[Federal Register Volume 60, Number 218 (Monday, November 13, 1995)]
[Notices]
[Pages 57046-57049]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-27885]



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SECURITIES AND EXCHANGE COMMISSION
[Investment Company Act Release No. 21470; 812-9532]


The Vanguard Group, Inc., et al.; Notice of Application

November 3, 1995.
AGENCY: Securities and Exchange Commission (``SEC'').

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

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APPLICANTS: The Vanguard Group, Inc. (``TVGI''); and Vanguard Balanced 
Index Fund, Inc., Vanguard Index Trust, Vanguard International Equity 
Index Fund, Inc., Vanguard Bond Index Fund, Inc., Vanguard 
Institutional Index Fund, Vanguard Institutional Portfolios, Inc., 
Vanguard California Tax-Free Fund, Vanguard New York Insured Tax-Free 
Fund, Vanguard Pennsylvania Tax-Free Fund, Vanguard Fixed Income 
Securities Fund, Inc., Vanguard Preferred Stock Fund, Vanguard Asset 
Allocation Fund, Inc., Vanguard/Trustees' Equity Fund, Vanguard/Windsor 
Funds, Inc., Vanguard Tax-Managed Fund, Inc., Vanguard Florida Insured 
Tax-Free Fund, Inc., Vanguard/Primecap Fund, Inc., Vanguard/Morgan 
Growth Fund, Inc., Vanguard Variable Insurance Fund, Vanguard Money 
Market Reserves, Inc., Vanguard Municipal Bond Fund, Inc., Vanguard New 
Jersey Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard/Wellesley 
Income Fund, Inc., Vanguard Convertible Securities Fund, Inc., 
Vanguard/Wellington Fund, Inc., Vanguard Equity Income Fund, Inc., 
Vanguard Quantitative Portfolios, Inc., Vanguard World Fund, Inc., 
Vanguard Explorer Fund, Inc., Vanguard Specialized Portfolios, Inc., 
Vanguard Admiral Funds, Inc., Gemini II, Inc. and any future registered 
open-end management investment company, or portfolio thereof, in which 
a Fund of Index Funds (as defined below) invests that (a) is part of a 
group of investment companies which holds itself out to investors as 
related companies for purposes of investment and investor services, and 
(b) obtains corporate management, administrative, and distribution 
services from TVGI.

RELEVANT ACT SECTIONS: Order of exemption requested pursuant to section 
6(c) of the Act from section 12(d)(1) of the Act, pursuant to sections 
6(c) and 17(b) of the Act from section 17(a) of the Act, and pursuant 
to rule 17d-1 under the Act permitting certain joint transactions in 
accordance with section 17(d) of the Act and rule 17d-1 thereunder.

SUMMARY OF APPLICATION: The requested order would permit applicants to 
create a ``fund of index funds'' that would invest according to 
specified ratios or weightings in shares of two or more Vanguard index 
funds without regard to the percentage limitations of section 12(d)(1) 
(``Fund of Index Funds''). The requested order also would permit the 
boards of trustees/directors of the funds constituting the Vanguard 
Group of Investment Companies to modify the funds' service agreement to 
provide that a Fund of Index Funds may become a member of The Vanguard 
Group of Investment Companies without bearing duplicative capital 
contribution or expense allocation costs.

FILING DATE: The application was filed on March 16, 1995, and amended 
on November 1, 1995.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be 

[[Page 57047]]
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 28, 1995, and should be 
accompanied by proof of service on 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, c/o The Vanguard Group, Inc., P.O. Box 2600, Valley Forge, 
Pennsylvania 19482.

FOR FURTHER INFORMATION CONTACT:
Sarah A. Buescher, Staff Attorney, at (202) 942-0573, or C. David 
Messman, 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 Vanguard Funds are 32 registered management investment 
companies that currently offer shares in 86 portfolios (the 
``Portfolios''). The Vanguard Funds organized and operate TVGI, 
pursuant to the terms of a Second Amended and Restated Funds' Service 
Agreement dated May 15, 1993 (the ``Funds' Service Agreement'') in 
order to provide the Funds with services on an ``internalized,'' at-
cost, no-load basis.\1\ Each Fund is organized as a business trust 
under Pennsylvania law, or as a Maryland corporation. Each Fund is 
registered as an open-end management investment company, except for 
Gemini II, Inc., which is registered as a closed-end company. Each Fund 
has a board of directors/trustees (the ``Board of Directors'') that 
consists of the same ten persons, eight of whom are not ``interested 
persons'' of the Fund under section 2(a)(19) of the Act. Nine of the 
directors compose the board of directors of TVGI. The Funds that are 
party to the Funds' Service Agreement constitute The Vanguard Group of 
Investment Companies (``The Vanguard Group''). Vanguard Institutional 
Index Fund is a registered management investment company that receives 
services from the Vanguard Group, Inc., but is not a member of The 
Vanguard Group.

    \1\ The Funds operate TVGI pursuant to a number of exemptive 
orders. The Vanguard Group, Inc., Investment Company Act Release 
Nos. 19011 (Oct. 9, 1992) (notice) and 19184 (Dec. 29, 1992) 
(order); Wellington Fund, Inc., Investment Company Act Release Nos. 
15788 (June 9, 1987) (notice) and 15846 (July 2, 1987) (order); 
Wellington Fund, Inc., Investment Company Act Release Nos. 13566 
(Oct. 5, 1983) (notice) and 13613 (Nov. 3, 1983) (order); The 
Vanguard Group, Inc., Investment Company Act Release Nos. 11718 
(Apr. 6, 1981) (notice) and 11761 (May 4, 1981) (order); The 
Vanguard Group, Inc., Investment Company Act Release Nos. 9850 (July 
15, 1977) (notice), and 9927 (Sept. 13, 1977) (temporary order) and 
11645 (Feb. 25, 1981) (order); Wellington Fund, Inc., Investment 
Company Act Release Nos. 8644 (Jan. 17, 1975) and 8676 (Feb. 18, 
1975) (order).
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    2. Within the Vanguard Funds are the following index funds: 
Vanguard Balanced Index Fund, Inc., Vanguard Index Trust, Vanguard 
International Equity Index Fund, Inc., Vanguard Bond Index Fund, Inc. 
(collectively, with the Vanguard Institutional Index Fund, the ``Index 
Funds''). The Index Funds currently offer shares in 15 separate 
portfolios (``Index Portfolios''). Except for Vanguard Balanced Index 
Fund, each Index Portfolio seeks to provide investment results that 
correspond to the results of a particular securities index (or 
benchmark) by investing its assets in the same proportion as the 
securities represented in the index (or a representative sampling 
thereof). Vanguard Balanced Index Fund seeks to provide investment 
results that correspond to the results of a 60%/40% weighting of two 
indices, the Wilshire 5000 Index and the Lehman Brothers Aggregate Bond 
Index.
    3. As a matter of fundamental policy, the Index Portfolios invest 
all of their investable assets in securities selected to replicate the 
composition of a specified securities index or benchmark. In addition, 
the Index Portfolios invest solely in liquid, readily marketable 
securities. Several Index Portfolios impose purchase charges that are 
designed to allocate transaction costs associated with new purchases to 
investors making the purchases. The Emerging Markets Portfolio is the 
only Index Portfolio that charges a redemption fee.
    4. Vanguard seeks to create a Fund of Index Funds. The initial 
portfolio of the Fund of Index Funds would be an ``International Index 
Portfolio,'' which would replicate the Morgan Stanley Capital 
International Europe, Australia and Far East Index (``EAFE''). Vanguard 
intends to create this International Index Portfolio by combining two 
existing Index Portfolios, the European Portfolio and the Pacific 
Portfolio, rather than creating a separate investment company or 
portfolio to invest in securities directly. By combining existing Index 
Portfolios, Vanguard seeks to avoid higher start-up and ongoing costs, 
and tracking errors.
    5. Applicants request that the relief sought herein apply to any 
future Fund of Index Funds, whether organized as an open-end investment 
company or as a portfolio thereof, which operates in all material 
respects in accordance with the representations contained in the 
application, complies with the conditions to the requested order, and 
is a Vanguard Fund or is operated by TVGI.
    6. TVGI, a registered investment adviser under the Investment 
Advisers Act of 1940, is a wholly and jointly owned and capitalized 
subsidiary of the Vanguard Funds. TVGI provides to the Vanguard Funds 
on an at-cost basis almost all of their necessary corporate management, 
administrative, and shareholder accounting services, distribution 
services, and, for certain Portfolios, advisory services. TVGI also 
provides specified services to two funds, Vanguard STAR Fund and 
Vanguard Institutional Index Fund, that do not contribute to the 
capital of TVGI.
    7. Under current provisions of the Funds' Service Agreement, a Fund 
of Index Funds, if structured as a separate investment company, could 
not become a member of The Vanguard Group without making a capital 
investment in TVGI, and being allocated a portion of TVGI's corporate 
management and distribution expenses, even though Fund of Index Funds 
shareholders would bear a portion of these expenses through the fees 
they pay with respect to the Index Portfolios. The Boards of Directors 
of the Funds propose to amend the Funds' Service Agreement to permit a 
Fund of Index Funds, whether structured as a separate investment 
company or as a portfolio of a Vanguard Fund, to become a member of The 
Vanguard Group.
    8. The amendment to the Funds' Service Agreement would provide, in 
substance, that: (a) The obligation of a Fund of Index Funds to make 
capital contributions to TVGI would be reduced or eliminated to the 
extent that its assets consist of shares of an Index Portfolio that is 
already contributing to the capital of TVGI; (b) a Fund of Index Funds 
would not be allocated any portion of the corporate management and 
administrative expenses, or the distribution expenses, that are 
allocated under the Funds' Service Agreement; and (c) a Fund of Index 
Funds would be obligated to pay for services rendered by outside 
parties and certain other direct Fund of Index Funds expenses 
customarily borne by each Fund pursuant to the Funds' Service 

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Agreement, subject to the partial or complete elimination of these 
charges by the savings which would accrue to the benefit of the Index 
Portfolios.

Applicants' Legal Analysis

A. Section 12(d)(1)

    1. Section 12(d)(1)(A) provides that no registered investment 
company may acquire securities of another investment company if such 
securities represent more than 3% of the acquired company's outstanding 
voting stock, more than 5% of the acquiring company's total assets, or 
if such securities, together with the securities of any other acquired 
investment companies, represent more than 10% of the acquiring 
company's total assets. Section 12(d)(1)(B) provides that no registered 
open-end investment company may sell its securities to another 
investment company if the sale will cause the acquiring company to own 
more than 3% of the acquired company's voting stock, or if the sale 
will cause more than 10% of the acquired company's voting stock to be 
owned by investment companies.
    2. Section 6(c) provides that the SEC may exempt persons or 
transactions 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. Applicants request an order under section 6(c) 
exempting them from section 12(d)(1) to permit any Fund of Index Funds 
to invest in the Index Portfolios in excess of the percentage 
limitations of section 12(d)(1).
    3. Section 12(d)(1) was intended to mitigate or eliminate actual or 
potential abuses that might arise when one investment company acquires 
shares of another investment company. These abuses include the 
acquiring fund imposing undue influence over the management of the 
acquired funds through the threat of large-scale redemptions, the 
acquisition by the acquiring company of voting control of the acquired 
company, the layering of sales charges, advisory fees, and 
administrative costs, and the creation of a complex pyramidal structure 
that may be confusing to investors.
    4. Applicants believe that none of these potential abuses would be 
present in the structure of a Fund of Index Funds. A Fund of Index 
Funds would not exercise any influence over the management of the 
acquired Index Portfolios by the threat of redemptions. A Fund of Index 
Funds would invest its assets solely to establish and maintain 
specified ratios or weightings of Index Portfolios. Unless a Fund of 
Index Funds would cease using one Index Portfolio and begin using 
another, the Fund of Index Funds would have no investment management 
authority to select which Index Portfolios to purchase or redeem, and 
would not hold itself out as doing so. Redemptions from the acquired 
Index Portfolios would result solely in the ordinary course of business 
as a result of a Fund of Index Fund's receipt of net redemption 
requests from its shareholders. The acquired Index Portfolios, as a 
matter of policy and practice, are at all times fully invested in 
liquid, publicly traded securities. Thus, they would have no reason to 
hold a cash position to protect their other shareholders against 
potential redemptions by a Fund of Index Funds.
    5. The structure of a Fund of Index Funds would contain no improper 
layering of sales charges or advisory fees. Neither a Fund of Index 
Funds nor the Index Portfolios currently intend to impose any sales 
charges or fees pursuant to rule 12b-1. Applicants currently do not 
intend to charge an advisory fee at the Fund of Index Funds level with 
respect to assets invested in the Index Portfolios. Similarly, 
virtually all administrative fees would be imposed at the Index 
Portfolio level, and shareholders of a Fund of Index Funds would bear a 
portion of these fees only in proportion to their holdings of the Index 
Portfolios.
    6. A Fund of Index Funds would not have a complex structure that 
would make it difficult for a shareholder to determine the true value 
of his or her interest in the Fund of Index Funds. The Fund of Index 
Funds would seek to replicate specified indices by investing in shares 
of Index Portfolios that hold securities replicating the indices, 
rather than by direct investments in these securities.
    7. In addition to not containing the actual and potential abuses 
which led to the enactment of section 12(d)(1), applicants believe that 
the structure of a Fund of Index Funds would provide a number of 
benefits to a Fund of Index Funds and its shareholders, including: (a) 
The opportunity to obtain through a single investment account a 
diversified investment program suitable for retirement or long-term 
savings; (b) a simpler method for an investor to allocate his or her 
assets on a continuous basis without, at a minimum, the inconvenience 
of initiating the steps periodically to ``rebalance'' his or her 
portfolio; (c) a modest reduction in the investor's account maintenance 
costs, because an investor would not need to maintain two or more 
accounts to attain a desired allocation; and (d) the lower expense 
ratios and increased diversification which result from a new Fund of 
Index Fund's ability to take advantage of the existing asset base 
created by the acquired Index Portfolios.
    8. The acquired Index Portfolios benefit from the existence of a 
Fund of Index Funds in three major respects: (a) The likely addition of 
assets from a Fund of Index Funds would reduce the expense ratios of 
the Index Portfolios; (b) to the extent many shareholders of a Fund of 
Index Funds would otherwise open accounts with each of the Index 
Portfolios, the number of accounts maintained by the Index Portfolios 
in the aggregate, and the resulting transfer agency fees, would be 
reduced; and (c) the costs of printing and mailing prospectuses, sales 
material, and periodic reports would be reduced because The Vanguard 
Group can combine information concerning two or more funds in a single 
document. All of the Vanguard Funds are also likely to benefit from the 
existence of a Fund of Index Funds since increased distribution and the 
resulting addition of assets to The Vanguard Group produces cost 
savings and other benefits for all Funds even if they are not the 
acquired Funds.

B. Section 17(a)

    1. Section 17(a) makes it unlawful for an affiliated person of a 
registered investment company to sell securities to, or purchase 
securities from, the company. A Fund of Index Funds and the acquired 
Index Portfolios may be considered affiliated persons because they 
share common officers and/or directors/trustees. An acquired Index 
Portfolio's issuance of its shares to a Fund of Index Funds may be 
considered a sale prohibited by section 17(a).
    2. Section 17(b) provides that the SEC shall exempt a proposed 
transaction from section 17(a) if evidence establishes that: (a) The 
terms of the proposed transaction are reasonable and fair and do not 
involve overreaching; (b) the proposed transaction is consistent with 
the policies of the registered investment company involved; and (c) the 
proposed transaction is consistent with the general provisions of the 
Act. Applicants request an exemption under sections 6(c) and 17(b) to 
permit the Index Portfolios to sell their shares to a Fund of Index 
Funds.\2\

    \2\ Section 17(b) applies to specific proposed transactions and 
not to an ongoing series of future transactions. See Keystone 
Custodian Funds, 21 S.E.C. 295, 298-299 (1945). Section 6(c) can be 
used to grant relief from section 17(a) for an ongoing series of 
future transactions.

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    3. Applicants believe that the proposed transactions meet the 
standards of sections 6(c) and 17(b). All purchases and redemptions of 
shares of an Index Portfolio would be effected at current net asset 
value. A Fund of Index Fund's purchase and sale of shares of the Index 
Portfolios is consistent with the Fund of Index Funds' policy, as set 
forth in its registration statement. Applicants also believe that the 
proposed transactions are consistent with the general purposes of the 
Act.

C. Section 17(d) and Rule 17d-1

    1. Section 17(d) prohibits an affiliated person of a registered 
investment company, or an affiliated person of such person, acting as 
principal, from effecting any transaction in which such investment 
company is a joint, or joint and several, participant with such person 
in contravention of SEC rules and regulations. Rule 17d-1 provides that 
an affiliated person of a registered investment company or an 
affiliated person of such person, acting as principal, shall not 
participate in, or effect any transaction in connection with, any joint 
enterprise or other joint arrangement in which the registered 
investment company is a participant unless the SEC has issued an order 
approving the arrangement. The Vanguard Funds and TVGI are engaged in a 
joint enterprise within the meaning of section 17(d).
    2. Applicants request an order under section 17(d) and rule 17d-1 
to permit the Boards of Directors of the Vanguard Funds to modify the 
Funds' Service Agreement. Applicants believe that, for the reasons 
discussed above, the proposed amendments to the Funds' Service 
Agreement are consistent with the standards of rule 17d-1. Requiring a 
Fund of Index Funds to make an asset-related capital contribution to 
TVGI, when the assets of the Fund of Index Funds will already be 
bearing a capital assessment indirectly at the Index Portfolio level, 
would unfairly impose duplicative expenses upon the shareholders of the 
Fund of Index Funds, and confer an unjustified benefit on the acquired 
Index Portfolios, as well as the other Vanguard Funds, which will be 
deriving other benefits from the Fund of Index Funds' participation in 
TVGI.

Applicants' Conditions

    Applicants agree that the order granting the requested relief shall 
be subject to the following conditions:
    1. The Fund of Index Funds and each underlying Index Portfolio will 
be part of a group of investment companies which holds itself out to 
investors as related companies for purposes of investment and investor 
services, and which obtains corporate management, administrative, and 
distribution services from TVGI.
    2. No underlying Index Portfolio shall acquire securities of any 
other investment company in excess of the limits contained in section 
12(d)(1)(A) of the Act.
    3. A majority of the directors of the Fund of Index Funds will not 
be ``interested persons,'' as defined in section 2(a)(19) of the Act.
    4. Before approving any advisory contract under section 15 of the 
Act, the board of directors of the Fund of Index Funds, including a 
majority of the directors who are not ``interested persons,'' as 
defined in section 2(a)(19), shall find that advisory fees charged 
under such contract are based on services provided that are in addition 
to, rather than duplicative of, services provided pursuant to any 
underlying Index Portfolio's advisory contract. Such finding, and the 
basis upon which the finding was made, will be recorded fully in the 
minute books of the Fund of Index Funds.
    5. Any sales charges or service fees charged with respect to 
securities of the Fund of Index Funds, when aggregated with any sales 
charges or service fees paid by the Fund of Index Funds with respect to 
shares of the underlying Index Portfolios, shall not exceed the limits 
set forth in Article III, section 26, of the Rules of Fair Practice of 
the National Association of Securities Dealers, Inc.
    6. The applicants agree to provide the following information, in 
electronic format, to the Chief Financial Analyst of the SEC's Division 
of Investment Management: monthly average total assets for each Fund of 
Index Funds portfolio and each of its underlying Index Portfolios; 
monthly purchases and redemptions (other than by exchange) for each 
Fund of Index Funds portfolio and each of its underlying Index 
Portfolios; monthly exchanges into and out of each Fund of Index Funds 
Portfolio and each of its underlying Index Portfolios; month-end 
allocations of each Fund of Index Funds portfolio's assets among its 
underlying Index Portfolios; annual expense ratios for each Fund of 
Index Funds portfolio and each of its underlying Index Portfolios; and 
a description of any vote taken by the shareholders of any underlying 
Index Portfolio, including a statement of the percentage of votes cast 
for and against the proposal by the Fund of Index Funds and by the 
other shareholders of the underlying Index Portfolios. Such information 
will be provided as soon as reasonably practicable following each 
fiscal year-end of the Fund of Index Funds (unless the Chief Financial 
Analyst shall notify applicants in writing that such information need 
no longer be submitted).

    For the Commission, by the Division of Investment Management, 
pursuant to delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-27885 Filed 11-9-95; 8:45 am]
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