[Federal Register Volume 66, Number 173 (Thursday, September 6, 2001)]
[Notices]
[Pages 46670-46673]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-22386]


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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 25144; 812-12134]


The Charles Schwab Family of Funds, et al.; Notice of Application

August 29, 2001.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of an application for an order under section 12(d)(1)(J) 
of the Investment Company Act of 1940 (the ``Act'') for an exemption 
from section 12(d)(1) of the Act, under section 6(c) and 17(b) of the 
Act for an exemption from section 17(a) of the Act, and under section 
17(d) of the Act and rule 17d-1 under the Act to permit certain joint 
transactions.

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SUMMARY OF APPLICATION: Applicants request an order to permit certain 
registered management investment companies to use cash collateral from 
securities lending transactions to purchase shares of affiliated 
registered management investment companies or affiliated private 
investment funds, and to pay fees based on a share of the revenue 
generated from securities lending transactions to an affiliated agent.
    Applicants: The Charles Schwab Family of Funds, Schwab Investments, 
Schwab Capital Trust, Schwab Annuity Portfolios (each a ``Trust'' and, 
together, the ``Trusts''), on behalf of each of their existing or 
future series (each a ``Fund'' and, together, the ``Funds''), Charles 
Schwab Investment Managements, Inc. (``CSIM''), and Charles Schwab & 
Co., Inc. (CS&Co.).
    Filing Dates: The application was filed on June 20, 2000, and 
amended on August 17, 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 a copy of the request, personally 
or by mail. Hearing requests should be received by the Commission by 
5:30 p.m. on September 24, 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 who wish to be notified of a hearing may request 
notification by writing to the Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC 20549-0609; Applicants, 101 Montgomery 
Street, San Francisco, CA 94104.

FOR FURTHER INFORMATION CONTACT: Deepak T. Pai, Senior Counsel, at 
(202) 942-0574 or Mary Kay Frech, Branch Chief, at (202) 942-0564, 
(Division of Investment Management, Office of Investment Company 
Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained for a fee at the 
Commission's Public Reference Branch, 450 Fifth Street, NW., 
Washington, DC 20549-0102 (telephone (202) 942-8090).

Applicants' Representations

    1. Each Trust is a Massachusetts business trust registered under 
the Act as an open-end management investment company. Each Trust offers 
multiple Funds. The Money Market Fund, Value Advantage Fund, Government 
Securities Fund, and Treasury Fund (the ``Registered Investment 
Funds'') are money market Funds that comply with the requirements of 
rule 2a-7 under the Act. CSIM, a wholly-owned subsidiary of The Charles 
Schwab Corporation (``Charles Schwab''), is registered as an investment 
adviser under the Investment Advisers Act of 1940. CSIM serves an 
investment adviser and provide administrative services to each Fund. 
CS&Co., a wholly-owned subsidiary of Charles Schwab, acts as principal 
underwriter of the shares of each Registered Investment Fund and 
provides shareholder and transfer agency services to each Fund.
    2. Applicants request that any relief granted pursuant to the 
application also apply to (a) any other registered open-end investment 
company that is advised or sub-advised by CSIM or any entity 
controlling, controlled by, or under common control with CSIM and is 
part of the same group of investment companies, as defined in section 
12(d)(1)(G)(ii) of the Act as the Trust (``Future Fund'') and (b) any 
investment entity excluded from the definition of investment company 
under section 3(c)(1) or section 3(c)(7) of the Act, advised by CSIM, 
and established for the purpose of investment of cash collateral in 
connection with the securities lending program described below 
(``Private Investment Fund'' and together with the Registered 
Investment Funds, the ``Investment Funds'').\1\
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    \1\ All existing entities that currently intend to rely on the 
requested relief have been named as applicants. Any future Fund or 
Private Investment Fund will rely on the requested relief only in 
accordance with the terms and conditions of the application.
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    3. CS&Co. proposes to establish and administer a securities lending 
program (``Program'') for the Funds. In connection with the Program, 
CS&Co. will enter into a securities lending agreement (``Securities 
Lending Agreement'') with the Funds that participate as lenders in the 
Program (``Lending Funds''). The Securities Lending Agreement will 
authorize CS&Co., as agent for a Lending Funds, to enter into a 
borrowing agreement (``Borrowing Agreement'') with one or more entities 
designated by CS&Co and approved by the Lending Funds as eligible to 
borrow portfolio securities (``borrowers''). The Securities Lending 
Agreement and the Borrowing Agreement will establish, with respect to 
each transaction, the initial and on-going collateralization 
requirements, the types of collateral that may be accepted, and the 
manner in which the Borrower's rebate will be established. With respect 
to cash collateral, a Borrower will be paid a fixed return on the cash 
collateral for the term of the loan. The difference between the fixed 
return and the actual return on the investment of the cash collateral 
is divided between the Lending Fund and CS&Co. In the case of 
collateral other than cash, the Borrower pays the Lending Fund a 
lending fee, which is split between the Lending Fund and CS&Co.
    4. The Securities Lending Agreement will authorize and instruct 
CS&Co. as agent for the Lending Fund to invest the cash collateral in 
accordance with specific guidelines or instructions

[[Page 46671]]

provided by the Lending Fund. These guidelines or instructions will 
identify the particular Investment Funds or other investment vehicles, 
instruments, and accounts, if any, in which cash collateral may be 
invested, and the amounts or percentages of cash collateral that may be 
invested in each Investment Funds and other authorized investments. 
Applicants state that the personnel who will provide lending agency 
services to the Lending Funds will not provide investment advisory 
services to the Lending Funds or participate in any way in the 
selection of portfolio securities or other aspects of the portfolio 
management of the Lending Funds.
    5. CS&Co. is proposing to invest cash collateral received in the 
Program on behalf of a Lending Fund in units of beneficial interests of 
one or more of the Investment Funds (``Shares'') to the extent 
permitted by the Securities Lending Agreement between CS&Co. and a 
Lending Fund. Shares will not be subject to any sales load, redemption 
fee, asset-based sales charge, or service fee (as defined in rule 
2830(b)(9) of the Rules of Conduct of the National Association of 
Securities Dealers, Inc. (``NASD'')). The Private Investment Funds will 
comply with the requirements of rule 2a-7 under the Act, except CSIM as 
the general partner of the Private Investment Funds shall take any 
action required to be taken by the board of directors under rule 2a-7. 
Each Private Investment Fund will offer daily redemption of Shares at 
the current net asset value per share. As agent for the Lending Fund, 
CS&Co. will not purchase Shares of an Investment Fund with cash 
collateral unless participation in the Program has been approved by a 
majority of the trustees of the Lending Fund who are not ``interested 
persons'' within the meaning of section 2(a)(19) of the Act 
(``Independent Trustees''). In addition, CS&Co. will not purchases 
Shares of any Investment Fund, unless the Lending Fund has represented 
to CS&Co., among other things, that: (a) Its policies generally permit 
the Lending Fund to engage in securities lending transactions; (b) the 
transactions will be conducted in accordance with the conditions 
prescribed by the staff in various no-action and interpretive letters 
as they may be modified or updated; (c) it policies permit the Lending 
Fund to purchase Shares of the Investment Funds; and (d) its securities 
lending activities will be conducted in accordance with all 
representations and conditions in the application applicable to the 
Lending Fund.
    6. Applicants request an order to permit the Lending Funds to use 
cash collateral received from Borrowers to purchase Shares of the 
Investment Funds. Applicants also request an order to permit the 
Lending Funds to pay CS&Co., for its services as lending agent, fees 
based on a share of the revenue generated from securities lending 
transactions undertaken pursuant to the Program.

Applicants' Legal Analysis

A. Investment of Cash Collateral by the Lending Funds in the Investment 
Funds

    1. Section 12(d)(1)(A) of the Act provides that no registered 
investment company may acquire securities of another investment company 
if such securities represent more than 3% of the acquired company's 
outstanding voting stock, more than 5% of the acquiring company's total 
assets, or if such securities, together with the securities of other 
investment companies, represent more than 10% of the acquiring 
company's total assets. Section 12(d)(1)(B) provides that no registered 
open-end investment company may knowingly sell its securities to 
another investment company if the sale will cause the acquiring company 
to own more than 3% of the acquired company's voting stock, or if the 
sale will cause more than 10% of the acquired company's voting stock to 
be owned by the investment companies.
    2. Section 12(d)(1)(J) of the Act provides that the Commission may 
exempt persons or transactions from any provision of section 12(d)(1) 
if and to the extent the exemption is consistent with the public 
interest and the protection of investors.
    3. Applicants seek an order under section 12(d)(1)(I) of the Act 
exempting them from the provisions of section 12(d)(1) of the Act to 
permit the Lending Funds to purchase, and the Registered Investment 
Funds to sell, Shares in excess of the limits imposed by sections 
12(d)(1)(A) and 12(d)(1)(B) in connection with the Lending Funds' 
investment of cash collateral.
    4. Applicants state that the proposed investment of cash collateral 
in Shares of the Registered Investment Funds will not give rise to the 
policy concerns underlying sections 12(d)(1)(A) and (B). Shares will 
not be subject to any sales load, redemption fee, asset-based sales 
charge, or service fee. Applicants state that the advisory and other 
fees of the Lending Fund associated with securities lending activities 
will be determined solely with respect to its own assets (including the 
assets that are being loaned) and will not be affected by the value of 
the collateral received in connection with the loan because the 
collateral will not increase the net asset value of the Lending Funds. 
Accordingly, applicants state that the fees charged by an Investment 
Fund with respect to these additional assets, including fees for 
advisory, custody, transfer agency, and administrative services should 
not be viewed as duplicative of the fees charged by the Lending Funds 
with respect to the underlying securities that have been loaned. 
Applicants state that each Registered Investment Fund, because it will 
comply with rule 2a-7, has the necessary liquidity to satisfy the 
demands of the Program and will not be susceptible to control through 
the threat of large-scale redemptions. Moreover, an Investment Fund 
will not invest in any investment company in excess of the limits of 
section 12(d)(1)(A) of the Act.
    5. Section 17(a)(1) and 17(a)(2) of the Act make it unlawful for 
any affiliated person of a registered investment company, or any 
affiliated person of the affiliated person, acting as principal, to 
sell any security to, or purchase any security from, the registered 
investment company. Section 2(a)(3) of the Act defines an ``affiliated 
person'' of another person to include any person 5% or more of whose 
outstanding voting securities are directly or indirectly owned, 
controlled, or held with power to vote by the other person; any person 
directly or indirectly controlling, controlled by, or under common 
control with the other person; and, in the case of an investment 
company, its investment adviser. As investment adviser to the Lending 
Funds and the Investment Funds, CSIM could be deemed to control both 
the Lending Funds and the Investment Funds. Accordingly, the Lending 
Funds and Investment Funds could be deemed to be under common control 
and affiliated persons of each other. In addition, if a Lending Fund 
acquire 5% or more of an Investment Fund's securities, the Lending Fund 
and Investment Fund would be deemed affiliated persons of each other. 
In light of these possible affiliations, section 17(a) could prevent an 
Investment Fund from selling Shares to and redeeming Shares from the 
Lending Funds.
    6. Section 17(b) of the Act authorizes the Commission to exempt a 
transaction from section 17(a) if the terms of the proposed 
transactions, including the consideration to be paid or received, are 
reasonable and fair and do not involve overreaching on the part of any 
person concerned, the proposed transaction is consistent with the 
policy of each registered investment company concerned, and the general 
purposes of the Act. Section 6(c) of the Act provides

[[Page 46672]]

that the Commission may exempt any person, security, or transaction 
from any provision of the Act if the exemption is necessary or 
appropriate in the public interest and consistent with the protection 
of investors and the purposes fairly intended by the policy and 
provisions of the Act.
    7. Applicants request an order under sections 6(c) and 17(b) of the 
Act to permit the Lending Funds to purchase and redeem from the 
Investment Funds, and the Investment Funds to sell and to redeem for 
the Lending Funds, Shares in one or more of the Investment Funds. 
Applicants state that the Lending Funds will purchase, hold, and redeem 
Shares on the same basis as any other holder of Shares. Applicants 
assert that a Lending Fund's cash collateral will be invested in a 
particular Investment Fund only if that Investment Fund invests in the 
types of instruments that the Lending Fund only if that Investment Fund 
invests in the types of instruments that the Lending Fund has 
authorized for the investment of its cash collateral. Applicants state 
that cash collateral of a Lending Fund that complies with rule 2a-7 
under the Act will not be used to acquire Shares of any Investment Fund 
that does not comply with rule 2a-7 under the Act. Applicants state 
that permitting the Lending Funds to invest cash collateral in the 
Private Investment Funds enables the Lending Funds to invest in a 
lower-cost vehicle with liquidity, maturity, quality and 
diversification similar to a registered investment company that 
complies with rule 2a-7. For these reasons, applicants believe their 
requested relief meets the standards of sections 6(c) and 17(b) of the 
Act.
    8. Section 17(d) of the Act and rule 17d-1 under the Act prohibit 
any affiliated person of or principal underwriter for a registered 
investment company or any other affiliated person of such persons, 
acting as principal, from effecting any transaction in connection with 
any joint enterprise or other joint arrangement or profit sharing plan 
in which the investment company participates, unless an application 
regarding the joint transaction has been filed with the Commission and 
granted by an order. CSIM, as investment adviser, is an affiliated 
person of the Lending Funds and the Investment Funds. CS&Co. is an 
affiliated person of an affiliated person of the Lending Funds and the 
Investment Funds, because CS&Co. and CSIM are both wholly-owned 
subsidiaries of Charles Schwab and are therefore under common control.
    9. Applicants state that the Lending Funds, CSIM (by serving as 
investment adviser to and providing other services to the Investment 
Funds at the same time that the Investment Funds sell Shares to and 
redeem them from the Lending Funds and by managing the portfolio 
securities of the Lending Funds and the Investment Funds at the same 
time that the Lending Funds' cash collateral is invested in Shares), 
CS&Co. (by acting as lending agent, investing cash collateral in Shares 
and receiving a portion of the revenue generated by securities lending 
transactions), and the Investment Funds (by selling Shares to and 
redeeming them for the Lending Funds), could be deemed to be 
participants in a joint enterprise or arrangement within the meaning of 
section 17(d) and rule 17d-1 under the Act.
    10. Under rule 17d-1, in passing on applications for orders under 
section 17(d), the Commission considers whether the company's 
participation in the proposed transaction is consistent with the 
provisions, policies, and purposes of the Act, and the extent to which 
the participation is on a basis different from or less advantageous 
than that of other participants. Applicants submit that the proposed 
transactions meet these standards, because the Lending Funds will 
invest in the Investment Funds on the same basis as any other 
shareholder.

B. Payment of Fees by the Lending Funds to CS&Co.

    1. Applicants state that CS&Co. as an entity under common control 
with CSIM, the investment adviser to the Lending Funds, is an 
affiliated person of an affiliated person of the Lending Funds. As 
noted above, section 17(d) and rule 17d-1 generally prohibit joint 
transactions involving investment companies and their affiliated 
persons unless the Commission has approved the transaction. Applicants 
state that a lending agent agreement between a registered investment 
company and an affiliated person of the investment company under which 
compensation is based on a share of the revenue generated by the 
lending agent's efforts may constitute a joint arrangement within the 
meaning of section 17(d) and rule 17d-1. Consequently, applicants 
request an order to permit the Lending Funds to pay, and CS&Co. as 
lending agent to accept, fees based on a share of the revenue generated 
from securities lending transactions undertaken pursuant to the 
Program.
    2. Applicants propose that each Trust, on behalf of a Lending Fund, 
adopt the following procedures to ensure that the proposed fee 
arrangement and the other terms governing the relationship with CS&Co., 
as lending agent, will meet the standards of rule 17d-1:
    a. In connection with the approval of CS&Co. as lending agent for a 
Trust on behalf of a Lending Fund and implementation of the proposed 
fee arrangement, a majority of the board of trustees (``Board'') of the 
Lending Fund, including a majority of the Independent Trustees, will 
determine that: (i) the contract with CS&Co. is in the best interests 
of the Lending Fund and its shareholders; (ii) the services to be 
performed by CS&Co. are appropriate for the Lending Fund; (iii) the 
nature and quality of the services provided by CS&Co. are at least 
equal to those provided by others offering the same or similar services 
for similar compensation; and (iv) the fees for CS&Co.'s services are 
fair and reasonable in light of the usual and customary charges imposed 
by others for services of the same nature and quality.
    b. Each Trust's contract with CS&Co. on behalf of its Lending Funds 
for lending agent services will be reviewed annually and will be 
approved for continuation only if a majority of the Board, including a 
majority of the Independent trustees, makes the findings referred to in 
paragraph (a) above.
    c. In connection with the initial implementation of an arrangement 
whereby CS&Co. will be compensated as lending agent based on a 
percentage of the revenue generated by a Lending Fund's participation 
in the Program, the Board will obtain competing quotes with respect to 
lending agent fees from at least three independent lending agents to 
assist the Board in making the findings referred to in paragraph (a) 
above.
    d. The Board of each Trust, including a majority of its Independent 
Trustees, (i) at each regular quarterly meeting will determine, on the 
basis of reports submitted by CS&Co., that the loan transactions during 
the prior quarter were conducted in compliance with the conditions and 
procedures set forth in the application and (ii) will review no less 
frequently than annually the conditions and procedures set forth in the 
application for continuing appropriateness.
    e. Each Lending Fund will (i) maintain and preserve permanently in 
an easily accessible place a written copy of the procedures and 
conditions (and modifications thereto) described in the application or 
otherwise followed in connection with lending securities pursuant to 
the Program and (ii) maintain and preserve for a period of not less 
than six years from the end of

[[Page 46673]]

the fiscal year in which any loan transaction pursuant to the Program 
occurred, the first two years in an easily accessible place, a written 
record of each loan transaction setting forth a description of the 
security loaned, the identity of the person on the other side of the 
loan transaction, and the terms of the loan transaction. In addition, 
each Lending Fund will maintain all information or materials upon which 
a determination was made in accordance with the procedures set forth 
above and the conditions to the application.

Applicants' Conditions

    Applicants agree that any order of the Commission granting the 
requested relief will be subject to the following conditions:
    1. The securities lending program of each Lending Fund will comply 
with all present and future applicable Commission and staff positions 
regarding securities lending arrangements.
    2. The approval of the relevant Trust's Board, including a majority 
of the Independent Trustees, will be required for the initial and 
subsequent approvals of CS&Co.'s service as securities lending agent 
for each Lending Fund pursuant to the Program, for the institution of 
all procedures relating to the Program as it related to a Lending Fund, 
and for any periodic review of loan transactions for which CS&Co. acted 
as lending agent pursuant to the Program.
    3. A majority of the Board of each relevant Trust, including a 
majority of the Independent Trustees, will initially and at least 
annually thereafter determine that the investment of securities lending 
cash collateral in Shares of the Investment Funds is in the best 
interests of the shareholders of each Lending Fund.
    4. Investment in Shares of an Investment Fund by a particular 
Lending Fund will be consistent with such Lending Fund's investment 
objectives and policies.
    5. Investment in Shares of an Investment Fund by a particular 
Lending Fund will be in accordance with the guidelines regarding the 
investment of securities lending cash collateral specified by the 
Lending Fund in the Securities Lending Agreement. A Lending Fund's cash 
collateral will be invested in a particular Investment Fund only if 
that Investment Fund has been approved for investment by the Lending 
Fund and if that investment Fund invests in the types of instruments 
that the Lending Fund has authorized for the investment of its cash 
collateral.
    6. The Shares of an Investment Fund will not be subject to a sales 
load, redemption fee, any asset-based sales charge, or service fee (as 
defined in rule 2830(b)(9) of the Conduct Rules of the NASD).
    7. An Investment Fund will not acquire securities of any investment 
company in excess of the limits contained in section 12(d)(1)(A) of the 
Act.
    8. Each Private Investment Fund will comply with the requirements 
of sections 17(a), (d), and (e) and 18 of the Act as if such Private 
Investment Fund were a registered open-end investment company. With 
respect to all redemption requests made by a Lending Fund, each Private 
Investment Fund will comply with section 22(e) of the Act. CSIM, as 
investment adviser to a Private Investment Fund, with the approval of 
its board or other governing body, shall adopt procedures designed to 
ensure that the Private Investment Fund will comply with sections 
17(a), (d), and (e), 18, and 22(e) of the Act. CSIM will also 
periodically review and update, as appropriate, such procedures and 
maintain books and records describing such procedures, as well as 
records required by rules 31a-1(b)(1), 31a-1(b)(2)(ii), and 31a-1(b)(9) 
under the Act. All books and records required to be maintained pursuant 
to this condition will be maintained and preserved for a period of not 
less than six years from the end of the fiscal year in which any 
transaction occurred, the first two years in an easily accessible 
place, and will be subject to examination by the Commission and the 
staff.
    9. Each Investment Fund will use the amortized cost method of 
valuation, as defined in rule 2a-7, and will comply with rule 2a-7. 
Each Private Investment Fund will value its shares as of the close of 
business on each business day using the amortized cost method to 
determine its net asset value per share. Each Private Investment Fund 
will adopt the procedures described in rule 2a-7(c)(7), and CSIM will 
comply with these procedures and take any other actions as are required 
to be or may be taken pursuant to these procedures.
    10. Each Lending Fund will purchase and redeem Shares of the 
Private Investment Funds as of the same time and at the same price, and 
will receive dividends and bear its proportionate share of expenses on 
the same basis, as other shareholders of the Private Investment Funds. 
A separate account will be established in the shareholder records of 
the Private Investment Funds for the account of each applicable Lending 
Fund.
    11. The net asset value per share with respect to Shares of a 
Private Investment Fund will be determined separately for each Private 
Investment Fund by dividing the value of the assets belonging to that 
Private Investment Fund, less the liabilities of that Private 
Investment Fund, by the number of Shares outstanding with respect to 
the Private Investment Fund.

    For the Commission, by the Division of Investment Management, 
under delegated authority.
Jonathan G. Katz,
Secretary.
[FR Doc. 01-22386 Filed 9-5-01; 8:45 am]
BILLING CODE 8010-01-M