Senate Passes Military Financial Antifraud Bill with Broader Provisions
By unanimous consent, the Senate passed a military financial products antifraud bill that completely bans investment companies from issuing periodic payment plan certificates, an outdated form of mutual fund with high up-front costs. The House passed a similar bill last year by a vote of 405-2. A conference committee can now be assigned to reconcile differences between the House and Senate versions or the House can take up the Senate version of the bill. As can be seen by the complete ban on contractual plans, the measure is broader than its military genesis. Moreover, the broad and deep bi-partisan support for this legislation argues strongly for its final passage this year.
The Military Personnel Financial Services Protection Act (S. 418) amends section 27 of the Investment Company Act to forbid the issuance and sale of periodic payment plan certificates, effective 30 days after the date of enactment. But the bill preserves preexisting rights related to existing plans, including administrative transactions, conversions, transfers, or amount or name changes. The bill also directs the SEC to submit a report to Congress on refunds, sales practices, and revenues from periodic payment plans over the last five years.
These contractual plans represent an obscure investment vehicle that has virtually disappeared from the civilian market due to its unusually high and front-loaded sales charge. The hallmark of such plans is a sales load of 50 percent, paid by the investor to the broker selling the plan, assessed against the first year of contributions. Created so that investors able to make only small monthly contributions could reap the rewards of stock market investing, contractual plans have actually been associated with rampant abuses since their introduction in 1930.
In recent years, the contractual plan has fallen further into disrepute. The GAO has identified three reasons supporting its recommendation urging Congress to ban contractual plans. First, less-costly and widely accessible alternatives exist for small investors to begin and maintain investments in mutual funds. Second, only 10 to 43 percent of investors that purchased contractual plans between 1980 and 1987 had completed the full 15 years required under the contract. As might be expected, investors who did not complete the contract paid much higher effective sales loads than investors in conventional mutual funds. Third, and perhaps most important, contractual plans have been associated with sales practice abuses for decades.
Another provision of S.418 reorganizes and codifies in section 204 of the Investment Advisers Act provisions of the National Securities Markets Improvement Act, in which Congress directed the SEC to establish an electronic filing system, and mandated the creation of a public disclosure program, for investment advisers. Pursuant to this directive, the SEC designated the NASD to operate the electronic filing system, which is called the Investment Adviser Registration Depository (IARD), and created an internet-based public disclosure program containing investment adviser registration and disciplinary information.
The bill codifies the SEC's designation of the NASD as the operator of the IARD, although it requires a toll-free telephone listing, or electronic means, for receiving and responding to inquiries for registration information. It also provides the NASD with immunity from liability for actions taken in good faith in operating the investment adviser public disclosure program.
The bill also clarifies that state securities laws apply to securities activities conducted on federal land and facilities, including military installations in the U.S. and abroad. The state within which the base is located would have primary jurisdiction in cases when multiple state laws would otherwise apply. With respect to overseas military bases, the state that issued the resident license of the agent in question would have jurisdiction.
Finally, the measure amends section 15A(i) of the Exchange Act, which requires securities associations to maintain a toll-free telephone listing to receive inquiries regarding disciplinary actions involving its members and to respond to those inquiries in writing. The amended language requires the association to establish an easily accessible electronic or other process, in addition to the toll-free telephone listing, to respond to inquiries about registration information. The securities association also will be required to adopt rules relating to inquiries and responses, and on the establishment of an administrative process for disputing the accuracy of registration information. Consistent with current law, the association and participating exchanges will not be liable to any persons for actions taken or omitted in good faith under this provision.