[Federal Register Volume 62, Number 152 (Thursday, August 7, 1997)]
[Rules and Regulations]
[Pages 42401-42410]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-20747]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release Nos. IC-22775, IS-1095; File No. S7-7-96]
RIN 3235-AG61


Exemption for the Acquisition of Securities During the Existence 
of An Underwriting or Selling Syndicate

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Commission is adopting amendments to the rule under the 
Investment Company Act of 1940 that permits an investment company that 
is related to certain participants in an underwriting to purchase 
securities during an offering, if certain conditions are met. The 
amendments increase the percentage of an underwriting that investment 
companies having the same investment adviser may purchase in reliance 
on the rule, and expand the scope of the rule to include securities of 
certain foreign and domestic issuers that are not registered with the 
Commission under the Securities Act of 1933. The amendments respond to 
changes in the investment company and underwriting industries that have 
occurred since the rule last was substantively amended in 1979.

EFFECTIVE DATE: The rule amendments will become effective October 6, 
1997.

FOR FURTHER INFORMATION CONTACT: C. Hunter Jones, Special Counsel, 
Office of Regulatory Policy, or Nadya B. Roytblat, Assistant Director, 
Office of Investment Company Regulation, Division of Investment 
Management, at (202) 942-0690, U.S. Securities and Exchange Commission, 
450 5th Street, N.W., Mail Stop 10-2, Washington, D.C. 20549.
    Requests for formal interpretive advice should be directed to the 
Office of Chief Counsel at (202) 942-0659, Division of Investment 
Management, U.S. Securities and Exchange Commission, 450 5th Street, 
N.W., Mail Stop 10-6, Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Commission today is adopting amendments 
to rule 10f-3 (17 CFR 270.10f-3) under the Investment Company Act of 
1940 (15 U.S.C. 80a) (the ``Investment Company Act'').

Table of Contents

Executive Summary

I. Background
    A. Introduction
    B. Proposed Amendments to Rule 10f-3
II. Discussion
    A. Quantity Limitations
    1. Percentage of Offering Purchased
    2. Percentage of Fund Assets
    B. Foreign Offerings and Rule 144A Securities
    1. Eligible Foreign Offerings
    2. Rule 144A Offerings
    3. Calculation of Percentage Limit in Global Offerings
    C. Price and Timing of the Purchase
    D. Group Sales
    E. Role of Fund Board of Directors
    F. Reporting and Recordkeeping
    G. U.S. Government Securities
III. Cost-Benefit Analysis
IV. Paperwork Reduction Act
V. Summary of Regulatory Flexibility Analysis
VI. Statutory Authority
Text of Rule

Executive Summary

    The Commission is adopting amendments to rule 10f-3 under the 
Investment Company Act. Rule 10f-3 provides an exemption from section 
10(f), which prohibits any registered investment company (``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 for the securities. The amendments are intended to 
provide funds with additional flexibility, consistent with the 
protection of investors, to make investments that may be in the best 
interests of investors.
    The amendments will permit a fund subject to the rule, together 
with other funds that have the same investment adviser, to purchase, 
during the existence of an underwriting or selling syndicate:
     Up to 25% of the principal amount of an offering;
     Securities of foreign issuers or of domestic reporting 
issuers in an ``Eligible Foreign Offering''; and
     Certain securities that are exempt from registration and 
are eligible for resale pursuant to rule 144A under the Securities Act 
of 1933 (``Securities Act'').
    The Commission is not adopting the amendment that would have 
permitted a fund subject to the rule to purchase municipal securities 
in a group sale (i.e., a purchase for which all members of an 
underwriting syndicate, including the affiliated underwriter, receive 
credit). Rather, in light of the comments, the Commission has concluded 
that there is insufficient justification at this time to alter the 
treatment of group sales of municipal securities under rule 10f-3.

I. Background

A. Introduction

    Section 10(f) of the Investment Company Act was designed to address 
one of the major abuses noted in the period before enactment of the 
Investment Company Act--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 by facilitating 
price stabilization in connection with an underwriting.
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    \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).
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    Section 10(f) prohibits any fund from purchasing any security for 
which an affiliated underwriter is acting as a principal 
underwriter,2 during the existence of an underwriting or 
selling syndicate for that security.3 Congress

[[Page 42402]]

recognized that section 10(f), by prohibiting all purchases by a fund 
having the specified relationships with an underwriter (``affiliated 
fund'') during the existence of the underwriting or selling syndicate, 
could be overly broad. Thus, Congress gave the Commission specific 
authority to exempt persons from that prohibition when an exemption 
would be consistent with the protection of investors.4
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    \2\ ``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.
    \3\ Section 10(f) [15 U.S.C. 80a-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. As noted above, for purposes of 
this release, a person that falls within one of these categories is 
referred to as an ``affiliated underwriter,'' even though the 
Investment Company Act defines the term ``affiliated person'' to 
include a broader set of relationships. See section 2(a)(3) of the 
Investment Company Act [15 U.S.C. 80a-2(a)(3)]. Similarly, this 
release refers to a fund that is subject to section 10(f) as a 
result of its relationship with an ``affiliated underwriter,'' as an 
``affiliated fund.''
    \4\ Section 10(f) authorizes the Commission to exempt, by rule 
or order, conditionally or unconditionally, ``any transaction or 
classes of transactions from any of the provisions [of section 
10(f)], if and to the extent that such exemption is consistent with 
the protection of investors.'' By contrast, section 6(c) of the 
Investment Company Act [15 U.S.C. 80a-6(c)] authorizes the 
Commission more generally to exempt persons, securities, or 
transactions from provisions of the Investment Company Act if 
``necessary or appropriate in the public interest and consistent 
with the protection of investors and the purposes fairly intended by 
the policy and provisions'' of the Investment Company Act.
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    In 1958, the Commission used its exemptive authority under section 
10(f) to adopt rule 10f-3. 5 The rule currently permits a 
fund to purchase securities in a transaction that otherwise would 
violate section 10(f) if, among other things, (i) the securities either 
are registered under the Securities Act or are municipal securities, 
(ii) the offering involves a ``firm commitment'' underwriting, 
6 (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) (the 
``percentage limit''), (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 day 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.7 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.
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    \5\ 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 (Dec. 10, 1958)]. 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.
    \6\ 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 amended rule 10f-3(b)(5) 
[17 CFR 270.10f-3(b)(5)].
    \7\ 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]. See Prohibited 
Transaction Class Exemption 75-1 (Oct. 24, 1975) (Department of 
Labor class exemption permitting purchases in limited circumstances, 
subject to conditions similar to rule 10f-3); section 23B(b) of the 
Federal Reserve Act [12 U.S.C. 371c-1(b)] (prohibiting a bank or its 
subsidiary from purchasing, as principal or fiduciary, securities 
from underwriting syndicates in which an affiliate of the bank 
participates, but permitting acquisitions of such securities if a 
majority of the bank's independent directors have approved the 
acquisition in advance).
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B. Proposed Amendments to Rule 10f-3

    On March 21, 1996, the Commission issued a release proposing 
amendments to rule 10f-3 (``Proposing Release'').8 The 
proposed amendments to rule 10f-3 were intended to respond to concerns 
that the dramatic growth in the fund industry, combined with increasing 
concentration in the underwriting industry, and increasing business 
affiliations between funds and underwriters, had made the percentage 
limit too restrictive. The Proposing Release also noted that these 
trends have caused more funds to be subject to the prohibitions of 
section 10(f).9
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    \8\ Exemption for the Acquisition of Securities During the 
Existence of an Underwriting Syndicate, Investment Company Act 
Release No. 21838 (Mar. 21, 1996) [61 FR 13630 (Mar. 27, 1996)].
    \9\ See Proposing Release, supra note 8, at nn.9-20 and 
accompanying text; see also Jack Willoughby, Fortify'40--or Fight, 
Institutional Investor, Jan. 1997, at 15-16 (noting increasing 
affiliation between fund management and securities underwriting 
firms).
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    The proposed amendments were 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. The 
proposed amendments would have eased some of the restrictions of the 
rule to take into account fundamental changes in the industry, while 
preserving those parts of the rule that continue to protect investors.
    The Commission received 18 comment letters on the proposed 
amendments to rule 10f-3. Commenters were supportive of the direction 
of the proposed amendments; many urged the Commission to further loosen 
the restrictions imposed by the rule. The Commission is adopting 
amendments to rule 10f-3 with a number of changes from the amendments 
as proposed, in view of the issues raised by commenters.10
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    \10\ The amendments also add headings to the text of rule 10f-3 
in order to make the rule more understandable and usable. In 
addition, the title of the rule has been changed to ``Exemption for 
the acquisition of securities during the existence of an 
underwriting or selling syndicate'' to conform to the language of 
section 10(f).
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II. Discussion

A. Quantity Limitations

1. Percentage of Offering Purchased
    Rule 10f-3 limits the amount of securities that affiliated funds 
may purchase during the existence of an underwriting or selling 
syndicate. As discussed in the Proposing Release, the purpose of the 
percentage limit is to provide an indication that a significant portion 
of an offering is being purchased by persons other than a single 
affiliated fund complex.11
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    \11\ See Proposing Release, supra note 8, at n.14 and 
accompanying text.
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    The percentage limit in 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 more than 10% of the 
offering.12 The Proposing Release noted that the current 
percentage limit appears to be more restrictive than necessary for the 
protection of fund investors. As a result, the percentage limit may 
impose unnecessary costs. Affiliated funds that are limited to 
purchasing 4% of an offering, if they wish to purchase more than that 
amount, must wait until the underwriting or selling syndicate 
terminates, and purchase the securities in the secondary market. This 
delay can cause these funds to pay a significantly higher price for the 
securities and incur significant additional transaction 
costs.13 Thus, funds that are restricted

[[Page 42403]]

by the percentage limit of rule 10f-3 might not be able to purchase 
desirable securities at prices that would benefit their 
portfolios.14 In addition, because compliance with the 
percentage limit is based on purchases by all funds with the same 
investment adviser, the percentage limit presents particular problems 
for fund complexes that have several funds that might have an interest 
in purchasing the security.15
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    \12\ Rule 10f-3(d).
    \13\ 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, 
Securities Regulation 333 n.28 (1989); 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, for example, funds must pay brokerage commissions that 
they usually do not pay when purchasing directly in an underwritten 
offering.
    \14\ 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 significant effect on the funds' 
portfolios. The portfolio managers of the funds may then decide not 
to purchase the security at all.
    \15\ For example, some fund complexes have over fifty funds. 
Perhaps as many as twenty of the funds might be interested in 
purchasing a security in a primary offering because investing in the 
security is consistent with each fund's investment objectives. In 
that case, those twenty funds must limit their total purchases of 
the security to the greater of 4% of the offering or $500,000, but 
in no event more than 10% of the offering.
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    In response to these concerns and changes in the industry, the 
Commission proposed to amend the percentage 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 million, but in no event more 
than 15% of the offering.16 Commenters generally agreed with 
the reasons for raising the percentage limit. Most commenters stated 
that the percentage limit should be significantly higher than that 
proposed, and many suggested that the percentage limit be eliminated 
entirely. No commenter suggested that the current percentage limit be 
retained or lowered. Commenters differed, however, on the appropriate 
percentage limit.17
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    \16\ See Proposing Release, supra note 8, at nn.21-26 and 
accompanying text.
    \17\ Comments ranged from supporting the percentage limit as 
proposed, to a percentage limit as high as 80%.
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    The Commission continues to believe that the percentage limit 
provides assurance that a significant portion of an offering will be 
purchased by persons other than a single fund complex affiliated with 
an underwriter, and should continue to be a component of the 
protections afforded by rule 10f-3. At the same time, the constraints 
of the percentage limit appear to be more restrictive on funds than 
they have been in the past, as a result of the growth in the fund 
industry and the increasing importance of funds as purchasers of 
securities.18 These effects have been particularly acute for 
municipal bond funds.19
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    \18\ As the Proposing Release noted, in 1980 there were 564 
funds with total assets of $134.8 billion, and in 1995 there were 
5,789 funds with total assets of over $2.8 trillion. Proposing 
Release, supra note 8, at n.10. By December 1996, there were 6,270 
funds with total assets of over $3.5 trillion. Investment Company 
Institute, Press Release (Jan. 28, 1997). Assets invested in funds 
currently exceed account deposits at commercial banks. See Board of 
Governors of the Federal Reserve System, Flow of Funds Accounts of 
the United States (Mar. 14, 1997) (table L.109).
    \19\ Increases in the demand for municipal bonds by mutual funds 
have outpaced increases in the supply of new municipal bonds. In 
1980, 42 municipal bond funds held under $3 billion in municipal 
bonds. By 1996, 1,180 municipal bond funds held over $287 billion in 
municipal bonds. By contrast, the growth in municipal bond supply 
has grown only modestly: in 1980, approximately $47 billion in 
municipal bonds were issued; by 1996, issuances had only grown about 
fourfold, to $184 billion. Investment Company Institute, 1997 Mutual 
Fund Fact Book 68; Investment Company Institute, 1986 Mutual Fund 
Fact Book 19; Investment Company Institute, 1981 Mutual Fund Fact 
Book 77; Investment Company Institute, Press Release (Jan. 28, 
1997); Bond Buyer, 1997 Yearbook 11; Bond Buyer, 1990 Yearbook 38; 
Lipper Closed-End Fund Performance Analysis Service (Jan. 1997), at 
78. Some commenters noted that the withdrawal of several investment 
banks from the municipal bond business has intensified these 
pressures.
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    Subsequent to the Commission's adoption of the current percentage 
limit in 1979, fund ownership of securities increased substantially, 
both in absolute levels and as a percentage of total securities owned 
by all securityholders.20 Given the consistent, dramatic 
growth in fund assets, and in light of the Commission's administrative 
experience with rule 10f-3 as well as the protections provided by the 
rule's other conditions, the Commission believes that adopting a 
percentage limit higher than the proposed limit is 
appropriate.21
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    \20\ In 1979, funds (not including insurance company separate 
accounts) owned approximately 2% ($61.6 billion) of outstanding 
securities (including U.S. government securities); in 1996, funds 
owned approximately 13% ($2.7 trillion) of outstanding securities, 
an increase in the percentage of ownership of over 500% compared to 
1979. See Board of Governors of the Federal Reserve System, Flow of 
Funds Accounts of the United States, 1979-1988 (Mar. 14, 1997) 
(tables L.209 through L.214); Board of Governors of the Federal 
Reserve System, Flow of Funds Accounts of the United States (Mar. 
14, 1997) (tables L.209 through L.214).
    \21\ See amended rule 10f-3(b)(7) [17 CFR 270.10f-3(b)(7)].
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    The Commission has amended rule 10f-3 to provide a 25% limit on the 
principal amount of an offering that affiliated funds may purchase. A 
percentage limit of 25% of the principal amount of an offering should 
provide assurance that a significant portion of the offering is being 
distributed to investors not affiliated with the funds, while affording 
significant relief to purchasing funds compared to the percentage limit 
currently imposed in rule 10f-3. The Commission believes that a 25% 
limit would prevent a single fund complex affiliated with an 
underwriter from purchasing the majority of an offering, and should 
provide some assurance that purchasers other than one or two fund 
complexes affiliated with the underwriters are purchasing securities in 
the offering.22 The Commission recognizes that this limit is 
significantly below that suggested by many industry commenters. The 
Commission is unconvinced at this time, however, that the case for 
raising the percentage limit higher has been made persuasively by 
commenters.
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    \22\ With respect to the calculation of the percentage limit in 
Eligible Rule 144A Offerings, see infra note 34 and accompanying 
text. With respect to the calculation of the percentage limit in 
multi-class or multi-tranche offerings, see infra Section II.B.3.
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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 in reliance on the 
rule (the ``3% limit'').23 The Commission proposed to 
eliminate this limit, noting that the other provisions of rule 10f-3 
provide sufficient protections against dumping, and that the 
diversification provisions of the Investment Company Act provide 
shareholders of most funds with protections similar to those provided 
by the 3% limit.24 Commenters supported the proposed 
amendment eliminating the 3% limit, which the Commission is adopting.
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    \23\ Rule 10f-3(e).
    \24\ See section 5(b)(1) of the Investment Company Act [15 
U.S.C. 80a-5(b)(1)] (limiting 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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B. Foreign Offerings and Rule 144A Securities

    A fund currently cannot rely on rule 10f-3 to purchase securities 
of any issuer, including a foreign issuer, unless the securities are 
registered under the Securities Act or are municipal securities. The 
proposed amendments would have permitted a fund to purchase securities 
issued by a foreign issuer that were not registered under the 
Securities Act if the securities were issued in either an ``Eligible 
Foreign Offering'' or a ``Foreign Issuer Rule 144A Offering,'' as 
defined in the proposed amendments. Commenters generally supported 
extending the rule to purchases of foreign securities that are not 
registered under the Securities Act. The Commission is adopting the 
amendments related to foreign

[[Page 42404]]

securities, with certain modifications from the proposal in response to 
issues raised by commenters, as described below.
    In considering the proposed amendments related to offerings of 
foreign securities, the Commission also focused on similar issues 
related to domestic issuers that might sell their securities outside 
the United States or privately in unregistered offerings. The 
Commission has concluded that rule 10f-3 should be extended to 
securities of certain domestic issuers that are sold in foreign 
offerings or that are exempt from registration and eligible for resale 
pursuant to rule 144A.25
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    \25\ 17 CFR 230.144A.
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1. Eligible Foreign Offerings
    The amendments permit an affiliated fund to purchase securities in 
a public offering that is conducted under the laws of a country other 
than the United States (``Eligible Foreign Offering'').26 An 
Eligible Foreign Offering must be subject to regulation by a foreign 
financial regulatory authority, as defined in the Investment Company 
Act, in the country in which the public offering occurs.27 
The rule also requires that financial statements of the issuer of the 
securities that are prepared and audited in a manner required or 
permitted by the appropriate foreign financial regulatory authority in 
the country in which the Eligible Foreign Offering occurs, for the two 
years prior to the offering, must be made available in connection with 
the offering.28
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    \26\ Amended rule 10f-3(a)(2) [17 CFR 270.10f-3(a)(2)].
    \27\ Amended rule 10f-3(a)(2)(i) [17 CFR 270.10f-3(a)(2)(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.
    \28\ Amended rule 10f-3(a)(2)(iii) [17 CFR 270.10f-
3(a)(2)(iii)]. The amendments as adopted do not specify the format 
of the financial statements that must be provided, in recognition 
that financial reporting standards differ from country to country. 
Nor do the amendments specify that applicable foreign law must 
require the issuer to disclose information about itself and the 
offering to prospective purchasers. The other components of the 
definition of an Eligible Foreign Offering should make this 
condition unnecessary. Fund management should determine whether 
there is sufficient information concerning the issuer and the 
offering to ensure that the securities are marketable and that the 
other conditions of the rule, particularly those related to the 
price and timing of the purchase of the securities, are satisfied.
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    The rule, as proposed, would have limited Eligible Foreign 
Offerings to offerings by foreign issuers. The Commission has decided 
to permit an affiliated fund to purchase a domestic issuer's securities 
offered in an Eligible Foreign Offering, provided that the domestic 
issuer is a reporting issuer.29 This requirement is designed 
to provide assurance that the issuer is not making a foreign offering 
in order to avoid the disclosure requirements of the U.S. securities 
laws to facilitate the dumping of securities on affiliated funds.
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    \29\ Amended rule 10f-3(a)(2)(iv) [17 CFR 270.10f-3(a)(2)(iv)] 
(requiring that the domestic issuer (1) have a class of securities 
registered pursuant to section 12(b) or 12(g) of the Securities 
Exchange Act of 1934 (``Exchange Act'') or be required to file 
reports pursuant to section 15(d) of the Exchange Act, and (2) have 
filed all the material required to be filed pursuant to section 
13(a) or 15(d) of the Exchange Act for the 12 months preceding the 
offering).
    Separate from the conditions included in rule 10f-3, Regulation 
S under the Securities Act [17 CFR 230.901-.904] contains certain 
limitations on the availability of its safe harbor from registration 
for foreign offers and sales by domestic issuers. Rule 10f-3 exempts 
certain transactions only from the prohibitions contained in section 
10(f) of the Investment Company Act. Nothing in this release should 
be interpreted to suggest that the requirements and limitations of 
Regulation S do not apply to transactions permitted under rule 10f-
3. See Offshore Offers and Sales, Securities Act Release No. 6863 
(Apr. 24, 1990) [55 FR 18306 (May 2, 1990)]. The Commission recently 
proposed amendments to Regulation S that would, if adopted, treat 
equity securities of domestic issuers and equity securities of 
foreign issuers with primary trading markets in the United States as 
restricted securities for purposes of rule 144 under the Securities 
Act [17 CFR 230.144]. See Offshore Offers and Sales, Securities Act 
Release No. 7392 (Feb. 20, 1997) [62 FR 9258 (Feb. 28, 1997)].
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2. Rule 144A Offerings
    Many fund purchases of foreign issuer securities are made in 
offerings that are exempt from the registration provisions of the 
Securities Act and in which the securities are eligible for resale 
pursuant to rule 144A under the Securities Act (``rule 144A 
offerings'').30 Rule 144A is a non-exclusive safe harbor 
that exempts from the registration provisions of the Securities Act 
resales of securities to certain institutions, known as Qualified 
Institutional Buyers (``QIBs'').31
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    \30\ 17 CFR 230.144A. In 1993, funds purchased more foreign 
equity securities in rule 144A offerings than did any other type of 
purchaser. See Securities and Exchange Commission, Staff Report on 
Rule 144A 15 (1994) (``Staff Report'').
    \31\ 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 that owns or invests on a discretionary basis at least 
$100 million of certain 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 owns, in the aggregate, 
at least $100 million of certain securities. 17 CFR 
230.144A(a)(1)(iv).
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    A rule 144A offering of a foreign issuer's securities often is part 
of a larger global offering. Sometimes 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. Other times, there 
is a single home country tranche from which limited amounts of 
securities may be sold in the United States and elsewhere. In both 
cases, the price for the securities is uniform to all purchasers, and 
the issuer prepares an offering document that provides detailed 
information about the issuer and the offered securities.32
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    \32\ 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 30, at 26. It has been suggested, 
however, that most securities eligible for resale pursuant to rule 
144A are sold in underwriting arrangements with terms and conditions 
substantially similar to those applicable to registered public 
offerings. See 1 Edward Greene et al., U.S. Regulation of the 
International Securities Markets: A Guide for Domestic and Foreign 
Issuers and Intermediaries 141 (1993); see also Report of The 
Advisory Committee on the Capital Formation and Regulatory 
Processes, Appendix A at 39-42 (1996) (stating that rule 144A 
offerings bear increasing resemblance to public offerings, and that, 
due to the active participation of mutual funds as buyers and 
sellers of rule 144A debt securities, ``liquidity is readily 
available, even without subsequent registration.'' (footnote 
omitted)). Rule 144A requires an issuer to provide certain 
information about itself 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) under the Exchange Act [17 CFR 240.12g3-
2(b)]. See 17 CFR 230.144A(d)(4)(i).
---------------------------------------------------------------------------

    The proposed amendments would have permitted a fund to purchase 
securities in a ``Foreign Issuer Rule 144A Offering,'' subject to the 
other conditions of rule 10f-3 (except for the Securities Act 
registration requirement). Most commenters supported this proposal. The 
Commission is adopting these amendments with a number of changes that 
should accommodate a greater variety of offering structures, in a 
manner consistent with the protection of investors.33
---------------------------------------------------------------------------

    \33\ The adopted amendments define the phrase ``Eligible Rule 
144A Offering'' in lieu of the phrase ``Foreign Issuer Rule 144A 
Offering'' because, as discussed further below, the amendments 
permit the purchase of securities of both foreign and domestic 
issuers in Rule 144A offerings. Amended rule 10f-3(a)(4) [17 CFR 
270.10f-3(a)(4)]. In order to clarify the nature of an Eligible Rule 
144A Offering, the definition specifies that the securities must be 
sold in certain types of transactions exempt from the registration 
requirements of the Securities Act. Amended rule 10f-3(a)(4)(i) [17 
CFR 270.10f-3(a)(4)(i)]. The amended rule provides that the fund may 
reasonably rely on the written statements of the issuer or an 
underwriter in determining whether this condition has been 
satisfied. See amended rule 10f-3(b)(3) [17 CFR 270.10f-3(b)(3)].
    The amendments in no way affect the determination that must be 
made by a fund's board 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 (Apr. 30, 1990)].

---------------------------------------------------------------------------

[[Page 42405]]

    The proposed amendments would have required that securities offered 
in a Foreign Issuer Rule 144A Offering also be offered in a concurrent 
Eligible Foreign Offering. The Proposing Release stated that the 
concurrent public offering requirement was designed to provide 
assurance that there would be a widespread distribution of securities 
that are fungible with the securities purchased by the fund. One 
commenter specifically supported this approach, but several commenters 
opposed it, stating that rule 144A offerings often do not involve a 
concurrent foreign public offering of securities of the same class. In 
response to a request for comment, several commenters also suggested 
that the rule should permit affiliated funds to purchase securities of 
domestic issuers in rule 144A offerings. The Commission has decided to 
amend rule 10f-3 to permit the purchase of securities in rule 144A 
offerings of foreign and domestic issuers, subject to the other 
conditions of the rule.
    The Commission is making two additional changes that are reflected 
in the definition of ``Eligible Rule 144A Offering.'' The proposed 
amendments would have required that securities purchased in an Eligible 
Rule 144A Offering be purchased ``in the United States.'' This 
requirement has been eliminated. Second, the proposed amendments would 
have required that the offer or sale be made ``exclusively'' to QIBs. 
Several commenters suggested that the sale of a portion of the offering 
to non-QIBs should not prevent an affiliated fund from purchasing 
securities in the offering. The amended rule therefore does not include 
the exclusivity requirement because, as suggested by commenters, it may 
be unnecessarily limiting. The percentage limit as applied to an 
Eligible Rule 144A Offering, however, would be measured with respect to 
the portion of the offering sold to QIBs.34
---------------------------------------------------------------------------

    \34\ A purchasing fund under the rule need not be a QIB. If 
there is a concurrent Eligible Foreign Offering with respect to an 
Eligible Rule 144A Offering, the percentage limit may be calculated 
by reference to the securities sold in both offerings. See amended 
rule 10f-3(b)(7)(ii) [17 CFR 270.10f-3(b)(7)(ii)].
---------------------------------------------------------------------------

3. Calculation of Percentage Limit in Global Offerings
    Several commenters recommended that the Commission clarify that the 
percentage limit in the context of a global offering applies to the 
entire global offering rather than to the U.S. portion of the offering. 
The Commission staff has stated that in a global, multi-tranche 
offering of securities with identical terms at an identical offering 
price, with various closings that are conditioned upon each other, 
calculation of the percentage limit may properly be based on the total 
amount of the entire global offering.35
---------------------------------------------------------------------------

    \35\ See Rowe Price-Fleming International Inc., SEC No-Action 
Letter (Apr. 12, 1996).
---------------------------------------------------------------------------

    The Commission believes that this approach is consistent with the 
purpose of section 10(f) and rule 10f-3, and with the protection of 
investors. This method of calculating the percentage limit would not be 
appropriate, however, in an offering of different classes or series of 
a security when each class or series has different terms, whether 
conducted in one country or in many countries.36
---------------------------------------------------------------------------

    \36\ For example, if an issuer offers multiple classes, series 
or tranches of a security, with each class, series or tranche having 
different maturity dates, interest rates and yields, it would be 
inappropriate to calculate the percentage limit with respect to the 
total value of all of the securities offered. Rather, the percentage 
limit would be calculated with respect to each class, series or 
tranche of the issue. With respect to municipal securities, the 
Commission has stated in the past that a single offering of 
municipal securities would not be deemed to be separate classes of 
securities for purposes of the percentage limit solely by virtue of 
differing maturity dates. See Exemption of Acquisition of Securities 
During the Existence of Underwriting Syndicate, Investment Company 
Act Release No. 10592 (Feb. 13, 1979) [44 FR 10580 (Feb. 21, 1979)] 
at n.21.
---------------------------------------------------------------------------

C. Price and Timing of the Purchase

    Rule 10f-3 currently requires that a security purchased in reliance 
on the rule be ``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.'' 37 This 
provision is intended to provide assurance that the price paid by the 
affiliated fund is no higher than that paid by similarly situated but 
unaffiliated purchasers, and that the purchase occur before the 
underwriters know if the offering is fully subscribed.38
---------------------------------------------------------------------------

    \37\ Rule 10f-3(a)(2).
    \38\ See Investment Company Acquisition of Securities 
Underwritten by an Affiliate of That Company, Investment Company Act 
Release No. 14924 (Jan. 29, 1986) [51 FR 4386 (Feb. 4, 1986)] at 
n.17 and accompanying text.
---------------------------------------------------------------------------

    The amended rule clarifies this language and provides that the 
securities must be purchased ``prior to the end of the first day on 
which any sales are made, at a price that is not more than the price 
paid by each other purchaser of securities in that offering or in any 
concurrent offering of the securities.'' 39 The provision 
should be applied to offerings registered under the Securities Act, 
municipal offerings, and to Eligible Foreign Offerings in the same way 
as the pre-amendment provision.40 With regard to Eligible 
Rule 144A Offerings, this provision requires funds purchasing 
securities to pay no more than the public offering price in any 
concurrent public offering of the same securities. In addition, the 
price that funds pay for securities in the Eligible Rule 144A Offering 
must not be higher than that paid by other purchasers (other than 
underwriters or members of the selling syndicate) in the same offering.
---------------------------------------------------------------------------

    \39\ Amended rule 10f-3(b)(2)(i) [17 CFR 270.10f-3(b)(2)(i)]. As 
proposed, the amended rule provides an exception from the pricing 
requirement in an Eligible Foreign Offering if rights to purchase 
the securities are offered as ``required by law to be granted to 
existing security holders of the issuer.'' Id.
    \40\ The change in language from referring to the day on which 
the securities are ``offered to the public'' to referring to the day 
on which ``any sales are made'' is not intended to make a 
substantive change to this condition; rather, it is intended to 
reflect the development of shelf registration as well as current 
business practice and usage of the terms. Sales would be made on the 
first day on which the underwriter accepts orders to purchase the 
securities--not the day on which the underwriter purchases the 
securities from the issuer. The amended requirement that the 
purchase must occur ``prior to the end of the first day'' conforms 
the rule text to the Commission's long-standing interpretation of 
this condition. Id.
---------------------------------------------------------------------------

D. Group Sales

    The proposed amendments to rule 10f-3 would have permitted the 
purchase of municipal securities in ``group sales.'' 41 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.42 Rule 10f-3 currently 
prohibits a fund from purchasing a security, directly or indirectly, 
from its affiliated underwriter. This provision of the rule permits a 
purchase from a syndicate manager, but not if the purchase is through a 
group sale.43 This

[[Page 42406]]

provision is 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 from 
an affiliate of an affiliate.44
---------------------------------------------------------------------------

    \41\ Rule 10f-3 currently defines ``municipal securities'' by 
reference to section 3(a)(29) of the Exchange Act [15 U.S.C. 
78c(a)(29)]. See rule 10f-3(a)(1)(ii).
    \42\ 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) [59 
FR 54665 (Nov. 1, 1994)] (Notice of Application).
    \43\ By contrast, an affiliated fund may, under rule 10f-3, 
purchase a municipal security through an order in which the fund 
designates one or more of the syndicate participants to receive 
credit for the sale (also known as a ``designated order''), provided 
that the fund does not designate its affiliated underwriter as one 
of the recipients of the credit.
    \44\ 15 U.S.C. 80a-17(a).
---------------------------------------------------------------------------

    According to Municipal Securities Rulemaking Board rules, a 
syndicate that is offering municipal securities must establish a 
priority by which orders for the securities will be 
filled.45 The proposed amendments related to group sales 
were based on the assumption that group orders frequently receive first 
priority,46 and that the prohibition in rule 10f-3 on group 
sales therefore could act to the detriment of affiliated municipal bond 
funds by preventing them from purchasing municipal bonds in 
oversubscribed offerings in which only group orders are filled. The 
proposed amendments would have permitted group sales if (1) the 
syndicate were to establish that orders designated as group orders 
would have first priority, or that only group orders would be filled 
and (2) at the time of sale, the affiliated underwriters were not 
committed to underwrite more than 50% of the principal amount of the 
offered securities.
---------------------------------------------------------------------------

    \45\ See MSRB Rule G-11(e), MSRB Manual (CCH) para. 3551.
    \46\ See Proposing Release, supra note 8, at n.57 and 
accompanying text (citing Public Securities Association, 
Fundamentals of Municipal Bonds 80 (1990)).
---------------------------------------------------------------------------

    Two commenters disagreed with the factual premise of the proposed 
group sale provision. These commenters stated that group orders 
typically do not receive first priority in offerings, but rather that 
``designated orders'' (orders in which the purchaser designates one or 
more members of the syndicate to receive credit for the sale) often 
receive first priority. One commenter suggested that the proposed 
amendment could have the unintended effect of encouraging syndicate 
managers to give group orders first priority in municipal offerings 
when they otherwise would not.
    Under the current rule, an affiliated fund may purchase municipal 
securities through a designated order, as long as the fund does not 
designate its affiliated underwriter as the recipient of the credit. In 
view of the availability of this option, the Commission has determined 
not to adopt the proposed group sale amendments.47 The 
Commission considered permitting group sales if the offering were 
oversubscribed and only group orders would be filled in the offering, 
but concluded that it would be impracticable to include such a 
condition in the rule at the present time. To the extent that the 
prioritization of group orders poses an impediment to the purchase of 
municipal securities under rule 10f-3, funds may seek exemptive relief 
from sections 10(f) and 17(a) as they have in the past, on a case-by-
case basis.
---------------------------------------------------------------------------

    \47\ In order to clarify that a purchase of municipal securities 
in a group sale proposed to be permitted by rule 10f-3 also would be 
exempt from the prohibition against affiliate transactions contained 
in section 17(a) of the Investment Company Act, the Commission 
proposed new rule 17a-10, to exempt any purchase of municipal 
securities in a group sale that complied with rule 10f-3 from 
section 17(a)(1). This rule is not being adopted.
---------------------------------------------------------------------------

E. Role of Fund Board of Directors

    Rule 10f-3 currently requires fund boards of directors to adopt 
procedures pursuant to which a fund may purchase securities in reliance 
on the rule. The Commission proposed to amend the requirement related 
to directors' duties to clarify that the directors must approve, rather 
than adopt, procedures for the purchase of securities pursuant to rule 
10f-3, in order to reflect more accurately the role of the board in 
approving policies and procedures developed by fund 
management.48 Two commenters specifically supported this 
proposed amendment. The Commission is adopting the amendment as 
proposed.49
---------------------------------------------------------------------------

    \48\ Proposing Release, supra note , at n.52.
    \49\ Amended rule 10f-3(b)(10) [17 CFR 270.10f-3(b)(10)].
---------------------------------------------------------------------------

    The Commission also requested comment on the role of fund directors 
in determining compliance with the proposed foreign securities 
provisions, and whether the existing requirements for the establishment 
and review of procedures are sufficient to cover the proposed 
amendments. Several commenters responded that the existing requirement 
concerning board duties is sufficient. The Commission has determined 
not to adopt any substantive change in the requirement concerning board 
duties. Fund boards are reminded, however, that changes in procedures 
will likely be required to accommodate purchases made under the 
amendments to rule 10f-3, including procedures concerning the 
reasonableness of commissions, spread or profit received by principal 
underwriters.50
---------------------------------------------------------------------------

    \50\ See amended rule 10f-3(b)(6) [17 CFR 270.10f-3(b)(6)].
---------------------------------------------------------------------------

    The Commission continues to recognize the important role played by 
the fund directors in safeguarding the interests of fund 
investors.51 A fund's board should be vigilant in reviewing 
the procedures and transactions as required by rule 10f-3 as well as in 
conducting any additional reviews that it determines are needed to 
protect the interests of investors, particularly if the fund purchases 
significant amounts of securities in reliance on rule 10f-3. For 
example, the board should consider monitoring how the performance of 
securities purchased in reliance on rule 10f-3 compares to securities 
not purchased in reliance on the rule, or to a benchmark such as a 
comparable market index. Such monitoring would enable the board to 
determine not only whether existing procedures are being followed, but 
also whether the procedures are effective in fulfilling the policies 
underlying section 10(f).52
---------------------------------------------------------------------------

    \51\ See., e.g., Burks v. Lasker, 441 U.S. 471, 484 (1979) 
(noting the importance of fund directors in ``furnishing an 
independent check upon management''); Division of Investment 
Management, U.S. Securities and Exchange Commission, Protecting 
Investors: A Half Century of Investment Company Regulation 251-260 
(1992) (describing the important functions of fund directors as 
required by the Investment Company Act and the rules thereunder).
    \52\ See amended rule 10f-3(b)(10)(ii) [17 CFR 270.10f-
3(b)(10)(ii)] (requiring the board to make and approve ``such 
changes to the procedures as the board deems necessary''). See also 
Exemption of Acquisition of Securities During the Existence of 
Underwriting Syndicate, Investment Company Act Release No. 10736 
(June 14, 1979) [44 FR 36152 (June 20, 1979)] (stating that the 
``Commission expects that investment company directors, in 
establishing procedures under [rule 10f-3] and determining 
compliance with such procedures, will address the concerns embodied 
in section 10(f) of the Act against overreaching and the placing of 
otherwise unmarketable securities with an investment company'').
---------------------------------------------------------------------------

F. Reporting and Recordkeeping

    The proposed amendments would have eliminated the current 
requirement in rule 10f-3 that a fund report any transactions under 
rule 10f-3 to the Commission in its semi-annual report on Form N-SAR 
and attach to that form certain written records of those 
transactions.53 In view of the increase in the percentage 
limit and the other amendments the Commission is adopting today, the 
Commission believes that the current reporting

[[Page 42407]]

requirement will provide useful information to the Commission in 
monitoring compliance with the amended rule. The Commission has decided 
to retain the Form N-SAR reporting requirement of rule 10f-
3.54
---------------------------------------------------------------------------

    \53\ Rule 10f-3(g) currently requires that a fund attach to its 
report on Form N-SAR ``a written record of each [rule 10f-3] 
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 
board determined that the purchases were made in accordance with the 
fund's procedures concerning compliance with rule 10f-3. Reports on 
Form N-SAR are available for public inspection from the Commission 
in hard copy, and through the Commission's Electronic Data 
Gathering, Analysis and Retrieval (``EDGAR'') database, which is 
accessible through the Commission's Internet Web site (http://
www.sec.gov).
    \54\ Amended rule 10f-3(b)(9) [17 CFR 270.10f-3(b)(9)]. The 
Commission intends to monitor reports concerning rule 10f-3 
transactions and take appropriate action in response to any problems 
that arise.
---------------------------------------------------------------------------

    As noted above, rule 10f-3 requires that the information attached 
to Form N-SAR include, among other things, the terms of the transaction 
and the information or materials upon which the board of directors 
makes a determination that all transactions during the preceding 
quarter were effected in accordance with the fund's procedures for 
ensuring compliance with the rule. The information reported pursuant to 
these provisions generally should include the date of the purchase, the 
maturity date and interest rate of any series purchased, the number and 
value of securities purchased (specific as to each series if 
applicable), and the aggregate number and value of securities offered 
through the underwriting or selling syndicate.

G. U.S. Government Securities

    The Proposing Release requested comment whether rule 10f-3 should 
be amended to permit the purchase of other types of securities, such as 
U.S. government securities, that rule 10f-3 currently does not address, 
and the extent to which the conditions of the rule should apply to such 
purchases. In requesting comment, the Commission noted that it might 
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).55 Two commenters 
suggested that section 10(f) should not be interpreted to prohibit fund 
purchases of securities issued by agencies or instrumentalities of the 
U.S. government if a fund affiliate is a dealer in the primary 
distribution of the securities and that, in the alternative, the 
Commission should amend rule 10f-3 to permit such purchases.
---------------------------------------------------------------------------

    \55\ See Proposing Release, supra note, at n.684 (citing 
Institutional Liquid Assets, SEC No-Action Letter (Dec. 16, 1981) 
(granting no-action relief under section 10(f) to Goldman, Sachs, 
which had sought relief in order to act as one of a limited number 
of broker-dealers participating in a distribution of Federal Home 
Loan Bank notes, arguing that it should not be considered a member 
of an ``underwriting or selling syndicate'' for purposes of section 
10(f))).
---------------------------------------------------------------------------

    The Commission has determined not to adopt amendments to rule 10f-3 
related to additional types of securities. As noted above and in the 
Proposing Release, section 10(f) does not apply to certain types of 
offerings of U.S. government securities.56 The Commission 
has not received any applications for exemptive relief with respect to 
offerings of U.S. government securities to which the section does 
apply, which suggests that relief may not be necessary at this time. 
Moreover, in light of the variety of these types of offerings and 
securities, and the unique issues they may present under section 10(f), 
it may be more appropriate to address these offerings of securities on 
a case-by-case basis in connection with individual requests for 
exemption.
---------------------------------------------------------------------------

    \56\ See Institutional Liquid Assets, SEC No-Action Letter (Dec. 
16, 1981).
---------------------------------------------------------------------------

III. Cost-Benefit Analysis

    The 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 should 
benefit funds, which will be able to (i) purchase securities of foreign 
and domestic issuers in Eligible Foreign Offerings and Eligible Rule 
144A Offerings in reliance upon rule 10f-3, without having to seek an 
exemptive order from the Commission and (ii) in many cases, purchase 
more desirable quantities of securities at advantageous prices. The 
potential benefits to fund investors of these proposed amendments are 
better investment performance and lower costs to the funds.
    The costs of the amendments to funds and investors are likely to be 
minimal. Fund investment advisers and boards of directors will be 
required to determine whether purchases of securities in foreign 
offerings and rule 144A offerings comply with the standards in the 
amended rule. Rule 10f-3, however, currently has standards that must be 
met for purchases permitted under the rule. Thus, the additional cost 
of complying with the standards related to purchases of securities in 
foreign offerings and rule 144A offerings are likely to be 
minimal.57
---------------------------------------------------------------------------

    \57\ Purchases of securities in foreign offerings and rule 144A 
offerings, of course, are voluntary. If a fund were to determine 
that the costs of a purchase would outweigh the benefits, it could 
decide not to purchase.
---------------------------------------------------------------------------

    Similarly, with respect to costs of reporting rule 10f-3 
transactions on Form N-SAR, the increased opportunities to purchase 
greater quantities and types of securities may result in an increased 
aggregate cost of reporting for funds that purchase in reliance on the 
rule. At the same time, however, due to the increased number of 
securities that are likely to be purchased, the average compliance 
costs (per security purchased) of reporting rule 10f-3 transactions 
will probably diminish.
    The increased risk of the dumping of unmarketable securities on 
affiliated funds appears to be minimal. The amendments are designed to 
loosen the restrictions of rule 10f-3 while maintaining those features 
of the rule that protect investors. The Commission is not aware of any 
evidence that dumping has been problematic under the current conditions 
of the rule, and the Commission intends to monitor transactions 
undertaken in reliance on rule 10f-3 after the amendments become 
effective.
    Comment letters on the Proposing Release did not provide empirical 
data quantifying the dollar benefits of amending the rule. Therefore, 
it is difficult to estimate what effect, if any, the rule amendments 
will have on the prices of securities, on issuers' capital costs, or on 
the securities markets generally. However, the amendments are likely to 
increase efficiency in the securities markets because the amendments 
remove unnecessary restrictions on certain market participants. Funds 
with affiliated underwriters likely will purchase a larger proportion 
of their portfolios through primary offerings and a smaller proportion 
in the secondary market. Conversely, other investors likely will 
purchase a smaller proportion of their portfolios in primary offerings 
and larger proportions in the secondary market.

IV. Paperwork Reduction Act

    As set forth in the Proposing Release, rule 10f-3 contains 
``collection of information'' requirements within the meaning of the 
Paperwork Reduction Act of 1995 (``PRA'').58 Accordingly, 
the collection of information requirements contained in the rule 
amendments were submitted to the Office of Management and Budget 
(``OMB'') for review pursuant to section 3507(d) of the PRA. No 
comments were received on the proposal with respect to the PRA. The 
collection of information requirements are in accordance with section 
3507 of the PRA. An agency may not conduct or sponsor, and a person is 
not required to respond to, a collection of information unless the 
agency displays a valid OMB control number. OMB approved the PRA 
request and assigned a control

[[Page 42408]]

number of 3235-0226, with an expiration date of May 31, 1999.
---------------------------------------------------------------------------

    \58\ 44 U.S.C. 3501-3520.
---------------------------------------------------------------------------

    The collections of information under rule 10f-3, and as required to 
be reported on Form N-SAR, are necessary for investment companies to 
obtain the benefit of exemption from section 10(f) of the Investment 
Company Act that rule 10f-3 provides. As described in more detail in 
the Proposing Release and in this release above, the collections of 
information are necessary to provide the Commission with information 
regarding compliance with rule 10f-3. The Commission may review this 
information during periodic examinations or with respect to 
investigations. Except for the information required to be kept under 
paragraph (b)(11)(ii) of rule 10f-3 as amended, none of the information 
required to be collected or disclosed for PRA purposes will be kept 
confidential. If the records required to be kept pursuant to these 
rules are requested by and submitted to the Commission, they will be 
kept confidential to the extent permitted by relevant statutory and 
regulatory provisions.
    The amendments to rule 10f-3 as adopted do not impose a greater 
paperwork burden upon respondents than that estimated and described in 
the Proposing Release. The retention of the reporting requirement on 
Form N-SAR will not increase the estimated burden for respondents, 
because the proposed elimination of this reporting requirement was not 
calculated as a reduction in burden for purposes of the proposed 
amendments.

V. Summary of Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis (``IRFA'') 
was published in the Proposing Release. No comments were received on 
the IRFA. The Commission has prepared a Final Regulatory Flexibility 
Analysis (``FRFA'') in accordance with 5 U.S.C. 604 regarding 
amendments to rule 10f-3 under the Investment Company Act.
    The FRFA discusses the need for, and objectives of, the rule 
amendments. The FRFA states that rule 10f-3 permits funds to purchase 
securities notwithstanding section 10(f) of the Investment Company Act 
if certain conditions are met. The amendments to rule 10f-3 expand the 
circumstances in which funds subject to section 10(f) may purchase 
securities. The FRFA further states that the amendments are designed to 
increase the flexibility of funds to purchase (i) quantities of 
securities that are in the interest of fund investors and (ii) certain 
domestic and foreign securities that are not registered under the 
Securities Act, while minimizing the risk of abuses that section 10(f) 
was enacted to address.
    The FRFA estimates that out of approximately 3,850 active 
investment companies registered with the Commission as of December 31, 
1996, a total of approximately 800 would be considered small entities. 
The amendments to rule 10f-3 would apply to approximately 40 of these 
800 small entities. The FRFA indicates that the proposed amendments 
would affect small entities in the same manner as other entities 
subject to section 10(f), but that the amendments increase flexibility 
for all funds.
    Finally, the FRFA states that in adopting the amendments the 
Commission considered: (a) The establishment of differing compliance 
requirements that take into account the resources available to small 
entities; (b) simplification of the rule's requirements for small 
entities; (c) the use of performance rather than design standards; and 
(d) an exemption from the rule for small entities. The FRFA states that 
the Commission concluded that different requirements for small entities 
are not necessary and would be inconsistent with investor protection, 
and that the amended rule incorporates performance standards to the 
extent practicable. Cost-benefit information reflected in the ``Cost-
Benefit Analysis'' section of this Release also is reflected in the 
FRFA. The FRFA is available for public inspection in File No. S7-7-96, 
and a copy may be obtained by contacting C. Hunter Jones, Securities 
and Exchange Commission, 450 Fifth Street, N.W., Mail Stop 10-2, 
Washington, D.C. 20549.

VI. Statutory Authority

    The Commission is adopting amendments to 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)].

Text of Rule

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 amended as follows:

PART 270--RULES AND REGULATIONS, INVESTMENT COMPANY ACT OF 1940

    1. 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;
* * * * *
    2. Section 270.10f-3 is revised to read as follows:


Sec. 270.10f-3.  Exemption for the acquisition of securities during the 
existence of an underwriting or selling syndicate.

    (a) Definitions.--(1) Domestic Issuer means any issuer other than 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.
    (2) Eligible Foreign Offering means a public offering of 
securities, conducted under the laws of a country other than the United 
States, that meets the following conditions:
    (i) The offering is subject to regulation by a ``foreign financial 
regulatory authority,'' as defined in section 2(a)(50) of the Act [15 
U.S.C. 80a-2(a)(50)], in such country;
    (ii) The securities are offered at a fixed price to all purchasers 
in the offering (except for any rights to purchase securities that are 
required by law to be granted to existing security holders of the 
issuer);
    (iii) Financial statements, prepared and audited in accordance with 
standards required or permitted by the appropriate foreign financial 
regulatory authority in such country, for the two years prior to the 
offering, are made available to the public and prospective purchasers 
in connection with the offering; and
    (iv) If the issuer is a Domestic Issuer, it meets the following 
conditions:
    (A) It has a class of securities registered pursuant to section 
12(b) or 12(g) of the Securities Exchange Act of 1934 [15 U.S.C. 78l(b) 
or 78l(g)] or is required to file reports pursuant to section 15(d) of 
the Securities Exchange Act of 1934 [15 U.S.C. 78o(d)]; and
    (B) It has filed all the material required to be filed pursuant to 
section 13(a) or 15(d) of the Securities Exchange Act of 1934 [15 
U.S.C. 78m(a) or 78o(d)] for a period of at least twelve months 
immediately preceding the sale of securities made in reliance upon this 
(or for such shorter period that the issuer was required to file such 
material).
    (3) Eligible Municipal Securities means ``municipal securities,'' 
as defined in section 3(a)(29) of the Securities Exchange Act of 1934 
[15 U.S.C. 78c(a)(29)], that 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, has been in continuous operation

[[Page 42409]]

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.
    (4) Eligible Rule 144A Offering means an offering of securities 
that meets the following conditions:
    (i) The securities are offered or sold in transactions exempt from 
registration under section 4(2) of the Securities Act of 1933 [15 
U.S.C. 77d(2)], rule 144A thereunder [Sec. 230.144A of this chapter], 
or rules 501-508 thereunder [Secs. 230.501-230.508 of this chapter];
    (ii) The securities are sold to persons that the seller and any 
person acting on behalf of the seller reasonably believe to include 
qualified institutional buyers, as defined in Sec. 230.144A(a)(1) of 
this chapter; and
    (iii) The seller and any person acting on behalf of the seller 
reasonably believe that the securities are eligible for resale to other 
qualified institutional buyers pursuant to Sec. 230.144A of this 
chapter.
    (5) NRSRO has the same meaning as that set forth in Sec. 270.2a-
7(a)(14).
    (b) Conditions. Any purchase of securities by a registered 
investment company prohibited by section 10(f) of the Act [15 U.S.C. 
80a-10(f)] shall be exempt from the provisions of such section if the 
following conditions are met:
    (1) Type of Security. The securities to be purchased are:
    (i) Part of an issue registered under the Securities Act of 1933 
[15 U.S.C. 77a-aa] that is being offered to the public;
    (ii) Eligible Municipal Securities;
    (iii) Securities sold in an Eligible Foreign Offering; or
    (iv) Securities sold in an Eligible Rule 144A Offering.
    (2) Timing and Price. 
    (i) The securities are purchased prior to the end of the first day 
on which any sales are made, at a price that is not more than the price 
paid by each other purchaser of securities in that offering or in any 
concurrent offering of the securities (except, in the case of an 
Eligible Foreign Offering, for any rights to purchase that are required 
by law to be granted to existing security holders of the issuer); and
    (ii) 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.
    (3) Reasonable Reliance. For purposes of determining compliance 
with paragraphs (b)(1)(iv) and (b)(2)(i) of this section, an investment 
company may reasonably rely upon written statements made by the issuer 
or a syndicate manager, or by an underwriter or seller of the 
securities through which such investment company purchases the 
securities.
    (4) Continuous Operation. If the securities to be purchased are 
part of an issue registered under the Securities Act of 1933 [15 U.S.C. 
77a--aa] that is being offered to the public or are purchased pursuant 
to an Eligible Foreign Offering or an Eligible Rule 144A Offering, the 
issuer of the securities shall have been in continuous operation for 
not less than three years, including the operations of any 
predecessors.
    (5) Firm Commitment Underwriting. 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 of the securities.
    (6) Reasonable Commission. 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.
    (7) Percentage Limit. 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:
    (i) If purchased in an offering other than an Eligible Rule 144A 
Offering, 25 percent of the principal amount of the offering of such 
class; or
    (ii) If purchased in an Eligible Rule 144A Offering, 25 percent of 
the total of:
    (A) The principal amount of the offering of such class sold by 
underwriters or members of the selling syndicate to qualified 
institutional buyers, as defined in Sec. 230.144A(a)(1) of this 
chapter, plus
    (B) The principal amount of the offering of such class in any 
concurrent public offering.
    (8) Prohibition of Certain Affiliate Transactions. 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:
    (i) Such underwriter does not benefit directly or indirectly from 
the transaction; or
    (ii) In respect to the purchase of Eligible Municipal Securities, 
such purchase is not designated as a group sale or otherwise allocated 
to the account of any person from whom this paragraph prohibits the 
purchase.
    (9) Periodic Reporting. The existence of any transactions effected 
pursuant to this section shall be reported on the Form N-SAR 
[Sec. 274.101 of this chapter] of the investment company and 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 (b)(10)(iii) of this 
section was made shall be attached thereto.
    (10) Board Review. The board of directors of the investment 
company, including a majority of the directors who are not interested 
persons of the investment company:
    (i) 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;
    (ii) Approves such changes to the procedures as the board deems 
necessary; and
    (iii) Determines no less frequently than quarterly that all 
purchases made during the preceding quarter were effected in compliance 
with such procedures.
    (11) Maintenance of Records. The investment company:
    (i) Shall maintain and preserve permanently in an easily accessible 
place a written copy of the procedures, and any modification thereto, 
described in paragraphs (b)(10)(i) and (b)(10)(ii) of this section; and
    (ii) 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 (b)(10)(iii) of this 
section was made.

    By the Commission.


[[Page 42410]]


    Dated: July 31, 1997.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-20747 Filed 8-6-97; 8:45 am]
BILLING CODE 8010-01-P