[Federal Register Volume 66, Number 22 (Thursday, February 1, 2001)]
[Rules and Regulations]
[Pages 8509-8519]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-1967]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-24828; File No. S7-11-97]
RIN 3235-AH11


Investment Company Names

AGENCY: Securities and Exchange Commission, (SEC).

ACTION: Final rule; request for comments on Paperwork Reduction Act 
burden estimate.

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SUMMARY: The Securities and Exchange Commission is adopting a new rule 
under the Investment Company Act of 1940 to address certain broad 
categories of investment company names that are likely to mislead 
investors about an investment company's investments and risks. The rule 
requires a registered investment company with a name suggesting that 
the company focuses on a particular type of investment (e.g., an 
investment company that calls itself the ABC Stock Fund, the XYZ Bond 
Fund, or the QRS U.S. Government Fund) to invest at least 80% of its 
assets in the type of investment suggested by its name. The rule also 
would address names suggesting that an investment company focuses its 
investments in a particular country or geographic region, names 
indicating that a company's distributions are exempt from income tax, 
and names suggesting that a company or its shares are guaranteed or 
approved by the United States government.

DATES: Effective Date: March 31, 2001. Compliance Date: Registered 
investment companies must comply with Sec. 270.35d-1 by July 31, 2002.

FOR FURTHER INFORMATION CONTACT: Paul G. Cellupica, Senior Special 
Counsel, or John L. Sullivan, Senior Counsel, Office of Disclosure 
Regulation, at (202) 942-0721, or, regarding accounting issues, Kenneth 
B. Robins, Office of the Chief Accountant, at (202) 942-0590, in the 
Division of Investment Management, Securities and Exchange Commission, 
450 5th Street, NW., Washington, DC 20549-0506.

SUPPLEMENTARY INFORMATION: The Securities and Exchange Commission 
(``Commission'') is adopting new rule 35d-1 (17 CFR 270.35d-1) under 
the Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.) 
(``Investment Company Act'').\1\
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    \1\ Unless otherwise noted, all references to ``rule 35d-1'' or 
any paragraph of the rule will be to 17 CFR 270.35d-1, as adopted by 
this release.

Table of Contents

I. Introduction
II. Discussion
    A. General
    1. Names Indicating an Investment Emphasis in Certain 
Investments or Industries
    2. Names Indicating an Investment Emphasis in Certain Countries 
or Geographic Regions
    3. Tax-Exempt Investment Companies
    4. Applying the 80% Investment Requirement
    B. Names Suggesting Guarantee or Approval by the U.S. Government
    C. Other Investment Company Names
    1. General
    2. Names and Average Weighted Portfolio Maturity and Duration
    D. Compliance Date
III. Cost/benefit Analysis
IV. Summary of Final Regulatory Flexibility Analysis
V. Paperwork Reduction Act
VI. Statutory Authority

I. Introduction

    Section 35(d) of the Investment Company Act, as amended by the 
National Securities Markets Improvement Act of 1996, prohibits a 
registered investment company from using a name that the Commission 
finds by rule to be materially deceptive or misleading.\2\ Before 
section 35(d) was amended, the Commission was required to declare by 
order that a particular name was misleading and, if necessary, obtain a 
federal court order prohibiting further use of the name. In amending 
section 35(d), Congress reaffirmed its concern that investors may focus 
on an investment company's name to determine the company's investments 
and risks, and recognized that investor protection would be improved by 
giving the Commission rulemaking authority to address potentially 
misleading investment company names.\3\
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    \2\ 15 U.S.C. 80a-34(d); Pub. L. No. 104-290, Sec. 208, 110 
Stat. 3416, 3432 (1996).
    \3\ See S. Rep. No. 293, 104th Cong., 2d Sess. 8-9 (1996).
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    Today the Commission is adopting new rule 35d-1 to address certain 
investment company names that are likely to mislead an investor about a 
company's investment emphasis. The Commission believes that investors 
should not rely on an investment company's name as the sole source of 
information about a company's investments and risks.\4\ An investment

[[Page 8510]]

company's name, like any other single piece of information about an 
investment, cannot tell the whole story about the investment 
company.\5\ As Congress has recognized, however, the name of an 
investment company may communicate a great deal to an investor.
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    \4\ See generally ``Investor Protection: Tips from an SEC 
Insider,'' Remarks by Arthur Levitt, Chairman, SEC, before the 
Investors' Town Meeting at the Houstonian Hotel, Washington, D.C. 
(Apr. 12, 1995) (``An informed investor looks beyond the packaging 
of a fund, and also sees what's inside.''); ``The SEC and the Mutual 
Fund Industry: An Enlightened Partnership,'' Remarks by Arthur 
Levitt, Chairman, SEC, before the General Membership Meeting of the 
Investment Company Institute (``ICI'') at the Washington Hilton 
Hotel, Washington, D.C. (May 19, 1995) (``some fund names can leave 
investors with the wrong impression about (the fund's) safety.'').
    \5\ See Herman, The Confusion is Mutual: Buyers Beware When 
Funds Drift From Original Intent, New York Daily News, Oct. 24, 
1999, at 5; Millman, First Pop The Hood: A Fund's Name May Tell You 
Nothing About How It Acts, U.S. News & World Rep., Feb. 3, 1997, at 
70.
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    The rule applies to all registered investment companies, including 
mutual funds, closed-end investment companies, and unit investment 
trusts (``UITs''), and requires an investment company with a name that 
suggests a particular investment emphasis to invest in a manner 
consistent with its name. The rule, for example, would require an 
investment company with a name that suggests that the company focuses 
on a particular type of security (e.g., an investment company that 
calls itself the ABC Stock Fund, the XYZ Bond Fund, or the QRS U.S. 
Government Fund) to invest at least 80% of its assets in the type of 
security indicated by its name. An investment company seeking maximum 
flexibility with respect to its investments would be free to select a 
name that does not connote a particular investment emphasis.
    Under current positions of the Division of Investment Management 
(``Division''), an investment company with a name suggesting that the 
company focuses on a particular type of investment generally is 
required to invest only 65% of its assets in the type of investment 
suggested by its name.\6\ In 1997, we proposed rule 35d-1 to replace 
the staff's positions with a rule codifying the Commission's views and 
to increase the 65% threshold to 80%.\7\
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    \6\ The Division continues to take this position in reviewing 
investment company disclosure, although the Division's formal 
guidance in this area was rescinded as part of the general overhaul 
of Form N-1A in 1998. See Former Guide 1 to Form N-1A, Investment 
Company Act Release No. 13436 (Aug. 12, 1983) (48 FR 37928 (Aug. 22, 
1983)) (``N-1A Guidelines Release'') (rescinded by Investment 
Company Act Release No. 23064 (Mar. 13, 1998) (63 FR 13916 (March 
23, 1998) at 13940 n.214) (``N-1A Amendments'')).
    \7\ Investment Company Act Release No. 22530 (Feb. 27, 1997) (62 
FR 10955 (Mar. 10, 1997), correction 62 FR 24161 (May 2, 1997)) 
(``Proposing Release'').
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    Today we are adopting rule 35d-1 and the 80% investment requirement 
to guard against the use of misleading investment company names and to 
implement Congress's intent in amending section 35(d). Requiring an 
investment company to invest at least 80% of its assets in the type of 
investment suggested by its name will provide an investor greater 
assurance that the company's investments will be consistent with its 
name. The need for investment companies to invest in a manner 
consistent with their names is particularly important to retirement 
plan and other investors who place great emphasis on allocating their 
investment company holdings in well-defined types of investments, such 
as stocks, bonds, and money market instruments.\8\ As of the end of 
1999, an estimated 82.8 million individuals in 48.4 million U.S. 
households held $ 5.5 trillion in mutual fund assets.\9\ These 
investors face an increasingly diverse universe of investment companies 
when choosing a company suitable for their investment needs.\10\ The 
80% investment requirement will help reduce confusion when an investor 
selects an investment company for specific investment needs and asset 
allocation goals.
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    \8\ See, e.g., Vickers, A Price of Success: An Unbalanced 
Portfolio, N.Y. Times, Jan. 12, 1997, at F6; Glassman, With New 
Year, Stock Up a 401(k) for the Long Term, Wash. Post, Jan. 1, 1997, 
at C13. The amount of retirement assets invested in mutual funds 
totaled $2.5 trillion at the end of 1999, representing an increase 
of $553 billion, or 29%, over the 1998 year-end total of $1.9 
trillion. ICI, Mutual Fund Fact Book 49-50 (2000). This $2.5 
trillion in mutual fund retirement plan assets represented 36% of 
all mutual fund assets at year-end 1999. Id. at 49. The ICI 
estimates that, in 1998, 77% of fund shareholders invested primarily 
for retirement purposes. ICI, 1998 Profile of Mutual Fund 
Shareholders (1999).
    \9\ Id. at 41.
    \10\ According to Division estimates based on data from the ICI 
and Lipper Analytical Services, between September 1985 and July 
2000, investment company assets increased from $591 billion to $7.4 
trillion, and the number of investment companies (including the 
individual series of registered mutual funds) increased from 9,200 
to 32,403.
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II. Discussion

    The Commission received 28 letters commenting on proposed rule 35d-
1.\11\ Most of the commenters supported the proposal, asserting that an 
investment company with a name indicating that it will invest in a 
particular security or industry should follow an overall investment 
strategy consistent with its name. Many commenters recommended 
revisions to the proposed rule. In addition, the Commission has 
received five rulemaking petitions urging adoption of the proposed 
rule.\12\ The Commission is adopting rule 35d-1 with the modifications 
described below that address commenters' concerns.
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    \11\ A summary of the comments prepared by the staff of the 
Division of Investment Management is available in the public comment 
file for S7-11-97.
    \12\ Rulemaking Petition by the Financial Planning Association 
(June 28, 2000); Rulemaking Petition by Fund Democracy, LLC (June 
28, 2000); Rulemaking Petition by Consumer Federation of America, et 
al. (Aug. 8, 2000); Rulemaking Petition by National Association of 
Investors Corporation (Oct. 9, 2000); Rulemaking Petition by the 
American Federation of Labor and Congress of Industrial 
Organizations (``AFL-CIO'') (Dec. 20, 2000). The rulemaking 
petitions are available for inspection and copying in File No. 4-439 
in the Commission's Public Reference Room.
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A. General

1. Names Indicating an Investment Emphasis in Certain Investments or 
Industries
    We are adopting, substantially as proposed, the requirement that an 
investment company with a name that suggests that the company focuses 
its investments in a particular type of investment (e.g., the ABC Stock 
Fund or XYZ Bond Fund) or in investments in a particular industry 
(e.g., the ABC Utilities Fund or the XYZ Health Care Fund) invest at 
least 80% of its assets in the type of investment suggested by the 
name.\13\ The 80% requirement will allow an investment company to 
maintain up to 20% of its assets in other investments. In the case of 
mutual funds, these assets, for example, could include cash and cash 
equivalents that could be used to meet redemption requests. While many 
commenters supported setting the investment

[[Page 8511]]

requirement at 80%, some commenters opposed the level of the investment 
requirement, arguing that it would unduly restrict legitimate portfolio 
strategies and result in decreased diversification and increased risk 
and deter investment companies from using descriptive names.
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    \13\ Rule 35d-1(a)(2). A mutual fund that uses a name suggesting 
that it is a money market fund would continue to be subject to the 
maturity, quality, and diversification requirements of rule 2a-7 
under the Investment Company Act, and its name would be deemed 
misleading under section 35(d) of the Investment Company Act if it 
did not comply with these requirements. (17 CFR 270.2a-7(b) & (c)).
    The language of the proposal would have required an investment 
company with a name that suggests that the company focuses its 
investments in a particular type of security to invest at least 80% 
of its assets in the indicated securities. Proposed rule 35d-
1(a)(2). We have modified this language to require that an 
investment company with a name that suggests that the company 
focuses its investments in a particular type of investment invest at 
least 80% of its assets in the indicated investments. Rule 35d-
1(a)(2). In appropriate circumstances, this would permit an 
investment company to include a synthetic instrument in the 80% 
basket if it has economic characteristics similar to the securities 
included in that basket.
    We note that, for purposes of applying the 80% investment 
requirement, an investment company may ``look through'' a repurchase 
agreement to the collateral underlying the agreement (typically, 
government securities), and apply the repurchase agreement toward 
the 80% investment requirement based on the type of securities 
comprising its collateral. Cf. Treatment of Repurchase Agreements 
and Refunded Securities as an Acquisition of the Underlying 
Securities, Investment Company Act Release No. 24050 (Sept. 23, 
1999) ((64 FR 52476 (Sept. 29, 1999)) (proposing rule that would 
codify prior staff positions permitting investment companies to 
``look through'' counterparties to certain repurchase agreements and 
treat securities comprising the collateral as investments for 
certain purposes under the Act).
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    The Commission disagrees with these commenters. Investment 
companies are not required to adopt names that describe their 
investment policies. Those investment companies that do not adopt such 
a name are not subject to the 80% requirement. We believe that if an 
investment company elects to use a name that suggests its investment 
policy, it is important that the level of required investment be high 
enough that the name will accurately reflect the company's investment 
policy. Moreover, we believe that certain modifications to the proposed 
rule (e.g., allowing an investment company to have a policy that it 
will notify its shareholders 60 days prior to a change in its 
investment policy, rather than requiring that the investment policy be 
fundamental) will maintain the rule's flexibility and prevent the 
percentage investment requirement from being too restrictive.\14\
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    \14\ See infra note and accompanying text (discussing notice 
alternative).
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    One commenter recommended that the Commission adopt an additional 
requirement that the remaining 20% of an investment company's assets be 
invested in securities that are substantially equivalent to its primary 
investments. We are not adopting the commenter's recommendations 
because we do not believe that an investment company's name, standing 
alone, can be expected to fully inform investors about all of the 
investments of the company.\15\ Further, we are concerned that 
restricting the investment of the remaining 20% of an investment 
company's assets would unnecessarily reduce the manager's flexibility 
without providing significant additional benefit to shareholders.
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    \15\ See, e.g., Item 2(b) of Form N-1A (requiring a mutual 
fund's prospectus to identify its principal investment strategies, 
including the types of securities in which the fund invests 
principally). We note that an investment company that is covered by 
the rule should disclose its policy to invest its assets in 
accordance with the 80% investment requirement suggested by its name 
as one of its principal investment strategies in the prospectus. We 
would not object if mutual funds that change an existing investment 
policy from 65% to 80% to comply with rule 35d-1 file an amendment 
to a registration statement disclosing the 80% investment policy 
pursuant to rule 485(b) under the Securities Act of 1933, provided 
that the post-effective amendment otherwise meets the conditions for 
immediate effectiveness under the rule. 17 CFR 230.485(b). This also 
would apply to closed-end interval funds filing post-effective 
amendments pursuant to rule 486(b) under the Securities Act. 17 CFR 
230.486(b). In other circumstances, mutual funds must determine 
whether an amendment to a registration statement that discloses 
changes in investment policy should be filed pursuant to rule 485(a) 
or may be filed pursuant to rule 485(b) under the Securities Act. 17 
CFR 230.485(a) and 230.485(b). Likewise, closed-end interval funds 
filing post-effective amendments in other circumstances must 
determine whether they must file pursuant to rule 486(a) or may file 
pursuant to rule 486(b) of the Securities Act. 17 CFR 230.486(a) and 
230.486(b).
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    We note, however, that the 80% investment requirement is not 
intended to create a safe harbor for investment company names. A name 
may be materially deceptive and misleading even if the investment 
company meets the 80% requirement. Index funds, for example, generally 
would be expected to invest more than 80% of their assets in 
investments connoted by the applicable index. Similarly, a UIT with a 
name indicating that its distributions are tax-exempt may have a 
misleading name even if it invests 80% of its assets in tax-exempt 
investments.\16\
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    \16\ The Division currently applies a 95% investment requirement 
to tax-exempt UITs. Cf. Guide 1 of Proposed Form N-7, Investment 
Company Act Release No. 15612 (Mar. 9, 1987) (52 FR 8268 (Mar. 17, 
1987) at 8295) (proposing release for Form N-7, proposed form for 
registration of UITs) (``The staff takes the position that a (tax-
exempt) trust must have at least 95% of its net assets invested in 
tax-exempt securities in order to have substantially all of its net 
assets so invested.'').
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    We are modifying the requirement in the proposal that the 80% 
investment requirement be a fundamental policy of the investment 
company, i.e., a policy that may not be changed without shareholder 
approval.\17\ Most commenters opposed the fundamental policy 
requirement, arguing that it would be too burdensome for investment 
companies, constraining their ability to respond efficiently to market 
events or to new regulatory requirements, and discouraging them from 
using descriptive names.
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    \17\ See section 8(b)(3) of the Investment Company Act, 15 
U.S.C. 80a-8(b)(3) (regarding policies deemed fundamental by an 
investment company), and section 13(a)(3) of the Investment Company 
Act, 15 U.S.C. 80a-13(a)(3) (requiring shareholder approval to 
change a policy deemed fundamental under section 8(b)(3)).
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    The Commission is persuaded by the commenters' arguments, and the 
rule, as adopted, generally will provide investment companies with an 
alternative to the fundamental policy requirement. In lieu of adopting 
the 80% investment requirement as a fundamental policy, an investment 
company may adopt a policy that it will provide notice to shareholders 
at least 60 days prior to any change to its 80% investment policy.\18\ 
This notice alternative will ensure that when shareholders purchase 
shares in an investment company based on its name, and with the 
expectation that it will follow the investment policy suggested by that 
name, they will have sufficient time to decide whether to redeem their 
shares in the event that the investment company decides to pursue a 
different investment policy.\19\ Any investment company that changes 
its 80% investment policy would, of course, also be required to change 
its name, as necessary to comply with the requirements of rule 35d-1 in 
light of its new investment policy.
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    \18\ Rule 35d-1(a)(2)(ii) and (a)(3)(iii). The notice must be in 
plain English in a separate written document. See rule 35d-1(c)(1). 
Securities Act rule 421(d)(2) (17 CFR 230.421(d)(2)) lists the 
following plain English principles: (i) Short sentences; (ii) 
definite, concrete, everyday words; (iii) active voice; (iv) tabular 
presentation or bullet lists for complex material, whenever 
possible; (v) no legal jargon or highly technical terms; and (vi) no 
multiple negatives. The notice, as well as the envelope containing 
the notice, also must contain a prominent statement such as 
``Important Notice Regarding Change in Investment Policy.'' As an 
alternative to this requirement, if the notice is sent in a separate 
mailing, the prominent statement may appear either on the envelope 
or on the notice itself. See rule 35d-1(c)(2) and (3).
    \19\ We believe that an investment company should update its 
prospectus to reflect an upcoming change in its 80% investment 
policy by means of an amendment to its registration statement or a 
prospectus supplement or ``sticker'' no later than the time that it 
provides notice to its current shareholders of the change in policy. 
In addition, after an investment company and/or its investment 
adviser have taken steps that will result in a change in the 
company's 80% investment policy but before the time when notice to 
current shareholders is required by rule 35d-1, it may be materially 
misleading for an investment company to sell its shares to investors 
without prospectus disclosure of the upcoming change. The time at 
which prospectus disclosure is required depends on all the facts and 
circumstances, including the degree of certainty that the change 
will occur and the steps that have been taken to effect the change.
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    We are, however, adopting, as proposed, the provision that the 80% 
investment requirement be adopted as a fundamental policy for tax-
exempt investment companies. This requirement is consistent with the 
long-standing Division position that a tax-exempt fund may not change 
its tax-exempt status without shareholder approval.\20\ The Commission 
believes that the 80% investment requirement should continue to be a 
fundamental policy for a tax-exempt investment company because of the 
critical importance of the tax-exempt status to its investors.
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    \20\ See Certain Matters Concerning Investment Companies 
Investing in Tax-Exempt Securities, Investment Company Act Release 
No. 9785 (May 31, 1977) (42 FR 29130 (June 7, 1977)); Letter to 
Matthew P. Fink, Senior Vice President and General Counsel, ICI, 
from Mary Joan Hoene, Deputy Director, Division of Investment 
Management, SEC (pub. avail. Dec. 3, 1987) (``Fink Letter'').

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[[Page 8512]]

2. Names Indicating an Investment Emphasis in Certain Countries or 
Geographic Regions
    We are modifying our proposal to require investment companies with 
names that suggest that they focus their investments in a particular 
country (e.g., The ABC Japan Fund) or in a particular geographic region 
(e.g., The XYZ Latin America Fund) to meet a two-part 80% investment 
requirement.\21\ Rule 35d-1, as adopted, requires that an investment 
company with a name that suggests that it focuses its investments in a 
particular country or geographic region adopt a policy to invest at 
least 80% of its assets in investments that are tied economically to 
the particular country or geographic region suggested by its name.\22\ 
The investment company also must disclose in its prospectus the 
specific criteria that are used to select investments that meet this 
standard.\23\
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    \21\ The language of the proposal would have required an 
investment company with a name that suggests that the company 
focuses its investments in a particular country or geographic region 
to invest at least 80% of its assets in securities of issuers that 
are tied economically to that country or region. Proposed rule 35d-
1(a)(3). We have modified this language to require that such an 
investment company invest at least 80% of its assets in investments 
that are tied economically to the particular country or geographic 
region suggested by its name. Rule 35d-1(a)(3)(i). See supra note 
13.
    \22\ Rule 35d-1(a)(3)(i). The term ``geographic region'' 
includes one or more states of the United States or a geographic 
region within the United States.
    One commenter expressed concern that the rule, by its terms, 
would apply to an investment company with a long-standing trade name 
that includes a geographic location, such as the city where the 
company is headquartered, but which is not intended to refer to the 
geographic region in which the company invests. We do not intend 
that rule 35d-1 would require an investment company to change its 
name in these circumstances, where the connotation of the name is 
clear through long-standing usage and there is no risk of investor 
confusion.
    \23\ Rule 35d-1(a)(3)(ii).
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    As proposed, rule 35d-1 would have required these investment 
companies to invest in securities that met one of three criteria 
specified in the rule.\24\ Most commenters addressing this aspect of 
the proposed rule opposed the two-part test, arguing that the specific 
criteria would be too restrictive because there may be additional 
securities that would not meet any of the criteria but would expose an 
investment company to the economic fortunes and risks of the country or 
geographic region indicated in the company's name. We are persuaded by 
these comments, which are consistent with the historical position of 
the Division of Investment Management.\25\ The disclosure approach that 
we are adopting will allow an investment company the flexibility to 
invest in additional types of investments that are not addressed by the 
three proposed criteria, but expose the company's assets to the 
economic fortunes and risks of the country or geographic region 
indicated by its name.\26\
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    \24\ Proposed rule 35d-1(a)(3). Specifically, the investment 
would have to have been in: (i) securities of issuers that are 
organized under the laws of the country or of a country within the 
geographic region suggested by the company's name or that maintain 
their principal place of business in that country or region; (ii) 
securities that are traded principally in the country or region 
suggested by the company's name; or (iii) securities of issuers 
that, during the issuer's most recent fiscal year, derived at least 
50% of their revenues or profits from goods produced or sold, 
investments made, or services performed in the country or region 
suggested by the company's name or that have at least 50% of their 
assets in that country or region.
    \25\ Cf. Letter to Registrants from Carolyn B. Lewis, Assistant 
Director, Division of Investment Management, SEC (Feb. 22, 1993) at 
II.A. (rescinded by N-1A Amendments, supra note 6, at 13940 n.214) 
(using substantially the same three proposed criteria, but 
indicating that the Division would consider other criteria).
    \26\ For example, an investment company may invest in a foreign 
stock index futures contract traded on a U.S. commodities exchange, 
which may not meet any of the three proposed criteria but could 
expose the investment company to the economic fortunes and risks of 
the geographic region covered by the index. We note, however, that 
if an investment company uses a criterion that requires qualifying 
investments to be in issuers that derive a specified proportion of 
their revenues or profits from goods produced or sold, investments 
made, or services performed in the applicable country or region, or 
that have a specified proportion of their assets in that country or 
region, the Division, consistent with its current position, would 
expect the proportion used to be at least 50%, in order for the 
investments to be deemed to be tied economically to the country or 
region.
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3. Tax-Exempt Investment Companies
    We are adopting substantially as proposed the requirement that an 
investment company that uses a name suggesting that its distributions 
are exempt from federal income tax or from both federal and state 
income taxes adopt a fundamental policy: (i) to invest at least 80% of 
its assets in investments the income from which is exempt, as 
applicable, from federal income tax or from both federal and state 
income tax; \27\ or (ii) to invest its assets so that at least 80% of 
the income that it distributes will be exempt, as applicable, from 
federal income tax or from both federal and state income tax. 
Consistent with current Division positions, the requirements would 
apply to a company's investments or distributions that are exempt from 
federal income tax under both the regular tax rules and the alternative 
minimum tax rules.\28\
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    \27\ Rule 35d-1(a)(4)(i). The language of the proposal would 
have required an investment company with a name that suggests that 
the company's distributions are exempt from federal income tax or 
from both federal and state income tax to invest at least 80% of its 
assets in securities the income from which is exempt from the 
applicable taxes. Proposed rule 35d-1(a)(4). We have modified this 
language to require that such an investment company invest at least 
80% of its assets in investments the income from which is exempt 
from the applicable taxes. See supra note 13.
    \28\ See Fink Letter, supra note 20.
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    One commenter recommended that single state tax-exempt money market 
funds be exempt from the requirements of rule 35d-1, arguing that in 
several states, the supply of tax-free instruments that are eligible 
for purchase by money market funds is severely limited and, as a 
result, some of these funds may not be able to meet the 80% investment 
requirement. The Commission has determined not to provide this 
exemption. We note that a single state tax-exempt money market fund, 
like other tax-exempt investment companies, will be subject to the 80% 
investment requirement ``under normal circumstances.'' \29\ Thus, a 
single state tax-exempt fund could deviate from the 80% requirement in 
limited circumstances, such as a temporary shortage of securities of 
appropriate quality that distribute income that is tax-exempt in that 
particular state.\30\ If, however, the supply of such securities is so 
limited that the fund cannot meet the 80% requirement under normal 
circumstances, we believe that the investment company should not use a 
name suggesting that it is a single state tax-exempt fund.\31\
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    \29\ Rule 35d-1(a)(4)(i) and (ii). See infra notes 37-38 and 
accompanying text (discussing ``under normal circumstances'' 
requirement).
    \30\ Under rule 35d-1, a single state tax-exempt fund may 
include a security of an issuer located outside of the named state 
in the 80% basket if the security pays interest that is exempt from 
both federal income tax and the tax of the named state, provided 
that the fund discloses in its prospectus that it may invest in tax-
exempt securities of issuers located outside of the named state. 
Investors are generally more interested in the tax-exempt nature of 
an issuer's distributions than the issuer's location. Cf. Rule 2a-
7(a)(23) (defining a single state fund by reference to the amount of 
its distributed income that is exempt from the income taxes or other 
taxes on investments of a particular state, rather than the location 
of the issuers in which it invests).
    \31\ Rule 2a-7(a)(23), by contrast, defines a single state fund 
as a tax-exempt fund ``that holds itself out as seeking to maximize 
the amount of its distributed income that is exempt from the income 
taxes or other taxes on investments of a particular state.'' 
(emphasis added) Rule 2a-7 provides relief from its diversification 
requirements to single state funds in recognition of the fact that 
such a fund may have difficulty in meeting these standards without 
sacrificing credit quality, and this relief is appropriate when a 
fund is seeking to maximize its distributions that are tax-exempt in 
a particular state. We do not, however, believe that it is 
appropriate for a fund to suggest, through its name, that it is a 
single state tax-exempt money market fund unless it complies with 
the 80% investment requirement.

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[[Page 8513]]

4. Applying the 80% Investment Requirement

Time of Application

    The 80% investment requirement generally applies, as proposed, at 
the time when an investment company invests its assets.\32\ We are, 
however, including a grandfather provision so that a UIT that has made 
an initial deposit of securities prior to the rule's compliance date 
will not be required to comply with the 80% investment requirement.\33\ 
Because of the fixed nature of UIT portfolios, such UITs would not be 
able to adjust their portfolios to comply with the rule.
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    \32\ The rule would require an investment company that no longer 
meets the 80% investment requirement (e.g., as a result of changes 
in the value of its portfolio holdings or other circumstances beyond 
its control) to make future investments in a manner that would bring 
the company into compliance with the 80% requirement. However, an 
investment company subject to the requirement would not have to sell 
portfolio holdings that have increased in value. See Proposing 
Release, supra note 7, at 10958 n.28 and accompanying text.
    \33\ Rule 35d-1(b).
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Assets to Which Requirement Applies

    As adopted, the 80% investment requirement will be based on an 
investment company's net assets plus any borrowings for investment 
purposes.\34\ This is a modification from the proposed requirement that 
would have based the 80% investment requirement on a company's net 
assets plus any borrowings that are senior securities under section 18 
of the Investment Company Act.\35\
---------------------------------------------------------------------------

    \34\ Rule 35d-1(d)(2).
    \35\ 15 U.S.C. 80a-18. See proposed rule 35d-1(b)(2)(ii).
---------------------------------------------------------------------------

    The use of net assets rather than total assets was intended to 
reflect more closely an investment company's portfolio investments. 
Commenters were generally supportive of the proposed use of net assets. 
Several commenters, however, recommended that the 80% investment 
requirement be applied to net assets plus borrowings used for 
investment purposes, arguing that this modification would more closely 
track the Commission's stated objective of preventing an investment 
company from circumventing the 80% investment requirement by investing 
borrowed funds in investments that are not consistent with its name. 
The Commission agrees with these commenters, and has modified the 
proposal accordingly.\36\
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    \36\ Whether a particular transaction is considered borrowing 
for investment purposes would depend on all of the facts and 
circumstances. For purposes of this provision, however, a typical 
securities lending transaction (in which an investment company lends 
its portfolio securities and enters an agreement with a lending 
agent to reinvest cash collateral in highly liquid fixed-income 
securities, such as U.S. government securities) would not be 
considered borrowing for investment purposes.
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Temporary Departure From 80% Requirement

    Consistent with current Division positions, the rule, as adopted, 
will require investment companies to comply with the 80% investment 
requirement ``under normal circumstances.'' \37\ This is a modification 
of the proposed rule, which contemplated that an investment company may 
depart from the 80% requirement in order to take a ``temporary 
defensive position'' to avoid losses in response to adverse market, 
economic, political, or other conditions.\38\ We are persuaded by the 
commenters who argued that the ``temporary defensive position'' 
exception was too narrow and did not give investment companies 
sufficient flexibility to manage their portfolios, particularly in the 
case of large cash inflows or anticipated large redemptions.
---------------------------------------------------------------------------

    \37\ See former Guide 1 in the N-1A Guidelines Release, supra 
note (applying 65% investment requirement ``under normal 
circumstances'').
    \38\ Proposed rule 35d-1(b)(3).
---------------------------------------------------------------------------

    The ``under normal circumstances'' standard will provide funds with 
flexibility to manage their portfolios, while requiring that they would 
normally have to comply with the 80% investment requirement. This 
standard will permit investment companies to take ``temporary defensive 
positions'' to avoid losses in response to adverse market, economic, 
political, or other conditions. In addition, it will permit investment 
companies to depart from the 80% investment requirement in other 
limited, appropriate circumstances, particularly in the case of 
unusually large cash inflows or redemptions. For example, a new 
investment company will be permitted to comply with the 80% investment 
requirement within a reasonable time after commencing operations. We 
remind investment companies, however, that in the Division's view, an 
investment company generally must not take in excess of six months to 
invest net proceeds in order to operate in accordance with its 
investment objectives and policies.\39\ In addition, we would generally 
expect new mutual funds, which typically invest in relatively liquid 
assets and which receive cash from share purchases on an ongoing basis, 
to be fully invested within a much shorter time.\40\ We emphasize that 
an investment company should not use a name subject to the rule unless 
it intends to, and does, comply with the 80% investment requirement 
absent unusual circumstances.
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    \39\ See Guide 1 to Form N-2, Registration Statement of Closed-
End Management Investment Companies.
    \40\ In very limited circumstances, it may be appropriate for a 
closed-end fund that invests in securities whose supply is limited 
to take longer than six months to invest offering proceeds. See 
Guide 1 to Form N-2, Registration Statement of Closed-End Management 
Investment Companies (may be appropriate for a closed-end fund 
investing in a single foreign country or small businesses to take up 
to two years to invest offering proceeds).
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B. Names Suggesting Guarantee or Approval by the U.S. Government

    Consistent with the requirements of section 35(a) of the Investment 
Company Act, rule 35d-1, as adopted, prohibits an investment company 
from using a name that suggests that the company or its shares are 
guaranteed or approved by the United States government or any United 
States government agency or instrumentality.\41\ The prohibited types 
of names include names that use the words ``guaranteed'' or ``insured'' 
or similar terms in conjunction with the words ``United States'' or 
``U.S. government.''
---------------------------------------------------------------------------

    \41\ Rule 35(d)-1(a)(1).
---------------------------------------------------------------------------

C. Other Investment Company Names

1. General
    Rule 35d-1, as adopted, does not codify positions of the Division 
of Investment Management with respect to investment company names 
including the terms ``balanced,'' ``index,'' ``small, mid, or large 
capitalization,'' ``international,'' and ``global.'' \42\ In

[[Page 8514]]

addition, the rule does not apply to fund names that incorporate terms 
such as ``growth'' and ``value'' that connote types of investment 
strategies as opposed to types of investments. The Division will 
continue to scrutinize investment company names not covered by the 
proposed rule.\43\ In determining whether a particular name is 
misleading, the Division will consider whether the name would lead a 
reasonable investor to conclude that the company invests in a manner 
that is inconsistent with the company's intended investments or the 
risks of those investments.\44\
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    \42\ See Letter to Registrants from Carolyn B. Lewis, Assistant 
Director, Division of Investment Management, SEC (Feb. 25, 1994) at 
II.D. (rescinded by N-1A Amendments, supra note 6, at 13940 n.214) 
(``small, medium, and large capitalization''); Letter to Registrants 
from Carolyn B. Lewis, Assistant Director, Division of Investment 
Management, SEC (Jan. 17, 1992) at II.A. (rescinded by N-1A 
Amendments, supra note 6, at 13940 n.214) (``index''); Letter to 
Registrants from Carolyn B. Lewis, Assistant Director, Division of 
Investment Management, SEC (Jan. 3, 1991) at II.A. (rescinded by N-
1A Amendments, supra note 6, at 13940 n.214) (``international'' and 
``global'').
    The terms ``small, mid, or large capitalization'' and ``index'' 
suggest a focus on a particular type of investment, and investment 
companies that use these terms will be subject to the 80% investment 
requirement of the rule. The term ``balanced,'' however, does not 
suggest a particular investment focus, but rather a particular type 
of diversification among different investments, and ``balanced'' 
funds will not be subject to the rule. The Division takes the 
position that an investment company that holds itself out as 
``balanced'' should invest at least 25% of its assets in fixed 
income senior securities and should invest at least 25% of its 
assets in equities. Cf. Former Guide 4 in the N-1A Guidelines 
Release, supra note 6 (rescinded by N-1A Amendments, supra note 6, 
at 13940 n.214) (requiring an investment company that purports to be 
``balanced'' to maintain at least 25 percent of the value of its 
assets in fixed income senior securities).
    The term ``foreign'' indicates investments that are tied 
economically to countries outside the United States, and an 
investment company that uses this term would be subject to the 80% 
requirement. The terms ``international'' and ``global,'' however, 
connote diversification among investments in a number of different 
countries throughout the world, and ``international'' and ``global'' 
funds will not be subject to the rule. We would expect, however, 
that investment companies using these terms in their names will 
invest their assets in investments that are tied economically to a 
number of countries throughout the world. See Proposing Release, 
supra note 7, at 10960 n.38 and accompanying text (``The Division no 
longer distinguishes the terms `global' and `international.' '').
    \43\ As a general matter, an investment company may use any 
reasonable definition of the terms used in its name and should 
define the terms used in its name in discussing its investment 
objectives and strategies in the prospectus. See Letter to 
Registrants from Carolyn B. Lewis, Assistant Director, Division of 
Investment Management, SEC (Feb. 25, 1994) at II.D (rescinded by N-
1A Amendments, supra note 6, at 13940 n.214) (using this approach 
for investment companies that include the words ``small, mid, or 
large capitalization'' in their names).
    \44\ See In re Alliance North Am. Gov't Income Trust, Inc. 
Securities Litigation, No. 95 Civ. 0330 (LMM), 1996 U.S. Dist. LEXIS 
14209, at *8 (S.D.N.Y. Sept. 27, 1996); The Private Investment Fund 
for Governmental Personnel, Inc., 37 S.E.C. 484, 487-88 (1957).
---------------------------------------------------------------------------

2. Names and Average Weighted Portfolio Maturity and Duration
    Investment companies investing in debt obligations often seek to 
distinguish themselves by limiting the maturity of the instruments they 
hold. These investment companies may call themselves, for example, 
``short-term,'' ``intermediate-term,'' or ``long-term'' bond or debt 
funds. Historically, the Division of Investment Management has required 
investment companies with these types of names to have average weighted 
portfolio maturities of specified lengths. In particular, the Division 
has required an investment company that included the words ``short-
term,'' ``intermediate-term,'' or ``long-term'' in its name to have a 
dollar-weighted average maturity of, respectively, no more than 3 
years, more than 3 years but less than 10 years, or more than 10 
years.\45\ Although the Proposing Release stated that the Division did 
not intend to continue to use these criteria, the Division has re-
evaluated this position in light of its subsequent experience and the 
comments received on the Proposing Release. The Division has concluded 
that it will continue to apply these maturity criteria to investment 
companies that call themselves ``short-term,'' ``intermediate-term,'' 
or ``long-term'' because they provide reasonable constraints on the use 
of those terms.
---------------------------------------------------------------------------

    \45\ See Investment Company Act Release No. 15612 (Mar. 9, 1987) 
(52 FR 8268 (Mar. 17, 1987) at 8301) (proposing to codify these 
positions in a guideline).
---------------------------------------------------------------------------

    We note, however, that there may be instances where the average 
weighted maturity of an investment company's portfolio securities may 
not accurately reflect the sensitivity of the company's share prices to 
changes in interest rates.\46\ The Commission and the Division, 
therefore, do not intend compliance with the Division's maturity 
guidelines to act as a safe harbor in determining whether a name is 
misleading. In a case, for example, where an investment company's name 
was consistent with the Division's maturity guidelines, but the 
``duration'' of the company's portfolio was inconsistent with the 
sensitivity to interest rates suggested by the company's name, the name 
may be misleading.\47\
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    \46\ In 1994, some investors did not anticipate how certain 
investment companies would perform when interest rates declined over 
a relatively short period of time. See, e.g., Antilla, A New Concept 
in Fund Ads: Truth, N.Y. Times, July 10, 1994, at C13 (regarding the 
performance of certain short-term bond funds).
    \47\ In view of the shortcomings associated with analyzing 
interest rate volatility based on average weighted maturity, 
investment companies and investment professionals increasingly 
evaluate bond portfolios based on ``duration,'' which reflects the 
sensitivity of an investment company's return to changes in interest 
rates. See, e.g., Wright, Duration: The Second Step, Morningstar 
Mutual Funds 1-2 (Sept. 12, 1997); Rekenthaler, Duration Arrives, 
Morningstar Mutual Funds 1-2 (Jan. 21, 1994). Whether a name was 
misleading in the circumstances outlined above would depend on all 
the facts and circumstances, including other disclosures to 
investors.
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D. Compliance Date

    Rule 35d-1 will become effective March 31, 2001. The Commission 
proposed to allow an investment company up to one year from the 
effective date of the proposed rule to comply with the rule's 
requirements. The Commission is persuaded by commenters that additional 
time may be required to make portfolio adjustments; internal compliance 
system changes; and, for those companies that do not wish to be subject 
to the rule, to adopt name changes. Therefore, the Commission will 
permit an investment company until July 31, 2002, to comply with the 
rule's requirements.

III. Cost/Benefit Analysis

    The Commission is sensitive to the costs and benefits imposed by 
its rules. The Commission did not solicit any comments on the costs and 
benefits associated with the rule and did not receive any comments 
addressing the costs and benefits. While it is difficult to quantify 
the costs and benefits related to the rule, the Commission notes that 
the commenters generally supported the proposed rule.
    Rule 35d-1 will provide significant benefits to investors, by 
helping to ensure that an investment company that has a name suggesting 
that it focuses on a particular type of investment, or in investments 
in a particular industry, invests at least 80% of its assets in the 
type of investment suggested by its name. The 80% investment threshold 
represents an increase from the staff's current position that an 
investment company with a name suggesting that the company focuses on a 
particular type of investment only needs to invest 65% of its assets in 
the type of investment suggested by its name. By increasing the 
investment requirement from 65% to 80%, the rule will enable investors 
to more efficiently compare one fund with another before making 
investment decisions, which will tend to promote competition among 
investment companies, and will reduce the time that investors must 
spend searching for an investment company that meets their particular 
needs. In addition, the rule will benefit investors by reducing the 
amount of time and resources that they must devote to monitoring 
whether the investment companies that they have invested in are 
continuing to follow their stated investment objectives. Further, by 
decreasing the likelihood that an investment company will deviate from 
the investment objective and policy suggested by its name, and invest 
in ways that do not correspond with investors' individual investment 
needs and asset allocation goals, the rule will also lower the costs 
imposed on investors by inefficient allocation of their assets.
    Moreover, the rule will enable an investment company affected by 
the rule to adopt a policy that it will notify its investors before 
changing its investment policy; such a policy would allow investors 
more time to reallocate their assets if the company's investment

[[Page 8515]]

focus changes. The rule will thereby help to ensure that investors' 
assets in mutual funds and other investment companies are invested in 
accordance with their expectations, and will enhance the efficiency and 
accuracy with which investors can design their fund portfolios to meet 
their individual investment needs.
    We believe the benefits to investors resulting from the rule are 
significant, although they are difficult to quantify. The Commission 
estimates that total investment company assets are $7.4 trillion.\48\ 
We estimate that approximately $ 429.9 billion of these assets are 
invested in investment companies that would be affected by the rule and 
that do not currently meet an 80% investment threshold.\49\ We estimate 
that investors in these investment companies would receive benefits 
from the imposition of an 80% investment requirement under the rule 
equivalent to one basis point (0.01%) of assets invested in these 
investment companies, or $43.0 million.\50\
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    \48\ See supra note 10.
    \49\ We estimate that approximately 83% of investment companies, 
with $6.142 trillion in assets, have names that would be covered by 
the rule. We estimate further that 7% of investment companies with 
names covered by the rule currently meet the Division's 65% 
investment requirement, but would not meet an 80% threshold.
    \50\ This estimate is based on an estimate of the total savings 
resulting from reductions in the costs of monitoring these 
investment companies, and the costs to investors of inefficient 
asset allocation.
---------------------------------------------------------------------------

    Rule 35d-1 will also impose certain costs on investment companies 
and therefore indirectly on investors. First, an investment company 
affected by the rule that currently has less than 80% of its 
investments in the type of investments indicated by its name will have 
to take one of two actions in order to comply with the 80% investment 
requirement of the rule. It may increase its investments in the type of 
investments described by its name to 80% or more. Alternatively, it may 
choose to change its name.
    The Commission estimates that there are currently 8,675 open-end 
management investment companies, series of such companies, or closed-
end management investment companies that are registered with the 
Commission and would fall within the definition of ``Fund'' contained 
in rule 35d-1.\51\ Of this total, the Commission estimates that 7,200, 
or 83%, have descriptive names that would be covered by the rule.
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    \51\ An additional 11,922 investment companies and series of 
investment companies would fall within the definition of ``Fund'' in 
the rule, but are unlikely to be significantly affected by the rule. 
The vast majority of these 11,922 investment companies and series 
are UITs or UIT offerings that are largely exempted from the 80% 
investment requirement by a grandfather provision. See Rule 35d-
1(b).
---------------------------------------------------------------------------

    The Commission estimates that 6,696, or approximately 93%, of these 
7,200 investment companies and series would currently meet or exceed an 
80% investment threshold.\52\ Of the 504 investment companies and 
series that the Commission estimates do not currently meet this 80% 
threshold, the Commission estimates that approximately 30%, or 151, 
fail to meet the threshold principally because of large cash positions; 
presumably, these cash positions are temporary, and these investment 
companies would intend to reduce these cash positions and would in all 
probability satisfy the 80% investment threshold in the near future.
---------------------------------------------------------------------------

    \52\ This estimate, and the estimate of the percentage of 
investment companies with descriptive names, are based on the 
Commission's analysis of a database of mutual fund annual and semi-
annual reports and other data concerning portfolio holdings of 
funds, compiled by a large mutual fund data provider.
---------------------------------------------------------------------------

    The remaining estimated 353 investment companies and series would 
need to take steps to meet the 80% investment requirement in the rule, 
by either changing their name or changing their investments. Although 
the costs to these investment companies of either changing their 
investments or their names cannot be quantified, we believe they will 
be relatively small. We note that investment companies do not have to 
be in compliance with the rule until July 31, 2002. Those investment 
companies that choose to change their investment policy in order to 
have 80% of their investments consistent with their names will incur 
brokerage costs in connection with adjusting their investments. 
However, many of these investment companies normally experience 
substantial portfolio turnover each year, so it is unclear whether they 
would incur brokerage costs in order to comply with the rule that they 
would not be incurring otherwise. Investment companies that choose to 
change their names in order to comply with the rule may incur certain 
limited legal and administrative expenses, which we estimate would be 
$1,000 for each affected investment company or series, exclusive of 
printing and mailing costs. The Commission estimates that the average 
number of shareholder accounts in investment companies or series of 
investment companies that are likely to be affected by the rule is 
28,000. The Commission estimates that printing and mailing costs in 
connection with a name change are $.25 per shareholder, or $7,000 
(28,000 x $.25) for an average-sized investment company series.\53\
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    \53\ These estimates of the cost to an investment company of 
changing its name or the name of one of its series are based on 
information provided to the staff by a large mutual fund complex. An 
investment company that changes the name of one of its series may 
need to provide a prospectus supplement or ``sticker'' to 
shareholders. Based on information provided to the staff by this 
mutual fund complex, we estimated that the ``sticker'' would cost 
$.25 per shareholder to print and mail.
---------------------------------------------------------------------------

    Second, after the compliance date, investment companies subject to 
rule 35d-1(a)(2), (a)(3) and (a)(4) may want to monitor their 
investment activity on an ongoing basis to confirm that they are in 
compliance with the rule. We believe these monitoring costs will be 
quite limited. The 80% investment requirement of these sections of the 
rule will apply to net assets, plus borrowings for investment 
purposes.\54\ Investment companies already have to calculate net assets 
daily. In addition, investment companies may already monitor their 
investment activity in order to comply with the Division's current 65% 
investment requirement.
---------------------------------------------------------------------------

    \54\ An investment company affected by Rule 35d-1(a)(4) 
(applying to tax-exempt funds) will either have to invest 80% of its 
assets, as defined by the rule, in securities the income from which 
is exempt from federal income tax or federal and state income tax, 
or will have to invest its assets so that at least 80% of the income 
that it distributes is so exempt.
---------------------------------------------------------------------------

    Third, there may also be costs associated with the rule in the 
event that an investment company affected by the rule seeks to change 
its 80% investment policy subsequent to the compliance date.\55\ By the 
compliance date, an investment company that chooses to comply with rule 
35d-1(a)(2) and (a)(3) will have to adopt either an 80% investment 
policy as a fundamental policy, or a policy to notify investors 60 days 
prior to any change in its 80% investment policy. We believe that most 
investment companies will choose the latter option. The Commission 
estimates that in the event that such an investment company decides to 
change its investment policy, the required notice would take 
approximately 20 hours for an investment company to prepare, and would 
cost $1,260, based on an estimated hourly wage rate of $63 for in-house 
legal counsel.\56\
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    \55\ An investment company that changes its 80% investment 
policy would also be required to change its name, as necessary to 
comply with the requirements of rule 35d-1 in light of its new 
investment policy. It would therefore also incur estimated legal and 
administrative expenses of $1,000 and estimated printing and mailing 
costs of $7,000. See supra note and accompanying text.
    \56\ See Section V., infra. The wage rate used is based on 
salary information for the securities industry compiled by the 
Securities Industry Association. See Securities Industry 
Association, Report on Management & Professional Earnings in the 
Securities Industry 1999 (Sept. 1999).

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[[Page 8516]]

    Printing costs and the costs of mailing or otherwise providing the 
prior notice to shareholders will vary for each investment company, 
depending on the number of shareholders who are affected. However, 
because the notice may be a brief one-page document, and could be 
enclosed in the same envelope with other printed matter (e.g., an 
account statement, prospectus, or report), the Commission believes that 
this cost of the notice will be less than $.25 per shareholder, or 
$7,000 for an average-sized investment company or series, which we 
estimate has 28,000 shareholder accounts.\57\ While it is impossible to 
predict accurately how many investment companies and series would send 
out notice in connection with a change in their investment policies, 
the Commission believes that a reasonable estimate over a three-year 
period is 72, or one percent of the estimated number of investment 
companies and series with descriptive names (7,200). Thus, we estimate 
the total cost to the investment company industry of providing prior 
notice to shareholders of changes in their 80% investment policies 
under the notice policy provision of the rule will be $594,720 over 
three years, or $198,240 annually.\58\
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    \57\ This estimate is based on the Commission's estimate that 
the ``sticker'' that an investment company would have to provide to 
its shareholders, notifying them of a name change, would cost $.25 
per shareholder. See supra note. We estimate that the notice that 
would be provided to shareholders of a change in investment policy 
would be a similarly brief document.
    \58\ The total cost of $594,720 was reached by adding printing 
and mailing costs of $7,000 (28,000 accounts  x  $.25 per 
shareholder) and the $1,260 cost of preparing the notice, and 
multiplying the total cost of $8,260 by the number of investment 
companies that are estimated to send out notice over a three-year 
period (72).
---------------------------------------------------------------------------

    Fourth, an investment company with a name suggesting that it 
focuses its investments in a particular country or geographic region 
must disclose in its prospectus the specific criteria that are used to 
select investments that meet this standard. The staff has estimated 
that incorporating the required disclosure into the prospectus would 
take approximately two hours for each of the affected 202 open-end 
investment companies or series registered or to be registered on Form 
N-1A, and each of 26 affected closed-end investment companies 
registered on Form N-2, for a total annual industry burden of 456 
hours.\59\ The Commission, using an hourly wage rate of $63 for in-
house legal counsel, estimates that the total annual industry cost of 
the hour burden imposed by the prospectus disclosure requirement under 
rule 35d-1 is $28,728 (456 (annual hour burden)  x  $63 (hourly wage 
rate)).\60\
---------------------------------------------------------------------------

    \59\ These totals are based on an estimate of 193 open-end 
management investment companies or series currently registered on 
Form N-1A that have names suggesting an investment focus in a 
particular country or geographic region, and an estimate of 9 new 
open-end management investment companies or series with such names 
that are registered annually; and an estimate of 26 closed-end 
management investment companies that register annually with the 
Commission on Form N-2 that have names suggesting an investment 
focus on a particular country or geographic region. See Section V., 
infra.
    \60\ See supra note 56.
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IV. Summary of Final Regulatory Flexibility Analysis

    A summary of the Initial Regulatory Flexibility Analysis (``IRFA'') 
regarding proposed rule 35d-1, which was prepared in accordance with 5 
U.S.C. Sec. 603, was published in the Proposing Release. No comments 
were received on the IRFA. We have prepared a Final Regulatory 
Flexibility Analysis (``FRFA'') in accordance with 5 U.S.C. Sec. 604 
relating to the adopted rule.
    The FRFA discusses the need for, and objectives of, the new rule. 
The FRFA explains that the rule requires a registered investment 
company with a name suggesting that the company focuses on a particular 
type of investment to invest at least 80% of its assets in the type of 
investment suggested by its name. The FRFA also explains that the rule 
is intended to address investment company names that are likely to 
mislead investors about an investment company's investments and risks.
    The FRFA discusses the impact of the rule on small entities, which 
are defined, for the purposes of the Investment Company Act, as 
investment companies with net assets of $50 million or less as of the 
end of the most recent fiscal year (17 CFR 270.0-10). As of June 2000, 
there were approximately 4,387 registered investment companies.\61\ Of 
these 4,387, approximately 215 (4.9%) are investment companies that 
meet the Commission's definition of small entity for purposes of the 
Investment Company Act. The Commission estimates that 83% of these 215 
small entities, or 179, have descriptive names and would therefore be 
subject to rule 35d-1.\62\
---------------------------------------------------------------------------

    \61\ For purposes of determining the existing number of 
registered investment companies and the number of small entities in 
this analysis, the Commission did not count a series of an 
investment company as an entity separate from the investment 
company. Many investment companies have multiple series. Thus, the 
total of registered investment companies (4,387) is significantly 
smaller than the total of investment companies and series that would 
fall within the definition of ``Fund'' under the rule (8,675). See 
supra note 51 and accompanying text.
    \62\ The Commission also used this 83% figure to compute the 
number of open-end and closed-end management investment companies 
and series that have descriptive names. See supra note 51 and 
accompanying text.
---------------------------------------------------------------------------

    Only those investment companies that have names suggesting a 
particular investment emphasis are required to comply with the rule. In 
general, to comply with the rule, an investment company with a name 
that suggests that the company focuses on a particular type of 
investment will either have to adopt a fundamental policy to invest at 
least 80% of its assets in the type of investment suggested by its name 
or adopt a policy of notifying its shareholders at least 60 days prior 
to any change in its 80% investment policy. The 80% investment 
requirement will allow an investment company to maintain up to 20% of 
its assets in other investments. An investment company seeking maximum 
flexibility with respect to its investments will be free to use a name 
that does not connote a particular investment emphasis.
    Additionally, an investment company with a name suggesting that it 
focuses its investments in a particular country or geographic region 
must disclose in its prospectus the specific criteria that are used to 
select investments that are tied economically to the particular country 
or region.
    As stated in the FRFA, the Commission considered several 
alternatives to rule 35d-1 including, among others, establishing 
different compliance or reporting requirements for small entities or 
exempting them from all or part of the rule. Because an investment 
company could choose to use a name that does not suggest a particular 
investment, the Commission believes that the rule will not impose 
additional burdens on small entities and that separate treatment for 
small entities would be inconsistent with the protection of investors.
    The FRFA is available for public inspection in File No. S7-11-97, 
and a copy may be obtained by contacting John L. Sullivan, Office of 
Disclosure Regulation, Securities and Exchange Commission, 450 5th 
Street, NW., Washington, DC 20549-0506.

V. Paperwork Reduction Act

    Certain provisions of the rule contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501 et seq.), and the Commission has 
submitted the proposed collections of information to

[[Page 8517]]

the Office of Management and Budget for review in accordance with 44 
U.S.C. 3507(d) and 5 CFR 1320.11. The titles for the collections of 
information are (1) ``Rule 35d-1 under the Investment Company Act of 
1940, Investment Company Names''; (2) ``Form N-1A under the Investment 
Company Act of 1940 and Securities Act of 1933, Registration Statement 
of Open-End Management Investment Companies''; and (3) ``Form N-2 under 
the Investment Company Act of 1940 and Securities Act of 1933, 
Registration Statement of Closed-End Management Companies.'' An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless it displays a currently valid 
control number.
    Form N-1A (OMB Control No. 3235-0307) and Form N-2 (OMB Control No. 
3235-0026) were adopted pursuant to section 8(a) of the Investment 
Company Act (15 U.S.C. 80a-8) and section 5 of the Securities Act (15 
U.S.C. 77e). The Commission is proposing to create a new information 
collection entitled ``Rule 35d-1 under the Investment Company Act of 
1940, Investment Company Names.'' This information collection will 
encompass the rule's notice policy provision described below.
    Rule 35d-1 is designed to address certain broad categories of 
investment company names that, in the Commission's view, are likely to 
mislead an investor about a company's investments and risks. The rule 
requires registered investment companies to invest at least 80% of 
their assets in the type of investments suggested by their names, if 
their names suggest investments in:
     A particular type of investment (e.g., the ABC Stock Fund, 
XYZ Bond Fund, or QRS U.S. Government Fund);
     A particular industry (e.g., the ABC Utilities Fund or XYZ 
Health Care Fund); and
     A particular country or geographic region (e.g., the ABC 
Japan Fund or XYZ Latin America Fund).
    Rule 35d-1 also requires an investment company that uses a name 
suggesting that its distributions are exempt from federal income tax or 
from both federal and state income taxes to invest:
     At least 80% of its assets in securities the income from 
which is exempt, as applicable, from federal income tax or from both 
federal and state income tax; or
     Its assets so that at least 80% of the income that it 
distributes will be exempt, as applicable, from federal income tax or 
both federal and state income tax.
    The rule also prohibits investment company names that represent or 
imply that the investment company or the securities issued by it are 
guaranteed, sponsored, recommended, or approved by the U.S. government 
or any U.S. government agency or instrumentality.
    The rule will generally require that, following the compliance 
date, the 80% investment requirement either must be a fundamental 
policy of an investment company affected by the rule, or the investment 
company must have adopted a policy to provide notice to shareholders at 
least 60 days prior to any change in its 80% investment policy in order 
for its name not to be deemed misleading under the rule. Additionally, 
an investment company with a name suggesting that it focuses its 
investments in a particular country or geographic region must disclose 
in its prospectus the specific criteria that are used to select 
investments that meet this standard.

Notice Policy Provision Under Rule 35d-1

    The Commission anticipates that any notice provided to shareholders 
under a notice policy that meets the requirements of rule 35d-1 will 
typically be a short, one-page document that may be enclosed with other 
written materials sent to shareholders, such as prospectuses, annual 
and semi-annual reports, and account statements. The number of burden 
hours spent preparing and arranging delivery of these notices therefore 
will be low. The Commission estimates that the annual burden associated 
with the notice requirement of the rule would be 20 hours per affected 
investment company or series. The Commission anticipates that each 
affected respondent would incur these burden hours only once.
    The Commission estimates that there are currently 7,200 open-end 
and closed-end management investment companies and series that have 
descriptive names that would be covered by the rule.\63\ The Commission 
estimates that 72, or 1%, of these investment companies and series will 
at some point provide prior notice to their shareholders of a change in 
their investment policies pursuant to a policy adopted in accordance 
with this rule. Of these estimated 72 investment companies and series 
that are expected to provide prior notice to their shareholders of a 
change in their investment policies, the Commission anticipates that 
24, or one-third, will do so within one year of the rule's compliance 
date. The Commission estimates that each of these 24 investment 
companies and series will spend an average of 20 hours complying with 
the notice alternative provided by the rule, for an annual total of 480 
hours.
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    \63\ The Commission estimates that there are currently 8,675 
open-end management investment companies, series of such investment 
companies, and closed-end investment companies that are registered 
with the Commission and would fall within the definition of ``Fund'' 
contained in rule 35d-1. Of this total, the Commission estimates 
that 83%, or 7,200, have descriptive names that would be covered by 
the rule. See supra notes 51-52 and accompanying text.
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    Providing prior notice to shareholders under rule 35d-1 is not 
mandatory. An investment company may choose to have a non-descriptive 
name. Further, if an investment company has a descriptive name, it will 
only need to provide prior notice to shareholders of a change in its 
80% investment policy if it first has adopted a policy to provide 
notice and then has decided to change this investment policy. There is 
no mandatory retention period associated with a notice policy that 
meets the requirements of the rule, and responses to such a notice 
policy will not be kept confidential.

Prospectus Disclosure

    With respect to the prospectus disclosure regarding the specific 
criteria that are used to select investments for an investment company 
with a name suggesting that it focuses its investments in a particular 
country or geographic region, the Commission estimates that the annual 
burden will be two hours for each affected investment company and 
series of an investment company. The likely respondents to this 
information collection are open-end management investment companies 
registering with the Commission on Form N-1A and closed-end management 
investment companies registering with the Commission on Form N-2. Both 
Form N-1A and Form N-2 contain collection of information requirements. 
The purpose of Form N-1A and Form N-2 is to meet the registration and 
disclosure requirements of the Securities Act and Investment Company 
Act and to enable investment companies to provide investors with 
information necessary to evaluate an investment in the investment 
company.

Form N-1A

    The Commission estimates that there are currently 193 open-end 
management investment companies or series registered with the 
Commission on Form N-1A that have names suggesting a focus on a 
particular country or geographic region. The Commission

[[Page 8518]]

estimates that each of these investment companies and series will spend 
an average of two hours to prepare and incorporate the required 
disclosure into its annual update of its prospectus by post-effective 
amendment, for a total of 386 hours. In addition, we estimate that 298 
open-end management investment companies and series file initial 
registration statements on Form N-1A annually. Based on the overall 
percentage of investment companies and series that have names 
suggesting a focus on a country or geographical region, we estimate 
that 9 of these registration statements annually will have to include 
disclosure required by the rule, at a cost of two hours per registrant, 
or 18 hours. Thus, we estimate that the required prospectus disclosure 
of rule 35d-1 will add 404 hours ((193 open-end management investment 
companies or series + 9 investment companies or series) x 2 hours) to 
the previous Form N-1A annual burden of 1,159,311, resulting in a new 
total Form N-1A annual hour burden, after adjusting for a decrease of 
98 in the number of respondents filing on Form N-1A, of 1,145,843 
hours.

Form N-2

    The Commission estimates that 130 closed-end management investment 
companies file registration statements annually on Form N-2. We 
estimate that approximately 20% of these closed-end management 
investment companies, or 26, have names suggesting a focus on a 
particular country or geographic region. We believe that the disclosure 
burden of two hours will be the same for Form N-2 as for an open-end 
management investment company or series.\64\ Thus, we estimate that the 
required prospectus disclosure of rule 35d-1 will add 52 hours (26 
closed-end management investment companies x two hours) to the current 
Form N-2 annual burden of 61,760 hours, resulting in a total Form N-2 
annual hour burden of 61,812 hours.
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    \64\ Closed-end management investment companies, however, 
generally do not file post-effective amendments.
---------------------------------------------------------------------------

    The prospectus disclosure required by the rule in Form N-1A and 
Form N-2 is mandatory for an investment company suggesting that it 
focuses its investments in a particular country or geographic region. 
There is no mandatory retention period for the information disclosed, 
and responses to the disclosure requirement will not be kept 
confidential.

Request for Comments

    We request your comments on the accuracy of our estimates. Pursuant 
to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) 
evaluate whether the proposed collection of information is necessary 
for the proper performance of the functions of the agency, including 
whether the information will have practical utility; (ii) evaluate the 
accuracy of the Commission's estimate of burden of the proposed 
collection of information; (iii) determine whether there are ways to 
enhance the quality, utility, and clarity of the information to be 
collected; and (iv) evaluate whether there are ways to minimize the 
burden of the collection of information on those who are to respond, 
including through the use of automated collection techniques or other 
forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Room 3208, 
New Executive Office Building, Washington, D.C. 20503, and should send 
a copy to Jonathan G. Katz, Secretary, Securities and Exchange 
Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-0609, with 
reference to File No. S7-11-97. Request for materials submitted to OMB 
by the Commission with regard to this collection of information should 
be in writing, refer to File No. S7-11-97, and be submitted to the 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
D.C. 20549, Attention: Records Management, Office of Filings and 
Information Services. OMB is required to make a decision concerning the 
collection of information between 30 and 60 days after publication of 
this release. Consequently, a comment to OMB is best assured of having 
its full effect if OMB receives it within 30 days after publication of 
this release.

VI. Statutory Authority

    The Commission is adopting rule 35d-1 pursuant to the authority set 
forth in sections 8, 30, 34, 35, and 38 of the Investment Company Act 
(15 U.S.C. 80a-8, 80a-29, 80a-33, 80a-34, and 80a-37). The authority 
citations for the rule precede the text of the amendments.

List of Subjects in 17 CFR Part 270

    Investment companies, Securities.

Text of Rule

    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-34(d), 80a-37, 80a-39 
unless otherwise noted.


    2. Section 270.35d-1 is added to read as follows:


Sec. 270.35d-1  Investment company names.

    (a) For purposes of section 35(d) of the Act (15 U.S.C. 80a-34(d)), 
a materially deceptive and misleading name of a Fund includes:
    (1) Names suggesting guarantee or approval by the United States 
government. A name suggesting that the Fund or the securities issued by 
it are guaranteed, sponsored, recommended, or approved by the United 
States government or any United States government agency or 
instrumentality, including any name that uses the words ``guaranteed'' 
or ``insured'' or similar terms in conjunction with the words ``United 
States'' or ``U.S. government.''
    (2) Names suggesting investment in certain investments or 
industries. A name suggesting that the Fund focuses its investments in 
a particular type of investment or investments, or in investments in a 
particular industry or group of industries, unless:
    (i) The Fund has adopted a policy to invest, under normal 
circumstances, at least 80% of the value of its Assets in the 
particular type of investments, or in investments in the particular 
industry or industries, suggested by the Fund's name; and
    (ii) Either the policy described in paragraph (a)(2)(i) of this 
section is a fundamental policy under section 8(b)(3) of the Act (15 
U.S.C. 80a-8(b)(3)), or the Fund has adopted a policy to provide the 
Fund's shareholders with at least 60 days prior notice of any change in 
the policy described in paragraph (a)(2)(i) of this section that meets 
the requirements of paragraph (c) of this section.
    (3) Names suggesting investment in certain countries or geographic 
regions. A name suggesting that the Fund focuses its investments in a 
particular country or geographic region, unless:
    (i) The Fund has adopted a policy to invest, under normal 
circumstances, at least 80% of the value of its Assets in investments 
that are tied economically to the particular country or geographic 
region suggested by its name;

[[Page 8519]]

    (ii) The Fund discloses in its prospectus the specific criteria 
used by the Fund to select these investments; and
    (iii) Either the policy described in paragraph (a)(3)(i) of this 
section is a fundamental policy under section 8(b)(3) of the Act (15 
U.S.C. 80a-8(b)(3)), or the Fund has adopted a policy to provide the 
Fund's shareholders with at least 60 days prior notice of any change in 
the policy described in paragraph (a)(3)(i) of this section that meets 
the requirements of paragraph (c) of this section.
    (4) Tax-exempt Funds. A name suggesting that the Fund's 
distributions are exempt from federal income tax or from both federal 
and state income tax, unless the Fund has adopted a fundamental policy 
under section 8(b)(3) of the Act (15 U.S.C. 80-8(b)(3)):
    (i) To invest, under normal circumstances, at least 80% of the 
value of its Assets in investments the income from which is exempt, as 
applicable, from federal income tax or from both federal and state 
income tax; or
    (ii) To invest, under normal circumstances, its Assets so that at 
least 80% of the income that it distributes will be exempt, as 
applicable, from federal income tax or from both federal and state 
income tax.
    (b) The requirements of paragraphs (a)(2) through (a)(4) of this 
section apply at the time a Fund invests its Assets, except that these 
requirements shall not apply to any unit investment trust (as defined 
in section 4(2) of the Act (15 U.S.C. 80a-4(2))) that has made an 
initial deposit of securities prior to July 31, 2002. If, subsequent to 
an investment, these requirements are no longer met, the Fund's future 
investments must be made in a manner that will bring the Fund into 
compliance with those paragraphs.
    (c) A policy to provide a Fund's shareholders with notice of a 
change in a Fund's investment policy as described in paragraphs 
(a)(2)(ii) and (a)(3)(iii) of this section must provide that:
    (1) The notice will be provided in plain English in a separate 
written document;
    (2) The notice will contain the following prominent statement, or 
similar clear and understandable statement, in bold-face type: 
``Important Notice Regarding Change in Investment Policy''; and
    (3) The statement contained in paragraph (c)(2) of this section 
also will appear on the envelope in which the notice is delivered or, 
if the notice is delivered separately from other communications to 
investors, that the statement will appear either on the notice or on 
the envelope in which the notice is delivered.
    (d) For purposes of this section:
    (1) Fund means a registered investment company and any series of 
the investment company.
    (2) Assets means net assets, plus the amount of any borrowings for 
investment purposes.

    Dated: January 17, 2001.
    By the Commission.

Jonathan G. Katz,
Secretary.
[FR Doc. 01-1967 Filed 1-31-01; 8:45 am]
BILLING CODE 8010-01-P