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August 7, 1989
TO: SEC RULES MEMBERS NO. 37-89
OPERATIONS MEMBERS NO. 25-89
RE: SEC ADOPTS RULE 11a-3, GOVERNING EXCHANGE OFFERS BY
MUTUAL FUNDS
__________________________________________________________
The SEC has adopted Rule 11a-3 under the 1940 Act, which
will permit mutual funds to make exchange offers to shareholders,
subject to various conditions. Rule 11a-3 was originally
proposed in December 1986 and was reproposed in July 1988. The
Institute filed a comment letter on the reproposed rule, which
opposed several of its provisions. Portions of the rule were
changed in response to comments by the Institute and others.
Rule 11a-3 will supersede prior orders issued by the
Commission that allowed funds to make exchange offers. Funds
that received such orders that were not expressly conditioned on
compliance with Rule 11a-3, when adopted, will have one year from
the Rule's effective date to comply with the Rule's limitations
on fees and sale charges.
In its July 1988 release reproposing Rule 11a-3, the
Commission announced that the Chase Fund of Boston no-action
letter (pub. avail. July 28, 1980), which deemed an exchange
offer with a $5.00 administrative fee to be at net asset value,
would be withdrawn "after the effective date of rule 11a-3" at
which time "funds relying on that letter . . . will be required
to bring their exchange offers into compliance with the
provisions of the rule". The adopting release does not mention
the withdrawal of the Chase Fund of Boston letter.
A brief summary of Rule 11a-3 follows.
Limits on Sales Loads and Fees
Rule 11a-3 allows a fund or its principal underwriter (the
"offering company") to make an exchange offer to a shareholder in
that fund or another fund in the same group of investment
companies and to charge that shareholder a sales load, redemption
fee, administrative fee or any combination thereof, subject to
the following conditions.
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Calculation of Sales Load The sales load on the security
acquired in the exchange cannot exceed a percentage rate equal to
the excess of the sales load rate applicable to the acquired
security over the sum of the rates of all sales loads previously
paid on the exchanged security and any predecessor of the
exchanged security.
In calculating the permissible sales load, where a
shareholder exchanges less than all of his or her securities, the
securities subject to the highest load are to be deemed exchanged
first. Exchanged securities that were acquired through
reinvestment of dividends or capital gains distributions are
deemed to have been subject to the same sales load rate as the
security on which the dividend or capital gains distribution was
paid.
Deferred Sales Loads The imposition of a deferred load on
the exchanged security at the time of the exchange is prohibited.
A deferred load may be imposed at the time the acquired security
is redeemed (as a result of a deferred load normally imposed on
either the exchanged security or the acquired security). Such
load is limited to the excess of the applicable rate over the sum
of the rates of all loads previously paid on the acquired
security. In addition, the total of the rates of all sales loads
charged prior to and at the time the acquired security is
redeemed cannot exceed the maximum rate that would be applicable,
in the absence of any exchange, to the exchanged security or the
acquired security, whichever is higher.
In general, a deferred sales load must be calculated as if
the shareholder held the acquired security from the date on which
he became the holder of the exchanged security. (Holding periods
may be computed as of month end.) This applies to deferred loads
with respect to both the exchanged and the acquired security.
However, the time period during which the acquired security was
held need not be included (i.e., may be "tolled") in order to
compute a deferred load on the exchanged security if no loads are
imposed with respect to the acquired security and the deferred
load on the exchanged security is reduced by the amount of any
12b-1 fees collected on the acquired security. Conversely, the
time period during which the exchanged security was held may be
tolled for purposes of computing a deferred load on the acquired
security provided no loads are imposed with respect to the
exchanged security and the deferred load on the acquired security
is reduced by 12b-1 fees collected on the exchanged security. As
a result, tolling for a fund with a 12b-1 plan will only be
permitted if the fund can account for 12b-1 payments on an
individual shareholder basis.
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Administrative Fees A fund may charge an administrative
fee, which must be either slight or de minimis, or reasonably
intended to cover the costs of processing exchanges. If the
latter, the fund must maintain and preserve records with respect
to costs incurred in processing exchanges. Any administrative
fee or scheduled variation must be applied uniformly.
Redemption Fees A fund may charge a redemption fee, which
is a fee paid to the fund and is reasonably intended to
compensate the fund for expenses related to redemptions of
shares. The fee must be applied uniformly and cannot exceed a
redemption fee charged in the absence of an exchange. Any
scheduled variation of the fee must be reasonably related to the
costs involved in processing redemptions of the type for which
the fee is charged.
Disclosure Requirements
Advertising and Sales Literature Any advertising and sales
literature that mentions an exchange offer must disclose (1) the
existence of any administrative fee or redemption fee and (2) if
the offering company reserves the right to terminate or change
the terms of the offer, that the offer is subject to termination
or its terms are subject to change.
Prospectus The prospectus of an offering company must
disclose (1) the amount of any administrative fee or redemption
fee and (2) that the offer is subject to termination or its terms
subject to change, if either is the case.
Termination or Amendment of Offer An offering company must
provide notice to any holder of a security subject to an exchange
offer 60 days prior to terminating or materially amending such
offer (except for reductions in fees or sales charges). The
notice requirement does not apply (1) if redemptions of the
exchanged securities are suspended under Section 22(e) of the
1940 Act or (2) if the offering company delays or ceases sales of
the acquired securities "because it is unable to invest amounts
effectively in accordance with applicable investment objectives,
policies and restrictions".
Effectiveness of Rule
Rule 11a-3 is effective sixty days after the date of its
publication in the Federal Register. However, funds that have
obtained orders under Section 11 that are not conditioned upon
compliance with Rule 11a-3, when adopted, have one year from the
effective date to adjust fees and sales loads in conformity with
Rule 11a-3. All shares acquired prior to the time the offer has
been brought into compliance with Rule 11a-3, as well as shares
acquired through reinvestment of dividends and capital gains
distributions based on those shares, may continue to be subject
to the "old" fees and sales loads, until those shares are redeemed.
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A fund with an existing exchange offer may rely on the rule
to amend its offer only if its prospectus disclosed for at least
two years prior to the amendment (or the entire time the offer
was outstanding, if less than two years) that the terms of the
offer were subject to change, unless the only effect of the
change is to reduce fees or sales loads.
Therefore, if a fund's existing exchange offer is subject
to terms different from the terms of the rule and the fund has
not had the required disclosure in its prospectus for the past
year, the fund may have to terminate its exchange offer or apply
for exemptive relief from Section 11 within a year because the
fund would not be able to rely on the rule to amend its offer of
exchange to bring that offer into compliance with the rule.
Other Provisions
Holding Period If there is no sales load imposed on the
acquired security or the load is less than the maximum allowed,
the offering company may establish a minimum holding period prior
to any exchange, provided it is applied uniformly.
"Group of Investment Companies" Rule 11a-3 defines "group
of investment companies" for purposes of the rule to include
funds with affiliated investment advisers or principal
underwriters.
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A copy of the release adopting Rule 11a-3 is attached. The
release contains an appendix with examples of how to calculate
sales loads on exchanges.
Craig S. Tyle
Assistant General Counsel
Attachment