The fund industry is concerned that evolving interpretations of the act which authorizes the use of electronic signatures in commerce will inhibit the mutual fund industry's use of the Internet. The Investment Company Institute outlined its concerns in a letter to the Federal Trade Commission last month.
Last June, Congress enacted the Electronic Signature in Global and National Commerce Act, commonly known as ESIGN. The act is intended to facilitate the use of electronic records and signatures in commerce, and to remove any uncertainty about the validity of contracts entered into electronically.
Although Congress has acted, how signatures are to be used is far from settled. The Securities and Exchange Commission was to complete last week a comment period on rules proposed to put the signatures act into effect. The Federal Trade Commission has also recently stopped taking comments on the act, which will be used to develop a report required by Congress. How the act is ultimately interpreted will have a dramatic effect on how financial service providers, including funds and investment advisers, will be able to conduct business.
In addition to establishing the validity of electronic signatures, the statute requires electronic consent, by consumers, to the use of electronic records in fulfillment of legal disclosure requirements. This is of particular interest to the mutual fund and variable annuities industries, which are subject to numerous disclosure requirements under federal securities law.
However, the act leaves unclear whether prospectuses, transaction confirmations, shareholder reports and proxy statements to shareholders must be in writing, according to Frances Stadler, deputy senior counsel of the Investment Company Institute and the author of the ICI's March 16 letter to the FTC.
Stadler said the consent requirement of the act applies when the law requires that the information provided to a consumer be in writing. Mutual funds are subject to a number of regulations that could trigger this provision, including securities disclosures and tax reporting provisions.
The ICI said in its letter that it is unclear whether existing guidance on electronic delivery of information, which in part addresses consent issues, still applies. As a result, the ICI requested in its letter guidance as to which mutual fund disclosures are required to be in writing.
The electronic consent requirement also places an added burden on consumers that could inhibit use of electronic signatures, the ICI's letter said.
"Under ESIGN, a fund shareholder cannot simply call or write to a fund organization, or walk in to a fund customer service center and complete a request to change document delivery preferences from paper to electronic," the letter said. "Rather, the shareholder would have to re-consent [or confirm consent] from his or her own computer upon returning to his or her own home or office. Several of the Institute's members have expressed concern that this inconvenience will discourage, rather than encourage, increased use of paperless technologies."
The SEC's existing guidance does not require that consent be conveyed electronically, said Stadler, in his letter. Paper and telephone consents have been adequate and this has been a satisfactory arrangement for both the industry and apparently consumers, the letter said. The ICI is concerned that subsequent interpretation of the act will eliminate this flexibility, according to the letter.
The ICI is also concerned about the act's "reasonable demonstration" provision. The act requires not only that a consumer's consent or confirmation be electronic, but also that it be given in a manner that "reasonably demonstrates" that the consumer can gain access to information in the electronic form in which it is provided. The ICI has said its members have generally taken a common sense approach to the reasonable demonstration requirement and that this has been acceptable under existing guidance. The ICI is concerned that subsequent definition of what constitutes "reasonable demonstration" will be onerous, according to the letter.
There is also concern that the reasonable demonstration requirement has already had a negative impact on the use of electronic record keeping in financial services. The Electronic Financial Services Council, of which the Principal Financial Group of Des Moines, Iowa, is a member - the only fund or annuity company that is - wrote in a comment letter March 17 to the FTC that the reasonable demonstration requirement discourages the use of widely available and reliable file formats, such as Adobe Acrobat PDF and Microsoft Word. Companies have instead used formats compatible with the browser used to gain access to the information being conveyed. The more common formats are better suited to the job and more efficient, the council's letter said.
While the industry has expressed concerns regarding ESIGN's consent provisions, the SEC's proposed changes to rules that now require that mutual funds and investment companies store records electronically if they were received or created electronically, are likely to be less controversial. These changes have been proposed in light of ESIGN. The proposed changes would allow funds and advisers to convert records, which were originally created as paper documents, into electronic formats and then store them electronically. The standards would be different from those that the SEC has previously adopted for broker/dealers. Broker/dealers must store records in a "non-rewritable", non-erasable format. The SEC has proposed that no such requirement be placed on funds or advisers.
In the past, the SEC's staff has issued no-action letters that have conditionally permitted funds and advisers to convert records into electronic format. The proposed amendments would codify the permissions in the no-action letters, but would eliminate many of the conditions in the letters that apply to electronic archives of non-electronic originals.
The SEC has also proposed changes designed to clarify the obligation funds and advisers have to provide copies of their records to SEC examiners. Current SEC rules require funds and advisers to "promptly provide" computer printouts of records stored in computers upon request. The proposed amendments would make clear that copies of such records must be provided no more than one business day after the request, that the copies must be legible and complete, and that the fund or adviser must provide a means for regulators to gain access to, search, view, and sort the records. The SEC does not believe the proposed amendments will create any additional costs for funds or advisers, according to its proposal. The use of electronic record-keeping is entirely optional and the SEC assumes that funds and advisers will not opt for electronic record-keeping unless it is advantageous for them, the proposal said.