[Federal Register Volume 60, Number 213 (Friday, November 3, 1995)]
[Notices]
[Pages 55877-55880]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27316]



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SECURITIES AND EXCHANGE COMMISSION
[Investment Company Act Release No. 21458; 812-8868]


ESC Strategic Funds, Inc. and Equitable Securities Corporation; 
Notice of Application

October 27, 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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APPLICANTS: ESC Strategic Funds, Inc. (the ``Company'') and Equitable 
Securities Corporation (the ``Adviser'').

RELEVANT ACT SECTIONS: Exemption requested under section 6(c) of the 
Act from the provisions of section 15(a) and rule 18f-2; and from 
certain disclosure requirements set forth in item 22 of Schedule 14A 
under the Securities Exchange Act of 1934 (the ``Exchange Act''); items 
2, 5(b)(iii), and 16(a)(iii) of Form N-1A; item 3 of Form N-14; item 48 
of Form N-SAR; and sections 6-07.2(a), (b), and (c) of Regulations S-X.

SUMMARY OF APPLICATION: Applicants seek a conditional order permitting 
sub-advisers (the ``Managers'') approved by the Company's board of 
directors to serve as portfolio managers for the Company's series 
without obtaining shareholder approval of the agreements with the 
Managers, and permitting the Company to disclose only aggregate sub-
advisory fees for each series in its prospectuses and other reports.

FILING DATES: The application was filed on March 3, 1994, and amended 
on August 3, 1995, and October 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 
applicants with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on November 21, 
1995, and should be accompanied by proof of service on the applicants, 
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 may request 
notification of a hearing by writing to the SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 Fifth Street, NW., Washington, DC 20549. 
Applicants, 800 Nashville City Center, 511 Union Street, Nashville, 
Tennessee 37219-1743 (Attention: W. Howard Cammack, Jr.).

FOR FURTHER INFORMATION CONTACT:
Mary Kay Frech, Senior Attorney at (202) 942-0579, or Alison E. Baur, 
Branch Chief, 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 from 
the SEC's Public Reference Branch.

Applicants' Representations

    1. The Company is a registered open-end management investment 
company incorporated under Maryland law. The Company offers five 
separate investment portfolios (each a ``Fund,'' and together, the 
``Funds''), each with distinct investment objectives, policies, and 
restrictions. These Funds are: ESC Strategic Appreciation Fund, ESC 
Strategic Global Equity Fund, ESC Strategic Small Cap Fund, ESC 
Strategic Income Fund, and ESC Strategic Asset 

[[Page 55878]]
Preservation Fund.\1\ Shares of the Funds are offered to individuals, 
institutions, corporations, and fiduciaries.

    \1\Applicants also request relief with respect to any additional 
Fund organized in the future and for any open-end, management 
investment company advised by the Adviser, or a person controlling, 
controlled by or under common control with the Adviser, in the 
future, provided that such investment company operates in 
substantially the same manner as the Funds and complies with the 
conditions to the requested order (``Future Company'').
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    2. The Adviser is a registered investment adviser and broker-dealer 
that provides overall investment management for the Funds pursuant to 
an investment advisory agreement (``Investment Advisory Agreement'').
    3. The specific investment decisions for each Fund are made by one 
or more Managers, each of whom has discretionary authority to invest 
all or a portion of the assets of a particular Fund, subject to general 
supervision by the Adviser and the board of directors of the Company. 
Each Manager has been recommended by the Adviser, and selected and 
approved by the board of directors of the Company, including a majority 
of the Company's directors who are not interested persons of the 
Company, the Adviser, or the Manager, as well as by the initial sole 
shareholder of each Fund. Each Manager performs services pursuant to a 
written portfolio management agreement (``Portfolio Management 
Agreement''). Applicants currently do not anticipate that the number of 
Managers for any Fund will be reduced. The number of Managers may be 
increased, however, if the Company or one or more Funds experience a 
significant increase in total assets over time.
    4. One of the Managers, Equitable Asset Management (``EAM''), is an 
affiliated person (as defined in section 2(a)(3) of the Act) of the 
Adviser. EAM is one of three Managers of ESC Strategic Appreciation 
Fund, and is the sole Manager of ESC Strategic Small Cap Fund and ESC 
Strategic Asset Preservation Fund.
    5. The Adviser is responsible for recommending to the Company's 
board of directors the retention of one or more Managers for each Fund, 
for allocating and reallocating assets among Managers of Funds with 
multiple Managers, and for recommending the termination of a Manager 
when deemed advisable. The Adviser selects Managers based on the 
continuing quantitative and qualitative evaluation of their skills and 
proven abilities in managing assets pursuant to a specific investment 
style. The Adviser monitors continually the performance of Managers as 
well as management firm staffs and organizations to assess overall 
competence. For the advisory services the Adviser provides the Funds, 
each Fund pays an investment advisory fee to the Adviser. The Adviser, 
out of these fees, pays the Managers' fees at no additional cost to the 
Funds.
    6. For three of the Funds, the Adviser seeks to enhance performance 
and reduce market risk by allocating a Fund's assets among multiple 
``specialist'' Managers (the ``Multiple Manager Strategy''). Under this 
strategy, the Adviser allocates portions of a Fund's assets among 
multiple Managers with dissimilar investment styles and security 
selection disciplines. The Adviser monitors the performance of both the 
total Fund portfolio and of each Manager. The Adviser, to the extent it 
deems appropriate to achieve the overall objectives of the particular 
Fund, will reallocate Fund assets among individual Managers or 
recommend to the Company's board of directors that it employ or 
terminate particular Managers. As a result of this strategy, the 
Adviser believes the Funds with multiple Managers may achieve a better 
rate of return with lower volatility than typically would be expected 
of any one management style.
    7. Applicants request an order permitting the Company to enter into 
new or materially amended Portfolio Management Agreements with the 
Managers without obtaining shareholder approval. Without the requested 
relief, the Company would be prohibited from entering promptly into a 
new Portfolio Management Agreement or amending materially an existing 
Portfolio Management Agreement, and would be prohibited from continuing 
relations with an existing Manager whose contract has been assigned as 
a result of a change of control, unless the particular Fund involved 
were to incur the expense of convening a special shareholder meeting. 
Although shareholders will not vote on a new Manager or a materially 
amended Portfolio Management Agreement, applicants will furnish 
shareholders an information statement within sixty days that includes 
all the information that would have been provided in a proxy statement. 
Moreover, applicants will not enter into a Portfolio Management 
Agreement with any Manager that is an affiliated person (as defined in 
section 2(a)(3) of the Act) of the Company or the Adviser other than by 
reason of serving as a Manager to one or more of the Funds (an 
``Affiliated Manager'') without such agreements being approved by the 
shareholders of the applicable Fund. The Investment Advisory Agreement 
between the Adviser and the Fund would in all cases continue to be 
subject to the shareholder voting requirements of the Act.
    8. Applicants request an exemption from the various disclosure 
provisions that may require applicants or others to disclose the fees 
paid by the Adviser to individual Managers. Applicants propose to 
disclose (both as a dollar amount and as a percentage of a Fund's net 
assets) in the Funds' registration statements and other public 
documents only the aggregate amount of fees paid by the Adviser to the 
Managers of each Fund (``Limited Fee Disclosure''). Limited Fee 
Disclosure means: (a) Fees paid to the Adviser by each Fund, in dollar 
amount and as a percentage of each Fund's assets; (b) aggregate fees 
paid by the Adviser to Managers of each Fund; (c) net advisory fees 
retained by the Adviser with respect to each Fund after payment of 
Managers' fees; and (d) fees paid by a Fund to any Affiliated Manager.

Applicants' Legal Analysis

    1. Section 15(a) makes it unlawful for any person to act as an 
investment adviser to a registered investment company except pursuant 
to a written contract which precisely describes all compensation to be 
paid thereunder and which has been approved by a majority of the 
investment company's outstanding securities. Rule 18f-2 provides that 
each series or class of stock in a series company affected by a matter 
must approve such matter if the Act requires shareholder approval.
    2. Applicants state that the Company's structure is different from 
that of traditional investment companies. In addition to its Adviser/
Manager structure for all Funds, the Company offers the Multiple 
Manager strategy of portfolio management to investors with certain 
investment objectives. Applicants state that shareholders receive the 
benefit of the Adviser's constant supervision of these Managers, so 
that the proportion of their assets subject to particular Manager 
styles can be reallocated (or new Managers introduced) in response to 
changing market conditions or Manager performance, in an attempt to 
improve the Fund's overall performance.
    3. Applicants assert that, by investing in a Fund, investors are 
effectively electing to have the Adviser select one or more Managers 
best suited to achieve that Fund's investment objectives. Applicants 
argue that, because the Managers are concerned only with selection of 
portfolio investments in accordance with a Fund's investment objectives 
and policies, the role of the Managers is comparable to that of 
individual portfolio managers employed 

[[Page 55879]]
by other investment firms. Applicants contend, therefore, that it is 
the Adviser, not the Managers, on whom the Company's investors rely for 
investment management services.
    4. Applicants state that the Company's prospectuses and statements 
of additional information have continuously disclosed that applicants 
were seeking exemptive relief from the requirement for shareholders to 
approve the retention of new Managers. Applicants assert that, without 
exemptive relief, the Company would be required to call a shareholders 
meeting whenever it decides to employ new or additional Managers, or to 
approve a new Portfolio Management Agreement after an assignment or due 
to a material change in terms. Applicants argue that, given the nature 
of the Company's operations and investors' reasons for investing in the 
Funds, requiring shareholder approval of the Portfolio Management 
Agreements would merely increase the Funds' expenses and delay the 
prompt implementation of actions deemed advisable by the Adviser and 
the Company's board of directors.
    5. Form N-1A is the registration statement used by open-end 
management investment companies to register under the Act and register 
their securities under the Securities Act of 1933 (the ``Securities 
Act''). Items 2, 5(b)(iii), and 16(a)(iii) of Form N-1A require the 
Company to disclose in its prospectus the investment adviser's 
compensation and the method of computing the advisory fee.
    6. Item 3 of Form N-14, the registration form for business 
combinations involving mutual funds, requires the inclusion of a 
``table showing the current fees for the registrant and the company 
being acquired and pro forma fees, if different, for the registrant 
after giving effect to the transaction using the format prescribed'' in 
item 2 of Form N-1A.
    7. Rule 20a-1 under the Act requires proxies solicited with respect 
to an investment company to comply with Schedule 14A under the Exchange 
Act. Item 22 of Schedule 14A sets forth the requirements concerning the 
information that must be included in a proxy statement. Item 
22(a)(3)(iv) requires a proxy statement for a shareholder meeting at 
which a new fee will be established or an existing fee increased to 
include a table of the current and pro forma fees using the format 
prescribed in item 2 of Form N-1A. Items 22(c)(1)(ii), 22(c)(1)(ii), 
22(c)(8), and 22(c)(9), taken together, require that a proxy statement 
for a shareholder meeting at which an advisory contract is to be voted 
upon shall include the ``rate of compensation of the investment 
adviser,'' the ``aggregate amount of the investment adviser's fee,'' 
the ``terms of the contract to be acted upon,'' and, if a change in 
fees is proposed, the existing and proposed rate schedule for advisory 
fees paid to the advisers, including the Managers.
    8. Form N-SAR is the semi-annual report filed with the SEC by 
registered investment companies. Item 48 of Form N-SAR provides that 
the Funds must disclose the rate schedule for fees paid to their 
investment advisers, including the Managers.
    9. Regulation S-X sets forth the requirements for financial 
statements required to be included as part of the registration 
statements and shareholder reports filed with the SEC under the Act and 
under the Securities Act. Items 6-07(2) (a), (b), and (c) of Regulation 
S-X require that the Funds' financial statements contain information 
concerning fees paid to the Managers by the Adviser.
    10. Applicants state that all shareholders of the Funds will be 
fully advised of the fees charged by the Adviser for its investment 
advisory services because these fees will be disclosed in the Company's 
prospectuses and statements of additional information. Thus, each 
investor will know in advance the rate of investment advisory fees that 
each Fund will bear. Applicants argue that each investor, therefore, 
will be able to determine whether its cost for investment advisory 
services, including the selection and supervision of Managers and the 
reallocation of assets among multiple Managers from time to time, is 
competitive with the services and costs that the investor could obtain 
elsewhere. Under these circumstances, applicants assert that the 
particular fees of the Managers are not relevant to the investor.
    11. Applicants believe that it is desirable for the Adviser to have 
maximum flexibility in negotiating fees with Managers. Applicants argue 
that some organizations will be unwilling to serve as Managers at any 
fee rate other than their ``posted'' fee rates unless the rates 
negotiated for the Funds are not publicly disclosed. Therefore, to 
force disclosure of a Manager's fees would tend to deprive the Adviser 
of its bargaining power while producing no benefit to shareholders. 
Applicants assert that the Adviser's ability to secure the services of 
Managers for the Funds at rates lower than their posted rates benefits 
both the Funds and their shareholders. If the Adviser were to lose 
negotiating flexibility through forced disclosure of a Manager's fees, 
applicants state that the Adviser might be forced to seek an increase 
in its own fees or to back off from its expense cap commitment. 
Further, they argue that opportunities for future reductions as Fund 
assets increase might be diminished. Thus, applicants believe that 
forced disclosure of Managers' fees could have negative repercussions 
for the Funds' shareholders.
    12. Section 6(c) authorizes the Commission to exempt persons or 
transactions from the provisions of the Act to the extent that such 
exemptions are appropriate in the public interest and consistent with 
the protection of investors and the purposes fairly intended by the 
policies and provisions of the Act. Applicants assert that their 
request satisfies these standards.

Applicants' Conditions

    Applicants agree that the following conditions may be imposed in 
any order of the Commission granting the requested relief:
    1. The Company will disclose in its registration statement the 
Limited Fee Disclosure.
    2. The Adviser will not enter into a Portfolio Management Agreement 
with any Affiliated Manager without such agreement, including the 
compensation to be paid thereunder, being approved by the shareholders 
of the applicable Fund.
    3. At all times, a majority of the Company's directors will be 
persons each of whom is not an ``interested person'' of the Company as 
defined in section 2(a)(19) of the Act (``Independent Directors''), and 
the nomination of new or additional Independent Directors will be 
placed with the discretion of the then existing Independent Directors.
    4. Independent counsel knowledgeable about the Act and the duties 
of Independent Directors will be engaged to represent the Independent 
Directors of the Company. The selection of such counsel will be placed 
within the discretion of the then existing Independent Directors.
    5. The Adviser will provide the board of directors of the Company, 
no less frequently than quarterly, information about the Adviser's 
profitability on a per-Fund basis. Such information will reflect the 
impact on profitability of the hiring or termination of any Managers 
during the applicable quarter.
    6. Whenever a Manager is hired or terminated, the Adviser will 
provide the board of directors of the Company information showing the 
expected impact on the Adviser's profitability.

[[Page 55880]]

    7. When a Manager change is proposed for a fund with a Affiliated 
Manager, the Company's directors, including a majority of the 
Independent Directors, will make a separate finding, reflected in the 
Company's board minutes, that such change is in the best interests of 
the Fund and its shareholders and does not involve a conflict of 
interest from which the Adviser or the Affiliated Manager derives an 
inappropriate advantage.
    8. The Adviser will provide general management services to the 
Company and the Funds and, subject to review and approval by the 
Company's board of directors will: (a) set the Funds' overall 
investment strategies; (b) select Managers; (c) allocate and, when 
appropriate, reallocate a Fund's assets among Managers; (d) monitor and 
evaluate the performance of Managers; and (e) ensure that the Managers 
comply with the Funds; investment objectives, policies, and 
restrictions.
    9. Within 60 days of the hiring of any new Manager or the 
implementation of any proposed material change in a Portfolio 
Management Agreement, shareholders will be furnished all information 
about a new Manager or Portfolio Management Agreement that would be 
included in a proxy statement, except as modified by the order to 
permit Limited Fee Disclosure. Such information will include Limited 
Fee Disclosure and any change in such disclosure caused by the addition 
of a new Manager or any proposed material change in a Portfolio 
Management Agreement. The Adviser will meet this condition by providing 
shareholders, within 60 days of the hiring of a Manager or the 
implementation of any material change to the terms of a Portfolio 
Management Agreement, with an information statement meeting the 
requirements of Regulation 14C and Schedule 14C under the Exchange Act. 
The information statement will also meet the requirements of Schedule 
14A, except as modified by the order to permit Limited Fee Disclosure.
    10. The Company will disclosure in its prospectuses the existence, 
substance, and effect of any other granted pursuant to the application.
    11. Before a Future Company that does not presently have an 
effective registration statement may rely on the order, its initial 
shareholder will approve the Adviser/Manager structure before such 
Future Company offers its shares to the public.
    12. No director or officer of the Company or the Adviser will own 
directly or indirectly (other than through a pooled investment vehicle 
that is not controlled by any such director or officer) any interest in 
a Manager except for: (a) ownership of interests in the Adviser or any 
entity that controls, is controlled by, or is under common control with 
the Adviser; or (b) ownership of less than 1% of the outstanding 
securities of any class of equity or debt to a publicly-traded company 
that is either a Manager or an entity that controls, is controlled by, 
or is under common control with a Manager.

    For the SEC, by the Division of Investment Management, under 
delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-27316 Filed 11-2-95; 8:45 am]
BILLING CODE 8010-01-M