposing Release, supra note 8, at n.17.
    \13\ See rule 22c-2(c)(5) (defining ``shareholder information
agreement,'' which is discussed further in Section II.B below).
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    After we adopted the rule in 2005, many fund managers expressed
concern that the rule would require them to review a large number of
their shareholder accounts in order to determine which shareholders are
``financial intermediaries'' as defined under the rule.\14\ They noted
that, because the definition encompassed any entity that holds
securities in nominee name for other investors, it would include, for
example, a small business retirement plan that holds mutual fund shares
on behalf of only a few employees and that may not identify itself as a
financial intermediary to the fund. These commenters emphasized that
the task of identifying these intermediaries, as well as negotiating
agreements with them, would be costly and burdensome.
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    \14\ See, e.g., Comment Letter of OppenheimerFunds, Inc. (May 9,
2005).
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    To address these concerns, earlier this year we proposed to narrow
the scope of the rule by excluding from the definition of ``financial
intermediary'' those intermediaries that the fund treats as individual
investors for purpose of the fund's frequent trading policies. Our
proposal was premised on the understanding that when a fund places
restrictions on transactions at the intermediary level (i.e., when the
fund treats the intermediary itself as an individual investor), the
fund is unlikely to need data about frequent trading by individual
shareholders who hold shares through that intermediary, because abusive
short-term trading by the individual shareholders holding through the
omnibus account would ordinarily trigger application of those policies
to the intermediary's trades.\15\ Therefore, transparency regarding
underlying shareholder transactions executed through these accounts
seemed unnecessary to achieve the goals of the rule. We believed that
this new approach would substantially eliminate the need for funds to
devote resources to identifying intermediaries, because the funds will
have already identified the relevant intermediaries in the course of
administering their policies on short-term trading. Commenters agreed
with our analysis and urged that we adopt the amendments.\16 \
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    \15\ A fund typically exempts from its frequent trading policies
the transactions of an intermediary that holds fund shares, on
behalf of its customers, in an omnibus account with the fund. See,
e.g., Mandatory Redemption Fees For Redeemable Fund Securities,
Investment Company Act Release No. 26375A, at text accompanying n.
39 (Mar. 5, 2004) [69 FR 11762 (Mar. 11, 2004)] (``2004 Proposing
Release''). The fund exempts the intermediary because the daily
changes in the intermediary's position, on behalf of its various
customers' purchases and redemptions, result in a single purchase or
redemption each day in the intermediary's omnibus account. If the
intermediary were not exempt, its daily net trades would likely
subject it to redemption fees or trading limitations. See The
Coalition of Mutual Fund Investors, An Evaluation of the Redemption
Fee and Market Timing Policies of the Largest Mutual Fund Groups
(May 5, 2005) (available at http://www.investorscoalition.com/CMFIMarketTimingStudy05.pdf.
).

    \16\ See, e.g., Comment Letter of the Investment Company
Institute (Apr. 10, 2006); Comment Letter of Charles Schwab & Co.,
Inc. (Apr. 10, 2006).
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    Today we are amending the definition of ``financial intermediary''
in rule 22c-2 to exclude from that definition any entity that the fund
treats as an ``individual investor'' for purposes of the fund's
policies intended to eliminate or reduce dilution of the value of fund
shares, i.e., frequent trading and redemption fee policies.\17\ As a
result, if a fund, for example, applies a redemption fee or exchange
limits to transactions by a retirement plan (an intermediary) rather
than to the purchases and redemptions of the employees in the plan,
then the plan would not be considered a ``financial intermediary''
under the rule, and the fund would not be required to enter into an
agreement with that plan.\18\
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    \17\ Rule 22c-2(c)(1)(iv). If a fund has not established
frequent trading policies and thus has not determined which persons
it does not treat as individual investors, this exclusion from the
definition of ``financial intermediary'' would not apply, and the
fund would need to identify those shareholder accounts that are
``financial intermediaries.'' See 2006 Proposing Release, supra note
8, at n.23.
    \18\ We have not, as recommended by some commenters, revised the
rule to specify the circumstances under which a fund may treat an
intermediary as an individual investor rather than an intermediary
for purposes of its frequent trading policies. See, e.g., Comment
Letter of Charles Schwab & Co., Inc. (Apr. 10, 2006). We continue to
believe that funds are in the best position to determine the
treatment of an account as an individual investor under their
frequent trading policies. Moreover, we believe a fund will have
little incentive to ``inappropriately'' treat any intermediary as an
individual shareholder, because the intermediary is free to
terminate its relationship with the fund.
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    The Commission is making one change from our proposal in response
to commenters who pointed out that, in some cases, purchase and
redemption orders are aggregated and submitted by agents of
intermediaries on behalf of the intermediaries.\19\ These commenters
stated that under the rule as proposed, it was unclear whether an order
submitted by an agent of an intermediary would be covered by the rule.
In order to clarify the rule in response to those comments, we have
revised it to provide that funds must enter into agreements with ``each
financial intermediary that submits orders, itself or through its
agent, to purchase or redeem shares directly to the fund * * *''
(changes in italics).\20\ This revision clarifies that funds must enter
into agreements with financial intermediaries or their agents even if
the intermediaries submit orders through entities that do not qualify
as financial intermediaries.
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    \19\ See, e.g., Comment Letter of Matrix Settlement & Clearing
Services, L.L.C. (Apr. 10, 2006).
    \20\ Rule 22c-2(a)(2). We are also revising paragraph (a)(2)(i)
of the rule to require that the fund enter into an agreement with
each such ``intermediary (or its agent).'' Rule 22c-2(a)(2)(i).
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2. Intermediary Chains
    In some cases, an intermediary such as a broker-dealer may hold
shares of a mutual fund not only on behalf of individual investors, but
also on behalf of other financial intermediaries, such as pension plans
or other broker-dealers (``indirect intermediaries'') through one or
more layers of intermediaries or ``chains.'' After we adopted rule 22c-
2 in 2005, fund managers expressed uncertainty as to how the rule
applied to these arrangements, and expressed concern how, as a
practical matter, a fund could obtain shareholder information through
multiple layers of intermediaries.\21\ In response to these concerns,
we proposed and are now adopting amendments to clarify the operation of
the rule as it applies to ``chains of intermediaries.''
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    \21\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc.
(May 24, 2005).
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    The revised rule requires that a fund (or, on the fund's behalf,
its principal underwriter or transfer agent \22\) enter

into a shareholder information agreement \23\ only with those financial
intermediaries \24\ that submit purchase or redemption orders directly
to the fund, its principal underwriter or transfer agent, or a
registered clearing agency (``first-tier intermediaries'').\25\ The
rule does not require first-tier intermediaries to enter into
shareholder information agreements with any indirect intermediaries.
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    \22\ When rule 22c-2 was adopted in 2005, it required a fund, or
a principal underwriter acting on behalf of the fund, to enter into
shareholder information agreements with intermediaries. In addition
to the amendments described above, as proposed, we are also revising
the rule to include a fund's transfer agent as an entity that may
enter into a shareholder information agreement on the fund's behalf.
As we noted when we proposed this change, the fund's transfer agent
often has preexisting agreements with a fund's financial
intermediaries, and thus permitting transfer agents to enter into
information agreements may avoid potentially duplicative agreements
or inefficiencies in the process. See 2006 Proposing Release, supra
note 8, at text accompanying n.38. If a transfer agent enters into
an agreement on behalf of the fund, the agreement must require the
financial intermediary to provide the requested information to the
fund upon the fund's request. See id. at n.37.
    We are not adopting the proposed revision that would have
permitted a registered clearing agency to enter into shareholder
information agreements on behalf of a fund. We received comment from
the only registered clearing agency that receives orders for
transactions in fund shares, noting that it does not have the
capability to serve in this function (because it does not act as an
agent for funds) and requesting that we revise the final rule to
reflect this fact. See Comment Letter of the National Securities
Clearing Corporation (Apr. 10, 2006). We agree with the commenter's
concern that including this reference to clearing agencies might
cause confusion.
    \23\ Rule 22c-2(c)(5). The agreement, which must be in writing,
may be part of another contract or agreement, such as a distribution
agreement.
    \24\ We understand that retirement plan administrators and other
persons that maintain the plan's participant records typically
submit fund shares transactions to the fund or its transfer agent,
principal underwriter, or a registered clearing agency. The rule as
we adopted it last year specifically includes these administrators
and recordkeepers within the definition of a ``financial
intermediary.'' See rule 22c-2(c)(1)(iii).
    \25\ Rule 22c-2(a)(2). We also considered, as an alternative to
this requirement, that shareholder information agreements not
require the collection of any shareholder information from indirect
intermediaries. We did not take that approach because we are
concerned that providing such an exception might encourage abusive
short-term traders to conduct their activities through an indirect
intermediary in order to avoid detection by the fund.
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    Under the proposed rule amendments, a shareholder information
agreement would obligate a first-tier intermediary to, upon request of
the fund, use its best efforts to identify any accountholders who are
themselves intermediaries, and obtain and forward (or have forwarded)
the underlying shareholder identity and transaction information from
those indirect intermediaries farther down the chain.\26\ Some
commenters expressed concern that shareholder information agreements
might require first-tier intermediaries (and indirect intermediaries)
to canvass all of their shareholder accounts to determine which
accountholders are themselves intermediaries if a fund made a blanket
request to identify all indirect intermediaries.\27\
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    \26\ See proposed rule 22c-2(c)(5)(iii) (discussed in 2006
Proposing Release, supra note 8, at Section II.B).
    \27\ See Comment Letter of the Securities Industry Assoc. (Apr
10, 2006); Comment Letter of Charles Schwab & Co., Inc. (Apr. 10,
2006).
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    In light of these concerns, we have revised the rule text to
clarify that a fund, after receiving initial transaction information
from a first-tier intermediary, must make a specific further request to
the first-tier intermediary for information on certain
shareholders.\28\ As adopted, the amended rule defines ``shareholder
information agreement'' as an agreement under which a financial
intermediary agrees to ``[u]se best efforts to determine, promptly upon
request of the fund, whether any specific person about whom it has
received the identification and transaction information * * * [required
by the rule], is itself a financial intermediary * * *'' (changes in
italics).\29\ Under the revised rule, a shareholder information
agreement need not obligate a first-tier intermediary to perform a
complete review of its books and records to identify all indirect
intermediaries. Instead, pursuant to a shareholder information
agreement, a first-tier intermediary must use its best efforts to
identify whether or not certain specific accounts identified by the
fund are indirect intermediaries.\30\ If an indirect intermediary that
holds an account with a first-tier intermediary does not provide
underlying shareholder information, the agreement must obligate the
first-tier intermediary to prohibit, upon the fund's request, that
indirect intermediary from purchasing additional shares of the fund
through the first-tier intermediary.\31\
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    \28\ See rule 22c-2(c)(5)(iii). For example, after receiving
identity and transaction information from a first-tier intermediary,
the fund could then request information from the first-tier
intermediary concerning those frequent trading shareholders whose
transactions were particularly active, in order to determine whether
those shareholders are themselves intermediaries. Under the
shareholder information agreement, the first-tier intermediary would
then be required to use its best efforts to determine, on behalf of
the fund, whether any of those shareholders are intermediaries
(i.e., second-tier intermediaries). After the first-tier
intermediary informs the fund which of the shareholders are second-
tier intermediaries, the fund could then request that the first-tier
intermediary obtain underlying shareholder transaction information
from any or all of those second-tier intermediaries.
    \29\ See rule 22c-2(c)(5)(iii).
    \30\ Rule 22c-2(a)(2). A first-tier intermediary also may choose
to indicate to the fund, when the intermediary initially discloses
transaction information requested by the fund, which shareholders it
knows to be indirect intermediaries. This practice may reduce a
fund's need to request further information about indirect
intermediaries.
    \31\ Rule 22c-2(c)(5)(iii)(B). Under the rule, therefore, if,
upon specific request of the fund, an indirect intermediary (such as
a third-tier intermediary) does not provide information whether one
or more of its shareholders is an intermediary, then upon further
request by the fund, the first-tier intermediary would be required
to restrict or prohibit that indirect intermediary from purchasing
additional shares of the fund on behalf of other investors.
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3. Effect of Lacking an Agreement
    After we adopted the rule, some commenters expressed concern that
the rule, which made it unlawful for a fund to redeem a security within
seven days without entering into a shareholder information agreement,
could be interpreted to prevent a fund from redeeming any of its shares
if it failed to enter into an agreement with any intermediary.
Therefore we proposed, and are today adopting, an amendment to the rule
that clarifies and further limits the consequences of failing to enter
into an information agreement.
    Under rule 22c-2, as amended, if a fund does not have an agreement
with a particular intermediary, the fund thereafter must prohibit that
intermediary from purchasing securities issued by the fund.\32\ The
prohibition applies only to the intermediary with which the fund does
not have an agreement; purchases from other intermediaries will not be
affected.\33\ One commenter argued that the rule

should not prohibit purchases that are fully disclosed to the fund.\34\
We agree that the fund does not need further information under an
agreement to scrutinize those purchases. Therefore, we have revised the
final rule to provide that, if there is no shareholder information
agreement with a particular intermediary, the fund must prohibit the
intermediary from purchasing the fund's securities only ``in nominee
name on behalf of other persons.'' \35\ We have also, for the same
reason, revised this provision so that it does not apply to the
intermediary's purchases of fund securities on behalf of the
intermediary itself.\36\
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    \32\ Rule 22c-2(a)(2)(ii). One commenter suggested that we
clarify that in these circumstances a ``purchase'' would not include
the automatic reinvestment of dividends. See Comment Letter of the
Investment Company Institute (Apr. 10, 2006). We agree that the
reinvestment of dividends does not present the types of frequent
trading risks that the rule is designed to help funds prevent. We
therefore have revised the rule text to clarify that, for purposes
of this provision, a ``purchase'' does not include the automatic
reinvestment of dividends. See rule 22c-2(a)(2)(ii).
    \33\ A number of commenters expressed concerns about possible
conflicts with the Employee Retirement Income Security Act of 1974,
29 U.S.C. 1001 (``ERISA''), and Department of Labor rules under
ERISA, in complying with rule 22c-2. They stated that those laws:
(i) Require certain ``blackout'' disclosures before a plan sponsor
may carry out a fund's request to prohibit future purchases; and
(ii) provide a safe harbor under section 404(c) of ERISA from
liability as a fiduciary only if the plan provides participants an
adequate number of investment alternatives and the ability to trade
among them with appropriate frequency, in light of the market
volatility of those alternatives. See, e.g., Comment Letter of the
American Bankers Assoc. (Apr. 14, 2006) (citing ERISA section
101(i), ERISA section 404(c), 29 CFR 2520, and 29 CFR 2550.404c-1);
Comment Letter of the American Benefits Council (Apr. 10, 2006). Our
staff has conferred with representatives of the Department of Labor,
who have advised us that these concerns have been addressed in
guidance on the duties of employee benefit plan fiduciaries in light
of alleged abuses involving mutual funds. See Statement of Ann L.
Combs, Assistant Secretary, Department of Labor, Fiduciary
Responsibilities Related to Mutual Funds, (Feb. 17, 2004) (available
at http://www.dol.gov/ebsa/newsroom/sp021704.html) (reasonable

redemption fees and reasonable plan or investment fund limits on the
number of times a participant can move in and out of a particular
investment within a particular period ``represent approaches to
limiting market timing that do not, in and of themselves, run afoul
of the `volatility' and other requirements set forth in the
Department's regulation under section 404(c), provided that any such
restrictions are allowed under the terms of the plan and clearly
disclosed to the plan's participants and beneficiaries.'').
    \34\ See Comment Letter of the American Bankers Assoc. at 6
(Apr. 14, 2006).
    \35\ A similar revision has been made to the same type of
provision concerning chains of intermediaries. See rule 22c-
2(c)(5)(iii)(B).
    \36\ Rule 22c-2(a)(2)(ii), (c)(5)(iii)(B). One commenter
requested that the Commission provide further guidance to financial
intermediaries that attempt to carry out instructions from a fund,
under rule 22c-2(c)(5)(ii), to ``restrict or prohibit further
purchases or exchanges'' by a particular investor whom the fund has
identified as violating its frequent trading policies. See Comment
Letter of the Committee of Annuity Insurers (submitted by Sutherland
Asbill & Brennan LLP) (Apr. 10, 2006). The commenter noted that an
``exchange'' (or transfer) request is actually two simultaneous
orders: an order to redeem shares of one fund and an order to
purchase, with the proceeds of the redemption, shares of another
fund. This commenter questioned whether the rule was meant to
include both the redemption and purchase order. As noted, the rule
permits a fund to restrict or prohibit ``exchanges.'' We agree with
the commenter that an ``exchange'' request includes both a
redemption order and purchase order, and if a fund instructs an
intermediary to restrict an ``exchange'' (or a purchase), the
intermediary may notify the investor that it will not effect the
redemption portion of a request to exchange into the fund, as well
as the purchase portion of the request.
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    Some commenters suggested alternative approaches that we have
decided not to adopt. One recommended that the rule preclude
intermediaries that lack an agreement with funds from redeeming shares
within seven days of purchase, rather than prohibiting further
purchases of fund shares.\37\ This approach is not acceptable to us
because it would deny investors access to their funds for seven days
after purchasing shares through such an intermediary, thereby
penalizing investors for the inability or unwillingness of a fund and
intermediary to enter into a shareholder information agreement. Another
commenter argued that the rule should instead preclude a fund from
making further payments under selling or dealer agreements to
intermediaries that lack shareholder information agreements.\38\
However, all funds do not necessarily have selling or dealer agreements
with all of their ``financial intermediaries'' as defined in the rule,
and restricting the rule's scope to those intermediaries that have such
agreements would likely seriously restrict a fund's ability to gather
information and enforce its policies. After careful consideration of
the suggested alternatives, we believe that barring future purchases by
intermediaries best serves the purposes of the rule.
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    \37\ See Comment Letter of the American Benefits Council (Apr.
10, 2006).
    \38\ See Comment Letter of Federated Investors, Inc. (submitted
by ReedSmith LLP) (Apr. 6, 2006).
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B. Operation of the Rule

    When we adopted rule 22c-2, we explained that the shareholder
information agreement requirement is designed to give fund managers
(and their chief compliance officers) a compliance tool to monitor
trading activity in order to detect frequent trading and to assure
consistent enforcement of fund policies.\39\ But we also explained that
the rule gives managers flexibility to request information periodically
such as when circumstances suggested that abusive trading activity is
occurring.\40\
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    \39\ Adopting Release, supra note 4, at text accompanying n.49.
    \40\ Id. at text following n.42.
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    We recognize that in some cases, frequent use of this tool might be
costly for funds and intermediaries. Commenters expressed concerns
about these costs, and several commenters urged us to impose limits on
the frequency of information requests made by funds pursuant to the
information agreements.\41\ We are not imposing limits because, as we
noted in the Adopting Release, we expect funds that are susceptible to
market timing to use the tool regularly.\42\ Not all funds, however,
are susceptible to market timing.
---------------------------------------------------------------------------

    \41\ See, e.g., Comment Letter of Massachusetts Mutual Life
Insurance Company (Apr. 10, 2006); Supplemental Comment Letter of
the SPARK Institute, Inc. (May 1, 2006).
    \42\ Adopting Release, supra note 4, at text accompanying n.50.
---------------------------------------------------------------------------

    A fund, in determining the frequency with which it should seek
transaction information from its intermediaries, could consider: (i)
Unusual trading patterns, such as abnormally large inflows or outflows,
that may indicate the existence of frequent trading abuses; (ii) the
risks that frequent trading poses to the fund and its shareholders in
light of the nature of the fund and its portfolio; (iii) the risks to
the fund and its shareholders of frequent trading in light of the
amount of assets held by, or the volume of sales and redemptions
through, the financial intermediary; and (iv) the confidence the fund
(and its chief compliance officer \43\) has in the implementation by an
intermediary of trading restrictions designed to enforce fund frequent
trading policies or similar restrictions designed to protect the fund
from abusive trading practices. In some cases, fund managers may seek
transaction information only occasionally to determine whether the
intermediary is, in fact, enforcing trading restrictions or imposing
redemption fees on behalf of the fund.\44\
---------------------------------------------------------------------------

    \43\ See, e.g., Compliance Programs of Investment Companies and
Investment Advisors, Investment Company Act Release No. 26299, at
n.69 and accompanying text (Dec. 17, 2003) [68 FR 74714 (Dec. 24,
2003)] (``[U]nder rule 38a-1, a fund must have procedures reasonably
designed to ensure compliance with its disclosed policies regarding
market timing. These procedures should provide for monitoring of
shareholder trades or flows of money in and out of the funds in
order to detect market timing activity, and for consistent
enforcement of the fund's policies regarding market timing.'').
    \44\ Some commenters expressed concern about the ability of
financial intermediaries to provide information to funds, in light
of applicable privacy laws. See, e.g., Comment Letter of the
American General Life Insurance Company, et al (submitted by
O'Melveny & Myers LLP), (May 9, 2005); 15 U.S.C. 6801-09, 6821-27
(privacy provisions of Gramm-Leach-Bliley Act); Regulation S-P, 17
CFR Part 248 (Commission rules implementing privacy provisions for
funds, broker-dealers, and registered investment advisers). Under
those laws, financial institutions such as funds, broker-dealers,
and banks must provide a notice describing the institution's privacy
policies and an opportunity for consumers to opt out of the sharing
of information with nonaffiliated third parties. These privacy laws
also contain important exceptions to the notice and opt-out
requirements. Under the Commission's privacy rules, for example,
these requirements do not apply to the disclosure of information
that is ``necessary to effect, administer, or enforce a transaction
that a consumer requests or authorizes,'' which includes a
disclosure that is ``[r]equired, or is a usual, appropriate, or
acceptable method * * * [t]o carry out the transaction or the
product or service business of which the transaction is a part * *
*'' 17 CFR 248.14(a), (b)(2). See also 17 CFR 248.15(a)(7)(i)
(notice and opt-out requirements not applicable to disclosure of
information to comply with law). Financial privacy rules that are
substantially identical to these rules apply to financial
intermediaries other than broker-dealers, and contain comparable
exceptions. See, e.g., 12 CFR Part 40 (rules applicable to national
banks, adopted by the Comptroller of the Currency). We believe that
the disclosure of information under shareholder information
agreements, and the fund's request and receipt of information under
those agreements, are covered by these exceptions. We also note that
financial institutions often state in their privacy policy notices
that the institution makes ``disclosures to other nonaffiliated
third parties as permitted by law.'' See 17 CFR 248.6(b). Therefore
we believe it will not be necessary for intermediaries such as
broker-dealers and banks to provide new privacy notices or opt-out
opportunities to their customers, in order to comply with rule 22c-
2. Commenters on the 2006 Proposing Release generally agreed that
complying with rule 22c-2 should not require broker-dealers and
banks to provide new privacy notices to their customers. See Comment
Letter of the Investment Company Institute (Apr. 10, 2006); Comment
Letter of the American Bankers Assoc. (Apr. 14, 2006).
    A fund that receives shareholder information for a purpose
permitted by the privacy rules under the exceptions to consumer
notice and opt out requirements may not disclose that information
for other purposes, such as marketing, unless permitted under the
intermediary's privacy policy. See Adopting Release, supra note 4,
at n.47.

---------------------------------------------------------------------------

    Some intermediaries have responded to market timing concerns by
enforcing their own frequent trading policies, which may be different
from policies established by fund boards. We believe that a fund in
appropriate circumstances could reasonably conclude that an
intermediary's frequent trading policies sufficiently protect fund
shareholders, and could therefore defer to the intermediary's policies,
rather than seek to apply the fund's policies on frequent trading to
shareholders who invest through that intermediary. In those
circumstances, the fund should describe in its prospectus that certain
intermediaries through which a shareholder may own fund shares may
impose frequent trading restrictions that differ from those of the
fund, generally describe the types of intermediaries (e.g., broker-
dealers, insurance company separate accounts, and retirement plan
administrators), and direct shareholders to any disclosures provided by
the intermediaries with which they have an account to determine what
restrictions apply to the shareholder. We note that a fund is required
to disclose whether each restriction imposed by the fund to prevent or
minimize frequent trading applies to trades that occur through omnibus
accounts at intermediaries, and to describe with specificity the
circumstances, if any, under which each such restriction will not be
imposed.\45\
---------------------------------------------------------------------------

    \45\ See Item 6(e) of Form N-1A [17 CFR 239.15A and 274.11A];
Item 8(e) of Form N-3 [17 CFR 239.17a and 274.11b]; Item 7(e) of
Form N-4 [17 CFR 239.17b and 274.11c], Item 6(f) of Form N-6 [17 CFR
239.17c and 274.11d]. These disclosure items would not require a
fund to describe the frequent trading policies of each intermediary
to whose policies the fund defers.
---------------------------------------------------------------------------

C. Redemption Fees

    Rule 22c-2 requires fund directors to consider whether to adopt a
redemption fee, but the rule neither requires funds to adopt such a fee
nor specifies the terms under which such a fee should be assessed.\46\
A number of commenters raised concerns about redemption fees, and
encouraged us to become involved in establishing the terms and
conditions under which funds charge them.\47\ A number of commenters,
for example, urged us to require that fund redemption fee policies
waive fees that might be imposed as a result of transactions not
initiated by investors.\48\
---------------------------------------------------------------------------

    \46\ The rule does, however, require that any redemption fee
charged not exceed two percent and apply to redemptions no less than
seven days after purchase. See rule 22c-2(a)(1)(i).
    \47\ See, e.g., Supplemental Comment Letter of the SPARK
Institute, Inc. (May 1, 2006); Comment Letter of the American
Council of Life Insurers (Apr. 10, 2006); Comment Letter of the
Committee of Annuity Insurers (submitted by Sutherland Asbill &
Brennan) (Apr. 10, 2006).
    \48\ See, e.g., Comment Letter of the American Society of
Pension Professionals & Actuaries (Apr. 10, 2006); Supplemental
Comment Letter of the SPARK Institute, Inc. (May 1, 2006). Non-
investor initiated transactions may include automatic asset
rebalancing, automatic distributions, and prearranged periodic
contributions.
---------------------------------------------------------------------------

    We appreciate the commenters' suggestions that standardizing the
terms and conditions of redemption fee policies might reduce the costs
that intermediaries and others (including funds themselves) will bear
in implementing fund redemption fees. However, we have decided not to
propose to standardize the terms or conditions to preserve the
flexibility of each fund to fashion policies that are best suited to
protect the investors in each fund. We have done this after receiving
extensive comment on the matter and after observing a lack of consensus
among industry participants on the appropriate terms of a uniform
redemption fee.\49\ Although we may reconsider our decision at a later
time, until then, the terms of redemption fee policies are a matter for
fund boards to determine.\50\
---------------------------------------------------------------------------

    \49\ See 2006 Proposing Release, supra note 8, at text following
n.12.
    \50\ Several commenters noted that a number of state insurance
and contract law issues might arise in connection with a redemption
fee charged to investors who invest in funds through insurance
company separate accounts. See, e.g., Supplemental Comment Letter of
the SPARK Institute, Inc. (May 1, 2006); Comment Letter of the
American Council of Life Insurers (Apr. 10, 2006). As we stated in
the 2006 Proposing Release, we believe that because redemption fees
and frequent trading policies are imposed by the fund, and not the
insurance company, enforcing those limits or fees with respect to
these investors should not cause insurance companies to breach their
contracts. See 2006 Proposing Release, supra note 8, at n.12.
Moreover, nothing in this rule would preclude a fund that is
concerned about the legality under existing contracts of imposing
these limits or fees on certain insurance contractholders, from
choosing not to impose them with regard to investors whose policies
would not permit imposition of such limits or fees.
---------------------------------------------------------------------------

III. Compliance Dates

    When the Commission adopted rule 22c-2 in March 2005, we
established a compliance date of October 16, 2006. In the 2006
Proposing Release, we requested comment on whether we should extend
that compliance date. Nearly every commenter requested an extension,
pointing out the need for significant time to revise agreements with
intermediaries and change systems to accommodate the transmission and
receipt of trading information. Commenters requested a variety of
compliance date extensions, ranging from 6 months to 18 months.
    Today we are extending the compliance date for the shareholder
information agreement provisions of rule 22c-2. We are extending by 6
months, until April 16, 2007, the date by which funds must enter into
shareholder information agreements with their intermediaries.\51\ We
also are extending by 12 months, until October 16, 2007, the date by
which funds must be able to request and promptly receive shareholder
identity and transaction information pursuant to shareholder
information agreements. This latter extension is designed to allow
additional time for funds, intermediaries, and others to revise their
systems to accommodate the request, provision, and use of information
from intermediaries after the negotiation of shareholder information
agreements.
---------------------------------------------------------------------------

    \51\ See rule 22c-2(a)(2).
---------------------------------------------------------------------------

    We did not propose, nor did we receive comment on, an extension of
the compliance date for section 22c-2(a)(1), which requires a fund's
board to consider the adoption of a redemption fee policy. The
compliance date for that provision, October 16, 2006, remains in
effect.

IV. Cost-Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by
its rules. As discussed above, the amendments we are adopting today
will (i) limit the types of intermediaries with which funds must enter
into shareholder information agreements, (ii) address the rule's
application when there are chains of intermediaries, and (iii) clarify
the effect of a fund's failure to obtain an agreement with any of its
intermediaries. These amendments are designed to respond to concerns
that commenters identified during the course of implementing rule 22c-
2, and in response to our request for comment on these proposed
amendments. We believe that the amendments will result in substantial
cost savings to funds, financial intermediaries, and investors, and
provide clarification of the rule's requirements.

A. Benefits

    We anticipate that funds, financial intermediaries, and investors
will benefit from these amendments to rule 22c-2. As discussed more
fully in the Adopting Release we issued in 2005, rule 22c-2 is designed
to allow a fund to deter, and to provide the fund and its shareholders
reimbursement for the costs of, short-term trading in fund shares.\52\
---------------------------------------------------------------------------

    \52\ See Adopting Release, supra note 4, at Section IV.A.

---------------------------------------------------------------------------

    The amendments to rule 22c-2 that we are adopting today will likely
result in additional benefits to funds, financial intermediaries, and
investors. As discussed in the previous sections of this Release, some
commenters on the Adopting Release argued that the rule's definition of
``financial intermediary'' was too broad because it would have required
funds to identify and enter into agreements with a number of
intermediaries that may not pose a significant short-term trading risk
to funds, and may have imposed unnecessary costs to market
participants.\53\ For example, one large fund complex indicated that,
under the rule as adopted, identifying their ``financial
intermediaries'' could cost that fund complex $8.5 million or more.\54\
These amendments will modify the definition of financial intermediary
to exclude entities that a fund treats as an individual investor for
purposes of the fund's policies on market timing or frequent trading.
We believe that these amendments will reduce the burden on funds of
identifying those entities that might have qualified as financial
intermediaries under the rule as adopted, because a fund should already
know which entities it treats as intermediaries for purposes of its
policies on market timing or frequent trading.\55\ As further discussed
in the Paperwork Reduction Act Section below, for purposes of the
Paperwork Reduction Act we have estimated that identifying the
intermediaries with which a fund complex must enter into agreements may
take the average fund complex a total of 250 hours of a service
representative's time, at a cost of $40 per hour,\56\ for a total
burden to all funds of 225,000 hours, at a total cost of $9 million.
These amendments will likely provide a significant benefit because they
should reduce the costs associated with the intermediary identification
process.
---------------------------------------------------------------------------

    \53\ See Comment Letter of the Investment Company Institute at 3
(May 9, 2005). The ICI stated in its 2005 comment letter that, under
the rule as adopted in 2005, three large fund complexes alone would
have to evaluate 6.5 million accounts that are ``not in the name of
a natural person and thus could be held as an intermediary for
purposes of the rule'' and might have to enter into agreements with
a significant portion of those accounts that are held in nominee
name. Id. The ICI noted that many of these accounts are likely
associated with small retirement plans, small businesses, trusts,
bank nominees and other entities that are unlike typical financial
intermediaries such as broker-dealers. It added that funds typically
do not have agreements with such small entities, other than
agreements incidental to the opening of an account.
    \54\ See 2006 Proposing Release, supra note 8, at n.48.
    \55\ Under the revised rule, if the fund does not exempt an
intermediary from its frequent trading policies, i.e. if the fund
treats the intermediary as an individual investor for purposes of
those policies, then the entity would not be a ``financial
intermediary'' (with respect to that fund), and the fund would not
have to enter into a shareholder information agreement with it.
These intermediaries might include small retirement plans that do
not identify themselves as intermediaries or omnibus accounts to the
fund and request an exemption from the fund's frequent trading
policies. These intermediaries will likely either have very few
underlying investors, and/or restrict their transactions so that
transactions by investors do not trigger application of a redemption
fee or violate the fund's frequent trading policies.
    \56\ See infra note 95.
---------------------------------------------------------------------------

    By enabling funds to forego the cost of entering into agreements
with omnibus accountholders that they treat as individual investors, we
anticipate that the large majority of small omnibus accountholders will
now fall outside the shareholder information agreement provisions of
the rule. This will likely result in significant cost and time savings
to funds and financial intermediaries through reduction of the expenses
associated with these agreements. The reduction of these costs also may
benefit fund investors and fund advisers, to the extent that these
costs may have been passed on to them. We estimate that this will
significantly reduce the burden on many entities that would otherwise
have qualified as intermediaries under the rule as adopted, because the
excluded entities would no longer need to enter into shareholder
information agreements, or develop and maintain systems to provide the
relevant information to funds. Commenters on the 2006 Proposing Release
generally agreed that the rule amendments are likely to reduce costs to
market participants.\57\
---------------------------------------------------------------------------

    \57\ See, e.g., Comment Letter of the Investment Company
Institute (Apr. 10, 2006) (``[The proposed approach] should reduce
the costs and burdens associated with the rules implementation while
still providing funds access to underlying shareholder
information.'')
---------------------------------------------------------------------------

    Commenters on the 2005 adoption were also concerned that the rule
as adopted might have required funds to enter into agreements with
intermediaries that hold fund shares in the name of other
intermediaries (a ``chain of intermediaries''), potentially resulting
in a fund having to enter into agreements with intermediaries with
which it may not have a direct relationship (i.e., indirect
intermediaries).\58\ These amendments further clarify and define the
operation of the rule with respect to intermediaries that invest
through other intermediaries. These amendments to rule 22c-2 define the
term ``shareholder information agreement,'' and provide that funds need
only enter into shareholder information agreements with intermediaries
that directly submit orders to the fund, its principal underwriter,
transfer agent, or to a registered clearing agency. Accordingly, funds
will not need to enter into agreements with indirect intermediaries and
may incur lower systems development costs related to the collection of
underlying shareholder information, thereby reducing the costs of
compliance.
---------------------------------------------------------------------------

    \58\ See Comment Letter of T. Rowe Price Associates, Inc. at 2
(May 24, 2005); Comment Letter of OppenheimerFunds, Inc. at 3 (May
9, 2005).
---------------------------------------------------------------------------

    Under the amendments adopted today, a first-tier intermediary, in
its agreement with the fund, must agree to, upon further request by the
fund: (i) Provide the fund with the underlying shareholder
identification and transaction information of any other intermediary
that trades through the first-tier intermediary (i.e., indirect
intermediary); or (ii) prohibit the indirect intermediary from
purchasing, on behalf of others, securities issued by the fund. This
approach is designed to preserve the investor protection goals of the
rule by ensuring that funds have the ability to identify short-term
traders that may attempt to evade the reach of the rule by trading
through chains of financial intermediaries.
    By defining minimum standards for what must be included in these
shareholder information agreements, we intended to balance the need for
funds to acquire shareholder information from indirect intermediaries
who trade in fund shares, with practical concerns regarding the
difficulty that funds might face in identifying these intermediaries
and entering into agreements with them. Because an intermediary that
trades directly with a fund already has a relationship with its second-
tier intermediaries (and is likely to have a closer relationship than
the fund to any intermediary that is farther down the ``chain''), a
first-tier intermediary appears to be in the best position to arrange
for the provision of information to a fund regarding the transactions
of shareholders trading through its indirect intermediaries. By
providing a definition of the term ``shareholder information
agreement,'' the amended rule clarifies the balance of duties and
obligations between funds and financial intermediaries. Because first-
tier intermediaries may already have access to the shareholder
transaction and identification information of their indirect
intermediaries, they will likely be able to provide this information to
funds at a minimal cost, especially compared to the significant costs
that funds would incur if they were required to collect the same
information from indirect intermediaries themselves. Although first-
tier intermediaries may

incur some costs in collecting and gathering this information from
indirect intermediaries, there is a benefit in having the entity that
has the easiest access to the relevant information have the
responsibility for arranging for its delivery to funds.
    In general, commenters on the 2006 Proposing Release agreed that
first tier intermediaries are in a better position than funds to
collect data from indirect intermediaries,\59\ although one commenter
disagreed and stated that intermediaries are not in a better position
than funds to collect information from indirect intermediaries.\60\ We
continue to believe that the amended rule's approach of having the
agreements require first-tier intermediaries to identify and collect
information from indirect intermediaries appears to be the most cost
effective method of handling the chain of intermediaries issue while
still effectuating the purposes of the rule. Funds and intermediaries
are also likely to engage in negotiations that will distribute the
costs of information sharing between the entities, resulting in
incentives for funds to narrowly target their information requests.
---------------------------------------------------------------------------

    \59\ See Comment Letter of Massachusetts Mutual Life Insurance
Company (Apr. 10, 2006); Comment Letter of the Investment Company
Institute (Apr. 10, 2006).
    \60\ See Supplemental Comment Letter of the SPARK Institute,
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    As discussed in the previous sections, these amendments clarify the
result if a fund lacks an agreement with a particular intermediary. In
such a situation, the fund may continue to redeem securities within
seven calendar days, but it must prohibit that financial intermediary
from purchasing fund shares in nominee name, on behalf of any other
person. Some commenters had stated that the rule, as adopted in 2005,
could be interpreted to require a different approach to these
situations.\61\ The amendments will provide the benefit of certainty
regarding the duties of funds and financial intermediaries under the
rule without imposing additional costs.
---------------------------------------------------------------------------

    \61\ See Comment Letter of the Investment Company Institute at 4
(May 9, 2005).
---------------------------------------------------------------------------

B. Costs

    Many commenters expressed concerns about the costs of rule 22c-2 as
adopted in 2005. As discussed above, we anticipate that the amendments
adopted today will allow funds, financial intermediaries, and investors
to incur significantly reduced costs. Although these amendments will
reduce many of the costs of the rule, they should nonetheless maintain
the investor protections afforded by the rule.
    One of the primary results of these amendments will be to reduce
the number of financial intermediaries with which funds must enter into
shareholder information agreements. This should reduce costs to all
participants by allowing funds to enter into shareholder information
agreements only with those intermediaries that hold omnibus accounts
that are most likely to trade fund shares frequently. The rule's
investor protections will be maintained because funds will continue to
monitor the short-term trading activity of the rest of the fund's
omnibus accounts as if they were individual investors in the fund,
according to the fund's policies on short-term trading.
    The amendments will reduce the number of entities that will be
considered financial intermediaries under the rule. Commenters in 2005
raised concerns about the costs of identifying which accountholders are
financial intermediaries.\62\ The costs related to this review will be
greatly reduced under the rule as we have revised it, because we expect
that a fund will generally already have identified those accountholders
that it does not treat as an individual investor for purposes of its
restrictions on short-term trading. As discussed above in the benefits
section, for purposes of the Paperwork Reduction Act, we have estimated
that completion of this identification process will cost all funds a
total of approximately $9 million.
---------------------------------------------------------------------------

    \62\ As discussed above, the ICI noted that, between just three
large fund complexes, 6.5 million accounts may need to be reviewed,
and estimated that the total number of accounts which would be
evaluated by all funds could be in the ``tens of millions.'' Comment
Letter of the Investment Company Institute at 3 (May 9, 2005).
OppenheimerFunds noted that, although it has more than 7.5 million
shareholder accounts in its records, 137,000 or fewer of those
accounts may qualify as financial intermediaries under the rule as
adopted last spring. See Comment Letter of OppenheimerFunds, Inc. at
8 (May 9, 2005). Neither commenter estimated the costs of performing
this review.
---------------------------------------------------------------------------

    We also received a few comments on the 2005 adoption regarding the
number of accounts maintained by funds that qualify as financial
intermediaries.\63\ Commenters indicated that revising the rule to
address concerns about the definition of financial intermediaries would
significantly reduce the costs of entering into or modifying these
agreements, as well as the costs of developing, maintaining and
monitoring the systems that will collect the shareholder information
related to these agreements for funds.\64\ Omnibus accountholders that
previously would have qualified as financial intermediaries are also
likely to realize substantial savings under the amended rule. When an
omnibus accountholder is treated as an individual investor (or does not
trade directly with the fund), such an omnibus account will no longer
be treated as a financial intermediary and will not incur the costs of
entering into or modifying agreements with that fund. There will also
no longer be the start-up and ongoing costs of developing and
maintaining shareholder information-sharing systems for those
accountholders.
---------------------------------------------------------------------------

    \63\ OppenheimerFunds estimated that it has 137,000 omnibus
accounts that might qualify as financial intermediaries, USAA
Investment Management Company stated that it has ``thousands'' of
these accounts, and T. Rowe Price estimated 1.3 million accounts
that are not registered as natural persons. See Comment Letter of
OppenheimerFunds, Inc. at 8 (May 9, 2005); Comment Letter of USAA
Investment Management Company at 2 (May 9, 2005); Comment Letter of
T. Rowe Price Associates, Inc. at 2 (May 24, 2005).
    \64\ See Comment Letter of USAA Investment Management Company at
2 (May 9, 2005); Comment Letter of the ICI at 3 (May 9, 2005).
---------------------------------------------------------------------------

    In 2005, we received a few comments regarding the costs of
modifying or entering into shareholder information agreements. One of
the few commenters that gave specific numbers indicated that it would
take approximately four hours to modify and/or enter into, follow up
on, and maintain an agreement on its systems for each account
identified as a financial intermediary.\65\ The same commenter
indicated that it may have as many as 137,000 accounts that might
qualify as financial intermediaries under the rule as adopted. We
anticipate that the large majority of the omnibus accountholders that
would have qualified as financial intermediaries under the rule as
initially adopted, will now be treated as individual investors by
funds, and therefore no new agreements will be required. As discussed
in the 2006 Proposing Release, we anticipate that in most cases,
complying with the amended rule will require a very limited number of
new agreements between funds and intermediaries (in many cases
virtually no new agreements would be required).\66\ We understand that
the number of existing agreements that funds have with their
intermediaries can vary greatly, from less than 10 agreements for a
small direct-sold fund, to 3,000 or more agreements for a very large
fund complex sold through various channels.\67\ Although funds will
still need to modify the existing agreements

that they have with their intermediaries (i.e., distribution
agreements), we believe that these amendments will greatly reduce or
eliminate the need for most funds to identify and negotiate new
agreements. Funds are also likely to incur lower costs when modifying
existing agreements than when entering into new agreements, and the
actual hours required to modify an existing agreement thus may be less
than the four hour figure suggested by the commenter.\68\ Accordingly,
based on the cost data provided by this commenter, we estimate that the
cost reduction that may result from the amendments for a fund complex
in a similar position as the commenter could be approximately 536,000
hours.\69\
---------------------------------------------------------------------------

    \65\ See Comment Letter of OppenheimerFunds, Inc. at 8 (May 9,
2005).
    \66\ See 2006 Proposing Release, supra note 8, at text following
n.55.
    \67\ See id.
    \68\ See Comment Letter of OppenheimerFunds, Inc. (May 9, 2005).
Section VI below contains a discussion, in the context of the
Paperwork Reduction Act, of some of the estimated costs of the
shareholder information agreement and information-sharing system
development and operations aspects of the rule.
    \69\ See Comment Letter of OppenheimerFunds, Inc. (May 9, 2005).
This estimate is based on the following calculations: 137,000
potential accounts times 4 hours per account equals 548,000
potential hours. However, the amendments might eliminate the burden
of reviewing and modifying those 137,000 potential accounts, and
could limit the burden to a far reduced number, perhaps 3,000
agreements for a very large fund. (3,000 agreements to be modified
times 4 hours equals 12,000 hours.) Instead of potentially incurring
548,000 hours complying with the agreement portion of the rule, a
similar fund might incur 12,000 hours in modifying its existing
agreements, for a savings of 536,000 hours (548,000 potential hours
minus 12,000 hours equals 536,000 hours saved).
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act as discussed below, we
have estimated that it will cost all funds and financial intermediaries
a total of approximately $53,550,000 to enter into and/or modify the
agreements required under the amended rule.\70\ This represents a
significant cost reduction from the estimates provided to us in
response to the rule's adoption.\71\
---------------------------------------------------------------------------

    \70\ See infra Section VII.
    \71\ However, this revised estimate is a significant increase
over the amount we estimated in the Adopting Release ($3,353,279)
for funds and intermediaries to enter into shareholder information
agreements. See Adopting Release, supra note 4, at n.108. In
response to our request for comment on any aspect of the rule's
implementation, we received new information and updated estimates
that noted that the cost of entering into agreements for funds and
intermediaries would be significantly higher than the estimate
included in the Adopting Release. After reviewing the comments we
received in response to the Adopting Release, as well as other
information received from fund representatives prior to the 2006
Proposing Release, we estimated in the 2006 Proposing Release that
on average, a fund complex might incur $250,000 or more in expenses
related to entering into or modifying the agreements required under
the rule as adopted. See 2006 Proposing Release, supra note 8, at
n.59. With approximately 900 fund complexes currently operating, we
therefore estimate that the agreement portion of the rule as adopted
could potentially cost all funds a total of approximately
$225,000,000. Despite the increase in estimated costs for entering
into agreements that we have included here over the cost estimates
included in the Adopting Release, we anticipate that the amendments
will reduce the costs of the agreement portion of the rule as
adopted by approximately $171,450,000 ($225,000,000 (updated cost
estimate) minus $53,550,000 (cost estimate after proposed
amendments) equals $171,450,000 (total potential cost reduction)).
---------------------------------------------------------------------------

    There will also be some costs related to the amendments we are
adopting to the rule regarding chains of intermediaries. By clearly
defining the duties that a fund's agreement must impose on
intermediaries in the ``chain of intermediaries'' context, the proposed
rule amendments may result in first-tier intermediaries incurring some
costs that might otherwise have been borne by funds. These may include
costs related to negotiating agreements (if necessary) with indirect
intermediaries, processing requests from funds to investigate accounts,
costs related to collecting and providing the underlying shareholder
information to funds from the indirect intermediaries and restricting
further trading by indirect intermediaries if the fund requests it. We
believe that first-tier intermediaries are in a better position than
funds to fulfill these obligations. Unlike funds, first-tier
intermediaries have a direct relationship with second-tier
intermediaries (and may be in a better position than funds to collect
information from other indirect intermediaries), and will thus be able
to identify, communicate with, and collect information from these
indirect intermediaries at a lower cost than if funds were to conduct
such activities. First-tier intermediaries are also in a better
position than funds to identify and gather shareholder information from
more distant indirect intermediaries because of their relationships
with second-tier intermediaries.
    As further discussed in connection with the Paperwork Reduction
Act, we have estimated that the costs of entering into arrangements
between first-tier and more indirect intermediaries will be
approximately $63 million.\72\ We anticipate that intermediaries will
generally use the same systems that they use to provide the required
underlying shareholder identity and transaction information directly to
funds to process the information that first-tier intermediaries will
forward (or have forwarded) to funds from indirect intermediaries, thus
resulting in significant cost efficiencies.
---------------------------------------------------------------------------

    \72\ See infra note 131 and accompanying text.
---------------------------------------------------------------------------

    Funds and intermediaries may also incur some costs related to
drafting or revising terms for the agreements required by rule 22c-2.
We have been informed that industry representatives are working
together to develop a uniform set of model terms, and anticipate that
such model terms may significantly reduce the costs related to
developing individualized agreement terms for each fund and
intermediary.\73\ As further discussed in the Paperwork Reduction Act
section of this release, for purposes of the Paperwork Reduction Act,
we estimate that a typical fund complex will incur a total of 5 hours
of legal time at $300 per hour in drafting these agreement terms, for a
total of 4,500 hours for all 900 fund complexes at a total cost of
$1,350,000.
---------------------------------------------------------------------------

    \73\ See Supplemental Comment Letter of the SPARK Institute,
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    We understand that several service providers are developing systems
to accommodate the transmission and receipt of transaction information
between funds and intermediaries pursuant to contracts negotiated to
comply with rule 22c-2. At least one of these organizations is revising
the infrastructure that it already has in place, in order to facilitate
the communication of fund trades and other ``back office'' information
between funds and financial intermediaries, including the information
required under the rule. We understand that, with the exception of some
smaller to mid-sized funds and intermediaries, the large majority of
funds and intermediaries currently use the organization's existing
infrastructure to process fund trades.\74\ In addition, some funds,
intermediaries, or third party vendors may develop their own competing
or complementary information-sharing systems.\75\
---------------------------------------------------------------------------

    \74\ See 2006 Proposing Release, supra note 8, at text following
n.61.
    \75\ See id. at n.40.
---------------------------------------------------------------------------

    Commenters on the 2006 Proposing Release suggested that in
complying with the amended rule, funds and intermediaries may choose to
incur certain additional costs in analyzing data received under
shareholder information agreements, including costs for additional
staffing, third-party vendors, and data repositories.\76\ Generally,
any such potential costs would be a consequence of the initial rule
adoption, and are not a result of these rule amendments. These
potential costs are also likely to vary significantly among entities
depending on their size, the services they use, and the frequency with
which they request and analyze information, among other factors.
---------------------------------------------------------------------------

    \76\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc.
(Apr. 10, 2006); Supplemental Comment Letter of the SPARK Institute,
Inc. (May 1, 2006).

---------------------------------------------------------------------------

    One commenter on the 2006 Proposing Release noted that, as a large
fund complex, it had received estimates of up to $730,000 a year for a
third party to provide information transmittal systems, certain data
analysis, and data repository services for the information requested
under shareholder information agreements.\77\ Such third-party vendor
systems costs will vary significantly depending on the size of the fund
complex, the frequency that information is requested, the length of
time the information is stored, any analysis performed, a fund's
preexisting internal resources, and many other factors. In the
Paperwork Reduction Act section below, we have estimated the costs we
believe an average fund will incur in building these systems
internally, or in using a third party vendor to provide these services.
The same commenter also suggested that intermediaries might incur third
party vendor costs to store and process data, and make it available to
funds, with such costs possibly ranging up to $170,000 in start up
costs, and $360,000 a year in annual costs.\78\ We have incorporated
the estimates provided by commenters on the 2006 Proposing Release into
the cost calculations we made for purposes of the Paperwork Reduction
Act, and as a result have increased the cost estimates made in this
release over the estimates provided in the 2006 Proposing Release.\79\
---------------------------------------------------------------------------

    \77\ See Comment Letter of T. Rowe Price Associates, Inc. (Apr.
10, 2006). The commenter has informed our staff that the latest
estimates it has received have been revised downwards to $620,000 a
year for these services.
    \78\ Id.
    \79\ See infra Section VI.
---------------------------------------------------------------------------

    One commenter also suggested that funds and intermediaries might
choose to hire additional staff to process information received under
the rule, although it noted that if the current volume of transactions
continues, a fund in its position probably would not need to hire
additional staff.\80\ Other commenters did not estimate the potential
costs related to hiring additional staff, the number of additional
staff that might be hired, or the likelihood that more staff would be
needed. In some circumstances, funds or intermediaries might choose to
hire additional staff to process information received under the rule,
but funds and intermediaries are likely to have sufficient staff in
place to monitor frequent trading abuses that violate fund policies,
and therefore are unlikely to need more staff under the amended
rule.\81\ The rule, by requiring funds to set up formalized
information-sharing networks with their intermediaries, might also
result in more efficient monitoring of frequent trading by funds and
possible opportunities to reduce staff.
---------------------------------------------------------------------------

    \80\ See Comment Letter of T. Rowe Price Associates, Inc. (Apr.
10, 2006). During further discussions with the commenter, it noted
that the cost of hiring one additional analyst to monitor
information received under rule 22c-2 and these amendments could be
approximately $35,000-40,000 a year, exclusive of overhead. Although
we believe that most funds will not need to hire additional staff to
comply with rule 22c-2, we estimate that the cost of hiring one
additional senior compliance examiner could be $347,000 a year,
inclusive of overhead and other expenses (based on compensation
estimates for a Senior Compliance Examiner, from the Securities
Industry Assoc., Report on Management & Professional Earnings in the
Securities Industry (2005), multiplied by 5.35 to account for
bonuses, firm size, employee benefits, and overhead).
    \81\ See, e.g., Compliance Programs of Investment Companies and
Investment Advisers, supra note 43 at n.75 and surrounding text.
---------------------------------------------------------------------------

    In response to comments received on the 2006 Proposing Release, we
have revised certain of our cost estimates upwards over those discussed
in the 2006 Proposing Release. As further described in Section VI
below, for purposes of the Paperwork Reduction Act, we have estimated
that all funds will incur a total of approximately $47,500,000 \82\ in
one-time capital costs to develop or upgrade their software and other
technological systems to collect, store, and receive the required
identity and transaction information from intermediaries, and a total
of $22,655,000 each year thereafter in operation costs related to the
transmission and receipt of the information.\83\ We have also estimated
that financial intermediaries may incur $280,000,000 \84\ in one-time
capital costs to develop or upgrade their software and other
technological systems to collect, store, and transmit the required
identity and transaction information to funds and from other
intermediaries, and a total of $192,500,000 \85\ each year thereafter
in operation costs related to the transmission and receipt of the
information. These estimates were made for purposes of the Paperwork
Reduction Act, and do not include certain costs, discussed above, that
funds and intermediaries may incur which are not related to collections
of information required by the rule. For example, the Paperwork
Reduction Act estimates do not include all potential staffing costs,
outside vendor analysis of information to discern trading patterns, or
data repository costs that funds and intermediaries may incur in
analyzing the information that they may collect under the agreements
required by the rule. Although these are costs that funds and
intermediaries may choose to incur, they are not required by the rule,
and may vary significantly between every fund and intermediary
depending on the frequency of data requests, their policies on frequent
trading, their ability to analyze information, and many other factors.
---------------------------------------------------------------------------

    \82\ This estimate, as well as many other estimates in this
section may differ from the estimates made in the 2006 Proposing
Release. These differences reflect new information provided to us by
commenters, and are further discussed in Section VI.
    \83\ See infra Section VI.
    \84\ We estimate a total of approximately $327,500,000 in one
time start-up costs ($280,000,000 + $47,500,000 = $327,500,000) for
purposes of the Paperwork Reduction Act.
    \85\ We estimate a total of approximately $215,155,000 in
ongoing annual costs ($192,500,000 + $22,655,000 = $215,155,000) for
purposes of the Paperwork Reduction Act.
---------------------------------------------------------------------------

    For the reasons discussed above, we anticipate that these
amendments will not create additional costs beyond the rule as adopted.
In fact, we anticipate that the amendments will significantly reduce
costs to most market participants.\86\
---------------------------------------------------------------------------

    \86\ See infra note 135.
---------------------------------------------------------------------------

V. Consideration of Promotion of Efficiency, Competition and Capital
Formation

    Section 2(c) of the Investment Company Act requires the Commission,
when engaging in rulemaking that requires it to consider or determine
whether an action is necessary or appropriate in the public interest,
to consider whether the action will promote efficiency, competition,
and capital formation. As discussed in the Cost-Benefit Analysis above,
these amendments to rule 22c-2 are designed to reduce the burdens of
the rule as adopted in 2005, while maintaining its investor
protections. Funds will no longer be required to incur the expense of
modifying or entering into agreements with omnibus accounts that they
already effectively monitor by treating as individual investors, and
would not need to enter into agreements with intermediaries that do not
trade directly with the fund. These amendments will promote efficiency
in the capital markets by enabling funds to focus their short-term
trading deterrence efforts on those omnibus accounts that could be used
to disguise this type of trading. These amendments will also promote
efficiency by reducing the number of omnibus accountholders that would
otherwise incur the expenses of entering into agreements, and of
establishing and maintaining systems for collecting and sharing
shareholder information.
    We do not anticipate that these amendments will harm competition.

They apply to all market participants and, as discussed in the Cost-
Benefit Analysis above, serve to reduce cost burdens for large funds as
well as small funds.\87\ Some commenters expressed concern that the
rule as adopted may disproportionately burden small intermediaries, and
thus hinder competition.\88\ We anticipate that under these amendments,
most omnibus accounts that are treated by the fund as individual
investors will be small intermediaries. By excluding these small
intermediaries from the rule's requirements, the amendments should
serve to alleviate potential anti-competitive effects on small
intermediaries.
---------------------------------------------------------------------------

    \87\ See supra Section IV.
    \88\ See, e.g., Comment Letter of the Investment Company
Institute (May 9, 2005).
---------------------------------------------------------------------------

    These amendments are designed to reduce the costs of imposing
redemption fees for both funds and intermediaries. Even after these
amendments, the competitive pressure of marketing funds, especially
smaller funds, coupled with the costs of imposing redemption fees in
omnibus accounts, may deter some funds from imposing redemption fees.
Intermediaries may use their market power to prevent funds from
applying the fees, or provide incentives for fund groups to waive fees.
However, by reducing the costs of imposing redemption fees, we believe
that these amendments will likely reduce such anti-competitive effects.
    We anticipate that these amendments may indirectly foster capital
formation by reducing the costs of the rule for funds and
intermediaries. If these cost savings are passed on to investors, they
may increase investment in funds, thereby promoting capital formation.
These amendments also may foster capital formation by improving the
beneficial effect of the rule on investor confidence, because the rule
is designed to permit funds to deter, and recoup the costs of, abusive
short-term trading. To the extent that the amended rule enhances
investor confidence in funds, investors are more likely to make assets
available through intermediaries for investment in the capital markets.

VI. Paperwork Reduction Act

    As discussed in the Adopting Release,\89\ the rule includes
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995.\90\ The Commission submitted the
collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11, and OMB approved these collections of information under
control number 3235-0620 (expiring 06/30/2009). The title for the
collection of information requirements associated with the rule is
``Rule 22c-2 under the Investment Company Act of 1940, Redemption fees
for redeemable securities.'' An agency may not conduct or sponsor, and
a person is not required to respond to, a collection of information
unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \89\ See Adopting Release, supra note 4, at Section V.
    \90\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    In response to the 2006 Proposing Release, we received a number of
comments on the estimates made in the Paperwork Reduction Act section,
and which provided additional cost estimates and other information.\91\
In light of those comments, we have revised upwards several of the per-
fund estimates made in this section. However, because these amendments
reduce the number of shareholder information agreements required, we
estimate that the amendments should, in general, reduce the aggregate
burden associated with the collections of information required by the
rule, and will not create new collections of information. We have
revised our previous burden estimates under the Paperwork Reduction Act
to reflect (i) new cost and time burden information that we have
received from market participants, and (ii) the revised number of
entities that will be affected by the amended rule.
---------------------------------------------------------------------------

    \91\ See, e.g., Comment Letter of T. Rowe Price Associates, Inc.
(Apr. 10, 2006); Supplemental Comment Letter of the SPARK Institute,
Inc. (May 1, 2006).
---------------------------------------------------------------------------

    This revised Paperwork Reduction Act section contains a number of
new cost and hour estimates that are significantly altered from the
estimates made in the Adopting Release. Some of these estimates are
based on different methods, and different sources, from those in the
Adopting Release. Therefore there is not a strict comparability between
the estimates made here and those made in the Adopting Release. These
cost estimates, hourly rate estimates, and the methodology used to make
these proposed estimates are based on comments we received in response
to the Adopting Release and the 2006 Proposing Release, as well as
information received from funds, intermediaries, and other market
participants.\92\
---------------------------------------------------------------------------

    \92\ See 2006 Proposing Release, supra note 8, at Sections VI
and VIII. In general, the cost estimates provided in this section
are derived from rounded and weighted averages of the cost estimates
provided during conversations with industry representatives that
took place prior to the 2006 Proposing Release, combined with the
additional information submitted by commenters on that release.
---------------------------------------------------------------------------

    Rule 22c-2 includes two distinct ``collections of information'' for
purposes of the Paperwork Reduction Act. The first is related to
shareholder information agreements, including the costs and time
related to identifying the relevant intermediaries, drafting the
agreements, negotiating new agreements or modifying existing ones, and
maintaining the agreements in an easily accessible place. The second is
related to the costs and time related to developing, maintaining, and
operating the systems to collect, transmit, and receive the information
required under the shareholder information agreements.\93\
---------------------------------------------------------------------------

    \93\ This second collection of information does not include
potential costs or time that funds or intermediaries might incur in
analyzing or using the provided information.
---------------------------------------------------------------------------

    Both collections of information are mandatory for funds that choose
to redeem shares within seven days of purchase. These funds will use
the information collected to ensure that shareholders comply with the
fund's policies on abusive short-term trading of fund shares. There is
a six year recordkeeping retention requirement for the shareholder
information agreements required under the rule. Any responses that are
provided in the context of the Commission's examination and oversight
program are generally kept confidential.\94\
---------------------------------------------------------------------------

    \94\ For a discussion of restrictions on the disclosure of
information under applicable privacy laws, see supra note 44.
---------------------------------------------------------------------------

A. Shareholder Information Agreements

    The Commission staff anticipates that most shareholder information
agreements will be entered into at the fund complex level, and
estimates that there are approximately 900 fund complexes. The
Commission staff understands that the number of intermediaries that
hold fund shares can vary for each fund complex, from less than 10 for
some fund complexes to more than 3000 for others. Based on
conversations with fund and financial intermediary representatives that
took place prior to the 2006 Proposing Release, our staff estimates
that, on average, under the revised definition of financial
intermediary, each fund complex has 300 financial intermediaries. We
understand that most funds already know and previously identified the
majority of their intermediaries that they do not treat as individual
investors. Therefore, funds should expend a limited amount

of time and costs related to the identification of such intermediaries.
Our staff estimates that identifying the intermediaries with which a
fund complex must enter into agreements may take the average fund
complex 250 hours of a service representative's time at a cost of $40
per hour,\95\ for a total of 225,000 hours at a cost of $9,000,000.\96\
Our staff estimates that for a fund complex to prepare the model
agreement, or provisions modifying a preexisting agreement, between the
fund and the intermediaries, it will require a total of 5 hours of
legal time at $300 per hour, for a total of 4500 hours \97\ at a total
cost of $1,350,000.
---------------------------------------------------------------------------

    \95\ The title and hourly cost of the person performing the
intermediary identification and entering into agreements may vary
depending on the fund or financial intermediary. This $40 per hour
cost is an average estimate for the hourly cost of employing the
person doing the relevant work, derived from conversations with
industry representatives that took place prior to the 2006 Proposing
Release.
    \96\ This estimate is based on the following calculations: 250
hours times 900 fund complexes equals 225,000 hours, and 225,000
hours times $40 equals $9,000,000.
    \97\ This estimate is based on the following calculation: 5
hours times 900 fund complexes equals 4500 hours of legal time.
---------------------------------------------------------------------------

    The Commission staff estimates that for a fund complex to enter
into or modify a shareholder information agreement with each existing
intermediary, it will require a total one-time expenditure of
approximately 2.5 hours of fund time and 1.5 hours of intermediary time
for each agreement, for a total of 4 hours expended per agreement.\98\
Therefore, for an average fund complex to enter into shareholder
agreements, the fund complex and its intermediaries may expend
approximately 1200 hours at a cost of $48,000,\99\ and all fund
complexes and intermediaries may incur a total one-time burden of
1,080,000 hours at a cost of $43,200,000.\100\ The Commission staff
understands that there are efforts under way (including an industry
task force devoted to the project) to produce standardized shareholder
information-sharing model agreements and terms.\101\ These efforts may
reduce the costs associated with the agreement provision of the rule
for both funds and intermediaries.\102\ Finally, the Commission staff
does not anticipate that funds or intermediaries will incur any new
costs in maintaining these agreements in an easily accessible place,
because such maintenance is already done as a matter of course.
---------------------------------------------------------------------------

    \98\ The 4 hour figure represents time incurred by both the fund
and the financial intermediary for each agreement. The Commission
staff estimates that this 4 hour figure is comprised of
approximately 2.5 hours of a fund service representative's time at
$40 per hour and 1.5 hours of an intermediary representative's time
at $40 per hour.
    \99\ This estimate is based on the following calculations: 4
hours times 300 intermediaries equals 1200 hours; and 1200 hours
times $40 dollars per hour equals $48,000.
    \100\ This estimate is based on the following calculations: 1200
hours times 900 fund complexes equals 1,080,000 hours; and 1,080,000
hours times $40 per hour equals $43,200,000.
    \101\ See 2006 Proposing Release, supra note 8, at text
accompanying n.45.
    \102\ See, e.g., Supplemental Comment Letter of the SPARK
Institute, Inc. (May 1, 2006).
---------------------------------------------------------------------------

    The staff therefore estimates that, for purposes of the Paperwork
Reduction Act, the shareholder information agreement provision of the
rule as revised will require a total of 1,309,500 hours at a total cost
of $53,550,000.\103\
---------------------------------------------------------------------------

    \103\ This estimate is based on the following calculations: 4500
hours of legal drafting time plus 1,080,000 hours of agreement
negotiating time plus 225,000 hours of intermediary identification
time equals 1,309,500 total hours; and $43,200,000 plus $1,350,000
plus $9,000,000 equals $53,550,000.
---------------------------------------------------------------------------

B. Information-Sharing

    Some funds and intermediaries will incur the system development
costs discussed in this section, but many will not because they already
process all of their trades on a fully disclosed basis, use a third
party administrator to handle their back office work,\104\ or already
have systems in place that allow intermediaries to transmit the
shareholder identity and transaction information to funds. Other funds
and intermediaries may have special circumstances that may increase the
costs they face in developing and operating systems to comply with the
rule. The estimates below represent the Commission staff's
understanding of the average costs that might be encountered by a
typical fund complex or intermediary in complying with the information-
sharing aspect of the rule as amended.
---------------------------------------------------------------------------

    \104\ Third party administrators maintain accounts for many
other intermediaries, and therefore incur the costs to develop a
single system.
---------------------------------------------------------------------------

1. Funds
    The Commission staff understands that various organizations have
developed, or are in the process of developing, enhancements to their
systems that will allow funds and intermediaries to share the
information required by the rule without developing or maintaining
systems of their own.\105\ Our staff anticipates that most funds and
intermediaries will use these systems, and will generally make minor
changes to their back office systems to comply with the rule
requirements and to match their systems to those of the service
providers. Our staff estimates that most funds could adapt their in-
house systems to utilize these service providers' systems at a one-time
cost of approximately $10,000 or less.\106\ Although the costs that
systems providers will charge may vary, one large provider has
indicated that it plans to charge a monthly fee of $200 and fees of 25
cents for every 100 account transactions requested through the
service.\107\
---------------------------------------------------------------------------

    \105\ These service providers systems include the National
Securities Clearing Corporation's Fund/SERV system, as well as other
systems being developed by a number of other providers such as
SunGard, BISYS, AccessData, and Charles Schwab. See, e.g., Comment
Letter of AccessData Corp. (Apr. 10, 2006).
    \106\ We expect that, in many cases, upgrades to fund transfer
agents' as well as fund complex's systems will take place, and the
transfer agents' costs will be charged back to the fund complex
    \107\ See National Securities Clearing Corporation, Networking
Service to Support SEC Rule 22c-2, Important Notice A 6228,
P&S 5798 (Apr. 12, 2006) (available at http://www.nscc.com/impnot/notices/notice2006/a6228.pdf.
)

---------------------------------------------------------------------------

    As an example of the cost of using these services, if a fund
complex requests information for 100,000 transactions each week,\108\
then it would incur costs of $250 each week, or $13,000 a year, plus
the monthly fee of $200, equaling $2,400 a year, for a total cost of
$15,400 a year.\109\ Our staff estimates that approximately 475 fund
complexes would use these systems (including substantially all of the
largest, and most of the medium-sized, fund complexes). If all of these
complexes use these service providers' systems at the rate described
above, they would incur a one-time system development cost of
$4,750,000 \110\ and an annual system use cost of approximately
$7,315,000.\111\ Those 475 fund complexes may also incur system
development costs related to the processing of information under the
rule on trades that they receive through other channels than these
service providers' systems, which we estimate to cost an average
approximately $50,000 per fund

complex, and $20,000 annually,\112\ for a total of $23,750,000 \113\ in
system development costs and $9,500,000 annually.\114\ Our staff
estimates that the total system development cost for these 475 fund
complexes that are likely to use these existing systems is $28,500,000
with annual operation costs of $16,815,000.\115\
---------------------------------------------------------------------------

    \108\ The number of transactions and weekly request used here is
an example, and is not intended to be a guideline as to how often a
fund should request information under the rule. The frequency of
information requests could vary significantly based on a wide
variety of factors, as discussed in Section II.C above.
    \109\ This estimate is based on the following calculations:
100,000 transaction requests times one quarter of a cent (the charge
is 25 cents per 100 transactions requested, or one quarter of a cent
per transaction) equals $250; $250 times 52 weeks equals $13,000;
$200 monthly charges times 12 months equals $2,400; and $13,000 plus
$2,400 equals $15,400. The costs of utilizing these services may
vary widely, based on the frequency funds make information sharing
requests, and the number of accounts requested.
    \110\ This estimate is based on the following calculation: 475
fund complexes times $10,000 (one-time system update costs) equals
$4,750,000.
    \111\ This estimate is based on the following calculation: 475
fund complexes times $15,400 (annual costs) equals $7,315,000.
    \112\ In response to the 2006 Proposing Release, many commenters
discussed the difficulty of estimating the costs of creating and
operating information-sharing systems. As a result, very few
monetary cost estimates were submitted by commenters. One fund
commenter did provide some monetary estimates, and noted that
although it agreed that many of the cost estimates made in the 2006
Proposing Release were reasonable, it believed that the Commission
may have underestimated some of the costs it will likely encounter
when designing and operating information sharing systems. See
Comment Letter of T. Rowe Price Associates, Inc. (Apr. 10, 2006).
The commenter noted that additional staffing, data repository, and
intermediary vendor costs related to information sharing systems may
result in costs significantly higher than those estimated in the
Paperwork Reduction Act section of the 2006 Proposing Release. We
agree that these may be significant costs, but note that the
estimates made in this section are limited to the scope of the
Paperwork Reduction Act, and therefore do not include all of the
costs encountered by funds and intermediaries in implementing the
rule that are not related to a ``collection of information'' as
defined under that Act. 44 U.S.C. 3501-3520. Other costs and
benefits of the rule, including the costs mentioned by that and
other commenters, are discussed in Section IV of this Release.
    \113\ This estimate is based on the following calculation: 475
fund complexes times $50,000 system development cost per fund
complex equals $23,750,000.
    \114\ This estimate is based on the following calculation: 475
fund complexes times $20,000 annual costs per fund complex equals
$9,500,000.
    \115\ This estimate is based on the following calculations:
$23,750,000 plus $4,750,000 (one-time system development costs)
equals $28,500,000 total start-up costs for fund complexes utilizing
existing systems; and $7,315,000 plus $9,500,000 equals $16,815,000
in annual costs.
---------------------------------------------------------------------------

    There are approximately 900 fund complexes currently operating, of
which approximately 475 may use these existing systems, leaving
approximately 425 fund complexes possibly needing to develop specific
systems to meet their own particular needs. Our staff understands that
approximately 75 percent of those fund complexes (or 319 complexes) are
small to medium-sized direct-sold funds that have a very limited number
of intermediaries. Our staff anticipates that those 319 fund complexes
would incur minimal system development costs to comply with the
information-sharing provisions of the rule, due to the limited number
of intermediaries with which they interact. Our staff estimates that
system development costs for handling information under the rule for
those 319 fund complexes will be approximately $25,000 each, with
annual operation costs of approximately $10,000, for a total system
development cost of $7,975,000 \116\ and an annual operations cost of
$3,190,000.\117\
---------------------------------------------------------------------------

    \116\ This estimate is based on the following calculation: 319
funds times $25,000 equals $7,975,000.
    \117\ This estimate is based on the following calculation: 319
funds times $10,000 equals $3,190,000.
---------------------------------------------------------------------------

    The remaining approximately 106 fund complexes may face additional
complexities or special circumstances in developing their systems. Our
staff estimates that the start-up costs for those fund complexes will
be approximately $100,000 per fund complex and the annual costs for
handling the information will be approximately $25,000, for a total
start-up cost of $10,600,000 and an annual cost of $2,650,000 for these
fund complexes.\118\
---------------------------------------------------------------------------

    \118\ This estimate is based on the following calculations: 106
funds times $100,000 equals $10,600,00; and 106 funds times $25,000
equals $2,650,000.
---------------------------------------------------------------------------

    For purposes of the Paperwork Reduction Act, our staff therefore
estimates that the information-sharing provisions of the rule as
amended will cost all fund complexes a total of approximately
$100,625,000 in one-time capital costs to enter into agreements and
develop or upgrade their software and other technological systems that
allows them to collect, store, and receive the required identity and
transaction information from intermediaries, and a total of $22,655,000
each year thereafter in operation costs related to the transmission and
receipt of the information.\119\
---------------------------------------------------------------------------

    \119\ This estimate is based on the following calculations:
$28,500,000 (funds that use service providers start-up costs) plus
$7,975,000 (direct-traded funds' start-up costs) plus $10,600,000
(other funds' start-up costs) equals $47,075,000 system development
costs; $47,075,000 (system development costs) plus $53,550,000
(agreement costs) equals $100,625,000 total fund start-up costs; and
$16,815,000 (funds that use service providers annual costs) plus
$3,190,000 (direct-traded funds' annual costs) plus $2,650,000
(other funds' annual costs) equals $22,655,000 annual funds' costs.
---------------------------------------------------------------------------

2. Intermediaries
    The Commission staff estimates that there are approximately 7000
intermediaries that may provide information pursuant to the
information-sharing provisions of rule 22c-2.\120\ Of those 7000
intermediaries, our staff anticipates that approximately 350 of these
intermediaries are likely to primarily use the existing systems that
are in place or under development. The staff understands that these
approximately 350 intermediaries include several major ``clearing
brokers'' and third-party administrators that aggregate trades and
handle the back-end work for thousands of other smaller broker-dealers
and intermediaries, thereby providing access to these service
providers' information-sharing systems to a significant majority of all
intermediaries in the marketplace. Our staff estimates that these
approximately 350 intermediaries will provide access to systems that
will allow for the transmission of information required by the rule and
other processing for the transactions of approximately 80 percent of
the 7,000 intermediaries (5,600 intermediaries) affected by the rule,
leaving 1,400 intermediaries that do not in some way utilize these
systems, that may need to develop their own systems.\121\
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    \120\ This number is a rounded estimate, based on the number of
intermediaries that may be affected by the rule. The number consists
of the following: 2,203 broker-dealers classified as specialists in
fund shares, 196 insurance companies sponsoring registered separate
accounts organized as unit investment trusts, approximately 2,400
banks that sell funds or variable annuities (the number of banks is
likely over inclusive because it may include a number of banks that
do not sell registered variable annuities or funds, or banks that do
their business through a registered broker-dealer on the same
premises), and approximately 2,000 retirement plans, third-party
administrators, and other intermediaries (this number may be either
over or under inclusive, because under the rule as we are amending
it, the actual number of intermediaries that funds have is dependent
on the precise application of varying fund policies on short-term
trading).
    \121\ This number is based on the following calculation: 7,000
total intermediaries times 20% (the percentage of intermediaries
that do not use these service providers systems or use the services
of those 350 intermediaries that use those service provider systems)
equals 1,400 intermediaries that do not use service providers'
systems.
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    Our staff understands that in general, the providers who have
developed or are developing these information sharing systems charge
the fund, and not the intermediary, for providing these systems to
transmit shareholder identity and transaction information, or else
include access to such systems as a complementary part of their other
processing systems, and do not charge additional fees to intermediaries
for its utilization. These intermediaries may be required to develop
systems to ensure that they are able to transmit the records to these
service providers in a standardized format.\122\ Our staff estimates
that it will cost each of these 350 intermediaries approximately
$200,000 to update its systems to record

and transmit shareholder identity and transaction records to these
service providers, and an additional $100,000 each year to operate
their own systems for communicating with the service providers, for a
total start-up cost of $70,000,000, and an annual cost of
$35,000,000.\123\ We understand that these approximately 350
intermediaries may also have to upgrade their systems to handle rule
22c-2 information on trades that do not go through the service
providers' systems. Our staff estimates that it will cost each of those
350 intermediaries \124\ an additional $400,000 \125\ to update their
systems, and $250,000 \126\ annually to process this information
through non-service provider networks, for a total cost of $140,000,000
in system development costs and $87,500,000 in annual costs to process
data through non-service provider networks.\127\ We have increased
these estimates over those made in the 2006 Proposing Release in light
of the new cost information provided to us by the commenters in 2006.
Our staff therefore estimates that these approximately 350
intermediaries will incur a total of approximately $210,000,000 in
start-up costs and $122,500,000 in annual costs associated with the
information-sharing provisions of the rule.\128\
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    \122\ Our staff anticipates that in most cases, first-tier
intermediaries will use the same or slightly modified systems that
have been developed to identify and transmit shareholder identity
and transaction information to funds when collecting and
transmitting this information from indirect intermediaries.
Therefore, we have also included the costs of developing and
operating systems to collect information from indirect
intermediaries and providing the information to funds in these
estimates.
    \123\ This estimate is based on the following calculations: 350
broker-dealer times $200,000 (start-up costs) equals $70,000,000;
and 350 broker-dealer times $100,000 (start-up costs and annual
costs) equals $35,000,000.
    \124\ The estimate includes higher costs for these 350
intermediaries in developing systems to handle non-service provider
information than for remaining intermediaries to handle the same
data due to our staff's understanding that, in general, these 350
intermediaries that utilize the service provider's networks
represent the largest intermediaries in the marketplace, and will
face the highest costs in complying with the rule.
    \125\ Many of the costs that intermediaries incur in developing
and operating systems to handle this information may be recouped
from fund complexes through a variety of methods. However, it is
unclear what recoupment might take place, and therefore the cost
estimates for funds and intermediaries are made here prior to any
potential recoupment.
    \126\ In response to the 2006 Proposing Release, a few
commenters provided additional cost estimates regarding the costs
intermediaries may face in designing and operating information
sharing systems under the amended rule. One commenter estimated that
some intermediary system start-up costs may range from approximately
$125,000 to $2,300,000, and that ongoing annual costs may range from
$150,000 to approximately $1,000,000. See Supplemental Comment
Letter of the SPARK Institute, Inc. (May 1, 2006). Another commenter
estimated that for some insurance company intermediaries, the cost
to comply with all aspects of the redemption fee rule could exceed
$2,000,000 per company. See Comment Letter of the National
Association for Variable Annuities (Apr. 7, 2006). We have
incorporated this additional information into our calculations for
our revised estimates.
    \127\ This estimate is based on the following calculations: 350
broker-dealers times $400,000 (start-up costs) equals $140,000,000;
and 350 broker-dealers times $250,000 (annual costs) equals
$87,500,000.
    \128\ This estimate is based on the following calculations:
$70,000,000 (intermediary start-up costs for processing information
through service providers) plus $140,000,000 (intermediary start-up
costs for handling information through other channels) equals
$210,000,000; and $35,000,000 (intermediary annual costs for
processing information through service providers) plus $87,500,000
(intermediary annual costs for handling information through other
channels) equals $122,500,000.
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    The fund complexes and intermediaries that do not use these service
providers' systems to process their trades will have to either develop
their own systems to share information under the rule or engage some
other third-party administrator to process the information. Our staff
estimates that approximately 1,400 intermediaries will not utilize
these service provider systems to process this information, and
estimates that each of these intermediaries will incur $50,000 in
system development costs and $50,000 in annual costs in complying with
the rule, for a total of $70,000,000 in development costs and
$70,000,000 in annual costs for those intermediaries.\129\
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    \129\ This estimate is based on the following calculations:
1,400 intermediaries times $50,000 (development costs) equals
$70,000,000; and 1,400 intermediaries times $50,000 (annual costs)
equals $70,000,000.
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    Although the amended rule does not require first-tier
intermediaries to enter into agreements with their indirect
intermediaries to share the indirect intermediaries' underlying
shareholder data to funds upon a fund's request, we anticipate that in
many cases, intermediaries will nonetheless enter into such agreements,
or at least enter into informal arrangements and design methods by
which to collect the shareholder information. Our staff estimates that
each of the 7,000 intermediaries potentially affected by the rule will
spend approximately 150 hours of service representatives' time at $40
per hour, and 10 hours of legal counsel time at $300 per hour, for a
total of 1,050,000 hours of service representatives' time at a cost of
$42,000,000, and 70,000 hours of in-house legal time at a cost of
$21,000,000 to design and enter into these arrangements with other
intermediaries.\130\ The Commission staff therefore estimates that
intermediaries will expend a total of approximately 1,120,000 hours at
a cost of $63,000,000 to enter into arrangements to ensure the proper
transmittal of information to funds through chains of
intermediaries.\131\
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    \130\ This estimate is based on the following calculations:
7,000 intermediaries times 150 service representative hours at $40
per hour equals 1,050,000 hours at a cost of $42,000,000; and 7,000
intermediaries times 10 hours of in-house legal time at $300 per
hour equals 70,000 hours at a cost of $21,000,000.
    \131\ This estimate is based on the following calculations:
1,050,000 service representative hours at $42,000,000 plus 70,000
in-house counsel hours at $21,000,000 equals 1,120,000 hours at
$63,000,000.
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    Our staff estimates that the information-sharing provisions of the
rule will cost all intermediaries a total of approximately $343,000,000
in one-time capital costs to enter into agreements and develop or
upgrade their software and other technological systems to collect,
store, and transmit the required identity and transaction information
to funds and from other intermediaries, and a total of $192,500,000
each year thereafter in operation costs related to the transmission and
receipt of the information.\132\
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    \132\ This estimate is based on the following calculations:
$210,000,000 (intermediaries that use service providers start-up
costs) plus $70,000,000 (other intermediaries' start-up costs) plus
$63,000,000 (intermediary agreement costs) equals $343,000,000 in
intermediary start-up costs; and $122,500,000 (annual costs of
intermediaries that use service providers) plus $70,000,000 (other
intermediaries' annual costs) equals $192,500,000 in annual costs.
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C. Total Costs and Hours Incurred

    For purposes of the Paperwork Reduction Act, our staff estimates
that the amended rule will have a total collection of information cost
in the first year to both funds and intermediaries of $443,625,000 in
one-time start-up costs, and annual operation costs of
$215,155,000.\133\ Our staff estimates that the weighted average annual
cost of the rule to funds and intermediaries for each of the first
three years would be $363,030,000.\134\ The total hours expended by
both funds and intermediaries in complying with the amended rule will
be a one-time expenditure of 2,429,500 hours at a total internal cost
of $116,550,000.\135\ We

anticipate that there will be a total of approximately 7900 \136\
respondents, with approximately 14,310,000 total responses in the first
year, and 14,040,000 annual responses each year thereafter.\137\
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    \133\ This estimate is based on the following calculations:
$100,625,000 (fund start-up costs) plus $343,000,000 (intermediary
start-up costs) equals $443,625,000 in total start-up costs; and
$22,655,000 (fund annual costs) plus $192,500,000 (intermediary
annual costs) equals $215,155,000 in total annual costs.
    \134\ This estimate is based on the following calculations:
$443,625,000 in total start-up costs plus $645,465,000 (3 years at
$215,155,000 in total annual costs) equals $1,089,090,000 in total
costs over a three-year period. $1,089,090,000 divided by three
years, equals a weighted average cost of $363,030,000 per year.
    \135\ This estimate is based on the following calculations:
1,309,500 hours at a cost of $53,550,000 in agreement time plus
1,120,000 hours at a cost of $63,000,000 in chain of intermediary
arrangement time equals 2,429,500 hours at a cost of $116,550,000.
    For purposes of the Paperwork Reduction Act, Section VI of the
Adopting Release, supra note 4, included an estimate of the total
start-up costs to funds and financial intermediaries in complying
with the collection of information aspect of the rule of
approximately $1,111,500,000. We now estimate that funds and
intermediaries will incur the reduced amount of $443,625,000 in
start-up costs, for a potential cost reduction of approximately
$667,875,000 resulting from the amendments. In the Adopting Release
we also estimated that the ongoing annual costs will be
$390,556,800. We now estimate that after these amendments funds and
intermediaries will incur the reduced amount of $215,155,000 in
total annual costs, for a potential ongoing annual cost reduction of
approximately $175,401,800 resulting from the amendments.
    \136\ This estimate is based on the following calculation: 7,000
intermediaries plus 900 fund complexes equals 7,900 respondents.
    \137\ This estimate is based on the following calculation: 900
fund complexes with an average of 300 intermediaries each, equals
270,000 one time responses for the shareholder information portion
of the collection (900 funds times 300 intermediaries equals
270,000). Assuming that each fund requests information from each of
its intermediaries once each week (we have revised our initial
monthly assumption to a weekly assumption, although we expect that
the frequency of requests will vary significantly between funds
depending on their circumstances), the total number of annual
responses would be 14,040,000 (270,000 fund intermediaries times 52
weeks equals 14,040,000 annual responses). Therefore, in the first
year, there would be 14,310,000 total responses (14,040,000 weekly
responses plus the 270,000 initial responses required for the
agreements) and 14,040,000 annual responses thereafter.
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VII. Final Regulatory Flexibility Analysis

    This Final Regulatory Flexibility Analysis (``FRFA'') has been
prepared in accordance with 5 U.S.C. 604. It relates to amendments to
rule 22c-2 under the Investment Company Act, which we are adopting in
this Release. The Initial Regulatory Flexibility Analysis (``IRFA'')
which was prepared in accordance with 5 U.S.C. 603 was published in the
2006 Proposing Release.

A. Need For and Objectives of Rule

    Rule 22c-2 allows funds to recover some, if not all, of the direct
and indirect (e.g., market impact and opportunity) costs incurred when
shareholders engage in short-term trading of the fund's shares, and to
deter this short-term trading. As discussed more fully in Sections I
and II of this Release, the amendments to rule 22c-2 are necessary to
clarify the operation of the rule, to enable funds and intermediaries
to reduce costs associated with entering into agreements under the
rule, and to enable funds to focus their short-term trading deterrence
efforts on the entities most likely to violate fund policies. These
amendments also set forth the limitations on transactions between a
fund and an intermediary with whom the fund does not have an agreement.

B. Significant Issues Raised By Public Comment

    We requested comment on the IRFA. We specifically requested comment
on the number of small entities that would be affected by the rule
amendments, and the likely effect of the amendments on small entities,
the nature of any impact, and any empirical data supporting the extent
of the impact. We received a number of comments discussing the impact
that the rule amendments will have on small entities in the mutual fund
marketplace. Generally, these comments supported the rule amendments,
and agreed that the amendments would reduce the costs of compliance
with the rule for small entities, and would reduce the number of small
entities that would be required to comply with the rule.\138\ They
indicated that the rule amendments would reduce costs for all mutual
fund marketplace participants and would alleviate many of the concerns
they had expressed with the rule as it was originally adopted.