[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]]

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Part VI





Securities and Exchange Commission





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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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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).
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    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