[Federal Register Volume 61, Number 226 (Thursday, November 21, 1996)]
[Notices]
[Pages 59256-59257]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-29715]


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SECURITIES AND EXCHANGE COMMISSION
[Investment Advisers Act Release No. 1597; 803-100]


BlackRock Financial Management, Inc.; Notice of Application

November 15, 1996.
AGENCY: Securities and Exchange Commission (``SEC'').

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

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APPLICANT: BlackRock Financial Management, Inc.

RELEVANT ACT SECTIONS: Order requested under section 206A for an 
exemption from section 205(a)(1).

SUMMARY OF APPLICATION: Applicant requests an order to permit it to 
charge a performance fee to BlackRock Assets Investors (the ``Trust''), 
a closed-end investment company. Applicant requests the order because a 
limited number of its senior employees or senior employees of a Trust 
subsidiary who do not meet the minimum financial standards prescribed 
by rule 205-3(b) (1) under the Act may become shareholders of one of 
the Trust's feeder funds.

FILING DATES: The application was filed on November 28, 1995, and 
amended and fully restated applications were filed on April 26 and 
October 3, 1996.

HEARING OR NOTIFICATION OF HEARING: An order granting the application 
will be issued unless the SEC orders a hearing. Interested persons may 
request a hearing by writing to the SEC's Secretary and serving 
applicant with a copy of the request, personally or by mail. Hearing 
requests should be received by the SEC by 5:30 p.m. on December 10, 
1996, and should be accompanied by proof of service on applicant, in 
the form of an affidavit or, for lawyers, a certificate of service. 
Hearing requests should state the nature of the writer's interest, the 
reasons for the request, and the issues contested. Persons who wish to 
be notified of a hearing may request such notification by writing to 
the SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 Fifth Street, N.W., Washington, D.C. 
20549. Applicant, 345 Park Avenue, New York, N.Y. 10154.

FOR FURTHER INFORMATION CONTACT:
H.R. Hallock, Jr., Special Counsel, at (202) 942-0564 (Division of 
Investment Management, Office of Investment Company Regulation).

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

Applicant's Representations

    1. Applicant is an investment adviser registered under the Act. The 
Trust and BlackRock Fund Investors I, II and III (the ``Funds'') are 
each closed-end, non-diversified management investment companies formed 
as Delaware business trusts and registered under the Investment Company 
Act of 1940. The Trust and the Funds are organized in a master-feeder 
structure. Each Fund invests all of its assets in the Trust, which 
conducts all investment operations.
    2. The Funds have conducted an offering of interests exempt from 
registration under the Securities Act of 1933 pursuant to the exemption 
provided by section 4(2) thereof. At the conclusion of this private 
offering in the spring of 1995, the Funds had obtained capital 
commitments for approximately $560 million from institutional and 
higher net worth investors and in turn entered into back-to-back 
commitments with the Trust.\1\ The Funds have drawn approximately $130 
million in committed capital and have invested that amount in the 
Trust.
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    \1\ Investors in the Funds signed subscription agreements 
restricting the transferability of their shares of investors who do 
not meet the objective financial standards set forth in rule 205-3 
(b)(1) under the Act. Moreover, consent by the applicable Fund is 
required for any transfer other than among affiliates.
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    3. Applicant formed the Trust and the Funds to provide 
institutional investors with a way to participate in real estate debt 
markets. The primary investment objective of the Trust is to earn a 
high total rate of return through investment in a portfolio consisting 
primarily of subordinate commercial mortgage-backed securities 
(``CMBS'') and from its equity investments in mortgage affiliates 
engaged in acquiring, working out, pooling and repackaging real estate 
debt and issuing CMBS. The Trust and the Funds are scheduled to 
terminate on January 17, 2002.
    4. The Trust owns BlackRock Capital Finance L.P. (``BCF''), which 
was formed to acquire performing and distressed commercial and 
residential loans and work out its distressed investments and pool and 
repackage its performing mortgage loans as mortgage-backed securities 
or otherwise dispose of loans and related properties. Most of the 
Trust's approximately $130 million in capital has been invested in BCF.
    5. Under an investment advisory agreement between the Trust and 
applicant, the Trust will pay to applicant both a semi-annual 
management fee equal to .75% per year of the capital commitments 
(during the three-year commitment period ending in 1998) or average 
capital invested (after the commitment period) and a performance fee 
(the ``Performance Fee''). The Performance Fee is payable as of the 
first anniversary of the commencement of the Trust's operations, as of 
each October 31 thereafter and as of the Trust's termination date.
    6. The Performance Fee was extensively negotiated between applicant 
and three ``lead investors,'' large institutional investors in Funds II 
and III whose commitment represents almost 48% of the capital 
commitments of all the Funds. The Performance Fee was designed both to 
require that the Trust achieve at least a 10% annualized total return 
before applicant is entitled to any Performance Fee and then to further 
delay its entitlement to such fees until the investors have received 
distributions at least equal to the amount of capital invested in the 
Trust.
    7. The maximum Performance Fee is 20% of realized total return net 
of any unrealized losses plus an interest factor related to the delayed 
payment feature discussed above. In order to ``catch up'' after the 10% 
minimum annualized return is achieved, the stated rate of the 
Performance Fee is 40% on the total return between 10% and 20% per year 
and then reverts to the 20% rate for all incremental returns once the 
average annual performance has reached 20%.

Applicant's Legal Analysis

    1. Section 205(a)(1) of the Act prohibits an investment adviser 
from performing under an investment advisory contract that provides for 
compensation to the adviser based on a share of capital gains upon or 
capital appreciation of a client's funds. Section 206A authorizes the 
SEC to exempt any person from any provision of the Act to the extent 
necessary or appropriate in the public interest and consistent with the 
protection of investors and the purposes of the Act.
    2. Rule 205-3 under the Act allows a registered adviser to charge a 
fee based upon a share of capital gains or capital appreciation of a 
client's account under certain conditions. Paragraph (b)(1) of the rule 
requires that the client must

[[Page 59257]]

have either a minimum account size of $500,000 or a net worth over $1 
million.
    3. Although the Performance Fee is assessed against the Trust 
(rather than directly against investors in the Funds), paragraph (b)(2) 
of the rule requires in effect that each investor in each of the Funds 
must meet the objective financial test of $500,000 under management or 
$1,000,000 in net worth set forth in paragraph (b)(1). Applicant 
represents that, except for the objective financial qualifications 
established by rule 205-3, all the other requirements of rule 205-3 are 
satisfied.\2\
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    \2\ Rule 205-3 requires, first, that the adviser's compensation 
must be based upon a formula that includes realized capital losses, 
and under certain conditions, unrealized capital depreciation. 
Second, the compensation must be based upon performance over a 
period of not less than one year. Third, the adviser must disclose 
certain information to the client. Finally, the adviser must 
reasonably believe that the advisory contract represents an arm's-
length arrangement and that the client understands the performance 
fee and its risks.
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    4. Individuals who do not have $1,000,000 in net worth and who are 
employees either of applicant or of BCF seek to invest in Fund III in 
amounts less than $500,000. These individuals do not satisfy the 
objective financial test set out in rule 205-3(b)(1). Consequently, 
rule 205-3 does not permit, and section 205(a)(1) would prohibit, 
applicant from charging the Performance Fee to the Trust if such 
individuals invest in Fund III. Applicant requests that the SEC allow 
it to charge the Performance Fee to all investors, including the non-
qualifying employees of applicant and BCF.
    5. Applicant represents that each of the individuals in question 
has a college degree or graduate school training and years of 
experience in the mortgage securities investment business and is 
closely involved in the daily business of applicant or BCF. In 
addition, such non-qualifying personnel all hold positions of vice-
president and above (including principal and managing director). 
Accordingly, each of these individuals has a professional understanding 
of the risk associated with the Trust's investment program as well as 
the degree of risk being undertaken by applicant in achieving the 
program.
    6. Applicant argues that the financial sophistication of the non-
qualifying employees is exactly what the SEC sought to assure by 
imposing the exemptive conditions of rule 205-3. In the adopting 
release, the SEC stated that the objective financial criteria set forth 
in rule 205-3 are intended to assure that the rule will be limited to 
advisory contracts with clients who are financially sophisticated and 
capable of bearing the increased risks associated with incentive fee 
arrangements.\3\ In addition, applicant states that it will make a good 
faith judgment as to the sophisticated nature of each investor relative 
to the affairs of the Trust.
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    \3\ See Investment Advisers Act Release No. 996 (Nov. 14, 1985) 
(adopting rule 205-3).
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    7. Applicant further states that each of the individual employees 
who does not qualify under rule 205-3(b)(1) is an ``accredited 
investor,'' as such term is defined in rule 501 of Regulation D under 
the Securities Act of 1933.\4\ Each such employee who chooses to invest 
in Fund III also would execute a binding subscription agreement 
committing to invest between $25,000 and $100,000.
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    \4\ Rule 501 of Regulation D defines an accredited investor to 
include, as here relevant, any natural person having an income of 
greater than $200,000 for each of the previous two years and an 
expectation of the same income level for the current year.
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    8. Substantially all of applicant's most senior personnel who do 
qualify under rule 205-3(b)(1) have committed up to $28 million for 
Fund III and also share in applicant's profits through incentive 
compensation plans. Applicant believes that the fact that they have 
substantial amounts at stake moderates any incentive to take the kinds 
of investment risks that concerned Congress when it adopted section 
205(a)(1) and tends to ensure a community of interest with all other 
investors, including the proposed non-qualifying investors.
    9. Applicant believes that there is also a strong commonality of 
interest between the qualifying personnel and non-qualifying employees 
who may wish to invest in Fund III, because the two groups work closely 
together in conducting the business of the Trust or BCF. The non-
qualifying employees are, for example, actively involved in meeting 
with prospective sellers and buyers of real estate debt, structuring 
potential transactions, and preparing financial statements and reports 
to investors. These functions all require a high degree of financial 
sophistication. As members of the term who expect to make the Trust 
successful, they would like to be able to participate in that success 
along with the more senior personnel through an equity investment.
    10. Applicant believes that the terms of the Performance Fee 
eliminate the ability--and any incentive--for applicant to engage in 
speculative trading practices or artificially enhance its fee by 
loading profits into one year and losses into another year. The 
Performance Fee takes into account both realized and unrealized losses, 
but only realized gains. In addition, it is measured only against 
cumulative performance over the life of the Trust and is payable only 
after a cumulative minimum return to investors has been achieved. 
Further, its accrual and payment are further delayed to minimize the 
possibility that Performance Fees paid for good performance in the 
early years could not be recovered by the Trust in later years if 
performance fell. Applicant also notes that investors in the Funds will 
receive annual and semi-annual reports with attached financial 
statements regarding the Funds, the Trust and the Trust's ``downstream 
affiliates'' as well as tax information regarding those entities, 
including BCF.

Applicant's Conditions

    Applicant agrees that any order granting the requested exemptive 
relief may be made subject to the following conditions.
    1. Applicant's investment advisory arrangement with the Trust will 
satisfy all the conditions of rule 205-3 of the Act, except for the 
objective financial standards set forth in paragraph (b)(1) thereof as 
they apply to the ``non-qualifying'' employees of applicant or BCF.
    2. Applicant will use its best efforts to ensure that no shares of 
any of the Funds or any interests therein are transferred to any person 
that does not satisfy the applicable objective financial standards of 
rule 205-3(b)(1).

    For the SEC, by the Division of Investment Management, under 
delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-29715 Filed 11-20-96; 8:45 am]
BILLING CODE 8010-01-M