Regulatory Update

Rule 22c-2 and FundsNetwork

Introduction
As we all know, fund companies and financial intermediaries across the industry are going to great lengths to prepare for compliance with the SEC's Redemption Fee Rule (Rule 22c-2) that is scheduled for implementation on October 16, 2006. Here, we take a look at what the Rule is, what the issues are, and how FundsNetwork's approach will benefit all fund companies.

Overview
Rule 22c-2 allows a mutual fund to impose a redemption fee, not to exceed 2% of the amount redeemed, to enable a fund to recoup some of its direct and indirect costs incurred as a result of short-term trading strategies, such as market timing.

In situations where shares held are not fully disclosed and regardless of whether a fund's board of directors opts to impose a redemption fee, a fund company must enter into a written agreement with each direct (or 'first-tier') financial intermediary that holds shares on behalf of other investors. While most in the industry plan to adopt language from the model agreement recently released by the Investment Company Institute (ICI) and Securities Industry Association (SIA), each agreement should hold that:

1. The fund is responsible for determining when it needs a financial intermediary's assistance in monitoring and enforcing a fund's market timing policies. To monitor and enforce these policies, the fund will have the flexibility to request information periodically, or when circumstances suggest that a financial intermediary is not assessing redemption fees or that abusive market timing activity is occurring.
2. Upon a fund's request (which could be periodic such as daily or monthly, or ad hoc), the financial intermediary must agree to provide the fund with shareholder identity and transaction information to meet the request.
3. Upon the fund's instruction to do so, the financial intermediary must restrict or prohibit further purchases or exchanges by a specific shareholder (as identified by the fund) who has engaged in trading that violates the fund's market timing or excessive trading policies.

It should be noted that SEC Rule 22c-2 does not apply to money market funds, exchange-traded funds (ETFs), and funds that affirmatively permit market timing of shares.

Industry-wide potential areas of concern / complexity:
As fund companies and intermediaries prepare for compliance with Rule 22c-2, there are many complex issues that must be considered and addressed. Some of those issues include:

• Transfers/Conversions: Monitoring activity and shareholders as holdings transfer from one financial intermediary to another presents complex cross-referencing and reconciliation issues.
• Data formats: Though many will adhere to the NSCC's standards, formats may otherwise be disparate.
• Data storage: Fund companies and financial intermediaries may need to significantly upgrade their storage capacities to enable storage of millions upon millions of records of trade-related and position-related data.
• Data transmission/connectivity/security: Fund companies, financial intermediaries, and underlying clients may need to connect with each other, the NSCC, and/or multiple vendors in secure electronic methods that might not be in place today.
• Varied fund policies: Redemption policies and rules will likely vary across fund companies and thus effective rule (and contract) management is essential.
• Costs: Fund companies and financial intermediaries are forced into major systemic and infrastructural upgrades, while additional resources will be needed to monitor activity and handle manual touch-points.

FundsNetwork's Approach
Here at Fidelity, the FundsNetwork team is working with National Financial Services (NFS) in drafting a standard model agreement for all fund companies that is specific to Rule 22c-2 and based on the Investment Company Institute (ICI) and Securities Industry Association's (SIA) recently released model. In preparing this draft, NFS aims to include standards that the majority of fund companies can adopt.

As you are aware, we asked for your participation in our Rule 22c-2 survey. Responses to this survey are being used simply to help determine the most agreeable terms across all fund companies and facilitate the agreement establishment process. To those that completed the survey, we appreciate your participation and your feedback has proven valuable.

Beyond this survey, be on the lookout for future distributions from us as we reach out to you over the next several weeks to convey our plans for establishing agreements and detail our expected process in handling Rule 22c-2.

As a preview, fund companies can anticipate enhancements to the Real-Time Trade Activity (RTTA) tool that is available on FundsNetwork.com. We consistently hear positive feedback on our RTTA reporting, and we plan to build on this by expanding search capabilities and adding more robust functionality that will add substantial value to a fund company's monitoring process. We will be sharing further details on the forthcoming updates to RTTA as we approach Rule 22c-2's implementation date.

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