[Federal Register Volume 61, Number 60 (Wednesday, March 27, 1996)]
[Proposed Rules]
[Pages 13630-13639]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-7335]
[[Page 13629]]
_______________________________________________________________________
Part VI
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Part 270
Exemption for the Acquisition of Securities During the Existence of an
Underwriting Syndicate; Proposed Rule
Federal Register / Vol. 61, No. 60 / Wednesday, March 27, 1996 /
Proposed Rules
[[Page 13630]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 270
[Release No. IC-21838, File No. S7-7-96]
RIN 3235-AG61
Exemption for the Acquisition of Securities During the Existence
of an Underwriting Syndicate
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Commission is proposing amendments to the rule under the
Investment Company Act of 1940 that permits investment companies that
are affiliated with members of underwriting syndicates to purchase
securities underwritten by these syndicates if certain conditions are
met. The proposed amendments are designed to make the rule more
flexible by, among other things, increasing the percentage of an
underwriting that an investment company may purchase in reliance on the
rule and expanding the scope of the rule to include foreign securities.
The proposed amendments, and a proposed new companion rule, also would
permit investment companies to acquire municipal securities from
underwriting syndicates in ``group sales.'' The proposed amendments
respond to changes in the investment company and underwriting
industries that have occurred since the rule last was substantively
amended in 1979.
DATES: Comments must be received on or before June 3, 1996.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Stop 6-9, Washington, DC 20549. Comments also may be submitted
electronically at the following E-mail address: [email protected].
All comment letters should refer to File No. S7-7-96; this file number
should be included on the subject line if E-mail is used. Comment
letters will be available for public inspection and copying in the
Commission's Public Reference Room, 450 Fifth Street, NW., Washington,
DC 20549. Electronically submitted comment letters will be posted on
the Commission's Internet web site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: David M. Goldenberg, Senior Counsel,
or Kenneth J. Berman, Assistant Director, at (202) 942-0690, Office of
Regulatory Policy, Division of Investment Management, Stop 10-6, 450
Fifth Street, NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission today is requesting public
comment on proposed amendments to rule 10f-3 (17 CFR 270.10f-3) and a
proposed new rule, rule 17a-10 (17 CFR 270.17a-10), under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) (the
``Investment Company Act'').
Table of Contents
Executive Summary
I. Background
A. Introduction
B. Rule 10f-3
C. Need for Amendments
II. Discussion
A. Quantity Limitations
1. Amount Purchased
2. Percentage of Fund Assets
3. Request for Comment on Quantity Limitations
B. Purchases of Foreign Securities
1. Eligible Foreign Offering
a. General
b. Disclosure
c. Offering Price
2. Foreign Issuer Rule 144A Offerings
3. General Request for Comment
C. Group Sales
D. Reporting and Recordkeeping
III. General Request for Comments
IV. Cost/Benefit Analysis
V. Paperwork Reduction Act
VI. Summary of Regulatory Flexibility Analysis
VII. Statutory Authority
Text of Proposed Rule and Form Amendments
Executive Summary
Section 10(f) of the Investment Company Act was designed to address
the practice prior to 1940 by some securities underwriters
(``underwriters'') of ``dumping'' unmarketable securities on their
affiliated investment companies (``funds''). The section prohibits a
fund from purchasing securities for which an underwriter having certain
relationships with the fund (``affiliated underwriter'') is acting as a
principal underwriter during the existence of an underwriting or
selling syndicate. Rule 10f-3 under the Investment Company Act permits
funds to purchase securities during the existence of an underwriting
syndicate under specified conditions designed to assure that the
purchase is consistent with the protection of fund investors. These
conditions include requirements that (i) the purchased securities be
either registered under the Securities Act of 1933 (``Securities Act'')
or municipal securities, (ii) the fund (along with other funds advised
by the same investment adviser) purchase no more than the greater of
four percent of the underwritten securities, or $500,000, but in no
case more than 10% of the offering (the ``percentage limit''), (iii)
the fund use no more than three percent of its assets to purchase
securities in a transaction subject to the rule, and (iv) the fund not
purchase the securities from the affiliated underwriter. The last
condition also prohibits a fund from purchasing municipal securities in
a ``group sale,'' which is a sale for which all members of a syndicate
receive credit in proportion to their respective underwriting
commitments.
The Commission believes that the conditions of rule 10f-3 should be
reevaluated in light of changes in the fund and financial services
industries since the principal provisions of rule 10f-3 were last
amended in 1979 and is proposing amendments to the rule that reflect
these changes. The proposed amendments are intended to provide funds
with additional flexibility, consistent with the policies underlying
section 10(f), to make investments that may be in the best interests of
investors.
The proposed amendments would raise the percentage limit to the
greater of 10% of an offering or $1,000,000 (but not to exceed 15% of
the offering). The proposed amendments also would eliminate the current
limit on the amount of a fund's assets that may be used to make
purchases pursuant to the rule and the current requirement that funds
report rule 10f-3 transactions in their semi-annual reports filed with
the Commission on Form N-SAR.
In recognition of the increase in the extent to which funds invest
in foreign securities, the proposed amendments would expand rule 10f-3
to permit funds to purchase securities of foreign issuers (``foreign
securities'') that are not registered under the Securities Act, subject
to certain conditions. These conditions are designed to permit funds to
purchase foreign securities in transactions having certain
characteristics similar to public offerings in the United States, such
as disclosure of specified information and a single public offering
price.
The proposed amendments would permit funds to purchase municipal
securities in group sales, subject to certain conditions designed to
protect against overreaching by fund affiliates. Purchases of
securities in group sales would be permitted, for example, only when
the underwriting syndicate has established that group sales would have
priority over other types of sales.
I. Background
A. Introduction
A central theme underlying the regulation of investment companies
is the concern that fund affiliates could
[[Page 13631]]
use fund assets for their own purposes, to the detriment of fund
shareholders. One of the major abuses noted in the period preceding the
Investment Company Act was the use of funds by underwriters that
controlled these funds as a ``dumping ground'' for unmarketable
securities.1 An underwriter could, for example, ``dump''
unmarketable securities on its controlled fund, either by causing the
fund to purchase the securities from the underwriter itself, or by
encouraging the fund to purchase securities from another member of the
underwriting syndicate. Fund assets also could be used to absorb the
risks of an underwriting in more subtle ways, such as to facilitate
price stabilization in connection with an underwriting.2
\1\ See Investment Trusts and Investment Companies: Hearings on
S. 3580 Before a Subcomm. of the Senate Comm. on Banking and
Currency, 76th Cong., 3d Sess. 35 (1940) (statement of Commissioner
Healy).
\2\ In its study of the fund industry prior to 1940, the
Commission gave specific examples of cases in which underwriters had
used the assets of their affiliated funds to benefit the
underwriters or to save them from insolvency. See generally SEC,
Investment Trusts and Investment Companies, H.R. Doc. No. 279, 76th
Cong., 1st Sess., pt. 3, at 2519-2624 (1939). The Commission
explained:
The control of an investment company by an investment banker
naturally impresses the client, who desires to be financed, with the
resources that the investment banker may call upon to make the
financing operation successful, such as, selling some of the
securities to the investment company, securing the company's
participation in the underwriting commitment, including the company
in trading accounts or using the company's funds in stabilizing the
market.
Id. at 2535-36.
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Section 10(f) of the Investment Company Act was designed to address
these concerns.3 The section prohibits a fund from purchasing
securities for which an affiliated underwriter is acting as a principal
underwriter during the existence of an underwriting or selling
syndicate.4 Recognizing that section 10(f), by prohibiting all
purchases by funds affiliated with members of an underwriting syndicate
during the existence of the syndicate, could be overly broad, Congress
gave the Commission specific authority to exempt persons from that
section by order or rule when the exemption is consistent with the
protection of investors.5
\3\ See 2 T. Frankel, The Regulation of Money Managers 555
(1978) (``The purpose of [section 10(f)] is to protect investment
companies from purchasing securities to advance the interests of
their affiliates rather than their own.''). Even in the absence of
section 10(f), a fund effectively would be prohibited by section
17(a) of the Investment Company Act from purchasing securities
directly from its affiliated underwriter or from an affiliate of its
affiliate. See 15 U.S.C. 80a-17(a). That section 10(f) prevents a
fund from acquiring securities from an unaffiliated member of the
underwriting syndicate would seem to reflect the view that the
affiliated underwriter has the potential to pressure the fund into
acquiring the securities through another underwriter in order to
facilitate the underwriting. If each member of a syndicate has
proportionate liability for securities remaining unsold, as is
frequently the case in many municipal securities syndicates, for
example, the successful sale of all of the securities, regardless of
from which member of the syndicate the securities are purchased,
benefits all members of the syndicate, including the affiliated
underwriter.
\4\ ``Principal Underwriter'' is defined in section 2(a)(29) of
the Investment Company Act, 15 U.S.C. 80a-2(a)(29), to mean (in
relevant part) an underwriter who, in connection with a primary
distribution of securities, (A) is in privity of contract with the
issuer or an affiliated person of the issuer, (B) acting alone or in
concert with one or more other persons, initiates or directs the
formation of an underwriting syndicate, or (C) is allowed a rate of
gross commission, spread, or other profit greater than the rate
allowed another underwriter participating in the distribution.
\5\ Section 10(f) prohibits a fund from purchasing a security
during the existence of an underwriting or selling syndicate if a
principal underwriter of the security is an officer, director,
member of an advisory board, investment adviser, or employee of the
fund, or is a person of which any such officer, director, member of
an advisory board, investment adviser, or employee is an affiliated
person. For purposes of this release, a person that falls within one
of these categories is referred to as an ``affiliated underwriter,''
and the syndicate of which such person is a member is referred to as
an ``affiliated underwriting syndicate.'' Funds that are subject to
section 10(f) because an affiliated underwriter is a member of a
syndicate are referred to as ``affiliated funds.''
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B. Rule 10f-3
In 1958, the Commission used its exemptive authority under section
10(f) to adopt rule 10f-3.6 The rule permits a fund to purchase
securities in a transaction that otherwise would violate section 10(f)
if, among other things (i) the securities are either registered under
the Securities Act or municipal securities, (ii) the offering involves
a ``firm commitment'' underwriting,7 (iii) the fund and all other
funds advised by the same investment adviser do not in the aggregate
purchase more than the greater of 4% of the principal amount of the
securities being offered or $500,000 (but in no event greater than 10%
of the offering), (iv) the fund does not use more than 3% of its assets
to purchase the securities, (v) the fund purchases the securities from
a member of the syndicate other than the affiliated underwriter, (vi)
the fund purchases the securities at a price not more than the public
offering price prior to the end of the first full business day after
the first date on which the securities are offered, and (vii) the
fund's directors have adopted procedures for purchases made in reliance
on the rule and regularly review fund purchases to determine whether
they comply with these procedures.8 The conditions of rule 10f-3
are designed to ensure that a purchase by a fund from a syndicate in
which an affiliated underwriter is participating is consistent with the
protection of fund investors.
\6\ See Adoption of Rule N-10F-3 Permitting Acquisition of
Securities of Underwriting Syndicate Pursuant to Section 10(f) of
the Investment Company Act of 1940, Investment Company Act Release
No. 2797 (Dec. 2, 1958), 23 FR 9548 (hereinafter ``1958 Adopting
Release''). The rule codified the conditions of orders that the
Commission had granted prior to 1958 exempting certain funds from
section 10(f) to permit them to purchase specific securities. See,
e.g., The Chicago Corporation, Release No. 40-107 (Apr. 8, 1941);
The Pennroad Corporation, Investment Company Act Release No. 1636
(Aug. 10, 1951).
The Commission amended rule 10f-3 in 1979 to permit its use for
the purchase of municipal securities, in 1985 to reflect changes in
the periodic reporting requirements for all funds, and again in 1993
to remove a requirement that fund boards annually review procedures
adopted pursuant to the rule. See Exemption of Acquisition of
Securities During the Existence of Underwriting Syndicate,
Investment Company Act Release No. 10736 (June 14, 1979), 44 FR
36152 (hereinafter ``1979 Adopting Release''); Withdrawal of
Quarterly Reporting Forms and Filing Obligation of Certain
Registered Investment Companies, Securities Act Release No. 6591
(July 1, 1985), 50 FR 29368; Revision of Certain Annual Review
Requirements of Investment Company Boards of Directors, Securities
Act Release No. 7013 (Sept. 17, 1993), 58 FR 49919.
\7\ A ``firm commitment'' underwriting, for purposes of rule
10f-3, is one in which the underwriters are committed to purchase
all of the securities being offered, if the underwriters purchase
any of the securities being offered. See rule 10f-3(a)(3).
\8\ The provisions of rule 10f-3 are similar to provisions
permitting limited affiliated transactions by persons subject to
section 406 of the Employee Retirement Income Security Act of 1974
(``ERISA''), 29 U.S.C. 1106, and by banks subject to section 23B of
the Federal Reserve Act, 12 U.S.C. 371c-1. Section 406 of ERISA, as
interpreted by the Department of Labor, prohibits a plan fiduciary
from purchasing a security for the plan from a syndicate in which an
affiliate of the fiduciary is an underwriter. See Prohibited
Transaction Class Exemption 75-1 (Oct. 24, 1975) (``PTCE 75-1'').
The Department of Labor has issued a class exemption permitting
purchases in limited circumstances, subject to conditions similar to
rule 10f-3. Id.
Section 23B of the Federal Reserve Act, 12 U.S.C. 371c-1(b),
like section 10(f) of the Investment Company Act, prohibits a bank
or its subsidiary from purchasing, as principal or fiduciary,
securities from underwriting syndicates in which an affiliate of the
bank participates. Section 23B, however, permits acquisitions of
these securities if a majority of the bank's independent directors
have approved the acquisition in advance. 12 U.S.C. 371c-1(b)(2).
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C. Need for Amendments
The Commission believes that the conditions of rule 10f-3 should be
reevaluated in light of changes in the financial markets, particularly
in the fund and financial services industries.9
[[Page 13632]]
The number of funds and the amount of assets invested in funds has
grown exponentially since 1980.10 The increase in the number and
size of funds has resulted in funds becoming major sources of capital
and significant purchasers in syndicated offerings.11 This growth,
however, has had an effect on the ability of funds to use rule 10f-3.
The provisions in the rule limiting the amount of an offering that a
fund may purchase may, in effect, be more restrictive today than they
were when the Commission last substantively amended the rule in
1979.12
\9\ The Commission first recognized a need to reevaluate rule
10f-3 when it issued a release in 1986 requesting comment on whether
the Commission should amend the rule, and requesting suggestions on
possible amendments. See Advance Notice and Request for Comment on
Whether the Commission Should Amend an Existing Rule that Permits an
Investment Company to Acquire Securities Underwritten by an
Affiliate of that Company, Investment Company Act Release No. 14924
(Jan. 29, 1986), 51 FR 4386 (``1986 Concept Release''). In response,
the Commission received 11 letters commenting on nearly every aspect
of the rule. The Commission's Division of Investment Management
(``Division'') further evaluated the rule in connection with its
1992 study of the Investment Company Act. The Division recommended
at that time that the Commission amend rule 10f-3 to permit the
purchase of foreign securities. See Division of Investment
Management, U.S. Securities and Exchange Commission, Protecting
Investors: A Half Century of Investment Company Regulation 499-500
(1992).
\10\ In 1980, there were 564 funds with total assets of $134.8
billion. By December 1995, there were 5,789 funds with total assets
of over $2.8 trillion. Investment Company Institute, Press Release
(Jan. 25, 1996).
\11\ See, e.g., The Boom in IPOs, Bus. Wk., Dec. 18, 1995, at
64, 68 (stating that ``mutual funds are major buyers of new equity
issues'').
\12\ The average size of a municipal bond fund, for example, has
increased at a much greater rate than the average size of a
municipal bond offering. In 1980, the average municipal bond fund
had $69.5 million in assets and the average municipal bond offering
was $8.5 million. Investment Company Institute, 1982 Mutual Fund
Fact Book 27; Investment Company Institute, 1986 Mutual Fund Fact
Book 19; Bond Buyer, 1990 Yearbook 38. In 1995, the average
municipal bond fund had more than tripled in size, with $249.6
million in assets, while the average municipal bond offering, $15.2
million, had not even doubled in size. See Investment Company
Institute, Press Release (Jan. 25, 1996); 1995 Year-End Statistics
Supplement, Bond Buyer, Jan. 26, 1996, at 13A. See also infra note
and accompanying text.
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The growth of the fund industry has been accompanied by changes in
the financial services industry that have limited the usefulness of
rule 10f-3. Over the recent past, the financial services industry has
become more concentrated as large financial conglomerates have replaced
smaller, independent underwriting firms.13 Increasing
concentration in the underwriting industry has made it more likely that
an affiliated underwriter will participate in an underwriting
syndicate. In addition, more underwriters have either developed or
otherwise become affiliated with fund complexes, and the sponsors of
some fund complexes have established broker-dealer affiliates.14
As a result of the increasing affiliations among funds and
underwriters, more funds have become, and more are likely in the future
to become, subject to section 10(f).
\13\ See, e.g., Shawn Tully, Can Lehman Survive?, Fortune, Dec.
11, 1995, at 154; see also Helene Duffy, Few to Get Fewer in
Investment Banking, Bank Mgmt., Mar. 1991, at 8; From the Many,
Perhaps Just a Few, Bus. Month, Feb. 1988, at 69. Some commentators
have suggested that there has been an increased concentration in the
municipal securities industry as firms have departed from that
business. See, e.g., Michael Stanton, Chemical Securities to Close
Muni Division; 50 Jobs Lost, Bond Buyer, Jan. 17, 1996, at 1; Muni
Market Liquidity Not Seen Growing Significantly, Sec. Industry
Daily, Sept. 29, 1995, at 15.
\14\ See, e.g., Mercedes M. Cardona, Wall St. Managers Pay Off,
Pensions & Investments, Sept. 5, 1994, at 3 (``money managers owned
by big Wall Street brokerage and investment banking firms
increasingly are contributing to their parents' bottom lines, while
underwriting and brokerage activities slow down''); Geoffrey Smith,
This Little Broker Went to Market--And Got Big, Bus. Wk., Jan. 27,
1992, at 76 (describing the development and increasing growth of a
broker-dealer affiliate of the nation's largest fund complex).
According to statistics compiled by the Division, in 1970 only 8 of
the top 25 underwriters (ranked by percentage of amount of
securities underwritten, giving full credit to the lead underwriter)
were affiliated with funds. By 1980, that number had risen to 13. By
1995, 23 of the top 25 underwriters were affiliated with fund
groups.
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Another significant change in the fund industry since 1980 has been
the dramatic increase in the number of funds that invest in foreign
securities.15 This trend may be the result of a combination of
several factors, including the internationalization of the securities
markets and increased investor interest in overseas investment
opportunities.16 The increase in demand for foreign securities by
U.S. funds has been accompanied by an increase in the participation of
U.S. underwriters in the global offerings of these securities.17
Additionally, funds that invest only in securities of issuers located
in particular countries often employ investment advisers located in
those countries, many of which advisers are affiliated with major
underwriters in those countries.18 As a result of these
developments, funds that invest in foreign securities increasingly are
subject to the prohibitions of section 10(f), but often cannot rely
upon rule 10f-3 for purchases of these securities because the
securities frequently are not registered under the Securities
Act.19
\15\ According to statistics compiled by the Division, 21 funds,
with aggregate assets of $2.2 billion, invested primarily in foreign
securities as of December 1980. By December 1995, 682 funds, with
aggregate assets of $230.3 billion, invested primarily in foreign
securities. See Investment Company Institute, Press Release (Jan.
25, 1996).
\16\ See, e.g., Michael Hurley, Comments: International Debt and
Equity Markets: U.S. Participation in the Globalization Trend, 8
Emory Int'l L. Rev. 701 (1994) (describing the internationalization
of the securities markets); William Glasgall, Who's Afraid of the
Global Markets? Not U.S. Investors, Bus. Wk., Sept. 18, 1995, at 70
(describing how U.S. investors ``continue to roam the world in
search of portfolio diversification and growth'').
\17\ See, e.g., Michael R. Sesit, Top Dogs: U.S. Financial Firms
Seize Dominant Role In the World Markets, Wall St. J., Jan. 5, 1996,
at A1; see also Michael Carroll, As the Cycle Turns, Inst. Inv.,
Sept. 1994, at 138-39 (describing how U.S. firms are in a
``preeminent worldwide position in underwriting'').
\18\ See, e.g., Irish Investment Fund, Investment Company Act
Release Nos. 20220 (Apr. 14, 1994), 59 FR 19035 (Notice of
Application) and 20286 (May 10, 1994), 56 SEC Docket 1843 (Order);
Brazilian Equity Fund, Investment Company Act Release Nos. 19601
(July 28, 1993), 58 FR 41533 (Notice of Application) and 19650 (Aug.
24, 1993), 54 SEC Docket 1840 (Order); First Philippine Fund,
Investment Company Act Release Nos. 19034 (Oct. 16, 1992), 57 FR
48534 (Notice of Application) and 19096 (Nov. 12, 1992), 52 SEC
Docket 2436 (Order).
\19\ If a fund is prohibited by section 10(f) from purchasing a
security during the existence of an underwriting syndicate, the fund
theoretically can wait until the syndicate is completed and purchase
the security in the market. This option has disadvantages, however.
See infra note and accompanying text.
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The Commission believes that amendments to rule 10f-3 may be
desirable in light of these changes. Because the incentives that could
lead fund affiliates to seek to use fund assets to facilitate
underwritings are substantially the same today as they were in 1940,
however, the concerns underlying section 10(f) remain important.20
The proposed amendments are designed to balance these concerns with the
need for funds to have more flexibility to purchase securities when
their affiliated underwriters are members of syndicates.
\20\ See I Louis Loss & Joel Seligman, Securities Regulation 378
(1989) (``The high turnover of underwriting capital in this country
means that investment bankers for the most part cannot retain the
securities they underwrite for any length of time even if they
should want to.''); id. at 379-80 (``It is a simple fact * * * that
diminution of risk and its by-product, speed, are the keynotes in
distribution.''). Members of the fund industry, on the other hand,
have observed that the increased contributions of funds to the
revenues of major financial conglomerates, and the increased
scrutiny given funds by the financial press, have reduced the
likelihood that funds would be used to facilitate underwritings to
the disadvantage of fund shareholders. See, e.g., Letter from IDS
Financial Services, Inc. to John P. Wheeler, III, Secretary, SEC,
Apr. 4, 1986 (commenting on 1986 Concept Release, File No. S7-3-86).
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II. Discussion
A. Quantity Limitations
1. Amount Purchased
Rule 10f-3 currently prohibits funds advised by the same investment
adviser from purchasing, in the aggregate, more than 4% of the
principal amount of the offering, or $500,000, whichever is greater,
but in no event greater than 10% of the offering.21 The Commission
is proposing to amend the percentage
[[Page 13633]]
limit to permit funds relying on the rule to purchase up to the greater
of 10% of the principal amount of an offering, or $1,000,000 (but not
more than 15% of the offering).22 This proposed change is designed
to respond to the increasing size of funds and the increasing
concentration in the underwriting industry in general.
\21\ Rule 10f-3(d).
\22\ Proposed rule 10f-3(f).
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When originally adopted in 1958, rule 10f-3 limited funds to
purchasing 3% of the amount offered by the syndicate in which the
affiliated underwriter participated. The exemptions from section 10(f)
obtained by funds prior to 1958 generally had involved purchases that
would not exceed this amount.23 In 1979, the Commission increased
the percentage limit to its current level.24
\23\ See 1958 Adopting Release, supra note 6.
\24\ See 1979 Adopting Release, supra note 6.
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The current percentage limit, in some instances, may be more
restrictive than is necessary for the protection of fund investors. A
fund that is limited to purchasing 4% of an offering must, if it wishes
to purchase more than that amount, wait until the syndicate has closed
and purchase the securities in the secondary market. This delay may
result in a fund paying a significantly higher price for the securities
and incurring significant additional transaction costs.25 Thus, a
fund that is restricted by the percentage limit in rule 10f-3 may not
be able to purchase desirable securities at prices that would benefit
its portfolio. Large funds or funds in a large fund complex also may
find it inefficient to purchase only 4% of an offering, particularly if
the total offering amount is small. For these funds, 4% of an offering
may be too small an amount to have any effect on the fund's
portfolio.26 The portfolio manager of such a fund may then decide
not to purchase the security at all.
\25\ In many instances, particularly in the equity market, the
price of a security increases, sometimes dramatically, after an
initial public offering. See, e.g., I Louis Loss & Joel Seligman,
supra note 20, at 333 n.28; Jonathan A. Shayne & Larry D.
Soderquist, Inefficiency in the Market for Initial Public Offerings,
48 Vand. L. Rev. 965 (1995). There are additional potential costs to
purchasing securities in the secondary market. In secondary market
purchases, funds would be required to pay brokerage commissions that
they usually would not pay when purchasing directly in an
underwritten offering. A fund that must wait until the dissolution
of the underwriting syndicate to purchase more than 4% of an
offering also may not have the opportunity to purchase the amount of
the security that is desirable for its portfolio because of limited
supply. This particularly would be the case for popular securities
that are in high demand.
\26\ See, e.g., Letter from Alliance Capital Management Corp. to
John P. Wheeler, III, Secretary, SEC, Apr. 14, 1986 (commenting on
1986 Concept Release, File No. S7-3-86); Application of First Funds,
File No. 812-9248; see also supra note 12 and accompanying text. In
the case of municipal securities, smaller blocks of securities often
are more difficult to sell than larger blocks. If a fund manager is
able to purchase only a small block of municipal securities because
of the percentage limit in rule 10f-3, the liquidity of the fund's
portfolio may be adversely affected.
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Notwithstanding these potential disadvantages, the percentage limit
would appear to limit the possibility that securities will be
``dumped'' on an affiliated fund. The percentage limit provides an
indication that a significant portion of the offering is being
purchased by persons other than the affiliated fund. In view of its
administrative experience with rule 10f-3, however, the Commission
believes that the percentage limit can be raised to afford funds
additional flexibility. The proposed 10% purchase limit would continue
to provide assurance that a significant portion of the offering is
being distributed to persons not affiliated with the fund.
2. Percentage of Fund Assets
Rule 10f-3 currently prohibits a fund from using more than 3% of
its assets to acquire securities in a transaction subject to the rule
(the ``3% limit'').27 The Commission is proposing to eliminate
this condition. The Commission believes that the other provisions of
rule 10f-3 provide sufficient protection against dumping. In addition,
the diversification provisions of the Investment Company Act provide
shareholders of most funds with similar protections.28
\27\ Rule 10f-3(e).
\28\ Section 5(b)(1), 15 U.S.C. 80a-5(b)(1), of the Investment
Company Act, for example, generally limits a diversified fund to
investing, with respect to 75% of its assets, no more than 5% of its
assets in the securities of a single issuer.
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3. Request for Comment on Quantity Limitations
The Commission requests comment on the percentage limit and the 3%
limit generally. Does the percentage limit continue to serve a useful
regulatory purpose? Should the percentage limit be retained at all?
Would increasing the percentage limit to 10% provide sufficient
flexibility to funds while addressing the concerns underlying section
10(f)? 29 Would a higher limit (such as 15% or 20%) be
appropriate? Does the 3% limit serve a useful purpose, and if so,
should the limit be retained or raised?
\29\ The Commission notes that a factor in determining the
percentage limit is the possibility that several underwriters would
together agree to underwrite an offering and sell the entire
offering to their affiliated funds. The higher the percentage limit,
the fewer the number of underwriters necessary to make such an
agreement.
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The Commission also requests comment whether other types of
quantity limits, in addition or as an alternative to the current and
proposed limits, are appropriate or necessary to reduce the risk that
an underwriter will seek to cause an affiliated fund to purchase
unmarketable securities. One industry commenter, for example, has
suggested raising the percentage limit dramatically while limiting the
percentage of a fund's assets that may consist of securities acquired
in rule 10f-3 transactions.30 Another possible approach would be
to limit the amount of an offering all funds affiliated with members of
the underwriting syndicate may purchase. Commenters are requested to
provide specific suggestions for these types of provisions and indicate
whether they would supplement or replace existing quantity limitations
in the rule.
\30\ Letter from Smith Barney Inc. to Kenneth J. Berman,
Assistant Director, Office of Regulatory Policy, Division of
Investment Management, SEC, Feb. 28, 1996 (available in public file
S7-7-96).
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B. Purchases of Foreign Securities
Funds cannot rely on rule 10f-3 to purchase foreign securities from
syndicates in which their affiliated underwriters participate when
those offerings are not registered under the Securities Act. As a
result, several funds have, over time, applied for orders from the
Commission that would exempt them from section 10(f) and allow them to
make these purchases.31 The proposed amendments would permit funds
to rely on rule 10f-3 to purchase foreign securities in circumstances
similar to those described in prior Commission orders.
\31\ See, e.g., Brazilian Investment Fund, Investment Company
Act Release Nos. 19301 (Mar. 1, 1993), 58 FR 12613 (Notice of
Application) and 19366 (Mar. 30, 1993), 53 SEC Docket 2139 (Order);
France Growth Fund, Investment Company Act Release Nos. 19097 (Nov.
13, 1992), 57 FR 54627 (Notice of Application) and 19151 (Dec. 9,
1992), 52 SEC Docket 3001 (Order). The orders granted by the
Commission generally have required the applicants to comply with all
of the provisions of rule 10f-3 except for the Securities Act
registration requirement.
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The Commission has granted orders permitting funds to purchase
foreign securities in accordance with rule 10f-3 when the securities
have been offered in foreign public offerings that have characteristics
similar to those present in offerings registered under the Securities
Act.32 One important factor present in all of the orders, for
example,
[[Page 13634]]
has been that the securities were publicly offered and distributed at a
uniform public offering price.33 Another important factor has been
that the applicable laws or regulations of the country in which the
public offering was taking place required information about the issuer
to be made available to the public. These and other factors outlined in
the orders suggested that the securities would be widely distributed,
that a wide range of market participants would agree that the offering
price of the securities was fair, and that a secondary market for the
securities would likely develop.
\32\ See, e.g., The Mexico Fund, Investment Company Act Release
Nos. 20156 (Mar. 23, 1994), 59 FR 14946 (Notice of Application) and
20225 (Apr. 19, 1994), 56 SEC Docket 1455 (Order); The New Germany
Fund, Investment Company Act Release Nos. 19353 (Mar. 24, 1993), 58
FR 16723 (Notice of Application) and 19421 (Apr. 20, 1993), 53 SEC
Docket 2481 (Order); The First Philippine Fund, supra note 18.
\33\ At least one applicant that received a Commission order
invested in securities in a country where existing shareholders
could be offered securities on terms different than those offered to
other potential purchasers. See The New Germany Fund, supra note 32.
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The Commission proposes to amend rule 10f-3 to permit purchases of
foreign securities in circumstances in which the offerings have
characteristics similar to those described above. The proposed
amendments would permit a fund to purchase, through an affiliated
underwriting syndicate, securities issued by a foreign issuer and not
registered under the Securities Act if they are issued in either an
``Eligible Foreign Offering'' or a ``Foreign Issuer Rule 144A
Offering,'' described below.34 The fund also would be required to
comply with all other provisions of rule 10f-3.
\34\ A ``foreign issuer'' would be defined in the same manner as
it is in rule 405 under the Securities Act, 17 CFR 230.405, to mean
any issuer which is a foreign government, a national of any foreign
country or a corporation or other organization incorporated or
organized under the laws of any foreign country.
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1. Eligible Foreign Offering
a. General. The proposed amendments would define an Eligible
Foreign Offering as a public offering, conducted under the laws of a
country other than the United States, of the securities of a foreign
issuer.35 The offering would be required to be subject to
regulation by a Foreign Financial Regulatory Authority (``FFRA''), as
defined in the Investment Company Act, in the country in which the
public offering occurs.36 Thus, an offering would meet the terms
of the proposed definition if it is conducted in a country that has
laws, rules or regulations regarding public offerings. An offering also
would fall within the definition if an organization such as a stock
exchange in that country has rules that regulate the offering of the
securities. The Commission requests comment whether the proposed
requirement for regulation by a FFRA appropriately recognizes that
securities regulatory schemes differ among countries. Comment is
requested whether a narrower definition of regulatory scheme would be
appropriate for the protection of investors. Are additional or
alternative provisions, such as a requirement that the country have
laws imposing liability for misleading disclosure, or a requirement
that the country have a system for the registration of securities,
appropriate or necessary for the protection of investors?
\35\ The proposed amendments do not affect the obligation of any
issuer, whether domestic or foreign, to comply with U.S. securities
laws. The proposed definition of Eligible Foreign Offering, for
example, would not affect an issuer's obligation to determine
whether the offering is conducted in such a manner as to bring it
within the reach of the registration requirements of section 5 of
the Securities Act.
\36\ Proposed rule 10f-3(k)(1)(i). ``Foreign Financial
Regulatory Authority'' is defined in section 2(a)(50) of the
Investment Company Act, 15 U.S.C. 80a-2(a)(50), generally as any (A)
Foreign securities authority, (B) other governmental body or foreign
equivalent of a self-regulatory organization empowered by a foreign
government to administer or enforce its laws relating to certain
financial activities, or (C) membership organization a function of
which is to regulate the participation of its members in such
financial activities.
A ``foreign securities authority'' is defined in section
2(a)(49) of the Investment Company Act, 15 U.S.C. 80a-2(a)(49), as
any foreign government or any governmental body or regulatory
organization empowered by a foreign government to administer or
enforce its laws as they relate to securities matters.
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The public offering requirement may provide some assurance that a
market for the securities will develop. The Commission requests comment
whether additional conditions, such as a minimum market float or a
requirement that there be no legal restrictions on transferability, are
necessary to provide adequate assurance that a market for the
securities will exist after the offering is complete. The Commission
also requests comment whether the proposal should require all foreign
securities purchased pursuant to the rule to be listed on a securities
exchange, either as an alternative or an addition to the proposed
provisions. Would a listing requirement provide greater assurance that
the securities are widely distributed?
b. Disclosure. An offering subject to regulation by a FFRA would
meet the terms of the definition of Eligible Foreign Offering only if,
under applicable law or the rules of the applicable FFRA, the issuer of
the securities is required to disclose information about the issuer and
the offering to prospective purchasers.37 The proposed amendments
also would require that financial statements, audited in accordance
with the accounting standards of the appropriate country, for the two
years prior to the offering, be made available to the public and
prospective purchasers in connection with the offering.38
\37\ This condition would not require that the issuer become
subject to an ongoing disclosure regime. The condition would be
satisfied if information about the issuer and the offering were
required to be disclosed to prospective purchasers in connection
with the sale of the securities.
\38\ Proposed rule 10f-3(k)(1)(iv). The proposed amendments
would not specify the format of the financial statements that must
be provided in recognition that financial reporting standards differ
from country to country.
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The proposed rule would not set objective disclosure standards,
other than the financial statement requirement, that must be met in
order to comply with the rule. The Commission requests comment whether
the rule should be amended to provide specific standards of disclosure
that would be applicable to purchases of foreign securities made
pursuant to the rule.
c. Offering Price. Under the proposed definition of Eligible
Foreign Offering, the foreign securities would have to be offered at a
fixed price to all purchasers in the offering. The single public
offering price requirement is designed to enable a fund to comply with
the provision of rule 10f-3 that requires the fund to purchase the
securities at not more than the public offering price prior to the end
of the first business day after the first date on which the securities
are offered to the public.39 The Commission believes the proposed
single price offering requirement is consistent with the purposes of
section 10(f) because it would preclude an underwriter from obtaining
an advantage for the syndicate by causing an affiliated fund to
purchase securities from the syndicate at a price that is higher than
the price offered to unaffiliated purchasers.
\39\ See rule 10f-3 (a)(2) (paragraph (b) of rule 10f-3 as
proposed to be amended).
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An exception from the single offering price requirement would be
available if applicable law requires an issuer to offer the securities
at a lower price to existing securities holders.40 The Commission
requests comment whether there are other discrete classes of persons to
whom discounts are offered, other than persons who may control a
company through ownership or influence over the company's operations,
that should be included in this exception. In privatization
transactions, for example, citizens of the country that formerly owned
the enterprise often are offered the securities at a discount.
\40\ See supra note 33.
[[Page 13635]]
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2. Foreign Issuer Rule 144A Offerings
Many fund purchases of foreign securities are made in transactions
(``rule 144A placements'') that are exempt from the registration
provisions of the Securities Act and that qualify the purchased
securities as eligible to be resold pursuant to rule 144A under the
Securities Act (``rule 144A-eligible securities'').41 Rule 144A is
a non-exclusive safe harbor that exempts from the registration
provisions of the Securities Act resales of securities to certain large
institutions, known as Qualified Institutional Buyers
(``QIBs'').42 Typically, a rule 144A placement involving a foreign
issuer's securities is part of a larger global offering of those
securities.43 Frequently, a global offering is divided into
several tranches--one for the issuer's home country, one for the United
States, and one or more for other countries. The securities in the U.S.
tranche are sold in either a registered public offering or an offering
that is exempt from registration under the Securities Act. Often, the
U.S. tranche is sold only to institutions that qualify as QIBs.
Usually, the price for the securities is uniform across all the
tranches and the issuer prepares an offering document that provides
detailed information about the issuer and the offered
securities.44 Securities purchased by a fund in a rule 144A
placement are transferable to another QIB in the United States, and may
be sold freely in a foreign market (assuming foreign law permits such
sale).45
\41\ 17 CFR 230.144A. In 1993, funds purchased more foreign
equity securities in rule 144A placements than did any other type of
purchaser. See SEC, Staff Report on Rule 144A 15 (1994) (hereinafter
Staff Report). The Commission has received applications from several
funds requesting exemptive relief from section 10(f) for purchases
of foreign securities in transactions that would produce rule 144A-
eligible securities. See, e.g., Application of the Brazilian
Investment Fund, Inc. et al., File No. 812-9676; Application of
Merrill Lynch Balanced Fund For Investment and Retirement et al.,
File No. 812-8346.
\42\ Under rule 144A, the seller must reasonably believe that
the purchaser is a QIB. A QIB is an institution of a type listed in
rule 144A and owning or investing on a discretionary basis at least
$100 million of securities. See 17 CFR 230.144A(a)(1). Many funds
qualify as QIBs in their own right, and others qualify because they
are part of a ``family'' of funds that own, in the aggregate, at
least $100 million in securities. 17 CFR 230.144A(a)(1)(iv).
\43\ One of the purposes of rule 144A was to encourage foreign
issuers to access the U.S. capital markets. See Securities Act
Release No. 6862 (April 30, 1990), 55 FR 17933. According to
statistics compiled by the Commission's Division of Corporation
Finance, from the adoption of rule 144A through December 31, 1994,
approximately $39 billion of equity and debt securities relating to
more than 480 foreign issuers were sold in rule 144A placements.
\44\ Although most foreign rule 144A placements appear to be
priced the same as concurrent foreign offerings, there is no
regulatory requirement that the securities be priced in this manner.
See Staff Report, supra note 41, at 26. It has been suggested,
however, that most rule 144A transactions are sold in underwriting
arrangements with terms and conditions substantially similar to
those applicable to registered public offerings. 1 E. Greene et al.,
U.S. Regulation of the International Securities Markets: A Guide for
Domestic and Foreign Issuers and Intermediaries 141 (1993). Rule
144A requires an issuer to provide certain information about the
issuer that the purchaser of the securities may request, including
financial information for its two most recent fiscal years of
operation. See 17 CFR 230.144A(d)(4). The rule exempts from this
information requirement foreign governments and foreign private
issuers that furnish information to the Commission pursuant to rule
12g3-2(b), 17 CFR 240.12g3-2(b), under the Securities Exchange Act
of 1934, 15 U.S.C. 78a et seq. (``Exchange Act''). See 17 CFR
230.144A(d)(4)(i).
\45\ Regulation S under the Securities Act generally permits the
sale of securities owned by a U.S. person into a foreign market if
certain conditions are met. See 17 CFR 230.901 et seq.
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In order to increase the flexibility of affiliated funds to
purchase securities in these types of transnational offerings, the
proposed amendments would permit a fund to purchase securities in a
Foreign Issuer Rule 144A Offering, subject to the other conditions of
rule 10f-3 (other than the Securities Act registration
requirement).46 A Foreign Issuer Rule 144A Offering generally
would be a distribution of securities of a foreign issuer, made
exclusively to QIBs, if the securities would be eligible to be resold
pursuant to rule 144A.47 In addition, the proposed amendments
would require that securities of the same class be offered in a
concurrent Eligible Foreign Offering.48 This condition is designed
to provide some assurance that there is a widespread distribution of
securities that are fungible with the rule 144A securities purchased by
the fund.
\46\ The proposed amendments would in no way affect the
determination that must be made by fund boards of directors whether
a security purchased by the fund in a rule 144A placement is deemed
a liquid security for purposes of the fund's liquidity policies. See
Resale of Restricted Securities, Securities Act Release No. 6862
(Apr. 23, 1990), 55 FR 17933.
\47\ Rule 144A provides that a person who offers or sells
securities in compliance with rule 144A is not deemed to be an
underwriter of such securities for purposes of section 2(11) of the
Securities Act. 17 CFR 230.144A(c). Rule 144A, however, does not
limit the scope of section 10(f).
\48\ Proposed rule 10f-3(k)(4). The definition of ``foreign
issuer'' for purposes of rule 10f-3 would not be limited to
``foreign private issuers,'' as defined in rule 405, 17 CFR 230.405,
under the Securities Act. A foreign issuer that is not a foreign
private issuer may have a substantial presence in the United States
(either through securities ownership or operation of business, or
both). Under the amended rule, for a fund to purchase securities of
that issuer in a rule 144A placement, the issuer would be required
to have a concurrent Eligible Foreign Offering of securities of the
same class in a foreign country.
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Consistent with the purpose of section 10(f), the proposed
amendments would require a fund purchasing securities in a Foreign
Issuer Rule 144A Offering to pay no more than the public offering price
in the concurrent Eligible Foreign Offering or the price paid by each
other QIB, whichever is lower.49 This provision is designed to
provide assurance that a fund does not pay more for the securities than
it would if it could engage in arm's length negotiations as to the
price of the securities.
\49\ Proposed rule 10f-3(b)(2). The proposed amendments would
provide that a fund will be deemed to have satisfied this condition
if it reasonably relies on written statements of the seller.
Proposed rule 10f-3(h).
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The proposed amendments would permit funds to purchase securities
in rule 144A placements of foreign issuers. The Commission recognizes
that rule 144A placements also often are used by U.S. issuers, and
requests comment whether rule 10f-3 should permit purchases of rule
144A-eligible securities of domestic issuers, subject to conditions
that protect investors by reducing the likelihood that dumping of
unmarketable securities will occur.50 The conditions applicable to
Foreign Issuer Rule 144A Offerings and Eligible Foreign Offerings,
however, generally could not be made applicable to domestic rule 144A
placements.51 Commentators in favor of expanding the rule to
permit the purchase of securities of domestic issuers in rule 144A
placements should suggest alternative conditions.
\50\ See Staff Report, supra note , at 3-4.
\51\ The requirement that there be a concurrent public offering
of securities of the same class, for example, could not be met
because rule 144A is not available for transactions in securities
if, at issuance, securities of the same class were listed on a
national securities exchange.
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3. General Request for Comment
The Commission believes that the proposed conditions for purchases
of foreign securities should provide assurance that the purposes
underlying rule 10f-3 will be met in foreign offerings. Nonetheless,
the Commission requests comment on its overall approach to permitting
purchases of foreign securities under rule 10f-3. Commenters are
encouraged to suggest specific alternatives that would provide
flexibility without diminishing investor protection. The Commission
also requests comment whether the proposed standards for an Eligible
Foreign Offering and a Foreign Issuer Rule 144A Offering are
sufficiently clear. The Commission considered alternatives to the
proposed approach, such as specifically identifying countries in which
purchases may be made, but believes that its proposed approach
[[Page 13636]]
would protect investors while also affording greater flexibility to
funds.
The proposed amendments would not differentiate between securities
issued by foreign companies and those issued by foreign governments.
The definition of Eligible Foreign Offering, therefore, would permit an
affiliated fund to purchase foreign government securities if the
offering of those securities otherwise meets the conditions of the
definition. Comment is requested, however, whether these conditions are
appropriate for purchases of foreign government securities that could
be subject to section 10(f).
Rule 10f-3 currently requires fund directors to adopt procedures
pursuant to which a fund may purchase securities in reliance on the
rule.52 The Commission requests comment on the role of fund
directors in determining compliance with the proposed foreign
securities provisions. In particular, the Commission asks commenters to
consider whether the existing requirements for the establishment and
review of procedures are sufficient to cover the new proposals.
\52\ Rule 10f-3(h). The Commission proposes to amend this
requirement to clarify that the board of directors must approve,
rather than adopt, procedures for the purchase of securities of rule
10f-3. Proposed rule 10f-3(i)(1). The Commission believes that this
change would more accurately reflect the role of the board of
directors of approving policies and procedures developed by fund
management.
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C. Group Sales
A ``group sale'' is a sale of municipal securities resulting from a
``group order,'' which is an order for securities for the account of
all members of a syndicate in proportion to their respective
participations in the syndicate.53 Rule 10f-3 prohibits a fund
from purchasing a security, directly or indirectly, from its affiliated
underwriter, and, in effect, provides that a purchase from a syndicate
manager that is designated as a group sale is deemed a purchase from
the affiliated underwriter.54 These provisions are designed to
ensure that a purchase permitted by rule 10f-3 does not violate section
17(a) of the Investment Company Act, which prohibits a fund from
purchasing securities from an affiliate or an affiliate of an
affiliate.55
\53\ See Municipal Securities Rulemaking Board (``MSRB'') Rule
G-11(a)(iii), MSRB Manual (CCH) para.3551; see also The Galaxy Fund
et al., Investment Company Act Release No. 20660 (Oct. 26, 1994)
(Notice of Application).
\54\ Rule 10f-3(f) provides that a purchase from a syndicate may
not be made from, or directly or indirectly benefit, an affiliated
underwriter. The rule implicitly permits certain purchases of
municipal securities to indirectly benefit an affiliated
underwriter, however, so long as such purchases are not designated
as group sales or otherwise allocated to the account of the
affiliated underwriter. See Exemption of Acquisition of Securities
During the Existence of Underwriting Syndicate, Investment Company
Act Release No. 10592 (Feb. 13, 1979) (proposing amendments to rule
10f-3).
\55\ Rule 10f-3 currently defines ``municipal securities'' by
reference to section 3(a)(29) of the Exchange Act. See rule 10f-
3(a)(1)(ii). The proposed rule would continue to refer to the
definition under the Exchange Act. See proposed rule 10f-3(k)(7).
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The prohibition in rule 10f-3 on group sales may act to the
detriment of funds that invest in municipal bonds. The rules of the
Municipal Securities Rulemaking Board (``MSRB''), which govern the sale
of municipal securities, require a syndicate that is offering municipal
securities to establish a priority by which orders for the securities
will be filled.56 Frequently, group orders are designated to
receive first priority.57 Thus, if a municipal securities offering
were oversubscribed, it is possible that only prospective purchasers
who placed group orders would be able to purchase the securities being
offered. A fund that is prohibited by rule 10f-3 from placing group
orders would be precluded from purchasing any securities in that
offering. Because of the potential cost of this prohibition to
municipal bond funds and their shareholders, particularly during times
in which demand for municipal securities is increasing and supply of
these securities is decreasing, the Commission believes that funds
subject to rule 10f-3 should be given more flexibility to place group
orders for municipal securities.58
\56\ MSRB Rule G-11(e), MSRB Manual (CCH) para.3551.
\57\ See, e.g., Public Securities Association, Fundamentals of
Municipal Bonds 80 (1990). After group orders, ``designated orders''
generally are next in priority to be filled. A designated order is
an order submitted by a member of the syndicate on behalf of a buyer
on which all or a portion of the sale is to be credited to certain
members of the syndicate. MSRB, Glossary of Municipal Securities
Terms 34 (1985). Because rule 10f-3 prohibits funds that are
purchasing municipal securities from placing group orders, these
funds generally must place designated orders, designating
underwriters other than affiliated underwriters to be credited with
the sale.
\58\ The increase in the number of municipal bond funds over the
past 15 years has contributed to an increase in demand for municipal
securities. See, e.g., Investment Company Institute, Trends in
Mutual Fund Activity, (Sept. 1995); Investment Company Institute,
1986 Mutual Fund Fact Book; Investment Company Institute, 1982
Mutual Fund Fact Book. The supply of newly issued municipal
securities varies from year to year, depending upon a number of
factors, including interest rates, tax considerations and political
factors. Between 1986 and 1995, for example, the annual amount of
issuances of new-money municipal securities ranged from a low of
approximately $59.4 billion in 1987 to a high of $119.3 billion in
1993. See 1995 Year-End Statistics Supplement, Bond Buy., Jan. 26,
1996, at 16A.
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The proposed provision that would permit group sales contains two
conditions designed to limit the likelihood that a group sale would be
motivated primarily by an affiliated underwriter's intention to be the
primary beneficiary of the group sale. First, a purchase designated as
a group sale could be made only if the syndicate has established that
orders designated as group orders have first priority, or that only
group orders will be filled.59 Second, a purchase designated as a
group sale would be permitted only if, at the time of the sale, the
affiliated underwriter is not committed to underwriting more than 50%
of the principal amount of the offered securities.60 In
determining whether the conditions have been satisfied, the proposed
amendments would permit a fund reasonably to rely upon the written
statements of a member of the syndicate.61
\59\ Proposed rule 10f-3(g)(2)(i).
\60\ Proposed rule 10f-3(g)(2)(ii).
\61\ Proposed rule 10f-3(h). MSRB rule G-11(f) requires a member
of a municipal securities syndicate, upon request, to promptly
furnish in writing information about the syndicate's priority
provisions. A fund attempting to comply with rule 10f-3 could
therefore easily obtain the required information.
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Absent an exemption by order or rule, section 17(a) of the
Investment Company Act could prohibit a fund from purchasing securities
in a group sale. To clarify that a purchase of municipal securities in
a group sale permitted by rule 10f-3 also is exempt from section 17(a),
the Commission is proposing new rule 17a-10. The new rule would exempt
any purchase of municipal securities in a group sale that complies with
rule 10f-3 from section 17(a)(1).
The Commission requests comment whether permitting funds to
purchase through group sales would give needed flexibility to funds. To
further reduce the likelihood that the syndicate is giving group sales
first priority to benefit the affiliated underwriter, should the
proposed amendments require there to be at least a certain number of
syndicate members for a fund to take advantage of the provision
permitting group sales? Comment also is requested whether there are
other arrangements similar to group sales with respect to securities
other than municipal securities and whether rule 10f-3 should be
amended to permit these types of arrangements.
D. Reporting and Recordkeeping
The Commission proposes eliminating the current requirement that
funds report all rule 10f-3 transactions to the Commission in their
semi-annual reports on Form N-SAR by filing an
[[Page 13637]]
exhibit setting forth certain details about each transaction.62
Information about transactions that rely on rule 10f-3 currently are
required to be kept with other records pursuant to rule 10f-3 and is
available to Commission staff during periodic on-site examinations of
funds and investment advisers.63 The Commission thus believes that
it is unnecessary for funds to continue to file these reports. The
Commission requests comment whether any changes to the reporting and
recordkeeping requirements of rule 10f-3, other than the elimination of
the requirement to report on Form N-SAR, are necessary.
\62\ See rule 10f-3(g).
\63\ See rule 10f-3(i).
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III. General Request for Comments
Any interested persons wishing to submit written comments on the
rule changes that are the subject of this Release, to suggest
additional changes, or to submit comments on other matters that might
have an effect on the proposals contained in this Release, are
requested to do so. Comment is specifically requested whether the
Commission should amend or eliminate conditions in rule 10f-3 other
than those addressed in this Release. Does the requirement that the
issuer have three years of operations and, in the case of municipal
securities, have at least an investment grade rating, for example,
continue to serve the purposes of rule 10f-3? Suggestions for such
amendments should explain how they are consistent with the protection
of investors and the purposes of section 10(f). The Commission also
requests comments whether rule 10f-3 should be amended to permit the
purchase of other classes of securities, such as U.S. government
securities, that currently are not addressed by the rule, and the
extent to which the conditions of the rule should apply to such
purchases.64
\64\ The Commission notes that it may not be necessary for rule
10f-3 to permit the purchase of U.S. government securities because
the arrangements among distributors of these securities may not
always constitute underwriting or selling syndicates for purposes of
section 10(f). See Institutional Liquid Assets (pub. avail. Dec. 16,
1981).
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IV. Cost/Benefit Analysis
The proposed amendments to rule 10f-3 would increase the
flexibility for funds to purchase securities during the existence of a
syndicate in which an affiliated underwriter participates. These
amendments would benefit funds, which would be able to (i) purchase
foreign securities in reliance upon rule 10f-3, without having to seek
an exemptive order from the Commission, (ii) in many cases, purchase
more desirable quantities of securities at advantageous prices, and
(iii) purchase municipal securities that are in high demand. Funds also
would no longer be required to file information about rule 10f-3
transactions on Form N-SAR. The potential benefits to fund investors of
the proposed amendments are better investment performance, lower fund
expenses, and less paperwork burden.
The costs to funds and investors of the proposed amendments are
minimal. Fund advisers and boards of directors would be required to
determine whether purchases of foreign securities and municipal
securities in group sales comply with the proposed standards. Rule 10f-
3, however, currently has standards that must be met for purchases
permitted under the rule. Thus, the additional cost of determining
compliance with the standards related to foreign securities and
municipal securities in group sales should be minimal. These costs
likely would be outweighed by the potential benefits to funds and
investors described above.
V. Paperwork Reduction Act
Certain provisions of the proposed amendments to rule 10f-3 contain
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (44 U.S.C. 3501 et seq.), and the
Commission has submitted the proposed amendments to the Office of
Management and Budget for review in accordance with 44 U.S.C. 3507(d).
The title for the collection of information is ``Exemption for the
Acquisition of Securities During the Existence of an Underwriting
Syndicate.'' The Supporting Statement to the Paperwork Reduction Act
submission notes that the proposed amendments to rule 10f-3 would
permit funds to purchase foreign securities and to purchase municipal
securities in group sales, if certain conditions are met. The proposed
amendments also would permit funds to purchase up to the greater of 10%
of the offering amount or $1,000,000 (but not greater than 15% of the
offering amount).
The submission further notes that the amendments would require
funds that wish to rely upon the proposed new provisions to amend the
procedures that are required by the rule to account for purchases of
foreign securities and municipal securities in group sales. Adoption,
and occasional revision, of procedures is important to ensure continual
board oversight of transactions relying upon rule 10f-3. The Division
of Investment Management estimates that 600 funds rely upon rule 10f-3
each year, and that 140 of those funds purchase municipal and/or
foreign securities (although not all such funds rely upon rule 10f-3 to
purchase such securities). It is estimated that the proposed amendments
would increase the recordkeeping burden of funds that invest in foreign
and/or municipal securities by an estimated 0.50 hours per fund per
year. Thus, the total additional burden of the proposed amendments is
estimated to be 70 hours.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments concerning: whether the proposed collection of information is
necessary for the proper performance of the function of the Commission,
including whether the information shall have practical utility; on the
accuracy of the Commission's estimate of the burden of the proposed
collection of information; on the quality, utility, and clarity of the
information to be collected; and whether the burden of collection of
information on those who are to respond, including through the use of
automated collection techniques or other forms of information
technology, may be minimized.
Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington
D.C. 20503, and should also send a copy of their comments to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth St.,
N.W., Washington, D.C. 20549 with reference to File No. S7-7-96. The
Office of Management and Budget is required to make a decision
concerning the collection of information between 30 and 60 days after
publication, so a comment to the Office of Management and Budget is
best assured of having its full effect if the Office of Management and
Budget receives it within 30 days of publication.
VI. Summary of Regulatory Flexibility Analysis
The Commission has prepared an Initial Regulatory Flexibility
Analysis in accordance with 5 U.S.C. 603 regarding amendments to rule
10f-3 under the Investment Company Act. The analysis indicates that the
proposed amendments would affect small entities in the same manner as
other entities subject to section 10(f), but that the proposed
amendments increase flexibility for all funds. Cost-benefit information
reflected in the ``Cost/Benefit Analysis'' section
[[Page 13638]]
of this Release also is reflected in the analysis. A copy of the
Initial Regulatory Flexibility Analysis may be obtained by contacting
David M. Goldenberg, Securities and Exchange Commission, 450 Fifth
Street, N.W., Mail Stop 10-6, Washington, D.C. 20549.
VII. Statutory Authority
The Commission is proposing to amend rule 10f-3 pursuant to the
authority set forth in sections 10(f), 31(a) and 38(a) of the
Investment Company Act [15 U.S.C. 80a-10(f), 80a-30(a), 80a-37(a)]. New
rule 17a-10 is proposed pursuant to the authority set forth in sections
6(c) and 38(a) of the Investment Company Act [15 U.S.C. 80a-6(c), 80a-
37(a)].
Text of Proposed Rule and Form Amendments
List of Subjects in 17 CFR Part 270
Investment companies, Reporting and recordkeeping requirements,
Securities.
For the reasons set out in the preamble, Title 17, Chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940
The authority citation for Part 270 continues to read, in part, as
follows:
Authority: 15 U.S.C. 80a-1 et seq., 80a-37, 80a-39 unless
otherwise noted;
* * * * *
Section 270.10f-3 is revised to read as follows:
Sec. 270.10f-3. Exemption of acquisition of securities during the
existence of underwriting syndicate.
Any purchase of securities by a registered investment company
prohibited by section 10(f) of the Act shall be exempt from the
provisions of such section if the following conditions are met:
(a) The securities to be purchased are:
(1) Part of an issue registered under the Securities Act of 1933
(15 U.S.C. 77a et seq.) which is being offered to the public;
(2) Municipal Securities; or
(3) Securities of a Foreign Issuer sold in either an Eligible
Foreign Offering or a Foreign Issuer Rule 144A Offering.
(b) The securities are purchased at not more than the public
offering price prior to the end of the first full business day after
the first date on which the issue is offered to the public; provided,
however, that:
(1) If the securities are offered for subscription upon exercise of
rights, the securities shall be purchased on or before the fourth day
preceding the day on which the rights offering terminates; and
(2) If the securities are part of a Foreign Issuer Rule 144A
Offering, the securities shall be purchased at not more than the lesser
of the public offering price in the concurrent Eligible Foreign
Offering or the price paid by each other purchaser of securities in the
Foreign Issuer Rule 144A Offering, in each case prior to the end of the
first full business day after the first date on which the issue is
offered.
(c)(1) If the securities to be purchased are not Municipal
Securities, the issuer of such securities shall have been in continuous
operation for not less than three years, including the operations of
any predecessors; or
(2) If the securities to be purchased are Municipal Securities, the
securities shall have received an investment grade rating from at least
one NRSRO; provided, that if the issuer of the Municipal Securities, or
the entity supplying the revenues or other payments from which the
issue is to be paid, shall have been in continuous operation for less
than three years, including the operation of any predecessors, the
securities shall have received one of the three highest ratings from an
NRSRO.
(d) The securities are offered pursuant to an underwriting or
similar agreement under which the underwriters are committed to
purchase all of the securities being offered, except those purchased by
others pursuant to a rights offering, if the underwriters purchase any
thereof.
(e) The commission, spread or profit received or to be received by
the principal underwriters is reasonable and fair compared to the
commission, spread or profit received by other such persons in
connection with the underwriting of similar securities being sold
during a comparable period of time.
(f) The amount of securities of any class of such issue to be
purchased by the investment company, or by two or more investment
companies having the same investment adviser, shall not exceed 10
percent of the principal amount of the offering of such class, or
$1,000,000 in principal amount, whichever is greater, but in no event
greater than 15 percent of the principal amount of the offering of such
class.
(g) Such investment company does not purchase the securities being
offered directly or indirectly from an officer, director, member of an
advisory board, investment adviser or employee of such investment
company or from a person of which any such officer, director, member of
an advisory board, investment adviser or employee is an affiliated
person; provided, that a purchase from a syndicate manager shall not be
deemed to be a purchase from a specific underwriter if:
(1) Such underwriter does not benefit directly or indirectly from
the transaction; or
(2) In the case of a purchase of Municipal Securities that is
designated as a group sale:
(i) The syndicate manager has determined that group orders for the
securities will be given first priority or that only group orders for
the securities will be accepted; and
(ii) At the time of the purchase by the investment company, a
person referred to in the introductory sentence of paragraph (g) of
this section is not obligated to underwrite more than 50 percent of the
securities being offered.
(h) For purposes of determining compliance with paragraphs (b)(2)
and (g)(2) of this section, an investment company may reasonably rely
upon written statements made by a seller of the securities or a member
of the underwriting syndicate through which the securities are
purchased.
(i) The board of directors, including a majority of the directors
of the investment company who are not interested persons with respect
thereto:
(1) Has approved procedures, pursuant to which such purchases may
be effected for the company, that are reasonably designed to provide
that the purchases comply with all the conditions of this section;
(2) Makes and approves such changes as the board deems necessary;
and
(3) Determines no less frequently than quarterly that all purchases
made during the preceding quarter were effected in compliance with such
procedures.
(j) The investment company:
(1) Shall maintain and preserve permanently in an easily accessible
place a written copy of the procedures (and any modification thereto)
described in paragraph (i)(1) of this section; and
(2) Shall maintain and preserve for a period not less than six
years from the end of the fiscal year in which any transactions
occurred, the first two years in an easily accessible place, a written
record of each such transaction, setting forth from whom the securities
were acquired, the identity of the underwriting syndicate's members,
the terms of the transaction, and the information or materials upon
which the determination described in paragraph (i)(3) of this section
was made.
[[Page 13639]]
(k) For purposes of this section:
(1) Eligible Foreign Offering means a public offering, conducted
under the laws of a country other than the United States, of securities
issued by a Foreign Issuer, meeting the following conditions:
(i) The offering is subject to regulation by a Foreign Financial
Regulatory Authority in such country;
(ii) The laws of such country, or the rules and regulations of such
Foreign Financial Regulatory Authority, require the issuer, in
connection with the offering, to make information about the issuer and
the offering available to the public;
(iii) The securities are offered at a fixed price to all purchasers
in the offering (except for any rights to purchase that are required by
law to be granted to existing security holders of the issuer); and
(iv) Financial statements, audited in accordance with the
accounting standards of such country, for the two years prior to the
offering, are made available to the public and prospective purchasers
in connection with the offering.
(2) Foreign Financial Regulatory Authority has the same meaning as
that set forth in section 2(a)(50) of the Act (15 U.S.C. 80a-2(a)(50)).
(3) Foreign Issuer means any issuer which is a foreign government,
a national of any foreign country, or a corporation or other
organization incorporated or organized under the laws of any foreign
country.
(4) Foreign Issuer Rule 144A Offering means a distribution of
securities of a foreign issuer if such securities are offered or sold
in the United States solely to persons that the seller and any person
acting on behalf of the seller reasonably believe to be qualified
institutional buyers, as defined in Sec. 230.144A(a)(1) of this
chapter, which securities (``offered securities'') would be eligible
for resale to other qualified institutional buyers pursuant to
Sec. 230.144A of this chapter, provided, that securities of the same
class as the offered securities are offered in a concurrent Eligible
Foreign Offering.
(5) Group Order means an order for securities for the account of
all members of a syndicate on a pro rata basis in proportion to their
respective participations in the syndicate.
(6) Group Sale means a sale resulting from a group order.
(7) Municipal Securities has the same meaning as that set forth in
section 3(a)(29) of the Securities Exchange Act of 1934 [15 U.S.C.
78c(a)(29)].
(8) NRSRO has the same meaning as that set forth in Sec. 270.2a-
7(a)(10).
3. By adding Sec. 270.17a-10 to read as follows:
Sec. 270.17a-10. Exemption of certain group sales.
Any group sale of municipal securities exempted pursuant to
Sec. 270.10f-3 shall be exempt from the provisions of section 17(a)(1)
of the Act [15 U.S.C. 80a-17(a)(1)].
Dated: March 21, 1996.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-7335 Filed 3-26-96; 8:45 am]
BILLING CODE 8010-01-P