[Federal Register Volume 66, Number 216 (Wednesday, November 7, 2001)]
[Notices]
[Pages 56363-56365]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-27945]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. IA-1993; File No. 803-160]


Sterling Johnston Capital Management, L.P.; et al.; Notice of 
Application

November 1, 2001.
AGENCY:  Securities and Exchange Commission (the ``SEC'').

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

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    Applicants: Sterling Johnston Capital Management, L.P. ``SJCM'' 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 SJCM 
and its affiliates to charge a performance fee based on the performance 
of that portion of a Trust portfolio managed by SJCM (``SJCM 
Account''). Applicants further request that the order permit them to 
compute the performance-related portion of the fee using changes in the 
SJCM Account's gross asset value rather than net asset value.
    Filing Dates: The application was filed on June 4, 2001, and 
amended on October 31, 2001.
    Hearing or Notification of Hearing: An order granting the 
application will be issued unless the SEC orders a hearing. Interested 
persons may request a hearing by writing to the SEC's Secretary and 
serving applicants with copies of the request, personally or by mail. 
Hearing requests should be received by the SEC by 5:30 p.m. on November 
26, 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 SEC's Secretary.

ADDRESSES: Secretary, SEC, 450 5th Street, NW, Washington, DC 20549-
0609. Applicants, Sterling Johnston Capital Management, L.P., One 
Sansome Street, Suite 1800, San Francisco, CA 94104; Hirtle Callaghan 
Trust, 575 Swedesford Road, Wayne, Pennsylvania 19087.

FOR FURTHER INFORMATION CONTACT: Sarah B. Ackerson, Senior Special 
Counsel at (202) 942-4780 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 
SEC's Public Reference Branch.

Applicants' Representations

    1. SJCM is an investment adviser registered under the Advisers Act. 
The Trust is an open-end management investment company registered under 
the Investment Company Act of 1940. The Trust was organized by Hirtle, 
Callaghan & Co. (``Hirtle Callaghan''), an investment adviser 
registered under the Advisers Act. The Trust is a series 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.
    2. 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 that manage the Trust's 
portfolios. Hirtle Callaghan may also from time to time recommend that 
the Trust's Board of Trustees (the ``Board'') 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.
    3. SJCM, Frontier Capital Management (``Frontier''), and Geewax, 
Terker & Co. (``Geewax'') provide portfolio management services to the 
Small Capitalization Equity Portfolio (``Portfolio''), one of several 
separate investment portfolios that comprise the Trust. Pursuant to a 
portfolio management agreement, SJCM provides portfolio management 
services for a portion of the Portfolio's assets that the Trust's Board 
allocates to SJCM (``SJCM Account''). SJCM, Frontier, and Geewax are 
assigned responsibility to manage a separate portion of the Portfolio 
and each acts as though it were advising a separate investment company. 
Percentage limitations on investments are applied to each portion of 
the Portfolio without regard to the investments in the other advisers' 
portions of the Portfolio. When each adviser receives information about 
portfolio positions from the Trust or its custodian, the adviser 
generally receives only information about the portion of the Portfolio 
assigned to it, and not information about the 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.
    4. SJCM is not affiliated with Hirtle Callaghan, the Trust or any 
other investment advisory organization that provides portfolio 
management and services to the Trust.\1\ Services provided to the Trust 
by SJCM are limited to investment selection for the SJCM Account, 
placement of transactions for execution and certain compliance 
functions directly related to such services. SJCM and its affiliates do 
not act as a distributor or sponsor for the Trust or Portfolio. No 
member of the Trust's Board is affiliated with SJCM.
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    \1\ SJCM does not have any affiliates at this time. Future 
affiliates, if any, will comply with the terms of any order issued 
by the Commission in connection with this application.
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    5. SJCM currently receives a fee at the annual rate of 0.40 percent 
of the average daily net assets of the SJCM Account, payable monthly. 
On October 18, 2000 the Trust's Board and the Trust's disinterested 
trustees approved an amendment to the portfolio management agreement 
between SJCM and the Trust under which the existing fee structure would 
be replaced with a fee structure that includes a performance component. 
On December 1, 2000 the shareholders of the Portfolio approved the 
amendment to the agreement.\2\ The proposed amendment would become 
effective on the first day of the month following receipt of an order 
from the SEC approving the proposed fee schedule. SJCM's fee would be 
adjusted to reflect the performance of the SJCM Account only after the 
proposed amendment has been in effect for 12 months (the ``Initial 
Period'').
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    \2\ The proxy statement associated with this shareholder meeting 
specifically informed shareholders that, if approved by the 
shareholders, the proposed fee would not become effective until 
receipt of assurances from the SEC that calculating the fee as 
proposed would not be viewed as inconsistent with the Advisers Act, 
and that there could be no guarantee that the SEC would give such 
assurances.
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    6. Under the proposed fee arrangement, at the end of each of the 
first three quarters of the Initial Period, SJCM would receive a base 
fee of 0.10

[[Page 56364]]

percent of the average daily net assets of the SJCM Account during the 
quarter (``Base Fee'').\3\ At the end of the fourth quarter of the 
Initial Period, SJCM would receive the Base Fee, plus or minus a 
performance component multiplied by the average net assets of the SJCM 
Account during the Initial Period. The performance component 
(``Performance Component'') would be equal to 25 percent of the 
difference between (i) the total return of the SJCM Account calculated 
without regard to expenses incurred in the operation of the SJCM 
Account (``Gross Total Return'') and (ii) the sum of the total return 
of the Russell 2000 Growth Index (``Index Return'') plus a performance 
hurdle of 40 basis points.
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    \3\ Applicants may seek in the future to amend the terms of the 
proposed fee arrangement to provide for a base fee that is 
calculated at the annual rate of 0.40% of the SJCM Account's average 
daily net assets. Calculating the base fee at an annual rate would 
result in the payment to SJCM of a base fee (before any performance 
adjustment) that is approximately the same as the quarterly base fee 
payable under the proposed fee arrangement. It is Applicant's 
position that any such amendment to the proposed fee arrangement 
would not constitute a material change in the nature of the proposed 
fee arrangement, or a change in any material fact set forth in this 
Application and upon which Applicants rely in their analysis of 
those provisions of the Advisers Act from which relief is hereby 
requested. Accordingly, it is Applicant's position that any such 
amendment would not alter Applicant's ability to rely upon any order 
issued by the Commission pursuant to this Application.
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    7. None of the expenses of the Portfolio, including SJCM's advisory 
fee, would be deducted from the performance of the SJCM Account for 
purposes of calculating Gross Total Return. However, Gross Total Return 
would reflect the effect (i.e., reducing performance) of all applicable 
brokerage and transaction costs.
    8. For each quarter following the fourth quarter of the Initial 
Period, SJCM would receive the Base Fee, plus or minus 25% of the 
Performance Component multiplied by the average net assets of the SJCM 
Account for the immediately proceeding 12-month period, on a ``rolling 
basis.'' The maximum annual fee payable for any 12-month period would 
not exceed 80 basis points, or 20 basis points with respect to any 
quarter (except the fourth quarter of the Initial Period). The minimum 
fee payable would be zero with respect to any 12-month period or 
quarter. The maximum and minimum fees were set by the portfolio 
management agreement between the Trust and SJCM and are not necessary 
mathematical outcomes of the fee formula.\4\
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    \4\ If the aggregate payments made to SJCM with respect to the 
first 12 month period exceed the performance-adjusted fee to which 
SJCM would be entitled, the amount of any excess fee would be 
credited to the Portfolio in subsequent quarters before additional 
fee amounts would be payable to SJCM. If the portfolio management 
agreement between the Trust and SJCM 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 and certain other entities 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 performance as the [SEC] by rule, 
regulation or order may specify.''
    3. Rule 205-1 under the Advisers Act requires that the investment 
performance of an investment company be computed based on the change in 
the net (of all expenses and fees) asset value per share of the 
investment company.
    4. Applicants request exemptive relief from section 205 and rule 
205-1 of the Advisers Act to permit them to charge the proposed fee (i) 
applying the proposed fee only to the SJCM Account and not to the 
Portfolio as a whole, and (ii) computing the Performance Component 
measured by the change in the SJCM Account's gross asset value, rather 
than the change in the net asset value of the SJCM Account.
    5. Applicants state that Congress, in adopting and amending section 
205 of the Advisers Act, and the SEC, 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 SEC 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, SJCM would not receive the Performance Component of its 
fee unless its management of the SJCM Account has resulted in 
performance in excess of the Index Return plus a ``performance hurdle'' 
equal to 40 basis points. Applicants assert that increasing the 
performance of the Index Return by the 40 basis point hurdle would have 
an effect similar to deducting SJCM's fees. In the event the Base Fee 
changes, the performance hurdle also would be changed to match the Base 
Fee. Applicants state that because the fee structure contains a 
performance hurdle, the Portfolio's shareholders will have protections 
similar to those contemplated by the net asset value requirement of 
rule 205-1.
    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 
proposed fee, however, was negotiated actively at arm's length between 
the parties. Applicants state that SJCM 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 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. SJCM did not sponsor or organize the Trust, or serve as a 
distributor or principal underwriter of the Trust. SJCM does not own 
any shares issued by the Trust. No officer, director or employee of 
SJCM serves as an executive officer or director of the Trust. SJCM is 
not 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 may exist by 
reason of SJCM serving as investment adviser to the Trust).
    9. Applicants argue that the proposed fee arrangement satisfies the 
purpose of rule 205-1 because it was negotiated at arms-length and the 
Trust does not need the protections afforded by calculating a 
performance fee based on net assets. Applicants argue that the proposed 
fee arrangement therefore is consistent with the underlying policies of 
section 205 and rule 205-1 and that the exemption would be consistent 
with the protection of investors.

Applicants' Conditions

    1. If the base fee changes, the performance hurdle will be changed 
to match the base fee.

[[Page 56365]]

    2. To the extent SJCM relies on the requested order with respect to 
advisory arrangements with other investment companies that it advises, 
these arrangements will meet the following requirements: (i) The 
investment advisory fee will be negotiated between SJCM, or the 
applicable affiliate of SJCM, 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 
SJCM 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 SJCM or SJCM's affiliates; (v) neither 
SJCM nor any of its affiliates will organize the investment company; 
and (vi) neither SJCM nor any of its affiliates will be an affiliated 
person or any primary adviser to the investment company or of any other 
person who consults or provides advice with respect to the investment 
company's advisory relationships (except to the extent that SJCM or its 
affiliates may be affiliated with another portfolio manager by virtue 
of the fact that SJCM or the affiliate serves as a portfolio manager to 
the investment company or to another investment company).

    For the SEC, by the Division of Investment Management, under 
delegated authority.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-27945 Filed 11-6-01; 8:45 am]
BILLING CODE 8010-01-M