[Federal Register Volume 60, Number 106 (Friday, June 2, 1995)]
[Notices]
[Pages 28818-28820]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-13464]



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SECURITIES AND EXCHANGE COMMISSION
[Rel. No. IC-21098; 812-6902]


IDS Certificate Company, Notice of application

May 26, 1995.
AGENCY: Securities and Exchange Commission (``SEC'').

ACTION: Notice of Application for Exemption under the Investment 
Company Act of 1940 (the ``Act'').

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APPLICANT: IDS Certificate Company (``IDSC'').

RELEVANT ACT SECTIONS: Order requested under sections 6(c), 28(b), 
18(j)(1), and (28(c).

SUMMARY OF APPLICATION: IDSC requests an order under section 28(b) to 
permit it to hold as ``qualified investments'' those investments 
permitted under the Minnesota life insurance code (``Minnesota Code'') 
and to value these investments in accordance with the Minnesota Code; 
under section 6(c) to adopt a more conservative formula to calculate 
its minimum reserve requirements; under section 18(j)(1) to engage in 
certain hedging transactions that are permitted under the Minnesota 
Code; and under section 28(c) to authorize certain custodial 
arrangements. The order under section 6(c) would supersede a prior 
order (the ``Interest Rate Order'') relating to IDSC's reserve 
calculations.\1\ In addition, the order under section 28(c) would amend 
two prior orders (the ``Custody Orders'') concerning IDSC's custodial 
arrangements.\2\

    \1\IDS Certificate Company, Investment Company Act Release Nos. 
14981 (Mar. 11, 1986) (notice) and 15045 (Apr. 7, 1986) (order).
    \2\IDS Certificate Company, Investment Company Act Release Nos. 
14652 (July 31, 1985) (notice) and 14712 (Sept. 11, 1985) (order); 
IDS Certificate Company, Investment Company Act Release Nos. 17652 
(Aug. 3, 1990) (notice) and 17723 (Aug. 31, 1990).

FILING DATE: The application was filed on October 15, 1987, and amended 
on March 30, 1988, March 3, 1989, December 22, 1989, May 24, 1990, 
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August 20, 1990, September 27, 1994, and May 26, 1995.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the SEC orders a hearing. Interested persons may 
request a hearing by writing to the SEC's Secretary and serving 
applicant with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on June 20, 1995, 
and should be accompanied by proof of service on applicant, in the form 
of an affidavit or, for lawyers, a certificate of service. Hearing 
requests should state the nature of the writer's interest, the reason 
for the request, and the issues contested. Persons who wish to be 
notified of a hearing may request notification by writing to the SEC's 
Secretary.

ADDRESSES: Secretary, SEC, 450 5th Street, NW., Washington, DC 20549. 
Applicant, IDS Tower 10, Minneapolis, Minnesota 55440, Attn: Bruce A. 
Kohn.

FOR FURTHER INFORMATION CONTACT: Robert A. Robertson, Branch Chief, at 
(202) 942-0564, or Elizabeth G. Osterman, Assistant Director, at (202) 
942-0564 (Division of Investment Management, Office of Investment 
Company Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee for the 
SEC's Public Reference Branch.

Applicant's Representations

    1. IDSC, a registered face-amount certificate company, is a wholly-
owned subsidiary of IDS Financial Corporation, a registered broker-
dealer and investment adviser. IDSC issues several types of ``face-
amount certificates'' with varying terms and maturities. Face-amount 
certificates are debt obligations of the issuing company. These 
certificates obligate the issuer to pay a certain amount to the holder 
thereof upon maturity or to pay a specified surrender value prior to 
maturity.
    2. IDSC is located in Minnesota. A specific statutory mandate 
subjects IDSC to oversight and periodic inspections by the Minnesota 
Department of Commerce, which administers the Minnesota Code and also 
regulates insurance companies. The Department inspects IDSC at least 
annually, and focuses particularly on portfolio quality and the 
adequacy of reserves for losses.

A. Qualified Investments

    1. As a face-amount certificate company, the Act requires IDSC to 
hold assets having a value of not less than the aggregate amount of its 
required paid-in capital and certificate reserves. Section 28(b) 
provides that these assets must consist of cash or ``qualified 
investments,'' which are defined as those investments that life 
insurance companies are permitted to invest in or hold under the Code 
of the District of Columbia (the ``D.C. Code'') or investments that the 
SEC may authorized by rule, regulation, or order. In addition, the 
section provides that these investments must be valued in accordance 
with the D.C. Code.
    2. Investments available in the marketplace have changed 
substantially since the adoption of the D.C. Code, and applicants 
believe that the D.C. Code is largely outdated as the last substantive 
amendments were passed in 1960. Under the D.C. Code, life insurance 
companies may not invest more than 5% of their assets in investments 
not expressly permitted by the D.C. Code (the ``5% Limitation'').
    3. IDSC requests and order under section 28(b) to permit it to hold 
as ``qualified investments'' those financial instruments that life 
insurance companies may hold under the Minnesota Code, as in effect at 
the time relief is granted. In addition, if the requested relief is 
granted, these investments will be valued in accordance with the 
Minnesota Code. The Minnesota Code allows ``financial 
[[Page 28819]] transactions solely for the purpose of managing the 
interest rate risk associated with the Company's assets and liabilities 
and not for speculative or other purposes.''\3\ These transactions may 
involve ``futures, options to buy or sell fixed income securities, 
repurchase and reverse repurchase agreements, and interest rate swaps, 
caps, and floors.''\4\

    \3\Minn. Stat. Sec. 61A.28, subdib. 9a (emphasis added).
    \4\Minn. Stat. Sec. 61A.28, subdiv. 9a.
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    4. IDSC's current procedures for hedging include approval of any 
hedging program by an asset/liability committee that has been created 
by IDSC's investment adviser and includes senior managers of the 
investment adviser and managers of IDSC. The investment adviser is 
IDSC's parent company, IDS Financial Corporation. The committee does 
not review specific transactions before the fact. However, both the 
committee and IDSC's board of directors are informed of the 
implementation at their meetings or in written materials prepared for 
those meetings.
    5. There are other significant differences between the D.C. Code 
and the Minnesota Code:
    a. Under the D.C. Code, there is no limit on investments in high-
yield, lower grade bonds. In contrast, the Minnesota Code permits no 
more than 15% of a company's assets to be invested in bonds rated below 
investment grade by a nationally recognized rating agency or below the 
two highest of the six rating categories of the National Association of 
Insurance Commissioners (``NAIC'').
    b. The percentage of a portfolio that may be invested in equities 
is not limited under the D.C. Code, whereas the Minnesota Code permits 
no more than 20% to be invested in common stock, and no more than 25% 
to be invested in common and preferred stocks combined. No more than 
five percent may be invested in preferred stock rated in one of the 
four lowest NAIC rating categories.
    c. Under the D.C. Code, foreign investments other than in Canada 
are subject to the 5% Limitation. In addition to the investments in 
Canada, the Minnesota Code allows a company to invest up to ten percent 
of its assets in certain foreign investments in countries where the 
obligations of the government are rated in one of the two highest 
rating categories by a U.S. rating agency.
    6. In both Minnesota and the District of Columbia, NAIC principles 
are used to value the investments of life insurance companies, and most 
investments are valued at acquisition cost, with amortization of 
premiums and accretion of discounts, when applicable. IDSC states that 
there are few differences in valuation requirements between the two 
jurisdictions. In Minnesota, securities rated by the NAIC in its 
category 6--the lowest NAIC rating category--are required to be marked 
to a market value determined by the NAIC, which the D.C. Code does not 
require. In addition, unlike the D.C. Code, the Minnesota Code contains 
rules on valuation of commercial mortgage loans and real estate owned 
as a result of foreclosure on such loans.
    7. Section 28(b) provides that the SEC may authorize face-amount 
certificate companies to invest in qualified investments in addition to 
those permitted under the D.C. Code. IDSC requests an order under the 
section to permit it to use the Minnesota Code--instead of the D.C. 
Code--to determine its qualified investments. IDSC believes that the 
Minnesota Code governing investments by insurance companies contains 
several provisions that would enhance the protection of investors and 
be consistent with the policies and purposes of the Act.
    8. IDSC will explain its expanded use of derivative instruments in 
its prospectus and in a publication to its current certificate holders. 
In particular, IDSC will explain that it may enter into financial 
transactions, including futures and other derivatives, for the purpose 
of managing the interest rate exposures associated with its assets or 
liabilities. IDSC also will explain that derivatives are financial 
instruments whose performance is derived, at least in part, from the 
performance of an underlying asset, security or index, and that a small 
change in the value of the underlying asset, security or index may 
cause a sizable gain or loss in the fair value of the derivative.

B. Reserves

    1. IDSC also requests an order to change the formula for 
calculating its minimum reserves. Sections 28(a) and 28(i) specify the 
amount of reserves required to be maintained on fully paid (or single 
pay) certificates and installment certificates. The underlying 
principle in calculating a face-amount certificate company's reserves 
is to start with the amount of money that will have to be paid at 
maturity and then to work backward through an analysis similar to a 
present value calculation. For instance, with a fully paid (or single 
pay) certificate, section 28(a) requires IDSC to maintain reserves at 
least equal to the amount, when accumulated at 3\1/2\% per annum 
compounded annually, that will provide the value payable at maturity.
    2. The Interest Rate Order permits IDSC to calculate its minimum 
reserves using a weighted Moody's Corporate Bond Yield Average 
(``Moody's Index''), as opposed to using the statutory 3\1/2\%. IDSC 
believes that a different formula for calculating its reserves could 
more closely approximate the usual average maturity of the investments 
in IDSC's portfolio. Accordingly, IDSC requests an order under section 
6(c) to calculate its reserves using the rate of Treasury bonds with 
seven years remaining to maturity. IDSC requests this order such that, 
if it so chose, it could comply with the condition to, and rely on, 
this amended exemption without complying with the other conditions to, 
or relying on, the other exemptions requested in this application. 
However, if IDSC relies on the relief requested herein to determine 
qualified investments, it will comply with all the conditions set forth 
in this application.
    3. Section 6(c) provides that the SEC may exempt any person from 
any provision of the Act, if and to the extent that such exemption is 
necessary or appropriate in the public interest and consistent with the 
protection of investors and the purposes fairly intended by the policy 
and provisions of the Act. Congress sought adequate and secure reserves 
for face-amount certificate companies. While it could not have 
specifically anticipated the country's recent history of widely 
fluctuating interest rates, Congress did recognize a need for 
flexibility with changing conditions. Section 6(c) was adopted by 
Congress to permit the SEC to grant exemptions consistent with the 
Act's purpose of protecting investors. IDSC believes that its proposal 
would continue to meet Congress' goal of adequate reserves.

C. Issuing Additional Securities

    1. IDSC also requests an order under section 18(j)(1). The section 
generally provides that face-amount certificate companies may not issue 
any securities other than face-amount certificates, common stock, and 
private short-term debt, except as the SEC authorizes by rule, 
regulation, or order.
    2. As discussed above, the Minnesota Code permits companies to 
engage in certain hedging transactions. To the extent these 
transactions may involve the issuance of securities other than those 
permitted by section 18(j)(1), IDSC requests approval to issue these 
securities. [[Page 28820]] 

D. Custody

    1. Section 28(c) requires a face-amount certificate company to 
deposit and maintain, upon such terms and conditions as the SEC may 
prescribe by rule, regulation, or order, all certificate reserve 
investments with a bank. The Custody Orders approve various custodial 
arrangements for IDSC. Under these arrangements, IDSC's custodian holds 
assets either directly or in the book entry system of the Depository 
Trust Company or the Federal Reserve. In addition, a transnational 
depository, Centrale de Livraison de Valeuers Mobilieres, S.A., holds a 
small number of foreign bonds. From time to time, the custodian's agent 
bank, State Street Bank and Trust Co. in New York City, holds short-
term securities. Finally, the custodian's agent, Marquette Bank 
Minneapolis, holds a small number of unregistered bearer securities. 
IDSC believes that it can maintain custody for most of the investments 
permitted under the Minnesota Code in accordance with the Custody 
Orders.
    2. IDSC, however, requests an order under section 28(c) to allow 
certain custody arrangements for exchange-trade options. IDSC proposes 
to maintain custody of exchange-traded options indirectly through 
clearing members who will be participating members in the Options 
Clearing Corporation (``OCC''). The clearing member will hold such 
options in nonproprietary accounts. IDSC or its custodian will prepare 
an activity report of every option transaction or exercise, and will 
identify on its records the quantity of options belonging or 
attributable to IDSC on the books of the clearing member. IDSC or its 
custodian will monitor account activity to assure that IDSC's options 
are appropriately recorded. IDSC's board of directors initially will 
approve IDSC's use of the OCC system and will review it annually 
thereafter, together with the annual report from IDSC or its custodian, 
in conjunction with its overall review of IDSC's custody arrangements.
    3. IDSC believes that, in general, these custodial arrangements 
will be similar to how a management investment company may maintain 
custody of similar investments under section 17(f). Thus, IDSC believes 
that it would be appropriate to permit custody of options under 
safeguards similar to those that apply to custody of such investments 
when they are made by management investment companies.

Applicant's Conditions

    As conditions to the requested relief, applicant agrees to the 
following, provided that only condition 6 applies to applicant's 
request to amend applicant's exemption related to its calculation of 
reserves in order to change the benchmark for such calculation:
    1. Qualified investments under section 28(b) of the Act will be 
determined by reference to Minnesota law governing investments by life 
insurance companies as such law exists as of the date of the order 
granting the relief requested in this application, and such other 
investments as the Commission shall by rule, regulation, or order 
authorize as qualified investments. However, any investment in 
municipal revenue bonds held by applicant that is a qualified 
investment under applicable law immediately prior to the time that the 
requested exemptions are granted will continue to be a qualified 
investment even if it would not otherwise be a qualified investment 
under the requested exemptions.
    2. Qualified investments under section 28(b) of the Act will be 
determined by reference to Minnesota law governing investments by life 
insurance companies only so long as applicant remains subject to the 
jurisdiction of and periodic examinations by the Minnesota Commissioner 
of Commerce.
    3. Applicant will not invest in an illiquid security if, 
immediately after the investment, more than 15% of its investment 
portfolio would be held in illiquid securities. For these purposes, an 
illiquid security will be any security which may not be sold or 
disposed of in the ordinary course of business within seven days at 
approximately the current market value at which applicant has valued 
the investment.
    4. To the extent required by generally accepted accounting 
principles, applicant will employ market-based accounting in valuing 
its portfolio investments for financial reporting purposes.
    5. In its prospectuses and in a communication to existing 
certificate owners, applicant will explain its expanded use of 
derivative instruments. In particular, applicant will explain that it 
may enter into financial transactions, including futures and other 
derivatives, for the purpose of managing interest rate exposures 
associated with its assets or liabilities. Applicant also will explain 
that derivatives are financial instruments whose performance is 
derived, at least in part, from the performance of an underlying asset, 
security or index, and that a small change in the value of the 
underlying asset, security or index may cause a sizable gain or loss in 
the fair value of the derivative. For these purposes, derivatives are 
interest rate futures, options, forwards, swaps, caps and similar 
financial transactions.
    6. Applicant will maintain an amount of unappropriated earned 
surplus and capital equal to at least 5% of net certificate reserves. 
Net certificate reserves means certificate reserves less outstanding 
certificate loans. In determining compliance with this condition, 
qualified investments shall be valued in accordance with the provisions 
of Minnesota Statutes where such provisions are applicable.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-13464 Filed 6-1-95; 8:45 am]
BILLING CODE 8010-01-M