[Federal Register: January 22, 2003 (Volume 68, Number 14)]
[Rules and Regulations]
[Page 3141-3154]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr22ja03-19]
[[Page 3141]]
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Part V
Securities and Exchange Commission
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17 CFR Part 270
Transactions of Investment Companies With Portfolio and Subadviser
Affiliates; Final Rule
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
[Release No. IC-25888; File No. S7-13-02]
RIN 3235-AI28
Transactions of Investment Companies With Portfolio and
Subadviser Affiliates
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting amendments to rules under the Investment Company Act of 1940
to expand the current exemptions for investment companies (``funds'')
to engage in transactions with ``portfolio affiliates''--companies that
are affiliated with the fund solely as a result of the fund (or an
affiliated fund) controlling them or owning more than five percent of
their voting securities. The Commission is also adopting one new rule
and several rule amendments to permit funds to engage in transactions
with subadvisers of affiliated funds. The rules are designed to permit
transactions between funds and certain affiliated persons under
circumstances where it is unlikely that the affiliate would be in a
position to take advantage of the fund.
EFFECTIVE DATE: Effective Date: February 24, 2003. Compliance Date:
April 23, 2003. Section II of this document contains more information
on transition prior to the compliance date.
FOR FURTHER INFORMATION CONTACT: William C. Middlebrooks, Jr.,
Attorney, or Martha B. Peterson, Special Counsel, at (202) 942-0690,
Office of Regulatory Policy, Division of Investment Management,
Securities and Exchange Commission, 450 Fifth Street, NW, Washington,
DC 20549-0506.
SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission today
is adopting new rule 17a-10 (17 CFR 270.17a-10) and amendments to rules
10f-3 (17 CFR 270.10f-3), 12d3-1 (17 CFR 270.12d3-1), 17a-6 (17 CFR
270.17a-6), 17d-1 (17 CFR 270.17d-1), and 17e-1 (17 CFR 270.17e-1)
under the Investment Company Act of 1940 (15 U.S.C. 80a) (``Investment
Company Act'' or ``Act'').\1\
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\1\ Unless otherwise noted, when we refer to rules 10f-3, 12d3-
1, 17a-6, 17a-10, 17d-1, or 17e-1, or any paragraph of those rules,
we are referring to the following sections of the Code of Federal
Regulations in which each of these rules is published, as amended by
this release: 17 CFR 270.10f-3, 17 CFR 270.12d3-1, 17 CFR 270.17a-6,
17 CFR 270.17a-10, 17 CFR 270.17d-1, or 17 CFR 270.17e-1
respectively.
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Table of Contents
Executive Summary
I. Discussion
A. Portfolio Affiliates
1. Second-Tier Affiliates
2. Financial Interests
3. Time Periods
B. Subadviser Affiliates
1. Principal Transactions with Subadvisers: Section 17(a)
2. Transactions with Subadvisers as Brokers: Section 17(e)
3. Purchases During Primary Offering Underwritten by
Subadvisers: Section 10(f)
4. Ownership of Securities Issued by Subadvisers: Section
12(d)(3)
II. Effective Date
III. Cost-Benefit Analysis
A. Benefits
B. Costs
IV. Consideration of Promotion of Efficiency, Competition, and
Capital Formation
V. Paperwork Reduction Act
A. Portfolio Affiliates
B. Subadviser Affiliates
VI. Summary of Final Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Rules
Executive Summary
The Commission is adopting one new rule and amending five current
rules to permit investment companies (``funds'') and certain of their
affiliated persons to enter into a variety of transactions and joint
arrangements without first obtaining an individual exemptive order from
the Commission. Amendments to rules 17a-17d-1(d)(5) expand the
circumstances in which a fund may enter into principal transactions and
joint arrangements with its portfolio affiliates, and the portfolio
affiliates of affiliated funds. New rule 17a-10 and the amendments to
rules 10f-3, 12d3-1, and 17e-1 expand the circumstances in which a fund
may engage in transactions and arrangements with persons who are
affiliated persons of the fund because they provide investment advice
with respect to (i) an affiliated fund, or (ii) a portion of the fund's
assets that will be unaffected by the transaction.
I. Discussion
The Investment Company Act prohibits certain transactions between
investment companies and their affiliated persons (``first-tier
affiliates'') and affiliated persons of their affiliated persons
(``second-tier affiliates'').\2\ The Act's restrictions are designed to
prevent these persons from managing the fund for their own benefit,
rather than for the benefit of the fund's shareholders.\3\ Affiliated
persons of a fund include (i) its investment adviser and any
subadvisers,\4\ (ii) companies the fund controls or five percent (or
more) of whose securities are held by the fund, (iii) persons who
control the fund, and (iv) persons who are under common control with
the fund.\5\
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\2\ See section 17(a) [15 U.S.C. 80a-17(a)] (prohibiting first-
and second-tier affiliates of a fund from borrowing money or other
property from, or selling or buying securities or other property to
or from the fund, or any company that the fund controls); section
17(d) [15 U.S.C. 80a-17(d)] (making it unlawful for first- and
second-tier affiliates of a fund, the fund's principal underwriters,
and affiliated persons of the fund's principal underwriters, acting
as principal, to effect any transaction in which the fund or a
company controlled by the fund is a joint or a joint and several
participant in contravention of Commission rules); rule 17d-1(a)
(prohibiting first- and second-tier affiliates of a fund, the fund's
principal underwriter, and affiliated persons of the fund's
principal underwriter, acting as principal, from participating in or
effecting any transaction in connection with any joint enterprise or
other joint arrangement or profit-sharing plan in which any such
fund or company controlled by a fund is a participant unless an
application regarding such enterprise, arrangement or plan has been
filed with the Commission and has been granted); section 10(f) [15
U.S.C. 80a-10(f)] (prohibiting a fund from purchasing securities in
a primary offering if certain affiliated persons of the fund are
members of the underwriting or selling syndicate); section 17(e) [15
U.S.C. 80a-17(e)] (limiting the remuneration that first- and second-
tier affiliates of a fund may receive in transactions involving the
fund, and companies that the fund controls); and section 12(d)(3)
[15 U.S.C. 80a-12(d)(3)] and rule 12d3-1 (together prohibiting a
fund from acquiring securities issued by, among others, its own
investment adviser).
\3\ See Investment Trusts and Investment Companies: Hearings on
S. 3580 Before a Subcomm. of the Senate Comm. On Banking and
Currency, 76th Cong., 3d Sess. 37 (1940) (Statement of Commissioner
Healy).
\4\ Many funds use ``subadvisers'' to help manage fund assets. A
subadviser is an investment adviser for purposes of the 1940 Act.
The 1940 Act describes an ``investment adviser'' as a person who
regularly furnishes advice to the fund with respect to the
desirability of investing in, purchasing, or selling securities or
other property, or is empowered to determine what securities or
other property are to be purchased or sold by the fund. 15 U.S.C.
80a-2(a)(20). The investment adviser may act pursuant to a contract
with a fund [15 U.S.C. 80a-2(a)(20)(A)] or pursuant to a contract
with an investment adviser that has contracted with the fund. 15
U.S.C. 80a-2(a)(20)(B).
\5\ See 15 U.S.C. 80a-2(a)(3) (defining ``affiliated person'').
Unless otherwise noted, in this release we will use the term
``affiliated person'' to include both first- and second-tier
affiliates of a fund.
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In April 2002, we proposed to exempt certain persons from the Act's
restrictions on affiliated transactions.\6\ Under the proposal, funds
would be permitted to enter into transactions with two types of
affiliated persons--
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\6\ See Transactions of Investment Companies With Portfolio and
Subadvisory Affiliates, Investment Company Act Release No. 25557
(Apr. 30, 2002) [67 FR 31081 (May 8, 2002)] (``Proposing Release'').
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[sbull] Portfolio affiliates, which are companies that are
affiliated persons of a fund because the fund controls the company, or
holds five percent or more of the company's voting securities, and
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[sbull] Subadviser affiliates, which are persons that are
affiliated persons of a fund because they are the fund's subadvisers
(first-tier affiliates), affiliated persons of the fund's subadvisers
(second-tier affiliates), or subadvisers of other affiliated funds
(second-tier affiliates).
We published the proposals in response to the growth of funds and
changes in their organization, which have resulted in a growing number
of persons with whom a fund may not enter into transactions.\7\ The
amendments were designed to permit transactions between funds and these
affiliated persons in circumstances in which it is unlikely that the
affiliate would be in a position to take advantage of the fund. We
received nine comments on the proposal.\8\ The commenters supported the
proposed rule and amendments, but suggested changes. Today we are
adopting rule 17a-10 and amendments to rules 10f-3, 12d3-1, 17a-6, 17d-
1, and 17e-1 substantially as proposed, with changes that respond to
issues raised by commenters.
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\7\ Id. at nn. 12-16 and accompanying text.
\8\ The comment letters and a summary of comments prepared by
our staff are available for public inspection and copying in the
Commission's Public Reference Room, 450 5th Street, NW, Washington,
DC (File No. S7-21-01). The comment summary is also available on the
Commission's Internet Web site.
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A. Portfolio Affiliates
1. Second-Tier Affiliates
Rules 17a-6 and 17d-1(d)(5) permit a fund and its portfolio
affiliates to engage in principal transactions and enter into joint
arrangements that would otherwise be prohibited by section 17(a), or by
section 17(d) and rule 17d-1(a). We proposed to amend rules 17a-6 and
17d-1(d)(5) to permit a fund to enter into principal transactions and
joint arrangements not only with its own portfolio affiliates, but also
with portfolio affiliates of funds that are under common control with
the fund. Commenters supported the amendments, and we are adopting them
substantially as proposed.\9\ The amendments permit funds to enter into
transactions with portfolio affiliates of other funds in the same fund
complex, subject to the same conditions under which a fund may enter
into transactions and arrangements with its own portfolio
affiliates.\10\
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\9\ One technical change we have made is discussed in note 13
infra.
\10\ See note 19, infra, discussing when funds in a fund complex
are affiliated persons because they are under common control.
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2. Financial Interests
A fund may not rely on the exemptions in rules 17a-6 and 17d-
1(d)(5) to enter into principal transactions or joint arrangements with
portfolio affiliates if certain persons (such as the fund's adviser,
officers, and principal underwriter, which we will refer to as
``Prohibited Participants''), have a financial interest in a party to
the transaction or arrangement (other than the fund itself).\11\ We
proposed to amend the rules to permit a portfolio affiliate to enter
into a transaction or arrangement with the fund if a Prohibited
Participant has a financial interest that the fund's board determines
is not ``material.''\12\ Commenters supported the amendment, and we are
adopting it substantially as proposed.\13\ In determining whether a
financial interest is ``material,'' the board should consider whether
the nature and extent of the interest in the transaction is
sufficiently small that a reasonable person would not believe that the
interest affected the determination of whether to enter into the
transaction or arrangement or the terms of the transaction or
arrangement.
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\11\ See rules 17a-6(a) and 17d-1(d)(5)(i) (prohibiting the
following persons from participating in, or having a financial
interest in a participant in the transaction or arrangement: (1) an
officer, director, employee, investment adviser, member of an
advisory board, depositor, promoter of, or principal underwriter for
the fund; (2) a person directly or indirectly controlling the fund;
(3) a person directly or indirectly owning, controlling, or holding
with power to vote five percent or more of the outstanding voting
securities of the fund; (4) a person directly or indirectly under
common control with the fund; and (5) affiliated persons of the
foregoing).
\12\ See Proposing Release, supra note 6, at n. 28 and
accompanying text. We also proposed to eliminate a condition in rule
17d-1(d)(5) that limited a fund to committing no more than five
percent of its assets to a joint enterprise with a portfolio
affiliate. Id. at nn.32-34 and accompanying text. We received no
comment on this proposal and are adopting the amendment as proposed.
\13\ One commenter pointed out that a fund might be unable to
rely on the proposed rules if an affiliated fund has a financial
interest in, but is not affiliated with, the portfolio affiliate.
For example, assume that Fund A and Fund B, which have the same
principal adviser, own six percent and three percent, respectively,
of the outstanding voting securities of Company X. Fund A wants to
enter into a transaction to purchase commercial paper issued by
Company X. Under the proposed amendments to rule 17a-6, Fund A might
have been unable to do so. This is because Fund B, a Prohibited
Participant, might be deemed to have a disqualifying ``financial
interest'' in a party to the transaction (Company X). A second
commenter made a similar observation. We have revised the rules to
make clear that this type of transaction is permissible. See rule
17a-6(a)(4)(ii) (providing that a fund under common control with the
participating fund is not a Prohibited Participant if the fund's
``sole interest in the transaction or a party to the transaction is
an interest in [the portfolio affiliate]'').
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3. Time Periods
Currently, rule 17a-6 prohibits transactions with portfolio
affiliates when a Prohibited Participant ``has, or within six months
prior to the transaction had, or pursuant to an arrangement will
acquire'' a financial interest in a party to the transaction.\14\ Rule
17d-1(d)(5) prohibits joint transactions with portfolio affiliates if
the Prohibited Participant ``is, was, or proposes to be a participant''
in the joint arrangement.\15\ The Commission proposed to reconcile
these time periods, using the more limited approach of rule 17a-6.\16\
Under the proposed amendments, the rule would be available unless a
Prohibited Participant had a financial interest in a party to the
transaction within the previous six months (as opposed to a financial
interest at any time in the past).\17\ We are adopting the amendment as
proposed.\18\
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\14\ See prior rule 17a-6(a)(5)(ii).
\15\ See prior rule 17d-1(d)(5)(i).
\16\ See Proposing Release, supra note 6, at nn. 29-30 and
accompanying text.
\17\ As discussed above, the fund's board of directors could
also determine that a financial interest held within the 6 months
preceding the transaction is not material.
\18\ See rules 17a-6(b)(1)(ii) and 17d-1(d)(5)(ii)(B). One
commenter argued that the rules' exemptions should be available
without regard to the past financial interests of the fund's
affiliated persons. The commenter asserted that the past financial
interest of an affiliated person would probably not raise the
investor protection concerns that the rules are intended to address.
We disagree. The rules protect funds in circumstances where the
actions of an affiliated person may continue to be influenced by the
person's prior financial interests. The rules are, in this respect,
analogous to regulations that in other contexts prohibit an employee
from working on matters that involve former employers or clients.
See, e.g., 17 CFR 210.2-01(c)(2)(iii) and (iv) (describing
circumstances in which an accountant is not independent as a result
of employment by the accountant of a former employee of the audit
client, or employment by the audit client of a former employee of
the accountant).
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B. Subadviser Affiliates
Most funds are today organized by an investment adviser that
advises and provides administrative services to a number of other funds
in the same fund complex. As a result, advisers and subadvisers to a
fund are not only first-tier affiliates of any funds they advise; they
may also be second-tier affiliates of the other funds in the
complex.\19\
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Several provisions of the Act may restrict the ability of subadviser
affiliates to enter into transactions or arrangements with a fund even
if the subadviser affiliate lacks the ability to influence the
fund.\20\ We proposed one rule and a number of rule amendments to
exempt transactions and arrangements between funds and their subadviser
affiliates where there is little risk that the affiliated person is in
a position to take advantage of the fund.
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\19\ Funds in a fund complex are under the common control of an
investment adviser or other person when the adviser or other person
exercises a controlling influence over the management or policies of
the funds. 15 U.S.C. 80a-2(a)(9). Not all advisers control the funds
they advise. The determination of whether a fund is under the
control of its adviser, officers or directors depends on all of the
relevant facts and circumstances. See Proposing Release, supra note
6, at n.14. Throughout this release, we presume that the funds in a
fund complex are under common control, as funds that are not
affiliated persons will not require and thus will not rely on the
proposed exemptions.
\20\ For example, if Funds A and B are under the common control
of a principal adviser, and Subadviser A provides investment advice
only with respect to Fund A, then Subadviser A is a second-tier
affiliate of Fund B, and subject to all of the Act's prohibitions
against transactions involving second-tier affiliates, even though
Subadviser A may not have the ability to influence Fund B.
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1. Principal Transactions With Subadvisers: Section 17(a)
Section 17(a) of the Act prohibits a subadviser that is an
affiliated person of a fund from borrowing money or other property
from, or selling or buying securities or other property to or from, the
fund or any company that the fund controls.\21\ We proposed new rule
17a-10 to permit (i) a subadviser of a fund to enter into transactions
with funds the subadviser does not advise but which are affiliated
persons of a fund that it does advise (e.g., other funds in the fund
complex), and (ii) a subadviser (and its affiliated persons) to enter
into transactions and arrangements with funds the subadviser does
advise, but only with respect to discrete portions of the subadvised
fund for which the subadviser does not provide investment advice.\22\
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\21\ Section 17(a) also prohibits affiliated persons of the
subadviser from entering into such transactions if the subadviser is
a first-tier affiliate of the fund.
\22\ See Proposing Release, supra note 6, at nn. 42-46 and
accompanying text. This second category of relief would thus be
available only when a fund has one or more subadvisers, which are
responsible for managing discrete portions of the fund's assets. The
rule permits the adviser of one portion of the fund to direct that
portion to engage in a principal transaction with the subadviser of
another portion of the fund's assets.
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Our proposed exemption was subject to two conditions. First, the
subadvisory relationship must be the sole reason why section 17(a)
prohibits the transaction; and second, the participating subadviser
(i.e., the one who, or whose affiliated person, enters into the
transaction or arrangement) and any subadviser of the participating
fund or portion of a fund's portfolio (i.e., the one advising the fund
to enter into the transaction) must be prohibited by their advisory
contracts from consulting with each other concerning securities
transactions of the participating fund or portion.\23\
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\23\ See Proposing Release, supra note 6, at nn. 44-45 and
accompanying text. We note that while the rule does not contain a
condition prohibiting subadvisers and principal advisers from
consulting with each other, the principal adviser (like the
subadvisers) remains a fiduciary of the fund and may not collaborate
with fund subadvisers for purposes of overreaching the fund. See
Proposing Release, supra note 6, at n. 45.
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While all commenters supported the new exemption, two asserted that
we should not condition the exemption in rule 17a-10 on fund
subadvisers being contractually prohibited from consulting with one
another concerning securities transactions of the fund.\24\ These
commenters suggested that the condition was unnecessary because
subadvisers rarely, if ever, consult with one another concerning fund
transactions. The rule's exemption, however, is premised on the
unlikelihood that a subadviser participating in the transaction will be
able to influence investment decisions made on behalf of a fund (or
portion of a fund) that it does not advise. To the extent that such
discussions among subadvisers do occur, they increase the likelihood of
reciprocal arrangements. We are, therefore, adopting the provision as
proposed, with one revision that clarifies that the prohibitions extend
to transaction of the fund in any type of assets, not just
securities.\25\
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\24\ Two commenters requested that we affirmatively state that
two funds, with different principal advisers but a common
subadviser, are not under common control, and therefore not
affiliated persons. One commenter argued that otherwise the rule
would be unnecessary, as two funds that share a principal investment
adviser, but different subadvisers could not then be under common
control. As we stated in the Proposing Release, not all advisers
control the funds they advise, and the determination of whether a
fund is under the control of its adviser (or subadviser), officers,
or directors depends on the relevant facts and circumstances. See
Proposing Release, supra note 6, at n. 14.
\25\ Rule 17a-10(a)(2)(i). As we stated in the Proposing
Release, we would not view changes to subadvisory contracts that are
made to comply with the conditions of this rule to be material for
purposes of section 15 of the Investment Company Act [15 U.S.C. 80a-
15], and funds would not have to obtain shareholder approval of such
changes. See Proposing Release, supra note 6, at section III.B.2.
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2. Transactions With Subadvisers as Brokers: Section 17(e)
Section 17(e)(2) of the Act generally limits the remuneration that
an affiliated person of a fund, acting as broker, may receive for
effecting purchases and sales of securities on a securities exchange on
behalf of the fund, or a company the fund controls, to the ``usual and
customary broker's commission.'' \26\ Section 17(e)(2)'s limits apply
to purchases and sales made on behalf of a fund by affiliated persons,
which include the fund's subadviser (a first-tier affiliate),
affiliated persons of the subadviser (second-tier affiliates), and may
include subadvisers of funds under common control with the fund
(second-tier affiliates).
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\26\ Section 17(e)(2) limits the remuneration that an affiliated
person of a fund, acting as broker, may receive in connection with a
securities transaction to (A) the usual and customary broker's
commission for transactions effected on an exchange, (B) two percent
of the sales price for secondary distribution, and (C) one percent
of the purchase or sale price for other purchases or sales.
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Rule 17e-1 describes the circumstances in which remuneration
received by an affiliated person of a fund qualifies as the ``usual and
customary broker's commission.'' The rule, among other things, requires
that the fund's board of directors review transactions to determine
that they comply with procedures adopted by the board to ensure that
the remuneration received by the affiliated person does not exceed the
usual and customary broker's commission (``review requirement'').\27\
In addition, the fund must maintain a record of the transactions
(``recordkeeping requirement'').\28\ The review and recordkeeping
requirements of rule 17e-1 were designed to permit fund directors and
our examination staff to monitor the reasonableness and fairness of
remuneration received by affiliated persons of the fund.\29\
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\27\ Rule 17e-1(a) and (b). The rule also requires that a
majority of the directors of the fund not be ``interested persons''
of the fund, that those directors select and nominate any other
disinterested directors, and any person who acts as legal counsel
for the disinterested directors be an independent legal counsel.
Rule 17e-1(c). Section 2(a)(19) identifies persons who are
``interested persons'' of a fund. 15 U.S.C. 80a-2(a)(19).
\28\ Rule 17e-1(d).
\29\ Agency Transactions by Affiliated Persons on a Securities
Exchange, Investment Company Act Release No. 10605 (Feb. 27, 1979)
[44 FR 12202 (Mar. 6, 1979)] at n.10 and accompanying text.
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We proposed to amend rule 17e-1 to permit a fund's subadviser (or
other affiliated person) to receive remuneration for service as a
broker without complying with the recordkeeping and review
requirements, in circumstances in which the affiliated person has very
limited ability to influence decisions regarding execution of fund
securities transactions, i.e., when the affiliated person would be
eligible to enter into principal transactions with the fund under rule
17a-10.\30\ Commenters supported the
[[Page 3145]]
amendment, which we are adopting as proposed.\31\
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\30\ See Proposing Release, supra note 6, at n. 51 and
accompanying text.
\31\ Rule 17e-1(b)(3) and (d)(2). Under rule 17e-1, as amended,
a fund is exempted from the recordkeeping and review requirements to
the same extent that the fund would be permitted to enter into
principal transactions with a subadviser. Thus, a fund could use a
subadviser that is a first-tier affiliate (because it advises a
discrete portion of the fund for which it is not executing a
transaction), an affiliated person of such subadviser (a second-tier
affiliate of the fund), or a subadviser that is a second-tier
affiliate of the fund (because it advises another fund in the fund
complex) to execute brokerage transactions without complying with
rule 17e-1's recordkeeping and review requirements. Other of our
rules requiring funds to retain certain records of brokerage orders
by or on behalf of the fund are unaffected by today's amendments.
See rule 31a-1(b)(5) [17 CFR 270.31a-1(b)(5)].
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3. Purchases During Primary Offering Underwritten by Subadvisers:
Section 10(f)
Section 10(f) of the Act prohibits a fund from purchasing any
security during an underwriting or selling syndicate if the fund has
certain affiliated relationships with a principal underwriter of the
security.\32\ The section protects fund shareholders by preventing an
affiliated underwriter from placing or ``dumping'' unmarketable
securities with the fund.\33\ Rule 10f-3 provides an exemption from the
prohibition in section 10(f) if certain conditions are satisfied.\34\
One of rule 10f-3's key conditions is that a fund relying on the rule,
together with any other fund advised by the fund's adviser, purchase no
more than 25 percent of the offering (``percentage limit'').\35\ The
purpose of the percentage limit is to provide an indication that a
market for the issue exists independent of the adviser and that the
securities are not being ``dumped.'' \36\
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\32\ Section 10(f), in relevant part, prohibits a registered
investment company from knowingly purchasing or otherwise acquiring,
during the existence of any underwriting or selling syndicate, any
security (except a security of which the company is the issuer) a
principal underwriter of which is an officer, director, member of an
advisory board, investment adviser, or employee of the company, or
any person of which any of the foregoing are affiliated persons.
\33\ See Investment Trusts and Investment Companies: Hearings on
S. 3580 Before a Subcomm. of the Senate Comm. On Banking and
Currency, 76th Cong., 3d Sess. 35 (1940) (statement of Commissioner
Healy).
\34\ Rule 10f-3 permits a fund to purchase securities in a
transaction that otherwise would violate section 10(f) if, among
other things: (i) The securities either are registered under the
Securities Act of 1933 [15 U.S.C. 77a-aa], are part of an issue of
government securities, are municipal securities with certain credit
ratings, or are offered in certain foreign or private institutional
offerings; (ii) the offering involves a ``firm commitment''
underwriting; (iii) the fund (together with other funds advised by
the same investment adviser) purchases no more than 25 percent of
the offering; (iv) the fund purchases the securities from a member
of the syndicate other than its affiliated underwriter; (v) the
fund's directors have approved procedures for purchases under the
rule and regularly review the purchases to determine whether they
have complied with the procedures. See prior rule 10f-3(b) (new rule
10f-3(c)).
\35\ See rule 10f-3(c)(7).
\36\ See Exemption for the Acquisition of Securities During the
Existence of an Underwriting or Selling Syndicate, Investment
Company Act Release No. 24775 (Nov. 29, 2000) [65 FR 76189 (Dec. 6,
2000)] at n. 22 and accompanying text.
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As we discussed in the Proposing Release, when a fund has multiple
advisers or subadvisers, section 10(f) can limit significantly the
fund's ability to purchase securities in an offering.\37\ Under section
10(f), a fund is subject to the prohibition if any of its advisers (in
the case of a series fund) or subadvisers (in the case of a multi-
managed fund) participated in the underwriting or selling syndicate (or
are affiliated persons of participants), regardless of whether the
adviser or subadviser that recommended the purchase was a participant
in the syndicate.\38\ We proposed to amend rule 10f-3 to deem each
series of a series company (``series'') and the ``managed portions''
\39\ of a fund's portfolio (``portion'') to be separate registered
investment companies for purposes of section 10(f) and rule 10f-3.\40\
As a result, a fund would be subject to the limitation only when an
adviser recommending the transaction (or its affiliated person) is a
participant in the transaction and thus in a position to take advantage
of the fund. Commenters supported this amendment, and we are adopting
it substantially as proposed.\41\
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\37\ See Proposing Release, supra note at n. 59 and accompanying
text. A fund may have multiple subadvisers because more than one
subadviser has been retained to provide investment advice with
respect to various portions of the fund (a ``multi-managed'' fund).
A fund may also have multiple advisers because the fund is one of
several series of a series company, and different advisers provide
investment advice with respect to the assets of the different
series.
\38\ Unless otherwise noted, we will refer to a subadviser that
is a principal underwriter, or an affiliated person of a principal
underwriter of a security, as a ``participant'' in the underwriting
or selling syndicate.
\39\ A portion of a fund's portfolio would be a ``managed
portion'' if it is a discrete portion of the portfolio for which a
subadviser is responsible for providing investment advice, and the
subadviser (i) does not provide investment advice with respect to
any other portion of the fund's portfolio, (ii) is prohibited by its
advisory contract from consulting with any other investment adviser
of the investment company that is a principal underwriter or
affiliated person of a principal underwriter concerning securities
transactions of the fund, and (iii) is not an affiliated person of
any other investment adviser, or any promoter, underwriter, officer,
director, member of an advisory board, or employee of the investment
company. See Proposing Release, supra note 6, at n. 62 and
accompanying text.
\40\ See Proposing Release, supra note , at n. 63 and
accompanying text.
\41\ See rule 10f-3(a)(6) (defining ``managed portion'') and
10f-3(b) (deeming the series of a series company and Managed
Portions of an investment company to be separate investment
companies for purposes of section 10(f) and rule 10f-3). The effect
of the amendments is to exempt a purchase of securities by an
investment company from the prohibition in section 10(f), if the
purchase would not be prohibited if each series or portion were a
separately registered investment company.
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We also proposed parallel amendments to rule 10f-3 to revise the
way that funds must aggregate purchases to determine compliance with
the percentage limits of rule 10f-3 so that only purchases by funds
that are advised, and accounts that are controlled, by an investment
adviser that is a participant in the underwriting or selling syndicate
need be aggregated.\42\ If multiple investment advisers provide
investment advice to a fund (e.g., a principal adviser and one or more
subadvisers) but only one of those advisers (or its affiliated persons)
is a participant in the underwriting or selling syndicate, rule 10f-3's
percentage limit would apply only to purchases by the funds and
accounts of the participating investment adviser.\43\
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\42\ See Proposing Release, supra note 6, at nn. 67-68 and
accompanying text. We proposed to apply the percentage limit to
purchases by the accounts controlled by a fund's investment adviser,
as well as the funds advised by the adviser because we were
concerned that rule 10f-3's percentage limit may not provide
reliable evidence of a market for the security if most or all of the
offering is purchased by fund and non-fund clients of an adviser
participating in the underwriting or selling syndicate. The
amendment would not require an adviser to aggregate its purchases on
behalf of funds and other discretionary accounts with those made by
affiliated persons of the adviser. Section 48(a) would prohibit
those purchases, however, if they were coordinated purchases made
for purposes of circumventing the rule's percentage limits. Section
48(a) of the Act [15 U.S.C. 80a-47(a)].
\43\ See Proposing Release, supra note 6, at nn.67-68 and
accompanying text. For example, assume that Principal Adviser A
advises three funds (Funds 1, 2, and 3), and Subadviser B subadvises
Fund 1, and is the principal adviser to unaffiliated Fund 4. If
Principal Adviser A participates in the underwriting syndicate, then
the aggregate purchases of Funds 1, 2, and 3 must meet the
percentage limit, and if Subadviser B participates in the syndicate
then the aggregate purchases of Funds 1 and 4 must meet the
percentage limit. If more than one investment adviser of a fund is a
participant in the underwriting or selling syndicate then the
percentage limit would apply independently with respect to each such
investment adviser. See Proposing Release, supra note , at n. 68.
The percentage limit would not apply at all if a fund is prohibited
from purchasing a security because a person other than the fund's
investment adviser or an affiliated person of the investment adviser
(e.g., an officer, director, or employee of the fund) is a
participant in the underwriting or selling syndicate.
---------------------------------------------------------------------------
Although commenters strongly supported limiting the aggregation
requirement to purchases by funds and portions of a fund for which an
investment adviser that participates in the underwriting syndicate
provides investment advice, five commenters opposed requiring
aggregation of purchases of other accounts controlled by the investment
adviser. While these
[[Page 3146]]
commenters complained that the amendment could limit the ability of
funds to purchase securities in principal offerings, none suggested a
way to reconcile the policy underlying rule 10f-3's percentage limit
with continuing to permit non-fund accounts advised by the fund's
adviser to purchase unlimited amounts of the offering.\44\ One fund
commenter supporting the proposed requirement cited recent allegations
of abusive practices in the market for initial public offerings as
illustrative of the conflicts of interest that are inherent when
underwriting participants have other business relationships with
persons who purchase securities during an offering. This commenter
concluded that without a limit on aggregate purchases by non-fund
accounts, ``there can be no assurance that the fund was participating
in a bona fide offering to the public. * * *'' We agree, and are
adopting the amendments substantially as proposed.\45\
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\44\ Commenters also argued that other protections in rule 10f-3
make it unlikely that securities could be ``dumped'' in the fund.
These commenters, in effect, argued that there should be no
quantitative limitation on the amount of purchase under the rule, an
approach the Commission rejected when we amended the rule in 1997.
See Exemption for the Acquisition of Securities During the Existence
of an Underwriting or Selling Syndicate, Investment Company Act
Release No. 22775 (July 31, 1997) [62 FR 42401 (Aug. 7, 1997)].
\45\ See rule 10f-3(c)(7).
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At the suggestion of three commenters, we have narrowed the new
aggregation requirement. Instead of requiring funds to aggregate
purchases by accounts over which the fund adviser ``has discretionary
authority or otherwise exercises control,'' amended rule 10f-3 requires
aggregation of purchases by other accounts with respect to which the
adviser exercises ``investment discretion.''\46\ The revised approach
is more consistent with the current aggregation provision of rule 10f-
3, which assumes that advisers to multiple funds have investment
discretion with respect to fund assets.
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\46\ Rule 10f-3(c)(7)(i). Under the rule the purchase must be
aggregated if (i) the adviser has investment discretion over the
account, and (ii) the adviser has exercised such discretion in
connection with the purchase.
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4. Ownership of Securities Issued by Subadvisers: Section 12(d)(3)
Section 12(d)(3) of the Act generally prohibits funds, and
companies controlled by funds, from purchasing securities issued by a
registered investment adviser, broker, dealer, or underwriter
(``securities-related businesses'').\47\ Rule 12d3-1 permits a fund to
invest up to five percent of its assets in securities of an issuer
deriving more than fifteen percent of its gross revenues from
securities-related businesses,\48\ but a fund could not rely on rule
12d3-1 to acquire securities of its own investment adviser or any
affiliated person of its own investment adviser.\49\ As a result, a
fund could not rely on rule 12d3-1 to acquire securities issued by any
of its subadvisers.
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\47\ With minor exceptions, section 12(d)(3) prohibits a fund
from purchasing or otherwise acquiring ``any security issued by or
any other interest in the business of any person who is a broker, a
dealer, is engaged in the business of underwriting, or is [an]
investment adviser.''
\48\ Paragraph (a) of rule 12d3-1 permits a fund to acquire any
security issued by any person that, in its most recent fiscal year,
derived 15 percent or less of its gross revenues from securities-
related activities unless the fund would control such person after
the acquisition. Paragraph (b)(3) of rule 12d3-1 permits a fund to
invest up to five percent of the value of its total assets in the
securities of an issuer that derives more than 15 percent of its
gross revenues from securities-related activities. Rule 12d3-1(d)(1)
defines ``securities related activities'' as a person's activities
as a broker, a dealer, an underwriter, an investment adviser
registered under the Investment Advisers Act of 1940 [15 U.S.C.
80b], or an investment adviser to a registered investment company.
\49\ Rule 12d3-1(d)(8) provides that any class or series of an
investment company that issues two or more classes or series of
preferred or special stock, each of which is preferred over all
other classes or series with respect to assets specifically
allocated to that class or series, shall be treated as if it is a
registered investment company. Accordingly, a fund that is a series
of a series company may rely on rule 12d3-1 to purchase securities
issued by subadvisers (and persons affiliated with those
subadvisers) of the other series of the investment company.
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Consistent with our other proposals, we proposed to amend rule
12d3-1 to permit a fund to purchase securities issued by its
subadvisers (or affiliated persons of its subadvisers) in circumstances
in which the subadviser would have little ability to take advantage of
the fund, because it is not in a position to direct the fund's
securities purchases.\50\ The exemption in rule 12d3-1 would be
available in circumstances identical to those in which the subadviser
(or affiliated person) would be permitted by rule 17a-10 to enter into
a principal transaction with the fund.\51\ Commenters supported the
amendments, which we are adopting as proposed.\52\
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\50\ See Proposing Release, supra note 6, at n. 77 and
accompanying text.
\51\ Id. The exemption in rule 12d3-1 is available if (i) the
subadviser is not, and is not an affiliated person of, an investment
adviser that provides advice with respect to the portion of the fund
that is acquiring the securities, and (ii) the advisory contracts of
the subadviser, and any subadviser that is advising the purchasing
portion of the fund, prohibit them from consulting with each other
concerning securities transactions of the fund, and limit their
responsibility in providing advice to providing advice with respect
to discrete portions of the fund's portfolio. See rule 12d3-
1(c)(3)(i) and (ii).
\52\ Rule 12d3-1(c)(3).
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II. Effective Date
The Administrative Procedure Act generally provides that a
substantive rule may become effective no less than 30 days after
publication in the Federal Register.\53\ Accordingly, new rule 17a-10
and amendments to rules 10f-3, 12d3-1, 17a-6, 17d-1, and 17e-1 will
become effective February 24, 2003.
---------------------------------------------------------------------------
\53\ 5 U.S.C. 553(d).
---------------------------------------------------------------------------
We are, however, delaying the compliance date with respect to the
amendments to rule 10f-3 until April 23, 2003. After April 23, 2003, a
fund must comply with all of the conditions in rule 10f-3 as amended in
order to rely on the exemption in that rule. A registered investment
company that purchases securities between February 24, 2003 and April
23, 2003 may rely on either rule 10f-3 as amended, or rule 10f-3 as it
existed prior to today's amendments.
III. Cost-Benefit Analysis
The Commission is sensitive to the costs and benefits that result
from its rules. As described above, the rule and amendments expand the
circumstances under which portfolio companies and subadvisers that are
affiliated persons of funds may engage in otherwise prohibited
transactions with those funds without first obtaining an exemptive
order from the Commission. We have identified certain costs and
benefits that may result from today's rulemaking. Because the new rule
and rule amendments are exemptive, rather than prescriptive, funds and
their affiliated persons are not required to rely on them. Therefore,
we assume that funds will rely on the rule and amendments only if the
anticipated benefits from such actions would exceed the anticipated
costs. In the Proposing Release, we requested comment and specific data
regarding the costs and benefits of the proposed amendments. The
comments we received are discussed below; we did not receive any data.
A. Benefits
1. In General
We anticipate that funds, their shareholders, advisers and other
affiliated persons will benefit from the new rule and amendments.
Absent the rule and amendments, we anticipate that affiliated persons,
prohibited by the Act from entering into transactions with funds, would
continue to seek Commission exemptive orders. The process for obtaining
such an exemption
[[Page 3147]]
imposes direct costs on applicants.\54\ The new rule and amendments
will benefit funds, their shareholders, and their affiliated persons by
eliminating these costs.
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\54\ See Proposing Release, supra note 6, at section III.A.1.
(estimating the cost of applying for an order exempting affiliated
persons from the prohibitions of sections 17(a), 17(d), 17(e),
10(f), and 12(d)(3) to be between $20,000 and $80,000, depending on
the complexity of the application).
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The application process also produces indirect costs, because funds
and their affiliated persons forego beneficial transactions rather than
undertake to obtain an exemptive order. Funds and their affiliated
persons may forego transactions either because the anticipated benefit
of the transaction does not exceed the cost of obtaining an exemptive
order, or because the transaction is time-sensitive, and it is not
feasible to obtain an exemptive order quickly enough to permit the
transaction to occur.\55\ Encouraging beneficial transactions by
eliminating these potentially significant costs and delays will likely
be a benefit resulting from these changes. As discussed in the
Proposing Release, eliminating direct and indirect costs of filing
applications may also reduce factors that discriminate against smaller
funds and smaller transactions.\56\
---------------------------------------------------------------------------
\55\ See Proposing Release, supra note 6, at nn. 79-80
(estimating the length of time between filing of applications and
granting of exemptive orders to be between 4 to 17 months, depending
on the complexity of the application).
\56\ See Proposing Release, supra note 6, at section III.A.1.
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2. Portfolio Affiliates
The amendments to rules 17a-6 and 17d-1(d)(5) regarding
transactions and joint arrangements with portfolio affiliates may
expand the range of possible partners with which funds may enter into
transactions and joint arrangements. Funds, their second-tier portfolio
affiliates, and their shareholders each may benefit from the
transactions and arrangements made possible by the amendments.\57\
Similarly, amending rules 17a-6 and 17d-1(d)(5), to provide that the
term ``financial interest'' does not include interests that the fund's
board of directors finds to be not material, may expand the range of
possible partners for transactions and joint arrangements with funds by
making the rules' exemptions more widely available.\58\ A similar
benefit may result from the removal of rule 17d-1(d)(5)'s condition
limiting a fund to committing no more than five percent of its assets
in any particular joint enterprise.
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\57\ It has not been possible to quantify this benefit, which
varies on a case-by-case basis depending on the characteristics of
individual transactions and joint arrangements and on the extent to
which funds involved in such transactions have second-tier portfolio
affiliates.
\58\ Expansion of the exemption in this manner may also impose
costs by eliminating what has been a ``bright line'' prohibition and
expanding the opportunities for harmful transactions.
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3. Subadviser Affiliates
Principal Transactions
Rule 17a-10 may benefit subadvisers and funds by allowing
subadviser affiliates to enter into principal transactions with (i)
affiliated funds of the subadvised fund and (ii) those portions of the
subadvised fund for which the subadviser does not provide investment
advice. By broadening the markets available to both buyers and sellers,
rule 17a-10 may permit sellers to obtain more favorable pricing, and
may make a wider range of investment options available to buyers.
Brokerage Transactions
Rule 17e-1 will, under certain circumstances, permit subadvisers
and their affiliated persons to receive remuneration when acting as
broker for an affiliated fund, without complying with all of the rule's
recordkeeping and transaction review requirements. Our staff estimates
that boards of directors of funds that employ affiliated brokers
currently spend approximately 12.5 hours per year per fund conducting
the required review. Our staff further estimates that a fund that uses
in-house counsel to assist fund directors in reviewing these
transactions incurs a cost of $775 per year for counsel, based on an
hourly cost for in-house counsel of $62 per hour.\59\ Funds incur the
additional incremental cost of maintaining records of the transaction.
The amendments to rule 17e-1 may benefit funds and their shareholders
by allowing funds to avoid these burdens.
---------------------------------------------------------------------------
\59\ See notes 85-87 infra, and accompanying text.
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Purchases During Primary Offerings Underwritten by Affiliated
Subadvisers
The amendments to rule 10f-3 may benefit funds by broadening their
investment options. The Act prohibits a series of a series company from
purchasing securities during an underwriting or selling syndicate of
which an adviser to any of the series (or affiliated person of such
adviser) is a member. By providing that, for purposes of section 10(f)
and rule 10f-3, a series of a series company is a separate investment
company, the proposed amendments to rule 10f-3 could broaden (i) the
investment opportunities available to such funds and (ii) the range of
possible purchasers when a subadviser participates in an underwriting
syndicate. Funds, fund shareholders, and subadvisers all may benefit
from this change.
The Act also does not distinguish between a fund with multiple
subadvisers that manage discrete portions of its portfolio, and a fund
whose subadvisers manage the portfolio in its entirety. The amendments
to rule 10f-3 that deem separately managed portions of a fund's
portfolio to be separate investment companies for purposes of section
10(f) and rule 10f-3 may increase the investment opportunities of that
type of fund. Quantifying the potential magnitude of these benefits may
not be possible.
The amendment to the percentage limit of rule 10f-3 also may
broaden the investment options available to funds. The Act does not
distinguish between purchases by funds or portions of funds that are
recommended by a subadviser that is (or is an affiliated person of) a
participant in the underwriting or selling syndicate, and purchases by
funds or portions of funds for which other subadvisers provide
investment advice. By providing that the percentage limit of rule 10f-3
applies only to purchases by funds, portions of funds, and accounts for
which participants provide investment advice, the amendments to rule
10f-3 may increase the investment opportunities of a fund with multiple
subadvisers that manage discrete portions of its portfolio.
The amendments to the percentage limit may reduce the cost of
complying with rule 10f-3 because purchases made by funds that are not
advised by participants in the underwriting or selling syndicate will
no longer need to be aggregated with purchases made by funds that are
advised by advisers that are participants in the underwriting. Because
multiple advisers will no longer be required to coordinate their
actions, the amendment may make it easier to ensure compliance with the
rule, and less expensive to collect and compile the relevant
information.
Ownership of Securities Issued by Subadvisers
Similarly, the amendments to rule 12d3-1 may also benefit funds by
broadening their investment options. Amending rule 12d3-1 to permit a
fund to acquire securities issued by one of its subadvisers, or an
affiliated person of one of its subadvisers, when the subadviser is not
in a position to influence the decision by the fund to purchase the
securities, may increase the investment opportunities of these funds.
[[Page 3148]]
B. Costs
The Commission anticipates that funds, their shareholders, and
their advisers and other affiliated persons may incur certain costs,
including certain direct costs from complying with the new rule and
amendments. The exemptions resulting from today's rulemaking also may
encourage shifts in market behavior that could create direct and
indirect costs for certain entities. Furthermore, the exemptions may
allow funds to proceed with disadvantageous transactions that existing
restrictions would have prevented.
1. Portfolio Affiliates
We do not anticipate that there will be any costs associated with
the amendments to rules 17a-6 and 17d-1(d)(5), other than a cost
associated with the provision that a fund's board of directors may find
that an interest is not material and hence not a ``financial
interest.'' Because a fund may avail itself of the amendment only if
the fund's directors make certain findings and record the basis for
those findings in the minutes of their meeting, the benefit of the
change is minimally offset by the cost to the fund of the board
fulfilling its obligations. Based on discussions with industry
representatives, our staff estimates that reviewing the materiality of
a Prohibited Participant's interest in a party to the transaction and
recording the basis for those findings would require approximately 11.2
hours and $1,140 per meeting, in addition to the discussions that occur
during the board meeting.\60\ This cost may partially offset the
benefits of the exemption, including the direct benefit of allowing a
fund to forego the cost of applying for exemptive relief from the
restrictions of section 17(a) and rule 17d-1. We assume that if the
cost of holding such a meeting exceeds the benefit to the fund, the
fund will either forego the opportunity to engage in the transaction or
require the Prohibited Participant to divest itself of its interest.
---------------------------------------------------------------------------
\60\ See notes 68-74 infra, and accompanying text.
---------------------------------------------------------------------------
2. Subadvisory Affiliates
A fund and its advisers and subadvisers may incur costs in
complying with the requirements of rule 17a-10 and amended rules 10f-3,
12d3-1, and 17e-1 that partially offset the benefits of these rules. In
order for a fund to rely on the exemptions in the rule and amendments,
the fund's advisory contracts must include certain provisions that they
may not currently include. Because such contracts generally are subject
to renewal at regular intervals, adding such provisions may not entail
additional administrative costs. As discussed above, we do not view the
required changes to subadvisory contracts to be material for purposes
of section 15 of the Investment Company Act and, as a result, funds
will not have to obtain shareholder approval of the change.\61\ Based
on discussions with industry representatives, the staff estimates that
drafting and executing revised subadvisory contracts would require
approximately 6 hours. Assuming that all funds that are advised by
subadvisers modify their advisory contracts in order that they and
their affiliated funds may rely on the exemptions, the rule and rule
amendments would create an estimated initial one-time cost of
approximately $836,000.\62\
---------------------------------------------------------------------------
\61\ See note 25 supra.
\62\ See notes 75-78 infra, and accompanying text.
---------------------------------------------------------------------------
Rule 17e-1 may result in increased costs to funds as a result of
higher brokerage commissions. By exempting the commissions paid to
certain affiliated subadvisers from the requirement for scrutiny by the
board of directors, rule 17e-1 may allow a rise in brokerage
commissions that the fund pays. Whether this increased cost occurs will
depend on the extent to which the scrutiny currently required of boards
of directors has resulted in findings that commissions to be paid by
funds are excessive. Although we requested comment on the frequency of
boards of directors making such findings, we received no comments on
this issue.
The amendments to rule 10f-3 may encourage division of funds into
discrete parts managed by multiple subadvisers. A fund that is advised
by subadvisers that participate, or are affiliated with persons that
participate, in underwriting syndicates may have an incentive to
reorganize in order to take advantage of the opportunity to have a part
of the fund purchase securities during the syndicate. Likewise, a fund
that is advised by a subadviser that participates in underwriting
syndicates may have an incentive to reorganize in order to comply with
the percentage limit of rule 10f-3 and take advantage of the
opportunity to purchase securities in reliance on that rule's
exemption. Such a development would benefit subadvisers, but the use of
additional subadvisers could also result in increased costs to funds
and their shareholders.\63\
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\63\ It has been estimated that expenses of subadvised funds are
on average 15-20% higher than those of non-subadvised funds. See
James Paton, Outside Fund Managers Don't Bring Outsize Benefits,
Reuters, Sept. 11, 2002, available in Westlaw, Reuters Eng. News
Serv. File and Bridget O'Brian, Fund Track, Some Fund Managers Hand
Reins to `Subadvisers,' WALL ST. J., Aug. 31, 2001, at C1.
---------------------------------------------------------------------------
Investment advisers may incur costs in connection with the new
requirement of rule 10f-3 that fund purchases be aggregated with
purchases of certain non-funds for purposes of compliance with the
rule's percentage limits. Commenters suggested that fund complexes that
automate such calculations could incur significant one-time costs in
connection with reconfiguring existing information collection systems
to accommodate the amendments.\64\ We assume that if the cost of
compiling the required information would outweigh the benefits of
relying on the exemption in rule 10f-3, then these advisers will forego
the exemption in rule 10f-3, and comply with the prohibition in section
10(f).
---------------------------------------------------------------------------
\64\ One commenter stated that for a large fund complex with
many non-fund accounts the cost of such a system reconfiguration
would be $300,000 at a minimum.
---------------------------------------------------------------------------
IV. 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.\65\
---------------------------------------------------------------------------
\65\ 15 U.S.C. 80a-2(c).
---------------------------------------------------------------------------
Portfolio Affiliates
The amendments to rules 17a-6 and 17d-1(d)(5) will expand the
circumstances under which funds, and companies they control, may enter
into principal transactions and joint arrangements with portfolio
affiliates without first obtaining an exemptive order from the
Commission. The amendments will permit funds and companies they control
to engage in otherwise prohibited transactions with: (i) A broader
array of first-tier portfolio affiliates than the rules currently
permit; and (ii) certain second-tier portfolio affiliates.\66\ We
anticipate that the amendments will promote efficiency and competition.
The Act's restrictions on transactions involving funds and their
affiliated persons respond to market failures that can occur when an
affiliated person, in a position to influence the management of a fund,
causes the fund to behave in a manner
[[Page 3149]]
that benefits the affiliated person, rather than the shareholders of
the fund. The amendments to rules 17a-6 and 17d-1(d)(5) will permit
market forces to operate to allocate resources in circumstances where
market failure is unlikely because the affiliated person is not in a
position to influence fund management. The amendments to rules 17a-6
and 17d-1(d)(5) are unrelated to, and we believe will have no effect
on, capital formation.
---------------------------------------------------------------------------
\66\ An additional change to rule 17d-1(d)(5) would remove
existing limitations regarding the percentage of a fund's assets
that the fund could commit to a joint enterprise.
---------------------------------------------------------------------------
Subadvisory Affiliates
New rule 17a-10 and the amendments to rules 17e-1, 10f-3, and 12d3-
1 permit funds, and companies controlled by funds, to engage in
transactions with subadvisers that are affiliated persons of the fund,
but which are not in a position to influence the fund's decision to
participate in the transaction. The amendments to rule 17e-1 permit, in
limited circumstances, an affiliated subadviser acting as broker to
receive remuneration without complying with certain conditions of the
rule. As in the case of the amendments to rules 17a-6 and 17d-1(d)(5),
we anticipate that these amendments will promote efficiency and
competition by permitting market forces to operate in circumstances
where there is limited chance of market failure. We also believe that
the amendments to rule 10f-3 may enhance capital formation by enabling
funds to purchase securities during primary offerings, when they would
otherwise be prohibited from doing so without a Commission exemptive
order.
The rule and amendments may, however, adversely affect competition
by promoting increased concentration of the market for subadvisory
services. Rule 17a-10 may reduce or eliminate any incentive to select
subadvisers specifically because they are not affiliated with a large
number of funds, which may encourage funds to shift subadvisory
business toward certain particularly successful subadvisers. The
amendments to rule 10f-3 may remove an incentive to select subadvisers
that are not either major participants or affiliated with major
participants in the underwriting business. By removing disincentives
against market concentration, these rules may have the effect of
encouraging concentration in the market for subadvisory services.
V. Paperwork Reduction Act
Certain provisions of rule 17a-10 and the amendments to rules 10f-
3, 12d3-1, 17a-6, 17d-1, and 17e-1 contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 [44 U.S.C. 3501-3520] (``PRA''). The Commission
submitted the proposed 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. The titles for the collections of
information are: (i) ``Rule 10f-3 under the Investment Company Act of
1940, Exemption for the acquisition of securities during the existence
of an underwriting or selling syndicate''; (ii) ``Rule 12d3-1 under the
Investment Company Act of 1940, Exemption of acquisitions of securities
issued by persons engaged in securities related businesses''; (iii)
``Rule 17a-6 under the Investment Company Act of 1940, Exemption for
transactions with portfolio affiliates''; (iv) ``Rule 17a-10 under the
Investment Company Act of 1940, Exemption for transactions with certain
subadvisory affiliates''; (v) ``Rule 17d-1 under the Investment Company
Act of 1940, Applications regarding joint enterprises or arrangements
and certain profit-sharing plans''; and (vi) ``Rule 17e-1 under the
Investment Company Act of 1940, Brokerage transactions on a securities
exchange.'' 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.\67\ The OMB control number for rule
17a-10 is 3235-0563, and the control numbers for amended rules 10f-3,
12d3-1, 17a-6, 17d-1, and 17e-1 are 3235-0226, 3235-0561, 3235-0564,
3235-0562, and 3235-0217, respectively.
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\67\ Rule 10f-3 was adopted pursuant to authority set forth in
sections 10(f), 31(a), and 38(a) of the Investment Company Act [15
U.S.C. 80a-10(f), 80a-30(a), and 80a-37(a)]. Rule 12d3-1 was adopted
pursuant to authority set forth in sections 6(c) and 38(a) of the
Act. [15 U.S.C. 80a-6(c)]. Rule 17a-6 was adopted pursuant to
authority set forth in sections 6(c), 17(b), 31(a), and 38(a) of the
Act [15 U.S.C. 80a-17(b)]. Rule 17d-1 was adopted pursuant to
authority set forth in sections 6(c), 17(d), and 38(a). Rule 17e-1
was adopted pursuant to authority set forth in sections 6(c), 31(a),
and 38(a) of the Act.
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A. Portfolio Affiliates
Rules 17a-6 and 17d-1
Under rules 17a-6 and 17d-1, a fund or company controlled by a fund
may enter into principal and joint transactions with a portfolio
affiliate, or an affiliated person of a portfolio affiliate, as long as
certain other Prohibited Participants are not parties to the
transaction and do not have a financial interest in a party to the
transaction. Rules 17a-6 and 17d-1 include a list of interests that are
not ``financial interests'' for purposes of the rule.\68\ We have
amended that list to provide that ``financial interest'' does not
include an interest that the fund's board of directors finds to be not
material, provided that the directors record the basis for that finding
in the minutes of their meeting.\69\ This aspect of the amendments
creates a paperwork burden.
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\68\ Rules 17a-6(b)(1) and 17d-1(d)(5)(iii).
\69\ Rules 17a-6(b)(1)(H) and 17d-1(d)(8). Collection of this
information is necessary to obtain the benefit of the exemption in
the proposed rule amendments.
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Based on public filings with the Commission, the Commission's staff
estimates that 200 registered investment companies are affiliated
persons of 900 issuers as a result of the investment company's
ownership or control of the issuer's voting securities, and that there
are approximately 1,400 such affiliate relationships.\70\ The staff
estimates that annually there will be a total of 1,400 principal
transactions under rule 17a-6 \71\ and 1,400 joint arrangements under
rule 17d-1(d)(5),\72\ and that for each rule approximately 420
transactions or arrangements will result in a paperwork burden.\73\
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\70\ For purposes of this analysis, the staff estimates that
investment companies will enter into one principal transaction and
one joint arrangement each year with each of their portfolio
affiliates, and that in thirty percent of those transactions and
arrangements a Prohibited Participant will have a financial interest
in a party to the transaction that the board of directors of the
affected investment company will consider for purposes of
determining whether that financial interest is material.
\71\ 1,400 affiliate relationships x 1 principal transaction per
year = 1,400 transactions under rule 17a-6.
\72\ 1,400 affiliate relationships x 1 joint arrangement per
year = 1,400 joint arrangements under rule 17d-1(d)(5). As discussed
above, in addition to expanding fund business opportunities by
allowing funds to transact with a wider range of portfolio
affiliates, we have also eliminated the limit imposed by rule 17d-
1(d)(5) on the percentage of assets a fund can commit to any given
joint enterprise. Rule 17d-1(d)(5)(ii). The staff does not
anticipate that allowing funds to increase the size of their
commitment to a joint transaction will result in an increase in the
expected number of such transactions.
\73\ 1,400 transactions or arrangements x .30 (percentage of
transactions or arrangements in which a Prohibited Participant is
assumed to have a financial interest) = 420.
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The Commission staff estimates that compliance with the amendments
will impose a burden of .2 hours (12 minutes) for each transaction for
which there is a paperwork burden.\74\ Therefore we estimate 84 burden
hours to be associated with the amendments to rule 17a-6 annually and
84 burden
[[Page 3150]]
hours to be associated with the amendments to rule 17d-1 annually.
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\74\ The staff estimates the hourly burden to comply with the
board of director's obligation to make a finding as to the
materiality of a prohibited person's financial interest in a
transaction to be 11 hours. The staff estimates that funds will
spend .2 hours complying with the requirement that the basis for the
board's findings be recorded in the minutes of its meeting.
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B. Subadviser Affiliates
The Commission staff estimates that 1,900 portfolios of
approximately 800 investment companies use the services of one or more
subadvisers.\75\ Based on discussions with industry representatives,
the Commission staff estimates that it will require approximately 6
hours to draft and execute revised subadvisory contracts (5 staff
attorney hours, 1 supervisory attorney hour), in order for funds and
subadvisers to be able to rely on the exemptions in rule 17a-10 and the
proposed amendments to rule 10f-3, 17e-1, and 12d3-1.\76\ Assuming that
all funds that are advised by subadvisers modify their advisory
contracts in this manner, the new rule and rule amendments will create
an estimated initial one-time burden of approximately 11,400 burden
hours. The total estimated first year cost of these burden hours is
$836,000.\77\
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\75\ See Proposing Release, supra note 6, at n. 13 and
accompanying text.
\76\ The fund's advisory contracts must include these conditions
in order for the fund to obtain the benefit of the exemptions in the
new rule and rule amendments.
\77\ (5 in-house staff attorney hours x $62 = $310) + (1 deputy
general counsel hour x $130 = $130) = $440. $440 x 1,900 funds = $
836,000.
Estimated One Time Burden Hours and Cost of Subadvisory Rule and Amendments
----------------------------------------------------------------------------------------------------------------
Number of funds Cost per Total cost of
modifying Staff attorney Supervisory Total burden Cost per staff supervisory se 75burden
contracts hours attorney hours hours attorney hour attorney hour hours
----------------------------------------------------------------------------------------------------------------
1,900 5 1 11,400 $62 $130 $836,000
----------------------------------------------------------------------------------------------------------------
Rule 17a-10 and the amendments to rules 10f-3, 12d3-1, and 17e-1
would require virtually identical modifications to fund advisory
contracts. The Commission staff assumes that funds will rely equally on
the exemptions in all of these rules, and therefore the burden hours
associated with the required contract modifications should be
apportioned equally among the four rules. Therefore the estimated one-
time burden hours associated with rules 17a-10, 10f-3, 12d3-1, and 17e-
1 are 2,850 hours for each rule (11,400 total burden hours for all of
the rules/four rules), and the estimated one-time cost of these burden
hours is $209,000 for each rule ($836,000/four rules).\78\
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\78\ The amendments to rule 17e-1 will also, as discussed below,
decrease the burden hours associated with that rule.
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The staff estimates that a total of 60 funds will enter into
subadvisory agreements each year after the first year in which the rule
and rule amendments are adopted.\79\ Assuming that each of these funds
enters into a contract that permits it and its affiliated funds to rely
on the exemptions in rule 17a-10, and the amendments to rules 10f-3,
12d3-1, and 17e-1, an estimated 360 burden hours (90 hours per rule)
will be associated with these rules annually, with an associated cost
of $26,400 ($6,600 per rule).\80\
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\79\ Based on an analysis of investment company filings, the
staff estimates that approximately 250 funds are created annually.
Assuming that the number of these funds that will use the services
of subadvisers is proportionate to the number of funds that
currently use the services of subadvisers, then approximately 50 new
funds will enter into subadvisory agreements each year. The
Commission staff estimates, based on an analysis of investment
company filings, that an additional 10 funds, currently in
existence, will employ the services of subadvisers for the first
time each year.
\80\ 6 hours x 60 funds = 360 total hours. $440 x 60 funds =
$26,400.
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Proposed Amendments to Rule 10f-3
Rule 10f-3 currently has an estimated burden of 4,407.5 hours at a
cost of $793,752. This burden estimate will change as a result of the
amendments to rule 10f-3. As we discuss above,\81\ we assume that all
funds that are advised by subadvisers will modify their subadvisory
contracts so as to allow the fund and their affiliated funds to rely on
the proposed exemptions. The staff calculates that the estimated one-
time burden hours associated with the proposed amendments to rule 10f-3
would be 2,850 hours, with an estimated one-time cost of $209,000,\82\
and an ongoing estimated burden of 90 hours for subsequent years, with
an estimated cost associated with this hour burden of $6,600 for
subsequent years.\83\ We estimate that these additional burdens will,
for the first year following adoption, increase the burden hours of
compliance with rule 10f-3 from the current 4,407.5 hours at a cost of
$793,752, to 7,257.5 hours at a cost of $1,002,760. We anticipate that
in the years following the adoption of amended rule 10f-3 the ongoing
estimated burden hours for rule 10f-3 will be 4,497.5 hours at a cost
of $800,360.\84\
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\81\ See supra note 78 and accompanying text.
\82\ Id.
\83\ Id.
\84\ We are not seeking approval for any collection of
information based on burden data for any but the first year
following adoption of these proposals. The information regarding
burden hours and costs incurred after the first year of adoption is
provided to give a fuller understanding of our proposals' long-term
impact on the fund industry.
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Rule 17e-1
Based on an analysis of investment company filings, the staff
estimates that approximately 293 investment companies use at least one
affiliated broker and that each of these investment companies spends an
estimated 12.5 hours per year (at a cost of $775 per year) complying
with rule 17e-1's requirements that (i) the fund retain records of
transactions entered into pursuant to the rule (``recordkeeping
requirement''), and (ii) the fund's directors review those transactions
quarterly (``review requirement'').\85\ Based on conversations with
representatives of investment companies, the staff estimates that the
amendments to rule 17e-1 would exempt approximately 40 percent of
transactions that occur under rule 17e-1 from the rule's recordkeeping
and review requirements.
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\85\ In calculating the total annual cost of complying with
amended rule 17e-1, the Commission staff assumes that the entire
burden would be attributable to professionals with an average hourly
wage rate of $62 per hour.
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The Commission staff estimates, therefore, that the amendments to
rule 17e-1 will, in this respect, decrease the rule's information
collection burden to 2,200 hours,\86\ at a cost of $136,422 per
year.\87\
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\86\ 293 transactions x 12.5 hours = 3,663 hours if adopted; 60%
of the 293 transactions (or 176 transactions) would proceed under
rule 17e-1. 176 transactions (60% of the 293 transactions
anticipated to be impacted by rule) x 12.5 hours = 2,200 hours.
\87\ 3,663 hours x $62 = $227,106; 2,200 hours x $62 = $136,400.
[[Page 3151]]
Estimated Reduction in Burden Hours and Cost of Rule 17e-1
[effect of exemption from review and recordkeeping requirements]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number funds Burden hours Total burden Cost per hour
Number funds subject to of hours of of
relying on recordkeeping recordkeeping recordkeeping recordkeeping Total cost of
rule 17e-1 and review and review and review and review burden hours
requirements requirements requirements requirements
--------------------------------------------------------------------------------------------------------------------------------------------------------
Prior Rule.............................................. 293 293 12.5 3,663 $62 $227,106
As Amended.............................................. 293 176 12.5 2,200 62 136,400
--------------------------------------------------------------------------------------------------------------------------------------------------------
This reduction will be offset to some extent by the increase in
estimated burden hours described above with respect to the required
modifications of the funds' investment advisory contracts. Therefore
rule 17e-1, as amended, will impose an estimated burden of 5,050 hours
($345,400) in the first year after the amendments are adopted, and an
estimated burden of 2,290 hours ($143,000) in subsequent years.
VI. Summary of Final Regulatory Flexibility Analysis
We have prepared a Final Regulatory Flexibility Analysis (``FRFA'')
in accordance with 5 U.S.C. 604 regarding the adoption of new rule 17a-
10 and amendments to rules 10f-3, 12d3-1, 17a-6, 17d-1, and 17e-1 under
the Investment Company Act. A summary of the Initial Regulatory
Flexibility Analysis (``IRFA''), which was prepared in accordance with
5 U.S.C. 603, was published in the Proposing Release. The following
summarizes the FRFA.
A. Need for New Rule and Amendments
The FRFA summarizes the background of the amendments. The FRFA also
discusses the reasons for the new rule and amendments and the
objectives of, and legal basis for, these rulemaking initiatives. Those
items are discussed in the release. The FRFA discusses the effect of
the new rule and amendments on small entities.
B. Significant Issues Raised by Public Comment
The Commission received no comments on the IRFA.
C. Small Entities Subject to the New Rule and Amendments
The FRFA discusses the effect of the amendments on small entities.
For purposes of the Regulatory Flexibility Act,\88\ a fund is a small
entity if the fund, together with other funds in the same group of
related funds, has net assets of $50 million or less as of the end of
its most recent fiscal year.\89\ An investment adviser is a small
entity if it (i) manages less than $25 million in assets, (ii) has
total assets of less than $5 million on the last day of its most recent
fiscal year, and (iii) does not control, is not controlled by, and is
not under common control with another investment adviser that manages
$25 million or more in assets, or any person (other than a natural
person) that had total assets of $5 million or more on the last day of
the most recent fiscal year.\90\ An issuer, other than an investment
company, is a small entity if its total assets on the last day of its
most recent fiscal year were $5 million or less and it is engaged or
proposing to engage in an offering of securities which does not exceed
the dollar limitation prescribed by section 3(b) of the Securities Act
of 1933. The staff estimates, based upon Commission filings, that there
are approximately 3,650 active registered management investment
companies, of which approximately 200 are small entities. The staff
further estimates that there are approximately 7,560 registered
investment advisers, of which approximately 430 are small entities.\91\
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\88\ 5 U.S.C. 601-612.
\89\ 17 CFR 270.0-10.
\90\ 17 CFR 275.0-7.
\91\ The staff was unable to determine from Commission filings
the number of fund portfolio affiliates that are also small
entities. We estimate that 875 companies are portfolio affiliates of
funds.
---------------------------------------------------------------------------
Funds and portfolio companies that are small entities will be able
to rely on the amendments to rules 17a-6 and 17d-1(d)(5) if they
satisfy the rules' conditions. Funds and investment advisers that are
small entities will be able to rely on the amendments to rule 10f-3,
12d3-1, 17e-1, and rule 17a-10, if they meet the conditions of those
rules.
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
Portfolio Affiliates--Rules 17a-6 and 17d-1(d)(5)
The expanded exemptions in rules 17a-6 and 17d-1(d)(5) permitting
second-tier portfolio affiliates and funds to enter into principal
transactions and joint arrangements would not impose any new reporting,
recordkeeping, or other compliance requirements on funds or portfolio
affiliates that are small entities.
Subadviser Affiliates--Rules 17a-10, 10f-3, 12d3-1, and 17e-1
The rule and rule amendments permitting subadvisers to enter into
otherwise prohibited transactions and arrangements with affiliated
funds will impose compliance and recordkeeping requirements on funds
and subadvisers that rely on the rules' exemptions, as the funds'
advisory contracts will be required to prohibit the fund's subadvisers
from consulting with one another concerning the fund's securities
transactions.\92\ Based on discussions with industry representatives,
our staff estimates that modifying advisory contracts in this manner
will require 6 hours, at a cost of approximately $440 per fund. While
small funds and small advisers are unlikely to be disproportionately
impacted by this one-time requirement, a fund complex that includes a
large number of funds advised by subadvisers may experience economies
of scale, as the amendments to its advisory contracts will be largely
duplicative.
---------------------------------------------------------------------------
\92\ See, e.g., rule 12d3-1(c)(3)(ii)(A).
---------------------------------------------------------------------------
E. Agency Action To Minimize Effect on Small Entities
The FRFA explains that we have not identified any federal rules
that duplicate or conflict with the rule and rule amendments. The
Regulatory Flexibility Act directs the Commission to consider
significant alternatives that would accomplish the stated objectives,
while minimizing any significant adverse impact on small entities. In
connection with the amendments, the Commission considered the following
alternatives: (a) The establishment of differing compliance or
reporting requirements or timetables that take into account the
resources available to small entities; (b) the clarification,
consolidation, or simplification of compliance and reporting
requirements under the rule for small entities; (c) the
[[Page 3152]]
use of performance rather than design standards; and (d) an exemption
from coverage of the rule, or any part thereof, for small entities.
We do not believe that special compliance, timetable, or reporting
requirements or an exemption from coverage of the rule for small
entities would be consistent with investor protection. Similarly, any
further clarification, consolidation, or simplification of the
reporting requirements for small entities could compromise the
safeguards embodied in the new rule and amendments. The new rule and
rule amendments use performance, rather than design standards, in the
sense that they require the fund's board of directors to make certain
findings,\93\ and the fund's advisory contracts to include certain
conditions,\94\ rather than specifying the basis for the board's
findings, or the specific language to be included in the advisory
contracts.
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\93\ In the case of the amendments to rules 17a-6 and 17d-
1(d)(5).
\94\ In the case of rule 17a-10 and the amendments to rules 17e-
1, 10f-3, and 12d3-1.
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VII. Statutory Authority
The Commission has adopted amendments to rules 10f-3, 12d3-1, 17a-
6, 17d-1, and 17e-1 and new rule 17a-10 under the Investment Company
Act pursuant to authority set forth in sections 6(c), 10(f), 17(b),
17(d), 31(a), and 38(a) of the Investment Company Act.
List of Subjects in 17 CFR Part 270
Investment companies, Reporting and recordkeeping requirements,
Securities.
Text of Rules
For reasons set forth in the preamble, title 17, chapter II of the
Code of Federal Regulations is amended as follows:
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
1. The authority citation for part 270 continues to read in part as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-34(d), 80a-37, 80a-39,
unless otherwise noted;
* * * * *
2. Section 270.10f-3 is amended by:
a. Redesignating paragraph (b) as paragraph (c);
b. Adding paragraphs (a)(6), (a)(7), (a)(8), and new paragraph (b);
c. Revising the paragraph heading in newly redesignated paragraph
(c); and
d. Revising newly redesignated paragraph (c)(7).
The additions and revisions read as follows:
Sec. 270.10f-3 Exemption for the acquisition of securities during the
existence of an underwriting or selling syndicate.
(a) * * *
(6) Managed portion of a portfolio of a registered investment
company means a discrete portion of a portfolio of a registered
investment company for which a subadviser is responsible for providing
investment advice, provided that:
(i) The subadviser is not an affiliated person of any investment
adviser, promoter, underwriter, officer, director, member of an
advisory board, or employee of the registered investment company; and
(ii) The subadviser's advisory contract:
(A) Prohibits it from consulting with any subadviser of the
investment company that is a principal underwriter or an affiliated
person of a principal underwriter concerning transactions of the
investment company in securities or other assets; and
(B) Limits its responsibility in providing advice to providing
advice with respect to such portion.
(7) Series of a series company means any class or series of a
registered investment company that issues two or more classes or series
of preferred or special stock, each of which is preferred over all
other classes or series with respect to assets specifically allocated
to that class or series.
(8) Subadviser means an investment adviser as defined in section
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
(b) Exemption for purchases by series companies and investment
companies with managed portions. For purposes of this section and
section 10(f) of the Act (15 U.S.C. 80a-10(f)), each Series of a Series
Company, and each Managed Portion of a registered investment company,
is deemed to be a separate investment company. Therefore, a purchase or
acquisition of a security by a registered investment company is exempt
from the prohibitions of section 10(f) of the Act if section 10(f) of
the Act would not prohibit such purchase if each Series and each
Managed Portion of the company were a separately registered investment
company.
(c) Exemption for other purchases. * * *
(7) Percentage limit. (i) Generally. The amount of securities of
any class of such issue to be purchased by the investment company,
aggregated with purchases by any other investment company advised by
the investment company's investment adviser, and any purchases by
another account with respect to which the investment adviser has
investment discretion if the investment adviser exercised such
investment discretion with respect to the purchase, does not exceed the
following limits:
(A) If purchased in an offering other than an Eligible Rule 144A
Offering, 25 percent of the principal amount of the offering of such
class; or
(B) If purchased in an Eligible Rule 144A Offering, 25 percent of
the total of:
(1) The principal amount of the offering of such class sold by
underwriters or members of the selling syndicate to qualified
institutional buyers, as defined in Sec. 230.144A(a)(1) of this
chapter; plus
(2) The principal amount of the offering of such class in any
concurrent public offering.
(ii) Exemption from percentage limit. The requirement in paragraph
(c)(7)(i) of this section applies only if the investment adviser of the
investment company is, or is an affiliated person of, a principal
underwriter of the security; and
(iii) Separate aggregation. The requirement in paragraph (c)(7)(i)
of this section applies independently with respect to each investment
adviser of the investment company that is, or is an affiliated person
of, a principal underwriter of the security.
* * * * *
3. Section 270.12d3-1 is amended by revising paragraph (c) and
adding paragraph (d)(9) before the note:
Sec. 270.12d3-1 Exemption of acquisitions of securities issued by
persons engaged in securities related businesses.
* * * * *
(c) Notwithstanding paragraphs (a) and (b) of this section, this
section does not exempt the acquisition of:
(1) A general partnership interest; or
(2) A security issued by the acquiring company's promoter,
principal underwriter, or any affiliated person of such promoter, or
principal underwriter; or
(3) A security issued by the acquiring company's investment
adviser, or an affiliated person of the acquiring company's investment
adviser, other than a security issued by a subadviser or an affiliated
person of a subadviser of the acquiring company provided that:
(i) Prohibited relationships. The subadviser that is (or whose
affiliated person is) the issuer is not, and is not an affiliated
person of, an investment adviser responsible for providing advice with
respect to the portion of the acquiring company that is acquiring the
securities, or of any promoter, underwriter, officer, director, member
of
[[Page 3153]]
an advisory board, or employee of the acquiring company;
(ii) Advisory contract. The advisory contracts of the Subadviser
that is (or whose affiliated person is) the issuer, and any Subadviser
that is advising the portion of the acquiring company that is
purchasing the securities:
(A) Prohibit them from consulting with each other concerning
transactions of the acquiring company in securities or other assets,
other than for purposes of complying with the conditions of paragraphs
(a) and (b) of this section; and
(B) Limit their responsibility in providing advice to providing
advice with respect to a discrete portion of the acquiring company's
portfolio.
(d) * * *
(9) Subadviser means an investment adviser as defined in section
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
* * * * *
4. Section 270.17a-6 is revised to read as follows:
Sec. 270.17a-6 Exemption for transactions with portfolio affiliates.
(a) Exemption for transactions with portfolio affiliates. A
transaction to which a fund, or a company controlled by a fund, and a
portfolio affiliate of the fund are parties is exempt from the
provisions of section 17(a) of the Act (15 U.S.C. 80a-17(a)), provided
that none of the following persons is a party to the transaction, or
has a direct or indirect financial interest in a party to the
transaction other than the fund:
(1) An officer, director, employee, investment adviser, member of
an advisory board, depositor, promoter of or principal underwriter for
the fund;
(2) A person directly or indirectly controlling the fund;
(3) A person directly or indirectly owning, controlling or holding
with power to vote five percent or more of the outstanding voting
securities of the fund;
(4) A person directly or indirectly under common control with the
fund, other than:
(i) A portfolio affiliate of the fund; or
(ii) A fund whose sole interest in the transaction or a party to
the transaction is an interest in the portfolio affiliate; or
(5) An affiliated person of any of the persons mentioned in
paragraphs (a)(1)-(4) of this section, other than the fund or a
portfolio affiliate of the fund.
(b) Definitions. (1) Financial interest. (i) The term financial
interest as used in this section does not include:
(A) Any interest through ownership of securities issued by the
fund;
(B) Any interest of a wholly-owned subsidiary of a fund;
(C) Usual and ordinary fees for services as a director;
(D) An interest of a non-executive employee;
(E) An interest of an insurance company arising from a loan or
policy made or issued by it in the ordinary course of business to a
natural person;
(F) An interest of a bank arising from a loan or account made or
maintained by it in the ordinary course of business to or with a
natural person, unless it arises from a loan to a person who is an
officer, director or executive of a company which is a party to the
transaction, or from a loan to a person who directly or indirectly
owns, controls, or holds with power to vote, five percent or more of
the outstanding voting securities of a company which is a party to the
transaction;
(G) An interest acquired in a transaction described in paragraph
(d)(3) of Sec. 270.17d-1; or
(H) Any other interest that the board of directors of the fund,
including a majority of the directors who are not interested persons of
the fund, finds to be not material, provided that the directors record
the basis for that finding in the minutes of their meeting.
(ii) A person has a financial interest in any party in which it has
a financial interest, in which it had a financial interest within six
months prior to the transaction, or in which it will acquire a
financial interest pursuant to an arrangement in existence at the time
of the transaction.
(2) Fund means a registered investment company or separate series
of a registered investment company.
(3) Portfolio affiliate of a fund means a person that is an
affiliated person (or an affiliated person of an affiliated person) of
a fund solely because the fund, a fund under common control with the
fund, or both:
(i) Controls such person (or an affiliated person of such person);
or
(ii) Owns, controls, or holds with power to vote five percent or
more of the outstanding voting securities of such person (or an
affiliated person of such person).
5. Section 270.17a-10 is added to read as follows:
Sec. 270.17a-10 Exemption for transactions with certain subadvisory
affiliates.
(a) Exemption. A person that is prohibited by section 17(a) of the
Act (15 U.S.C. 80a-17(a)) from entering into a transaction with a fund
solely because such person is, or is an affiliated person of, a
subadviser of the fund, or a subadviser of a fund that is under common
control with the fund, may nonetheless enter into such transaction, if:
(1) Prohibited relationship. The person is not, and is not an
affiliated person of, an investment adviser responsible for providing
advice with respect to the portion of the fund for which the
transaction is entered into, or of any promoter, underwriter, officer,
director, member of an advisory board, or employee of the fund.
(2) Prohibited conduct. The advisory contracts of the subadviser
that is (or whose affiliated person is) entering into the transaction,
and any subadviser that is advising the fund (or portion of the fund)
entering into the transaction:
(i) Prohibit them from consulting with each other concerning
transactions for the fund in securities or other assets; and
(ii) If both such subadvisers are responsible for providing
investment advice to the fund, limit the subadvisers' responsibility in
providing advice with respect to a discrete portion of the fund's
portfolio.
(b) Definitions.
(1) Fund means a registered investment company and includes a
separate series of a registered investment company.
(2) Subadviser means an investment adviser as defined in section
2(a)(20)(B) of the Act (15 U.S.C. 80a-2(a)(20)(B)).
6. Section 270.17d-1 is amended by revising paragraphs (d)(5) and
(d)(6) to read as follows:
Sec. 270.17d-1 Applications regarding joint enterprises or
arrangements and certain profit-sharing plans.
* * * * *
(d) * * *
(5) Any joint enterprise or other joint arrangement or profit-
sharing plan (``joint enterprise'') in which a registered investment
company or a company controlled by such a company, is a participant,
and in which a portfolio affiliate (as defined in Sec. 270.17a-
6(b)(3)) of such registered investment company is also a participant,
provided that:
(i) None of the persons identified in Sec. 270.17a-6(a) is a
participant in the joint enterprise, or has a direct or indirect
financial interest in a participant in the joint enterprise (other than
the registered investment company);
(ii) Financial interest.
(A) The term financial interest as used in this section does not
include:
(1) Any interest through ownership of securities issued by the
registered investment company;
(2) Any interest of a wholly owned subsidiary of the registered
investment company;
[[Page 3154]]
(3) Usual and ordinary fees for services as a director;
(4) An interest of a non-executive employee;
(5) An interest of an insurance company arising from a loan or
policy made or issued by it in the ordinary course of business to a
natural person;
(6) An interest of a bank arising from a loan to a person who is an
officer, director, or executive of a company which is a participant in
the joint transaction or from a loan to a person who directly or
indirectly owns, controls, or holds with power to vote, five percent or
more of the outstanding voting securities of a company which is a
participant in the joint transaction;
(7) An interest acquired in a transaction described in paragraph
(d)(3) of this section; or
(8) Any other interest that the board of directors of the
investment company, including a majority of the directors who are not
interested persons of the investment company, finds to be not material,
provided that the directors record the basis for that finding in the
minutes of their meeting.
(B) A person has a financial interest in any party in which it has
a financial interest, in which it had a financial interest within six
months prior to the investment company's participation in the
enterprise, or in which it will acquire a financial interest pursuant
to an arrangement in existence at the time of the investment company's
participation in the enterprise.
(6) The receipt of securities and/or cash by an investment company
or a controlled company thereof and an affiliated person of such
investment company or an affiliated person of such person pursuant to a
plan of reorganization: Provided, That no person identified in Sec.
270.17a-6(a)(1) or any company in which such a person has a direct or
indirect financial interest (as defined in paragraph (d)(5)(iii) of
this section):
* * * * *
7. Section 270.17e-1 is amended by revising paragraphs (b)(3) and
(d) to read as follows:
Sec. 270.17e-1 Brokerage transactions on a securities exchange.
* * * * *
(b) * * *
(3) Determines no less frequently than quarterly that all
transactions effected pursuant to this section during the preceding
quarter (other than transactions in which the person acting as broker
is a person permitted to enter into a transaction with the investment
company by Sec. 270.17a-10) were effected in compliance with such
procedures;
* * * * *
(d) The investment company:
(1) Shall maintain and preserve permanently in an easily accessible
place a copy of the procedures (and any modification thereto) described
in paragraph (b)(1) of this section; and
(2) Shall maintain and preserve for a period not less than six
years from the end of the fiscal year in which any transactions
occurred, the first two years in an easily accessible place, a record
of each such transaction (other than any transaction in which the
person acting as broker is a person permitted to enter into a
transaction with the investment company by Sec. 270.17a-10) setting
forth the amount and source of the commission, fee or other
remuneration received or to be received, the identity of the person
acting as broker, the terms of the transaction, and the information or
materials upon which the findings described in paragraph (b)(3) of this
section were made.
By the Commission.
Dated: January 14, 2003.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-1229 Filed 1-21-03; 8:45 am]
BILLING CODE 8010-01-P