June 11, 1996
TO: SEC RULES COMMITTEE No. 58-96
RE: CONSIDERATION OF IMPACT OF REMOTE AFFILIATIONS AT JUNE 19
MEETING
______________________________________________________________________________
The Institute is considering whether to propose exemptive rules or other relief to
address situations in which investment companies activities may be unduly inhibited by the
affiliated transaction provisions in the Investment Company Act. Certain proposals along these
lines have been advanced over the past few years. For example, in its 1992 report on
investment company regulation, the SEC staff recommended permitting funds to engage in
joint transactions with certain remote affiliates, subject to prior board approval. The staff
specifically declined to recommend a similar approach with respect to principal transactions,
however. The Institute proposed in a July 1995 submission to the SEC staff that the SEC adopt
an exemptive rule to permit certain principal transactions involving "upstream affiliates" under
specified conditions. (See scenario #1 below.) The SEC has not formally acted upon either of
these proposals.
In recent years, the SEC has issued several exemptive orders and the staff has granted
no-action requests to provide additional flexibility to funds to engage in certain types of
affiliated transactions where the potential for abuse is limited and/or appropriate safeguards
against overreaching are in place. These include, for example, orders and no-action letters
permitting funds to engage in principal and agency transactions with an entity that is affiliated
with the subadviser to another fund with the same investment adviser. (See scenario #3 below.)
At the June 19th meeting of the SEC Rules Committee, we plan to discuss whether the
Institute should pursue further relief for investment companies from unnecessary constraints
that are imposed because of remote affiliations that do not raise any significant potential for
abuse. Such relief could be in the form of, for example, an exemptive rule that would exclude
certain entities from the definition of an "affiliated person;" amendments to existing exemptive
rules; interpretive relief; or some combination of the foregoing.
Set forth below for your consideration are examples of some possible scenarios for
discussion at the meeting.
1. A dealer firm or its affiliate owns more than 5% of the outstanding voting securities of a
fund. The SEC has interpreted Section 17(a) of the Investment Company Act to prohibit
principal transactions not only between the dealer firm and the fund of which it (or its affiliate)
is a 5% holder but also between the dealer firm and any other fund that has the same or a
related investment adviser, common officers and/or directors, or some combination of the
foregoing. Similar issues arise where a bank is a 5% holder of a funds shares (this often occurs
in the money market fund context) -- other funds with the same or a related investment adviser,
officers and/or directors cannot engage in transactions with the bank, such as securities
lending, repurchase agreements, etc.
2. A fund (Fund A) owns more than 5% of the outstanding voting securities of an issuer
(Portfolio Company) that offers to repurchase its shares. Portfolio Company, thus, is an
affiliated company of Fund A. Rule 17a-6 provides an exemption from Section 17(a) to allow a
transaction between a fund and an affiliated company if none of certain specified persons
(including, among others, any person "under common control" with the fund) either: (1) is a
party to the transaction; or (2) has a direct or indirect financial interest in a party (other than the
fund) to the transaction. Another fund advised by the same adviser (Fund B) also owns
Portfolio Companys securities. The SEC staff takes the position that Fund B is "under common
control" with Fund A because they have the same investment adviser. Fund B has a "financial
interest" in a party to the transaction, i.e., Portfolio Company, because Fund B owns the
securities that are the subject of the repurchase offer. As a result, Rule 17a-6 is not available to
Fund A and Fund A cannot engage in the transaction. (A similar issue arises under Rule 17d-
1(d)(5).)
3. The subadviser to a fund owns more than 5% of an issuers securities. Another fund
with the same investment adviser, but a different subadviser, cannot purchase the securities.
(This is just one example of the types of affiliated transaction issues that arise where fund
groups use subadvisers that otherwise are not affiliated with each other or the funds. As noted
above, the SEC and its staff have responded favorably to several requests for relief in this area.)
4. An independent director of a fund also serves as an independent director of an
underwriting firm. The fund is subject to Section 10(f) and Rule 10f-3 with respect to any
offering of securities where the underwriting firm is a principal underwriter in the
underwriting syndicate. As a result, the funds investment opportunities are restricted, even
though the director does not have the ability to influence either the specific investments made
by the fund or the underwriters decisions as to participation as a principal underwriter in any
particular underwriting syndicate.
* * *
Please call me at (202) 326-5822 if there are other issues involving remote affiliations that
you would like to discuss at the meeting.
Frances M. Stadler
Associate Counsel