[Federal Register Volume 64, Number 195 (Friday, October 8, 1999)] [Notices] [Pages 54939-54943] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 99-26253] ----------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION [Investment Company Act Release No. 24067; 812-10986] Schwab Capital Trust, et al.; Notice of Application October 1, 1999. AGENCY: Securities and Exchange Commission (``Commission''). ACTION: Notice of application for an order under section 12(d)(1)(J) of the Investment Company Act of 1940 (``Act'') for an exemption from sections 12(d)(1)(A) and (B) of the Act and under sections 6(c) and 17(b) of the Act for an exemption from section 17(a) of the Act. ----------------------------------------------------------------------- SUMMARY OF THE APPLICATION: The order would permit certain registered open-end management investment companies to acquire shares of other registered open-end management investment companies both within and outside the same group of investment companies. APPLICANTS: Schwab Capital Trust, Schwab Investments, and The Charles Schwab Family of Funds (the ``Trusts'') and Charles Schwab Investment Management, Inc. (``Adviser''). Filing Dates: The application was filed on February 2, 1998 and amended on August 31, 1999. Applicants have agreed to file an amendment to the application, the substance of which is reflected in this notice, during the notice period. HEARING OR NOTIFICATION OF HEARING: An order granting the application will be issued unless the Commission orders a hearing. Interested persons may request a hearing by writing to the Commission's Secretary and serving applicants with a copy of the request, personally or by mail. Hearing requests should be received by the Commission by 5:30 p.m. on October 26, 1999, and should be accompanied by proof of service on applicants in the form of an affidavit or, for lawyers, a certificate of service. Hearing requests should state the nature of the writer's interest, the reason for the request, and the issues [[Page 54940]] contested. Persons who wish to be notified of a hearing may request notification by writing to the Commission's Secretary. ADDRESSES: Secretary, Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609. Applicants, 101 Montgomery Street, 120KNY-14, San Francisco, CA 94104. FOR FURTHER INFORMATION CONTACT: Michael W. Mundt, Branch Chief, and Nadya B. Roytblat, Assistant Director, at (202) 942-0564 (Office of Investment Company Regulation, Division of Investment Management). SUPPLEMENTARY INFORMATION: The following is a summary of the application. The complete application may be obtained for a fee at the Commission's Public Reference Branch, 450 Fifth Street, N.W., Washington, D.C. 20549-0102, (202) 942-8090. Applicants' Representations 1. The Trusts are open-end management investment companies registered under the Act that are comprised of separate series, each of which pursues a distinct set of investment objectives and policies. The Adviser, a wholly-owned subsidiary of The Charles Schwab Corporation (``Schwab''), is registered as an investment adviser under the Investment Advisers Act of 1940 and serves as investment adviser to the Trusts. Another wholly-owned subsidiary of Schwab, Charles Schwab & Co., Inc. (the ``Distributor''), is a broker-dealer and transfer agent registered under the Securities Exchange Act of 1934 and serves as the principal underwriter/distributor, transfer agent, and shareholder servicing agent for the Trusts. The Distributor also operates Schwab's Mutual Fund OneSource Service (``OneSource Service''), which provides services to investment companies in return for a fee based on the assets invested in the investment companies through the OneSource Service. 2. Applicant request relief to permit certain series of the Trusts (the ``Funds of Funds'') to invest: (a) In other series of the Trusts and other registered open-end management investment companies that are part of the same ``group of investment companies,'' as that term is defined in section 12(d)(1)(G) of the Act discussed below, as the Trusts (``Affiliated Funds''), and (b) in other registered open-end management investment companies that are not part of the same group of investment companies as the Trusts (``Unaffiliated Funds'').\1\ The Affiliated and Unaffiliated Funds collectively are referred to as ``Underlying Funds.'' \2\ A Fund of Funds also may make direct investments in stocks, bonds, and any other securities which are consistent with its investment objective. --------------------------------------------------------------------------- \1\ With regard to purchases of shares of Unaffiliated Funds, the requested order would apply to purchases made by the Fund of Funds only where the Fund of Funds could not rely on the provisions of section 12(d)(1)(F) of the Act. \2\ All Funds of Funds and Affiliated Funds that currently intend to rely on the requested order are named as applicants. Any other investment company that relies on the order in the future will comply with the terms and conditions of the application. --------------------------------------------------------------------------- 3. Applicants state that each Fund of Funds will enable investors to create a comprehensive asset allocation program or achieve diversification in a specific segment of the market with just one investment. Applicants assert that a Fund of Funds will provide a simple, convenient, low-cost investment program for investors who are able to identify their long-term investment goals, but who may not be comfortable deciding how to invest their assets to achieve those goals. Applicants' Legal Analysis A. Section 12(d)(1) 1. Section 12(d)(1)(A) of the Act prohibits a registered investment company from acquiring shares of an investment company if the securities represent more than 3% of the total outstanding voting stock of the acquired company, more than 5% of the total assets of the acquiring company, or, together with the securities of any other investment companies, more than 10% of the total assets of the acquiring company. Section 12(d)(1)(B) of the Act prohibits a registered open-end investment company from selling its shares to another investment company to own more than 3% of the acquired company's voting stock, or if the sale will cause more than 10% of the acquired company's voting stock to be owned by investment companies generally. 2. Section 12(d)(1)(G) provides, in relevant part, that section 12(d)(1) will not apply to securities of a registered open-end investment company acquired by a registered open-end investment company if the acquired company and the acquiring company are part of the same group of investment companies, provided that certain other requirements contained in section 12(d)91)(G) are met. Applicants state that they may not rely on section 12(d)(1)(G) because a Fund of Funds will invest in Unaffiliated Funds in addition to Affiliated Funds. 3. Section 12(d)(1)(J) of the Act provides that the Commission may exempt any person, security, or transaction, or any class or classes of persons, securities or transactions, from any provision of section 12(d)(1) if the exemption is consistent with the public interest and the protection of investors. Applicants seek an exemption under section 12(d)(1)(J) to permit the Funds of Funds to acquire shares of Underlying Funds and to permit Underlying Funds to sell shares to the Funds of Funds beyond the limits set forth in sections 12(d)(1)(A) and (B). 4. Applicants state that section 12(d)(1)(J) was added to the Act by the National Securities Markets Improvement Act of 1996 (``NSMIA''). Applicants further state that the legislative history of NSMIA indicates that Congress intended that, in granting relief under section 12(d)(1)(J), the Commission consider, among other things, ``the extent to which a proposed arrangement is subject to conditions that are designed to address conflicts of interest and overreaching by a participant in the arrangement, so that the abuses that gave rise to the initial adoption of the Act's restrictions against investment companies investing in other investment companies are not repeated.'' \3\ --------------------------------------------------------------------------- \3\ H.R. Rep. No. 622, 104th Cong., 2d Sess., 44 (1966). --------------------------------------------------------------------------- 5. Applicants state that the proposed arrangement will not give rise to the policy concerns underlying sections 12(d)(1)(A) and (B), which include concerns about undue influence by a fund of funds over underlying funds, excessive layering of fees, and overly complex fund structures. Accordingly, applicants believe that the requested exemption is consistent with the public interest and the protection of investors. 6. Applicants state that the proposed arrangement will not result in undue influence by a Fund of Funds or its affiliates over Underlying Funds. Applicants note that investment by a Fund of Funds in Affiliated Funds is permitted under section 12(d)(1)(G) of the Act. To limit the control that a Fund of Funds may have over an Unaffiliated Fund, applicants propose a condition prohibiting the Adviser, the Fund of Funds, and certain affiliates (individually or in the aggregate) from controlling an Unaffiliated Fund within the meaning of section 2(a)(9) of the Act. 7. To limit further the potential for undue influence by a Fund of Funds or its affiliates over an Unaffiliated Fund, applicants state that a Fund of Funds [[Page 54941]] and its Adviser, promoter, and principal underwriter, and any person controlling, controlled by, or under common control with any of those entities (each a ``Fund of Funds Affiliate'') will not cause any investment by the Fund of Funds in shares of an Unaffiliated Fund to influence the terms of any services or transactions between the Fund of Funds or a Fund of Funds Affiliate and the Unaffiliated Fund or its investment adviser, promoter, and principal underwriter, and any person controlling, controlled by, or under common control with any of those entities (each an ``Unaffiliated Fund Affiliate''). The board of trustees of the Fund of Funds, including a majority of the trustees who are not ``interested persons'' of the Fund of Funds, as defined in section 2(a)(19) of the Act (``disinterested trustees''), also will adopt procedures designed to assure that the Adviser is conducting the investment program of the Fund of Funds without taking into account any consideration received by the Fund of Funds or a Fund of Funds Affiliate from an Unaffiliated Fund or an Unaffiliated Fund Affiliate in connection with any services or transactions. The board of directors of each Unaffiliated Fund, including a majority of the disinterested directors, also will determine that any consideration paid by the Unaffiliated Fund to the Fund of Funds or a Fund of Funds Affiliate is fair and reasonable and does not involve overreaching on the part of any person concerned. 8. To avoid the possibility that a Fund of Funds could force and Unaffiliated Fund to purchase unmarketable securities, applicants state that a Fund of Funds will not cause an Unaffiliated Fund to purchase a security from any underwriting or selling syndicate in which a principal underwriter is an officer, director, member of an advisory board, investment adviser, or employee of the Fund of Funds, or a person of which any such officer, director, member of an advisory board, investment adviser, or employee is an affiliated person (each an ``Underwriting Affiliate''). For the purposes of the requested relief, an offering of securities during the existence of an underwriting or selling syndicate of which a principal underwriter is an Underwriting Affiliate is considered an ``Affiliated Underwriting.'' 9. Applicants further state that the board of directors of an Unaffiliated Fund, including a majority of the disinterested directors, will adopt procedures designed to monitor any purchases of securities by the Unaffiliated Fund in Affiliated Underwritings and directly from Underwriting Affiliates, and will make certain findings to assess whether the purchases were influenced by the investment by the Fund of Funds in shares of the Unaffiliated Fund. An Unaffiliated Fund will keep certain records concerning these purchases. 10. As an additional assurance that an Unaffiliated Fund understands the implications of an investment by a Fund of Funds under the requested order, the Fund of Funds and Unaffiliated Fund will execute an agreement prior to the investment stating that the Unaffiliated Fund understands the terms and conditions of the order and agrees to fulfill its responsibilities under the order. Applicants note that an Unaffiliated Fund may choose to reject an investment from the Fund of Funds. 11. Applicants do not believe that the proposed arrangement will involve excessive layering of fees. Applicants sate that the Adviser may charge an investment advisory fee to each Fund of Funds and to Affiliated Funds. However, the board of trustees of a Fund of Funds, including a majority of the disinterested trustees, will be required to determine that the advisory fees charged to the Fund of Funds are based on services that are in addition to the services provided under the advisory contract of any Underlying Fund. In addition, to avoid the inference that fees payable to the Distributor by a Fund of Funds and by Unaffilated Funds are duplicative, the Distributor will waive fees otherwise payable to the Distributor by a Fund of Funds pursuant to transfer agent and shareholder servicing contracts and other similar contracts in an amount at least equal to any compensation received by the Distributor (including One Source Service fees) from Unaffiliated Funds in connection with any investment by the Fund of Funds. 12. Applicants also state that the aggregate sales charges and/or distribution-related fees of a Fund of Funds and any Underlying Fund in which it invests will not exceed the limits set forth in rule 2830 of the Conduct Rules of the National Association of Securities Dealers (``NASD Conduct Rules''). In addition, applicants represent that a Fund of Funds' prospectus and sales literature will contain concise, ``plain English'' disclosure designed to inform investors of the unique characteristics of the Fund of Funds structure, including, but not limited to, its expense structure and the additional expenses of investing in Underlying Funds. 13. Applicants state that the proposed arrangement will not create an overly complex fund structure. Applicants note that an Underlying Fund will be prohibited from acquiring securities of any investment company in excess of the limits contained in section 12(d)(1)(A), except to the extent permitted by an exemptive order allowing an Underlying Fund to purchase shares of an affiliated money market fund for short-term cash management purposes. B. Section 17(a) 1. Section 17(a) of the Act generally prohibits sales or purchases of securities between a registered investment company and any affiliated person of the company. Section 2(a)(3) of the Act defines an ``affiliated person'' of another person to include any person 5% or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote by the other person and any person directly or indirectly controlling, controlled by, or under common control with the other person. 2. Applicants state that the Funds of Funds and the Affiliated Funds might be deemed to be under common control. Applicants also state that a Fund of Funds and an Unaffiliated Fund might become affiliated persons if the Fund of Funds acquires more than 5% of the Unaffiliated Fund's outstanding voting securities. In light of these possible affiliations, section 17(a) could prevent an Underlying Fund from selling shares to and redeeming shares from the Fund of Funds. 3. Section 17(b) of the Act authorizes the Commission to grant an order permitting a transaction otherwise prohibited by section 17(a) if it finds that: (a) The terms of the proposed transaction are fair and reasonable and do not involve overreaching on the part of any person concerned; (b) the proposed transaction is consistent with the policies of each registered investment company involved; and (c) the proposed transaction is consistent with the general purposes of the Act. Section 6(c) of the Act permits the Commission to exempt any person or transactions from any provision of the Act if such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of the Act. 4. Applicants submit that the proposed arrangement satisfies the standards for relief under sections 17(b) and 6(c) of the Act. Applicants state that the terms of the arrangement are fair and reasonable and do not involve overreaching. Applicants note that the consideration paid for the sale and [[Page 54942]] redemption of shares of the Underlying Funds will be based on the net asset values of the Underlying Funds. Applicants state that the proposed arrangement will be consistent with the policies of each Fund of Funds, as set forth in each Fund of Funds' registration statement, and with the general purposes of the Act. Applicants' Conditions Applicants agree that the order granting the requested relief will be subject to the following conditions: 1. (a) The Adviser, (b) any person controlling, controlled by, or under common control with the Adviser, and (c) any investment company and any issuer that would be an investment company but for section 3(c)(1) or section 3(c)(7) of the Act advised by the Adviser or any person controlling, controlled by, or under common control with the Adviser (collectively, the ``Group'') will not control (individually or in the aggregate) an Unaffiliated Fund within the meaning of section 2(a)(9) of the Act. If, as a result of a decrease in the outstanding voting securities of an Unaffiliated Fund, the Group, in the aggregate, becomes a holder of more than 25% of the outstanding voting securities of the Unaffiliated Fund, the Group will vote its shares of the Unaffiliated Fund in the same proportion as the vote of all other holders of the Unaffiliated Fund's shares. 2. A Fund of Funds and a Fund of Funds Affiliate will not cause any existing or potential investment by the Fund of Funds in shares of an Unaffiliated Fund to influence the terms of any services or transactions between the Fund of Funds or Funds of Funds Affiliate and the Unaffiliated Fund or an Unaffiliated Fund Affiliate. 3. The board of trustees of the Fund of Funds, including a majority of the disinterested trustees, will adopt procedures reasonably designed to assure that the Adviser is conducting the investment program of the Fund of Funds without taking into account any consideration received by the Fund of Funds or a Fund of Funds Affiliate from an Unaffiliated Fund or an Unaffiliated Fund Affiliate in connection with any services or transactions. 4. The board of directors of each Unaffiliated Fund, including a majority of the disinterested directors, will determine that any consideration paid by the Unaffiliated Fund to the Fund of Funds or a Fund of Fund Affiliate in connection with any services or transactions: (a) Is fair and reasonable in relation to the nature and quality of the services and benefits received by the Unaffiliated Fund; (b) is within the range of consideration that the Unaffiliated Fund would be required to pay to another unaffiliated entity in connection with the same services or transactions; and (c) does not involve overreaching on the part of any person concerned. 5. A Fund of Funds will not cause an Unaffiliated Fund to purchase a security from any Affiliated Underwriting. 6. The board of directors of an Unaffiliated Fund, including a majority of the disinterested directors, will adopt procedures reasonably designed to monitor any purchase of securities by an Unaffiliated Fund in an Affiliated Underwriting, including any purchases made directly from an Underwriting Affiliate. The board of directors will review these purchases periodically, but no less frequently than annually, to determine whether the purchases were influenced by the investment by the Fund of Funds in shares of the Unaffiliated Fund. The board of directors should consider, among other things: (a) Whether the purchases were consistent with the investment objectives and policies of the Unaffiliated Fund: (b) how the performance of securities purchased in an Affiliated Underwriting compares to the performance of comparable securities purchased during a comparable period of time in underwritings other than Affiliated Underwritings or to a benchmark such as a comparable market index; and (c) whether the amount of securities purchased by the Unaffiliated Fund in Affiliated Underwritings and the amount purchased directly from an Underwriting Affiliate have changed significantly from prior years. The board of directors will take any appropriate actions based on its review, including, if appropriate, the institution of procedures designed to assure that purchases of securities from Affiliated Underwritings are in the best interests of shareholders. 7. The Unaffiliated Fund will maintain and preserve permanently in an easily accessible place a written copy of the procedures described in the preceding condition, and any modifications, and will maintain and preserve for a period not less than six years from the end of the fiscal year in which any purchase from an Affiliated Underwriting occurred, the first two years in an easily accessible place, a written record of each purchase, setting forth from whom the securities were acquired, the identify of the underwriting syndicate's members, the terms of the purchase, and the information or materials upon which the board's determinations were made. 8. Prior to an investment in shares of an Unaffiliated Fund in excess of the limit in section 12(d)(1)(F), the Fund of Funds and the Unaffiliated Fund will execute an agreement stating, without limitation, that the Unaffiliated Fund understands the terms and conditions of the order and agrees to fulfill its responsibilities under the order. At the time of its investment in shares of an Unaffiliated Fund in excess of the limit in section 12(d)(1)(F), a Fund of Funds will notify the Unaffiliated Fund of the investment. At such time, the Fund and Funds also will transmit to the Unaffiliated Fund a list of the names of each Fund of Funds Affiliates and Underwriting Affiliate. The Fund of Funds will notify the Unaffiliated Fund of any change to the list as soon as reasonably practicable after a change occurs. The Unaffiliated Fund and the Fund of Funds will maintain and preserve a copy of the order, the agreement, and the list with any updated information for a period of not less than six years from the end of the fiscal year in which any investment occurred, the first two years in an easily accessible place. 9. Prior to approving any advisory contract under section 15 of the Act, the board of trustees of each Fund of Funds, including a majority of the disinterested trustees, will find that the advisory fees charged under the contract are based on services provided that will be in addition to, rather than duplicative of, the services provided under the advisory contract of any Underlying Fund in which the Funds of Funds may invest. These findings and their basis will be recorded fully in the minute books of the appropriate Fund of Funds. 10. The Distributor will waive fees otherwise payable to the Distributor by a Fund of Funds pursuant to transfer agent and shareholder servicing contracts and other similar contracts in an amount at least equal to any compensation received by the Distributor (including OneSource Service fees) from Unaffiliated Funds in connection with the investment by a Fund of Funds in the in the Unaffiliated Funds. 11. Any sales charges and/or distribution-related fees charged with respect to shares of a Fund of Funds, when aggregated with any sales charges and/or distribution-related fees paid by the Fund of Funds with respect to its acquisition, holding, or disposition of shares of an Underlying Fund, will not exceed the limits set forth in rule 2830 of the NASD Conduct Rules. If the Fund of Funds and an Underlying Fund both [[Page 54943]] charge a ``service fee'' as defined in rule 2830, the board of trustees of the Fund of Funds, including a majority of the disinterested trustees, will find that the service fee being paid by the Fund of Funds to its service providers is based on services that will be in addition to, rather than duplicative of, the services provided to the Underlying Fund. 12. No Underlying Fund will acquire securities of any other investment company in excess of the limits contained in section 12(d)(1)(A) of the Act, except to the extent permitted by an exemptive order that allows the Underlying Fund to purchase shares of an affiliated money market fund for short-term cash management purposes. By the Commission. Jonathan G. Katz, Secretary. [FR Doc. 99-26253 Filed 10-7-99; 8:45 am] BILLING CODE 8010-01-M