[Federal Register Volume 66, Number 156 (Monday, August 13, 2001)]
[Notices]
[Pages 42570-42572]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-20233]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. IA-1960 803-154]


Capital Guardian Trust Company, et al.; Notice of Application

August 7, 2001.
AGENCY: Securities and Exchange Commission (``SEC'').

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

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    Applicants: Capital Guardian Trust Company (``CGTC'') and Hirtle 
Callaghan Trust (``Trust'').
    Relevant Advisers Act Sections: Exemption requested under section 
206A of the Advisers Act from section 205 of the Advisers Act and 
Advisers Act rule 205-1.
SUMMARY OF APPLICATION: Applicants request an order permitting CGTC to 
charge a performance fee based on the performance of that portion of a 
Trust portfolio managed by CGTC (``CGTC Account''). Applicants further 
request that the order permit them to commute the performance-related 
portion of the fee using changes in the CGTC Account's gross asset 
value rather than net asset value.

FILING DATES: The application was filed on November 27, 2000, and 
amended on July 29, 2001.
    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 copies of the request, personally 
or by mail. Hearing requests should be received by the Commission by 
5:30 p.m. on September 4, 2001, 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 
contested. Persons may request notification of a hearing by writing to 
the Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 450 5th 
Street, NW., Washington, DC 20549-0609. Capital Guardian Trust Company, 
333 South Hope Street, Los Angeles, California 90071. The Hirtle 
Callaghan Trust, 575 East Swedesford Road, Wayne, Pennsylvania 19087.

FOR FURTHER INFORMATION CONTACT: Robert L. Tuleya, Staff Attorney, or 
Jennifer L. Sawin, Assistant Director, at (202) 942-0719 (Division of 
Investment Management, Office of Investment Adviser Regulation).

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.

Applicant's Representations

    1. CGTC is a California-chartered, non-depository trust company. 
CGTC is a ``bank'' within the meaning of section 202(a)(2) of the 
Advisers Act. CGTC serves as investment adviser to the Trust and other 
registered investment companies. Before CGTC submitted its initial 
application for registration as an investment adviser under the 
Advisers Act, and until the effective date of section 217 of the Gramm-
Leach-Bliley Act, CGTC, as a bank, was excluded from the definition of 
``investment adviser'' under section 202(a)(11) of the Advisers Act, 
and thus was not required to register as an investment adviser under 
the Advisers Act. The Gramm-Leach-Bliley Act amended the Advisers Act 
to include a bank that serves as an investment adviser to a registered 
investment company in the definition of ``investment adviser.'' To 
comply with the Advisers Act, as amended, CGTC submitted its 
application for registration as an investment adviser with the 
commission through the IARD. The Commission issued an order granting 
CGTC's registration as an investment adviser under the Advisers Act on 
April 27, 2001.
    2. The Trust is an open-end management investment company 
registered with the Commission under the Investment Company Act of 1940 
(``1940 Act''). The Trust was organized by Hirtle, Callaghan & Co. 
(``Hirtle Callaghan''), an investment adviser registered with the 
Commission under the Advisers Act. The Trust is a series

[[Page 42571]]

company that currently consists of several separate investment 
portfolios. Shares of the Trust are available only to clients of Hirtle 
Callaghan or clients of financial intermediaries, such as investment 
advisers, that are acting in a fiduciary capacity with investment 
discretion and that have established relationships with Hirtle 
Callaghan.
    3. Hirtle Callaghan serves as a ``manager of managers'' for the 
Trust. Pursuant to its agreement with the Trust, Hirtle Callaghan is 
not authorized to exercise investment discretion with respect to the 
Trust's assets. Hirtle Callaghan is responsible for monitoring the 
overall investment performance of the Trust's portfolios and the 
performance of the portfolio managers who manage the Trust's 
portfolios. Hirtle Callaghan also may from time to time recommend that 
the Trust's Board of Trustees retain additional portfolio managers or 
terminate existing portfolio managers. Authority to select new 
portfolio managers and reallocate assets among the portfolio managers, 
however, resides with the Trust's Board.
    4. CGTC and Artisan Partners Limited Partnership (``Artisan'') 
provide portfolio management services to the International Equity 
Portfolio (``Portfolio'') of the Trust. Pursuant to a portfolio 
management agreement, CGTC provides portfolio management services for a 
portion of the Portfolio's assets that the Trust's Board allocates to 
CGTC (``CGTC Account''). CGTC and Artisan each manage a separate 
portion of the Portfolio, each acting as though it were advising a 
separate investment company. Percentage limitations on investments are 
applied to each portion of the Portfolio without regard to investments 
in the other adviser's portion of the Portfolio. Each adviser receives 
portfolio information, from the Trust or its custodian, only about the 
portion of the Portfolio assigned to it and not about positions held by 
the Portfolio as a whole. Each adviser generally is responsible for 
preparing reports to the Trust and the board only with respect to its 
discrete portion of the Portfolio.
    5. Neither CGTC nor any of its affiliates is affiliated with Hirtle 
Callaghan, the Trust, or Artisan.
    6. CGTC's services to the Trust are limited to investment selection 
for the CGTC Account, placement of transactions for execution and 
certain compliance functions directly related to such services. Neither 
CGTC nor any of its affiliates acts as a distributor or sponsor for the 
Trust or Portfolio. No member of the Trust's Board is affiliated with 
CGTC or any of its affiliates. CGTC is currently entitled to receive an 
investment advisory fee based on a percentage of the assets in the CGTC 
Account, payable quarterly.
    7. On April 14, 2000, the Trust's Board approved a portfolio 
management agreement between CGTC and the Trust (the ``CGTC 
Agreement'') under which CGTC is entitled to receive compensation for 
portfolio management services provided to the Trust based in part on 
the performance achieved by the CGTC Account. Only July 26, 2000, the 
shareholders of the Portfolio approved the agreement.\1\
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    \1\ The proxy statement associated with this meeting 
specifically informed the shareholders that, in the event that CGTC 
became subject to registration under the Advisers Act, the fulcrum 
fee arrangement would be suspended unless and until CGTC received 
assurances from the Commission or its staff that calculating the fee 
on the basis described herein would not be viewed as inconsistent 
with the Advisers Act. The proxy statement also noted that there 
could be no guarantee that the Commission or its staff would give 
such assurances.
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    8. Under the CGTC Agreement, CGTC is entitled to received an 
investment advisory fee based on a percentage of the assets in the CGTC 
Account. After the CGTC Agreement has been in effect for 12 months 
following the first business day of the month following the date on 
which the agreement became effective (``the Initial Period''), CGTC 
will be entitled to receive quarterly payments of a base fee (``Base 
Fee''), calculated at the annual rate of 0.40 percent of the average 
net assets of the CGTC Account, adjusted by a ``Performance 
Component.'' Each such quarterly payment will consist of \1/4\ of the 
Base Fee plus or minus the Performance Component multiplied by the 
average daily net assets of the CGTC Account for the immediately 
preceding 12-month period on a ``rolling basis.'' \2\ The Performance 
Component would equal 12.5 percent of the difference between (i) the 
total return of the CGTC Account during the 12 months immediately 
preceding the calculation date, calculated without regard to expenses 
incurred in the operation of the CGTC account (``Gross Total Return'') 
and (ii) the total return of the Morgan Stanley Capital International 
Europe, Australasian, Far East Index (``EAFE Index Return'') for the 
same period plus a performance hurdle of 0.40 percent (or 40 basis 
points).\3\ None of the expenses of the Portfolio, including the 
advisory fee paid to CGTC, would be deducted from the Gross Total 
Return of the CGTC account.\4\ The maximum annual fee payable to CGTC 
for any 12-month period would not exceed 0.60 percent (60 basis points) 
of the average net assets of the CGTC Account, and the minimum fee 
payable for any such period would be 0.20 percent (20 basis points).\5\
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    \2\ ``Rolling Basis'' means that, at each quarterly fee 
calculation, the Gross Total Return of the CGTC Account, the EAFE 
Index Return and the average daily net assets of the CGTC Account 
for the most recent quarter will be substituted for the 
corresponding values of the earliest quarter included in the prior 
fee calculation.
    \3\ Applicants state that the CGTC Agreement, as approved both 
by the Trust's Board and the shareholders of the Portfolio prior to 
its effective date, contains an error. The compensation schedule 
(``Schedule A'' to the CGTC Agreement) incorrectly states that the 
Performance Component with respect to periods following the Initial 
Period (``Subsequent Measuring Periods'') will be made in an amount 
equal to \1/8\ (12.5%) of the difference between the Gross Total 
Return of the CGTC Account and the EAFE Index Return. The correct 
factor is \1/4\ (25%) of that difference. The correct factor was 
negotiated by the Trust and CGTC and was designed to reflect the 
fact that, while advisory fees are calculated on an annual basis, 
advisory fee payments to CGTC are paid on a quarterly basis. To 
correct this error, Trust management represents that it will submit 
an amendment (``Correcting Amendment'') to the Trust's Board and to 
shareholders of the Portfolio in a manner consistent with the 
requirements of section 15(a) and rule 18f-2 under the 1940 Act. 
Trust management anticipates that final action with respect to the 
Correcting Amendment will be taken by the Board and shareholders 
before the date on which performance based fee adjustments (if any) 
to which CGTC may be entitled with respect to any Subsequent 
Measuring Period will be paid. Unless and until the Correcting 
Amendment is approved (and assuming that the CGTC Agreement is not 
sooner terminated in accordance with its terms or relevant law), the 
CGTC Agreement will remain in effect in the form in which is was 
approved by the Portfolio's shareholders on July 26, 2000 and the 
accrual of investment advisory fees payable by the Portfolio to CGTC 
will continue to be made in accordance with the terms of such 
Agreement.
    \4\ The performance of the CGTC account reflects brokerage and 
transaction costs.
    \5\ If application of the Performance Component would result in 
an annual fee at a rate lower than 20 basis points, the amount of 
any excess fee paid for the first year would be credited to the 
Portfolio in subsequent quarters before additional fee amounts would 
be payable to CGTC. If the CGTC Agreement is terminated, the Trust 
would not recoup any outstanding excess fees that had been paid in 
previous quarters.
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Applicants' Legal Analysis

    1. Section 205(a)(1) of the Advisers Act generally prohibits an 
investment adviser from entering into any investment advisory agreement 
that provides for compensation to the adviser on the basis of a share 
of capital gains or capital appreciation of a client's account.
    2. Section 205(b) of the Advisers Act provides a limited exception 
to this prohibition, permitting an adviser to charge a registered 
investment company a fee that increases and decreases ``proportionately 
with the investment performance of the investment company or fund over 
a specified period in relation to the investment record of an 
appropriate index of securities prices or such other measure of 
investment

[[Page 42572]]

performance as the Commission by rule, regulation or order may 
specify.''
    3. Under rule 205-1 of the Advisers Act, the ``investment 
performance'' of an investment company must be computed based on the 
change in the investment company's net asset value per share.
    4. Applicants request exemptive relief from section 205 and rule 
205-1 to permit CGTC to charge the fee in question (i) applying the fee 
only to the CGTC Account and not to the Portfolio as a whole, and (ii) 
computing the Performance Component measured by the change in the CGTC 
Account's gross asset value, rather than its net asset value. 
Applicants also request exemptive relief for CGTC and its affiliates to 
enter into similar fee arrangements with other investment companies, 
provided certain criteria are met.
    5. Applicants state that Congress, in adopting and amending section 
205 of the Advisers Act, and the Commission, in adopting rule 205-1, 
put into place safeguards designed to ensure that investment advisers 
would not take advantage of advisory clients.
    6. Applicants assert that the Commission required that performance 
fees be calculated based on the net asset value of the investment 
company's shares to prevent a situation where an adviser could earn a 
performance fee even though investment company shareholders did not 
derive any benefit from the adviser's performance after the deduction 
of fees and expenses.
    7. Applicants state that, unlike traditional performance fee 
arrangements, CGTC does not receive the Performance Component of its 
fee unless its management of the CGTC Account has resulted in 
performance in excess of the EAFE Index Return plus a ``performance 
hurdle'' equal to the 0.40 percent base fee. Applicants assert that 
adding the 0.40 percent hurdle to the performance of the EAFE Index has 
an effect similar to deducting CGTC's fees.\6\ Applicants argue that, 
therefore, the Portfolio's shareholders have protections similar to 
those contemplated by the net asset value requirement of rule 205-1.
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    \6\ If the Base Fee changes, the performance hurdle also would 
be changed to match the fee.
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    8. Applicants state that Congress' concern in enacting the 
safeguards of section 205 came about because the vast majority of 
investment advisers exercised a high level of control over the 
structuring of the advisory relationship. Applicants state that the fee 
in question, however, was negotiated at arm's length between the 
parties. Applicants state that CGTC has little, if any, influence over 
the overall management of the Trust or the Portfolio beyond stock 
selection. Management functions of the Trust and the Portfolio reside 
in the Trust's Board. The Trust itself is directly and fully 
responsible for supervising the Trust's service providers and 
monitoring expenses of each of the Trust's portfolios. The Trust's 
Board is responsible for allocating the assets of the several 
portfolios among the portfolio managers. Neither CGTC nor any of its 
affiliates sponsored or organized the Trust or serves as a distributor 
or principal underwriter of the Trust. Neither CGTC nor any of its 
affiliates owns any shares issued by the Trust. No officer, director or 
employee of CGTC, nor of any CGTC's affiliates, serves as an executive 
officer or director of the Trust. Neither CGTC nor any of its 
affiliates is an affiliated person of Hirtle Callaghan or any other 
person who provides investment advice with respect to the Trust's 
advisory relationships (except to the extent that such affiliation 
exists solely by reason of CGTC serving as investment adviser to the 
Trust).
    9. Applicants argue that the fulcrum fee arrangement is consistent 
with the purposes intended by rule 205-1 because the CGTC Agreement was 
negotiated at arm's-length with the Trust and that the Trust therefore 
does not need the protections afforded by calculating a performance fee 
based on net assets. Applicants argue that the proposed fee arrangement 
is therefore consistent with the underlying policies of section 205 and 
rule 205-1. Applicants argue that granting the exemption is necessary 
and appropriate in the public interest and consistent with the 
protection of investors and the purposes fairly intended by the 
policies and provisions of the Advisers Act and would therefore be 
consistent with the exemptive standards in section 206A of the Advisers 
Act.

Applicants' Conditions

    1. If the Base Fee changes, the performance hurdle will be changed 
to match the Base Fee.
    2. To the extent CGTC, or an affiliate of CGTC, relies on the 
requested order with respect to advisory arrangements with other 
investment companies that it advises, those arrangements will meet the 
following requirements: (i) The investment advisory fee will be 
negotiated between CGTC, or the applicable affiliate of CGTC, and the 
investment company or its primary investment adviser; (ii) the fee 
structure will contain a performance hurdle that is, at all times, no 
lower than the base fee; (iii) neither CGTC nor any of its affiliates 
will serve as distributor or sponsor of the investment company; (iv) no 
member of the board of the investment company will be affiliated with 
CGTC or its affiliates; (v) neither CGTC nor any of its affiliates will 
organize the investment company; and (vi) neither CGTC nor any of its 
affiliates will be an affiliated person of any primary adviser to the 
investment company or of any other person who provides advice with 
respect to the investment company's advisory relationships (except to 
the extent that CGTC and/or its affiliates may be affiliated with 
another portfolio manager by virtue of the fact that CGTC serves as a 
portfolio manager to the investment company or to another investment 
company.

    For the Commission, by the Division of Investment Management, 
under delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-20233 Filed 8-10-01; 8:45 am]
BILLING CODE 8010-01-M