It looks as if Fidelity Investments of Boston would rather switch than fight when it comes to the issue of a three percent redemption fee on one of its funds.

Executives at Fidelity are expected to recommend to the board of directors of Fidelity's Small Cap Stock Fund that they reduce the fund's three percent redemption fee to no more than two percent, according to a person familiar with the matter. The fund board's approval is necessary before the fee can be reduced.

The move comes after more than a month of talks between Fidelity's lawyers and the SEC over the Small Cap Fund's three percent redemption fee. SEC lawyers contend that federal securities laws bar funds from charging a redemption fee of more than two percent in most cases.

A spokesperson for the SEC declined to comment. Jessica Catino, a Fidelity spokesperson, said the firm has been in discussions with the SEC about the Small Cap Stock Fund's redemption fee but declined to comment on Fidelity's plans or to disclose the date of the next scheduled fund board meeting.

"We're still in discussions with the SEC and it's too premature to comment," Catino said.

The key federal law that governs mutual funds, the Investment Company Act, provides that shareholders of an open-end fund can redeem their shares at any time for the fund's net asset value. The SEC has interpreted the law as allowing funds to apply a redemption fee of up to two percent because doing so does not effectively render the fund unredeemable.

Paul Roye, director of the SEC's division of investment management, warned in a speech March 27 that in most cases, the SEC opposed redemption fees in excess of two percent.

"Redemption fees should not be imposed at a level that imposes a penalty on an investor's ability to redeem out of a fund," Roye said at a mutual fund industry conference.

Roye's speech was consistent with what SEC lawyers have been saying in recent months in response to informal requests from some funds for the SEC to approve their exceeding the two percent cap, according to fund industry lawyers.

The Deutsche Preservation Plus Income Fund also charges a redemption fee of three percent, according to data from Morningstar. A spokesperson for the fund's adviser, Deutsche Asset Management of New York, declined to comment. The Amerindo Technology Fund of New York had a redemption fee last year of three percent. The fund dropped the fee to two percent on Dec. 8, 1999, according to an SEC filing. A spokesperson for Amerindo did not return a call seeking comment. It was unclear whether any funds other than the Fidelity and Deutsche funds have redemption fees in excess of two percent.

Fidelity imposes redemption fees on 76 of its 162 retail funds. The fees - which are paid directly into a fund and not to the fund adviser - are intended to reimburse the fund for expenses associated with having to sell securities as a result of short-term trading, Catino said. The Fidelity Small Cap Fund has had the three percent redemption fee since the fund's inception on March 12, 1998. The fund had assets of $992 million as of March 31, according to Morningstar of Chicago, the fund rating firm.

A fund can seek special consideration from the SEC if the fund wants to exceed the two percent cap, industry lawyers said. Roye said in an interview last month that the SEC may permit funds to charge in excess of two percent as a redemption fee when a fund is converting from a closed-end to an open-end structure.

Fidelity and the Small Cap Fund's board could still seek special consideration. Fund lawyers, however, were not optimistic about the outcome of such a move unless there were unusual circumstances.

"You're not going to get much reception from the current staff" on permitting a redemption fee of more than two percent in most cases, said David Sturms, a partner with Vedder, Price, Kaufman & Kammholz of Chicago.

The industry would benefit if the SEC would issue an interpretive letter outlining the circumstances under which a fund could exceed the two percent cap on redemption fees, Sturms said.

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